Xunlei Limited Annual Report 2014

Plain-text annual report

Table of Contents UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549 FORM 20-F (Mark One)¨REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGEACT OF 1934OR xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2014.OR ¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934For the transition period from to .OR ¨SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934Date of event requiring this shell company reportCommission file number: 001-35224 Xunlei Limited(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)4/F, Hans Innovation Mansion, North Ring RoadNo. 9018 High-Tech Park, Nanshan DistrictShenzhen, 518057People’s Republic of China(Address of principal executive offices)Tao Thomas Wu, Chief Financial OfficerTelephone: +86-755-3391-2900Email: tom.wu@xunlei.com4/F, Hans Innovation Mansion, North Ring RoadNo. 9018 High-Tech Park, Nanshan DistrictShenzhen, 518057People’s Republic of 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 registeredAmerican depositary shares, eachrepresenting five common shares The NASDAQ Stock Market LLC(The NASDAQ Global Select Market)Common shares, par value US$0.00025per share* The NASDAQ Stock Market LLC(The 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:328,693, 840 common shares as of December 31, 2014.Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No xIf 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 theSecurities Exchange Act of 1934. Yes ¨ No xIndicate 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 1934during 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 filingrequirements 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 tobe 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 thatthe registrant was required to submit and post such files). Yes ¨ No ¨Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer xIndicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing: US GAAP x International Financial Reporting Standards as issuedby 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(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities ExchangeAct of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ¨ No ¨ Table of ContentsTABLE OF CONTENTS Page INTRODUCTION 1 FORWARD-LOOKING INFORMATION 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 3 Item 4. Information on the Company 53 Item 4A. Unresolved Staff Comments 89 Item 5. Operating and Financial Review and Prospects 89 Item 6. Directors, Senior Management and Employees 133 Item 7. Major Shareholders and Related Party Transactions 144 Item 8. Financial Information 150 Item 9. The Offer and Listing 151 Item 10. Additional Information 152 Item 11. Quantitative and Qualitative Disclosures about Market Risk 159 Item 12. Description of Securities Other than Equity Securities 160 PART II 162 Item 13. Defaults, Dividend Arrearages and Delinquencies 162 Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds 162 Item 15. Controls and Procedures 162 Item 16A. Audit Committee Financial Expert 164 Item 16B. Code of Ethics 164 Item 16C. Principal Accountant Fees and Services 164 Item 16D. Exemptions from the Listing Standards for Audit Committees 165 Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers 165 Item 16F. Change in Registrant’s Certifying Accountant 165 Item 16G. Corporate Governance 166 Item 16H. Mine Safety Disclosure 166 PART III 166 Item 17. Financial Statements 166 Item 18. Financial Statements 166 Item 19. Exhibits 167 SIGNATURES 171 iTable of ContentsINTRODUCTIONIn this annual report, except where the context otherwise requires and for purposes of this annual report only: • “we,” “us,” “our company,” “our,” or “Xunlei” refers to Xunlei Limited, a Cayman Islands company, its subsidiaries, its variable interestentity, or VIE, and the VIE’s subsidiaries; • “China” or “PRC” refers to the People’s Republic of China, excluding, for the purpose of this annual report only, Hong Kong, Macau andTaiwan; • “digital media content” refers to videos, music, games, software and documents transmitted in digital form; • “monthly active users” refers to the number of internet users who activated and used a Xunlei acceleration product for at least 60 minuteswithin a month; under this method, a user that activated and used multiple Xunlei acceleration products with the same user informationwould count only once no matter how many times such user activated and used the acceleration products; • “monthly unique visitors,” in relation to our platform, refers to the number of different individual visitors who accessed Xunlei products(including websites and software) on our platform from the same computer at least once within a month; under this method, a user whoaccessed Xunlei products from two different computers would count as two unique visitors. In relation to our Xunlei Kankan website,“monthly unique visitors” refers to the number of different individual visitors to our Xunlei Kankan website from the same computers,and each visitor counts only once no matter how many times he or she accesses the Xunlei Kankan website from the same computer; • “shares” or “common shares” refers to our common shares, par value US$0.00025 per share; • “ADSs” refers to our American depositary shares, each representing five common shares, and “ADRs” refers to any American depositaryreceipts that evidence our ADSs; • “RMB” or “Renminbi” refers to the legal currency of China; and • “US$,” “dollars” or “U.S. dollars” refers to the legal currency of the United States.We use U.S. dollar as reporting currency in our financial statements and in this annual report. Transactions in Renminbi are recorded at the ratesof exchange prevailing when the transactions occur. On December 31, 2014, the noon buying rate set forth in the H.10 statistical release of the FederalReserve Board was RMB6.2046 to US$1.00.FORWARD-LOOKING INFORMATIONThis annual report on Form 20-F contains forward-looking statements that reflect our current expectations and views of future events. Thesestatements are made under the “safe harbor” provisions of the U.S. Private Securities Litigation Reform Act of 1995. You can identify these forward-lookingstatements by words or phrases such as “may,” “could,” “should,” “would,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,”“likely to,” “project,” “continue,” “potential,” or other similar expressions. We have based these forward-looking statements largely on our currentexpectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, businessstrategy and financial needs. These forward-looking statements include, but are not limited to, statements about: • our business strategies, including the strategies to streamline our business and continue moving toward mobile internet; 1Table of Contents • our future business development, results of operations and financial condition; • our ability to maintain and strengthen our market position in China; • our ability to retain subscribers for our premium acceleration and other services; • our ability to develop new products and services and attract, maintain and monetize user traffic; • trends and competition in the internet industry in China; • rules and regulations governing the internet industry in China; • our ability to handle intellectual property rights-related matters; and • general economic and business conditions in China.You should not place undue reliance on these forward-looking statements and you should read these statements in conjunction other sections ofthis annual report, in particular the risk factors disclosed in “Item 3. Key Information—D. Risk Factors.” These statements involve known and unknown risks,uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from those expressed or implied bythe forward-looking statements. Moreover, we operate in a rapidly evolving environment. New risks emerge from time to time and it is impossible for ourmanagement 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 from those contained in any forward-looking statement. The forward-looking statements made in this annual report relateonly to events or information as of the date on which the statements are made in this annual report. We do not undertake any obligation to update or revisethe forward-looking statements except as required under applicable law.PART I Item 1.Identity of Directors, Senior Management and AdvisersNot applicable. Item 2.Offer Statistics and Expected TimetableNot applicable. 2Table of ContentsItem 3.Key Information A.Selected Financial DataThe following table presents the selected consolidated financial information of our company. The selected consolidated statements of operationsdata for the years ended December 31, 2012, 2013 and 2014 and the selected consolidated balance sheets data as of December 31, 2013 and 2014 have beenderived from our audited consolidated financial statements, which are included in this annual report beginning on page F-1. The selected consolidatedstatements of operations data for the year ended December 31, 2011 and the selected consolidated balance sheets data as of December 31, 2012 have beenderived from our audited consolidated financial statements which are not included in this annual report. We have not included financial information for theyear ended December 31, 2010 or the consolidated balance sheet data as of December 31, 2011, as such information is not available on a basis that isconsistent with the consolidated financial information available for the years ended December 31, 2011, 2012, 2013 and 2014 and cannot be obtainedwithout unreasonable effort or expense. Our audited consolidated financial statements are prepared and presented in accordance with accounting principlesgenerally accepted in the United States, or U.S. GAAP. Our historical results do not necessarily indicate results expected for any future period. You shouldread the following selected financial data in conjunction with the consolidated financial statements and related notes and “Item 5. Operating and FinancialReview and Prospects” included elsewhere in this annual report. (in thousands of US$, except for share, per share and per ADS data) For the Year Ended December 31, 2011 2012 2013 2014 Revenues, net of rebates and discounts 87,471 148,200 180,244 182,887 Business tax and surcharges (5,569) (7,679) (5,650) (3,358) Net Revenues 81,902 140,521 174,594 179,529 Cost of revenues (48,068) (84,012) (93,260) (98,459) Gross profit 33,834 56,509 81,334 81,070 Operating expenses(1) Research and development expenses (12,142) (20,357) (28,832) (35,287) Sales and marketing expenses (10,966) (20,219) (26,610) (29,253) General and administrative expenses (18,601) (18,474) (23,073) (29,960) Total operating expenses (41,709) (59,050) (78,515) (94,500) Net gain from exchanges of content copyrights 4,742 4,666 1,020 1,556 Operating (loss)/income (3,133) 2,125 3,839 (11,874) Interest income 270 1,377 1,189 6,733 Interest expense (339) (1,400) — (163) Other income, net 1,415 564 4,679 13,966 Shares of (loss)/income from equity investees (7) (45) 25 (259) (Loss)/income before income tax (1,794) 2,621 9,732 8,403 Income tax benefit/(expense) 1,783 (2,239) 647 1,459 Net income/(loss) (11) 382 10,379 9,862 Less: net loss attributable to the non-controlling interest (1) (121) (283) (950) Net income/(loss) attributable to Xunlei Limited (10) 503 10,662 10,812 Beneficial conversion feature of series C convertible preferred shares from their modification — (286) — — Deemed contribution from series C preferred shareholders — 2,979 — — Contingent beneficial conversion feature of series C to a series C shareholder — — — (57) Deemed dividend to series D shareholder from its modification — — — (279) Accretion of series D to convertible redeemable preferred shares redemption value — (3,509) (4,300) (1,870) Accretion of series E to convertible redeemable preferred shares redemption value — — — (12,754) Amortization of beneficial conversion feature of series E — — — (4,139) Acceleration of amortization of beneficial conversion feature of Series E upon initial public offering — — — (49,346) Deemed dividend to certain shareholders from repurchase of shares — — — (14,926) Deemed dividend to preferred shareholders upon initial public offering — — — (32,807) Allocation of net income to participating preferred shareholders — — (4,094) — Net (loss)/income attributable to Xunlei Limited’s common shareholders (10) (313) 2,268 (105,366) Weighted average number of common shares outstanding Basic 59,143,208 61,447,372 61,447,372 194,711,227 Diluted 59,143,208 61,447,372 76,065,898 194,711,227 Net (loss)/income per share attributable to Xunlei Limited Basic (0.00) (0.01) 0.04 (0.54) Diluted (0.00) (0.01) 0.01 (0.54) Net (loss)/income attributable to holders of common shares of Xunlei Limited per ADS(2) Basic 0.01 (2.70) Diluted 0.01 (2.70) 3Table of Contents Note: (1)Share-based compensation expenses were allocated in operating expenses as follows: For the Year Ended December 31, (in thousands of US$) 2011 2012 2013 2014 Research and development expenses 898 1,085 973 1,171 Sales and marketing expenses 73 46 43 66 General and administrative expenses 1,128 1,102 1,080 6,407 Total share-based compensation expenses 2,099 2,233 2,096 7,644 (2)Each ADS represents five common shares. Net income/(loss) attributable to holders of common shares of Xunlei Limited per ADS is calculated based onNet (loss)/income per share attributable to Xunlei Limited and multiplied by five. (in thousands of US$) 2012 2013 2014 Selected Consolidated Balance Sheet Data: Cash and cash equivalents 81,906 93,906 404,275 Short-term investments 6,523 40,993 29,427 Total current assets 163,830 193,781 495,309 Total assets 202,204 244,403 580,362 Accounts payables (including accounts payable of the consolidated variable interest entitiesand VIE’s subsidiaries without recourse to the Company of USD 62,603 and USD 49,771 asof December 31, 2013 and 2014, respectively) 31,834 39,820 40,204 Total current liabilities 79,544 105,385 102,551 Total liabilities 97,886 124,835 123,341 Mezzanine equity 35,990 40,290 — Total Xunlei Limited’s shareholders’ equity 67,968 79,194 457,891 Non-controlling interest 360 84 (870) Total liabilities, mezzanine equity and shareholders’ equity 202,204 244,403 580,362 4Table of Contents For the Year Ended December 31, (in thousands of US$) 2011 2012 2013 2014 Selected Cash Flow Statement Data: Net cash generated from operating activities 18,277 59,914 85,533 48,202 Net cash used in investing activities (36,875) (49,490) (78,352) (70,546) Net cash generated from financing activities 50,032 17,692 2,487 333,268 Net increase in cash and cash equivalents 31,434 28,116 9,668 310,924 Effect of exchange rates on cash and cash equivalents 562 441 2,332 (555) Cash and cash equivalents at beginning of year 21,353 53,349 81,906 93,906 Cash and cash equivalents at end of year 53,349 81,906 93,906 404,275 B.Capitalization and IndebtednessNot applicable. C.Reasons for the Offer and Use of ProceedsNot applicable. D.Risk FactorsAn investment in our ADSs involves significant risks. You should carefully consider all of the information in this annual report, including therisks and uncertainties described below, before making an investment in our ADSs. Any of the following risks could have a material adverse effect on ourbusiness, financial condition and results of operations. In any such case, the market price of our ADSs could decline, and you may lose all or part of yourinvestment.Risks related to our businessWe have a relatively limited operating history; our business model is currently undergoing significant innovation and transition, and our historical growthrate may not be indicative of our future performance.We have a relatively limited operating history. We launched our core product, Xunlei Accelerator, in 2004 and cloud acceleration subscriptionservices in 2009 to enable users to quickly access and consume digital media content. These cloud acceleration products have rapidly achieved nationwidepopularity in the past few years. Coupled with our core products and services, we provided a range of internet value-added services as well as online videostreaming. Revenues from our cloud acceleration subscription services have significantly increased since 2009 while revenues from our online advertisingand other internet value-added services have increased steadily over the years. However, our business model is currently undergoing significant innovationand transition, including the streamlining of our businesses and more importantly, our continued transition to mobile internet. For example, although ourmobile acceleration software has been officially adopted by Xiaomi’s latest operating system and installed on Xiaomi phones, and we intend to explorerelationships with other smartphone makers to achieve broader acceptance of the Xunlei mobile products, we have not yet begun monetizing our mobileproducts and have not formed significant business partnerships with smartphone makers other than Xiaomi, and cannot assure you that our mobile strategywill succeed. 5Table of ContentsWe are also devoting significant energy to continue to develop Project Crystal, our ongoing innovation in crowdsourcing for idle bandwidthand potentially storage from our users. Project Crystal targets to utilize our users’ computing power for bandwidth and storage in the same way our traditionalacceleration products utilize users’ computing power for establishing and indexing files. The project is still in its early stages and we have not generatedmeaningful cost savings or revenues from it, and cannot assure you as to its future prospects.In addition, as part of our initiative to streamline existing businesses, on March 31, 2015, we entered into a legally binding framework agreementwith an independent third party to sell our entire stake in our online video streaming platform, Xunlei Kankan, for a consideration of RMB130 million. Thecompletion of the transaction is subject to the signing of a definitive purchase agreement and the fulfillment of closing conditions contained therein.Although we expect benefits such as a more streamlined, efficient business model and reduced content costs as a result of the sale of Xunlei Kankan, XunleiKankan contributed to a significant portion of our revenues in the past, and the sale of the business, if completed, may have material adverse impact on ourresults of operations.Furthermore, our PC-based download acceleration subscriptions have declined recently, partly due to the ongoing and increased governmentscrutiny of internet content in China. Although we continue to enhance and update our products in order to make them attractive to our subscribers, ourefforts may not be successful. Our subscriber base declined from 5.1 million as of December 31, 2013 to 4.9 million as of December 31, 2014. See “—We maynot be able to retain our large user base, convert our users into subscribers of our premium services or maintain our existing subscribers.” and “—RisksRelated to Doing Business in China—Regulation and censorship of information disseminated over the internet in China, recently strengthened, mayadversely affect our business, and we may be liable for the digital media content on our platform.”Due to the abovementioned factors, our historical growth rate may not be indicative of our future performance, and we cannot assure you that wewill grow at the same rate as we did in the past, if at all.We may not be able to retain our large user base, convert our users into subscribers of our premium services or maintain our existing subscribers.Our platform had an average of approximately 306 million monthly unique visitors in 2014, according to iResearch. If we are unable toconsistently provide our users with quality services and experience, if users do not perceive our service offerings to be of value, or if we introduce new oradjust existing features or change the mix of digital media content in a manner that is not favorably received by our users, we may not be able to retain ourexisting user base.Our number of subscribers has recently experienced a decline partly due to the increasing scrutiny over internet content from the Chinesegovernment, and may experience further downward pressure in the future. With a government campaign against inappropriate internet content launched inApril 2014, we have had to increase the monitoring of content on our platform. All the measures we adopt in response to increasing regulatory scrutiny maymaterially and adversely affect user experience on our platform and make our services less attractive to our subscribers, leading to a decline in the number ofsubscribers. We saw a reduction in the number of total subscribers from 5.1 million as of December 31, 2013 to 4.9 million as of December 31, 2014, andpermitted temporary suspension of services by about 350,000 existing subscribers as of December 31, 2014. Similar government action or other forces maymake it challenging for us to retain our user base, or may contribute to a further decline in our user base, in the future. See “—Risks Related to DoingBusiness in China—Regulation and censorship of information disseminated over the internet in China, recently strengthened, may adversely affect ourbusiness, and we may be liable for the digital media content on our platform.” 6Table of ContentsIn the long term, even without taking into account the abovementioned government restrictions, we cannot assure you that we would be able toretain our large user or subscriber base. For example, our efforts to provide greater incentives for our users to subscribe, including marketing activities tohighlight the value of differentiated subscriber-only services, such as Green Channel and Offline Accelerator, may not continue to succeed. Our subscribersmay stop their subscriptions or other spending on our products or services because we no longer serve their needs or if we are unable to offer a satisfying userexperience or successfully compete with current and new competitors in both retaining our existing subscribers and attracting new subscribers, which wouldadversely impact our business, results of operations and prospects.If we are unable to successfully capture and retain the growing number of mobile internet users or if we are unable to successfully monetize our mobileproducts, our business, financial condition and results of operations may be materially and adversely affected.An increasing number of users access our products and services through mobile devices, and the transition to mobile internet is a key part of ourcurrent business strategies. Products such as Xunlei Accelerator are now available to users from PCs as well as mobile devices, and we intend to continueexpanding the number of mobile products we offer. An important element of our strategy to transition to mobile internet is to continue to further developfeatures for our mobile products and to develop new mobile products to capture a greater share of the growing number of users that access internet servicessuch as ours through mobile devices. As new laptops, mobile devices and operating systems are continually being released, it is difficult to predict theproblems we may encounter in developing our products for use on these devices and operating systems, and we may need to devote significant resources tocreate, support and maintain these services. Devices providing access to our products and services are not manufactured and sold by us, and we cannot assureyou that the companies manufacturing or selling these devices would always ensure that their devices perform reliably and are maximally compatible withour systems. Any faulty connection between these devices and our products may result in user dissatisfaction with our products, which could damage ourbrand and have a material and adverse effect on our financial results. In addition, the lower resolution, functionality and memory associated with somemobile devices may make the use of our products and services through such devices more difficult and the versions of our products and services we developfor these devices may fail to attract users. Manufacturers or distributors may establish unique technical standards for their devices and, as a result, ourproducts may not work or work properly or be viewable on all devices on which they are installed. Furthermore, new, comparable products which arespecifically created to function on mobile operating systems, as compared to some of our products that were originally designed to be accessed from PCs, andsuch new entrants may operate more effectively on mobile devices than our mobile products do.Although we have not begun monetizing our mobile products, if we are unable to attract and retain the increasing number of users who access ourproducts through mobile devices, or if we are slower than our competitors in developing attractive services adaptable for mobile devices, we may fail tocapture a significant share of an increasingly important portion of the market or may lose existing users. In addition, even if we are able to retain theincreasing number of users who access our services through mobile devices, we may not be able to successfully monetize them in the future. For example,because of the inherent limitations of mobile devices, we may not be able to provide as many kinds of products on mobile devices as we do on PC, whichmay limit the monetization potential of our mobile products and services. 7Table of ContentsIf we fail to keep up with the technological development in the internet industry and users’ changing demand, our business, financial condition and resultsof operations may be materially and adversely affected.The internet industry is rapidly evolving and subject to continual technological changes. As the internet infrastructure continues to develop, theinternet may become more easily accessible through alternative technological innovations in the future, which may make our existing products and servicesless attractive to our users, and we may lose our existing users and fail to attract new users, which may further adversely impact our business, financialcondition and results of operations.In addition, user demand for internet content may also shift over time. Currently, internet users appear to have significant demand for multimediaacceleration, online games and online streaming services, and we expect such demand to continue. However, we cannot assure you that the behavior ofinternet users will not change in the future. If we do not upgrade our services in response to changes in user demand in an effective and timely manner, thenumber of our users and advertisers may decrease. Furthermore, changes in technologies and user demand may require substantial capital expenditures inproduct development and infrastructure. To further expand our user base and offer our users a wider range of access points, we are expanding our business tomobile devices in part through potentially pre-installed acceleration products in mobile phones. In addition, we are continually developing and upgradingproducts and services and seeking strategic cooperation with hardware manufacturers such as smartphone makers, which may require significant resourcesfrom us. If our innovations cannot respond to the needs of our users or if our users are not attracted to our upgraded or new products and services, we may notbe able to maintain or expand our user base, and our business, results of operations and prospects may be materially and adversely affected.We face and expect to continue to face copyright infringement claims and other related claims, including claims based on content available through ourservices, which could be time-consuming and costly to defend and may result in damage awards, injunctive relief and/or court orders, divert ourmanagement’s attention and financial resources and adversely impact our business.Our success depends, in large part, on our ability to operate our business without infringing, misappropriating or otherwise violating third-partyrights, including third-party intellectual property rights. Internet, technology and media companies are frequently involved in litigation based on allegationsof infringement of intellectual property rights, unfair competition, invasion of privacy, defamation and other violations of other parties’ rights. 8Table of ContentsIn May 2014, we entered into a content protection agreement with the Motion Picture Association of America, Inc., or MPAA, and six major U.S.entertainment content providers, which are the members of MPAA. Under this agreement, we agreed to implement a comprehensive system of measuresdesigned to prevent unauthorized downloading of and access to such content providers’ works. Among these content protection measures, we agreed to(1) implement a filtering system that will be applied to these content providers’ video content, (2) filter these content providers’ video content prior tomaking any such content available to our users through our websites or client applications, (3) adopt state-of-the-art fingerprinting-based filteringtechnologies, (4) cooperate with these content providers going forward to ensure the effectiveness of our content protection measures, and (5) incorporateadditional content protection measures to the extent that they are necessary to effectively protect against copyright infringement. We may not be able tofulfill all of our obligations under such agreement in a timely manner, due to a variety of factors which may be outside of our control. In addition, even if wecomply with all of our obligations under the content protection agreement, the implementation of content protection measures may affect our users’experience or otherwise make our services and products less competitive than those of our competitors, which could in turn materially and adversely affectour business, financial condition and results of operations. In January 2015, a number of MPAA member studios filed copyright infringement lawsuits againstus in the Shenzhen Nanshan District Court in China, and the cases are awaiting trial as of the date of this annual report. Although we expect that the outcomeof these lawsuits would not have a substantial negative impact on our financials, we cannot provide you with any estimate as to such outcome or assure youthat it would not have material adverse impact upon our business. Even if we won the court ruling for these current proceedings or ultimately reachedsettlement with MPAA and the relevant members, we cannot assure you that any of these parties would not initiate other proceedings against us. Also see“Item 8. Financial Information—A. Consolidated Statements and Other Financial Information—Legal Proceedings.”In the ordinary course of our business, we receive, from time to time, written notices from third parties claiming that certain content and games inour network or on one or more of our websites infringe their copyrights or the copyrights of third parties. These notices may threaten to take legal actionsagainst us or request us to cease distribution, marketing or displaying such content or games on our network or websites. Claims alleging copyrightinfringement or other claims arising from the content accessible through our distributed computing network, or on our websites or through our other services,such as the legal proceeding initiated by MPAA members or any potential legal proceedings that may be initiated by, for example, the Motion PictureAssociation Inc., with or without merit, may lead to damage awards and/or court orders, diversion of our management’s attention and financial resources andnegative publicity affecting our brand and reputation, and therefore may adversely affect our results of operations and business prospects. In addition, asignificant number of these claims relate to content on Xunlei Kankan, and if we successfully complete our proposed sale of Xunlei Kankan to a third partybuyer pursuant to a binding framework agreement we entered into dated as of March 31, 2015, our future exposure to claims in relation to intellectualproperty may significantly decrease, although we still expect to face a number of copyright infringement claims and other related claims in the future inrelation to our other products and services.We were subject to a number of lawsuits in China for alleged copyright infringements over the years, a number of which are still outstanding asof the date of this annual report. Although we have not been, nor are we currently a party to or aware of, any legal proceeding, investigation or claim that, inthe view of our management, is likely to materially and adversely affect our business, financial position or results of operations, these existing and futureclaims may divert our management’s attention and financial resources and adversely impact our business.The premium acceleration services and other value-added services we provide to our subscribers may expose us to additional copyright infringementclaims, which could materially and adversely affect our existing business model.We provide subscribers with limited space to temporarily store content downloaded on our servers for optimal acceleration performance.Subscribers may also request our cloud servers to transmit a file on their behalf and upload it to their properties. See “Item 4. Information on the Company—B. Business Overview—Our Platform—Cloud accelerator—Subscription services.” In addition, certain of our services allow users to upload files after theycreate accounts with us, converting the files into links and sharing such links with designated persons. We may be liable for transmitting or temporarilystoring content or creating links representing content on behalf of our subscribers if such content infringes third-party intellectual property rights, and anysuch potential legal liabilities could materially and adversely affect our business. 9Table of ContentsOur technologies, business methods and services, including those relating to our resource discovery network, may be subject to third-party patent claims orrights, such as issued patents or pending patent applications, that limit or prevent their use.We cannot assure you that our technologies, business methods and services, including those relating to our resource discovery network, will befree from claims of patent infringements, and that holders of patents would not seek to enforce such patents against us in China, the United States or any otherjurisdictions. Based on our own analysis, we do not believe that we are currently infringing any third-party patents of which we are aware. However, ouranalysis may have failed to identify all relevant patents and patent applications. For example, there may be currently pending applications, unknown to us,that may later result in issued patents that are infringed by our products, services or other aspects of our business. There could also be existing patents ofwhich we are not aware that our products may inadvertently infringe. Third parties may attempt to enforce such patents against us. Further, the applicationand interpretation of China’s patent laws and the procedures and standards for granting patents in China are still evolving and are uncertain, and we cannotassure you that PRC courts or regulatory authorities would agree with our analysis. Any patent infringement claims, regardless of their merits, could be time-consuming and costly to us. If we were found to infringe third-party patents and were not able to adopt non-infringing technologies, we may be severelylimited in our ability to operate our business, and our results of operations could be materially and adversely affected.The intellectual property protection mechanism we have implemented may not be effective or sufficient and may subject us to future litigation or result inour inability to continue providing certain of our existing services in China.We may not have obtained licenses for all digital media content available via our services and the scope of the licenses we obtained for certaincontent may not be broad enough to cover all the methods we currently employ to distribute, market or display such content. For digital media content wehave lawfully obtained from an authorized licensor, we may not be able to timely detect the expiration of the licensing period of certain of the contentavailable via our services and disable access to such content via our services in a timely manner. We have been involved in litigations based on allegationsfrom rights owners that we have infringed their copyright interests in such content. Assisted by our intellectual property team dedicated to copyrightprotection, for example, we have implemented internal procedures to meet the requirements under relevant PRC laws and regulations to monitor and reviewthe content we license before it is released and remove any infringing content promptly after we receive notice of infringement from the legitimate rightsholder. See also “Item 4. Information on the Company—B. Business—Intellectual Property—Digital media data monitoring and copyright protection” formore details. However, due to the significant amount of digital media content available on Xunlei Kankan or accessible through our resource discoverynetwork and other services, we generally do not seek to identify infringing content absent receiving any notice of infringement. If we successfully completeour proposed sale of Xunlei Kankan to a third party buyer pursuant to the binding framework agreement dated March 31, 2015, our exposure to claims inrelation to intellectual property may be significantly reduced in the future, and we expect to adjust our monitoring procedures in relation to intellectualproperty and devote more resources to the monitoring of content accessible via our core services. For details of our proposed sale of Xunlei Kankan, see “Item4. Information on the Company — A. History and Development of the Company.” 10Table of ContentsIn addition, we organize and recommend to our users digital media content accessible through our services and provided on certain reputableaudio-visual websites that have cooperation relationships with us. As such, we may be exposed to the risk of copyright infringement liability in the event thatsuch content has not been duly licensed to us or to the operators of those websites. Moreover, some rights owners may not send us a notice before bringinglawsuits against us. Thus, our inability to identify unauthorized content hosted on our website or servers or accessible through our network subjects us toclaims of infringement of third-party intellectual property rights or other rights. In addition, we may be subject to administrative actions brought by theNational Copyright Administration of the PRC or its local branches for alleged copyright infringement.The validity, enforceability and scope of protection of intellectual property in internet-related industries, particularly in China, are uncertain andstill evolving. As we face increasing competition and as litigation becomes more common in China in resolving commercial disputes, we face a higher risk ofintellectual property infringement claims. The Supreme People’s Court of China promulgated a judicial interpretation on infringement of the right of internetdissemination in December 2012. This judicial interpretation provides that the courts will require service providers to remove not only links or content thathave been specifically mentioned in the notices of infringement from rights holders, but also links or content they “should have known” to containinfringing content. The interpretation further provides that where an internet service provider has directly obtained economic benefits from any content madeavailable by an internet user, it has a higher duty of care with respect to internet users’ infringement of third-party copyrights. This interpretation may subjectus and other internet service providers to significant administrative burdens and litigation risks. See “Item 4. Key Information on the Company—B. BusinessOverview—Regulation—Regulation on Intellectual Property Rights.” Interested parties may lobby for more robust intellectual property protection injurisdictions in which we conduct business or may conduct business, and intellectual property laws in China and other such jurisdictions may become lessfavorable to our business. Intellectual property litigation may be expensive and time-consuming and could divert management attention and resources. Ifthere is a successful claim of infringement, we may be required to discontinue the infringing activities, pay substantial fines and damages and/or seek royaltyor license agreements that may not be available on commercially acceptable terms, if at all. Our failure to obtain the required licenses on a timely basis couldharm our business. Any intellectual property litigation and/or any negative publicity by third parties alleging our intellectual property infringement couldhave a material adverse effect on our business, reputation, financial condition or results of operations. To address the risks relating to intellectual propertyinfringement, we may have to substantially modify, limit or, in extreme cases, terminate some of our services. Any of such changes could materially affect ourusers’ experience and in turn have a material adverse impact on our business.We may be subject to claims or lawsuits outside of China, which could increase our risk of direct or indirect liabilities for our existing or future serviceofferings.Although we have not been subject to claims or lawsuits outside China, we cannot assure you that we will not become subject to copyright lawsin other jurisdictions, such as the United States, by virtue of our listing in the United States, the ability of users to access our services in the United States andother jurisdictions, the ownership of our ADSs by investors, the extraterritorial application of foreign law by foreign courts or for other reasons. We haveattracted and expect to continue to attract attention from intellectual property owners outside of China, despite our efforts to control access to our productsand services by users outside China. For example, the Recording Industry Association of America filed a letter with the Office of the United States TradeRepresentative in November 2010 accusing certain of our divested or discontinued products of facilitating intellectual property infringement. Although wetake steps to block IP addresses that are located in certain jurisdictions, including the United States, from accessing certain of our services, due totechnological limitations, such efforts may not be 100% successful, and any unintended access to our services may increase our risk of becoming subject tocopyright laws in such jurisdictions. Even if our efforts to block IP addresses located in the United States or other jurisdictions are successful, recent efforts toamend the laws in such jurisdictions, such as bills intended to expand the extraterritorial scope of the U.S. Copyright Act, may increase our risk of becomingsubject to copyright laws in such jurisdictions. In addition, as a publicly listed company, we may be exposed to increased risk of litigation. 11Table of ContentsAlthough U.S. copyright laws, including the Digital Millennium Copyright Act (17 U.S.C. § 512), or the DMCA, provide safeguards or “safeharbors” from claims in the United States for monetary relief for copyright infringement for certain entities that host user-uploaded content or provideinformation location tools that may link to infringing content, these safe harbors apply only to companies that comply with specified statutory requirements.We do not currently satisfy all of the statutory requirements of any DMCA safe harbor. If we are ever held to be subject to United States copyright law, thatcould increase our risk of direct or indirect copyright liability for our resource discovery, acceleration or other services. If a claim of infringement broughtagainst us in the United States or other jurisdictions is successful, we may be required to (i) pay substantial statutory or other damages and fines, (ii) removerelevant content from our website, (iii) discontinue products or services and/or (iv) seek royalty or license agreements that may not be available oncommercially reasonable terms or at all.We may not be able to prevent unauthorized use of our intellectual property or disclosure of our trade secrets and other proprietary information, whichcould reduce demand for our services and have material and adverse impact on our business, financial condition and results of operations.Our patents, trademarks, trade secrets, copyrights and other intellectual property rights are important assets for us. Events that are outside of ourcontrol may pose a threat to our intellectual property rights. For example, effective intellectual property protection may not be available in China and someother jurisdictions in which our services are distributed or made available through the internet. Also, the efforts we have made to protect our proprietary rightsmay not be sufficient or effective. Any significant impairment of our intellectual property rights could harm our business or our competitiveness. Also,protecting our intellectual property rights is costly and time consuming. Any increase in the unauthorized use of our intellectual property could make it moreexpensive to conduct our business and harm our results of operations.We seek to obtain patent protection for our innovations. However, it is possible that patent protection may not be available for some of theseinnovations. In addition, given the costs of obtaining patent protection, we may choose not to protect certain innovations that later turn out to be important.Furthermore, there is always the possibility, despite our efforts, that the scope of the protection gained will be insufficient or that an issued patent may bedeemed invalid or unenforceable.We also seek to maintain certain intellectual property as trade secrets. We require our employees, consultants, advisors and collaborators to enterinto confidentiality agreements in order to protect our trade secrets and other proprietary information. These agreements might not effectively preventdisclosure of our trade secrets, know-how or other proprietary information and might not provide an adequate remedy in the event of unauthorized disclosureof such confidential information. In addition, others may independently discover our trade secrets and proprietary information, in which case we could notassert such trade secret rights against such parties. Any unauthorized disclosure or independent discovery of our trade secrets would deprive us of theassociated competitive advantages. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights,and failure to obtain or maintain trade secret protection could adversely affect our competitive position. 12Table of ContentsThe success of our business depends on our ability to maintain and enhance a strong brand. If we fail to sustain or improve the strength of our brand, wemay subsequently experience difficulty in maintaining market share.We believe that maintaining and enhancing our Xunlei brand is of significant importance to the success of our business. A well-recognizedbrand is critical to increasing our user base and, in turn, enhancing our attractiveness to advertisers, subscribers and paying users. Since the Chinese internetmarket is highly competitive, maintaining and enhancing our brand depends largely on our ability to retain a significant market share in China, which maybe difficult and expensive.We have developed our reputation and established a leading position by providing our users with a superior acceleration and video viewingexperience. We will continue to conduct various marketing and brand promotion activities. We cannot assure you, however, that these activities will besuccessful and achieve the brand promotion effects we expect. In addition, any negative publicity in relation to our services or our marketing or promotionpractices, regardless of its veracity, could harm our brand image and, in turn, result in a reduced number of users and advertisers. Historically, there has beennegative publicity about our company, our products and services and certain key members of our management team, which has adversely affected our brand,public image and reputation. If we fail to maintain and enhance our brand, or if we incur excessive expenses in this effort, our business, financial conditionand results of operations may be materially and adversely affected.System failure, interruptions and downtime, including those caused by cyber attacks or network issues, can result in user dissatisfaction and adversepublicity, and our business, financial condition and results of operations may be materially and adversely affected.Our operations rely on our networks and servers, which can suffer system failures, interruptions and downtime. Our network systems arevulnerable to damage from computer viruses, fires, floods, earthquakes, power losses, telecommunication failures, computer hacking and similar eventsdespite our implementation of security measures, which may cause interruptions to the services we provide, degrade the user experience, or cause users to loseconfidence in our products. Our efforts to protect our company data or the information we receive may also be unsuccessful due to software bugs or othertechnical malfunctions, employee error or malfeasance, government surveillance, or other factors.The satisfactory performance, stability, security and availability of our websites and our network infrastructure are critical to our reputation andour ability to attract and retain users and advertisers. Our network contains information regarding file index, advertising records, premium licensed digitalmedia content and various other facets of the business to assist management and help ensure effective communication among various departments and officesof our company. Any failure to maintain the satisfactory performance, stability, security and availability of our network, website or technology platform,whether such failure results from intentional cyber attacks by hackers, from issues with our own technology and team or from other factors beyond ourcontrol, may cause significant harm to our reputation and impact our ability to attract and maintain users and business partners.From time to time, our users in certain locations may not be able to gain access to our network or our websites for a period of time lasting fromseveral minutes to several hours, due to server interruptions, power shutdowns, internet connection problems or other reasons. Although we have notexperienced extended periods of such server interruptions, power shutdowns or internet connection problems across our entire network, we cannot assure youthat such instances will not occur in the future. Any server interruptions, break-downs or system failures, including failures which may be attributable toevents within or outside our control that could result in a sustained shutdown of all or a material portion of our network or website, could reduce theattractiveness of our service offerings. In addition, any substantial increase in the volume of traffic on our network or website will require us to increase ourinvestment in bandwidth, expand and further upgrade our technology platform. We do not maintain insurance policies covering losses relating to ournetwork systems. As a result, any system failure, interruptions or network downtime for an extended period may have a material adverse impact on ourrevenues and results of operations. 13Table of ContentsIf we fail to retain existing advertisers or attract new advertisers, our revenues may be materially and adversely affected.Historically, we generate a substantial portion of our revenues from online advertising. The revenues generated from online advertisingdecreased by 22.3% from US$61.8 million in the year ended December 31, 2012 to US$48.0 million in the year ended December 31, 2013 and by 20.1% from2013 to US$38.4 million in the year ended December 31, 2014, as a result of our discontinuing the delivering of advertisements on Xunlei Accelerator tofurther improve our user experience and enhance user engagement on Xunlei Accelerator. We cannot assure you that we can continue to retain ouradvertising agencies and advertisers or attract new advertising agencies and advertisers. The number of advertisers that use our online advertising servicesdecreased from 485 in 2011 to 420 in 2012, 399 in 2013, and further to 252 in 2014. If we cannot retain our existing advertisers or develop new advertisers inthe future, our revenues generated from online advertising will be materially and negatively affected. Since our arrangements with third-party advertisingagencies are typically one-year framework agreements, such advertising arrangements may be easily amended or terminated without incurring liabilities.A number of our advertisers are e-commerce companies and online game operators. The online game and e-commerce industries in China arerapidly evolving, and the growth of these industries and their demand for online advertising services is uncertain and may be affected by factors out of ourcontrol. We also have significant brand advertising and are seeking to further expand this portion of advertising. However, we cannot assure you that we willbe able to retain existing advertising agencies and advertisers or attract more advertising agencies and advertisers for brand advertising, and if we fail to doso, our business, results of operations and prospects may be materially and adversely affected.In addition, as Xunlei Kankan contributed a significant portion of our advertising revenues and advertisers on Xunlei Kankan constitute amajority of our advertisers, we expect that our revenue from online advertising and our number of advertisers will experience further significant decrease if wecomplete our sale of Xunlei Kankan as planned.We are strictly regulated in China. Any lack of requisite licenses or permits applicable to our business and any changes in government policies orregulations may have a material and adverse impact on our business, financial condition and results of operations.Our business is subject to governmental supervision and regulations by the relevant PRC governmental authorities including the State Council,the Ministry of Industry and Information Technology (formerly the Ministry of Information Industry), or MIIT, the General Administration of Press andPublication, Radio, Film and Television (established in March 2013 as a result of institutional reform integrating the State Administration of Radio, Film andTelevision, and the General Administration of Press and Publication), or GAPPRFT, Ministry of Culture, or MOC and other relevant government authorities.Together these government authorities promulgate and enforce regulations that cover many aspects of operation of telecommunications and internetinformation services, including entry into the telecommunications industry, the scope of permissible business activities, licenses and permits for variousbusiness activities and foreign investment. 14Table of ContentsA license for online transmission of audio-visual programs is required for the display of video content on our websites. See “Item 4. Informationon the Company—B. Business Overview—Regulation—Regulation on online transmission of audio-visual programs.” Shenzhen Xunlei NetworkingTechnologies, Co., Ltd., or Shenzhen Xunlei, our VIE and the operator of our online video streaming platform, has obtained a license for online transmissionof audio-visual programs. The list of websites covered by such license has not included www.xunlei.com and the list of terminals has not included mobileand TV devices. In addition, the business categories as indicated in such license fail to cover all the business activities that we are currently engaging, such asthe transmission of political news. We plan to apply for an update of our license for online transmission of audio-visual programs to cover thewww.xunlei.com website, the terminals of mobile devices and TVs and expanding the business categories to cover all of our current business activities.However, we cannot assure you that we will be able to obtain such updated license in a timely manner or at all. Due to our failure to update our license foronline transmission of audio-visual programs, we may be given a warning, ordered to rectify our violations and/or fined up to RMB30,000. In severe cases,our license for online transmission of audio-visual programs may be revoked.We source digital media content from various content providers, including China-based television and movie production studios, online videosites, media companies and online game companies. In dealing with content providers, we take a series of measures to monitor and protect copyright of suchcontent. For details of such content monitoring and copyright protection measures, see “Item 4. Information on the Company—B. Business Overview—Intellectual property—Digital media data monitoring and copyright protection.” However, we cannot guarantee that the content providers have the legalright to license us the content or are in full compliance with all the relevant PRC permits and licenses set forth by GAPPRFT, and the remedies provided bythese content providers, if any, may not be sufficient to compensate us for potential regulatory sanctions imposed by GAPPRFT due to violations of theapproval and permit requirements. Nor can we ensure that any such sanctions will not adversely affect either the general availability of video content on ourwebsite or our reputation. In addition, such risks may persist due to ambiguities and uncertainties relating to the implementation and enforcement of theapplicable regulations. We also source some audio-visual programs directly from foreign content providers. PRC law requires approval from and registrationwith GAPPRFT for introducing and broadcasting foreign movies and television programs into China. See “Item 4. Information on the Company—B. BusinessOverview—Regulation—Regulation on foreign movies and television programs.” We are in the process of applying for the approval and registration inrelation to introducing and broadcasting such foreign audio-visual programs into China, but we have not obtained relevant approvals from nor completed theregistration with GAPPRFT. In practice, it is not uncommon for internet content providers in China to introduce and broadcast foreign audio-visual programswithout such approvals. If GAPPRFT or its local branch specifically determines and requires us to rectify and obtain the approvals for our introduction andonline broadcasting of overseas audio-visual programs, we may not be able to obtain such approval in a timely manner or at all. In such case, the PRCgovernment would have the power to, among other things, levy fines against us, confiscate our income, order us to cease certain content service, or require usto temporarily or permanently discontinue the affected portion of our business.Pursuant to the relevant PRC regulations promulgated by the State Council Information Office, or SCIO, internet news information serviceentities engaging in news publishing services, current political news bulletin board services or dissemination of current political news to the public viainternet are required to obtain an internet news license from SCIO. See “Item 4. Information on the Company—B. Business Overview—Regulation—Regulation on internet news dissemination.” The content we currently provide on our websites include some current political news from third party newsproviders. Currently we do not hold an internet news license from SCIO and we plan to apply for such internet news license. However, we cannot assure youthat we will be able to obtain such license in a timely manner or at all. If we fail to obtain such license or fail to timely remove the current political newsrelated content due to the large volume of content we provide, we may be ordered by SCIO or the local SCIO branches at the provincial level to cease anyinternet news services, and in severe cases, as determined by SCIO or the local SCIO branches in writing, MIIT may order us to cease all the internetinformation services or require the internet service provider to disconnect us from the internet. 15Table of ContentsIf the PRC government considers that we were operating without the proper licenses or approvals or promulgates new laws and regulations thatrequire additional licenses or imposes additional restrictions on the operation of any part of our business, it has the power to, among other things, levy fines,confiscate our income, revoke our business licenses, and require us to discontinue our business or impose restrictions on the affected portion of our business.Any of these actions by the PRC government may have a material and adverse effect on our results of operations. In addition, the PRC government maypromulgate regulations restricting the types and content of advertisements that may be transmitted online, which could have a direct adverse impact on ourbusiness.Concerns about collection and use of personal data could damage our reputation, deter current and potential users from using our services andsubstantially harm our business and results of operations.Pursuant to the applicable PRC laws and regulations concerning the collection, use and sharing of personal data, our PRC subsidiaries, VIE andits subsidiaries are required to keep our users’ personal information confidential and are prohibited from disclosing such information to any third partieswithout such users’ consent. In December 2012 and July 2013, new laws and regulations were issued by the standing committee of the PRC National People’sCongress and MIIT to enhance the legal protection of information security and privacy on the internet. The laws and regulations also require internetoperators to take measures to ensure confidentiality of information of users. Concerns about our practices with regard to the collection, use or disclosure ofpersonal information or other privacy-related matters, even if unfounded, could damage our reputation and operating results.We apply strict management and protection to any information provided by users, and under our privacy policy, without our users’ prior consent,we will not provide any of our users’ personal information to any unrelated third party. While we strive to comply with our privacy guidelines as well as allapplicable data protection laws and regulations, any failure or perceived failure to comply may result in proceedings or actions against us by governmententities or others, and could damage our reputation. User and regulatory attitudes towards privacy are evolving and concerns about the security of personaldata could also lead to a decline in general usage of our products and services, which could lead to lower user numbers. For example, if the PRC governmentauthorities require real-name registration by our users, our user numbers may decrease and our business, financial condition and results of operations may beadversely affected. See “—Risks Related to Doing Business in China—We may be adversely affected by the complexity, uncertainties and changes in PRCregulations of internet-related business and companies.” In addition, we may become subject to the data protection or personal privacy laws of jurisdictionsoutside of China, where more stringent requirements may be imposed on us and we may have to allocate more resources to comply with the legalrequirements, and our user numbers may further decrease. A significant reduction in user numbers could have a material adverse effect on our business,financial condition and results of operations. 16Table of ContentsIf we are unable to collect accounts receivable in a timely manner or at all, our financial condition, results of operations and prospects may be materiallyand adversely affected.A large portion of our advertising revenues are generated from a limited number of advertising agencies. We typically enter into advertisingagreements with third-party advertising agencies that represent the advertisers, and under these agreements, the advertising fees are paid to us by theadvertising agencies after we deliver our services. In consideration for the third-party advertising agencies’ services, we pay them rebates based on the valueof business they bring to us. Thus, the financial soundness of our advertisers and advertising agencies with whom we sign these advertising contracts mayaffect our collection of accounts receivable. We make a credit assessment of our advertisers and advertising agencies to evaluate the collectability of theadvertising service fees before entering into any advertising contract. However, we cannot assure you that we are or will be able to accurately assess thecreditworthiness of each advertising agency or advertiser, as applicable, and any inability of advertisers or advertising agencies, especially those thataccounted for a significant percentage of our amounts receivables in the past, to pay us in a timely manner may adversely affect our liquidity and cash flows.In addition, the online advertising market in China is dominated by a small number of large advertising agencies. If the large advertising agencies that wehave business relationships with demand higher rebates for their agency services, our results of operations will be materially and adversely affected.We may not be able to generate sufficient cash from operations or to obtain sufficient capital to meet the additional capital requirements of our changingbusiness.In order to implement our development strategies, including our strategies to transition to mobile internet and continue working on ProjectCrystal, we will make continual capital investments in terms of devoting more research and development efforts into investigating user needs and developnew mobile products and update existing ones, continue enhancing the technologies involved in Project Crystal and provide more frequent updates to ourexisting products. Thus, we will continue to incur substantial capital expenditures on an ongoing basis, and it may become difficult for us to meet suchcapital requirements.To date, we have financed our operations primarily through cash flow from operations and, to a lesser degree, proceeds from private placementsof preferred shares, our initial public offering and bank loans. However, if we fail to retain a sufficient number of users and continue to convert such users intopaying users or subscribers, we may not be able to generate sufficient revenues to cover our business development strategies, including our continuedtransition to mobile internet and the continued expansion of Project Crystal, and our business may be materially and adversely affected.We may obtain additional financing, including from equity offerings and debt financings in capital markets, to fund the operation and plannedexpansion of our business. Our ability to obtain additional financing in the future, however, is subject to a number of uncertainties, including: • our future business development, financial condition and results of operations; • general market conditions for financing activities by companies in our industry; and • macroeconomic, political and other conditions in China and elsewhere.If we cannot obtain sufficient capital to meet our capital expenditure needs, we may not be able to execute our growth strategies and ourbusiness, results of operations and prospects may be materially and adversely affected. 17Table of ContentsOur costs and expenses, such as research and development expenses, may increase and our results of operations may be adversely affected.The operation of our extensive resource discovery network and our online video and online game business require significant upfront capitalexpenditures as well as continual, substantial investment in content, technology and infrastructure. Since inception, we have invested substantially inresearch and development to maintain our technology leadership, in equipment to increase our network capacity and in expanding the content library for ouronline video business. We expect our research and development expenses to increase in the near term as we continue to expand our research anddevelopment team to develop new products and update existing products, particularly as we plan to continue devoting resources in the development ofProject Crystal and the development and updating of our mobile products. Most of our capital expenditures, such as expenditures on servers and otherequipment, are based upon our estimation of potential future demand and we are generally required to pay the entire purchase price and license fees up front.As a result, our cash flow may be negatively affected in the periods in which such payments are made. We may not be able to quickly generate sufficientrevenue from such expenditures, which may negatively affect our results of operations within certain periods thereafter; and if we over-estimate futuredemand for our services, we may not be able to achieve expected rates of return on our capital expenditures, or at all.In addition, bandwidth and other costs are subject to change and are determined by market supply and demand. For example, the market pricesfor professionally produced digital media content have increased significantly in China during the past few years, and there have been increases in therelevant license fees. In addition, if bandwidth and other providers cease their business with us or raise the prices of their products and services, we will incuradditional costs to find alternative service providers or to accept the increased costs in order to provide our services, although we expect that crowdsourcedbandwidth obtained through Project Crystal may offset some of the bandwidth costs and our contemplated sale of Xunlei Kankan may reduce our bandwidthcosts. If we cannot pass on our costs and expenses to our users, or if our costs to deliver our services do not decline commensurate with any future declines inthe prices we charge our users, our results of operations may be adversely affected and we may fail to achieve profitability.We may not be able to successfully address the challenges and risks we face in the online games market, such as a failure to successfully implement ourplan to acquire exclusive rights to operate and sub-license games or to obtain all the licenses required to operate online games, which may subject us topenalties from relevant authorities, including the discontinuance of our online game business.Since 2010, we have entered into exclusive operating agreements with online game developers so that we can gain exclusive rights to certainonline games and, in addition to offering these games on our own websites, also have the option of sub-licensing these games to other websites to diversifyour game revenue stream. Exclusive arrangements of this type require more initial capital investment in acquiring operating rights for the games, and involvemore business risks, such as risks associated with the potential failure to find appropriate sub-licensees for the games or failure to engage a sufficient numberof game players to make these games profitable for us. We expect that we will continue to make investments to acquire operating rights under such exclusiveoperating arrangements. If we are unable to generate sufficient revenues in these markets to obtain sufficient return for our investments, our future results ofoperations and financial condition could be materially and adversely affected. 18Table of ContentsIn addition, to operate online games in China, a variety of permits and approvals are required. For example, publication of online games, musicworks and other internet publishing activities are subject to the regulation of the GAPPRFT, which requires operators of online games and other internetpublishing services to obtain an internet publication license prior to providing any such services. See “Item 4. Information on the Company—B. BusinessOverview—Regulation—Regulation on internet publication.” Shenzhen Xunlei has obtained an internet publication license for the publication of internetgames and is in the process of applying for expansion of the business scope therein to include the publication of music works and other internet publishingactivities, and Xunlei Games Development (Shenzhen) Co., Ltd., or Xunlei Games, is in the process of applying for the internet publication license for itspublication of online games. However, there is no assurance that we will be granted such licenses. Applicable regulations also specify that each online gamemust be screened and approved in advance by GAPPRFT before it is allowed to be launched online. Also, an imported online game should be approved inadvance by MOC before its initial operation while a domestically developed online game should be filed with MOC within 30 days of commencingoperations. See “Item 4. Information on the Company—B. Business Overview—Regulation—Regulation on online games.” We license from online gamedevelopers and operate MMOGs, and we share profits with these developers. We require developers of certain online games to obtain the requisite approvalsfrom GAPPRFT, and make the filings with MOC, for relevant online games. As of the date of this annual report, most of our online games currently inoperation exclusively by us have obtained GAPPRFT’s approval and completed filing with MOC. However, we cannot assure you that we or such onlinegame developers can obtain GAPPRFT’s approvals or complete the filings with MOC for all the games in a timely manner or at all. If we or such online gamedevelopers fail to obtain these licenses, approvals or filings in a timely manner or at all, the relevant authority may challenge the commercial operation of ouronline games and determine that we are in violation of the relevant laws and regulations regarding online games, it would have the power to, among otherthings, levy fines against us, confiscate our income generated from operation of our online games and require us to discontinue our online game business.We operate in a competitive market and may not be able to compete effectively.We face significant competition in different areas of our business. For example, although we currently have a leading presence in the China market for cloudacceleration products and services, we cannot guarantee that we will be able to maintain our leading position in the future. We may face competition fromleading Chinese internet companies, such as Tencent and Baidu, if they start to allocate resources and focus on the development in this business sector. Withmore entrants into the cloud acceleration business, aggressive price cutting by competitors may result in the loss of our existing subscribers. We may have totake actions to retain our user base and attract more subscribers at significant cost, including upgrading and developing existing and new products andservices in order to meet users’ changing demand, but we cannot assure you that such efforts will succeed, especially given the tightening control overinternet content by the Chinese government. See “—If we fail to keep up with the technological development in the internet industry and users’ changingdemand, our business, financial condition and results of operations may be materially and adversely affected.” and “—Regulation and censorship ofinformation disseminated over the internet in China, recently strengthened, may adversely affect our business, and we may be liable for digital media contenton our platform.”Some of our existing or potential competitors have a longer operating history and significantly greater financial resources than we do, and inturn may be able to attract and retain more users and advertisers. Our competitors may compete with us in a variety of ways, including by conducting brandpromotions and other marketing activities and making acquisitions. If we are not able to effectively compete in any aspect of our business, which would havea material and adverse effect on our business, financial condition and results of operations. 19Table of ContentsUndetected programming errors or flaws or failure to maintain effective customer service could harm our reputation or decrease market acceptance of ourservices, particularly our resource discovery network and our online video website, which would materially and adversely affect our results of operations.Our programs may contain programming errors that may only become apparent after their release, especially in terms of upgrades to, for example,Xunlei Accelerator or cloud acceleration subscription services. We receive user feedback in connection with programming errors affecting their userexperience from time to time, and such errors may also come to our attention during our monitoring process. However, we cannot assure you that we will beable to detect and resolve all these programming errors effectively or in a timely manner. Undetected programming errors or defects may adversely affect userexperience and cause our users to stop using our services and our advertisers to reduce their use of our services, any of which could materially and adverselyaffect our business and results of operations.Advertisements we display may subject us to penalties and other administrative actions.Under PRC advertising laws and regulations, advertisement channels such as us are obligated to monitor the advertising content they display toensure that such content is true, accurate and in full compliance with applicable laws and regulations. PRC advertising laws and regulations set forth certaincontent requirements for advertisements in the PRC including, among other things, prohibitions on false or misleading content, superlative wording, sociallydestabilizing content or content involving obscenities, superstition, violence, discrimination or infringement of the public interest. In providing advertisingservices, we are required to review the supporting documents provided to us by advertising agencies or advertisers for the relevant advertisements and verifythat the content of the advertisements complies with applicable PRC laws and regulations. Prior to distributing advertisements that are subject to governmentcensorship and approval, we are obligated to verify that such censorship has been performed and approval has been obtained. Violation of these regulationsmay result in penalties, including fines, confiscation of advertising income, orders to cease dissemination of the advertisements and orders to publish anadvertisement correcting the misleading information. In circumstances involving serious violations, the State Administration for Industry and Commerce, orthe SAIC, or its local branches may revoke violators’ licenses or permits for their advertising business operations.To fulfill these monitoring functions specified by the PRC laws and regulations set forth above, we employ several measures. Almost all of ouradvertising contracts require that advertising agencies or advertisers that contract with us: (i) ensure the advertising content provided to us is true, accurateand in full compliance with PRC laws and regulations; (ii) ensure such content does not infringe any third-party’s rights and interests; and (iii) indemnify usfor any liabilities arising from such advertising content. In addition, a team of our employees reviews all advertising materials to ensure the content does notviolate relevant laws and regulations before displaying such advertisements. However, we cannot assure you that all the content contained in suchadvertisements is true and accurate as required by the advertising laws and regulations, especially given the uncertainty in the application of these laws andregulations, and we have occasionally received fines for certain inappropriate advertisements posted on Xunlei Kankan, and may be subject to similar finesand penalties in the future. Although we expect our liabilities with respect to advertising to decrease if we complete our contemplated sale of Xunlei Kankan,if we are found to be in violation of applicable PRC advertising laws and regulations in the future, we may be subject to penalties and our reputation may beharmed, which may have a material and adverse effect on our business, financial condition and results of operations.We face risks relating to third parties’ billing and payment systems.The billing and payment systems of third parties such as online third-party payment processors help us maintain accurate records of payments ofsales proceeds by certain subscribers and other paying users and collect such payments. Our business and results of operations could be adversely affected ifthese third parties fail to accurately account for or calculate the revenues generated from the sales of our products and services. Moreover, if there are securitybreaches or failure or errors in the payment process of these third parties, user experience may be affected and our business results may be negativelyimpacted. 20Table of ContentsThe channels for the payment of our services and products typically comprise third-party online system, fixed phone line and mobile phonepayment. Although we have been able to control our payment handling fees by encouraging our subscribers to use the third-party online system whichcharges relatively lower levels of handling fees compared with other payment channels, the subscribers may change their habits to make payments throughmobile phones or other channels with higher costs. Approximately 32%, 36%, 18% and 13% of the payments were made by our subscribers via distributionchannels such as mobile service operators in 2011, 2012, 2013 and 2014, respectively. If a majority of subscribers use the mobile phone as their paymentchannels and the cost remains unchanged or even increases in the future, our cost of operations may significant increase. If we fail to minimize the associatedpayment handling fees and further diversify the payment channels, our business, prospects and results of operations may be adversely affected.We also do not have control over the security measures of our third-party payment service providers, and security breaches of the online paymentsystems that we use could expose us to litigation and possible liability for failing to secure confidential customer information and could, among other things,damage our reputation and the perceived security of all of the online payment systems we use. In addition, there may be billing software errors that woulddamage customer confidence in these payment systems. If any of the above were to occur, we may lose paying users and users may be discouraged frompurchasing our products, which may have an adverse effect on our business and results of operations.We have granted, and may continue to grant, share awards under our share incentive plans, which may result in increased share-based compensationexpenses.We have granted share-based compensation awards, including share options and restricted shares, to various employees, key personnel and othernon-employees to incentivize performance and align their interests with ours. We adopted a share incentive plan on December 30, 2010, or the 2010 Plan, asecond share incentive plan on November 18, 2013, as supplemented, or the 2013 Plan, and a third share incentive plan on April 24, 2014, as supplemented,or the 2014 plan. Under the 2010 Plan, we are authorized to issue a maximum number of 26,822,828 common shares of our company upon the exercise of theoptions or other types of awards (excluding an aggregate of 8,410,200 shares already issued to the directors who are our founders upon exercise of founderoptions, which were not granted pursuant to the 2010 Plan). As of March 31, 2015, options to purchase a total of 4,242,220 common shares of our companywere outstanding under the 2010 Plan. Under the 2013 Plan, we are authorized to issue a maximum number of 9,073,732 restricted shares to members of oursenior management, counsel or consultant to our company. Under the 2014 Plan, we are authorized to issue a maximum number of 14,195,412 restrictedshares to our directors, officers, employees and advisors or consultants to our company. As of March 31, 2015, 8,492,350 restricted shares (excluding thoseforfeited) have been granted to certain executive officers and other employees under the 2013 Plan, and 5,665,500 restricted shares have been granted tocertain executive officers and other employees under the 2014 Plan. Our unrecognized share-based compensation expenses relating to the restricted sharesgranted under each of the 2013 Plan and the 2014 Plan amounted to US$18.4 million and US$8.7 million, respectively, as of March 31, 2015. See “Item 6.Directors, Senior Management and Employees—B. Compensation—Share incentive plans” for details.We will issue the equivalent number of common shares upon the vesting and exercise of these options. The amount of these expenses is based onthe fair value of the share-based compensation award we granted. The expenses associated with share-based compensation have affected our net income andmay reduce our net income in the future, and any additional securities issued under share-based compensation schemes will dilute the ownership interests ofour shareholders, including holders of our ADSs. We believe the granting of incentive awards is of significant importance to our ability to attract and retainkey personnel and employees, and we will continue to grant stock options, restricted shares and other share awards to employees in the future. As a result, ourexpenses associated with share-based compensation may increase, which may have an adverse effect on our results of operations. 21Table of ContentsThe continuing and collaborative efforts of our senior management and key employees are crucial to our success, and our business may be harmed if wewere to lose their services.Our success depends on the continual efforts and services of Mr. Sean Shenglong Zou, our co-founder, chairman and chief executive officer, andother members of our senior management team. If however, one or more of our executives or other key personnel are unable or unwilling to continue toprovide services to us, we may not be able to find suitable replacements easily or at all. Competition for management and key personnel in our industry isintense and the pool of qualified candidates is limited. We may not be able to retain the services of our executives or key personnel, or attract and retainexperienced executives or key personnel in the future. If any of our executive officers or key employees joins a competitor or forms a competing company, wemay lose advertisers, know-how and key professionals and staff members. Each of our executive officers has entered into an employment agreement(including a non-compete provision) with us. However, if any dispute arises between us and our executives or key employees, these agreements may not beenforceable in China, where these executives and key employees reside, in light of uncertainties with China’s legal system.In addition, while we often grant additional incentive shares to management personnel and other key employees after their hire dates, the initialgrants are usually much larger than subsequent grants. Employees may be more likely to leave us after their initial incentive share grant fully vests, especiallyif the value of the incentive shares have significantly appreciated in value relative to the exercise price. If any member of our senior management team orother key personnel leaves our company, our ability to successfully operate our business and execute our business strategy could be impaired.We may not be able to effectively identify or pursue targets for acquisitions or investment, and even if we complete such transactions, we may be unable tosuccessfully integrate the acquired businesses into, or realize anticipated benefits to our business, which may adversely affect our growth and results ofoperations.We have in the past and may in the future selectively acquire or invest in businesses that complement our existing business. We may not,however, be able to identify suitable targets for acquisitions or investments in the future. Even if we are able to identify suitable candidates, we may beunable to complete a transaction on terms commercially acceptable to us. If we fail to identify appropriate candidates or complete the desired transactions,our growth may be impeded.Even if we complete the desired acquisitions or investment, such acquisitions and investment may expose us to new operational, regulatory,market and geographic risks and challenges, including: • diversion of our management’s attention and other resources from our existing business; • our inability to maintain the key business relationships and the reputation of the businesses we acquire or invest in; • our inability to retain key personnel of the acquired or invested company; • uncertainty of entry into markets in which we have limited or no prior experience and in which competitors have stronger marketpositions; • failure to comply with laws and regulations as well as industry or technical standards of the markets into which we expand; • our dependence on unfamiliar affiliates and partners of the companies we acquire or invest in; 22Table of Contents • unsatisfactory performance of the businesses we acquire or invest in; • our responsibility for the liabilities associated with the businesses we acquire, including those that we may not anticipate; • goodwill impairment risks associated with the businesses that we acquire; • our inability to integrate acquired technology into our business and operations; • our inability to develop and maintain a successful business model and to monetize and generate revenues from the businesses weacquire; and • our inability to maintain internal standards, controls, procedures and policies.Any of these events could disrupt our ability to manage our business. These risks could also result in our failure to derive the intended benefitsof the acquisitions or investments, and we may be unable to recover our investment in such initiatives or may have to recognize impairment charges as aresult.Furthermore, the financing and payment arrangements we use in any acquisition could have a negative impact on you as an investor, because ifwe issue shares in connection with an acquisition, your holdings could be diluted. Moreover, if we take on significant debt to finance such acquisitions, wewould incur additional interest expenses, which would divert resources from our working capital and potentially have a material adverse impact on ourresults of operations.Our business, financial condition and results of operations, as well as our ability to obtain financing, may be adversely affected by the downturn in theglobal or Chinese economy.The industries in which we operate, including the mobile internet industry, may be affected by economic downturns. For example, a prolongedslowdown in the world economy, including in the Chinese economy, may lead to a reduced amount of mobile internet advertising, which could materiallyand adversely affect our business, financial condition and results of operations. In addition, certain of our products and services may be viewed asdiscretionary by our users, who may choose to discontinue or reduce spending on such products and services during an economic downturn. In such an event,our ability to retain existing users and increase new users will be adversely affected, which would in turn negatively impact our business and results ofoperations.Moreover, a slowdown or disruption in the global or Chinese economy may have a material and adverse impact on financings available to us.The weakness in the economy could erode investor confidence, which constitutes the basis of the credit market. The recent financial turmoil affecting thefinancial markets and banking system may significantly restrict our ability to obtain financing in the capital markets or from financial institutions oncommercially reasonable terms, or at all. Although we are uncertain about the extent to which the global financial and economic fluctuations and slowdownof Chinese economy may impact our business in the short-term and long-term, there is a risk that our business, results of operations and prospects would bematerially and adversely affected by any global economic downturn or disruption or slowdown of Chinese economy. 23Table of ContentsOur operations depend on the performance of the internet infrastructure in China.The successful operation of our business depends on the performance of the internet infrastructure and telecommunications networks in China. InChina, almost all access to the internet is maintained through state-owned telecommunications operators under the administrative control and regulatorysupervision of the MIIT. Moreover, we have entered into contracts with various subsidiaries of a limited number of telecommunications service providers ineach province for network-related services. On the one hand, if the internet industry in China does not grow as quickly as expected, our business andoperations will be negatively affected. We have limited access to alternative networks or services in the event of disruptions, failures or other problems withChina’s internet infrastructure or the telecommunications networks provided by telecommunications service providers. Our network and website regularlyserve a large number of users and advertisers. With the expansion of our business, we may be required to upgrade our technology and infrastructure to keepup with the increasing traffic on our website. However, we have no control over the costs of the services provided by telecommunications service providers. Ifthe prices we pay for telecommunications and internet services rise significantly, our results of operations may be materially and adversely affected. Ifinternet access fees or other charges to internet users increase, our user traffic may decline and our business may be harmed. On the other hand, if the internetindustry grows faster than expected and we cannot react to the market demand in a timely manner in terms of our research and development effort, the userexperience and the attractiveness of our services may be harmed, which will negatively impact our business and results of operations.If we fail to implement and maintain an effective system of internal control over financial reporting, we may be unable to accurately report our financialresults or prevent fraud or fail to meet our reporting obligations, and investor confidence in our company and the market price of our ADSs may beadversely affected.We are subject to reporting obligations under the U.S. securities laws. Our reporting obligations as a public company will place a significantstrain on our management, operational and financial resources and systems for the foreseeable future. Prior to our initial public offering, we were a privatecompany and have had limited accounting personnel and other resources with which to address our internal control over financial reporting. Our independentregistered public accounting firm has not conducted an audit of our internal control over financial reporting. In preparing our consolidated financialstatements in connection with our initial public offering, we and our independent registered public accounting firm identified one material weakness, onesignificant deficiency and other control deficiencies, each as defined in the standards established by U.S. Public Company Accounting Oversight Board, inour internal control over financial reporting as of December 31, 2013. The material weakness identified related to the lack of accounting resources in U.S.GAAP and SEC reporting requirements, and the significant deficiency remaining related to the lack of documented comprehensive U.S. GAAP accountingmanuals and financial reporting procedures and lack of related implementation controls.Neither we nor our independent registered public accounting firm undertook a comprehensive assessment of our internal control under theSarbanes-Oxley Act for purposes of identifying and reporting material weaknesses and other control deficiencies in our internal control over financialreporting. It is possible that, had we performed a formal assessment of our internal control over financial reporting or had our independent registered publicaccounting firm performed an audit of our internal control over financial reporting, additional material weaknesses or significant deficiencies may have beenidentified.Following the identification of the material weakness, significant deficiency and other control deficiencies, we have taken measures and plan tocontinue to take measures to remedy these deficiencies. We are working with an external consulting firm to conduct a comprehensive assessment of ourinternal control processes and procedures. For details of these remedies, see “Item 15. Control and Procedures—Changes in internal control over financialreporting.” However, our management has determined that, as of December 31, 2014, we had the same material weakness in our internal control over financialreporting as we did on December 31, 2013, as we had relatively limited time to remedy the material weakness and we have not finished all the necessarytesting on our internal controls. The implementation of the measures we take to remedy the material weakness, significant deficiency and other deficienciesmay not fully address these deficiencies in our internal control over financial reporting, and we cannot conclude that they have been fully remedied. Ourfailure to correct these control deficiencies or our failure to discover and address any other control deficiencies could result in inaccuracies in our financialstatements and could also impair our ability to comply with applicable financial reporting requirements and related regulatory filings on a timely basis. As aresult, our business, financial condition, results of operations and prospects, as well as the trading price of our ADSs, may be materially and adverselyaffected. 24Table of ContentsAs a U.S. public company, we are subject to the Sarbanes-Oxley Act of 2002. Section 404 of the Sarbanes-Oxley Act, or Section 404, will requirethat we include a report from management on the effectiveness of our internal control over financial reporting in our annual report on Form 20-F beginningwith our annual report for the fiscal year ending December 31, 2015. In addition, once we cease to be an “emerging growth company” as such term is definedin the JOBS Act, our independent registered public accounting firm must attest to and report on the effectiveness of our internal control over financialreporting. If we fail to timely achieve and maintain the adequacy of our internal controls, our management and our independent registered public accountingfirm may conclude that our internal control over financial reporting is not effective. This could adversely impact the market price of our ADSs due to a loss ofinvestor confidence in the reliability of our reporting processes. We will need to incur costs and use management and other resources in order to comply withSection 404.During the course of documenting and testing our internal control procedures, in order to satisfy the requirements of Section 404, we mayidentify other weaknesses and deficiencies in our internal control over financial reporting. In addition, if we fail to maintain the adequacy of our internalcontrol over financial reporting, as these standards are modified, supplemented or amended from time to time, we may not be able to conclude on an ongoingbasis that we have effective internal control over financial reporting in accordance with Section 404. If we fail to achieve and maintain an effective internalcontrol environment, we could suffer material misstatements in our financial statements and fail to meet our reporting obligations, which would likely causeinvestors to lose confidence in our reported financial information. This could in turn limit our access to capital markets, harm our results of operations, andlead to a decline in the trading price of our ADSs. Additionally, ineffective internal control over financial reporting could expose us to increased risk of fraudor misuse of corporate assets and subject us to potential delisting from the stock exchange on which we list, regulatory investigations and civil or criminalsanctions. We may also be required to restate our financial statements from prior periods.We have limited business insurance coverage and any uninsured business disruption may have an adverse effect on our results of operations and financialcondition.Insurance companies in China currently do not offer as extensive an array of insurance products as insurance companies do in more developedeconomies. We have limited business liability or disruption insurance to cover our operations. Any uninsured occurrence of business disruption may result inour incurring substantial costs and the diversion of resources, which could have an adverse effect on our results of operations and financial condition.We face risks related to natural disasters such as earthquakes and health epidemics and other outbreaks, which could significantly disrupt our operations.Our operations may be vulnerable to interruption and damage from natural and other types of catastrophes, including earthquakes, fire, floods,hail, windstorms, severe winter weather (including snow, freezing water, ice storms and blizzards), environmental accidents, power loss, communicationsfailures, explosions, man-made events such as terrorist attacks and similar events. Due to their nature, we cannot predict the incidence, timing and severity ofcatastrophes. If any such catastrophe or extraordinary event occurs in the future, our ability to operate our business could be seriously impaired. Such eventscould make it difficult or impossible for us to deliver our services and products to our users and could decrease demand for our products. As we do not carryproperty insurance and significant time could be required to resume our operations, our financial position and results of operations could be materially andadversely affected in the event of any major catastrophic event. 25Table of ContentsIn addition, our business could be adversely affected by the outbreak of pandemics such as influenza A (H1N1), avian influenza, H7N9 or severeacute respiratory syndrome (SARS). Any occurrence of these pandemic diseases or other adverse public health developments in China or elsewhere couldseverely disrupt our staffing or the staffing of our business partners, including our advertisers, and otherwise reduce the activity levels of our work force andthe work force of our business partners, causing a material and adverse effect on our business operations.Risks related to our corporate structureIf the PRC government finds that the agreements that establish the structure for operating our businesses in China do not comply with PRC governmentalrestrictions on foreign investment in internet-related business and foreign investors’ mergers and acquisition activities in China, or if these regulations orthe interpretation of existing regulations change in the future, we could be subject to severe penalties or be forced to relinquish our interests in thoseoperations.Current PRC laws and regulations place certain restrictions on foreign ownership of companies that engage in internet businesses, including theprovision of online video and online advertising services. For example, foreign investors’ equity interests in value-added telecommunication serviceproviders may not exceed 50%. In addition, foreign investors are prohibited from investing in or operating entities engaged in, among others, internetcultural operating service (including online game operation services), internet news service, and production and online transmission of audio-visualprograms service. We are a Cayman Islands company and Giganology Shenzhen and Xunlei Computer, our PRC subsidiaries, are considered foreign-investedenterprises. Accordingly, neither of these two PRC subsidiaries is eligible to provide value-added telecommunication services and the aforementionedinternet related services in China. As a result, we conduct our operations in China principally through contractual arrangements among GiganologyShenzhen and Shenzhen Xunlei and its shareholders. Shenzhen Xunlei holds the licenses and permits necessary to conduct our resource discovery network,online video, online advertising, online games and related businesses in China and hold various operating subsidiaries that conduct a majority of ouroperations in China. Our contractual arrangements with Shenzhen Xunlei and its shareholders enable us to exercise effective control over Shenzhen Xunleiand Shenzhen Xunlei’s operating subsidiaries and hence treat them as our consolidated entities and consolidate their results. For a detailed discussion ofthese contractual arrangements, see “Item 4. Information on the Company—C. Organizational Structure.”We cannot assure you, however, that we will be able to enforce these contracts. Although we have been advised by Zhong Lun Law Firm, ourPRC legal counsel, that each contract under these contractual arrangements with Shenzhen Xunlei and its shareholders is valid, binding and enforceableunder current PRC laws and regulations, we cannot assure you that the PRC government would agree that these contractual arrangements comply with PRClicensing, registration or other regulatory requirements, with existing policies or with requirements or policies that may be adopted in the future. PRC lawsand regulations governing the validity of these contractual arrangements are uncertain and the relevant government authorities have broad discretion ininterpreting these laws and regulations. If the PRC government determines that we do not comply with applicable laws and regulations, it could revoke ourbusiness and operating licenses, require us to discontinue or restrict our operations, restrict our right to collect revenues, block our website, require us torestructure our operations, impose additional conditions or requirements with which we may not be able to comply, or take other regulatory or enforcementactions against us that could be harmful to our business. The imposition of any of these penalties would result in a material and adverse effect on our abilityto conduct our business. 26Table of ContentsWe rely on contractual arrangements with our variable interest entity in China and its shareholders for our operations, which may not be as effective asdirect ownership in providing operational control the variable interest entity and its subsidiaries.Since PRC laws restrict foreign equity ownership in companies engaged in internet business in China, we rely on contractual arrangements withShenzhen Xunlei, our VIE, and the shareholders of Shenzhen Xunlei to operate our business in China. If we had direct ownership of Shenzhen Xunlei, wewould be able to exercise our rights as a shareholder to effect changes in the board of directors of Shenzhen Xunlei, which in turn could effect changes at themanagement level, subject to any applicable fiduciary obligations. However, under the current contractual arrangements, we rely on Shenzhen Xunlei and itsshareholders’ performance of their contractual obligations to exercise effective control. In addition, our operating contract with Shenzhen Xunlei has a termof ten years, which is subject to Giganology Shenzhen’s unilateral termination right and may be extended as requested by Giganology Shenzhen. In general,none of Shenzhen Xunlei or its shareholders may terminate the contracts prior to the expiration date. However, the shareholders of Shenzhen Xunlei may notact in the best interests of our company or may not perform their obligations under these contracts, including the obligation to renew these contracts whentheir initial contract term expires. Such risks exist throughout the period in which we intend to operate our business through the contractual arrangementswith Shenzhen Xunlei. We may replace the shareholders of Shenzhen Xunlei at any time pursuant to our contractual arrangements with Shenzhen Xunlei andits shareholders. However, if any dispute relating to these contracts remains unresolved, we will have to enforce our rights under these contracts through theoperations of PRC law and courts and therefore will be subject to uncertainties in the PRC legal system. See “—Any failure by Shenzhen Xunlei or itsshareholders to perform their obligations under our contractual arrangements with them may have a material adverse effect on our business” and “Item 4.Information on the Company—C. Organizational Structure.” Therefore, these contractual arrangements may not be as effective as direct ownership inproviding us with control over Shenzhen Xunlei.Any failure by Shenzhen Xunlei or its shareholders to perform their obligations under our contractual arrangements with them may have a materialadverse effect on our business.Shenzhen Xunlei or its shareholders may fail to take certain actions required for our business or follow our instructions despite their contractualobligations to do so. If they fail to perform their obligations under their respective agreements with us, we may have to rely on legal remedies under PRC law,including seeking specific performance or injunctive relief, which may not be effective. As of the date of this annual report, Mr. Sean Shenglong Zou, our co-founder, chairman and chief executive officer, owned 76% of the equity interest in Shenzhen Xunlei, our variable interest entity. Under the equity pledgeagreement among Giganology Shenzhen and the shareholders of Shenzhen Xunlei, as amended, the shareholders of Shenzhen Xunlei have pledged all oftheir equity interests in Shenzhen Xunlei to Giganology Shenzhen to guarantee Shenzhen Xunlei and its shareholders’ performance of their respectiveobligations under the related contractual arrangements. In addition, the shareholders of Shenzhen Xunlei have completed the registration of equity pledgeunder the equity pledge agreement with the competent governmental authority. If any of the shareholders of Shenzhen Xunlei, especially Mr. SeanShenglong Zou due to his significant equity interest in Shenzhen Xunlei, fails to perform his or her obligations under the contractual arrangements, we mayhave to enforce these agreements to transfer his or her equity interests to another appointee of Giganology Shenzhen. 27Table of ContentsMoreover, the exercise of call options under the equity interests disposal agreement, the intellectual properties purchase option agreement andcertain other contractual arrangements will be subject to the review and approval of competent governmental authorities and incur additional expenses.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 certain other jurisdictions, such as the United States. As a result, uncertainties in the PRC legalsystem could limit our ability to enforce these contractual arrangements, which may make it difficult to exert effective control over our variable interestentity and its subsidiaries, and our ability to conduct our business may be adversely affected.Contractual arrangements with our variable interest entity may result in adverse tax consequences to us.Under applicable PRC tax laws and regulations, arrangements and transactions among related parties may be subject to audit or scrutiny by thePRC tax authorities within ten years after the taxable year when the arrangements or transactions are conducted. See “Item 4. Information on the Company—B. Business Overview—Regulations—Regulation on tax—PRC enterprise income tax.” We could face material and adverse tax consequences if the PRC taxauthorities were to determine that the contractual arrangements among Giganology Shenzhen, our wholly-owned subsidiary in China, and Shenzhen Xunlei,our variable interest entity in China and its shareholders, as well as the intellectual property framework agreement between Xunlei Computer and ShenzhenXunlei were not entered into on an arm’s-length basis and therefore constituted unfavorable transfer pricing arrangements. Unfavorable transfer pricingarrangements could, among other things, result in an upward adjustment on taxation, and the PRC tax authorities may impose interest on late payments onShenzhen Xunlei, for the adjusted but unpaid taxes. Our results of operations may be materially and adversely affected if Shenzhen Xunlei’s tax liabilitiesincrease significantly or if it is required to pay interest on late payments.The shareholders of Shenzhen Xunlei may have potential conflicts of interest with us, which may materially and adversely affect our business.Sean Shenglong Zou, Hao Cheng, Fang Wang, Jianming Shi and Guangzhou Shulian Information Investment Co., Ltd. are shareholders ofShenzhen Xunlei. We provide no incentives to the shareholders of Shenzhen Xunlei for the purpose of encouraging them to act in our best interests in theircapacity as the shareholders of Shenzhen Xunlei. We may replace the shareholders of Shenzhen Xunlei at any time pursuant to the currently effective equityoption agreements between us and these shareholders.As a director and executive officer of our company, Mr. Zou and Mr. Cheng each has a duty of loyalty and care to us under Cayman Islands law.We are not aware that other publicly listed companies in China with a similar corporate and ownership structure as ours have brought conflicts of interestclaims against the shareholders of their respective variable interest entities. However, we cannot assure you that when conflicts arise, the shareholders ofShenzhen Xunlei will act in the best interests of our company or that conflicts will be resolved in our favor. If we cannot resolve any conflicts of interest ordisputes between us and the shareholders of Shenzhen Xunlei, we would have to rely on legal proceedings, which may be expensive, time-consuming anddisruptive to our operations. There is also substantial uncertainty as to the outcome of any such legal proceedings. 28Table of ContentsWe may rely principally on dividends and other distributions on equity paid by our PRC subsidiaries to fund any cash and financing requirements we mayhave. Any limitation on the ability of Giganology Shenzhen and Xunlei Computer to pay dividends to us could have a material adverse effect on our abilityto conduct our business.We are a holding company and we may rely principally on dividends and other distributions on equity paid by our wholly-owned PRCsubsidiaries including Giganology Shenzhen and Xunlei Computer, for our cash and financing requirements, including the funds necessary to pay dividendsand other cash distributions to our shareholders and service any debt we may incur. If Giganology Shenzhen incurs debt on its own behalf in the future, theinstruments governing the debt may restrict its ability to pay dividends or make other distributions to us. In addition, the PRC tax authorities may require usto adjust our taxable income under the contractual arrangements Giganology Shenzhen currently has in place with Shenzhen Xunlei, our variable interestentity, as well as the intellectual property framework agreement between Xunlei Computer and Shenzhen Xunlei, in a manner that would materially andadversely affect its ability to pay dividends and other distributions to us. As of December 31, 2014, we had cash or cash equivalents of approximatelyRMB516.4 million (US$83.2 million) and US$8.8 million located within the PRC, of which RMB268.3 million (US$43.2 million) is held by ShenzhenXunlei and its subsidiaries. The transfer of all the cash or cash equivalents is subject to PRC government’s restrictions on currency conversion.Under PRC laws and regulations, Giganology Shenzhen and Xunlei Computer, as wholly foreign-owned enterprises in the PRC, may paydividends only out of its accumulated after-tax profits as determined in accordance with PRC accounting standards and regulations. In addition, whollyforeign-owned enterprises such as Giganology Shenzhen and Xunlei Computer are required to set aside at least 10% of their accumulated after-tax profitseach year, if any, to fund certain statutory reserve funds, until the aggregate amount of such a fund reaches 50% of their respective registered capital. At theirdiscretion, wholly foreign-owned enterprises may allocate a portion of their after-tax profits based on PRC accounting standards to staff welfare and bonusfunds. These reserve funds and staff welfare and bonus funds are not distributable as cash dividends. Any limitation on the ability of Giganology Shenzhenand Xunlei Computer to pay dividends or make other distributions to us could materially and adversely limit our ability to grow, make investments oracquisitions that could be beneficial to our business, pay dividends, or otherwise fund and conduct our business. See also “—Risks related to doing businessin China—Our global income may be subject to PRC taxes under the PRC EIT Law, which may have a material adverse effect on our results of operations.”PRC regulation of loans to, and direct investment in, PRC entities by offshore holding companies and governmental control of currency conversion mayrestrict or prevent us from making loans to our PRC subsidiaries and variable interest entity and its subsidiaries or making additional capitalcontributions to our PRC subsidiaries, which may materially and adversely affect our liquidity and our ability to fund and expand our business.We may (i) make additional capital contributions to our PRC subsidiaries, (ii) establish new PRC subsidiaries and make capital contributions tothese new PRC subsidiaries, (iii) make loans to our PRC subsidiaries or variable interest entity and its subsidiaries, or (iv) acquire offshore entities withbusiness operations in China in an offshore transaction. However, most of these uses are subject to PRC regulations and approvals. For example: • capital contributions to our PRC subsidiaries, whether existing ones or newly established ones, must be approved by the PRC Ministry ofCommerce or its local counterparts; 29Table of Contents • loans by us to our PRC subsidiaries, which are foreign-invested enterprises, to finance their respective activities cannot exceed statutorylimits and must be registered with the PRC State Administration of Foreign Exchange, or SAFE, or its local branches; and • loans by us to our variable interest entity, which is a domestic PRC entity, must be approved by the National Development and ReformCommission and must also be registered with SAFE or its local branches.On August 29, 2008, SAFE promulgated the Circular on the Relevant Operating Issues Concerning the Improvement of the Administration of thePayment and Settlement of Foreign Currency Capital of Foreign Invested Enterprises, or SAFE Circular No. 142, regulating the conversion by a foreign-invested enterprise of foreign currency registered capital into Renminbi by restricting how the converted Renminbi may be used. SAFE Circular No. 142provides that the Renminbi capital converted from foreign currency registered capital of a foreign-invested enterprise may only be used for purposes withinthe business scope approved by the applicable governmental authority and unless otherwise provided by law, such Renminbi capital may not be used forequity investments within the PRC. SAFE also strengthened its oversight of the flow and use of the Renminbi capital converted from foreign currencyregistered capital of a foreign-invested company. The use of such Renminbi capital may not be altered without SAFE approval, and such Renminbi capitalmay not in any case be used to repay Renminbi loans if the proceeds of such loans have not been used. Violations of SAFE Circular No. 142 could result insevere monetary or other penalties. On March 30, 2015, SAFE issued SAFE Circular No. 19, which will take effective and replace SAFE Circular No. 142 fromJune 1, 2015. Although SAFE Circular No. 19 allows for the use of RMB converted from the foreign currencydenominated capital for equity investments inthe PRC, the restrictions will continue to apply as to foreign-invested enterprises’ use of the converted RMB for purposes beyond the business scope, for theentrusted loans or for the inter-company RMB loans. We expect that if we convert the net proceeds we received from our initial public offering into Renminbipursuant to SAFE Circular No. 142 and SAFE Circular No. 19, our use of Renminbi funds will be for purposes within the approved business scope of our PRCsubsidiaries. The business scopes of Giganology Shenzhen and Xunlei Computer include “technical services,” which we believe permits GiganologyShenzhen to purchase or lease servers and other equipment for its own technical data and research and to provide operational support to our variable interestentity and its subsidiaries.However, we may not be able to use such Renminbi funds to make equity investments in certain entities in the PRC through our PRCsubsidiaries.We may lose the ability to use and enjoy assets held by our variable interest entity and its subsidiaries that are important to the operation of our business ifany of such entities goes bankrupt or becomes subject to a dissolution or liquidation proceeding.As part of our contractual arrangements with our variable interest entity, our variable interest entity and its subsidiaries hold certain assets thatare important to the operation of our business, including patents for the proprietary technology and related domain names and trademarks. If any of ourvariable interest entity or its subsidiaries goes bankrupt and all or part of its assets become subject to liens or rights of third-party creditors, we may be unableto continue some or all of our business activities, which could materially and adversely affect our business, financial condition and results of operations.Under the contractual arrangements, our variable interest entity and its subsidiaries may not, in any manner, sell, transfer, mortgage or dispose of their assetsor legal or beneficial interests in the business without our prior consent. If our variable interest entity undergoes a voluntary or involuntary liquidationproceeding, the unrelated third-party creditors may claim rights to some or all of these assets, thereby hindering our ability to operate our business, whichcould materially and adversely affect our business, financial condition and results of operations. 30Table of ContentsSubstantial uncertainties exist with respect to the enactment timetable, interpretation and implementation of draft PRC Foreign Investment Law and howit may impact the viability of our current corporate structure, corporate governance and business operations.The MOFCOM published a discussion draft of the proposed Foreign Investment Law in January 2015 aiming to, upon its enactment, replace thetrio of existing laws regulating foreign investment in China, namely, the Sino-foreign Equity Joint Venture Enterprise Law, the Sino-foreign CooperativeJoint Venture Enterprise Law and the Wholly Foreign-invested Enterprise Law, together with their implementation rules and ancillary regulations. The draftForeign Investment Law embodies an expected PRC regulatory trend to rationalize its foreign investment regulatory regime in line with prevailinginternational practice and the legislative efforts to unify the corporate legal requirements for both foreign and domestic investments. The MOFCOM iscurrently soliciting comments on this draft and substantial uncertainties exist with respect to its enactment timetable, interpretation and implementation. Thedraft Foreign Investment Law, if enacted as proposed, may materially impact the viability of our current corporate structure, corporate governance andbusiness operations in many aspects.Among other things, the draft Foreign Investment Law expands the definition of foreign investment and introduces the principle of “actualcontrol” in determining whether the investment in China is made by a foreign investor or a PRC domestic investor. The draft Foreign Investment Lawspecifically provides that an entity established in China but “controlled” by foreign investors will be treated as a foreign investor, whereas an entity set up ina foreign jurisdiction would nonetheless be, upon market entry clearance by the MOFCOM or its local branches, treated as a PRC domestic investor providedthat the entity is “controlled” by PRC entities and/or citizens. In this connection, “control” is broadly defined in the draft law to cover, among others, havingthe power to exert decisive influence, via contractual or trust arrangements, over the subject entity’s operations, financial matters or other key aspects ofbusiness operations. If the foreign investment falls within a “negative list”, to be separately issued by the State Council in the future, market entry clearanceby the MOFCOM or its local branches would be required. Otherwise, all foreign investors may make investments on the same terms as Chinese investorswithout being subject to additional approval from the government authorities as mandated by the existing foreign investment legal regime.The “variable interest entity” structure, or VIE structure, has been adopted by many PRC-based companies, including us, to obtain necessarylicenses and permits in the industries that are currently subject to foreign investment restrictions in China. See “—Risks Related to Our Corporate Structure—If the PRC government finds that the structure we have adopted for our business operations does not comply with PRC governmental restrictions on foreigninvestment in internet businesses, or if these laws or regulations or interpretations of existing laws or regulations change in the future, we could be subject tosevere penalties, including the shutting down of our platform and our business operations.” and “Item 4. Information on the Company—C. OrganizationalStructure.” Under the draft Foreign Investment Law, if a variable interest entity is ultimate controlled by a foreign investor via contractual arrangement, itwould be deemed as a foreign investment. Accordingly, for the companies with a VIE structure in an industry category that is on the “negative list”, the VIEstructure may be deemed legitimate only if the ultimate controlling person(s) is/ are of PRC nationality (either PRC individual, or PRC government and itsbranches or agencies) Conversely, if the actual controlling person(s) is/are of foreign nationalities, then the variable interest entities will be treated as foreigninvested enterprises and any operation in the industry category on the “negative list” without market entry clearance may be considered as illegal. 31Table of ContentsAs of the date of this annual report, over 50% of the voting power of our issued and outstanding share capital is controlled by PRC nationals.However, the draft Foreign Investment Law has not taken a position on what actions will be taken with respect to the existing companies with a VIE structure,whether or not these companies are controlled by Chinese parties, although a few possible options were proffered to solicit comments from the public on thispoint. Under these options, a company with VIE structure that is engaged in a business set forth in a “negative list” to be published at the time of theenactment of the new Foreign Investment Law has either the option or obligation to disclose its corporate structure to the authorities, while the authorities,after reviewing the ultimate control structure of the company, may either permit the company to continue its business by maintaining the VIE structure (whenthe company is deemed ultimately controlled by PRC citizens), or require the company to dispose of its businesses and/or VIE structure based onconsideration of the particular circumstances involved. Moreover, it is uncertain whether the value-added telecommunication services and other internetrelated services, which our VIE provides, will be subject to the foreign investment restrictions or prohibitions set forth in the “negative list” to be issued. Ifthe enacted version of the Foreign Investment Law and the final “negative list” mandate further actions, such as MOFCOM market entry clearance or certainrestructuring of our corporate structure and operations, to be completed by companies with existing VIE structure like us, we will face substantialuncertainties as to whether these actions can be timely completed, or at all, and our business and financial condition may be materially and adverselyaffected.The draft Foreign Investment Law, if enacted as proposed, may also materially impact our corporate governance practice and increase ourcompliance costs. For instance, the draft Foreign Investment Law imposes stringent ad hoc and periodic information reporting requirements on foreigninvestors and the applicable foreign invested entities. Aside from investment implementation report and investment amendment report that are required ateach investment and alteration of investment specifics, an annual report is mandatory, and large foreign investors meeting certain criteria are required toreport on a quarterly basis. Any company found to be non-compliant with the information reporting obligations may potentially be subject to fines and/oradministrative or criminal liabilities, and the persons directly responsible may be subject to criminal liabilities.Risks related to doing business in ChinaChanges in China’s economic, political or social conditions or government policies could have a material adverse effect on our business and operations.Substantially all of our assets and operations are located in China. Accordingly, our business, financial condition, results of operations andprospects may be influenced to a significant degree by political, economic and social conditions in China generally and by continued economic growth inChina as a whole.The Chinese economy differs from the economies of most developed countries in many respects, including the level of government involvement,level of development, growth rate, control of foreign exchange and allocation of resources. Although the Chinese government has implemented measuresemphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets, and the establishment of improvedcorporate governance in business enterprises, a substantial portion of productive assets in China is still owned by the government. In addition, the Chinesegovernment continues to play a significant role in regulating industry development by imposing industrial policies. The Chinese government also exercisessignificant control over China’s economic growth through allocating resources, controlling payment of foreign currency-denominated obligations, settingmonetary policy, and providing preferential treatment to particular industries or companies, such as those qualified to operate in free trade zones designatedin certain major cities in China.While the Chinese economy has experienced significant growth over the past decades, growth has been uneven, both geographically and amongvarious sectors of the economy. The Chinese government has implemented various measures to encourage economic growth and guide the allocation ofresources. Some of these measures may benefit the overall Chinese economy, but may have a negative effect on us. For example, our financial condition andresults of operations may be adversely affected by government control over capital investments or changes in tax regulations. In addition, in the past theChinese government has implemented certain measures, including interest rate increases, to control the pace of economic growth. 32Table of ContentsThese measures may cause decreased economic activity in China, which may adversely affect our business and operating results.Regulation and censorship of information disseminated over the internet in China, recently strengthened, have adversely affected our business and maycontinue to adversely affect our business, and we may be liable for the digital media content on our platform.China has strict regulations governing telecommunication service providers, internet and wireless access and the distribution of news and otherinformation. Under these regulations, ICPs like us are prohibited from posting or displaying over the internet or wireless networks content that, among otherthings, violates PRC laws and regulations. If an ICP finds that prohibited content is transmitted on its website or stored in its system, it must terminate thetransmission of such information or delete such information immediately and keep records and report to relevant authorities. Failure to comply with theserequirements could lead to the revocation of the ICP License and other required licenses and the closure of the offending websites, and cloud networkoperators or website operators may also be held liable for prohibited content displayed on, retrieved from or linked to such network or website. However,efforts to constantly self-monitor in order to comply with these requirements could negatively impact user experience and lead to a decline in user numbers.The Chinese government has recently intensified its efforts to remove inappropriate content disseminated over the internet and wirelessnetworks, and our efforts to monitor content on our platform and website led to a decline in subscriber numbers. In April 2014, the Chinese governmentinitiated a campaign to enhance and enforce its scrutiny on internet content in China, particularly for pornographic content, and various websites weresubject to penalties and in some cases outright suspension of website operations. We conducted an internal compliance investigation to ensure that thecontent transmitted by our products is in compliance with the standards set out by the authorities. As a result, to date, we have deleted millions of cachedfiles, blocked over one million digital files and added thousands of key words to our automatic keyword filtration system. As we continued our complianceefforts in response to the government’s internet content campaign, we saw a reduction in the number of total subscribers in the second, third and fourthquarters of 2014 and the first quarter of 2015. In addition, we permitted temporary suspension of services by about 350,000 existing subscribers as of the endof 2014. We may experience still further decline in user and subscriber numbers as we continue in our efforts to comply with the rules and regulations of theChinese government.Uncertainties with respect to the PRC legal system could adversely affect us.We conduct our business primarily through our PRC subsidiaries and variable interest entity and its subsidiaries in China. Our operations inChina are governed by PRC laws and regulations. Giganology Shenzhen is a foreign-invested enterprise and is subject to laws and regulations applicable toforeign investment in China and, in particular, laws applicable to foreign-invested enterprises. The PRC legal system is a civil law system based on writtenstatutes. Unlike the common law system, prior court decisions under the civil law system may be cited for reference but have limited precedential value.In 1979, the PRC government began to promulgate a comprehensive system of laws and regulations governing economic matters in general. Theoverall effect of legislation over the past three 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 ofeconomic activities in China. In particular, the interpretation and enforcement of these laws and regulations involve uncertainties. Since PRC administrativeand court authorities have significant discretion in interpreting and implementing statutory and contractual terms, it may be difficult to evaluate the outcomeof administrative and court proceedings and the level of legal protection we enjoy. These uncertainties may affect our judgment on the relevance of legalrequirements and our ability to enforce our contractual or tort rights. In addition, the regulatory uncertainties may be exploited through unmerited orfrivolous legal actions or threats in attempts to extract payments or benefits from us.Furthermore, the PRC legal system is based in part on government policies and internal rules, some of which are not published on a timely basisor at all and may have retroactive effect. As a result, we may not be aware of our violation of any of these policies and rules until sometime after the violation.In addition, any administrative and court proceedings in China may be protracted, resulting in substantial costs and diversion of resources and managementattention.We believe that our patents, trademarks, trade secrets, copyrights, and other intellectual property are important to our business. We rely on acombination of patent, trademark, copyright and trade secret protection laws in China and other jurisdictions, as well as confidentiality procedures andcontractual provisions to protect our intellectual property and our brand. Protection of intellectual property rights in China may not be as effective as in theUnited States or other jurisdictions, and as a result, we may not be able to adequately protect our intellectual property rights, which could adversely affect ourrevenues and competitive position. 33Table of ContentsWe may be adversely affected by the complexity, uncertainties and changes in PRC regulations of internet-related business and companies.The PRC government extensively regulates the internet industry, including foreign ownership of, and the licensing and permit requirementspertaining to, companies in the internet industry. These internet-related laws and regulations are relatively new and evolving, and their interpretation andenforcement involve significant uncertainty. As a result, in certain circumstances it may be difficult to determine what actions or omissions may be deemed tobe in violations of applicable laws and regulations. Issues, risks and uncertainties relating to PRC regulation of the internet business include, but are notlimited to, the following: • We only have contractual control over our resource discovery network and Xunlei Kankan. We do not own the resource discoverynetwork or the Xunlei Kankan website due to the restriction of foreign investment in businesses providing value-addedtelecommunication services in China, including internet content provision services. This may significantly disrupt our business, subjectus to sanctions, compromise enforceability of related contractual arrangements, or have other harmful effects on us. • There are uncertainties relating to the regulation of the internet business in China, including evolving licensing practices and therequirement for real-name registrations. This means that permits, licenses or operations at some of our companies may be subject tochallenge, or we may fail to obtain permits or licenses that may be deemed necessary for our operations or we may not be able to obtainor renew certain permits or licenses. If we fail to maintain any of these required licenses or approvals, we may be subject to variouspenalties, including fines and discontinuation of or restriction on our operations. Any such disruption in our business operations mayhave a material and adverse effect on our results of operations. For example, we are providing mobile applications to mobile device usersfree of charge and we do not believe we, as an internet content provider, or ICP, need to obtain a separate operating license in addition tothe operating licenses for the value added telecommunications service, or the ICP Licenses, which we have already obtained. Althoughwe believe this is in line with the current market practice, there can be no assurance that we will not be required to apply for an operatinglicense for our mobile applications in the future and if so, we may not qualify or succeed in obtaining such license. • New laws and regulations may be promulgated that will regulate internet activities, including online video, online games and onlineadvertising businesses. If these new laws and regulations are promulgated, additional licenses may be required for our operations. If ouroperations do not comply with these new regulations after they become effective, or if we fail to obtain any licenses required under thesenew laws and regulations, we could be subject to penalties. • In June 2010, MOC promulgated the Provisional Measures on the Administration of Online Games, or the Online Game Measures, whichbecame effective on August 1, 2010. The Online Game Measures provide that any entity engaging in online game operation activitiesshould obtain an Online Culture Operating Permit and must meet certain requirements such as a minimum amount of the registeredcapital. Online game developers are generally involved in the purchase of servers and bandwidth, the control and management of gamedata, the maintenance of game systems and certain other maintenance tasks in our operation of online games. There exist uncertainties onMOC’s interpretation and implementation of these measures. If MOC determines in the future that such Online Culture Operating Permitor relevant requirement apply to the online game developers for their involvement in the online game operations, we may have toterminate our revenue sharing arrangements with certain unqualified online game developers and may even be subject to variouspenalties, which may negatively impact our results of operations and financial condition. 34Table of ContentsThe interpretation and application of existing PRC laws, regulations and policies and possible new laws, regulations or policies relating to theinternet industry have created substantial uncertainties regarding the legality of existing and future foreign investments in, and the businesses and activitiesof, internet businesses in China, including our business. For example, in September 2009, GAPPRFT and the National Office of Combating Pornography andIllegal Publications jointly published a notice, or Circular 13, which expressly prohibits foreign investors from participating in online game operatingbusiness via wholly owned, equity joint venture or cooperative joint venture investments in China, and from controlling and participating in such businessesdirectly or indirectly through contractual or technical support arrangements. Other government agencies with substantial regulatory authority over onlinegame operations and foreign investment entities in China, such as MIIT and MOC, did not join GAPPRFT in issuing Circular 13. While Circular 13 isapplicable to us and our online game business on an overall basis, to date, GAPPRFT has not issued any interpretation of Circular 13 and, to our knowledge,has not taken any enforcement action under Circular 13 against any company that relies on contractual arrangements with affiliated entities to operate onlinegames in China. We cannot assure you that we have obtained all the permits or licenses required for conducting our business in China or will be able tomaintain our existing licenses or obtain any new licenses required under any new laws or regulations. There are also risks that we may be found to violate theexisting or future laws and regulations given the uncertainty and complexity of China’s regulation of internet business. 35Table of ContentsSubject to interpretation by the relevant authorities, it may not be possible for us to determine in all cases the type of content that could result inliability for us, especially if the Chinese government continues to maintain or strengthen its heightened scrutiny on internet content in China. We may not beable to control or restrict all of the digital media content generated or placed on our network by our users, despite our attempt to monitor and filter suchcontent. To the extent that regulatory authorities find any portion of our content on our network or website objectionable or requiring any license or permitthat we have not obtained, they may require us to limit or eliminate the dissemination of such information or otherwise curtail the nature of such content, andkeep records and report to relevant authorities, which may reduce our user traffic. In addition, we may be subject to significant penalties for violations ofthose regulations arising from prohibited content displayed on, retrieved from or uploaded to our network or website, including a suspension or shutdown ofour operations. The enforcement activities may be intensified in connection with any ongoing government campaigns. In addition, while we maintain aregular internal monitoring and compliance protocol, we cannot ascertain that we would not fall foul of any changing or new government regulations orstandards in the future. If we receive a public warning from the relevant government authorities or our licenses for acceleration or online video streamingservices are revoked, our reputation would be harmed and if the operation of our acceleration or online video streaming services or other products issuspended or shut down entirely or in part, our revenues and results of operation may be materially and adversely affected. Furthermore, the internalcompliance investigation and the removal of content may have a material impact on our cloud acceleration services, which in turn may lead to a decrease inusers and have an adverse effect on our revenues and results of operations. Currently, we are unable to quantify the magnitude and extent of such impact.We may be sued by our game players and held liable for losses of virtual assets by such players, which may negatively affect our reputation and business,financial condition and results of operations.While playing online games or participating in other online activities, players acquire and accumulate some virtual assets, such as specialequipment and other accessories. Such virtual assets may be important to online game players and have monetary value and, in some cases, are sold for actualmoney. In practice, virtual assets can be lost for various reasons, often through unauthorized use of the game account of one user by other users andoccasionally through data loss caused by a delay of network service, a network crash or hacking activities.Currently, there is no PRC law or regulation specifically governing virtual asset property rights. As a result, there is uncertainty as to who thelegal owner of virtual assets is, whether and how the ownership of virtual assets is protected by law, and whether an operator of online games such as us wouldhave any liability to game players or other interested parties (whether in contract, tort or otherwise) for loss of such virtual assets. Based on recent PRC courtjudgments, the courts have typically held online game operators liable for losses of virtual assets by game players, and ordered online game operators toreturn the lost virtual items to game players or pay damages and losses. In case of a loss of virtual assets, we may be sued by our game players or users andheld liable for damages, which may negatively affect our reputation and business, financial condition and results of operations.Non-compliance with the laws or regulations governing virtual currency may result in penalties that could have a material adverse effect on our onlinegames business and results of operations.The issuance and use of “virtual currency” in the PRC has been regulated since 2007 in response to the growth of the online games industry inChina. In January 2007, the Ministry of Public Security, MOC, MIIT and GAPPRFT jointly issued a circular regarding online gambling which hasimplications for the use of virtual currency. To curtail online games that involve online gambling, as well as address concerns that virtual currency could beused for money laundering or illicit trade, the circular (a) prohibits online game operators from charging commissions in the form of virtual currency inrelation to winning or losing of games; (b) requires online game operators to impose limits on use of virtual currency in guessing and betting games; (c) bansthe conversion of virtual currency into real currency or property; and (d) prohibits services that enable game players to transfer virtual currency to otherplayers. On June 4, 2009, MOC and the Ministry of Commerce jointly issued a notice regarding strengthening the administration of online game virtualcurrency, or the Virtual Currency Notice. Furthermore, MOC issued the Online Game Measures in June 2010, which provides, among other things, that virtualcurrency issued by online game operators may only be used to exchange its own online game products and services and may not be used to pay for theproducts and services of other entities. 36Table of ContentsWe issue virtual currency to our clients for them to purchase various items to be used in online games and premium services. Although webelieve we do not offer online game virtual currency transaction services, we cannot assure you that the PRC regulatory authorities will not take a viewcontrary to ours. For example, certain virtual items we issue to users based on in-game milestones they achieve or time spent playing games are transferableand exchangeable for our virtual currency or the other virtual items we issue to users. If the PRC regulatory authorities deem such transfer or exchange avirtual currency transaction, then we may be deemed to be engaging in the issuance of virtual currency and we may also be deemed to be providingtransaction platform services that enable the trading of such virtual currency. Simultaneously engaging in both of these activities is prohibited under theVirtual Currency Notice. In that event, we may be required to cease either our virtual currency issuance activities or such deemed “transaction service”activities and may be subject to certain penalties, including mandatory corrective measures and fines. The occurrence of any of the foregoing could have amaterial adverse effect on our online games business and results of operations.In addition, the Virtual Currency Notice prohibits online game operators from setting game features that involve the direct payment of cash orvirtual currency by players for the chance to win virtual items or virtual currency based on random selection through a lucky draw, wager or lottery. Thenotice also prohibits game operators from issuing currency to game players through means other than purchases with legal currency. Although we believethat we are generally in compliance with such requirements and have taken adequate measures to prevent any of the above-mentioned prohibited activities,we cannot assure you that the PRC regulatory authorities will not take a view contrary to ours and deem such feature as prohibited by the Virtual CurrencyNotice, thereby subjecting us to penalties, including mandatory corrective measures and fines. The occurrence of any of the foregoing could materially andadversely affect our online games business and results of operations.Intensified government regulation of the internet industry in China could restrict our ability to maintain or increase our user base.The PRC government has, in recent years, intensified regulation on various aspects of the internet industry in China. For example, in January2011, MIIT and seven other PRC central government authorities jointly issued a circular entitled Implementation Scheme regarding Parental GuardianshipProject for Minors Playing Online Games, under which online game operators are required to adopt various measures to maintain a system to communicatewith the parents or other guardians of minors playing their online games and are required to monitor the online game activities of minors and suspend theaccounts of minors if so required by their parents or guardians. These restrictions could limit our ability to increase our online game business among minors.See “Item 4. Information on the Company—B. Business Overview—Regulation—Regulation on anti-fatigue system, real-name registration system andparental guardianship project.” Failure to implement these restrictions, if detected by the relevant government agencies, may result in fines and otherpenalties for us, including the shutting down of our online games operations and license revocation. Furthermore, if these restrictions were expanded to applyto adult game players in the future, our online games business could be materially and adversely affected.Further, the PRC government has tightened its regulation of internet cafes in recent years. In particular, a large number of unlicensed internetcafes have been closed. The PRC government has imposed higher capital and facility requirements for the establishment of internet cafes. Furthermore, thePRC government’s policy, which encourages the development of a limited number of national and regional internet cafe chains and discourages theestablishment of independent internet cafes, may slow down the growth of internet cafes in China. In June 2002, the Ministry of Culture, together with othergovernment authorities, issued a joint notice, and in February 2004, the State Administration for Industry and Commerce issued another notice, suspendingthe issuance of new internet cafe licenses. In May 2007, the State Administration for Industry and Commerce reiterated its position not to register any newinternet cafes in 2007. In 2008, 2009 and 2010, the Ministry of Culture, the State Administration for Industry and Commerce and other relevant governmentauthorities, individually or jointly, issued several notices that provide various ways to strengthen the regulation of internet cafes, including investigating andpunishing internet cafes that accept minors, cracking down on internet cafes without sufficient and valid licenses, limiting the total number of internet cafesand approving internet cafes within the planning made by relevant authorities, screening unlawful and adverse games and websites, and improving thecoordination of regulation over internet cafes and online games. Although currently most of our users access and consume our products and services fromtheir own devices, if internet cafes become one of the main venues for our users to access our website or online games, any reduction in the number, or anyslowdown in the growth, of internet cafes in China could limit our ability to maintain or increase our user base.In addition, the Chinese government has recently intensified its efforts to remove inappropriate content disseminated over the internet andwireless networks. In April 2014, the Chinese government initiated a campaign to enhance and enforce its scrutiny over internet content in China,particularly for pornographic content, and various websites were subject to penalties and in some cases outright suspension of website operations. As weimplemented programs to comply with these regulations, we saw our subscriber numbers decline and may see more subscriber or user decline in the future.See “—Regulation and censorship of information disseminated over the internet in China, recently strengthened, have adversely affected our business andmay continue to adversely affect our business, and we may be liable for the digital media content on our platform.” 37Table of ContentsFluctuations in exchange rates may have a material adverse effect on your investment.Fluctuation in the value of the Renminbi may have a material adverse effect on the value of your investment. The value of the Renminbi againstthe U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and economic conditions. In July 2005, thePRC government changed its decade-old policy of pegging the value of the Renminbi to the U.S. dollar. Under this policy, the Renminbi was permitted tofluctuate within a narrow and managed band against a basket of certain foreign currencies. For almost two years after reaching a high against the U.S. dollar inJuly 2008, the Renminbi traded within a narrow band against the U.S. dollar. As a consequence, the Renminbi fluctuated sharply since July 2008 againstother freely traded currencies, in tandem with the U.S. dollar. In June 2010, the PRC government announced that it would increase Renminbi exchange rateflexibility and since that time the Renminbi has gradually appreciated against the U.S. dollar, although there have been some periods when it has lost valueagainst the U.S. dollar, as it did for example during 2014. It is difficult to predict how market forces or PRC or U.S. government policy may impact theexchange rate between the RMB and the U.S. dollar in the future.Our financial statements are expressed in U.S. dollars, and most of our assets, costs and expenses are denominated in Renminbi. Substantially allof our revenues were denominated in Renminbi. We principally rely on dividends and other distributions paid by our subsidiaries in China which aredenominated in Renminbi. Our results of operations and the value of your investment in our ADSs will be affected by the foreign exchange rate between U.S.dollars and Renminbi. To the extent we hold assets denominated in Renminbi, any depreciation of the Renminbi against the U.S. dollar could result in areduction in the value of our Renminbi denominated assets. Similarly, should we repatriate any portion of the net proceeds to us from our initial publicoffering or cash from other offshore financing activities into China, such amount would also be affected by shifts in the exchange rate between the Renminbiand the U.S. dollar. On the other hand, a decline in the value of Renminbi against the U.S. dollar could reduce the U.S. dollar equivalent amounts of ourfinancial results, the value of your investment in our company and the dividends we may pay in the future, if any, all of which may have a material adverseeffect on the prices of our ADSs.Limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. We did not enter into any forwardcontracts to hedge our exposure to Renminbi-U.S. dollar exchange risk. While we may decide to enter into hedging transactions in the future, the availabilityand effectiveness of these hedges may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our currency exchange lossesmay be magnified by PRC exchange control regulations that restrict our ability to convert Renminbi into foreign currency. 38Table of ContentsGovernmental control of currency conversion may limit our ability to utilize our revenues effectively and affect the value of your investment.The PRC government imposes controls on the convertibility of the Renminbi into foreign currencies and, in certain cases, the remittance ofcurrency out of China. We receive substantially all of our revenues in Renminbi. Under our current corporate structure, our Cayman Islands holding companyprimarily relies on dividend payments from our wholly-owned PRC subsidiaries, to fund any cash and financing requirements we may have. Under existingPRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and trade and service-related foreignexchange transactions, can be made in foreign currencies without prior SAFE approval by complying with certain procedural requirements. However,approval from or registration with appropriate government authorities is required where the Renminbi is to be converted into foreign currency and remittedout of China to pay capital expenses such as the repayment of loans denominated in foreign currencies. Specifically, under the existing exchange restrictions,without prior approval of SAFE, cash generated from the operations of our PRC subsidiaries in China may be used to pay dividends by our PRC subsidiariesto our company and pay employees of our PRC subsidiaries who are located outside China in a currency other than the Renminbi. With prior approval fromSAFE, cash generated from the operations of our PRC subsidiaries and affiliated entity may be used to pay off debt in a currency other than the Renminbiowed by our PRC subsidiaries and variable interest entity and its subsidiaries to entities outside China, and make other capital expenditures outside China ina currency other than the Renminbi. If any of our variable interest entity or its subsidiaries liquidates, the proceeds from the liquidation of its assets may beused outside of the PRC or be given to investors who are not PRC nationals. The PRC government may at its discretion restrict access to foreign currenciesfor current account transactions in the future. If the foreign exchange control system prevents us from obtaining sufficient foreign currencies to satisfy ourforeign currency demand, we may not be able to pay dividends in foreign currencies to our shareholders, including holders of our ADSs.Certain regulations in the PRC may make it more difficult for us to pursue growth through acquisitions.Among other things, the M&A Rules and certain regulations and rules concerning mergers and acquisitions established additional proceduresand requirements that could make merger and acquisition activities by foreign investors more time-consuming and complex. For example, the M&A Rulesrequire that the Ministry of Commerce be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRCdomestic enterprise or a foreign company with substantial PRC operations, if certain thresholds under the Provisions on Thresholds for Prior Notification ofConcentrations of Undertakings, issued by the State Council on August 3, 2008, are triggered. Moreover, the Anti-Monopoly Law promulgated by theStanding Committee of the National People’s Congress on August 30, 2007 and took effect on August 1, 2008 requires that transactions which are deemedconcentrations and involve parties with specified turnover thresholds (i.e., during the previous fiscal year, (i) the total global turnover of all operatorsparticipating in the transaction exceeds RMB10 billion and at least two of these operators each had a turnover of more than RMB400 million within China,or (ii) the total turnover within China of all the operators participating in the concentration exceeded RMB2 billion, and at least two of these operators eachhad a turnover of more than RMB400 million within China) must be cleared by the Ministry of Commerce before they can be completed. In addition,according to the Implementing Rules Concerning Security Review on the Mergers and Acquisitions by Foreign Investors of Domestic Enterprises issued bythe Ministry of Commerce in August 2011, mergers and acquisitions by foreign investors involved in an industry related to national security are subject tostrict review by the Ministry of Commerce. These rules also prohibit any transactions attempting to bypass such security review, including by controllingentities through contractual arrangements. We believe that our business is not in an industry related to national security. However, we cannot preclude thepossibility that the Ministry of Commerce or other government agencies may publish interpretations contrary to our understanding or broaden the scope ofsuch security review in the future. Although we have no current definitive plans to make any acquisitions, we may elect to grow our business in the future inpart by directly acquiring complementary businesses in China. Complying with the requirements of these regulations to complete such transactions could betime-consuming, and any required approval processes, including obtaining approval from the Ministry of Commerce, may delay or inhibit our ability tocomplete such transactions. 39Table of ContentsPRC regulations relating to the establishment of offshore SPVs by PRC residents may subject our PRC resident beneficial owners or our PRC subsidiariesto liability or penalties, limit our ability to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to increase their registered capitalor distribute profits to us, or may otherwise adversely affect us.SAFE has promulgated several regulations that require PRC residents and PRC corporate entities to register with local branches of SAFE inconnection with their direct or indirect offshore investment activities. These regulations apply to our shareholders who are PRC residents and may apply toany offshore acquisitions that we make in the future. SAFE promulgated the Circular on Relevant Issues Concerning Foreign Exchange Control on DomesticResidents’ Offshore Investment and Financing and Roundtrip Investment through Special Purpose Vehicles, or SAFE No. Circular No. 37, on July 4, 2014.SAFE Circular No. 37 requires PRC residents to register with local branches of SAFE in connection with their direct establishment or indirect control of anoffshore entity, for the purpose of overseas investment and financing, with such PRC residents’ legally owned assets or equity interests in domesticenterprises or offshore assets or interests, referred to in SAFE Circular No. 37 as a “special purpose vehicle.” The term “control” under SAFE Circular No. 37 isbroadly defined as the operation rights, beneficiary rights or decision-making rights acquired by the PRC residents in the offshore special purpose vehicles orPRC companies by such means as acquisition, trust, proxy, voting rights, repurchase, convertible bonds or other arrangements. SAFE Circular No. 37 furtherrequires amendment to the registration in the event of any changes with respect to the basic information of the special purpose vehicle, such as changes in aPRC resident individual shareholder, name or operation period; or any significant changes with respect to the special purpose vehicle, such as increase ordecrease of capital contributed by PRC individuals, share transfer or exchange, merger, division or other material event. If the shareholders of an offshoreholding company who are PRC residents do not complete their registration with the local SAFE branches, the PRC subsidiaries of the offshore holdingcompany may be prohibited from distributing their profits and proceeds from any reduction in capital, share transfer or liquidation to the offshore company,and the offshore company may be restricted in its ability to contribute additional capital to its PRC subsidiaries. Moreover, failure to comply with SAFEregistration and amendment requirements described above could result in liability under PRC law for evasion of applicable foreign exchange restrictions. Inaddition, on February 13, 2015, SAFE issued SAFE Circular No. 13, which is scheduled to take effect on June 1, 2015. SAFE Circular No. 13 delegates to thequalified banks the authority to register all PRC residents’ investment in “special purpose vehicle” pursuant to SAFE Circular No. 37, except that those PRCresidents who have failed to comply with SAFE Circular No. 37 will continue to fall within the jurisdiction of the relevant local SAFE branches and mustcontinue to make their supplementary registration applications with the such local SAFE branches.We have requested PRC residents holding direct or indirect interest in our company to our knowledge to make the necessary applications, filingsand amendments as required under SAFE regulations. Mr. Sean Shenglong Zou, Mr. Hao Cheng and Ms. Fang Wang have completed the registration andamendment registration with the local SAFE branch in relation to all our previous private financings and their subsequent ownership changes by April 2012as required under the SAFE regulations and are in the process of applying for the relevant amendment registrations with the local SAFE branch in relation totheir ownership changes in our company in relation to our series E financing and our initial public offering. However, we may not be informed of theidentities of all the PRC residents holding direct or indirect interest in our company, and we cannot provide any assurances that these PRC residents willcomply with our request to make or obtain any applicable registrations or comply with other requirements required by SAFE regulations. The failure orinability of our PRC resident shareholders to make any required registrations or comply with other requirements under SAFE regulations may subject suchPRC residents or our PRC subsidiaries to fines and legal sanctions and may also limit our ability to raise additional financing and contribute additionalcapital into or provide loans to (including using the proceeds from our initial public offering) our PRC subsidiaries, limit our PRC subsidiaries’ ability to paydividends or otherwise distribute profits to us, or otherwise adversely affect us. 40Table of ContentsFurthermore, because of the uncertainty over how the SAFE regulations will be interpreted and implemented, and how SAFE will apply them tous, we cannot predict how these regulations will affect our business operations or future strategies. For example, we may be subject to a more stringent reviewand approval process with respect to our foreign exchange activities, such as remittance of dividends and foreign-currency-denominated borrowings, whichmay adversely affect our financial condition and results of operations. In addition, if we decide to acquire a PRC domestic company, we cannot assure youthat we or the owners of such company, as the case may be, will be able to obtain the necessary approvals or complete the necessary filings and registrationsrequired by the foreign exchange regulations. This may restrict our ability to implement our acquisition strategy and could adversely affect our business andprospects.Failure to comply with PRC regulations regarding the registration requirements for employee stock ownership plans or share option plans may subject thePRC plan participants or us to fines and other legal or administrative sanctions.In December 2006, the People’s Bank of China promulgated the Administrative Measures of Foreign Exchange Matters for Individuals, whichset forth the respective requirements for foreign exchange transactions by individuals (both PRC or non-PRC citizens) under either the current account or thecapital account. On February 15, 2012, SAFE promulgated the Notices on Issues Concerning the Foreign Exchange Administration for Domestic IndividualsParticipating in Stock Incentive Plans of Overseas Publicly-Listed Companies, or the Stock Option Rules, which replaced the Application Procedures ofForeign Exchange Administration for Domestic Individuals Participating in Employee Stock Ownership Plans or Stock Option Plans of Overseas Publicly-Listed Companies issued by SAFE on March 28, 2007. Under the Stock Option Rules and other relevant rules and regulations, PRC residents who participatein stock incentive plan in an overseas publicly-listed company are required to register with SAFE or its local branches 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 publiclylisted company or another qualified institution selected by such PRC subsidiary, to conduct the SAFE registration and other procedures with respect to thestock incentive plan on behalf of its participants. Such participants must also retain an overseas entrusted institution to handle matters in connection withtheir exercise of stock options, the purchase and sale of corresponding stocks or interests and fund transfers. In addition, the PRC agent is required to amendthe 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 overseasentrusted institution or other material changes. We and our PRC employees who have been granted stock options are subject to these regulations. Failure ofour PRC stock option holders to complete their SAFE registrations may subject these PRC residents to fines and legal sanctions and may also limit our abilityto contribute additional capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute dividends to us, or otherwise materially adverselyaffect our business. 41Table of ContentsWe face uncertainties with respect to indirect transfers of equity interests in PRC resident enterprises by their non-PRC holding companies.The State Administration of Taxation has issued several rules and notices to tighten its scrutiny over acquisition transactions in recent years,including the Notice on Strengthening Administration of Enterprise Income Tax for Share Transfers by Non-PRC Resident Enterprises issued in December2009, or SAT Circular 698, the Notice on Several Issues Regarding the Income Tax of Non-PRC Resident Enterprises issued in March 2011, or SAT Circular24, and the Notice on Certain Corporate Income Tax Matters on Indirect Transfer of Properties by Non-PRC Resident Enterprises issued in February 2015,or SAT Circular 7. Pursuant to these rules and notices, if a non-PRC resident enterprise indirectly transfers PRC taxable properties, which refer to properties ofan establishment or a place in the PRC, real estate properties in the PRC or equity investments in a PRC tax resident enterprise, by disposing of equityinterest in an overseas non-public holding company without a reasonable commercial purpose and resulting in the avoidance of PRC enterprise income tax,such indirect transfer should be deemed a direct transfer of PRC taxable properties, and gains derived from such indirect transfer may be subject to the PRCwithholding tax at a rate of up to 10%. SAT Circular 7 sets out several factors to be taken into consideration by tax authorities in determining whether anindirect transfer has a reasonable commercial purpose. An indirect transfer satisfying all the following criteria will be deemed to lack reasonable commercialpurpose and be taxable under PRC law: (i) 75% or more of the equity value of the intermediary enterprise being transferred is derived directly or indirectlyfrom the PRC taxable properties; (ii) at any time during the one-year period before the indirect transfer, 90% or more of the asset value of the intermediaryenterprise (excluding cash) is comprised directly or indirectly of investments in the PRC, or 90% or more of its income is derived directly or indirectly fromthe PRC; (iii) the functions performed and risks assumed by the intermediary enterprise and any of its subsidiaries that directly or indirectly hold the PRCtaxable properties are limited and are insufficient to prove their economic substance; and (iv) the foreign tax payable on the gain derived from the indirecttransfer of the PRC taxable properties is lower than the potential PRC enterprise income tax on the direct transfer of such assets. Nevertheless, the indirecttransfer falling into the safe harbor available under SAT Circular 7 may not be subject to PRC tax and the scope of the safe harbor includes qualified grouprestructuring, public market trading and tax treaty exemptions.Under SAT Circular 7, the entities or individuals obligated to pay the transfer price to the transferor are the withholding agents and mustwithhold the PRC enterprise income tax from the transfer price. If the withholding agent fails to do so, the transferor should report to and pay the PRCenterprise income tax to the PRC tax authorities. In the event that neither the withholding agent nor the transferor fulfills their obligations under SATCircular 7, apart from imposing penalties such as late payment interest on the transferor, the tax authority may also hold the withholding agent liable andimpose a penalty of 50% to 300% of the unpaid tax on the withholding agent. The penalty imposed on the withholding agent may be reduced or waived ifthe withholding agent has submitted the relevant materials in connection with the indirect transfer to the PRC tax authorities in accordance with SATCircular 7. 42Table of ContentsHowever, as these rules and notices are relatively new and there is a lack of clear statutory interpretation, we face uncertainties on the reportingand consequences on future private equity financing transactions, share exchange or other transactions involving the transfer of shares in our company byinvestors 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 CaymanIslands holding company and other non-resident enterprises in our company may be subject to filing obligations or may be taxed if our Cayman Islandsholding company and other non-resident enterprises in our company are transferors in such transactions, and may be subject to withholding obligations if ourCayman Islands holding company and other non-resident enterprises in our company are transferees in such transactions. For the transfer of shares in ourCayman Islands holding company by investors that are non-PRC resident enterprises, our PRC subsidiaries may be requested to assist in the filing under therules and notices. As a result, we may be required to expend valuable resources to comply with these rules and notices or to request the relevant transferorsfrom whom we purchase taxable assets to comply, or to establish that our Cayman Islands holding company and other non-resident enterprises in ourcompany should not be taxed under these rules and notices, which may have a material adverse effect on our financial condition and results of operations.There is no assurance that the tax authorities will not apply the rules and notices to our offshore restructuring transactions where non-PRC resident investorswere involved if any of such transactions were determined by the tax authorities to lack reasonable commercial purpose. As a result, we and our non-PRCresident investors may be at risk of being taxed under these rules and notices and may be required to comply with or to establish that we should not be taxedunder such rules and notices, which may have a material adverse effect on our financial condition and results of operations or such non-PRC residentinvestors’ investments in us. We have conducted acquisition transactions in the past and may conduct additional acquisition transactions in the future. Wecannot assure you that the PRC tax authorities will not, at their discretion, adjust any capital gains and impose tax return filing obligations on us or require usto provide assistance for the investigation of PRC tax authorities with respect thereto. Heightened scrutiny over acquisition transactions by the PRC taxauthorities may have a negative impact on potential acquisitions we may pursue in the future.Discontinuation or reduction of any of the preferential tax treatments or other government incentives available to us in the PRC, or imposition of anyadditional PRC taxes could adversely affect our financial condition and results of operations.The Chinese government has provided various tax incentives to our subsidiaries in China. These incentives include reduced enterprise incometax rates. For example, under the PRC Enterprise Income Tax Law which became effective in January 2008, or the EIT Law, the statutory enterprise incometax rate is 25%. The EIT Law permits companies established before March 16, 2007 to continue to enjoy their existing tax incentives, adjusted by certaintransitional phase-out rules set forth in the Circular to Implementation of the Transitional Preferential Policies for the Enterprise Income Tax promulgated bythe State Council on December 26, 2007, and provides tax incentives, subject to various qualification criteria. Pursuant to the circular, the income tax ratesfor us and our wholly-owned subsidiary established in the Shenzhen Special Economic Zone before March 16, 2007 were 24% for 2011 and are 25% startingfrom 2012. The EIT Law and its implementation rules also permit qualified “high and new technology enterprises,” or HNTEs, to enjoy a preferentialenterprise income tax rate of 15% upon filing with relevant tax authorities. The qualification as a HNTE generally has a valid term of three years and therenewal of such qualification is subject to review by the relevant authorities in China. Shenzhen Xunlei, our variable interest entity, obtained its HNTEcertificate in 2011 with a valid period of three years and subsequently renewed the HNTE certificate in September 2014 with a valid period of three years. Inaddition, the PRC government has provided various incentives to accredited “software enterprise” incorporated in the PRC in order to encouragedevelopment of the software industry. In December 2013, Shenzhen Xunlei obtained the certificate of the Key Software Enterprise for the years endedDecember 31, 2013 and 2014, which enables Shenzhen Xunlei to enjoy the preferential tax rate of 10% for the years of 2013 and 2014. Xunlei Computer hasbeen accredited as a “software enterprise” and become profitable since 2013 and thus enjoys a two-year income tax exemption for 2013 and 2014 and a 50%income tax reduction for 2015, 2016 and 2017. Moreover, local governments have adopted incentives to encourage the development of technologycompanies. As approved by the relevant local tax authority, our wholly-owned subsidiary, Giganology Shenzhen, and our variable interest entity, ShenzhenXunlei, were further exempt from enterprise income tax from the first year of profitable operation and are subject to phase-out tax reduction thereafter. XunleiComputer and Shenzhen Xunlei currently benefit from the tax incentives. See “Item 5. Operating and Financial Overview and Prospects—A. OperatingResults—Taxation.” We also benefited from government incentives in the form of cash subsidies in 2011. 43Table of ContentsPreferential tax treatment and other government incentives granted to Xunlei Computer and Shenzhen Xunlei by the local governmentalauthorities are subject to review and may be adjusted or revoked at any time. The discontinuation or reduction of any preferential tax treatment currentlyavailable to us and our wholly-owned PRC subsidiaries will cause our effective tax rate to increase, which could have a material adverse effect on ourfinancial condition and results of operations. We cannot assure you that we will be able to maintain our current effective tax rate in the future.Our global income may be subject to PRC taxes under the PRC EIT Law, which may have a material adverse effect on our results of operations.Under the EIT Law and its implementation rules, an enterprise established outside of the PRC with a “de facto management body” within thePRC is considered a resident enterprise and will be subject to the enterprise income tax at the rate of 25% on its global income. The implementation rulesdefine the term “de facto management bodies” as “establishments that carry out substantial and overall management and control over the manufacturing andbusiness operations, personnel, accounting, properties, etc. of an enterprise.” On April 22, 2009, the SAT issued a circular, or SAT Circular 82, which providescertain specific criteria for determining whether the “de facto management body” of a PRC-controlled enterprise that is incorporated offshore is located inChina. See “Item 4. Information on the Company—B. Business Overview—Regulation—Regulations on Tax—PRC enterprise income tax.” Although SATCircular 82 applies only to offshore enterprises controlled by PRC enterprises or PRC enterprise groups and not to those controlled by PRC individuals orforeigners, the determining criteria set forth in the SAT Circular 82 may reflect the SAT’s general position on how the “de facto management body” testshould be applied in determining the tax resident status of all offshore enterprises.According to SAT Circular 82, an offshore incorporated enterprise controlled by a PRC enterprise or a PRC enterprise group will be regarded as aPRC tax resident by virtue of having its “de facto management body” in China and will be subject to PRC enterprise income tax on its worldwide incomeonly if all of the following conditions set forth in the SAT Circular 82 are met: (i) the primary location of the day-to-day operational management is in thePRC; (ii) decisions relating to the enterprise’s financial and human resource matters are made or are subject to approval by organizations or personnel in thePRC; (iii) the enterprise’s primary assets, accounting books and records, company seals, and board and shareholder resolutions are located or maintained inthe PRC; and (iv) at least 50% of voting board members or senior executives habitually reside in the PRC.Xunlei Limited is not controlled by a PRC enterprise or PRC enterprise group and we do not believe that Xunlei Limited meets all of theconditions above. Xunlei Limited is a company incorporated outside the PRC. As a holding company, certain of Xunlei Limited’s key assets are located, andrecords (including the resolutions of its board of directors and the resolutions of its shareholders) are maintained, outside the PRC. Therefore, we do notbelieve Xunlei Limited should be treated as a “resident enterprise” for PRC tax purposes if the criteria for “de facto management body” as set forth in therelevant SAT Circular 82 were deemed applicable to us. However, as the tax resident status of an enterprise is subject to determination by the PRC taxauthorities and uncertainties remain with respect to the interpretation of the term “de facto management body” as applicable to Xunlei Limited, we may beconsidered a resident enterprise and may therefore be subject to the enterprise income tax at 25% on our global income. If we are considered a residententerprise and earn income other than dividends from our PRC subsidiaries, a 25% enterprise income tax on our global income could increase our tax burdenand adversely affect our cash flow and profitability. In addition to the uncertainty regarding how the new “resident enterprise” classification may apply, it isalso possible that the rules may change in the future, possibly with retroactive effect. 44Table of ContentsDividends paid by us to our foreign investors and gains on the sale of our ADSs or common shares by our foreign investors may be subject to taxes underPRC tax laws.Under the EIT Law and its implementation regulations issued by the State Council, a 10% PRC withholding tax is applicable to dividends paidto investors that are “non-resident enterprises,” which do not have an establishment or place of business in the PRC or which have such establishment orplace of business but the dividends are not effectively connected with such establishment or place of business, to the extent such dividends are derived fromsources within the PRC. Any gain realized on the transfer of ADSs or common shares by such investors is subject to PRC tax, at a rate of 10% unless otherwisereduced or exempted by relevant tax treaties, if such gain is regarded as income derived from sources within the PRC. If we are deemed a “PRC residententerprise,” dividends paid on our common shares or ADSs, and any gain realized from the transfer of our common shares or ADSs, may be treated as incomederived from sources within the PRC and may as a result be subject to PRC taxation (which in the case of dividends would be withheld at source). It is unclearwhether our non-PRC individual investors would be subject to any PRC tax in the event we are deemed a “PRC resident enterprise.” If any PRC tax were toapply to such dividends or gains of non-PRC individual investors, it would generally apply at a rate of 20% (unless a reduced rate is available under anapplicable tax treaty). It is also unclear whether, if we are considered a PRC “resident enterprise,” holders of our ADSs or common shares would be able toclaim the benefit of income tax treaties or agreements entered into between China and other countries or areas (and we do not expect to withhold at treatyrates if any withholding is required). If dividends payable to our non-PRC investors, or gains from the transfer of our common shares or ADSs by suchinvestors are subject to PRC tax, the value of your investment in our common shares or ADSs may be adversely affected.Increases in labor costs and enforcement of stricter labor laws and regulations in the PRC may adversely affect our business and our profitability.China’s overall economy and the average wage in China have increased in recent years and are expected to continue to grow. The average wagelevel for our employees has also increased in recent years. We expect that our labor costs, including wages and employee benefits, will continue to increase.Unless we are able to pass on these increased labor costs to our users by increasing prices for our products or services, our profitability and results ofoperations may be materially and adversely affected.In addition, we have been subject to stricter regulatory requirements in terms of entering labor contracts with our employees and paying variousstatutory employee benefits, including pensions, housing fund, medical insurance, work-related injury insurance, unemployment insurance and childbearinginsurance to designated government agencies for the benefit of our employees. Pursuant to the PRC Labor Contract Law, or the Labor Contract law, thatbecame effective in January 2008, as amended on December 28, 2012 and effective as of July 1, 2013, and its implementation rules that became effective inSeptember 2008, employers are subject to stricter requirements in terms of signing labor contracts, minimum wages, paying remuneration, determining theterm of employees’ probation and unilaterally terminating labor contracts. In the event that we decide to terminate some of our employees or otherwisechange our employment or labor practices, the Labor Contract Law and its implementation rules may limit our ability to effect those changes in a desirable orcost-effective manner, which could adversely affect our business and results of operations. On October 28, 2010, the Standing Committee of the NationalPeople’s Congress promulgated the PRC Social Insurance Law, or the Social Insurance Law, which became effective on July 1, 2011. According to the SocialInsurance Law, employees must participate in pension insurance, work-related injury insurance, medical insurance, unemployment insurance and maternityinsurance and the employers must, together with their employees or separately, pay the social insurance premiums for such employees. 45Table of ContentsAs the interpretation and implementation of labor-related laws and regulations are still evolving, we cannot assure you that our employmentpractice do not and will not violate labor-related laws and regulations in China, which may subject us to labor disputes or government investigations. If weare deemed to have violated relevant labor laws and regulations, we could be required to provide additional compensation to our employees and ourbusiness, financial condition and results of operations could be materially and adversely affected.The audit report included in this annual report is prepared by an auditor who is not inspected by the Public Company Accounting Oversight Board and, assuch, you are deprived of the benefits of such inspection.Auditors of companies that are registered with the Securities and Exchange Commission, or the SEC, and traded publicly in the United States,including our independent registered public accounting firm, must be registered with the Public Company Accounting Oversight Board, or the PCAOB, andare required by the laws of the United States to undergo regular inspections by PCAOB to assess their compliance with the laws of the United States andprofessional standards. Because we have substantiated operations within the Peoples’ Republic of China and the PCAOB is currently unable to conductinspections of the work of our auditors as it relates to those operations without the approval of the Chinese authorities, our auditor’s work related to ouroperations in China is not currently inspected by the PCAOB.This lack of PCAOB inspections of audit work performed in China prevents the PCAOB from regularly evaluating audit work of any auditorsthat was performed in China including that performed by our independent registered public accounting firm. As a result, investors may be deprived of the fullbenefits of PCAOB inspections.The inability of the PCAOB to conduct inspections of audit work performed in China makes it more difficult to evaluate the effectiveness of ourauditor’s audit procedures as compared to auditors in other jurisdictions that are subject to PCAOB inspections on all of their work. Investors may loseconfidence in our reported financial information and procedures and the quality of our financial statements.If additional remedial measures are imposed on certain PRC-based accounting firms in administrative proceedings brought by the SEC, we could beunable to file future financial statements on a timely basis compliance with the requirements of the Exchange Act.In December 2012, the SEC instituted administrative proceedings against certain PRC-based accounting firms, including our independentregistered public accounting firm, alleging that these firms had violated U.S. securities laws and the SEC’s rules and regulations thereunder by failing toprovide to the SEC the firms’ work papers related to their audits of certain PRC-based companies that are publicly traded in the United States. On January 22,2014, an initial administrative law decision was issued, sanctioning these accounting firms and suspending them from practicing before the SEC for a periodof six months. On February 12, 2014, four of these PRC-based accounting firms appealed to the SEC against this sanction. In February 2015, each of the fourPRC-based accounting firms 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 theSEC. 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 or if there is a failure in the process between the SEC and the CSRC, the SEC could impose penalties such assuspensions, or it could restart the administrative proceedings. 46Table of ContentsIn the event that the SEC restarts the administrative proceedings, depending upon the final outcome, listed companies in the United States withmajor PRC operations may find it difficult or impossible to retain auditors in respect of their operations in the PRC, which could result in financial statementsbeing determined to not be in compliance with the requirements of the Exchange Act, including possible delisting. Moreover, any negative news about theproceedings against these audit firms may cause investor uncertainty regarding China-based, United States-listed companies and the market price of ourADSs may be adversely affected.If our independent registered public accounting firm were denied, even temporarily, the ability to practice before the SEC and we were unable totimely find another registered public accounting firm to audit and issue an opinion on our financial statements, our financial statements could be determinedto not be in compliance with the requirements for financial statements of public companies registered under the Exchange Act, as amended, or the ExchangeAct. Such a determination could ultimately lead to the delisting of our common stock from the NASDAQ Global Select Market or deregistration from theSEC, which would substantially reduce or effectively terminate the trading of our common stock in the United States.Risks related to our ADSsThe market price for our ADSs may be volatile.The trading prices of our ADSs are likely to be volatile and could fluctuate widely due to factors beyond our control. This may happen becauseof broad market and industry factors, like the performance and fluctuation in the market prices or the underperformance or deteriorating financial results ofother similarly situated companies in China that have listed their securities in the United States in recent years. The securities of some of these companieshave experienced significant volatility since their initial public offerings, including, in some cases, substantial price declines in the trading prices of theirsecurities. The trading performances of these Chinese companies’ securities after their offerings, including companies in the internet businesses, may affectthe attitudes of investors toward Chinese companies listed in the United States, 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 fraudulentaccounting or other practices at other Chinese companies may also negatively affect the attitudes of investors towards Chinese companies in general,including us, regardless of whether we have engaged in such practices. In addition, securities markets may from time to time experience significant price andvolume fluctuations that are not related to our operating performance, which may have a material adverse effect on the market price of our ADSs.The market price for our ADSs is likely to be highly volatile and subject to wide fluctuations in response to factors including the following: • regulatory developments affecting us, our advertisers or our industry; • announcements of studies and reports relating to our services or those of our competitors; • changes in the economic performance or market valuations of other internet companies in China; • actual or anticipated fluctuations in our quarterly results of operations and changes of our expected results; • changes in financial estimates by securities research analysts; 47Table of Contents • conditions in the internet or online advertising industry in China; • announcements by us or our competitors of new services, acquisitions, strategic relationships, joint ventures or capital commitments; • additions to or departures of our senior management; • fluctuations of exchange rates between the Renminbi and the U.S. dollar; • release or expiry of lock-up or other transfer restrictions on our outstanding shares or ADSs; and • sales or perceived potential sales of additional shares or ADSs.In addition, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operatingperformance of any particular companies. These market fluctuations may also have a material adverse effect on the market price of our ADSs.If securities or industry analysts cease to publish research or reports about our business, or if they adversely change their recommendations regarding ourADSs, the market price for our ADSs and trading volume could decline.The trading market for our ADSs will be influenced by research or reports that industry or securities analysts publish about our business. If one ormore analysts who cover us downgrade our ADSs, the market price for our ADSs would likely decline. If one or more of these analysts cease to cover us or failto regularly publish reports on us, we could lose visibility in the financial markets, which, in turn, could cause the market price or trading volume for ourADSs to decline.As we do not expect to pay dividends in the foreseeable future, you must rely on price appreciation of our ADSs for return on your investment.We currently intend to retain most, if not all, of our available funds and any future earnings to fund the development and growth of our business.As a result, we do not expect to pay any cash dividends in the foreseeable future. Therefore, you should not rely on an investment in our ADSs as a source forany future dividend income.Our board of directors has discretion as to whether to distribute dividends, subject to applicable laws. Our shareholders may by ordinaryresolution declare dividends, but no dividend may exceed the amount recommended by our board of directors. Even if our board of directors decides todeclare and pay dividends, the timing, amount and form of future dividends, if any, will depend on, among other things, our future results of operations andcash flow, our capital requirements and surplus, the amount of distributions, if any, received by us from our subsidiaries, our financial condition, contractualrestrictions and other factors deemed relevant by our board of directors. Accordingly, the return on your investment in our ADSs will likely depend entirelyupon any future price appreciation of our ADSs. There is no guarantee that our ADSs will appreciate in value or even maintain the price at which youpurchased the ADSs. You may not realize a return on your investment in our ADSs and you may even lose your entire investment in our ADSs. 48Table of ContentsSubstantial future sales or perceived potential sales of our ADSs in the public market could cause the price of our ADSs to decline.Sales of our ADSs in the public market, or the perception that these sales could occur, could cause the market price of our ADSs to decline. As ofMarch 31, 2015, we had 335,073,840 common shares outstanding, but excluding (ii) 21,269,144 common shares issued to Leading Advice Holdings Limitedfor grants under our 2013 Plan and 2014 Plan that remained then unexercised or unvested, and (ii) 12,534,225 common shares issued to our depositary bankfor bulk issuance of ADSs reserved for future issuances upon the exercise or vesting of awards granted under our share incentive plans. All our outstandingcommon shares represented by ADSs were freely transferable by persons other than our “affiliates” without restriction or additional registration under theSecurities Act of 1933, as amended, or Securities Act. The remaining common shares will be available for sale subject to volume and other restrictions asapplicable under Rules 144 and 701 under the Securities Act.Certain holders of our common shares have the right to cause us to register under the Securities Act the sale of their shares. Registration of theseshares under the Securities Act would result in ADSs representing these shares becoming freely tradable without restriction under the Securities Actimmediately upon the effectiveness of the registration. Sales of these registered shares in the form of ADSs, in the public market could cause the price of ourADSs to decline.Your right to participate in any future rights offerings may be limited, which may cause dilution to your holdings, and you may not receive cash dividendsif it is impractical to make them available to you.We may from time to time distribute rights to our shareholders, including rights to acquire our securities. However, we cannot make rightsavailable to you in the United States unless we register both the rights and the securities to which the rights relate under the Securities Act or an exemptionfrom the registration requirements is available. Under the deposit agreement, the depositary will not make rights available to you unless both the rights andthe underlying securities to be distributed to ADS holders are either registered under the Securities Act or exempt from registration under the Securities Act.We are under no obligation to file a registration statement with respect to any such rights or securities or to endeavor to cause such a registration statement tobe declared effective and we may not be able to establish a necessary exemption from registration under the Securities Act. Accordingly, you may be unableto participate in our rights offerings and may experience dilution in your holdings.The depositary of our ADSs has agreed to pay to you the cash dividends or other distributions it or the custodian receives on our common sharesor other deposited securities after deducting its fees and expenses. You will receive these distributions in proportion to the number of common shares yourADSs represent. However, the depositary may, at its discretion, decide that it is inequitable or impractical to make a distribution available to any holders ofADSs. For example, the depositary may determine that it is not practicable to distribute certain property through the mail, or that the value of certaindistributions may be less than the cost of mailing them. In these cases, the depositary may decide not to distribute such property to you.You may be subject to limitations on transfer of your ADSs.Your ADSs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from time to timewhen it deems expedient in connection with the performance of its duties. In addition, the depositary may refuse to deliver, transfer or register transfers ofADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary deems it advisable to do so because of anyrequirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason. 49Table of ContentsYou may face difficulties in protecting your interests, and your ability to protect your rights through the U.S. federal courts may be limited because we areincorporated under Cayman Islands law, we conduct substantially all of our operations in China and substantially all of our directors and officers resideoutside the United States.We are incorporated in the Cayman Islands and conduct substantially all of our operations in China through our PRC subsidiaries and variableinterest entity and its subsidiaries. Substantially all of our directors and officers reside outside the United States and a substantial portion of their assets arelocated outside of the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in theCayman Islands or in the United States in the event that you believe that your rights have been infringed under the U.S. securities laws or otherwise. Even ifyou are successful in bringing an action of this kind, the laws of the Cayman Islands and of China may render you unable to enforce a judgment against ourassets or the assets of our directors and officers.There are uncertainties as to whether Cayman Islands courts would: • recognize or enforce against us judgments of courts of the United States based on certain civil liability provisions of U.S. securities laws;and • impose liabilities against us, in original actions brought in the Cayman Islands, based on certain civil liability provisions of U.S.securities laws that are penal in nature.There is no statutory recognition in the Cayman Islands of judgments obtained in the United States, although the courts of the Cayman Islandswill in certain circumstances recognize and enforce a non-penal judgment of a foreign court of competent jurisdiction without retrial on the merits.Our corporate affairs are governed by our memorandum and articles of association, as amended and restated from time to time, and by theCompanies Law (2013 Revision) and common law of the Cayman Islands. The rights of shareholders to take legal action against us and our directors, actionsby minority shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common lawof the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands aswell as from English common law, which provides persuasive, but not binding, authority in a court in the Cayman Islands. The rights of our shareholders andthe fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents inthe United States. In particular, the Cayman Islands has a less developed body of securities laws than the United States and provides significantly lessprotection to investors. In addition, shareholders in Cayman Islands companies may not have standing to initiate a shareholder derivative action in U.S.federal courts.As a result, our public shareholders may have more difficulty in protecting their interests through actions against us, our management, ourdirectors or our controlling shareholders than would shareholders of a corporation incorporated in a jurisdiction in the United States.We are an emerging growth company within the meaning of the Securities Act and may take advantage of certain reduced reporting requirements.We are an “emerging growth company,” as defined in the JOBS Act, and we may take advantage of certain exemptions from various requirementsapplicable to other public companies that are not emerging growth companies including, most significantly, not being required to comply with the auditorattestation requirements of Section 404 for so long as we are an emerging growth company. As a result, if we elect not to comply with such auditor attestationrequirements, our investors may not have access to certain information they may deem important. 50Table of ContentsThe JOBS Act also provides that an emerging growth company does not need to comply with any new or revised financial accounting standardsuntil such date that a private company is otherwise required to comply with such new or revised accounting standards. However, we have elected to “opt out”of this provision and, as a result, we will comply with new or revised accounting standards as required when they are adopted for public companies. Thisdecision to opt out of the extended transition period under the JOBS Act is irrevocable.Our memorandum and articles of association contains anti-takeover provisions that could adversely affect the rights of holders of our common shares andADSs.Our currently effective memorandum and articles of association contains certain provisions that could limit the ability of others to acquirecontrol of our company, including a provision that grants authority to our board directors to establish from time to time one or more series of preferred shareswithout action by our shareholders and to determine, with respect to any series of preferred shares, the terms and rights of that series. The provisions couldhave the effect of depriving our shareholders of the opportunity to sell their shares at a premium over the prevailing market price by discouraging thirdparties from seeking to obtain control of our company in a tender offer or similar transactions.Our corporate actions are substantially controlled by our directors, executive officers and other principal shareholders, who can exert significantinfluence over important corporate matters, which may reduce the price of our ADSs and deprive you of an opportunity to receive a premium for yourshares.As of March 31, 2015, our directors, executive officers and existing principal shareholders beneficially owned approximately 91.3% of ouroutstanding common shares. These shareholders, if acting together, could exert substantial influence over matters such as electing directors and approvingmaterial mergers, acquisitions or other business combination transactions. This concentration of ownership may also discourage, delay or prevent a change incontrol of our company, which could have the dual effect of depriving our shareholders of an opportunity to receive a premium for their shares as part of asale of our company and reducing the price of our ADSs. These actions may be taken even if they are opposed by our other shareholders. In addition, thesepersons could divert business opportunities away from us to themselves or others.We incur increased costs as a result of being a public company, particularly after we cease to qualify as an “emerging growth company.”As a public company in the United States, we incur significant accounting, legal and other expenses that we did not incur as a private company.The Sarbanes-Oxley Act, as well as rules subsequently implemented by the Securities and Exchange Commission and the NASDAQ Global Select Market,require significantly heightened corporate governance practices of public companies, including Section 404 relating to internal control over financialreporting. As a company with less than US$1.0 billion in revenues for our last fiscal year, we qualify as an “emerging growth company” pursuant to the JOBSAct. An emerging growth company may take advantage of specified reduced reporting and other requirements that are otherwise applicable generally topublic companies. These provisions include exemption from the auditor attestation requirement under Section 404 of the Sarbanes-Oxley Act of 2002 in theassessment of the emerging growth company’s internal control over financial reporting and permission to delay adopting new or revised accountingstandards until such time as those standards apply to private companies. However, we have elected to “opt out” of this provision and, as a result, we willcomply with new or revised accounting standards as required when they are adopted for public companies. This decision to opt out of the extended transitionperiod under the JOBS Act is irrevocable. 51Table of ContentsWe expect these and other rules and regulations applicable to public companies will increase our accounting, legal and financial compliancecosts and will make certain corporate activities more time-consuming and costly. After we are no longer an “emerging growth company,” we expect to incursignificant expenses and devote substantial management effort toward ensuring compliance with the requirements of Section 404 of the Sarbanes-Oxley Actof 2002 and the other rules and regulations of the SEC. Compliance with these rules and requirements may be especially difficult and costly for us becausewe may have difficulty locating sufficient personnel in China with experience and expertise relating to U.S. GAAP and U.S. public company reportingrequirements, and such personnel may command high salaries relative to similarly experienced personnel in the United States. If we cannot employ sufficientpersonnel to ensure compliance with these rules and regulations, we may need to rely more on outside legal, accounting and financial experts, which may becostly. If we fail to comply with these rules and requirements, or are perceived to have weaknesses with respect to our compliance, we could become thesubject of a governmental enforcement action and investor confidence could be negatively impacted and the market price of our ADSs could decline. Inaddition, we will incur additional costs associated with our public company reporting requirements. We are currently evaluating and monitoringdevelopments with respect to these rules and regulations, and we cannot predict or estimate with reasonable certainty the amount of additional costs we mayincur or the timing of such costs.There is a significant risk that we will be classified as a passive foreign investment company, which could subject United States investors in the ADSs orcommon shares to significant adverse United States income tax consequences.Based on the market price of our ADSs and the composition of our assets (in particular the retention of a substantial amount of cash), we believethat it is very likely that we were classified as a “passive foreign investment company,” (or a “PFIC”), for United States federal income tax purposes for ourtaxable year ended December 31, 2014, and we will very likely be a PFIC for our current taxable year ending December 31, 2015 unless the market price ofour ADSs increases and/or we invest a substantial amount of the cash and other passive assets we hold in assets that produce or are held for the production ofactive income. In addition, it is possible that one or more of our subsidiaries may be or become classified as a PFIC for United States federal income taxpurposes. A non-U.S. corporation will be classified as a PFIC for any taxable year if either (1) 75% or more of its gross income consists of certain types ofpassive income or (2) 50% or more of the average quarterly value of its assets (as generally determined on that basis of fair market value) during such yearproduce or are held for the production of passive income.If we were classified as a PFIC for any taxable year during which a U.S. Holder (as defined in Item 10. Additional Information—E. Taxation—United States Federal Income Tax Considerations) holds our ADSs or common shares, such U.S. Holder may incur significantly increased United Statesincome tax on gain recognized on the sale or other disposition of the ADSs or common shares and on the receipt of distributions on the ADSs or commonshares to the extent such gain or distribution is treated as an “excess distribution” under the United States federal income tax rules. Further, if we are classifiedas a PFIC for any year during which a U.S. Holder holds our ADSs or common shares, we generally will continue to be treated as a PFIC for all succeedingyears during which such U.S. Holder holds our ADSs or common shares (“PFIC Tainted Shares”) even if, we, in fact, cease to be a PFIC in subsequent taxableyears. Accordingly, a U.S. Holder of our ADSs or common shares is urged to consult its tax advisor concerning the United States federal income taxconsiderations related to holding and disposing of ADSs or common shares (including, to the extent an election is available, making a “mark-to-market”election to avoid owning PFIC-Tainted Shares and the unavailability of an election to treat us as a qualified electing fund). For more information see thesection titled “Item 10. Additional Information—E. Taxation—United States Federal Income Tax Considerations—Passive Foreign Investment CompanyConsiderations.” 52Table of ContentsItem 4.Information on the Company A.History and Development of the CompanyWe commenced operations in January 2003 through the establishment of Shenzhen Xunlei Networking Technologies Co., Ltd., or ShenzhenXunlei. Shenzhen Xunlei, together with its various subsidiaries in the PRC, currently operate our Xunlei internet platform.In February 2005, we established Xunlei Limited as our holding company in the Cayman Islands. Xunlei Limited directly owns Giganology(Shenzhen) Ltd., or Giganology Shenzhen, our wholly owned subsidiary in China established in June 2005. Giganology Shenzhen primarily engages in theresearch and development of new technologies.Giganology Shenzhen has entered into a series of contractual arrangements with Shenzhen Xunlei and its shareholders. These contractualarrangements enable us to exercise effective control over Shenzhen Xunlei and receive substantially all of the economic benefits of Shenzhen Xunlei. As aresult, Shenzhen Xunlei is our variable interest entity, or VIE, and we have consolidated the financial results of Shenzhen Xunlei and its subsidiaries in ourconsolidated financial statements in accordance with U.S. GAAP. The existing principal subsidiaries of Shenzhen Xunlei include the following: • Shenzhen Fengdong Networking Technologies Co., Ltd., which was established in December 2005, and it primarily engages in softwaredevelopment. • Shenzhen Xunlei KanKan Information Technologies Co., Ltd. (formerly named as 155 Networking (Shenzhen) Co., Ltd.), which wasestablished in August 2008, and it primarily engages in software development. • Xunlei Networking Technologies (Beijing) Co., Ltd., which was established in June 2009, and it primarily engages in the operating ofProject Crystal as well as software development. • Xunlei Software (Shenzhen) Co., Ltd., which was established in January 2010, and it primarily engages in the development of softwaretechnology and the development of computer software. • Xunlei Games Development (Shenzhen) Co., Ltd., which was established in February 2010, and it primarily engages in the developmentof online game and computer software and advertising services; and • Shenzhen Wangxin Technologies Co., Ltd., which was established in September 2013, and it has not started operation as of the date ofthis annual report and it will engage in sales and marketing activities of our services and products.In February 2011, we established a direct wholly owned subsidiary, Xunlei Network Technologies Limited, or Xunlei Network BVI, in theBritish Virgin Islands. In March 2011, we established Xunlei Network Technologies Limited, or Xunlei Network HK, in Hong Kong, which is the directwholly owned subsidiary of Xunlei Network BVI. Xunlei Network HK primarily engages in the development of computer software and advertising services. 53Table of ContentsIn November 2011, we established Xunlei Computer (Shenzhen) Co., Ltd., or Xunlei Computer, in China, which is the direct wholly ownedsubsidiary of Xunlei Network HK. Xunlei Computer primarily engages in the development of computer software and information technology services.In June 2014, we completed our initial public offering, in which we offered and sold 42,061,250 common shares in the form of ADSs inclusive ofthe over-allotment option. The ADSs, each representing five of our common shares, are listed on the NASDAQ Global Select Market under the symbol“XNET.”In September 2014, we, through Shenzhen Xunlei Network Technology Co., Ltd., acquired from subsidiaries of Kingsoft Corporation LimitedKuaipan Personal and Kansunzi, both software services in support of cloud-sourced storage and sharing, and their related business and assets, for an aggregatecash consideration of US$33 million.On March 31, 2015, we entered into a legally binding framework agreement with Beijing Nesound International Media Corp., Ltd., or Nesound,an independent third party, to sell our entire stake in Xunlei Kankan for a consideration of RMB130 million. Nesound has paid a deposit of RMB26 millionas of the date of this annual report. The completion of the transaction is subject to the signing of a definitive purchase agreement and fulfilling closingconditions contained therein, which may include the completion of a specific research and development project, the transfer of domain name, other assets andcertain liabilities and businesses of Xunlei Kankan, and the application for the transfer of permits and licenses required for Xunlei Kankan’s operations. If thetransaction fails to close due to the fault of either us or Nesound, including the failure to meet closing conditions, the responsible party shall be liable to payan additional fee of RMB52 million on top of the RMB26 million deposit. This proposed sale is part of our strategy to streamline our business and continueour transition into mobile internet. Our board approved the transaction after considering the benefits of the transaction to our company and shareholders. Weare currently negotiating the specific terms of the sale of Xunlei Kankan, and expect that the sale may be completed within six months of the date of thisannual report. If we completed our proposed sale of Xunlei Kankan, we expect our revenue from online advertising, sublicensing and pay per view willexperience significant decrease. We also expect our content costs to significantly decrease to an immaterial level and our bandwidth costs to decrease,without taking into account the expected growth of our business and cost savings provided by Project Crystal.Our principal executive offices are located at 4/F, Hans Innovation Mansion, North Ring Road, No. 9018 High-Tech Park, Nanshan District,Shenzhen, People’s Republic of China. Our telephone number at this address is +86 755-3391-2900. Our registered office in the Cayman Islands is located atthe offices of Maples Corporate Services Limited, PO Box 309, Ugland House, Grand Cayman, KY1-1104, Cayman Islands. Our agent for service of process inthe United States is Law Debenture Corporate Services Inc.See “Item 5.B. Operating and Financial Review and Prospects—Liquidity and Capital Resources—Capital Expenditures” for a discussion of ourcapital expenditures. B.Business OverviewOverviewWe are a leading Chinese internet company as measured by user base. We had an average of approximately 306 million monthly unique visitorsin 2014, according to iResearch. Digital media content is one of the most popular usages for internet users in China. We operate a powerful internet platformin China based on cloud computing to enable users to quickly access, manage, and consume digital media content. We are increasingly expanding to mobiledevices in part through potentially pre-installed acceleration products in mobile phones to further expand our user base and offer our users a wider range ofaccess points. We target to deliver superior user experience in terms of ease of access, management and consumption of digital media content anywhere,anytime, and on any device. 54Table of ContentsTo address deficiencies of digital media transmission over the internet in China, such as low speed and high delivery failure rates, we provideusers with quick and easy access to online digital media content through two core products and services: • Xunlei Accelerator, which enables users to accelerate digital transmission over the internet, is our most popular and free product,approximately 194 million monthly unique visitors in December 2014, according to the iResearch Report. Xunlei Accelerator enjoys amarket share of 84.1% based on the number of launches among all transmission and acceleration products in China in December 2014,according to iResearch; and • Our cloud acceleration subscription services, delivered through products such as Green Channel, Offline Accelerator and Yunbo, offerusers premium services for speed and reliability, and have attracted approximately 4.94 million subscribers as of December 31, 2014.Benefitting from the large user base for our core product, Xunlei Accelerator, we have further developed various value-added services to meet afuller spectrum of our users’ digital media content access and consumption needs including (i) online game services, including web games and MMOGs,offered on our gaming platform; (ii) pay per view services, providing access to premium content for a fee and (iii) Xunlei Kankan, where users can watch whatthey want for free from our comprehensive content library. As part of our strategy to streamline our business, we are in the process of divesting Xunlei Kankanto an independent third party; see “Item 4. Information on the Company—A. History and Development of the Company .”We are increasingly extending our services to mobile devices, as part of our cloud-based mobile strategies. We target to make our mobileapplications the central user interface for accessing and managing digital media content in a synchronized manner. Since 2012, we have entered into a pre-installing service agreement with a Xiaomi group company which manufactures Xiaomi phones, a well-recognized brand of smart phones in China. Pursuantto the agreement, we agree to provide our Xunlei mobile acceleration applications, and the mobile phone manufacturer agrees to install such applications onits phones, free of charge. Such pre-installment arrangement provides mobile phone users with access to our acceleration services, which we believe enhancesour ability to generate more user traffic. Our mobile acceleration software has been officially adopted by Xiaomi’s latest operating system, MIUI6, since theend of 2014, and as of the end of February 2015, the software has been installed on Xiaomi phones, including both new phones shipments and systemupgrades from existing Xiaomi phones. We intend for our mobile strategy, combined with our success on PC internet, to provide a seamless user experienceto access digital media content regardless of device or location.An important part of our strategies is to continue our ongoing innovation in crowdsourcing for idle bandwidth and potentially storage from ourusers in the form of Project Crystal, which targets to utilize our users’ computing power for bandwidth and storage in the same way our traditionalacceleration products utilize users’ computing power for downloading. We plan for crowdsourced bandwidth to supply an increasing percentage of thebandwidth that we use for our own acceleration services, and we also intend to sell crowdsourced bandwidth to third party internet content providers withbandwidth demand.The technological backbone of our products and services is our cloud acceleration technology, comprised of a proprietary file locating systemand massive file index database. Our technology enables us to support greater user expansion with incremental increases in server and bandwidth costs. Thistechnology, based on distributed computing architecture, along with our indexing technology, enables users to access content in an efficient manner. 55Table of ContentsWe generated revenues by monetizing our large user base, primarily through the following services: • Cloud acceleration subscription services. We provide premium acceleration services for subscribers to enable faster and more reliableaccess to digital media content; • Online advertising services. We offer advertising services by providing marketing opportunities on our online video streaming websitesand platform to our advertisers; and • Other internet value-added services. We offer multiple other value-added services to our users, including online games and pay per viewservices.Our revenues increased from US$148.2 million in 2012 to US$180.2 million in 2013 and US$182.9 million in 2014. We had net incomeattributable to Xunlei Limited of US$0.5 million, US$10.7 million and US$10.8 million in 2012, 2013 and 2014, respectively.Our platformOn our platform, users can accelerate digital media transmission and play a broad range of the latest online games, among other things.Cloud acceleratorAcceleratorWe launched our core product, Xunlei Accelerator, in 2004 to address deficiencies of digital media content transmission over internet in China,such as low speed and high delivery failure rates. Xunlei Accelerator allows users to accelerate digital transmission over the internet for free. XunleiAccelerator also bridges users with diverse needs to other services we offer, such as: our Xunlei Kankan website, which provides high-definition online video;Xunlei Media Player, which supports both online and offline video watching and our various online games, including web games and MMOGs, byrecommending and providing links to these services on its user interface.Xunlei Accelerator is designed to provide an effective digital media content transmission solution to our users. In addition to our featuredtransmission acceleration function, we have integrated certain features into the interface of Xunlei Accelerator to enhance the overall user experience whilehelping users transmit their desired content efficiently. For example, Xunlei Accelerator provides a platform to integrate other third-party plug-inapplications. Users can add application tabs to create shortcuts to various services that are provided by us, third-party application developers and applicationvenders who have business relationships with us. Xunlei Accelerator also has a task management console to allow users to track and manage theirtransmissions in progress, to manage and prioritize cloud-based data transmission tasks, or manage and synchronize transmitted content across multipleinternet-enabled devices.In September 2014, we acquired Kuaipan Personal and Kansunzi, two software services in support of cloud-sourced storage and sharing. Weintend to utilize such software to further enhance the customer experience associated with our accelerator. 56Table of ContentsMobile acceleration applicationThrough our mobile acceleration application, we enable our users to benefit from acceleration and higher download success rate, the samebenefits offered by Xunlei Accelerator for PCs, on mobile devices. Under our pre-installment service agreement with smartphone maker Xiaomi, Xiaomiinstalls Xunlei mobile acceleration applications on all of its phones free of charge, and Xiaomi phone users have access to our acceleration services. Ourmobile acceleration software was officially adopted by Xiaomi’s latest operating system, MIUI6, in 2014, and installed on Xiaomi phones. Our installed basefor mobile acceleration software comes from new phone shipments and systems upgrade from existing Xiaomi phones.Subscription servicesWe charge monthly or annual fees for our premium cloud acceleration subscription services and other exclusive services at different VIP levels.The benefits and services within the subscription package, which typically include incrementally larger bandwidth and faster acceleration speed, areupgraded according to the VIP levels. The subscription fees generally remain unchanged for subscribers at higher VIP levels. Our cloud accelerationsubscription services are delivered through the following major premium acceleration products: Type of Service Description of ServicesGreen Channel This product allows our subscribers to transmit digital media files from the internet with the facilitation of our servers, whichsignificantly improves speed and reliability of such transmission. This is particularly helpful when subscribers need to transmitfiles that are only available from slow or unreliable data transmission sources, or to transmit a group of files while having onlylimited internet connectivity time.Offline Accelerator This product allows our subscribers to engage us to transmit digital media files from the internet on their behalf. The transmittedfiles are temporarily cached on our servers, which the subscribers have easy access to and can consume and manage when theywant within a limited period of time.Yunbo This product allows our subscribers to watch digital media content without transmitting the files to their own devices. Thesubscribers can enjoy the content without incurring burden to recourses on their devices.We adopted different strategies and various promotion programs for each VIP level. For example, when we discovered that some of our users werenot aware of our subscription services, we provided users with greater exposure to our subscription services in different parts of our platform and promotedproducts with significant potential interests to specific users. We use our powerful digital data analysis capabilities to explore different areas of user needspreviously unmet by existing functions and research and develop relevant functions based on such analysis. We offer users promotional measures, such asproviding 120 seconds of free trials of premium acceleration services, to show the differences in the data transmission speeds to demonstrate how ourpremium services tremendously enhance data delivery speed and overall subscriber experience. 57Table of ContentsXunlei MobileXunlei Mobile is a mobile application that allows users to search and download content on their mobile devices. The application is an important partof our transition into mobile internet and, along with our mobile acceleration application, constitute one of the several important products to drive ourmobile strategy, especially now that mobile devices have bigger screens and increasingly bigger storage space and given the increasing number of mobileusers and their increasing need for reliable downloading services on their mobile phones. The daily active user of this product has surprised 6 million as ofthe end of February 2015.We plan to continue to develop partnerships with smartphone makers in China to increase the popularity of Xunlei mobile products, as we believe thatsuch partnerships would be crucial for us to develop direct interface with users and to gain awareness and explore potential monetization of our mobileproducts.Online video streaming websiteWe provide online video streaming services through our Xunlei Kankan website at www.kankan.com to enable our users to watch high-definition video in streaming form for free. The comprehensive content library of Xunlei Kankan consists primarily of licensed long-form videos, includingmovies, television series, variety shows and animations. The transmission of online video is supported by our distributed computing capacity, which reducesour infrastructure construction costs, such as bandwidth and server costs. As of December 31, 2014, we held licenses to online videos consisting ofapproximately 2,600 movie titles, 770 television series and over 1,800 other types of shows. We differentiate Xunlei Kankan and the viewing experience itdelivers by focusing on providing high-definition content. We had established long-term relationships with more than 280 professional media data providersas of December 31, 2014, either directly or through third-party copyright distributors. Other than free videos, we also offer pay per view premium videoswhich charge users different amount of fees for every video they watch and access. We provide pay per view services on subscription basis to encourage usersto visit Xunlei Kankan’s website more frequently. As of December 31, 2014, we had approximately 250,000 pay per view monthly subscribers on XunleiKankan and approximately 47% of these pay per view subscribers were also subscribers for Xunlei’s acceleration services.As part of our continuing strategy to streamline our business, we have entered into a legally binding framework agreement, dated as of March 31,2015, to sell our entire stake in Xunlei Kankan to an independent third party. For details, see “Item 4. Information on the Company — A. History andDevelopment of the Company.”Xunlei Media PlayerWe launched Xunlei Media Player in 2008 as a supplementary tool to help deliver a more comprehensive viewing experience of digital mediacontent to the users of both Xunlei Accelerator and Xunlei Kankan. Xunlei Media Player is our proprietary product that supports both online and offline playof digital media content as well as simultaneous play of digital media content while it is being transmitted by Xunlei Accelerator.Online game servicesTo better serve our users, we offer online games through our online game website and purchase licenses from, or enter into revenue sharingarrangements with, game developers. Such game play platform helps raise the average spending of our subscribers. Online game players can play the gamesfree of charge, but are offered the opportunity to purchase in-game virtual items for a fee to enhance their game-playing experience. 58Table of ContentsWe also provide other ancillary services catering to users’ needs and adjust our ancillary service offerings from time to time to supplement themajor services we provide.Project CrystalProject Crystal is our ongoing innovation in crowdsourcing idle bandwidth and potentially storage from our existing user base, by providingcrowd-sourced bandwidth at a more competitive rate without investing in hard assets. This project grew from our traditional technology for XunleiAccelerator, which utilizes users’ computing power to enhance download speed. Through Project Crystal, we have become an innovative bandwidthprovider, and the project is intended for our users to benefit from the increasing demand for bandwidth from ever-growing online content consumption in theinternet in China. We plan for crowdsourced bandwidth to supply a portion of the bandwidth that we use for our own acceleration services; instead of relyingentirely on bandwidth purchased from traditional third party carriers, we are now able to source some of the bandwidth we use from Project Crystal. Currently,we pay participants in the crowdsourcing efforts of Project Crystal market rates for the use of their bandwidth, but in the future, we plan to continue to scalethe magnitude of the bandwidth we can crowdsource and to sell crowdsourced bandwidth to third party internet content providers with bandwidth demand.TechnologyWe provide accelerated data transmission services, available on PC and mobile devices, based on our distributed file locating system, designedto utilize our proprietary file indexing technology.Indexing technologyKey elements of our file indexing technology include:File indexing. We have created, and continue to maintain, a proprietary file index database that stores a massive index of unique file signaturesrepresenting all digital media content file that Xunlei Accelerator has found across the internet. Each file signature uniquely identifies the index of a givenfile. We store a list of each unique file’s available data transmission locations from across the internet, which may include both peer and server computers,along with the estimated speed and reliability of each location.Data mining. We also employ data mining algorithms, studying user habits in order to maximize the speed of our data delivery by ranking thekeyword indexes that users search for and placing digital media content more likely to be searched by users in the more easily accessible locations in ournetwork for optimal delivery speed. As of December 31, 2014, our file index contained over 7.0 billion digital media content files available on third-partyservers and PCs connected to our distributed file locating system.Distributed internet crawling techniques. Our Xunlei Accelerator network acts as a system of distributed spiders to crawl the internet to searchfor digital media content files. Whenever the user initiates data transmission by using our Xunlei Accelerator, the URL of the data transmission location isuploaded to our server. We then use that URL to traverse and locate any other digital media content files that may also be available from the URL’s internetpage repositories. We then update our file index according to each traversal result. 59Table of ContentsDistributed file locating systemOur distributed file locating system is based on distributed computing architecture, which consists of all Xunlei Accelerator clients that arerunning and connected to the internet at a given time, along with the server addresses stored in our file index database. When users launch Xunlei Acceleratoron a network-connected device, they are automatically connected to our distributed file locating system and contribute their bandwidth and computingpower to our distributed file locating system, which enables users to locate and connect efficiently. Key technologies include:Multi-protocol file transfer technology. Our multi-protocol file transfer technology allows our product client to transmit, in parallel, frommultiple sources that may use different file transfer protocols. Our multi-protocol file transfer technology significantly increases the number of datatransmission sources available to further enhance data transmission performance.Distributed file locating system. Our distributed file locating system helps users discover the best data transmission locations from across theinternet, where a particular file may be transmitted or streamed for optimal performance. When a user requests data transmission using our Xunlei Accelerator,distributed file locating system will algorithmically prioritize and select from among the file’s available data transmission locations an optimized subset ofURLs based on their respective transmit speed and reliability, which is estimated through real-time collaborative interactions between our file index serverand our massive network of active Xunlei Accelerator clients across the internet.Network transport and traversal optimization. Our proprietary software algorithms perform dynamic internet bandwidth and throughputassessments across the Xunlei network and optimization of traffic routing to identify the most efficient path for data transport. These algorithms are designedto maximize delivery speed, reliability and efficiency, and support significant growth in network usage.Cloud-based implementationWe provide cloud acceleration subscription services powered by our indexing technology and distributed file locating system. Our platform iscompatible with different operating systems and hardware devices. As part of the infrastructure for the subscription services, except for proprietary loadbalancing and resource optimization algorithms, we maintain a virtual private network consisting of 42 co-location centers and over one million third partyservers and over 8,000 servers that we own located throughout China. 60Table of ContentsWe maintain proprietary load balancing and resource optimization algorithms, both of which help enhance our mass data mining on user habitsto compile and maintain information on users’ data transmission acceleration needs and requirements. As a cloud service provider, we use data mining foruser habit prediction and co-location purposes. In user habit prediction, we analyze, sample and index user behavior data to help predict user accelerationneeds and requirements. For co-location purposes, our program finds the most efficient and stable connection in our network for each transmission task. Wealso cooperate with telecom operators, maintaining logics and algorithms for our co-location centers in each telecom operator’s network to enable real-timedynamic allocation of our servers and bandwidth to support user acceleration requirements. Our system automatically optimizes user connections based onkey factors such as provincial network, firewall penetration and interconnection among various telecom operators.Advertising servicesOnline advertising has historically been a significant source of revenues for us. We provide advertising services primarily through various formsof advertisements placed on Xunlei Kankan. We had 399 advertisers in 2013 and 252 advertisers in 2014. Our brand advertisers include international anddomestic companies that operate in a variety of industries. A significant majority of our advertisers purchase our online advertising services through third-party advertising agencies.We focus on providing advertisers with creative and cost-effective advertising solutions. We strive to creatively utilize our integrated serviceinterface in designing a particular advertising campaign for our online advertisers. For example, we not only can deliver different forms of in-video anddisplay advertisements on Xunlei Kankan, but also can design tailored theme skins to be installed by our Xunlei Media Player users. We offer advertisementswith noticeable visual impact on Xunlei Kankan, such as high-definition background advertisements that border the video screen during the streaming andviewing of the video.MarketingOur user base has grown primarily through word-of-mouth. We believe satisfied users and customers are more likely to recommend our servicesto others. Thus, we continue to focus on improving our services and enhancing our user experience. We invest in a variety of marketing activities to furtherpromote our brand awareness among existing and potential users as well as other customers. For example, we host or attend various public relations events,such as seminars, conferences and trade shows, in the advertising, online video and online game industries to attract users and advertisers. To retain and drivethe growth of our subscribers, we market our premium paid services and place subscription advertisements at prominent locations throughout our integratedservice offerings. 61Table of ContentsIntellectual propertyProtection of our intellectual propertyOur patents, copyrights, trademarks, trade secrets and other intellectual property rights are critical to our business. We rely on a combination ofpatent, copyright, trademark, trade secret and other intellectual property-related laws in the PRC and contractual restrictions to establish and protect ourintellectual property rights. In addition, we require all of our employees to enter into agreements requiring them to keep confidential all information theyobtain during the course of their employment relating to our technology, methods, business practices, customers and trade secrets. As of December 31, 2014,we had 47 patents granted in the PRC and four granted in the United States, while another seven patent applications are being examined by the StateIntellectual Property Office of the PRC. We also seek to vigorously protect our Xunlei brand and the brands of our other services. As of December 31, 2014,we have applied to register 170 trademarks, of which we have received 141 registered trademarks in different applicable trademark categories including onetrademark registered with the United States Patent and Trademark Office and one trademark registered with World Intellectual Property Organization.Digital media data monitoring and copyright protectionWe take initiatives to protect third-party copyrights. The internet industry in China suffers from copyright infringement issues and online digitalmedia content providers are frequently involved in litigation based on allegations of infringement or other violations of copyrights. Assisted by anintellectual property team dedicated to copyright protection, we have implemented internal procedures pursuant to the legal requirements under relevantPRC laws and regulations to remove content from our Xunlei Kankan website and our digital media content file index and platform promptly after we receivenotice of infringement from the legitimate rights holder, and we work closely with the relevant regulatory authorities in China to ensure compliance with allrelevant rules and regulations. We seek assurances in our contracts with digital media content providers that (i) they have the legal right to license the digitalmedia data for the uses we require; (ii) the digital media content itself as well as the authorization or rights granted to us neither breach any applicable law,regulations or public morals, nor impair any third-party rights; and (iii) they will indemnify us for losses resulting from both the non-compliance of suchdigital media content with the laws and claims from third parties.As of the date of this annual report, we have implemented several initiatives to further commit to copyright protection. In May 2014, we enteredinto a content protection agreement with the MPAA and its members, which are six major U.S. entertainment content providers. We have agreed to implementa comprehensive system of measures designed to prevent unauthorized downloading of and access to such content providers’ works. Among these contentprotection measures, we have agreed to (1) implement a filtering system that will be applied to these content providers’ video content, (2) filter these contentproviders’ video content prior to making any such content available to our users through our websites or client applications, (3) adopt state-of-the-artfingerprinting-based filtering technologies, (4) cooperate with these content providers going forward to ensure the effectiveness of our content protectionmeasures, and (5) incorporate additional content protection measures to the extent that they are necessary to effectively protect against copyrightinfringement. However, our copyright protection measures would not be able to fully protect us against copyright infringement suits. For example, in January2015, a number of MPAA member studios filed copyright infringement lawsuits against us in the Shenzhen Nanshan District Court in China, and the cases areawaiting trial as of the date of this annual report. For details, see “Item 3. Key Information—D. Risk Factors—Risks related to our business—We face andexpect to continue to face copyright infringement claims and other related claims, including claims based on content available through our services, whichcould be time-consuming and costly to defend and may result in damage awards, injunctive relief and/or court orders, divert our management’s attention andfinancial resources and adversely impact our business” and “Item 8. Financial Information—A. Consolidated Statements and Other Financial Information—Legal Proceedings.” 62Table of ContentsUser data safetyUser data safety is a significant advantage we offer to our users. We try to improve user experience by usually maintaining two to four copies ofone specific user file for data recovery in extreme circumstances such as system shutdown, private transmission backbone network problems and othercontingencies beyond our control. The read and write characteristics of our distributed file locating system is identical to those of hard disks, and our uniqueuser file decomposition and encryption algorithm enables us to maintain high standards for user data safety.CompetitionDue to our multiple service offerings, we face competition in several aspects of the internet services market in China. We believe that the keycompetitive factors in the overall internet services market in China include brand recognition, user traffic, technology platform and monetization abilities.For example, Xunlei Mobile primarily competes with Storm Media Player and Baidu Cloud. Xunlei Kankan primarily competes with other major onlinevideo websites in China such as Youku.com, Tudou.com and iQiyi.com. We also face competition for the advertisement budgets of our advertisers from otherinternet companies and other forms of media.RegulationThis section sets forth a summary of the most significant rules and regulations that affect our business activities in China.Regulation on catalogue relating to foreign investmentInvestment activities in the PRC by foreign investors are subject to the Catalogue for the Guidance of Foreign Investment Industry, or theCatalogue, which was promulgated and is amended from time to time by the Ministry of Commerce and the National Development and Reform Commission,or the NDRC. The Catalogue divides industries into three categories: encouraged, restricted and prohibited. Industries not listed in the Catalogue aregenerally open to foreign investment unless specifically restricted by other PRC regulations.Pursuant to the latest Catalogue amended in March 2015, which took effect on April 10, 2015, the provision of value-added telecommunicationsservices falls in the restricted category and the percentage of foreign ownership cannot exceed 50%. The provision of internet cultural operating service(including online game operation services), internet news service, internet publication service and production and online transmission of audio-visualprograms service fall in the prohibited category and the foreign investors are prohibited to engage in such services. We conduct our operations in Chinaprincipally through contractual arrangements among Giganology Shenzhen, our wholly-owned PRC subsidiary, and Shenzhen Xunlei, our VIE, and itsshareholders. Shenzhen Xunlei holds the licenses and permits necessary to conduct our resource discovery network, online video, online advertising, onlinegames and related businesses in China and holds various operating subsidiaries that conduct a majority of our operations in China. Both of GiganologyShenzhen and Xunlei Computer, another wholly-owned PRC subsidiary of ours, engage in the development of computer software, technical consulting andother related technical services and businesses, none of which falls into any of encouraged, restricted or prohibited categories under the Catalogue. Hence,these activities are deemed as permitted and open to foreign investment.Regulation on telecommunications and internet information servicesThe telecommunications industry, including the internet sector, is highly regulated in the PRC. Regulations issued or implemented by the StateCouncil, MIIT, and other relevant government authorities cover many aspects of operation of telecommunications and internet information services,including entry into the telecommunications industry, the scope of permissible business activities, licenses and permits for various business activities andforeign investment. 63Table of ContentsThe principal regulations governing the telecommunications and internet information services we provide in the PRC include: • Telecommunications regulations (2014, revised), or the Telecom Regulations. The Telecom Regulations categorize all telecommunicationsbusinesses in the PRC as either basic or value-added. Value-added telecommunications services are defined as telecommunications andinformation services provided through public network infrastructures. The “Catalog of Telecommunications Business,” an attachment to theTelecom Regulations and updated by MIIT’s Notice on Adjusting the Catalog of Telecommunications Business effective from April 1, 2003,categorizes various types of telecommunications and telecommunications-related activities into basic or value-added telecommunicationsservices, according to which, internet information services, or ICP services, are classified as value-added telecommunications businesses. Underthe Telecom Regulations, commercial operators of value-added telecommunications services must first obtain an ICP License from MIIT or itsprovincial level counterparts. • Administrative measures on internet information services (2011, revised), or the Internet Measures. According to the Internet Measures, acommercial ICP service operator must obtain an ICP License from the relevant government authorities before engaging in any commercial ICPservice within the PRC. When the ICP service involves areas of news, publication, education, medical treatment, health, pharmaceuticals,medical equipment and other industry and if required by law or relevant regulations, prior approval from the respective regulating authoritiesmust be obtained prior to applying for the ICP License from MIIT or its local branch at the provincial level. Moreover, an ICP service operatormust display its ICP License number in a conspicuous location on its website and must monitor its website to remove categories of harmfulcontent that are broadly defined. • Administrative measures for telecommunications business operating license (2009, revised), or the Telecom License Measures. The TelecomLicense Measures set forth more specific provisions regarding the types of licenses required to operate value-added telecommunications services,the qualifications and procedures for obtaining such licenses and the administration and supervision of such licenses. For example, an ICPservice operator conducting business within a single province must apply for the ICP License from MIIT’s applicable provincial levelcounterpart, while an ICP service operator providing ICP services across provinces must apply for a Trans-regional ICP License directly fromMIIT. An ICP service operator that has been granted a Trans-regional ICP License must file a record with the local branch of MIIT at theprovincial level prior to conducting any value added telecommunications business in such provinces. The appendix to the ICP License mustdetail the permitted activities to be conducted by the ICP service operator. An approved ICP service operator must conduct its business inaccordance with the specifications recorded on its ICP License. The ICP License is subject to annual review and the annual review result will berecorded as an appendix to the ICP License, published to the public and notified to the applicable administrative authority for industryand commerce. • Detailed rules on the administration of internet websites (2005), which set forth that the website operator is required to apply for the ICP filingfrom MIIT or its local branches at the provincial level on its own or through the access service provider. 64Table of Contents • Regulations for administration of foreign-invested telecommunications enterprises (2008, revised), or the FITE Regulations. The FITERegulations set forth detailed requirements with respect to, among others, capitalization, investor qualifications and application procedures inconnection with the establishment of a foreign-invested telecommunications enterprise. Under the FITE Regulations, a foreign entity isprohibited from owning more than 50% of the total equity interest in any value-added telecommunications service business in the PRC and themajor foreign investor in any value-added telecommunications service business in the PRC shall have good and profitable records and operatingexperiences in such industry. • Circular on strengthening the administration of foreign investment in and operation of value-added telecommunications business (2006).Under this circular, a domestic PRC company that holds an ICP License is prohibited from leasing, transferring or selling the ICP License toforeign investors in any form, and from providing any assistance, including providing resources, sites or facilities, to foreign investors thatconduct value-added telecommunications business illegally in the PRC. Further, the domain names and registered trademarks used by anoperating company providing value-added telecommunications service shall be legally owned by such company and/or its shareholders. Inaddition, such company’s operation premises and equipment should comply with the approved covering region on its ICP License, and suchcompany should establish and improve its internal internet and information security policies and standards and emergency managementprocedures.To comply with these PRC laws and regulations, we operate our websites through Shenzhen Xunlei, our PRC variable interest entity. ShenzhenXunlei currently holds an ICP License expiring on April 30, 2020 for the provision of internet information services and also a value-addedtelecommunication license for the provision of internet data center services and internet access services expiring on March 10, 2020, and owns the essentialtrademarks and domain names in relation to our value-added telecommunications business.Under various laws and regulations governing ICP services, ICP services operators are required to monitor their websites. They may not produce,duplicate, post or disseminate any content that falls within the prohibited categories and must remove any such content from their websites, including anycontent that: • opposes the fundamental principles determined in the PRC’s Constitution; • compromises state security, divulges state secrets, subverts state power or damages national unity; • harms the dignity or interests of the State; • incites ethnic hatred or racial discrimination or damages inter-ethnic unity; • sabotages the PRC’s religious policy or propagates heretical teachings or feudal superstitions; • disseminates rumors, disturbs social order or disrupts social stability; • propagates obscenity, pornography, gambling, violence, murder or fear or incites the commission of crimes; • insults or slanders a third party or infringes upon the lawful rights and interests of a third party; or • includes other content prohibited by laws or administrative regulations. 65Table of ContentsThe PRC government may shut down the websites of ICP License holders that violate any of such content restrictions and requirement, revoketheir ICP Licenses or impose other penalties pursuant to applicable law. To comply with these PRC laws and regulations, we have adopted internalprocedures to monitor content displayed on our website.Regulation on online transmission of audio-visual programsOn July 6, 2004, GAPPRFT promulgated the Measures for the Administration of Publication of Audio-visual Programs through Internet or OtherInformation Network, or the 2004 Internet A/V Measures, which apply to the activities relating to the opening, broadcasting, integration, transmission ordownload of audio-visual programs via internet or other information network. An applicant who engages in the business of transmitting audio-visualprograms must apply for a license issued by GAPPRFT in accordance with the categories of business, receiving terminals, transmission networks and otheritems. Foreign invested enterprises are not allowed to engage in the above business. On April 13, 2005, the State Council promulgated the Certain Decisionson the Entry of the Non-State-owned Capital into the Cultural Industry. On July 6, 2005, MOC, GAPPRFT, the NDRC and the Ministry of Commerce, jointlyadopted the Several Opinions on Canvassing Foreign Investment into the Cultural Sector. According to these regulations, non-State-owned capital andforeign investors are not allowed to conduct the business of transmitting audio-visual programs via information network.On December 20, 2007, GAPPRFT and MIIT jointly promulgated the Administrative Provisions on Internet Audio-visual Program Service, orthe Audio-visual Program Provisions, which came into effect on January 31, 2008. The Audio-visual Program Provisions apply to the provision of audio-visual program services to the public via internet (including mobile network) within the territory of the PRC. Providers of internet audio-visual programservices are required to obtain a License for Online Transmission of Audio-visual Programs issued by GAPPRFT or complete certain registration procedureswith GAPPRFT. Providers of internet audio-visual program services are generally required to be either State-owned or State-controlled by the PRCgovernment, and the business to be carried out by such providers must satisfy the overall planning and guidance catalog for internet audio-visual programservices determined by GAPPRFT. In a press conference jointly held by GAPPRFT and MIIT to answer questions with respect to the Audio-visual ProgramProvisions in February 2008, GAPPRFT and MIIT clarified that providers of internet audio-visual program services who engaged in such services prior to thepromulgation of the Audio-visual Program Provisions shall be eligible to register their business and continue their operation of internet audio-visual programservices so long as those providers had not been in violation of the laws and regulations.On May 21, 2008, GAPPRFT issued a Notice on Relevant Issues Concerning Application and Approval of License for Online Transmission ofAudio-visual Programs, which further sets forth detailed provisions concerning the application and approval process regarding the License for OnlineTransmission of Audio-visual Programs. The notice also provides that providers of internet audio-visual program services who engaged in such services priorto the promulgation of the Audio-visual Program Provisions shall also be eligible to apply for the license so long as their violation of the laws andregulations is minor and can be rectified timely and they have no records of violation during the latest three months prior to the promulgation of the Audio-visual Program Provisions.On December 28, 2007, GAPPRFT issued the Notice on Strengthening the Administration of TV Dramas and Films Transmitted via the Internet,or the Notice on Dramas and Films. According to this notice, if audio-visual programs published to the public through an information network fall under thefilm and drama category, the requirements of the Permit for Issuance of TV Dramas, Permit for Public Projection of Films, Permit for Issuance of Cartoons oracademic literature movies and Permit for Public Projection of Academic Literature Movies and TV Plays will apply accordingly. In addition, providers ofsuch services should obtain prior consents from copyright owners of all such audio-visual programs. 66Table of ContentsFurther, on March 31, 2009, GAPPRFT issued the Notice on Strengthening the Administration of the Content of Internet Audio-visual Programs,or the Notice on Content of A/V Programs which reiterates the requirement of obtaining the relevant permit of audio-visual programs to be published to thepublic through information network, where applicable, and prohibits certain types of internet audio-visual programs containing violence, pornography,gambling, terrorism, superstition or other hazardous factors. In addition, on August 14, 2009, GAPPRFT issued the Notice on Relevant Issues RegardingStrengthening of the Administration of Internet Audio/visual Program Services Received by Television Terminals, which specifies that prior to providingaudio-visual program services for television terminals, an ICP service operator shall obtain the License for Online Transmission of Audio-visual Programscontaining the scope of “Integration and Operation Services of Audio-visual Programs Received by Television Terminals.” On April 1, 2010, GAPPRFTissued the Internet Audio/Visual Program Services Categories (Provisional), or the Provisional Categories, which classified internet audio-visual programsinto four categories. However, at this stage, the Provisional Categories do not include internet television or mobile television, and it is unclear as to how thecategorization system under the newly adopted Provisional Categories will be enforced or how will it evolve. To comply with these laws and regulations,Shenzhen Xunlei holds a License for Online Transmission of Audio-visual Programs which was updated in February 2012 with an effective period fromFebruary 29, 2012 to February 28, 2015. We have applied for the update of such license to cover the website of www.xunlei.com, the terminals of mobiledevices and TVs and to cover all of our current business activities, such as the transmission of political news. See “Risk factors—Risks related to our business—We are strictly regulated in China. Any lack of requisite licenses or permits applicable to our business and any changes in government policies orregulations may have a material and adverse impact on our business, financial condition and results of operations.”Regulation on foreign movies and television programsBroadcast of foreign movies and television programs is strictly regulated by GAPPRFT. On August 11, 1997, the State Council promulgated theAdministrative Regulations on Television and Radio, under which any foreign television drama or other foreign television program to be broadcast bytelevision or radio stations shall be subject to the prior inspection and approval by GAPPRFT or its authorized agencies. On December 25, 2001, the StateCouncil promulgated the Administrative Provisions on Films, under which any foreign films to be published or shown in public shall also be subject to theprior inspection and approval by GAPPRFT or its authorized agencies.In addition, on September 23, 2004, GAPPRFT promulgated the Administrative Regulations on the Introduction and Broadcasting of ForeignTelevision Programs, pursuant to which only organizations designated by GAPPRFT are qualified to apply to GAPPRFT or its authorized agencies forintroduction or broadcasting of foreign television dramas or foreign television programs. Approval of such application is subject to the general plan ofGAPPRFT and content of such foreign television dramas or programs must not by any means threaten the national security or violate any laws or regulations.In 2007, GAPPRFT issued the Notice on Further Strengthening the Administration of the Introduction and Broadcasting of Foreign Television Programs,emphasizing that the aforesaid regulations must be strictly followed. 67Table of ContentsThe 2004 Internet A/V Measures also explicitly prohibit the internet service providers from broadcasting any foreign television or radio programover the information network and any violation may result in warnings, monetary penalties or criminal liabilities in severe cases. On November 19, 2009,GAPPRFT issued a notice to extend the prohibition of broadcasting foreign television programs to mobile TV. However, pursuant to several notices issued byGAPPRFT, such as the Notice on Dramas and Films and the Notice on Content of A/V Programs referenced above under “—Regulation on onlinetransmission of audio-visual programs,” foreign audio-visual programs may be published to the public through the internet, provided that such foreignaudio-visual programs comply with the regulations on administration of radios, films and television, and that the relevant permits required by PRC laws andregulations, such as the Permit for Issuance of TV Dramas, Permit for Public Screening of Films, Permit for Issuance of Cartoons or academic literature moviesand Permit for Public Screening of Academic Literature Movies and TV Plays, have been obtained for such foreign audio-visual programs. The promulgationof the Notice on Dramas and Films and the Notice on Content of A/V Programs implies that the absolute restriction over broadcasting foreign television orradio programs on the Internet as set forth in the 2004 Internet A/V Measures has been lifted. In September 2014, GAPPRFT issued the Notice on FurtherImplementation of Relevant Provisions on Management of Online Foreign Film and Television Programs, emphasizing that foreign audio-visual programsmay be published through the internet provided that the aforesaid requirements are strictly followed. In addition, under the notice, website operators are eachrequired to file an annual plan in connection with the sourcing of online foreign film and television programs to GAPPRFT, and the total annual volume offoreign film and television programs sourced by a single website must not exceed 30% of the total volume of domestic film and television programsbroadcasted by such website in the last year. Each foreign film and television program is also required to be registered on the “Information RegistrationPlatform for Online Foreign Film and Television Programs” before March 31, 2015, or else it would be prohibited from being published online beginning onApril 1, 2015. In January 2015, GAPPRFT issued the Notice on Carrying Out the Information Declaration and Registration Work in relation to the OnlineForeign Film and Television Programs, further emphasizing and clarifying the registration requirements and procedures for sourcing online foreign film andtelevision programs.We source foreign movies and television programs from various content providers. In dealing with content providers, we seek general assurancein the contracts we enter into with them that the content granted to us shall neither breach any applicable laws, regulations or public morals, nor impair anythird party rights. We also source some foreign audio-visual programs directly from foreign content providers. We are in the process of applying for theapproval and registration for introducing and broadcasting such foreign audio-visual programs in China, but we have not obtained approvals from orregistered with GAPPRFT and cannot assure you that we will be able to obtain such approval in a timely manner. See “Risk factors—Risks related to ourbusiness—We are strictly regulated in China. Any lack of requisite licenses or permits applicable to our business and any changes in government policies orregulations may have a material and adverse impact on our business, financial condition and results of operations.”Regulation on production of radio and television programsOn July 19, 2004, GAPPRFT promulgated the Regulations on the Administration of Production of Radio and Television Programs, or the Radioand TV Programs Regulations, which came into effect as of August 20, 2004. Under the Radio and TV Programs Regulations, any entities that engage in theproduction of radio and television programs are required to apply for a license from GAPPRFT or its provincial branches. Entities with the Permit forProduction and Operation of Radio and TV Programs must conduct their business operation strictly in compliance with the approved scope of production andoperation and other than radio and TV stations, such entities must not produce radio and TV programs regarding current political news or similar subjects andcolumns. Shenzhen Xunlei holds a Permit for Production and Operation of Radio and TV Program which was last updated in September 2012 and will expireon September 24, 2015, with an approved scope of the production of radio plays, TV dramas, animations, featured shows and entertainment programs. 68Table of ContentsRegulation on online cultural activitiesOn February 17, 2011, MOC promulgated the new Provisional Measures on Administration of Internet Culture, or the Internet Culture Measures,which became effective as of April 1, 2011, and the Notice on Issues Relating to Implementing the Newly Amended Provisional Measures on Administrationof Internet Culture on Mar 18, 2011. MOC also abolished the Provisional Measures on Administration of Internet Culture promulgated on May 10, 2003and amended on July 1, 2004 as well as the Notice on Issues Relating to Implementing the Provisional Measures on Administration of Internet Cultureissued on July 4, 2003. The Internet Culture Measures apply to entities that engage in activities related to “online cultural products.” “Online culturalproducts” are classified as cultural products produced, disseminated and circulated via internet which mainly include: (i) online cultural products particularlyproduced for the internet, such as online music entertainment, network games, network performance programs, online performing arts, online artworks andonline animation features and cartoons; and (ii) online cultural products converted from music entertainment, games, performance programs, performing arts,artworks and animation features and cartoons, and disseminated via the internet. Pursuant to these measures, entities are required to obtain relevant OnlineCulture Operating Permits from the applicable provincial level culture administrative authority if they intend to commercially engage in any of the followingtypes of activities: • production, duplication, importation, distribution or broadcasting of online cultural products; • publication of online cultural products on the internet or transmission thereof via information networks such as the internet and the mobilenetworks to computers, fixed-line or mobile phones, television sets or gaming consoles for the purpose of browsing, reviewing, using ordownloading such products by online users; or • exhibitions or contests related to online cultural products.To comply with these then- and currently effective laws and regulations, Shenzhen Xunlei holds an Online Culture Operating Permit which wasupdated in September 2013 with an effective period from March 15, 2013 to March 15, 2016 for the operating of online games (including issuance of virtualcurrency), music entertainment products and animation and comic and Xunlei Games obtained an Online Culture Operating Permit in July 2013 with aneffective period from July 30, 2013 to July 30, 2016 for the operating of online games (including issuance of virtual currency).Regulation on online gamesMOC is the government agency primarily responsible for regulating online games in the PRC. On June 3, 2010, MOC promulgated theProvisional Measures on the Administration of Online Games, pursuant to which the content of the online games are subject to the review of MOC. Thesemeasures set forth a series of prohibitions regarding the content of the online games, including but without limitation the prohibition on content that opposethe fundamental principles stated in the PRC Constitution, compromise state security, divulge state secrets, subvert state power or damage national unity, andcontent that is otherwise prohibited by laws or administrative regulations. Moreover, in accordance with these measures, ICP service operators engaging inany activities involving the operation of online games, issuance or trading of virtual currency must obtain the Online Culture Operating Permit and handlethe censorship procedures for imported online games and the filing procedures for domestically developed online games with MOC and its provincialcounterparts. The procedures for the censorship of imported online games must be conducted with MOC prior to the commencement date of the onlineoperation and the filing procedures for domestic online games must be conducted with MOC within 30 days after the commencement date of the onlineoperation or the occurrence date of any material alteration of such online games. Regarding virtual currency trading, ICP service operators can only issuevirtual currency in exchange of the service provided by itself rather than trading for service or products provided by third parties. ICP service operatorscannot appropriate the advance payment by the players and are not allowed to provide trading service of virtual currency to minors. All the transactions inthe accounts shall be kept in records for a minimum of 180 days. To comply with these laws and regulations, Shenzhen Xunlei and Xunlei Games haveobtained the Online Culture Operating Permit respectively for operating online games. 69Table of ContentsFurther, the online publication of online games is subject to the regulation of GAPPRFT under the Tentative Administration Measures onInternet Publication and ICP service operators must obtain the Internet Publication License prior to provision of any online game services. On September 28,2009, GAPPRFT, the National Copyright Administration and the National Office of Combating Pornography and Illegal Publications jointly published theNotice Regarding the Consistent Implementation of the “Stipulations on ‘Three Provisions’ of the State Council and the Relevant Interpretations of theState Commission Office for Public Sector Reform and the Further Strengthening of the Administration of Pre-examination and Approval of Internet Gamesand the Examination and Approval of Imported Internet Games”, or the Notice of Three Provisions and Internet Games, which expressly requires that allonline games need to be screened by GAPPRFT through the advanced approvals before they are operated online, and any updated online game versions orany change to the online games shall be subject to further advanced approvals before they can be operated online. In addition, foreign investors areprohibited from operating online games by the forms of Sino-foreign joint ventures, Sino-foreign cooperatives and wholly foreign-owned enterprises. Theindirect functions such as contractual control and technology supply are also prohibited.Our online games services are currently provided by Shenzhen Xunlei and Xunlei Games. Shenzhen Xunlei holds an Internet PublicationLicense and Xunlei Games is in the process of applying for an Internet Publication License from GAPPRFT for its publication of online games. We alsorequire the developers of certain online games to obtain the requisite approvals of relevant online games from GAPPRFT, and make the filings with MOC, forrelevant online games. See “Risk factors—Risks related to our business—We may not be able to successfully address the challenges and risks we face in theonline games market, such as a failure to successfully implement our plan to acquire exclusive rights to operate and sub-license games or to obtain all thelicenses required to operate online games, which may subject us to penalties from relevant authorities, including the discontinuance of our online gamebusiness.”Regulation on anti-fatigue system, real-name registration system and parental guardianship projectIn April 2007, GAPPRFT and several other government agencies issued a circular requiring the implementation of an anti-fatigue system and areal-name registration system by all PRC online game operators to curb addictive online game playing by minors. Under the anti-fatigue system, three hoursor less of continuous playing by minors, defined as game players under 18 years of age, is considered to be “healthy,” three to five hours to be “fatiguing,”and five hours or more to be “unhealthy.” Game operators are required to reduce the value of in-game benefits to a minor player by half if the minor hasreached the “fatiguing” level, and to zero once reaching the “unhealthy” level. 70Table of ContentsTo identify whether a game player is a minor and thus subject to the anti-fatigue system, a real-name registration system must be adopted torequire online game players to register their real identity information before playing online games. The online game operators are also required to submit theidentity information of game players to the public security authority for verification. In July 2011, GAPPRFT, together with several other governmentagencies, jointly issued the Notice on Initializing the Verification of Real-name Registration for the Anti-Fatigue System on Online Games, or the Real-nameRegistration Notice, to strengthen the implementation of the anti-fatigue and real-name registration system. The main purpose of the Real-name RegistrationNotice is to curb addictive online game playing by minors and protect their physical and mental health. This notice indicates that the National CitizenIdentity Information Center of the Ministry of Public Security will verify identity information of game players submitted by online game operators. The Real-name Registration Notice also imposes stringent penalties on online game operators that do not implement the required anti-fatigue and real-nameregistration systems properly and effectively, including terminating their online game operations.In January 2011, MOC, together with several other government agencies, jointly issued a Circular on Printing and Distributing ImplementationScheme regarding Parental Guardianship Project for Minors Playing Online Games to strengthen the administration of online games and protect thelegitimate rights and interests of minors. This circular indicates that online game operators must have person in charge, set up specific service webpages andpublicize specific hotlines to provide parents with necessary assistance to prevent or restrict minors’ improper game playing behavior. Online game operatorsmust also submit a report regarding its performance under the Parental Guardianship Project to the local MOC office each quarter.We have developed and implemented an anti-fatigue and compulsory real-name registration system in our online games, and will cooperate withthe National Citizen Identity Information Center to launch the identity verification system upon the issuance of relevant implementing rules. For gameplayers who do not provide verified identity information, we assume that they are minors under 18 years of age. In order to comply with the anti-fatigue rules,we set up our system so that after three hours of playing our online games, minors only receive half of the virtual items or other in-game benefits they wouldotherwise earn, and after playing for more than five hours, minors would receive no in-game benefits.Regulation on online game virtual currencyOn February 15, 2007, MOC, the People’s Bank of China and other relevant government authorities jointly issued the Notice on FurtherStrengthening Administrative Work on the Internet Cafes and Online Games, or the Internet Cafes Notice, pursuant to which the People’s Bank of China isdirected to strengthen the administration of virtual currency in online games to avoid any adverse impact on the economy and financial system. This noticeprovides that the total amount of virtual currency issued by online game operators and the amount purchased by individual game players should be strictlylimited, with a strict and clear division between virtual transactions and real transactions carried out by way of electronic commerce. It also provides thatvirtual currency shall only be used to purchase virtual items. On June 4, 2009, MOC and Ministry of Commerce jointly issued the Notice on Strengtheningthe Administrative Work on Virtual Currency of Online Games, pursuant to which no enterprise may concurrently provide both virtual currency issuanceservice and virtual currency transaction service. In addition, the Provisional Measures on the Administration of Online Games require companies that (i) issueonline game virtual currency (including prepaid cards and/or pre-payment or prepaid card points) or (ii) offer online game virtual currency transactionservices to apply for the Online Culture Operating Permit from provincial branches of MOC. The regulations prohibit companies that issue online gamevirtual currency from providing services that would enable the trading of such virtual currency. Any company that fails to submit the requisite applicationwill be subject to sanctions, including but not limited to termination of operation, confiscation of incomes and fines. The regulations also prohibit onlinegame operators from allocating virtual items or virtual currency to players based on random selection through lucky draw, wager or lottery that involves cashor virtual currency directly paid by the players. In addition, companies that issue online game virtual currency must comply with certain specificrequirements, for example, online game virtual currency can only be used for products and services related to the issuance company’s own online games. 71Table of ContentsTo comply with these regulations, Shenzhen Xunlei and Xunlei Games have obtained the Online Culture Operating Permit for issuing onlinegame virtual currency, and we plan to make the requested filing of its issuance of virtual currency with the local branch of MOC in Guangdong.Regulation on internet news disseminationSCIO and MIIT promulgated the Provisional Regulations for the Administration of Internet Websites Engaging in News Publication Services,and the Provisions for the Administration of Internet News Information Services on November 7, 2000 and September 25, 2005, respectively. Pursuant tosuch regulations, websites established by non-news organizations may publish news released by certain official news agencies but may not publish newsgenerated by themselves or news sourced elsewhere. In order to disseminate news, such websites must satisfy the relevant requirements set forth in theforegoing two regulations and have acquired the approval from SCIO after securing permission from the news office of the local government at the provinciallevel. Moreover, the websites intending to publish the news released by the aforementioned news agencies must enter into agreements with the respectivenews agencies, and file copies of such agreements with the news office of the local government at the provincial level. In addition, any organization isprohibited from establishing Sino-foreign joint ventures, Sino-foreign cooperatives and wholly foreign owned enterprises to operate internet newsdissemination service. The content we currently provide on our websites includes some current political news from third party news providers. Currently wedo not hold an internet news license from SCIO and we plan to apply for such internet news license. However, we cannot assure you that we will be able toobtain such license in a timely manner or at all. See “Risk factors—Risks related to our business—We are strictly regulated in China. Any lack of requisitelicenses or permits applicable to our business and any changes in government policies or regulations may have a material and adverse impact on ourbusiness, financial condition and results of operations.”Regulation on internet publicationGAPPRFT is the government agency responsible for regulating publication activities in the PRC. On June 27, 2002, MIIT and GAPPRFT jointlypromulgated the Tentative Administration Measures on Internet Publication, or the Internet Publication Measures, which took effect on August 1, 2002. TheInternet Publication Measures require internet publishers to secure approval, or the Internet Publication License, from GAPPRFT to conduct internetpublication activities. The term “internet publication” is defined as an act of online dissemination where internet information service providers select, editand process works created by themselves or others (including content from books, newspapers, periodicals, audio and video products, electronic publications,and other sources that have already been formally published or works that have been made public in other media) which they then post on the internet ortransmit to users via the internet for browsing, use or downloading by the public. The Internet Publication Measures also provide the detailed qualificationsand application procedures for obtaining the Internet Publication License. Neither GAPPRFT nor MIIT has specified whether the approval required by theInternet Publication Measures is applicable to the dissemination of online audio and video programs. However, the Notice of Three Provisions and InternetGames issued jointly by GAPPRFT and other relevant administrations confirmed that the entities operating internet games must obtain the InternetPublication License. On February 21, 2008, the GAPPRFT promulgated the Rules for the Administration of Electronic Publication, or the ElectronicPublication Rules, which took effect on April 15, 2008. Under the Electronic Publication Rules and other regulations issued by the GAPPRFT, online gamesare classified as a kind of electronic publication, and publishing of online games is required to be conducted by licensed electronic publishing entities thathave been issued standard publication codes. Pursuant to the Electronic Publication Rules, if a PRC company is contractually authorized to publish foreignelectronic publications, it must obtain the approval of, and register the copyright license contract with, the GAPPRFT. 72Table of ContentsShenzhen Xunlei holds an Internet Publication License for the publication of internet games with an expiry date of September 17, 2017 and is inthe process of applying for expansion of the business scope therein to include the publication of music works and other internet publishing activities, andXunlei Games is in the process of applying for the internet publication license for its publication of online games. See “Risk factors—We may not be able tosuccessfully address the challenges and risks we face in the online games market, such as a failure to successfully implement our plan to acquire exclusiverights to operate and sub-license games or to obtain all the licenses required to operate online games, which may subject us to penalties from relevantauthorities, including the discontinuance of our online game business.”Regulation on internet privacyThe PRC Constitution states that PRC law protects the freedom and privacy of communications of citizens and prohibits infringement of suchrights. In recent years, PRC government authorities have enacted legislation on internet use to protect personal information from any unauthorizeddisclosure. The Internet Measures prohibit ICP service operators from insulting or slandering a third party or infringing upon the lawful rights and interests ofa third party. Pursuant to the BBS Measures, ICP service operators that provide electronic messaging services must keep users’ personal informationconfidential and must not disclose such personal information to any third party without the users’ consent, unless such disclosure is required by law. Theregulations further authorize the relevant telecommunications authorities to order ICP service operators to rectify unauthorized disclosure. ICP serviceoperators are subject to legal liability if the unauthorized disclosure results in damages or losses to users. The PRC government, however, has the power andauthority to order ICP service operators to turn over personal information if an internet user posts any prohibited content or engages in illegal activities onthe internet. Under the Several Provisions on Regulating the Market Order of Internet Information Services issued by MIIT on December 29, 2011, withoutthe consent of a user, an ICP operator may not collect any user personal information or provide any such information to third parties. An ICP service operatorshall expressly inform the users of the method, content and purpose of the collection and processing of such user personal information and may only collectsuch information necessary for the provision of its services. An ICP service operator is also required to properly keep the user personal information, and incase of any leak or likely leak of the user personal information, the ICP service operator shall take immediate remedial measures and in severe consequences,to make an immediate report to the telecommunications regulatory authority. In addition, pursuant to the Decision on Strengthening the Protection of OnlineInformation issued by the Standing Committee of the National People’s Congress of the PRC on December 28, 2012, or the Decision, and the Order for theProtection of Telecommunication and Internet User Personal Information issued by MIIT on July 16, 2013, or the Order, any collection and use of userpersonal information shall be subject to the consent of the user, abide by the principles of legality, rationality and necessity and be within the specifiedpurposes, methods and scopes. An ICP service operator shall also keep such information strictly confidential, and is further prohibited from divulging,tampering or destroying of any such information, or selling or proving such information to other parties. Any violation of the Decision or the Order maysubject the ICP service operator to warnings, fines, confiscation of illegal gains, revocation of licenses, cancellation of filings, closedown of websites or evencriminal liabilities.To comply with these laws and regulations, we have required our users to consent to our collecting and using their personal information,established information security systems to protect user’s privacy. 73Table of ContentsRegulation on internet medicine information serviceThe State Food and Drug Administration, or the SFDA, promulgated the Administration Measures on Internet Medicine Information Service onJuly 8, 2004 and certain implementing rules and notices thereafter. These measures set out regulations governing the classification, application, approval,content, qualifications and requirements for internet medicine information services. An ICP service operator that provides information regarding medicine ormedical equipment must obtain an Internet Medicine Information Service Qualification Certificate from the applicable provincial level counterpart of SFDA.Although we currently offer certain information regarding medicine or medical equipment on our platform, Shenzhen Xunlei obtained a MedicineInformation Service Qualification Certificate from Guangdong Food and Drug Administration for the provision of internet medical information services withan expiry date of November 26, 2018.Regulation on advertising businessThe State Administration for Industry and Commerce, or the SAIC, is the government agency responsible for regulating advertising activities inthe PRC.According to the PRC laws and regulations, companies that engage in advertising activities must obtain from SAIC or its local branches abusiness license which specifically includes operating an advertising business within its business scope. The business license of an advertising company isvalid for the duration of its existence, unless the license is suspended or revoked due to a violation of any relevant law or regulation. PRC advertising lawsand regulations set forth certain content requirements for advertisements in the PRC including, among other things, prohibitions on false or misleadingcontent, superlative wording, socially destabilizing content or content involving obscenities, superstition, violence, discrimination or infringement of thepublic interest. Advertisers, advertising agencies, and advertising distributors are required by PRC advertising laws and regulations to ensure that the contentof the advertisements they prepare or distribute is true and in full compliance with applicable law. In providing advertising services, advertising operatorsand advertising distributors must review the supporting documents provided by advertisers for advertisements and verify that the content of theadvertisements complies with applicable PRC laws and regulations. Prior to distributing advertisements that are subject to government censorship andapproval, advertising distributors are obligated to verify that such censorship has been performed and approval has been obtained. Violation of theseregulations may result in penalties, including fines, confiscation of advertising income, orders to cease dissemination of the advertisements and orders topublish an advertisement correcting the misleading information. In circumstances involving serious violations, SAIC or its local branches may revokeviolators’ licenses or permits for their advertising business operations.To comply with these laws and regulations, we have obtained a business license, which allows us to operate advertising businesses, and adoptedseveral measures. Our advertising contracts require that substantially all advertising agencies or advertisers that contract with us must examine theadvertising content provided to us to ensure that such content are truthful, accurate and in full compliance with PRC laws and regulations. In addition, wehave established a task force to review all advertising materials to ensure the content does not violate the relevant laws and regulations before displayingsuch advertisements, and we also request relevant advertisers to provide proof of governmental approval if an advertisement is subject to special governmentreview. See “Risk factors—Risks related to our business—Advertisements we display may subject us to penalties and other administrative actions.” 74Table of ContentsRegulation on information security and censorshipThe applicable PRC laws and regulations specifically prohibit the use of internet infrastructure where it may breach public security, providecontent harmful to the stability of society or disclose state secrets. According to these regulations, it is mandatory for internet companies in the PRC tocomplete security filing procedures and regularly update information security and censorship systems for their websites with the local public security bureau.In addition, the newly amended Law on Preservation of State Secrets which became effective on October 1, 2010 provides that whenever an internet serviceprovider detects any leakage of state secrets in the distribution of online information, it should stop the distribution of such information and report to theauthorities of state security and public security. As per request of the authorities of state security, public security or state secrecy, the internet service providershould delete any content on its website that may lead to disclosure of state secrets. Failure to do so on a timely and adequate basis may subject the internetservice provider to liability and certain penalties given by the State Security Bureau, the Ministry of Public Security and/or MIIT or their respective localcounterparts. As Shenzhen Xunlei is an ICP operator, it is subject to the laws and regulations relating to information security and censorship. To comply withthese laws and regulations, it has completed the mandatory security filing procedures with the local public security authorities, and regularly updates itsinformation security and content-filtering systems with newly issued content restrictions as required by the relevant laws and regulations.Regulation on tortsThe Tort Law was promulgated by the Standing Committee of the National People’s Congress on December 26, 2009 and became effective onJuly 1, 2010. Under this law, internet users and internet service providers shall bear tortious liability in the event they infringe upon other people’s civilrights and interests through the internet. Where an internet user is infringing upon the civil rights or interests of another person via internet, the injured partyshall have the right to demand the relevant internet service provider to take necessary measures such as deleting the infringing content, etc. by serving theinternet service provider a notice. Where the internet service provider fails to take any necessary measures, it shall be jointly and severally liable with theinternet user for any additional injury or damage incurred thereafter. Under the circumstance that the internet service provider is aware that an internet user isinfringing upon the civil rights or interests of another person and fails to take necessary measures, the internet service provider shall be jointly liable for suchinfringement with such internet user.Regulation on intellectual property rightsThe PRC has adopted comprehensive legislation governing intellectual property rights, including copyrights, patents, trademarks anddomain names.Copyright lawUnder the Copyright Law (1990), as revised in 2001 and 2010, and its related Implementing Regulations (2002), as revised in 2013, creators ofprotected works enjoy personal and property rights, including, among others, the right of dissemination via information network of the works. The term of acopyright, other than the rights of authorship, alteration and integrity of an author which shall be unlimited in time, is life plus 50 years for individualauthors and 50 years for corporations.To address the problem of copyright infringement related to content posted or transmitted on the internet, the PRC National CopyrightAdministration and MIIT jointly promulgated the Measures for Administrative Protection of Copyright Related to Internet on April 29, 2005. Thesemeasures, which became effective on May 30, 2005, apply to acts of automatically providing services such as uploading, storing, linking or searching works,audio or video products, or other contents through the internet based on the instructions of internet users who publish contents on the internet, withoutediting, amending or selecting any transmitted content. When imposing administrative penalties upon the act which infringes upon any users’ right ofcommunication through information networks, the Measures for Imposing Copyright Administrative Penalties, promulgated in 2009, shall be applied. 75Table of ContentsPursuant to the Regulation on Protection of the Right of Communication through Information Network (2006), as amended in 2013, an ICPservice provider may be exempted from indemnification liabilities under certain circumstances: • any ICP service provider, who provides automatic internet access service upon instructions of its users or provides automatic transmission serviceof works, performance and audio-visual products provided by its users, will not be required to assume the indemnification liabilities if (i) it hasnot chosen or altered the transmitted works, performance and audio-visual products; and (ii) it provides such works, performance and audio-visual products to the designated user and prevents any person other than such designated user from obtaining the access. • any ICP service provider who, for the sake of improving network transmission efficiency, automatically provides to its own users, based on thetechnical arrangement, the relevant works, performances and audio-visual products obtained from any other ICP service providers will not berequired to assume the indemnification liabilities if (i) it has not altered any of the works, performance or audio-visual products that areautomatically stored; (ii) it has not affected such original ICP service provider in grasping the circumstances where the users obtain the relevantworks, performance and audio-visual products; and (iii) when the original ICP service provider revises, deletes or shields the works, performanceand audio-visual products, it will automatically revise, delete or shield the same based on the technical arrangement. • any ICP service provider, who provides its users with information memory space for such users to provide the works, performance and audio-visual products to the general public via the information network, will not be required to assume the indemnification liabilities if (i) it clearlyindicates that the information memory space is provided to the users and publicizes its own name, contact person and web address; (ii) it has notaltered the works, performance and audio-visual products that are provided by the users; (iii) it is not aware of or has no reason to know theinfringement of the works, performance and audio-visual products provided by the users; (iv) it has not directly derived any economic benefitfrom the provision of the works, performance and audio-visual products by its users; and (v) after receiving a notice from the right holder, it hasdeleted such works, performance and audio-visual products as alleged for infringement pursuant to such regulation. • any ICP service provider, who provides its users with search services or links, will not be required to assume the indemnification liabilities if,after receiving a notice from the rights holder, it has deleted the works, performance and audio-visual products as alleged for copyrightinfringement pursuant to this regulation. However, the ICP service provider shall be subject to joint liabilities for copyright infringement if it isaware of or has reason to know the infringement of the works, performance and audio-visual products to which it provides links.In December 2012, the Supreme People’s Court of China promulgated the Provisions on Certain Issues Related to the Application of Law in theTrial of Civil Cases Involving Disputes over Infringement of the Right of Dissemination through Information Networks, which provides that the courts willrequire ICP service providers to remove not only links or content that have been specifically mentioned in the notices of infringement from rights holders,but also links or content they “should have known” to contain infringing content. The provisions further provide that where an ICP service provider hasdirectly obtained economic benefits from any content made available by an internet user, it has a higher duty of care with respect to internet users’infringement of third-party copyrights. 76Table of ContentsTo comply with these laws and regulations, we have implemented internal procedures to monitor and review the content we have licensed fromcontent providers before they are released on Xunlei Kankan and remove any infringing content promptly after we receive notice of infringement from thelegitimate rights holder.Patent lawThe National People’s Congress adopted the Patent Law in 1984, and amended it in 1992, 2000 and 2008, respectively. A patentable invention,utility model or design must meet three conditions: novelty, inventiveness and practical applicability. Patents cannot be granted for scientific discoveries,rules and methods for intellectual activities, methods used to diagnose or treat diseases, animal and plant breeds or substances obtained by means of nucleartransformation or designs that are mainly used for marking the pattern, color or combination of these two of prints. The State Intellectual Property Officeunder the State Council is responsible for receiving, examining and approving patent applications. A patent is valid for a twenty-year term in the case of aninvention and a ten-year term in the case of a utility model or design, starting from the application date. A third-party user must obtain consent or a properlicense from the patent owner to use the patent except for certain specific circumstances provided by law. Otherwise, the use will constitute an infringementof the patent rights. Among the patent applications we have filed, 47 were granted in the PRC, while another seven applications are being examined by theState Intellectual Property Office of the PRC.Trademark lawRegistered trademarks are protected under the Trademark Law adopted in 1982 and amended in 1993, 2001 and 2013 and its implementationrules. The PRC Trademark Office of SAIC is responsible for the registration and administration of trademarks throughout the PRC. The Trademark Law hasadopted a “first-to-file” principle with respect to trademark registration. Where a trademark for which a registration has been made is identical or similar toanother trademark that has already been registered or been subject to a preliminary examination and approval for use on the same kind of or similarcommodities or services, the application for registration of such trademark may be rejected. Any person applying for the registration of a trademark shall notprejudice the existing right of others obtained by priority, nor shall any person register in advance a trademark that has already been used by another personand has already gained “sufficient degree of reputation” through that person’s use. After receiving an application, the PRC Trademark Office will make apublic announcement if the relevant trademark passes the preliminary examination. Within three months after such public announcement, any person mayfile an opposition against a trademark that has passed a preliminary examination. The PRC Trademark Office’s decisions on rejection, opposition orcancellation of an application may be appealed to the PRC Trademark Review and Adjudication Board, whose decision may be further appealed throughjudicial proceedings. If no opposition is filed within three months after the public announcement period or if the opposition has been overruled, the PRCTrademark Office will approve the registration and issue a registration certificate, upon which the trademark is registered and will be effective for a renewableten-year period, unless otherwise revoked. As of December 31, 2014, we had applied for registration of 170 trademarks, of which we had received 144registered trademarks in different applicable trademark categories, including one trademark registered with the United States Patent and Trademark Office andone trademark registered with World Intellectual Property Organization. 77Table of ContentsRegulation on domain nameThe domain names are protected under the Administrative Measures on the Internet Domain Names promulgated by MIIT on November 5, 2004and effective on December 20, 2004. MIIT is the major regulatory body responsible for the administration of the PRC internet domain names, undersupervision of which China Internet Network Information Center, or CNNIC, is responsible for the daily administration of CN domain names and Chinesedomain names. On September 25, 2002, CNNIC promulgated the Implementation Rules of Registration of Domain Name, or the CNNIC Rules, which wasrenewed on June 5, 2009 and May 29, 2012, respectively. Pursuant to the Administrative Measures on the Internet Domain Names and the CNNIC Rules, theregistration of domain names adopts the “first to file” principle and the registrant shall complete the registration via the domain name registration serviceinstitutions. In the event of a domain name dispute, the disputed parties may lodge a complaint to the designated domain name dispute resolution institutionto trigger the domain name dispute resolution procedure in accordance with the CNNIC Measures on Resolution of the Domain Name Disputes, file a suit tothe People’s Court or initiate an arbitration procedure. We have registered www.xunlei.com, www.kankan.com and other domain names.Regulation on taxPRC enterprise income taxThe PRC enterprise income tax is calculated based on the taxable income determined under the PRC laws and accounting standards. OnMarch 16, 2007, the National People’s Congress of China enacted a new PRC Enterprise Income Tax Law, or the EIT Law, which became effective onJanuary 1, 2008. On December 6, 2007, the State Council promulgated the Implementation Rules to the PRC Enterprise Income Tax Law, or theImplementation Rules, which also became effective on January 1, 2008. On December 26, 2007, the State Council issued the Notice on Implementation ofEnterprise Income Tax Transition Preferential Policy under the PRC Enterprise Income Tax Law, or the Transition Preferential Policy Circular, which becameeffective simultaneously with the EIT Law. The EIT Law imposes a uniform enterprise income tax rate of 25% on all domestic enterprises, including foreign-invested enterprises unless they qualify for certain exceptions, and terminates most of the tax exemptions, reductions and preferential treatments availableunder previous tax laws and regulations. Under the EIT Law and the Transition Preferential Policy Circular, enterprises that were established before March 16,2007 and already enjoyed preferential tax treatments will continue to enjoy them (i) in the case of preferential tax rates, for a period of five years fromJanuary 1, 2008; during the five-year period, the tax rate will gradually increase from 15% to 25%, or (ii) in the case of preferential tax exemption orreduction for a specified term, until the expiration of such term. In addition, the EIT Law and its implementation rules permit qualified high and newtechnology enterprises, or HNTEs, to enjoy a reduced enterprise income tax rate of 15%.Moreover, under the EIT Law, enterprises organized under the laws of jurisdictions outside China with their “de facto management bodies”located within China may be considered PRC resident enterprises and therefore subject to PRC enterprise income tax at the rate of 25% on their worldwideincome. The Implementation Rules define the term “de facto management body” as the management body that exercises full and substantial control andoverall management over the business, productions, personnel, accounts and properties of an enterprise. In addition, the Circular Related to Relevant Issueson the Identification of a Chinese holding Company Incorporated Overseas as a Residential Enterprise under the Criterion of De Facto ManagementBodies issued by the State Administration of Taxation on April 22, 2009 provides that a foreign enterprise controlled by a PRC enterprise or a PRC enterprisegroup will be classified as a “resident enterprise” with its “de facto management bodies” located within China if the following requirements are satisfied:(i) the senior management and core management departments in charge of its daily operations function mainly in the PRC; (ii) its financial and humanresources decisions are subject to determination or approval by persons or bodies in the PRC; (iii) its major assets, accounting books, company seals, andminutes and files of its board and shareholders’ meetings are located or kept in the PRC; and (iv) at least half of the enterprise’s directors or seniormanagement with voting rights reside in the PRC. Although the circular only applies to offshore enterprises controlled by PRC enterprises or PRC enterprisegroups and not those controlled by PRC individuals or foreigners, the determining criteria set forth in the circular may reflect the State Administration ofTaxation’s general position on how the “de facto management body” text should be applied in determining the tax resident status of offshore enterprises,regardless of whether they are controlled by PRC enterprises, individuals or foreigners. 78Table of ContentsAlthough we are not controlled by a PRC enterprise or PRC enterprise group and we do not believe that we meet all of the above-mentionedconditions, substantial uncertainty exists as to whether we will be deemed a PRC resident enterprise for enterprise income tax purpose. In the event that weare considered a PRC resident enterprise, we would be subject to the PRC enterprise income tax at the rate of 25% on our worldwide income, but thedividends that we receive from our PRC subsidiaries would be exempt from the PRC withholding tax since such income is exempted under the PRCEnterprise Income Tax Law for a PRC resident enterprise recipient. See “Risk factors—Risks related to doing business in China—Our global income may besubject to PRC taxes under the PRC EIT Law, which may have a material adverse effect on our results of operations.”Under applicable PRC tax laws and regulations, arrangements and transactions among related parties may be subject to audit or scrutiny by thePRC tax authorities within ten years after the taxable year when the arrangements or transactions are conducted. We could face material and adverse taxconsequences if the PRC tax authorities were to determine that the contractual arrangements among Giganology Shenzhen, our wholly-owned subsidiary inChina and Shenzhen Xunlei, our variable interest entity in China and its shareholders were not entered into on an arm’s-length basis and therefore constitutedunfavorable transfer pricing arrangements. Unfavorable transfer pricing arrangements could, among other things, result in an upward adjustment to the taxliability of Shenzhen Xunlei, and the PRC tax authorities may impose interest on late payments on Shenzhen Xunlei for the adjusted but unpaid taxes. Ourresults of operations may be materially and adversely affected if Shenzhen Xunlei’s tax liabilities increase significantly or if it is required to pay interest onlate payments.PRC business taxPursuant to applicable PRC tax regulations, any entity or individual conducting business in the service industry is generally required to pay abusiness tax at the rate of 5% on the revenues generated from providing such services. However, if the services provided are related to technologydevelopment and transfer, such business tax may be exempted subject to the approval of relevant tax authorities.PRC value added taxOn January 1, 2012, the Chinese State Council officially launched a pilot value-added tax reform program, or the Pilot Program, applicable tobusinesses in selected industries. Businesses in the Pilot Program would pay value added tax, or VAT, instead of business tax. The Pilot Program initiallyapplied only to transportation industry and “modern service industries” in Shanghai and would be expanded to eight trial regions (including Beijing andGuangdong province) and nationwide if conditions permit. The pilot industries in Shanghai included industries involving the leasing of tangible movableproperty, transportation services, research and development and technical services, information technology services, cultural and creative services, logisticsand ancillary services, certification and consulting services. Revenues generated by advertising services, a type of “cultural and creative services”, are subjectto the VAT tax rate of 6%. According to official announcements made by competent authorities in Beijing and Guangdong province, Beijing launched thesame Pilot Program on September 1, 2012, and Guangdong province launched it on November 1, 2012. 79Table of ContentsThe business tax has been imposed primarily on our revenues from the provision of taxable services, assignments of intangible assets andtransfers of real estate. Prior to the implementation of the pilot program, our business tax generally ranged from 3% to 5%, subject to the nature of therevenues being taxed. Before the implementation of the pilot program, we were mainly subject to a small amount of VAT mainly for revenues of the sale ofsoftware. VAT has been imposed on those revenues at a rate of 17%. With the implementation of the Pilot Program, in addition to the revenues currentlysubject to VAT, our advertising and content sub-licensing revenues are in the scope of the pilot program and are now subject to VAT at a rate of 6%.On May 24, 2013, the Ministry of Finance and the State Administration of Taxation issued the Circular on Tax Policies in the Nationwide PilotCollection of Value Added Tax in Lieu of Business Tax in the Transportation Industry and Certain Modern Services Industries, or the Pilot CollectionCircular. The scope of certain modern services industries under the Pilot Collection Circular extends to the inclusion of radio and television services.PRC dividend withholding taxUnder the PRC tax laws effective prior to January 1, 2008, dividends paid to foreign investors by foreign-invested enterprises were exempt fromPRC withholding tax. Pursuant to the EIT Law and the Implementation Rules, dividends generated after January 1, 2008 and payable by a foreign-investedenterprise in China to its foreign enterprise investors are subject to a 10% withholding tax, unless any such foreign investor’s jurisdiction of incorporationhas a tax treaty with China that provides for a different withholding arrangement. Under the China-HK Taxation Arrangement, income tax on dividendspayable to a company resident in Hong Kong that holds more than a 25% equity interest in a PRC resident enterprise may be reduced to a rate of 5%.According to the SAT Circular 601, the 5% tax rate does not automatically apply and approvals from competent local tax authorities are required before anenterprise can enjoy the relevant tax treatments relating to dividends under the relevant taxation treaties. In addition, according to a tax circular issued bySAT in February 2009, if the main purpose of an offshore arrangement is to obtain a preferential tax treatment, the PRC tax authorities have the discretion toadjust the preferential tax rate enjoyed by the relevant offshore entity. Although Xunlei Computer is currently wholly owned by Xunlei Network HK, wecannot assure you that we may be able to enjoy the preferential withholding tax rate of 5% under the China-HK Taxation Arrangement.Regulation on labor laws and social insurancePursuant to the PRC Labor Law and the PRC Labor Contract Law, employers must execute written labor contracts with full-time employees. Allemployers must compensate their employees with wages equal to at least the local minimum wage standards. All employers are required to establish a systemfor labor safety and sanitation, strictly abide by state rules and standards and provide employees with workplace safety training. Violations of the PRC LaborContract Law and the PRC Labor Law may result in the imposition of fines and other administrative liabilities. Criminal liability may arise for seriousviolations.In addition, employers in China are obliged to provide employees with welfare schemes covering pension insurance, unemployment insurance,maternity insurance, work-related injury insurance, medical insurance and housing funds. 80Table of ContentsTo comply with these laws and regulations, we have caused all of our full-time employees to enter into labor contracts and provide ouremployees with the proper welfare and employment benefits.Regulation on foreign exchange control and administrationForeign exchange regulation in the PRC is primarily governed by the following regulations: • Foreign Exchange Administration Rules, or the Exchange Rules, promulgated by the State Council on January 29, 1996, which was amended onJanuary 14, 1997 and on August 5, 2008 respectively; and • Administration Rules of the Settlement, Sale and Payment of Foreign Exchange, or the Administration Rules promulgated by the People’s Bankof The PRC on June 20, 1996.Under the Exchange Rules, Renminbi is convertible for current account items, including the distribution of dividends, interest payments, tradeand service-related foreign exchange transactions. As for capital account items, such as direct investments, loans, security investments and the repatriation ofinvestment returns, however, the conversion of foreign currency is still subject to the approval of, or registration with, SAFE or its competent local branches;while for the foreign currency payments for current account items, the SAFE approval is not necessary for the conversion of Renminbi except as otherwiseexplicitly provided by laws and regulations. Under the Administration Rules, enterprises may only buy, sell or remit foreign currencies at banks that areauthorized to conduct foreign exchange business after the enterprise provides valid commercial documents and relevant supporting documents and, in thecase of certain capital account transactions, after obtaining approval from SAFE or its competent local branches. Capital investments by enterprises outside ofthe PRC are also subject to limitations, which include approvals by the Ministry of Commerce, SAFE and the National Development and ReformCommission, or their respective competent local branches. On July 21, 2005, the PRC government changed its policy of pegging the value of the Renminbito the U.S. dollar. Under the new policy, the Renminbi is permitted to fluctuate within a band against a basket of certain foreign currencies.On August 29, 2008, SAFE issued the Circular on the Relevant Operating Issues Concerning the Improvement of the Administration of thePayment and Settlement of Foreign Currency Capital of Foreign-Invested Enterprises, or Circular No. 142. Pursuant to Circular No. 142, the Renminbicapital from the settlement of foreign currency capital of a foreign-invested enterprise must be used within the business scope as approved by the applicablegovernment authority and unless it is otherwise provided by law, such Renminbi capital cannot be used for domestic equity investment. Documentscertifying the purposes of the settlement of foreign currency capital into Renminbi, including a business contract, must also be submitted for the settlement ofthe foreign currency. In addition, SAFE strengthened its oversight of the flow and use of the Renminbi capital converted from foreign currency registeredcapital of a foreign-invested company. The use of such Renminbi capital may not be altered without the SAFE’s approval, and such Renminbi capital maynot be used to repay Renminbi loans if such loans have not been used. Violations of the Circular No. 142 could result in severe monetary fines or penalties.On November 19, 2012, SAFE promulgated the Circular of Further Improving and Adjusting Foreign Exchange Administration Policies onForeign Direct Investment, or Circular 59, which became effective on December 17, 2012. Circular 59 substantially amends and simplifies the current foreignexchange procedure. The major developments under Circular 59 are that the opening of various special purpose foreign exchange accounts (e.g. pre-establishment expenses account, foreign exchange capital account, guarantee account) no longer requires the approval of SAFE. Furthermore, multiplecapital accounts for the same entity may be opened in different provinces, which was not possible before the issuance of Circular 59. Reinvestment of RMBproceeds by foreign investors in the PRC no longer requires SAFE approval or verification, and remittance of foreign exchange profits and dividends by aforeign-invested enterprise to its foreign shareholders no longer requires SAFE approval. 81Table of ContentsOn May 10, 2013, SAFE promulgated the Circular on Printing and Distributing the Provisions on Foreign Exchange Administration overDomestic Direct Investment by Foreign Investors and the Supporting Documents, which specifies that the administration by SAFE or its local branches overdirect investment by foreign investors in the PRC shall be conducted by way of registration. Institutions and individuals shall register with SAFE and/or itsbranches for their direct investment in the PRC. Banks shall process foreign exchange business relating to the direct investment in the PRC based on theregistration information provided by SAFE and its branches.Regulation on foreign exchange registration of offshore investment by PRC residentsOn October 21, 2005, SAFE issued the Circular on Several Issues concerning Foreign Exchange Administration for Domestic Residents toEngage in Financing and in Return Investments via Overseas Special Purpose Companies, or Circular No. 75, which went into effect on November 1, 2005.Circular No. 75 and related rules provide that if PRC residents establish or acquire direct or indirect interests of offshore special purpose companies, oroffshore SPVs, for the purpose of financing these offshore SPVs with assets of, or equity interests in, an enterprise in the PRC, or inject assets or equityinterests of PRC entities into offshore SPVs, they must register with local SAFE branches with respect to their investments in offshore SPVs. Circular No. 75also requires PRC residents to file changes to their registration if their offshore SPVs undergo material events such as capital increase or decrease, sharetransfer or exchange, merger or division, long-term equity or debt investments, and provision of guaranty to a foreign party. SAFE promulgated the Circularon Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Offshore Investment and Financing and Roundtrip Investment throughSpecial Purpose Vehicles, or SAFE Circular No. 37, on July 4, 2014, which replaced the SAFE Circular No. 75. SAFE Circular No. 37 requires PRC residentsto register with local branches of SAFE in connection with their direct establishment or indirect control of an offshore entity, for the purpose of overseasinvestment and financing, with such PRC residents’ legally owned assets or equity interests in domestic enterprises or offshore assets or interests, referred toin SAFE Circular No. 37 as a “special purpose vehicle.” The term “control” under SAFE Circular No. 37 is broadly defined as the operation rights, beneficiaryrights or decision-making rights acquired by the PRC residents in the offshore special purpose vehicles or PRC companies by such means as acquisition,trust, proxy, voting rights, repurchase, convertible bonds or other arrangements. SAFE Circular No. 37 further requires amendment to the registration in theevent of any changes with respect to the basic information of the special purpose vehicle, such as changes in a PRC resident individual shareholder, name oroperation period, or any significant changes with respect to the special purpose vehicle, such as increase or decrease of capital contributed by PRCindividuals, share transfer or exchange, merger, division or other material event. If the shareholders of the offshore holding company who are PRC residentsdo not complete their registration with the local SAFE branches, the PRC subsidiaries may be prohibited from distributing their profits and proceeds from anyreduction in capital, share transfer or liquidation to the offshore company, and the offshore company may be restricted in its ability to contribute additionalcapital to its PRC subsidiaries. Moreover, failure to comply with SAFE registration and the amendment requirements described above could result in liabilityunder PRC law for the evasion of applicable foreign exchange restrictions. On February 13, 2015, SAFE issued SAFE Circular No. 13, which is scheduled totake effect on June 1, 2015. SAFE Circular No. 13 has delegated to the qualified banks the authority to register all PRC residents’ investment in “specialpurpose vehicle” pursuant to the SAFE Circular No. 37, except that those PRC residents who have failed to comply with the SAFE Circular No. 37 willcontinue to fall within the jurisdiction of the relevant local SAFE branches and must make their supplementary registration application with such local SAFEbranches. 82Table of ContentsWe have requested PRC residents holding direct or indirect interest in our company to our knowledge to make the necessary applications, filingsand amendments as required under Circular No. 37 and other related rules. Our PRC resident shareholders, namely Sean Shenglong Zou, Hao Cheng and FangWang, have completed the registration and amendment registration with the local SAFE branch in relation to all our previous private financings and theirsubsequent ownership changes by April 2012 as required under the SAFE regulations and are in the process of applying for the relevant amendmentregistrations with the local SAFE branch in relation to their ownership changes in our company and our series E financing after April 2012. However, we maynot be informed of the identities of all the PRC residents holding direct or indirect interest in our company, and we cannot provide any assurances that thesePRC residents will comply with our request to make or obtain any applicable registrations or comply with other requirements required by Circular No. 37or other related rules. The failure or inability of our PRC resident shareholders to make any required registrations or comply with other requirements underCircular No. 37 and other related rules may subject such PRC residents or our PRC subsidiaries to fines and legal sanctions and may also limit our ability toraise additional financing and contribute additional capital into or provide loans to (including using the proceeds from our initial public offering) our PRCsubsidiaries, limit our PRC subsidiaries’ ability to pay dividends or otherwise distribute profits to us, or otherwise adversely affect us.Regulation on employee share optionsOn December 25, 2006, the People’s Bank of China promulgated the Administrative Measures for Individual Foreign Exchange. OnFebruary 15, 2012, SAFE issued the Notices on Issues concerning the Foreign Exchange Administration for Domestic Individuals Participating in StockIncentive Plans of Overseas Publicly-Listed Companies, or the Stock Option Rules, which replaced the Application Procedures of Foreign ExchangeAdministration for Domestic Individuals Participating in Employee Stock Ownership Plans or Stock Option Plans of Overseas Publicly-Listed Companiesissued by SAFE on March 28, 2007. Pursuant to the Stock Option Rules, PRC residents who are granted shares or stock options by companies listed onoverseas stock exchanges according to the stock incentive plans are required to register with SAFE or its local branches, and PRC residents participating inthe stock incentive plans of overseas listed companies shall retain a qualified PRC agent, which could be a PRC subsidiary of such overseas publicly-listedcompany or another qualified institution selected by such PRC subsidiary, to conduct the SAFE registration and other procedures with respect to the stockincentive plans on behalf of these participants. Such participants must also retain an overseas entrusted institution to handle matters in connection with theirexercise of stock options, purchase and sale of corresponding stocks or interests, and fund transfer. In addition, the PRC agents are required to amend theSAFE registration with respect to the stock incentive plan if there is any material change to the stock incentive plan, the PRC agents or the overseas entrustedinstitution or other material changes. The PRC agents shall, on behalf of the PRC residents who have the right to exercise the employee share options, applyto SAFE or its local branches for an annual quota for the payment of foreign currencies in connection with the PRC residents’ exercise of the employee shareoptions. The foreign exchange proceeds received by the PRC residents from the sale of shares under the stock incentive plans granted and dividendsdistributed by the overseas listed companies must be remitted into the bank accounts in the PRC opened by the PRC agents before distribution to such PRCresidents. In addition, the PRC agents shall file each quarter the form for record-filing of information of the Domestic Individuals Participating in the StockIncentive Plans of Overseas Listed Companies with SAFE or its local branches.Our PRC citizen employees who have been granted share options, or PRC optionees, will be subject to the Stock Option Rules when ourcompany becomes an overseas listed company upon the completion of our initial public offering. If we or our PRC optionees fail to comply with theIndividual Foreign Exchange Rule and the Stock Option Rules, we and/or our PRC optionees may be subject to fines and other legal sanctions. We may alsoface regulatory uncertainties that could restrict our ability to adopt additional option plans for our directors and employees under PRC law. In addition, theState Administration for Taxation has issued certain circulars concerning employee share options. Under these circulars, our employees working in the PRCwho exercise share options will be subject to PRC individual income tax. Our PRC subsidiaries have obligations to file documents related to employee shareoptions with relevant tax authorities and to withhold individual income taxes of those employees who exercise their share options. If our employees fail topay or we fail to withhold their income taxes according to relevant laws and regulations, we may face sanctions imposed by the tax authorities or other PRCgovernment authorities. 83Table of ContentsRegulation on dividend distributionsThe principal regulations governing the distribution of dividends paid by wholly foreign-owned enterprises include: • Company Law (2005); • Wholly Foreign-Owned Enterprise Law (1986), as amended in 2000; and • Wholly Foreign-Owned Enterprise Law Implementation Regulations (1990), as amended in 2001.Under these regulations, wholly foreign-owned enterprises in the PRC may pay dividends only out of their accumulated profits, if any, asdetermined in accordance with PRC accounting standards and regulations. In addition, a wholly foreign-owned enterprise in the PRC is required to set asideat least 10% of its after-tax profit based on PRC accounting standards each year to its general reserves until its cumulative total reserve funds reaches 50% ofits registered capital. The board of directors of a wholly foreign-owned enterprise has the discretion to allocate a portion of its after tax profits to its employeewelfare and bonus funds. These reserve funds, however, may not be distributed as cash dividends.Regulation on overseas listingsOn August 8, 2006, six PRC regulatory agencies, namely, the Ministry of Commerce, the State Assets Supervision and AdministrationCommission, the State Administration for Taxation, SAIC, CSRC and SAFE, jointly adopted the Regulations on Mergers and Acquisitions of DomesticEnterprises by Foreign Investors, or the M&A Rules, which became effective on September 8, 2006 and were amended on June 22, 2009. The M&A Rulespurport, among other things, to require that offshore special purpose vehicles, or SPVs, that are controlled by PRC companies or individuals and that havebeen formed for overseas listing purposes through acquisitions of PRC domestic interest held by such PRC companies or individuals, to obtain the approvalof the CSRC prior to publicly listing their securities on an overseas stock exchange. On September 21, 2006, the CSRC published a notice on its officialwebsite specifying documents and materials required to be submitted to it by SPVs seeking CSRC approval of their overseas listings. While the applicationof the M&A Rules remains unclear, our PRC legal counsel has advised us that based on its understanding of the current PRC laws, rules and regulations andthe M&A Rules, prior approval from the CSRC is not required under the M&A Rules for the listing and trading of our ADSs on the NASDAQ Global SelectMarket given that (i) our PRC subsidiaries were directly established by us as wholly foreign-owned enterprises, and we have not acquired any equity interestor assets of a PRC domestic company owned by PRC companies or individuals as defined under the M&A Rules that are our beneficial owners after theeffective date of the M&A Rules, and (ii) no provision in the M&A Rules clearly classifies the contractual arrangements as a type of transaction subject to theM&A Rules. 84Table of ContentsHowever, our PRC legal counsel has further advised us uncertainties still exist as to how the M&A Rules will be interpreted and implementedand its opinions summarized above are subject to any new laws, rules and regulations or detailed implementations and interpretations in any form relating tothe M&A Rules. If CSRC or another PRC regulatory agency subsequently determines that prior CSRC approval was required for our initial public offering,we may face regulatory actions or other sanctions from CSRC or other PRC regulatory agencies. These regulatory agencies may impose fines and penalties onour operations, limit our operating privileges, delay or restrict the repatriation of the proceeds from our initial public offering into the PRC or payment ordistribution of dividends by our PRC subsidiaries, or take other actions that could materially adversely affect our business, financial condition, results ofoperations, reputation and prospects, as well as the trading price of our ADSs. In addition, if CSRC later requires that we obtain its approval for our initialpublic offering, we may be unable to obtain a waiver of CSRC approval requirements, if and when procedures are established to obtain such a waiver. Anyuncertainties or negative publicity regarding CSRC approval requirements could have a material adverse effect on the trading price of our ADSs. C.Organizational StructureThe following diagram illustrates our corporate structure, including our subsidiaries and variable interest entity and the subsidiaries of ourvariable interest entity, as of the date of this annual report on Form 20-F: Note: (1)Shenzhen Xunlei is our variable interest entity. Mr. Sean Shenglong Zou, our co-founder, chairman and chief executive officer, Mr. Hao Cheng, our co-founder and director, Mr. Jianming Shi, Guangzhou Shulian Information Investment Co., Ltd. and Ms. Fang Wang respectively own 76.0%, 8.3%,8.3%, 6.7% and 0.7% of Shenzhen Xunlei’s equity interests.(2)The remaining 30% of the equity interest is owned by Mr. Hao Cheng. 85Table of ContentsContractual arrangements with Shenzhen XunleiAgreements that provide us effective control over Shenzhen XunleiBusiness operation agreementPursuant to the business operation agreement among Giganology Shenzhen, Shenzhen Xunlei and the shareholders of Shenzhen Xunlei, asamended, Shenzhen Xunlei’s shareholders must appoint the candidates nominated by Giganology Shenzhen to be the directors on its board of directors inaccordance with applicable laws and the articles of association of Shenzhen Xunlei, and must cause the persons recommended by Giganology Shenzhen to beappointed as its general manager, chief financial officer and other senior executives. Shenzhen Xunlei and its shareholders also agree to accept and strictlyfollow the guidance provided by Giganology Shenzhen from time to time relating to employment, termination of employment, daily operations and financialmanagement. Moreover, Shenzhen Xunlei and its shareholders agree that Shenzhen Xunlei will not engage in any transactions that could materially affect itsassets, business, personnel, liabilities, rights or operations, including but not limited to the amendment of Shenzhen Xunlei’s articles of association, withoutthe prior consent of Giganology Shenzhen and Xunlei Limited or their respective designees. For instance, in May 2011, Shenzhen Xunlei sought andobtained consent from Giganology Shenzhen and Xunlei Limited to increase its registered capital by RMB20 million and to revise its articles of associationaccordingly. The term of this agreement will expire in 2016 and may be extended at Giganology Shenzhen’s request prior to the expiration date.Equity pledge agreementPursuant to the equity pledge agreement between Giganology Shenzhen and the shareholders of Shenzhen Xunlei, as amended, the shareholdersof Shenzhen Xunlei have pledged all of their equity interests in Shenzhen Xunlei to Giganology Shenzhen to guarantee Shenzhen Xunlei and itsshareholders’ performance of their respective obligations and any ensuing liabilities under the exclusive technology support and service agreement, asamended, the exclusive technology consulting and training agreement, as amended, the proprietary technology license agreement, the business operationagreement, as amended, the equity interests disposal agreement, as amended, the loan agreements, as amended, and the intellectual properties purchaseoption agreement, as amended. In addition, the shareholders of Shenzhen Xunlei have completed the registration of equity pledge under the equity pledgeagreement with the competent governmental authority. If Shenzhen Xunlei and/or its shareholders breach their contractual obligations under thoseagreements, Giganology Shenzhen, as pledgee, will be entitled to certain rights, including the right to sell the pledged equity interests.Powers of attorneyPursuant to the irrevocable powers of attorney executed by each shareholder of Shenzhen Xunlei, each such shareholder appointed GiganologyShenzhen as its attorney-in-fact to exercise such shareholders’ rights in Shenzhen Xunlei, including, without limitation, the power to vote on its behalf on allmatters of Shenzhen Xunlei requiring shareholder approval in accordance with PRC laws and regulations and the articles of association of Shenzhen Xunlei.Each power of attorney will remain in force for 10 years from the date of execution unless the business operation agreement, as amended, among GiganologyShenzhen, Shenzhen Xunlei and the shareholders of Shenzhen Xunlei is terminated at an earlier date. The term may be extended at Giganology Shenzhen’sdiscretion. 86Table of ContentsAgreements that transfer economic benefits to usExclusive technology support and services agreementPursuant to the exclusive technology support and services agreement between Giganology Shenzhen and Shenzhen Xunlei, as amended,Giganology Shenzhen has the exclusive right to provide to Shenzhen Xunlei technology support and technology services related to all technologies neededfor its business. Giganology Shenzhen exclusively owns any intellectual property rights resulting from the performance of this agreement. The service feepayable by Shenzhen Xunlei to Giganology Shenzhen is a certain percentage of its earnings. The term of this agreement will expire in 2025 and may beextended with Giganology Shenzhen’s written confirmation prior to the expiration date. Giganology Shenzhen is entitled to terminate the agreement at anytime by providing 30 days’ prior written notice to Shenzhen Xunlei.Exclusive technology consulting and training agreementPursuant to the exclusive technology consulting and training agreement between Giganology Shenzhen and Shenzhen Xunlei, as amended,Giganology Shenzhen has the exclusive right to provide to Shenzhen Xunlei technology consulting and training services related to its business. GiganologyShenzhen exclusively owns any intellectual property rights resulting from the performance of this agreement. The service fee payable by Shenzhen Xunlei toGiganology Shenzhen is a certain percentage of its earnings. The term of this agreement will expire in 2025 and may be extended with GiganologyShenzhen’s written confirmation prior to the expiration date. Giganology Shenzhen is entitled to terminate the agreement at any time by providing 30 days’prior written notice to Shenzhen Xunlei.Proprietary technology license contractPursuant to the proprietary technology license contract between Giganology Shenzhen and Shenzhen Xunlei, Giganology Shenzhen grantsShenzhen Xunlei a non-exclusive and non-transferable right to use Giganology Shenzhen’s proprietary technology. Shenzhen Xunlei can only use theproprietary technology to conduct its business within China. Giganology Shenzhen or its designated representative(s) owns the rights to any improvementsdeveloped based on the proprietary technology licensed pursuant to this contract. The term of the agreement will expire in 2022 and, at GiganologyShenzhen’s discretion, may be extended for an additional 10 years or for other time period as agreed by both Giganology Shenzhen and Shenzhen Xunlei.Intellectual properties purchase option agreementPursuant to the intellectual properties purchase option agreement between Giganology Shenzhen and Shenzhen Xunlei, as amended, ShenzhenXunlei irrevocably grants Giganology Shenzhen (or its designated representative(s)) an exclusive option to purchase certain specified intellectual propertiesthat it owns for RMB1.0 or the minimum amount of consideration permitted under the PRC law. The term of the agreement will expire in 2022 and may beautomatically extended for an additional 10 years at each expiration date as long as these intellectual properties have not been transferred to GiganologyShenzhen and/or its designee and Shenzhen Xunlei then still exist.Agreements that provide us the option to purchase the equity interest in Shenzhen XunleiEquity interests disposal agreementPursuant to the equity interests disposal agreement among Giganology Shenzhen, Shenzhen Xunlei and the shareholders of Shenzhen Xunlei, asamended, Shenzhen Xunlei’s shareholders irrevocably grant Giganology Shenzhen (or its designated representative(s)) an exclusive option to purchase all orpart of their equity interests in Shenzhen Xunlei for RMB1.0 or the minimum amount of consideration permitted under PRC law. The term of the agreementwill expire in 2016 and may be extended at Giganology Shenzhen’s discretion. 87Table of ContentsLoan agreementsUnder the loan agreement between Giganology Shenzhen and Guangzhou Shulian Information Investment Co., Ltd., Sean Shenglong Zou, HaoCheng, Fang Wang and Jianming Shi, as amended, Giganology Shenzhen made interest-free loans of approximately RMB1.8 million, RMB2.5 million,RMB2.3 million, RMB0.2 million and RMB2.3 million, respectively, to each of the above shareholders of Shenzhen Xunlei and all of these shareholdershave used the full amount of loans to make capital contribution to Shenzhen Xunlei. The term of this agreement is two years from the date it was signed, andwill be automatically extended afterwards on a yearly basis until each shareholder of Shenzhen Xunlei has repaid the loan in its entirety in accordance withthe loan agreement. The loan for each shareholder will be deemed to be repaid under this agreement only when all equity interest held by the relevantshareholder in Shenzhen Xunlei has been transferred to Giganology Shenzhen or its designated parties. As of the date of this annual report, all the loans underthe loan agreements remain outstanding. At any time during the term of the loan agreement, Giganology Shenzhen may, at its sole discretion, require any ofthe shareholders of Shenzhen Xunlei to repay all or any portion of his outstanding loan under the agreement.In addition, following the loan agreement mentioned above, under a separate loan agreement between Giganology Shenzhen and Mr. SeanShenglong Zou as a shareholder of Shenzhen Xunlei, as amended, Giganology Shenzhen made an additional interest-free loan of RMB20 million to Mr. Zou,the entire amount of which was used to contribute to the registered capital of Shenzhen Xunlei, increasing the registered capital of Shenzhen Xunlei toRMB30 million. The term of this agreement is two years from the date it was signed, and will be automatically extended afterwards on a yearly basis untilMr. Zou has repaid the loan in its entirety in accordance with the loan agreement. This loan will be deemed to be repaid under this agreement only when allequity interest held by the relevant shareholder in Shenzhen Xunlei has been transferred to Giganology Shenzhen or its designated parties. At any timeduring the term of the loan agreement, Giganology Shenzhen may, at its sole discretion, require all or any portion of the outstanding loan under theagreement to be repaid.In the opinion of Zhong Lun Law Firm, our PRC legal counsel: • the ownership structures of our variable interest entity and our subsidiaries in China comply with all existing PRC laws andregulations; and • the contractual arrangements among Giganology Shenzhen, our PRC subsidiary, Shenzhen Xunlei and its shareholders governed by PRClaw are valid, binding and enforceable, and will not result in any violation of PRC laws or regulations currently in effect.We have been advised by Zhong Lun Law Firm, our PRC legal counsel, however, that there are substantial uncertainties regarding theinterpretation and application of current and future PRC laws, regulations and rules. Accordingly, the PRC regulatory authorities may take a view that iscontrary 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 theagreements that establish the structure for operating our business to provide digital media data transmission and streaming services, online games and othervalue-added telecommunication services do not comply with PRC government restrictions on foreign investment in the aforesaid business we engage in, wecould be subject to severe penalties including being prohibited from continuing operations. See “Item 3. Key Information—Risk factors—Risks related toour corporate structure—If the PRC government finds that the agreements that establish the structure for operating our businesses in China do not complywith PRC governmental restrictions on foreign investment in internet-related business and foreign investors’ mergers and acquisition activities in China, or ifthese regulations or the interpretation of existing regulations change in the future, we could be subject to severe penalties or be forced to relinquish ourinterests in those operations.” 88Table of ContentsD.Property, Plant and EquipmentOur principal executive offices are located at 4/F, Hans Innovation Mansion, North Ring Road, No. 9018 High-Tech Park, Nanshan District,Shenzhen, People’s Republic of China, which comprises approximately 5,300 square meters of office space. In addition to other offices in Shenzhen, we alsohave offices in Beijing, Shanghai and Hong Kong and representative offices in Xiamen and Guangzhou, respectively, totaling approximately 16,000 squaremeters. Our leased premises are leased from unrelated third parties who have valid title to the relevant properties. The lease for our principal executive officeswill expire in December 2016, and the other leases typically have terms of one to three years. Our servers are primarily hosted at internet data centers ownedby major domestic internet data center providers. The hosting services agreements typically have one-year terms and are renewed automatically uponexpiration. We believe that we will be able to obtain adequate facilities, principally through leasing, to accommodate our future expansion plans. Item 4A.Unresolved Staff CommentsNone. Item 5.Operating and Financial Review and ProspectsThe following discussion of our financial condition and results of operations is based upon, and should be read in conjunction with, our auditedconsolidated financial statements and the related notes included in this annual report on Form 20-F. This report contains forward-looking statements. See“Forward-Looking Information.” In evaluating our business, you should carefully consider the information provided under the caption “Item 3. KeyInformation—D. Risk Factors” in this annual report on Form 20-F. We caution you that our businesses and financial performance are subject to substantialrisks and uncertainties. A.Operating ResultsOverviewWe operate a powerful internet platform in China based on cloud computing to enable users to quickly access, manage and consume digitalmedia content. We are increasingly extending into mobile devices in part through potentially pre-installed acceleration products in mobile phones to furtherexpand our user base and offer our users a wider range of access points.We provide users with quick and easy access to digital media content on the internet through two core products and services, available to usersfor free and for a subscription fee, respectively. Our acceleration products and services include Xunlei Accelerator and our cloud acceleration subscriptionservices (delivered through products such as Green Channel, Offline Accelerator and Yunbo). Benefitting from the large user base accumulated by our coreproduct, Xunlei Accelerator, we have further developed various value-added services to meet a fuller spectrum of our users’ digital media content access andconsumption needs. These value-added products and services include Xunlei Kankan, online game and pay per view. 89Table of ContentsWe have successfully monetized our large user base. We generate revenues primarily through the following services: • Subscription services. We provide cloud acceleration subscription services for subscribers to enable faster and more reliable access todigital media content. Revenues from subscription services contributed to 48.1% of our revenues in 2013 and 53.7% in 2014.Subscription fees are time-based and are primarily collected up-front from subscribers on a monthly or yearly basis. • Online advertising services. We provide marketing opportunities on our online video streaming websites and platform to our advertisers.Online advertising revenues contributed to 26.7% of our revenues in 2013 and 21.0% in 2014 and the revenues are derived principallyfrom various forms of advertisements that we place on Xunlei Kankan. • Other internet value-added services. We offer multiple other value-added services to our users. Revenues from other internet value-addedservices contributed to 25.2% of our revenues in 2013 and 25.3% in 2014.Our revenues increased from US$148.2 million in 2012 to US$180.2 million in 2013 and US$182.9 million in 2014. We had net incomeattributable to Xunlei Limited of US$0.5 million, US$10.7 million and US$10.8 million in 2012, 2013 and 2014, respectively. We had net incomeattributable to Xunlei Limited’s common shareholders of US$2.3 million in 2013. However, we had net loss attributable to Xunlei Limited’s commonshareholders of US$0.3 million and US$105.4 million in 2012 and 2014, respectively; the amount of US$105.4 million in 2014 primarily due to theacceleration of amortization of beneficial conversion feature of series E preferred shares upon the initial public offering of US$49.3 million, the deemeddividend to preferred shareholders upon the initial public offering of US$32.8 million and the deemed dividend to certain shareholders from the repurchaseof shares of US$14.9 million.Major factors affecting our results of operationsOur business and operating results are subject to general factors affecting the internet industry in China, including overall economic growth,which has resulted in increases in disposable income and consumer spending, government and industry initiatives accelerating the technologicaladvancement and growth of internet industry, the growth of internet usage and penetration rate in China, strong preference of Chinese consumers foraccessing digital media content through the internet, the greater availability of digital media content on the internet, and the increasing acceptance of onlineadvertising as part of advertisers’ overall marketing strategy and spending. Our results of operations will continue to be affected by such general factors.Our results of operations are also directly affected by a number of company-specific factors, including:Our ability to continue to enhance and innovate our service offerings, including our mobile products and Project Crystal, and our efforts to streamline ourexisting business by divesting of non-core service offerings.As our industry evolves rapidly and user preference for our services may change quickly, our revenues and results of operations significantlydepend on our ability to continue enhancing and expanding our service offerings to meet evolving user preference and market demand, and to broaden ouruser base. We have a proven track record of developing our service offerings to successfully address the preferences of China’s internet users. To addressdeficiencies of digital media content transmission over the internet in China, we provide users with quick and easy access to digital media content on theinternet through two core products and services, Xunlei Accelerator and our cloud acceleration subscription services, available to users for free and for asubscription fee, respectively. To meet our users’ digital media content access and consumption needs, we have further developed various value-addedservices, including Xunlei Kankan, online game services and pay per view services. Furthermore, we focus more on user behaviors and study users’ life cycleson our platform, so that we can offer relevant services at the right time and encourage users to continue using our services. 90Table of ContentsAn important part of our business plan is to continue transitioning to mobile internet. As an increasing number of users are accessing onlineservices through mobile devices, we are increasingly expanding our services to mobile devices, particularly through cooperation with a smartphone maker,Xiaomi, which currently offers our mobile acceleration application pre-installed on its new phones and as updates on its existing phones. We intend to furtherwork with more smartphone makers in China so that a larger number of mobile users can benefit from our mobile products, including acceleration and highersuccess rates.In addition, we offer an important innovative service in Project Crystal, which crowdsources bandwidth and potentially storage space from ourusers. As internet usage continues to grow in China, bandwidth is becoming an increasingly precious commodity, and Project Crystal provides an innovativeway to utilize idle bandwidth and potentially unused storage space from users to maximize efficiency. We currently pay users who participate in ProjectCrystal market rates for the bandwidths they offer, and as the bandwidth we crowdsource continues to expand, we intend to generate external sales from thecrowdsourced bandwidth by selling them to third party internet content providers.Furthermore, as part of our continued drive to streamline our existing business, we analyze our existing business based on contribution to ourleadership position as a company with innovative technology as well as our profitability profile, and decide on whether to divest any portion of our businessto allow us to focus more our core competence, long-term strategy and profitability. As a result, we have entered into a binding framework agreement, datedMarch 31, 2015, to sell our entire interest in Xunlei Kankan to a third party, subject to certain conditions. If this sale is completed as we planned, we expectto put increasing focus on, and devote more management attention to, maintaining our technological leadership and focusing on research and development.Our ability to further monetize our user base.Our revenues and results of operations depend on our ability to further monetize our user base, to convert more users to subscribers and toincrease the spending of our subscribers. With enhanced knowledge of user behavior and preferences, we offer a diverse range of premium services tailored totheir individual needs. For example, our cloud acceleration subscription services offer users value-added services for speed. We intend to further monetize ouruser base and aim to convert users to subscribers by expanding our offering of value-added services, such as cloud-based storage and mobile access. We planto provide one-stop services for our users, in terms of accessing content and storage and synchronization of content across devices, including mobile devicesand PC. 91Table of ContentsOur ability to maintain our technology leadership and cost-efficient infrastructure.Our results of operations depend on our ability to maintain our technology leadership, with innovations such as our mobile technology, ourbandwidth crowdsourcing technology and our cloud acceleration technology. Our mobile technology allows users to access content from anywhere, ourbandwidth crowdsourcing technology enables us to utilize the idle bandwidth available from our large user base, and our cloud acceleration technologyenables users to access content in an efficient manner. Our proprietary technology and highly scalable massive distributed computing network form our corecompetitive advantage, enabling us to deliver superior transmission acceleration services and enhanced user experience anywhere and with an efficient sortof acceleration. Our resource discovery network leverages our distributed computing power, computing and storage capacity and significantly reduces ourreliance on servers operated by us, which in turn provides us with a clear cost advantage over our competitors. As part of our expansion strategy, we plan todevote substantial resources to research and development in order to better serve our users, particularly to Project Crystal and mobile products and services.Therefore, the expenses associated with our research and development are expected to increase in the near future. However, we plan to continue to increasethe bandwidth we crowdsource through Project Crystal, which is expected to continue to reduce our bandwidth cost and contribute to the cost efficiency ofour overall infrastructure.Our ability to control our costs and operating expenses.Our results of operations depend on our ability to control our costs and operating expenses. We expect our bandwidth costs to continue toincrease as we grow our business and raise the number of subscribers, although we expect such costs would be partly offset by the fact that we expect tosource an increasing amount of bandwidth from bandwidth crowdsourced through Project Crystal. Substantially all of our content cost is historicallyassociated with Xunlei Kankan and such content cost may increase if we continue to operate Xunlei Kankan, despite our efforts to secure the content in a costefficient manner; however, if we successfully sell Xuenlei Kankan to an independent third party, pursuant to the binding framework agreement we enteredinto and announced on March 31, 2015, we expect our content cost to significantly decrease in the future to an immaterial level. In addition, our operatingexpenses are expected to increase in the future, since we expect increased headcount to reflect the growth of our business. We plan to continue to invest inresearch and development to maintain our technology leadership, especially to increase our research and development expenses and sales and marketingexpenses in relation to Project Crystal.Description of certain statement of operations itemsRevenuesWe derive our revenues primarily from cloud acceleration subscription services, online advertising and other internet value-added servicesincluding online games, content sublicensing and pay per view services. The following table sets forth the principal components of our revenues by amountsand percentages of our revenues for the periods presented. For the Year Ended December 31, 2012 2013 2014 (in thousands of US$, except for percentages) Amount % of Revenues Amount % of Revenues Amount % of Revenues Subscriptions 51,055 34.4 86,733 48.1 98,189 53.7 Online advertising 61,795 41.7 48,028 26.7 38,378 21.0 Other internet value-added services 35,350 23.9 45,483 25.2 46,320 25.3 Total 148,200 100.0 180,244 100.0 182,887 100.0 Subscriptions. We introduced our cloud acceleration subscription services in March 2009 and we generate revenues from providing our userswith exclusive services, such as access to high-speed online transmission, premium acceleration or access privileges, for a time-based subscription fee. Thestandard subscription fee is RMB10 (US$1.6) per month or RMB99 (US$15.9) per year, and we introduced subscription packages of RMB15 (US$2.4) permonth or RMB149 (US$23.9) per year in 2012 and RMB30 (US$4.8) per month in late 2013 to cater to subscribers’ different demand for acceleration speedand user experience, which are becoming increasingly popular among our subscribers. Our subscription revenues, as a percentage of our revenues, increased34.4% in 2012 to 48.1% in 2013, and further to 53.7% in 2014. 92Table of ContentsThe most significant factor that directly affects our subscription revenues is the number of subscribers. We may maintain our subscriber base inthe future by expanding our offering of fee-based services, but important factors outside of our control, such as the PRC government’s regulation andcensorship of information disseminated over the internet, may have a material adverse impact on our cloud acceleration services, which in turn may have anadverse effect on the number of our subscribers and on our revenues and results of operations. For example, in April 2014, the Chinese government initiated acampaign to enhance and enforce its scrutiny on internet content in China, particularly for pornographic content, and various websites were subject topenalties and in some cases outright suspension of website operations. We conducted an internal compliance investigation to ensure that the contenttransmitted by our products is in compliance with the strict standards set out by the authorities, and as a result, deleted millions of cached files, addedthousands of keywords to our automatic keyword filtration system and permitted temporary suspension of services by approximately 350,000 existingsubscribers as of the end of 2014. Also see “Item 3. Key Information—D. Risk Factors—Risks related to our business—Regulation and censorship ofinformation disseminated over the internet in China, recently strengthened, may adversely affect our business, and we may be liable for digital media contenton our platform.” In the future, there may be other laws and regulations that lead to further voluntary or forced removal of content or other measures to ensurecompliance with standards set out by relevant regulatory authorities, which may further reduce our subscriber base. Currently, we are unable to quantify themagnitude and extent of such impact, although we expect our number of subscribers may experience decline in the near future.Online advertising. Our online advertising revenues were historically derived principally from various forms of advertisements that we place onXunlei Kankan. A significant majority of our advertisers purchase our online advertising services through third-party advertising agencies. As is customary inthe advertising industry in China, we pay rebates to third-party advertising agencies and recognize revenues net of these rebates.Historically, we derived advertising revenues of US$16.8 million, US$3.1 million and US$1.9 million from Xunlei Accelerator and US$45.0million, US$44.9 million and US$36.4 million from Xunlei Kankan in the years 2012, 2013 and 2014, respectively. In the first half of 2013, we discontinueddelivering advertisements on Xunlei Accelerator to further improve user experience and enhance user engagement, and do not expect to generate significantadvertising revenues from Xunlei Accelerator after 2014. We also do not expect to generate significant advertising revenues in the future, if at all, if wecomplete our proposed sale of Xunlei Kankan to an independent third party. For details of our planned sale of Xunlei Kankan, see “Item 4. Information on theCompany — A. History and Development of the Company.”The most significant factors that directly affect our online advertising revenues are the average spending per advertiser and the number ofadvertisers that use our online advertising services. The average spending per advertiser was approximately US$147,000 in 2012, which decreased toapproximately US$120,000 in 2013 but increased to US$152,000 in 2014. The amount of average advertising spend per advertiser is the result of our totaladvertising revenues during a given period divided by the number of advertisers for that period. The number of advertisers that use our online advertisingservices was 420 in 2012, which decreased to 399 in 2013 and further to 252 in 2014. We calculate the number of advertisers during a given period as thenumber of advertisers to whom we have delivered advertising services during that period. An advertiser to whom we have delivered services more than oncein a period is counted as one advertiser for that period. 93Table of ContentsOther internet value-added services. We actively seek new business opportunities that complement our existing core acceleration and videostreaming related services offerings to further improve our overall user experience. We primarily derive other internet value-added services revenues fromonline games, content sublicensing and pay per view services. Revenues from other internet value-added services increased from US$35.4 million in 2012 toUS$45.5 million in 2013 and further to US$46.3 million in 2014.A significant portion of revenues of other internet value-added services were generated from our online games. For web games, we hadapproximately 162,000, 210,000 and 283,000 paying users for the years ended December 31, 2012, 2013 and 2014, respectively. For the MMOGs, we hadapproximately 292,000, 181,000 and 156,000 paying users for the years ended December 31, 2012, 2013 and 2014, respectively. We calculate the number ofpaying users during a given period as the cumulative number of users that have purchased virtual items or other products and services for our web games orMMOGs at least once during the relevant period. The amount of revenue attributable to our new games with an operating history of less than 12 months isapproximately US$4.4 million in 2012, US$1.9 million in 2013 and US$13.5 million in 2014, representing 28.5%, 6.2%, 45.7% of our total revenues fromonline games in 2012, 2013, 2014, respectively. The amount of revenue attributable to our old games with an operating history of more than 12 months isapproximately US$11.1 million in 2012, US$28.8 million in 2013 and US$16.1 million in 2014. In addition, our top five games accounted for approximately7.7%, 11.5% and 8.8% of our total revenues in 2012, 2013, 2014, respectively.Cost of revenuesOur cost of revenues consists primarily of (i) bandwidth costs, (ii) content costs, (iii) payment handling fees, (iv) depreciation of servers and otherequipment and (v) games revenue sharing costs and others. The following table sets forth the components of our cost of revenues by amounts and percentagesof our revenues for the periods presented: For the Year Ended December 31, 2012 2013 2014 (in thousands of US$, except for percentages) Amount % ofRevenues Amount % ofRevenues Amount % ofRevenues Bandwidth costs 22,211 15.0 35,454 19.6 40,380 22.1 Content costs, including amortization 46,671 31.5 35,964 20.0 34,673 19.0 Payment handling fees 8,505 5.7 12,401 6.9 11,963 6.5 Depreciation of servers and other equipment 3,271 2.2 4,317 2.4 5,652 3.1 Games revenue sharing costs and others 3,354 2.3 5,124 2.8 5,791 3.1 Total 84,012 56.7 93,260 51.7 98,459 53.8 Bandwidth costs. Bandwidth costs are the fees we pay to telecommunications carriers and other service providers for telecommunicationsservices and for hosting our servers at their internet data centers. Bandwidth is a significant component of our cost of revenues. We expect our bandwidthcosts to increase on an absolute basis primarily due to an increased need for bandwidth to support the growth of our business, although we expect these coststo be partly offset by cost savings provided by Project Crystal, our efforts to crowdsource bandwidth, and be reduced significantly if our proposed sale ofXunlei Kankan is completed. For the three months ended December 31, 2014, a portion of the bandwidth we use for our acceleration services was supplied bybandwidth crowdsourced through Project Crystal, instead of buying such bandwidth from third parties. We believe that our distributed computing networkprovides us significant cost advantages in providing transmission and streaming services compared with traditional client-server architecture that may requireconsiderably more investment in infrastructure, including servers and bandwidth, to support the same level of user activities. In addition, we expect to reduceour bandwidth costs as we continue to scale in magnitude the bandwidth we crowdsource through Project Crystal. For details on Project Crystal, see “Item 4.Information on the Company — B. Business Overview.” In addition, as a significant portion of our bandwidth was historically consumed by Xunlei Kankan’sonline streaming business, we expect our bandwidth costs to decrease in the future if we complete our proposed sale of Xunlei Kankan to an independentthird party. For details of our planned sale of Xunlei Kankan, see “Item 4. Information on the Company — A. History and Development of the Company.” 94Table of ContentsContent costs. Content costs primarily consist of content licensing fees that we pay to copyright owners or content distributors. Our content costsincreased significantly from 2011 to 2012, primarily due to the fast expansion of our content library on Xunlei Kankan. The increase of our content costs isalso due to an increase in unit cost of professionally produced content due to increased market demand in China. Starting from April 2011, based on anaccumulation of data gathered on historical viewing patterns of our content, we changed the content amortization method from straight line to acceleratedmethod. Our content costs decreased from 2012 through 2014. We expect our content costs to continue to decrease in the future as we begin to secure contentin a cost efficient manner. Furthermore, if we successfully sell our entire interest in Xunlei Kankan to an independent third party, as planned, we expect ourcontent costs to decrease even further to immaterial levels as we would no longer pay for Xunlei Kankan’s extensive content library.Payment handling fees. Payment handling fees are the fees we pay to payment channels for cloud acceleration subscription services, onlinegames and other paid services. Users can make payments for such services through third-party online, fixed phone line and mobile phone payment channels.These third-party payment channels typically charge a handling fee for their services. Our subscribers used to make subscription payments through mobilephones. However, as mobile carriers generally charge higher handling fees than other channels, we have modified our subscription fee structure to encourageour subscribers to use other available payment channels. We expect such payment handling fees to increase as we continue to grow our subscription-basedand other paid service offerings.Depreciation of servers and other equipment. Depreciation expenses for servers and other equipment that are directly related to our businessoperations and technical support are included in our cost of revenues. We expect our depreciation expenses to increase on an absolute basis as we continue toinvest in additional servers and other equipment to accommodate the growth of our user and subscriber base, but to decrease as a percentage of our revenuesover time.Games revenue sharing costs and others. These costs mainly represent the share of online game revenue remitted to developers of exclusivelicensed games.Operating expensesOur operating expenses consist of (i) research and development expenses, (ii) sales and marketing expenses and (iii) general and administrativeexpenses. The following table sets forth the components of our operating expenses by amounts and percentages of our revenues for the periods presented: For the Year Ended December 31, 2012 2013 2014 (in thousands of US$, except for percentages) Amount % ofRevenues Amount % ofRevenues Amount % ofRevenues Research and development expenses 20,357 13.7 28,832 16.0 35,287 19.3 Sales and marketing expenses 20,219 13.6 26,610 14.8 29,253 16.0 General and administrative expenses 18,474 12.5 23,073 12.8 29,960 16.4 Total 59,050 39.8 78,515 43.6 94,500 51.7 95Table of ContentsResearch and development expenses. Research and development expenses consist primarily of salaries and benefits for our research anddevelopment personnel. Expenditures incurred during the research phase are expensed as incurred. Expenditures incurred for the development of theacceleration products prior to the establishment of technological feasibility are expensed when incurred. We expect our research and development expensesto increase in the near term as we continue to expand our research and development team to develop new products and update existing products, particularlyas we plan to continue devoting resources in the development of Project Crystal and the development and updating of our mobile products.Sales and marketing expenses. Sales and marketing expenses consist primarily of salaries, sales commissions and benefits for our sales andmarketing personnel and marketing and promotional expenses. We expect our sales and marketing expenses to increase in the near term as we expect to hireadditional sales personnel and invest in brand enhancement efforts and the promotion of our products, particularly as we plan to increase our efforts inpromoting Project Crystal and finding third party internet content providers who may be interested in purchasing the bandwidth we crowdsource throughProject Crystal in the future.General and administrative expenses. General and administrative expenses consist primarily of salaries and benefits, professional service feesand other administrative expenses. We expect our general and administrative expenses to increase in the near term as our business continues to grow and weincur increased costs related to complying with our reporting obligations under the U.S. securities laws as a public company.TaxationCayman IslandsWe are incorporated in the Cayman Islands. Under the current laws of the Cayman Islands, we are not subject to tax on income or capital gains.Additionally, there is no withholding tax on dividends paid by us to our shareholders.ChinaOn March 16, 2007, the PRC National People’s Congress promulgated the EIT Law, adopting a unified EIT rate of 25%. In addition, the EIT Lawalso provides a five-year transitional period starting from its effective date for those enterprises that were established before the date of promulgation of theEIT Law and that were entitled to preferential income tax rates under the then effective tax laws or regulations. On December 26, 2007, the State Councilissued the “Circular for Implementation of the Transitional Preferential Policies for the Enterprise Income Tax.” Pursuant to this Circular, the transitionalincome tax rates for enterprises established in the Shenzhen Special Economic Zone before March 16, 2007 were 18%, 20%, 22%, 24% and 25% for 2008,2009, 2010, 2011 and 2012, respectively. Thus, the applicable EIT rate for Giganology Shenzhen, the VIE and its subsidiaries, which were established in theShenzhen Special Economic Zone before March 16, 2007, was 25%, 25% and 25% for the years 2012, 2013 and 2014, respectively. 96Table of ContentsAs approved by the relevant tax authority, Giganology Shenzhen was further exempt from EIT for two years commencing from the first year ofprofitable operation after offsetting prior years’ tax losses, followed by a 50% reduction for the next three years, or 2-year Exemption and 3-year 50%Reduction, as a software enterprise. The first year of profit operation of Giganology Shenzhen was 2006. According to the EIT Law, Giganology Shenzhencould still enjoy the tax holidays which were grandfathered by the EIT Law in 2011. Accordingly, the applicable EIT rates for Giganology Shenzhen were25%, 25% and 25% for the year ended December 31, 2012, 2013 and 2014, respectively.On April 14, 2008, relevant PRC governmental regulatory authorities released further qualification criteria, application procedures andassessment processes for meeting the High and New Technology Enterprise, or HNTE status under the EIT Law which would entitle qualified and approvedentities to a favorable statutory tax rate of 15%. In April 2009, the State Administration for Taxation, or SAT, issued Circular Guoshuihan [2009] No. 203stipulating that entities qualified for the HNTE status should apply with the relevant tax authorities to enjoy the reduced EIT rate of 15% provided under theEIT Law starting from the year when the HNTE certificate becomes effective. In addition, an entity qualified for the HNTE status can continue to enjoy itsremaining tax holiday from January 1, 2008 provided that it has obtained the HNTE certificate according to the new recognition criteria set by the EIT Lawand the relevant regulations. In February 2011, Shenzhen Xunlei obtained the HNTE certificate in 2011 and has renewed the HNTE certificate with effectfrom September 30, 2014 for a term of three years.According to a policy of the PRC State tax bureau, enterprises that engage in research and development activities are entitled to claim 150% ofthe research and development expenses incurred in a year as tax deductible expenses in determining their tax assessable profits for that year, or SuperDeduction. Shenzhen Xunlei has been claiming this Super Deduction in ascertaining its tax assessable profits and brought forward tax losses from 2009onwards. In addition, following the approval by the relevant tax authority in July 2010, Shenzhen Xunlei was recognized as an enterprise engaged insoftware development activities. Accordingly, it is entitled to a tax holiday of 2-year Exemption and 3-year 50% Reduction from 2010 onwards. In December2013, Shenzhen Xunlei obtained the certificate of the Key Software Enterprise for the years ended December 31, 2013 and 2014, which enables ShenzhenXunlei to enjoy the preferential tax rate of 10% for the year of 2013. As a result, the applicable tax rate of Shenzhen Xunlei for the years ended December 31,2012, 2013 and 2014 were 12.5%, 10% and 10%, respectively.Pursuant to the relevant PRC regulations, Xunlei Computer is entitled to the 2-year Exemption and 3-year 50% Reduction treatment. The firstyear of profitable operation of Xunlei Computer is 2013. Our other subsidiaries and VIE’s subsidiaries, which were established after January 1, 2008, aresubject to EIT at a rate of 25%.In addition, according to the EIT Law and its implementation rules, foreign enterprises, which have no establishment or place in the PRC butderive dividends, interest, rents, royalties and other income (including capital gains) from sources in the PRC are subject to PRC withholding tax, or WHT, at10% (a further reduced WHT rate may be available according to the applicable double tax treaty or arrangement). The 10% WHT is generally applicable toany dividends to be distributed from Giganology Shenzhen and Xunlei Computer to us out of any profits of Giganology Shenzhen and Xunlei Computerderived after January 1, 2008. Although Xunlei Computer and Giganology Shenzhen had retained earnings as of December 31, 2014, the directors of thecompany decided to reinvest the retained earnings permanently in China and therefore no such WHT is required. 97Table of ContentsResults of operationsThe following table sets forth a summary of our consolidated results of operations by amounts and percentages of our revenues for the yearsindicated. This information should be read together with our consolidated financial statements and related notes included elsewhere in this annual report.The results of operations in any period are not necessarily indicative of the results that may be expected for any future period. For the Year Ended December 31, 2012 2013 2014 (in thousands of US$ except for percentage) Amount % ofRevenues Amount % ofRevenues Amount % ofRevenues Revenues, net of rebates and discounts 148,200 100.0 180,244 100.0 182,887 100.0 Business taxes and surcharge (7,679) (5.2) (5,650) (3.1) (3,358) (1.8) Net revenues 140,521 94.8 174,594 96.9 179,529 98.2 Cost of revenues (84,012) (56.7) (93,260) (51.7) (98,459) (53.8) Gross profit 56,509 38.1 81,334 45.1 81,070 44.3 Operating expensesResearch and development expenses (20,357) (13.7) (28,832) (16.0) (35,287) (19.3) Sales and marketing expenses (20,219) (13.6) (26,610) (14.8) (29,253) (16.0) General and administrative expenses (18,474) (12.5) (23,073) (12.8) (29,960) (16.4) Total operating expenses (59,050) (39.8) (78,515) (43.6) (94,500) (51.7) Net gain from exchanges of content copyrights 4,666 3.1 1,020 0.6 1,556 0.9 Operating income/(loss) 2,125 1.4 3,839 2.1 (11,874) (6.5) Interest income 1,377 0.9 1,189 0.7 6,733 3.7 Interest expense (1,400) (0.9) — — (163) (0.1) Other income, net 564 0.4 4,679 2.6 13,966 7.6 Share of (loss)/income from equity investees (45) (0.0) 25 0.0 (259) (0.1) Income before income tax 2,621 1.8 9,732 5.4 8,403 4.6 Income tax benefit / (expense) (2,239) 1.5 647 0.4 1,459 0.8 Net income 382 0.3 10,379 5.8 9,862 5.4 Less: Net loss attributable to the non-controlling interest (121) (0.1) (283) (0.2) (950) (0.5) Net income attributable to Xunlei Limited 503 0.3 10,662 5.9 10,812 5.9 Year ended December 31, 2014 compared with year ended December 31, 2013.Revenues. Our revenues increased by 1.5% from US$180.2 million in 2013 to US$182.9 million in 2014. The increase was primarily due to a13.2% increase in our revenues from subscription services and a 1.8% increase in other internet value added services, which was partially offset by a 20.1%decrease in our online advertising services as a result of a decrease in the number of advertisers in 2014.Our revenues from subscription services increased by 13.2% from US$86.7 million in 2013 to US$98.2 million in 2014. The increase was mainlyattributable to the increase in our subscriber numbers in the first three quarters of 2014, partially offset by a decline in subscriber numbers in the fourthquarter. The number of subscribers declined to 4.9 million as of December 31, 2014 due to the fact that our increased efforts in complying with strictergovernment regulation of internet content in China negatively affected user experience—part of our efforts included permitting a temporary suspension ofour subscription services to approximately 350,000 existing subscribers in the fourth quarter of 2014.Our online advertising revenues decreased by 20.1% from US$48.0 million in 2013 to US$38.4 million in 2014, primarily due to a decrease inthe number of advertisers from 399 in 2013 to 252 in 2014, which is partially offset by an increase in the average spending per advertiser from approximatelyUS$120,000 in 2013 to approximately US$152,000 in 2014. 98Table of ContentsRevenues derived from other internet value-added services increased by 1.8% from US$45.5 million in 2013 to US$46.3 million in 2014,primarily due to the increase in pay per view revenues from US$2.0 million in 2013 to US$3.9 million in 2014. The increase in pay per view revenues wasprimarily attributable to an increase in the number of pay per view monthly subscribers on Xunlei Kankan.Cost of revenues. Our cost of revenues increased by 5.6% from US$93.3 million in 2013 to US$98.5 million in 2014. The increase in our cost ofrevenues was primarily due to the increase in bandwidth costs associated with the expansion of our subscription and other services and an increase indepreciation of servers and other equipment, which were partially offset by a slight decrease in content costs.Bandwidth costs. Our bandwidth costs increased by 13.9% from US$35.5 million in 2013 to US$40.4 million in 2014, primarily due to theincreased bandwidth needs to support our subscription services. Bandwidth costs associated with subscription services have grown in line with the expansionof our subscription services.Content costs. Our content costs slightly decreased by 3.6% from US$36.0 million in 2013 to US$34.7 million in 2014, which primarily reflectsour continuing investments in content acquisition.Payment handling fees. Our payment handling fees decreased by 3.6% from US$12.4 million in 2013 to US$12.0 million, driven primarily by achange in the combination of payment channels used by our subscribers.Depreciation of servers and other equipment. Depreciation of servers and other equipment increased by 30.9% from US$4.3 million in 2013 toUS$5.7 million in 2014, as we acquired more servers and other equipment to accommodate the increased needs for our acceleration and other productservices.Games revenue sharing costs and others. These costs increased by 13.3% from US$5.1 million in 2013 to US$5.8 million in 2014, mainlybecause we generated more revenues from exclusive licensed games in 2014.Gross profit. As a result of the above, our gross profit decreased by 0.2% from US$81.3 million in 2013 to US$81.1 million in 2014. Gross profitmargin decreased from 45.1% in 2013 to 44.3% in 2014, primarily due to an increase in bandwidth costs.Operating expenses. Our operating expenses increased by 20.4% from US$78.5 million in 2013 to US$94.5 million in 2014, primarily due to anincrease of staff compensation expenses, including share-based compensation.Research and development expenses. Our research and development expenses increased by 22.4% from US$28.8 million in 2013 to US$35.3million in 2014. The increase in our research and development expenses was primarily due to the rise in staff compensation expenses, both due to an increasein headcount and an increase in average salary and bonus levels.Sales and marketing expenses. Our sales and marketing expenses increased by 9.9% from US$26.6 million in 2013 to US$29.3 million in 2014.The increase in our sales and marketing expenses was primarily due to our increased spending on marketing and promotion.General and administrative expenses. Our general and administrative expenses increased by 29.9% from US$23.1 million in 2013 to US$30.0million in 2014. The increase in our general and administrative expenses was primarily due to an increase in staff compensation expenses, including share-based compensation, both due to an increase in headcount and an increase in average salary and bonus levels. 99Table of ContentsNet gain from exchanges of content copyrights. We enter into agreements with third parties (mainly video streaming internet platforms) toexchange digital media content, which are non-monetary and similar to barter transactions. We had net gains from such exchange of content copyrights ofUS$1.0 million in 2013 and US$1.6 million in 2014. The increase in net gain corresponds to the increase in the content we purchased in the first half of 2014.Interest income. Our interest income increased by 466.4% from US$1.2 million in 2013 to US$6.7 million in 2014. The increase was primarilydue to an increase in cash held in the form of interest-bearing bank deposits representing net proceeds received from series E financing and our initial publicoffering in June 2014.Interest expense. We did not have any interest expense 2013 but had an interest expense of US$0.2 million in 2014, which represented interestexpenses accrued for long-term payables to certain shareholders resulting from repurchase of shares in 2014.Other income, net Our other income increased by 198.5% from US$4.7 million in 2013 to US$14.0 million in 2014, primarily due to an increaseof US$6.5 million in fair value changes of warrants liabilities resulting from expiration of series E warrants upon our initial public offering, and an increase ofUS$1.6 million in investment income from short-term investments and an increase of US$0.8 million in subsidy income.Income tax benefit. We had income tax benefit of US$0.6 million and US$1.5 million in 2013 and 2014, respectively. The income tax benefitfor 2014 was mainly attributable to the deferred tax asset related to our operating loss, which was carried forward to offset taxable income.Net income attributable to Xunlei Limited. As a result of the above, we generated net income attributable to Xunlei Limited of US$10.7 millionin 2013 and US$10.8 million in 2014.Year ended December 31, 2013 compared with year ended December 31, 2012.Revenues. Our revenues increased by 21.6% from US$148.2 million in 2012 to US$180.2 million in 2013. The increase was primarily due to asubstantial increase in our revenues from subscription services and other internet value added services, which was partially offset by the decrease in ouronline advertising services as a result of our decision to discontinue delivering advertisements on Xunlei Accelerator in the first half of 2013.Our revenues from subscription services increased by 69.9% from US$51.1 million in 2012 to US$86.7 million in 2013. The increase was mainlyattributable to a significant increase in the number of our subscribers, which grew from 4.0 million as of December 31, 2012 to 5.1 million as of December 31,2013.Our online advertising revenues decreased by 22.3% from US$61.8 million in 2012 to US$48.0 million in 2013, primarily due to a decrease inadvertising revenues from Xunlei Accelerator from US$16.8 million to US$3.1 million, as a result of our decision to discontinue delivering advertisements onXunlei Accelerator in the first half of 2013. The average spending per advertiser slightly decreased from approximately US$147,000 in 2012 toapproximately US$120,000 in 2013 and the number of advertisers decreased from 420 to 399 for the respective years. 100Table of ContentsRevenues derived from other internet value-added services increased by 28.7% from US$35.4 million in 2012 to US$45.5 million in 2013,primarily due to the increase in revenues from online games from US$15.5 million to US$30.7 million and the increase in pay per view revenues from US$0.5million to US$2.0 million during the same period, which was partially offset by decrease in content sublicensing revenues from US$15.2 million to US$7.3million. The increase in online games revenues were primarily attributable to an increase in the number of exclusive licensed games that we operated on ourplatform as well as the increased popularity of our existing games. The decrease in content sublicensing revenues was due to decrease in the exclusivecontents that we purchased in 2013.Cost of revenues. Our cost of revenues increased by 11.0% from US$84.0 million in 2012 to US$93.3 million in 2013. The increase in our cost ofrevenues was primarily due to the increase in bandwidth costs associated with the expansion of our subscription and other services and the increase inpayment handling fees, which were partially offset by the significant decrease in content costs.Bandwidth costs. Our bandwidth costs increased by 59.6% from US$22.2 million in 2012 to US$35.5 million in 2013, primarily due to theincreased bandwidth needs to support our subscription services and our increased provision of a larger amount of high-definition content on Xunlei Kankan.With the growth of our subscription services, bandwidth costs associated with subscription services have grown significantly.Content costs. Our content costs decreased by 22.9% from US$46.7 million in 2012 to US$36.0 million in 2013, primarily because we purchasedless content in 2013.Payment handling fees. Our payment handling fees increased by 45.8% from US$8.5 million in 2012 to US$12.4 million in 2013, drivenprimarily by the rapid growth of our cloud acceleration subscription services.Depreciation of servers and other equipment. Depreciation of servers and other equipment increased by 32.0% from US$3.3 million in 2012 toUS$4.3 million in 2013, as we acquired more servers and other equipment to accommodate the increased needs for acceleration and streaming services.Games revenue sharing costs and others. These costs increased by 52.8% from US$3.4 million in 2012 to US$5.1 million for the same period in2013, mainly because we generated more revenues from exclusive licensed games in 2013.Gross profit. As a result of the above, our gross profit increased by 43.9% from US$56.5 million in 2012 to US$81.3 million for the same periodin 2013. Gross profit margin increased from 38.1% in 2012 to 45.1% in 2013 due to changes in the revenue mix.Operating expenses. Our operating expenses increased by 33.0% from US$59.1 million in 2012 to US$78.5 million in 2013, primarily due toincreases in research and development expenses and sales and marketing expenses and, to a lesser extent, due to an increase in general and administrativeexpenses.Research and development expenses. Our research and development expenses increased by 41.6% from US$20.4 million in 2012 to US$28.8million in 2013. The increase in our research and development expenses was primarily due to increases in headcount and salaries.Sales and marketing expenses. Our sales and marketing expenses increased by 31.6% from US$20.2 million in 2012 to US$26.6 million in 2013.The increase in our sales and marketing expenses was primarily due to our increased spending on marketing and promotion and, to a lesser extent, due toincreases in headcount and salaries. 101Table of ContentsGeneral and administrative expenses. Our general and administrative expenses increased by 24.9% from US$18.5 million in 2012 to US$23.1million in 2013. The increase in our general and administrative expenses was primarily due to the increase of professional services fees, the impairmentcharge of US$0.8 million for one of our online games, increase in bad debt expenses of US$0.2 million relating to the deterioration of a limited number of oursmall to medium size advertising agency customer’s accounts receivables and expenses associated with a property we leased in October 2012 as our newoffice premises in Shenzhen.Net gain from exchanges of content copyrights. We enter into agreements with third parties (mainly video streaming internet platforms) toexchange digital media content, which are non-monetary and similar to barter transactions. We had net gains from such exchange of content copyrights ofUS$4.7 million in 2012 and US$1.0 million in 2013. The decrease in net gain corresponds to the decrease in the content we purchased in 2013.Interest income. Our interest income decreased by 13.7% from US$1.4 million in 2012 to US$1.2 million in 2013.Interest expense. Our interest expense decreased from US$1.4 million in 2012 to zero in 2013, because we repaid our outstanding bank loans in2013.Income tax benefit/(expense). We recorded an income tax expense of US$2.2 million in 2012 and an income tax benefit of US$0.6 million in2013. This primarily reflected lower corporate income tax, the increased tax holiday available to Shenzhen Xunlei, and the higher deferred tax assetsrecognized in 2013 due to the change in the tax rate.Net (loss) income attributable to Xunlei Limited. As a result of the above, we generated net income attributable to Xunlei Limited of US$0.5million in 2012 and US$10.7 million in 2013.InflationInflation in China has not affected our results of operations in recent years. According to the National Bureau of Statistics of China, the year-over-year percent changes in the consumer price index for December 2012, 2013 and 2014 were increases of 2.5%, 2.5% and 1.5%, respectively. Although wehave not been affected by inflation in the past, we may be affected if China experiences higher rates of inflation in the future.Critical accounting policiesWe prepare our financial statements in conformity with U.S. GAAP, which requires us to make estimates and assumptions that affect our reportingof, among other things, assets and liabilities, contingent assets and liabilities and revenues and expenses. We regularly evaluate these estimates andassumptions based on the most recently available information, our own historical experiences and other factors that we believe to be relevant under thecircumstances. Since our financial reporting process inherently relies on the use of estimates and assumptions, our actual results could differ from what weexpect. This is especially true with some accounting policies that require higher degrees of judgment than others in their application. We consider thepolicies discussed below to be critical to an understanding of our audited consolidated financial statements because they involve the greatest reliance on ourmanagement’s judgment. 102Table of ContentsRevenue recognition 1.Subscription revenuesWe operate a VIP subscription program where subscribers can have access to acceleration services and other access privileges. The subscriptionfee is time-based and is collected up-front from subscribers except in the cases when they elect to pay via their mobile operators. The subscription fee iscollected when the subscribers pay for their monthly phone bills. The terms of time-based subscriptions range from one to twelve months, with the subscribershaving the option to renew the contracts. The receipt of subscription fees is initially recorded as deferred revenue and revenues are recognized ratably overthe period of subscription as services are rendered. Unrecognized portion of the subscription fee beyond 12 months from balance sheet date is classified asnon-current liability. We evaluated the principal versus agent criteria and determined that we are the principal in the transaction and accordingly recordrevenues on a gross basis. In determining whether to report revenues gross for the amount of subscription revenues, we assesses whether it maintains theprincipal relationship with the VIP subscribers, whether it bears the credit risk and whether it establishes prices for the end users. Payment handling feeslevied by online system, fixed phone line and mobile payment channels are recorded as the cost of revenues in the same period as the revenues for thesubscription fee are recognized. 2.Advertising revenuesAdvertising revenues are derived principally from advertising arrangements where the advertisers pay to place their advertisements on ourplatform in different formats over a particular period of time. Such formats include but are not limited to videos, banners, links, logos and buttons.Advertisements on our platform are charged on the basis of duration, and advertising contracts are signed to establish the fixed price and theadvertising services to be provided. We enter into advertising contracts with third-party advertising agencies that represent advertisers, as well as directlywith advertisers. A typical contract term would range from a few days to three months. Both third party advertising agencies and direct advertisers are billedat the end of the display period and payments are due usually within three months.Where our customers purchase multiple advertising spaces with different display periods in the same contract, we allocate the total considerationto the various advertising elements based on their relative fair values and recognize revenues for the different elements over their respective display periods.We determine the fair values of different advertising elements based on the prices charged when these elements were sold on a standalone basis. We recognizerevenues on the elements delivered and defer the recognition of revenues for the fair value of the undelivered elements until the remaining obligations havebeen satisfied. Where all of the elements within an arrangement are delivered uniformly over the contract period, revenues are recognized on a straight linebasis over the contract period. a)Transactions with third-party advertising agenciesFor contracts entered into with third-party advertising agencies, the third-party advertising agencies will in turn sell the advertising services toadvertisers. Revenues are recognized ratably over the contract period of display based on the following criteria: • There is a persuasive evidence that an arrangement exists: we will enter into framework and execution contracts with the advertisingagencies, specifying price, advertising content, format and timing; 103Table of Contents • Price is fixed and determinable: price charged to the advertising agencies is specified in the contracts, including relevant discount andrebate rates; • Services are rendered: we recognize revenues ratably over the contract period of display; and • Collectability is reasonably assured: we assess credit history of each advertising agency before entering into any framework andexecution contracts. If the collectability from the agencies is assessed as not reasonably assured, we recognize revenues only when thecash is received and all the other revenues criteria are met.We provide sales incentives in the forms of discounts and rebates to third party advertising agencies based on purchase amount. As theadvertising agencies are viewed as the customers in these transactions, revenues are recognized based on the price charged to the agencies, net of sales rebatesprovided to the agencies. Sales incentives are estimated and recorded at the time of revenue recognition based on the contracted rebate rates and estimatedsales amount based on historical experience.We regularly monitor sales amount from each customer and adjust our estimated rebate at the end of each reporting period. Annual sales rebatesare assessed on a quarterly basis based on the contracted rebate rates and the estimated sales amount for the full year, and actual sales to date and estimatedsales for the rest of the year. Such rebates are adjusted at the year end based on actual sales amount achieved. b)Transactions with advertisersWe also enter into advertisement contracts directly with advertisers. Under these contracts, similar to transactions with third-party advertisingagencies, we recognize revenues ratably over the contract period of display. The terms and conditions, including price, are fixed according the contractsbetween us and the advertisers. We also perform credit assessment of all advertisers prior to entering into contracts. Revenues are recognized based on theamount charged to the advertisers, net of discounts. 3.Other internet value-added services (1)Online game revenuesUsers play games through our platform free of charge and are charged for purchases of virtual items including consumable and perpetual items,which can be utilized in the online games to enhance their game-playing experience. Consumable items represent virtual items that can be consumed by aspecific user within a specified period of time. Perpetual items represent virtual items that are accessible to the users’ account over the life of the online game.Pursuant to contracts signed between us and the game developers, revenues from the sale of virtual items are shared based on a pre-agreed ratio for each game.We enter into both non-exclusive and exclusive licensing contracts with game developers. a)Non-exclusive game licensed contractsThe games under non-exclusive licensed contracts are maintained, hosted and updated by the game developers. We mainly provide access to ourplatform and limited after-sale services to the game players. The determination of whether to record these revenues using the gross or net method is based onan assessment of various factors; the primary factors are whether we act as the principal in offering services to the game players or as agent in the transactions,and the specific requirements of each contract. We have determined that for non-exclusive game licensed arrangements, the third party game developers arethe principal given that the game developers design and develop the game services offered, have reasonable latitude to establish prices of virtual items, andare responsible for maintaining and upgrading the game content and virtual items. Accordingly, we record online game revenues, net of the portion remittedto the game developers. 104Table of ContentsGiven that online games are managed and administered by the game developers for non-exclusive licensed games, we do not have access to thedata on the consumption details and the types of virtual items purchased by the game players. However, we have data of when a particular user makes apurchase and logs into the game. We have adopted a policy to recognize revenues relating to both consumable and perpetual items, over the shorter of(1) estimated lives of the games and (2) the estimated lives of the user relationship with us, which were approximately two to six months for the periodspresented.Adjustments arising from the change of estimated lives of virtual items are applied prospectively as such change results from new informationindicating a change in the game player behavioral patterns. b)Exclusive game licensed contractsFor exclusive licensed contracts with game developers, the games are maintained and hosted by us. Accordingly, where we are determined to bethe principal, we record online game revenues on a gross basis, with the amount remitted to the game developers reported as cost of revenues. Paymenthandling fees are recognized as cost of revenues when the related revenues are recognized.For exclusive licensed games which are maintained on our servers, we have access to the data on the consumption details and types of virtualitems purchased by the game players. We do not maintain information on consumption details of virtual items, and only have limited information related tothe frequency of log-ons. Given that a substantial portion of the virtual items purchased by the game players in exclusive licensed games are perpetual items,our management has determined that it would be most appropriate to recognize the related revenues over the shorter of (1) estimated lives of the games and(2) estimated life of the user relationship with us, which is approximately one to three months. Revenues relating to consumable items are recognizedimmediately upon consumption. Any changes in our estimates of lives of virtual items may result in our revenues being recognized on a basis different fromprior periods and may cause our operating results to fluctuate.For both non-exclusive and exclusive licensed games, we estimate the life of virtual items to be the shorter of the estimated lives of the gamesand the estimated lives of the user relationship.The estimated user relationship period is based on data collected from those users who have purchased virtual items. To estimate the life of theuser relationship, we maintain a software system that captures the following information for each user: the date of first log-in, the date of first purchase for avirtual item, the date of last purchase for a virtual item and the date the user ceases to play the game. We estimate the life of the user relationship to be theaverage period from the first purchase of a virtual item to the date the user ceases to play the game. The estimate of the life of the user relationship is basedonly on the data of those users who have purchased virtual items and is made on a game-by-game basis.To estimate the date the user plays the game for the last time, we selected all paying users that logged on during a particular month and continueto track these users’ log-on behaviors over at least a six-month period to determine if each user is “active” or “inactive,” which is determined based on areview of the period of inactivity or idle period from the user’s last log-on. We observe the behaviors of these users to see whether they subsequently return toa game based on different inactive periods (e.g. not logging on) of one month, two months, three months and so forth. The percentage of users calculated thatdo not log back on is estimated to be the probability that users will not return to the game after a certain period of inactivity. 105Table of ContentsWe consider a paying player to be inactive once he or she has reached a period of inactivity for which it is probable (defined as at least 80%) thata player will not return to a specific game. We believe that using an 80% threshold for the likelihood that a player will not return to a game is a reasonableestimate that achieves the magnitude of “probable” under the threshold described in ASC 450 Contingencies. We have consistently applied this threshold toour analysis. Based on our assessment, the inactive period ranges generally from one to three months depending on the games.To estimate the life of the games, we consider both games that we operate as well as games in the market that are of a similar nature. We groupthese games by their nature, in categories such as simulation games, role playing games and others, which appeal to players belonging to differentdemographics. We estimate that the life of each group of the games to be the average period from the date of launch for such games to the date the games areexpected to be removed from the website or terminated altogether. When we launch a new game, we estimate the life of the game and user relationship basedon lives of other similar games in the market until the new game establishes its own history. We also consider the game’s profile, attributes, target audience,and its appeal to players of different demographic groups in estimating the user relationship period.The consideration of user relationship with each online game is based on our best estimate that takes into account all known and relevantinformation at the time of assessment. Adjustments arising from the changes of estimated lives of virtual items are applied prospectively as such changes areresulted from new information indicating a change in the game player behavioral patterns. Any changes in our estimates of lives of virtual items may result inour revenues being recognized on a basis different from prior periods and may cause our operating results to fluctuate. We periodically assess the estimatedlives of the virtual items and any changes from prior estimates are accounted for prospectively. Any adjustments arising from changes in user relationship as aresult of new information will be accounted as a change in accounting estimate in accordance with ASC 250 Accounting Changes and Error Corrections.Game players can purchase virtual currency via an online payment channel. We incur service fees levied by these payment channels, and suchpayment expenses are recorded as the cost of revenues when the related revenues are recognized. (2)Content sub-licensing revenuesWith copyright content that has been exclusively licensed to us, we have the right to sub-license the broadcasting rights on a recurring basis tothird parties. We generate revenues from sub-licensing these broadcasting rights to third party customers, mainly video streaming internet platforms for cash,at a fixed rate for a fixed period of time that falls within the original exclusive license period. Revenues are recognized in full at the later of the delivery ofthe copy of the content with acceptance acknowledged by the customers and the commencement of the license period, as we are not obliged to provide anyother services. We perform credit assessment of our customers prior to entering into contracts to ensure that collection of the arrangement fee is reasonablyassured. We have no on-going obligation after delivery of the copy of the content. (3)Pay per view revenuesWe operate a pay per view program in which subscribers pay a monthly fee to watch and access a collection of movie contents. The subscriptionfee is time-based and is collected up-front from subscribers except in the cases where they elect to pay via their mobile operators. The subscription fee iscollected when the subscribers pay for their monthly phone fees. The terms of time-based subscriptions range from one month to twelve months, with thesubscribers having the option to renew the contracts. The receipt of payment is initially recorded as deferred revenue and revenue is recognized ratably overthe period of subscription as services are rendered. 106Table of ContentsViewers can also pay to watch each individual movie for an unlimited number of times. Revenues are recognized when the movie is broadcastedto the viewers.Barter transactionsWe also enter into agreements with third parties (mainly video streaming internet platform) to exchange content. The exchanged contentprovides rights for each respective party only to broadcast the content received on its own website; though, each party retains the right to continuebroadcasting and or sub-license the rights to the content it surrendered in the exchange. These transactions are non-monetary transactions similar to bartertransactions, and we follow ASC 845, Non-Monetary Transactions and ASC 360-10, Property, Plant, and Equipment.Such barter transactions should be recorded at fair value of the surrendered assets in the transaction unless such fair value is not determinablewithin reasonable limits. We estimated the fair value of the content by gathering “price reference” of cash sub-licensing transaction of each exclusive contentright and categorizing it into two buckets (1) cash transaction prices with established counterparties and (2) cash transaction prices with less establishedcounterparties. With this information, we calculate an “average cash transaction price” for each category to be used as a reference for the non-monetarytransaction. The attributable cost of the related exclusive Content Copyright surrendered is released and recorded as the cost of the barter transaction inaccordance with ASC 926 Entertainment—Films in which the cost is computed using the individual-film-forecast-computation method. This methodcalculates such cost based on the ratio of the estimated fair value of the exchanged content over the aggregate estimated fair value to be generated by theexclusive Content Copyrights for their whole license period or estimated useful lives. We revisit the forecast at each quarter or year end and make adjustment,when appropriate.Share-based compensationWe awarded a number of share-based compensation options to our employees, officers and directors. The details of these share-based awards andthe respective terms and conditions are described in “Share-based compensation” in note 19 to our audited consolidated financial statements for the yearsended December 31, 2012, 2013 and 2014.Options are accounted for as equity-classified awards because there are no explicit repurchase rights specified in the award documents and thenumber of shares of our common shares issued under these awards are fixed and determined at the time of grants. All options are measured based on the fairvalue of the award on the grant date and recognized as compensation expenses based on the straight-line vesting method, net of estimated forfeitures, overthe requisite service period, which is generally the vesting period.The following table sets forth the options granted that were outstanding as of December 31, 2014: Date of Option Grant Optionsoutstanding Exercise price(US$) Fair value ofoptions(US$) Fair value ofcommon shares(US$) prior to 2012 8,618,325 — — — March 1, 2012 75,615 0.01-3.97 1.01-2.82 2.83 August 1, 2012 7,917 3.97 1.10 3.01 March 1, 2013 7,292 3.97 1.17 3.20 August 1, 2013 267,500 3.97 1.13 3.23 November 18, 2013 366,761 2.11-3.97 0.99-1.60 3.15 March 5, 2014 52,000 3.97 0.89 3.06 June 24, 2014 512,642 2.11 1.43 2.98 September 5, 2014 32,233 3.97 0.62-0.66 2.67 Total 9,940,285 107Table of ContentsWe estimate the fair value of share options granted using the Black-Scholes option pricing model. The key assumptions used to determine thefair value of the options at the relevant grant dates were as follows: For the Year Ended December 31, 2012 2013 2014Risk-free interest rate (1) 0.67% to 0.92% 0.77% to 1.76% 0.77% to 1.76%Dividend yield (2) — — — Volatility rate (3) 53.9% to 54.5% 43.8% to 51.3% 40.07% to 43.3%Expected term (in years) (4) 4.58 4.58 4.13 to 4.58Notes: (1)The risk-free interest rates of periods within the contractual life of the share options is based on the U.S. dollar Chinese government bond yield datafrom Bloomberg as of the valuation dates;(1)We have no history or expectation of paying dividends on our common stock;(2)Expected volatility is estimated based on the average historical volatilities of shares of the comparable publicly listed companies from Bloomberg asof the valuation dates; and(3)The expected term is estimated by assuming the share options will be exercised in the middle point between the vesting dates and maturity dates.We also awarded a number of restricted shares to our executive officers and employees. On November 18, 2013, December 31, 2013, March 5,2014, March 31, 2014, June 9, 2014, June 24, 2014, August 1, 2014, November 3, 2014 and December 1, 2014, we granted 7,605,238, 490,000, 1,830,000,270,000, 689,700, 60,000, 1,205,058, 1,800,000 and 3,781,087 restricted shares to our executive officers and employees, respectively. In March 2014,3,427,620 restricted shares were forfeited, and these are available for future grants to executive officers and employees. The details of these share-basedrestricted shares and the respective terms and conditions are described in “Share-based compensation” in note 19 to our audited consolidated financialstatements for the years ended December 31, 2012, 2013 and 2014.The restricted shares are accounted for as equity-classified awards because there are no explicit repurchase rights specified in the relevantdocuments and the number of shares of our common shares issued under these awards is fixed and determined at the time of grants. All restricted shares aremeasured based on the fair value of the awards on the grant date and recognized as compensation expenses based on the straight-line vesting method net ofestimated forfeitures over the requisite service period.In 2014, we granted 9,635,845 restricted shares to our executive officers and employees. The compensation costs that we expect to record forthese grants will be approximately US$18.6 million.Total compensation costs recognized for the years ended December 31, 2012, 2013 and 2014, respectively, are as follows: For the Year Ended December 31, (In thousands of US$) 2012 2013 2014 Sales and marketing expenses 46 43 66 General and administrative expenses 1,102 1,080 6,407 Research and development expenses 1,085 973 1,171 Total 2,233 2,096 7,644 108Table of ContentsDetermining the value of our share-based compensation expenses requires the input of highly subjective assumptions, including the expectedlife of the share-based awards, estimated forfeitures and the price volatility of the underlying shares. The assumptions used in calculating the fair value ofshare-based awards represent our best estimates, but these estimates involve inherent uncertainties and the application of our judgment. As a result, if factorschange and we use different assumptions, our share-based compensation expenses could be materially different in the future.Fair value of our common sharesPrior to the completion of our initial public offering, we were a private company with no quoted market prices for our common shares. We havetherefore estimated, with assistance from an independent valuation firm, the fair value of our common shares at certain dates in 2012, 2013, 2014.The following table sets forth the fair values of our common shares estimated from 2012 through the date of this annual report: Date Fair Valueof commonshares(per share) Type ofmethodology Type of valuation Purpose of valuationJanuary 31, 2012 3.36 Income approach Contemporaneous Series D valuationMarch 1, 2012 2.83 Income approach Contemporaneous Valuation of ESOPAugust 1, 2012 3.01 Income approach Contemporaneous Valuation of ESOPMarch 1, 2013 3.20 Income approach Contemporaneous Valuation of ESOPAugust 1, 2013 3.23 Income approach Contemporaneous Valuation of ESOPNovember 18, 2013 3.15 Income approach Contemporaneous Valuation of ESOP (includingrestricted shares)December 31, 2013 3.14 Income approach Contemporaneous Valuation of ESOP (includingrestricted shares)March 5, 2014 3.06 Income approach Contemporaneous Series E valuation and valuation ofESOP (including restricted shares)March 31, 2014 3.06 Income approach Contemporaneous Valuation of ESOP (includingrestricted shares)June 9, 2014 3.30 Income approach Contemporaneous Valuation of ESOP (includingrestricted shares) 109Table of ContentsWe estimated the fair value of our common shares based on valuations performed by our management with the assistance of an independentvaluer for options granted after January 1, 2008 and through June 9, 2014. Determining the fair values of our common shares requires our management tomake complex and subjective judgments regarding our projected financial and operating results, the unique business risks, the liquidity of our commonshares and operating history and prospects at the time of each grant. Therefore, these fair values are inherently uncertain and highly subjective.In determining the fair values of our common shares as of each award grant date, we consider a number of objective and subjective factors that webelieve market participants would consider, including (a) our business, financial condition, and results of operations, including related industry trendsaffecting our operations; (b) our forecasted operating performance and projected future cash flows; (c) the illiquid nature of our common shares;(d) liquidation preferences and other rights and privileges of our common shares; (e) market multiples of our most comparable public peers; (f) recent sales ofour securities; and (g) market conditions affecting our industry. Therefore, we considered three generally accepted approaches to value our common shares:market approach, cost approach and income approach. We believe that the market approach and cost approach are inappropriate for the valuation. Firstly, themarket approach requires market transactions of comparable assets as an indication of value, and we have not identified any current market transactionswhich are comparable. Secondly, the cost approach does not directly incorporate information about the economic benefits contributed by the underlyingbusiness. We decided to rely upon the income approach as the sole means of valuation since we believe we are a later-stage enterprise as opposed to an early-stage enterprise. We believe we have enough financial data on which to base a forecast of future results. In applying the income approach to determine thevalue of our common shares, a discount was applied to reach the final valuation of our common shares based on the fact that, inasmuch as we are a privatecompany, there are impediments to liquidity, including lack of publicly available information and the lack of a trading market. The discounted cash flowmethod is a method within the income approach whereby the present value of future expected net cash flows is calculated using a discount rate.The major assumptions used in calculating the fair values of our common shares include: • Weighted average cost of capital, or WACC: WACCs of 17.2%, 20.5%, 20.5%, 18.2%, 18.2%, 18.5%, 18.5%, 18.2%, 18.2% and 18.4%were used for dates as of January 31, 2012, March 1, 2012, August 1, 2012, March 1, 2013, August 1, 2013, November 18,2013, December 31, 2013, March 5, 2014, March 31, 2014 and June 9, 2014, respectively. The WACCs were determined based on aconsideration of the factors including risk-free rate, comparative industry risk, equity risk membership, company size and non-systematicrisk factors; • Comparable companies: In deriving the WACCs, which are used as the discount rates under the income approach, three China-basedonline marketing companies and one U.S.-based online marketing company, all of which are listed in the U.S., were selected for referenceas our guideline companies. • The income approach involves applying appropriate discount rates to estimated cash flows that are based on earnings forecasts. Ourrevenues and earnings growth rates, as well as major milestones that we have achieved, contributed significantly to the change in the fairvalue of our common shares from January 2011 to June 9 2014. However, these fair values are inherently uncertain and highlysubjective. The assumptions used in deriving the fair values are consistent with our business plan. These assumptions include: theprojected business performances can be achieved with the effort of our managements; there will be no material change in the existingpolitical, legal, technological, fiscal or economic conditions, which might adversely affect our business; the operational and contractualterms stipulated in the relevant contracts and agreements will be honored; and the facilities and systems proposed are sufficient for futureexpansion in order to realized the growth potential of the business and maintain a competitive edge; 110Table of Contents • For the income approach, we forecasted our future debt-free net cash flows for five to six years subsequent to the valuation date andapplied a H Model to calculate the terminal debt-free cash flow after five to six years. The net cash flow was then discounted to presentvalue using a risk-adjusted discount rate, which was based on market inputs using a capital asset pricing model that reflected the risksassociated with achieving our forecasts. The terminal or residual value at the end of the projection period was based on the H Model withthe terminal growth rate assumed to be 3% for all the valuation dates. The resulting terminal value and interim debt-free cash flows werethen discounted at a rate ranging from 17.2% to 20.5% for the respective valuation date which was based on the weighted average cost ofcapital of comparable companies, as adjusted for our specific risk profile. • Our total equity value was then allocated among the preferred shares and common shares. The valuation model allocated the equityvalue between the common shares and the preferred shares and calculated the fair value of common shares based on the option-pricingmethod. Under this method, common shares have value only if the funds available for distribution to shareholders exceed the value ofthe liquidation preference at the time of a liquidity event (for example, merger or sale). The common shares are considered to be a calloption with claim on the equity above the exercise price equal to the liquidation preferences of the preferred shares. • Discount for lack of marketability, or DLOM, a discount for lack of marketability was also applied to reflect the fact that there is no readypublic market for our shares as we were a closely held private company. When determining the discount for lack of marketability, theBlack-Scholes option model was used. Under the option pricing method, the fair value of the put option, which can hedge against a pricedecline before the privately held shares can be sold, was considered as a basis to determine the discount for lack of marketability. Basedon the analysis, a discount for lack of marketability of 19%, 26%, 26%, 19%, 16%, 14%, 14%, 12%, 12% and 8% was used onJanuary 31, 2012, March 1, 2012, August 1, 2012, March 1, 2013, August 1, 2013, November 18, 2013, December 31, 2013, March 5,2014, March 31, 2014 and June 9, 2014, respectively, for the valuation of our common shares, when we conducted valuations on thesedates in 2012, 2013, 2014. These assumptions are inherently uncertain. Different assumptions and judgments would affect ourcalculation of the fair value of the underlying common shares for the options granted, and the valuation results and the amount of share-based compensation expenses would also vary accordingly.We believe that the increase in fair value of our common shares from US$2.83 per common share as of March 1, 2012 to US$3.01 per commonshare as of August 1, 2012 is primarily attributable to the fast growth of our subscription business during this period. Our subscribers for subscription servicesincreased from approximately 3.2 million as of June 30, 2012 to approximately 3.6 million as of September 30, 2012.We believe that the increase in fair value of our common shares from US$3.01 per common share as of August 1, 2012 to US$3.20 per commonshare as of March 1, 2013 is primarily attributable to the continued growth of our subscription business during this period. Our subscribers for subscriptionservices increased from approximately 3.6 million as of September 30, 2012 to approximately 5.2 million as of March 31, 2013. 111Table of ContentsWe believe that the increase in fair value of our common shares from US$3.20 per common share as of March 1, 2013 to US$3.23 per commonshare as of August 1, 2013 is primarily attributable to the continued growth of our subscription business and online game business during this period.We believe that the decrease in fair value of our common shares from US$3.23 per common share as of August 1, 2013 to US$3.14 per commonshare as of December 31, 2013 is primarily attributable to the following factors: • The growth of revenues recently was more moderate compared to our previous forecast; • The growth of our cost structure outpaced that of revenues, which impacted our profitability in the near term; and • We granted restricted shares to our officers, which impacted the value per share.We believe that the decrease in fair value of our common shares from US$3.14 per common share as of December 31, 2013 to US$3.06 percommon share as of March 31, 2014 is primarily because the growth during the first quarter of 2014 was slower than the previous projection.We believe that the increase in fair value of our common shares from US$3.06 per common share as of March 31, 2014 to US$3.30 per commonshare as of June 9, 2014 is primarily attributable to the continued growth of our business and our initial public offering.Fair value of our series C convertible preferred sharesIn addition to our common shares, we have determined the fair value of the series C convertible preferred shares. The result of which is used todetermine amortization of the associated beneficial conversion feature. Consistent with common shares discussed above, the determination of the fair valueof our series C convertible preferred shares requires complex and subjective judgments to be made regarding our projected financial and operating results, ourunique business risk, the liquidity of these shares and our operating history and prospects at the time of valuation.The major assumptions used in calculating the fair values of our series C convertible preferred shares include: • Event scenario—Our best estimation of the occurrence and the timing of (1) a liquidation event or (2) an initial public offering, or IPO,event. The probability of the occurrence of an IPO is assumed to be 95% and the probability of the occurrence of a liquidation event isassumed to be 5%. • Risk free rate—The risk free rate used in the liquidation and the IPO scenario is assumed to be 0.1%, the 0.67 year US Treasury Bonds &Notes Yield. The risk free rate used in the redemption scenario is assumed to be 0.47%, the 4 year US Treasury Bonds & Notes Yield. • Volatility—The volatility estimate is based on the average volatility of the stock returns of selected comparable companies listed in theUS stock market which are engaged in the similar line of business. The volatility assumed to be 39.6%. Three China-based onlinemarketing companies and one U.S.-based online marketing company, all of which are listed in the U.S., were selected for reference as ourguideline companies. 112Table of ContentsThe option-pricing method was used to allocate enterprise value to preferred and common shares, taking into account the guidance prescribed bythe AICPA Audit and Accounting Practice Aid, “Valuation of Privately-Held Company Equity Securities Issued as Compensation”. The method treatscommon stock and preferred stock as call options on the enterprise’s value, with exercise prices based on the liquidation preference of the preferred shares.Modification of our series C convertible preferred sharesUpon issuance of the series D preferred shares in January 2012, we adjusted the conversion price of the series C preferred shares from US$5.24 pershare to US$4.14 per share; and obtained an exclusive option to purchase at any time within 12 months after January 2012 all of series C preferred shares atthe purchase price of US$4.607 per share. The conversion price of the series C preferred shares could be adjusted for any share dividends, sub-division andconsolidation, and unpaid dividend. As a result of this modification, we will issue a total of 7,248,293 common shares on a fully-converted basis of theoriginal 5,728,264 series C preferred shares. Other terms of the series C preferred shares including the original liquidation rights remained unchanged.We concluded that the downward conversion price adjustment from US$5.24 per share to US$5.13 per share is in accordance with the anti-dilution clause in the original financing agreement for the series C preferred shares. The incremental downward price adjustment from US$5.13 per share toUS$4.14 per share and the right to an exclusive purchase option are accounted for as modifications of the terms of series C preferred shares. The incrementalvalue contributed by the series C preferred shareholder amounts to US$2,905,000 and is deemed to be a wealth transfer between the preferred shareholder andcommon shareholders and charged to additional paid-in capital.In January 2014, we modified the anti-dilution terms relating to 5,613,699 series C preferred shares held by one investor. The modificationeffectively amended the anti-dilution triggering price from US$4.14 to US$2.81 per share. The incremental downward trigger price adjustment from US$4.14to US$2.81 is accounted for as modifications of the terms of series C preferred shares. The incremental value contributed by the series C preferred shareholderwas deemed to be a transfer of value between the preferred shareholders because the change in the value of the common shares before and after themodification was deemed to be negligible. We concluded that this can suggest that most of the value was transferred from this series C preferred shareholderto another existing preferred shareholder. No accounting charge was recorded.Triggering of the anti-dilution clause of series C convertible preferred sharesUpon issuance of series E preferred shares in March 2014, we adjusted the series C conversion price from USD$4.14 to US$3.64 per share relatingto 114,565 Series C preferred shares held by another investor. We concluded that the downward conversion price adjustment is in accordance with the anti-dilution clause in the series C financing documents. As a result of this anti-dilution, we will issue a total of 164,771 common shares on a fully-convertedbasis of the original 114,565 series C preferred shares when the conversion right is exercised by the holder. At the time of this anti-dilution, the series Cpreferred shares anti-diluted in 2014 contained a beneficial conversion feature of US$57,000 and the amount was charged to retained earnings in 2014 as adeemed dividend.Upon the completion of our initial public offering on June 24, 2014, we adjusted the series C conversion price from US$4.14 to US$3.89 andfrom US$3.63 to US$3.45 per share relating to 5,613,699 and 114,565 series C preferred shares held by two series C investors, respectively. We concludedthat the downward conversion price adjustment is in accordance with the anti-dilution clause in the latest shareholders agreement. As a result of this anti-dilution, we issued a total of 7,724,419 common shares on a fully-converted basis when the conversion right is exercised by the series C shareholders. Thetriggering of the anti-dilution clause resulted in a beneficial conversion feature amounted to US$ 1,403,000 as a deemed dividend to series C shareholdersand charged against retained earnings, and in the absence of retained earnings, a charge to additional paid-in capital. 113Table of ContentsFair value of our series D convertible redeemable preferred sharesIn addition to our common shares, we have determined the fair value of the series D convertible redeemable preferred shares. The result of whichis used to determine the amount of redemption value as well as the valuation of the warrant to acquire additional series D convertible redeemable preferredshares. Consistent with common shares discussed above, the determination of the fair value of our series D convertible redeemable preferred shares requirescomplex and subjective judgments to be made regarding our projected financial and operating results, our unique business risk, the liquidity of these sharesand our operating history and prospects at the time of valuation.The major assumptions used in calculating the fair values of our series D convertible redeemable preferred shares include: • Event scenario—Our best estimation of the occurrence and the timing of (1) a liquidation event, (2) an initial public offering event or(3) a redemption event. The probability of the occurrence of a liquidation event is assumed to be 30%, the probability of the occurrenceof an IPO is assumed to be 60%. And the probability of the occurrence of a redemption event is assumed to be 10%. • Risk free rate—The risk free rate is assumed to be 0.1%, the three months U.S. Treasury Bonds and Notes Yield. • Volatility—The volatility estimate is based on the average volatility of the stock returns of selected comparable companies listed in theUS stock market which are engaged in the similar line of business. The volatility is assumed to be 59.9%. Three China-based onlinemarketing companies and one U.S.-based online marketing company, all of which are listed in the U.S., were selected for reference as ourguideline companies.Option-pricing method was used to allocate enterprise value to preferred and common shares, taking into account the guidance prescribed by theAICPA Audit and Accounting Practice Aid, “Valuation of Privately-Held Company Equity Securities Issued as Compensation.” The method treats commonstock and preferred stock as call options on the enterprise’s value, with exercise prices based on the liquidation preference of the preferred stock.Fair value of our series D warrants and series E warrants to SkylineThe holder of the series D warrants has the right to exercise the warrants at the earlier of (i) 24 months from date of our initial public offering or(ii) immediately prior to the closing of the following transactions: (a) mergers or consolidation of Xunlei Limited, b) initial public offering, c) transaction inwhich in excess of 50% of our equity is transferred to any person, d) sale, transfer, lease, assignment conveyance, exchange, mortgage, or other disposition ofall or substantially all of our assets. The warrants are not entitled to dividend rights nor to vote until the warrants are exercised and shares become issuable.Series D warrants are classified as a liability and initially measured at their fair value at US$3,007,000. As of December 31, 2012 and 2013, the fair value ofSeries D warrants was US$3,717,000 and US$2,186,000. 114Table of ContentsThe warrants to purchase 1,952,663 and 266,272 series D preferred shares at US$3.38 per share expired on February 6, 2014 and March 1, 2014,respectively. On the date of the expiration, the warrants was measured at a fair value of US$2,414,000. Upon issuance of the series E preferred shares onMarch 5, 2014, we issued to Skyline warrants to purchase 3,406,824 series E preferred shares with an exercise price of US$2.82. These warrants wereexercisable at the option of the holder, at any time, no later than the earlier of (1) the pricing date of our initial public offering or (2) March 1, 2015. Skylinedid not exercise the warrants on the pricing date of our initial public offering and such warrants have expired as of the date of this annual report. As thewarrants are exercised into mezzanine equity, the warrants are classified as a liability and were initially measured at a fair value of US$2,819 thousand.The exchange of the series D warrants and the issuance of the series E warrants are considered to be a related transaction and are accounted for asa single transaction because the holder was willing to allow the series D warrants expire in contemplation that they will be issued series E warrants. A loss ofUS$405,000 which is the difference in value of the series D warrants on the expiration date and the value of the series E warrants on the issuance date, wascharged to the income statement in the first quarter of 2014.Upon the completion of our initial public offering on June 24, 2014, the series D investor did not exercise series E warrants, and the fair value ofseries E warrants was nil. The fair value gain of US$2,922 thousand was recorded for the year ended December 31, 2014 as other income.The fair value of the series D warrants and the series E warrants was estimated by us with the assistance of an independent valuation firm base onour estimates and assumptions. The valuation report provided us with guidelines in determining the fair value, but the ultimate determination was made byus. We applied the Black-Scholes Option Pricing Model to calculate the fair value of the series D warrants and series E warrants on the valuation date.The major assumptions used in calculating the fair value of the series D warrants includes: February 6,2012 December 31,2012 December 31,2013 February 6,2014 March 1,2014 Spot price (1) 3.66 4.48 4.36 4.47 4.47 Risk-free interest rate (2) 0.23% 0.15% 0.05% 0%* 0%* Volatility rate (3) 47.3% 41.2% 30.33% 0%* 0%* Dividend yield (4) — — — — — *Given that the maturity date of series D warrant was February 6, 2014 and March 1, 2014, the volatility rate and risk-free interest rate did not affect thevaluation of the warrant on February 6, 2014.The major assumptions used in calculating the fair value of the series E warrants includes: March 5, 2014Spot price (1) 3.31 - 4.65Risk-free interest rate (2) 0.04% - 0.12%Volatility rate (3) 38.39% - 38.81%Dividend yield (4) — (1)Spot price—based on the fair value of 100 percent equity interest of the Company which is allocated to preferred shares and common shares of theCompany as at the valuation date under different scenarios.(2)Risk-free interest rate—based on the US Treasury Bond & Notes BFV curve from Bloomberg as at the valuation date.(3)Volatility—based on the average historical volatility of the comparable companies from Bloomberg as at the valuation date.(4)The Company has no history or expectation of paying dividends on its common shares. 115Table of ContentsTriggering of the anti-dilution clause of series D convertible redeemable preferred sharesUpon issuance of series E preferred shares in March 2014, we adjusted the series D conversion price from US$3.5 to US$2.86 per share for6,771,454 series D preferred shares held by Skyline. The downward conversion price adjustment was made pursuant to the anti-dilution clause in transactiondocuments in our series D financing. As a result of this anti-dilution, we will issue a total of 8,387,806 common shares on a fully-converted basis of theoriginal 6,771,454 series D preferred shares when the conversion right is exercised by Skyline. For the remaining 3,808,943 Series D preferred shares held bySkyline, Skyline agreed to waive the anti-dilution clause as Skyline planned to sell these shares to us. The waiver of this anti-dilution clause is accounted foras a modification of the terms of the series D preferred shares. However, it was determined that the incremental value contributed by Skyline was deemed to bea transfer of value between the preferred shareholders because 1) the change in value of the common shares before and after the modification was deemed tobe negligible and 2) the modification of the series D preferred shares were also made concurrent with the sale of the series E preferred shares. We concludedthat this suggests that most of the value was transferred from Skyline to the other existing preferred shareholders. Therefore, no accounting charge wasrecorded.Upon the completion of our initial public offering on June 24, 2014, we adjusted the series D conversion price from US$2.86 to US$2.27 pershare relating to 6,771,454 series D preferred shares held by a series D investor. We concluded that the downward conversion price adjustment is inaccordance with the anti-dilution clause in the latest shareholders agreement. As a result of this anti-dilution, we would issue a total of 10,581,726 commonshares on a fully-converted basis of the original 6,771,454 series D preferred shares when the conversion right is exercised by the holder. At the time of thisanti-dilution, the series D preferred shares anti-diluted contained a beneficial conversion feature of US$4,008 thousand as a deemed dividend to series Dinvestor and charged against retained earnings, and in the absence of retained earnings, a charge to additional paid-in capital.Modification of redemption rights of series D convertible redeemable preferred sharesUpon issuance of the series E preferred shares in March 2014, we amended the redemption rights of 6,771,454 Series D preferred shares. Skylinehas the right to request us to purchase its shares after February 28, 2017 but no later than February 28, 2018. Prior to the modification, the holder had the rightto request us to purchase its shares after February 6, 2016 but no later than February 6, 2017. The amendment of the redemption date is accounted for asmodification of the terms of Series D preferred shares. The incremental value received by the Skyline amounted to US$279,000 and was deemed to be atransfer of value between the preferred shareholder and common shareholders and the amount was charged to retained earnings.In determining the accounting for the modification of the series D preferred shares, we estimated the valuation of the series D preferred shareswith the assistance of an independent valuation firm based on our estimates and assumptions. Option-pricing method was used to allocate enterprise value topreferred and common shares, taking into account the guidance prescribed by the AICPA Audit and Accounting Practice Aid, “Valuation of Privately-HeldCompany Equity Securities Issued as Compensation”. The method treats common stock and preferred stock as call options on the enterprise’s value, withexercise prices determined based on the liquidation preference of the preferred stock. The option-pricing method involves making estimates of theanticipated timing of a potential liquidity event, such as a sale of the Company or an initial public offering, and estimates of the volatility of our equitysecurities. The anticipated timing is based on the plans of management. Estimating the volatility of the share price of a privately held company is complexbecause there is no readily available market for the shares. We estimated the volatility of its shares to range from 38.39% to 43.40% based on the historicalvolatility of comparable publicly traded shares of companies engaged in similar lines of business. 116Table of ContentsModification of liquidation rightsUpon issuance of the series E preferred shares in March 2014, we amended the liquidation rights of Skyline’s common shares, series A preferredshares, series A-1 preferred shares, and series B preferred shares, or Skyline Shares. As a result of this amendment, Skyline Shares have priority to receiveproceeds from us upon liquidation over the common shares, series A preferred shares, series A-1 preferred shares, series B preferred shares and series Cpreferred shares held by other investors. The amendment of the liquidation rights is accounted for as modification of the terms of Skyline Shares. However,the incremental value received by Skyline is deemed to be negligible. No accounting charge was recorded by us. Similar to the modification of the series Dpreferred shares as stated above, the fair value of the series D preferred shares was estimated by us with the assistance of an independent valuation firm basedon the our estimates and assumptions. The option-pricing method as described above, was also used to account for this modification. We estimated thevolatility of its shares to range from 38.39% to 43.40% based on the historical volatility of comparable publicly traded shares of companies engaged insimilar lines of business.We have determined that there was no beneficial conversion feature attributable to the series D preferred shares because the initial and adjustedeffective conversion prices of these preferred shares were higher than the fair value of our common shares determined by us with the assistance from anindependent valuation firm.Fair value of our series E convertible redeemable preferred sharesIn addition to our common shares, we have determined the fair value of the series E convertible redeemable preferred shares to be per shareUS$3.56 and US$3.62 on March 5, 2014 and April 24, 2014, respectively. The result is used to determine the amount of redemption value as well as thevaluation of the warrant to acquire additional series E convertible redeemable preferred shares. Consistent with common shares discussed above, thedetermination of the fair value of our series E convertible redeemable preferred shares requires complex and subjective judgments to be made regarding ourprojected financial and operating results, our unique business risk, the liquidity of these shares and our operating history and prospects at the time ofvaluation.The major assumptions used in calculating the fair values of our series E convertible redeemable preferred shares include: Valuation as of March 5, 2014 IPO Scenario LiquidationScenario RedemptionScenario Expected Maturity Date Jun 30, 2014 Jun 30, 2014 Feb 28, 2018 Expected Volatility (1) 38.39% 38.39% 43.40% Risk-free interest rate (2) 0.06% 0.06% 1.18% Expected dividend yield — — — Probability (3) 80.00% 10.00% 10.00% 117Table of ContentsValuation as of April 24, 2014 IPO Scenario LiquidationScenario RedemptionScenario Expected Maturity Date Jun 30, 2014 Jun 30, 2014 Feb 28, 2018 Expected Volatility (1) 43.10% 43.10% 44.03% Risk-free interest rate (2) 0.02% 0.02% 1.29% Expected dividend yield — — — Probability (3) 80.00% 10.00% 10.00% Notes: (1)Volatility—The volatility estimate is based on the average volatility of the stock returns of selected comparable companies listed in the US stockmarket which are engaged in the similar line of business.(2)Risk free rate—The risk free rate is the three months U.S. Treasury Bonds and Notes Yield.(3)Event scenario—Our best estimation of the occurrence and the timing of (1) an initial public offering event, (2) a liquidation event or (3) a redemptionevent.Option-pricing method was used to allocate enterprise value to preferred and common shares, taking into account the guidance prescribed by theAICPA Audit and Accounting Practice Aid, “Valuation of Privately-Held Company Equity Securities Issued as Compensation.” The method treats commonstock and preferred stock as call options on the enterprise’s value, with exercise prices based on the liquidation preference of the preferred stock. We appliedthe Black-Scholes option pricing model to calculate the fair value of the series D warrant on the valuation date.The fair value per share of the series E preferred shares was determined to be US$ 3.56 on March 5, 2014. The issuance price of the series Econvertible redeemable preferred shares was mutually negotiated at US$2.82. The price was agreed in consideration of 1) Xiaomi brand, which is consideredto be a well-recognized smartphone vendor in the China market, and 2) the potential synergy that could be created from the two parties, strategic cooperationin the multi device environment.Exchange of Xiaomi options for transfer restrictionsAs part of the issuance of the series E preferred shares, Xiaomi Ventures and our founders and two other employees, or the Grantees, agreed that(i) Grantees will have the right to purchase certain number of restricted shares of Xiaomi Corporation with a total subscription consideration of not more thanUS$20 million at a subscription price per share that reflects the valuation of Xiaomi Corporation being US$10 billion, or Xiaomi Option; and (ii) theGrantees agreed to impose a transfer restriction on 39,934,162 common shares, 3,394,564 unvested restricted shares, and 360,000 vested and unvested shareoptions owned by the Grantees, or the Transfer Restriction. The Transfer Restriction prohibits the Grantees from transferring their shares to anotherperson/party until April 24, 2019 for one of founders or April 24, 2018 for the rest of the Grantees. The Xiaomi Option and the Transfer Restriction are nottied to the Grantees’ future employment with us.The value of the Transfer Restriction was determined to be significantly greater than the value of Xiaomi Option. In determining the value of theTransfer Restriction, we were assisted by an independent valuation firm, based on data provided by us. The valuation of the Transfer Restriction is estimatedto be US$43.3 million (refer to the valuation methodology below). For the valuation of the Xiaomi Option, we were only able to obtain limited financialinformation from Xiaomi, a private company, to perform a valuation analysis. This information includes high level 2013 revenue data and information of athird party investment transaction that valued the Xiaomi Corporation at US$10 billion in August 2013. Given the lack of financial information, we areunable to determine a more precise estimate of the fair value of the Xiaomi Option on the exchange date. If the fair value of the Xiaomi Option were worthUSD43.3 million, the estimated value of the Transfer Restriction, Xiaomi Corporation itself would need to be estimated at a valuation in excess of US$30billion on March 5, 2014. We do not expect the valuation of the Xiaomi Corporation to increase by 200% from US$10 billion in August 2013 to US$30billion in March 2014. Hence, no incremental benefit was given to the Grantees and no compensation expense was recognized. 118Table of ContentsTo determine the fair value of the Transfer Restriction, we valued the common shares with the Transfer Restriction and compared this value tothe value of the common shares without the restriction. The difference was determined to be the value of the Transfer Restriction. A put option pricing modelwas used to determine the discount to be applied to the common shares to arrive at the value of common shares with the Transfer Restriction. Pursuant to thatmodel, we used the cost of a put option, which can be used to hedge the price change before a share subject to transfer restriction can be sold, as the basis todetermine the discount for transfer restrictions. A put option was used because it incorporates certain company-specific factors, including timing of theexpected initial public offering or duration of the Transfer Restriction and the volatility of the share price companies engaged in the same industry.Fair value of series E warrants to Xiaomi VenturesThe series E warrants granted to Xiaomi Ventures, or Xiaomi Warrants, is exercisable at the option of Xiaomi Ventures, at any time, on or afterJanuary 1, 2015 and no later than March 1, 2015. The warrants are not exercisable if we have completed our initial public offering in the United States byDecember 31, 2014. The exercise price should be adjusted from time to time subject to proportionate adjustment for issuance of additional common shares,share split and combination, dividend and distributions, reclassification, reorganization, merger, and consolidations.The warrants are not entitled to dividend rights nor to vote until the warrants are exercised and shares become issuable. The Xiaomi warrants areinitially measured at its fair value and the initial carrying value for series E preferred shares is allocated on a residual basis as the warrant is liability classified.The Xiaomi warrants were initially measured at their fair value of US$6,477,000. As of March 31, 2014, the fair value of series E warrants was US$6,459,000.The fair value of the Xiaomi warrants were estimated by us with the assistance of an independent valuation firm based on data provided by us.The valuation report provided by us with guidelines in determining the fair value, but the determination was made by us. We applied the Black-ScholesOption Pricing Model to calculate the fair value of the series E Warrants on the valuation date.The major assumptions used in calculating the fair value of the Xiaomi warrants includes: March 5, 2014Spot price (1) 4.50 - 4.65Risk-free interest rate (2) 0.12%Volatility rate (3) 38.81%Dividend yield (4) — (1)Spot price—based on the fair value of 100 percent equity interest of Xunlei Limited which is allocated to our preferred shares and common shares as atthe valuation date under different scenarios. The probability of the occurrence of an initial public offering is assumed to be 80%, the probability of theoccurrence of a liquidation event is assumed to be 10% and the probability of the occurrence of a redemption event is assumed to be 10%.(2)Risk-free interest rate—based on the US Treasury Bond & Notes BFV curve from Bloomberg as at the valuation date.(3)Volatility—based on the average historical volatility of the comparable companies from Bloomberg as at the valuation date.(4)We has no history or expectation of paying dividends on its common shares. 119Table of ContentsFair value of subscription rights to Xiaomi VenturesWithin three months after March 5, 2014, Xiaomi Ventures shall have the right to purchase, or designate any other person/party to subscribe fromus an additional number of 35,487,746 series E preferred shares, at a price equal to the purchase price per share (US$2.82) of the series E issuance. Theexercise price will be adjusted from time to time subject to proportionate adjustment for issuance of additional common shares, share split and combination,dividend and distributions, reclassification, reorganization, merger, and consolidations. The subscription rights are not entitled to dividend rights nor to voteuntil the subscription rights have been exercised and shares are issued.The fair value of the subscription rights was estimated by us with the assistance of an independent valuation firm based on data provided by us.The valuation report provided by us with guidelines in determining the fair value, but the determination was made by us. We applied the Black-ScholesOption Pricing Model to calculate the fair value of the subscription rights on the valuation date.The major assumptions used in calculating the fair value of the subscription rights includes: March 5, 2014Spot price (1) 3.31 - 4.65Risk-free interest rate (2) 0.04%Volatility rate (3) 38.12%Dividend yield (4) — (1)Spot price—based on the fair value of 100 percent equity interest of Xunlei Limited which is allocated to our preferred shares and common shares as atthe valuation date under different scenarios. The probability of the occurrence of an initial public offering is assumed to be 80%, the probability of theoccurrence of a liquidation event is assumed to be 10% and the probability of the occurrence of a redemption event is assumed to be 10%.(2)Risk-free interest rate—based on the US Treasury Bond & Notes BFV curve from Bloomberg as at the valuation date.(3)Volatility—based on the average historical volatility of the comparable companies from Bloomberg as at the valuation date.(4)We has no history or expectation of paying dividends on its common shares. 120Table of ContentsConversion upon IPOUpon the completion of our initial public offering on June 24, 2014, we adjusted the series E conversion price from US$2.82 to US$2.4 per sharerelating to 110,014,440 series E preferred shares held by the series E investors. We concluded that the downward conversion price adjustment is inaccordance with the anti-dilution clause in the latest shareholders agreement. As a result of this anti-dilution, we issued a total of 129,166,667 commonshares on a fully-converted basis when the conversion right is exercised by the series E shareholders. The triggering of the anti-dilution clause resulted in abeneficial conversion feature amounted to US$27,396 thousand which was charged to retained earnings in 2014 as a deemed dividend to series Eshareholders. And the unamortized beneficial conversion features of series E preferred shares of US$49,346 thousand were recognized upon the completion ofour initial public offering as a deemed dividend to series E investors and charged against retained earnings, and in the absence of retained earnings, a chargeto additional paid-in capital.Upon the completion of our initial public offering on June 24, 2014, the series E warrants are no longer exercisable in the future. As a result, thefair value of series E warrants liability of US$6,381 thousand was derecognized and the related fair value gain was recognized as other income.Repurchase of common and preferred sharesOn April 15, 2014, we repurchased from Skyline 469,225 common shares, 27,180 series A preferred shares, 591,451 series A-1 preferred shares,725,237 series B preferred shares and 3,808,943 series D convertible redeemable preferred shares at a consideration of approximately US$24.3 million. Forthe common shares repurchased, we charged the excess of the purchased price over the par value to additional paid in capital. For the preferred shares, wecharged the excess of the purchase price over the carrying value to retain earnings or to additional paid in capital if retain earnings is zero.On April 24, 2014, we repurchased from a number of our existing shareholders the following common and preferred shares for a totalconsideration of US$49.8 million. We repurchased the following common and preferred shares at a per share price of US$2.82, equal to the issuance price ofthe series E preferred shares: • 10,334,679 common shares from Vantage Point Global Limited for US$29.1 million; • 3,860,733 common shares from Aiden & Jasmine Limited for US$10.9 million; • 450,000 Series A preferred shares from Bright Access International Limited for US$1.3 million; • 2,921,868 series B preferred shares from Fidelity Asia Ventures Fund L.P. for US$8.2 million; • 108,960 series B preferred shares from Fidelity Asia Principals Fund L.P. for US$0.3 million.For the common shares repurchased, we charged the excess of the purchased price over the par value to additional paid in capital. For thepreferred shares, we charged the excess of the purchase price over the carrying value to retain earnings or to additional paid in capital if retain earnings iszero. We determined the per share fair value of the common shares, series A preferred shares, and series B preferred shares to be US$3.13, US$3.13, andUS$3.19, respectively, on the date of repurchase. The repurchase price of US$2.82 was mutually negotiated at the time of the repurchase transactions. Therewere no other arrangements with the selling shareholders other than the exchange of Xiaomi Option for the Transfer Restrictions. The selling shareholderswere willing to sell its common and preferred shares at the US$2.82 per share price as it would provide them with as a form of liquidity. 121Table of ContentsAmortization of capitalized copyrights related to contentLicensed copyrights of movies, TV series and variety shows, or Content Copyrights, are capitalized when (1) the cost of the content is known(2) the content has been accepted by us in accordance with the conditions of the license agreement and (3) the content is available for its first showing on ourwebsite. Content Copyrights are carried at cost less accumulated amortization and impairment loss, if any.We have two types of Content Copyrights, 1) non-exclusive Content Copyrights and 2) exclusive Content Copyrights. With non-exclusiveContent Copyrights, we have the right to broadcast the content on our own websites. While, with exclusive Content Copyrights, besides the broadcastingright, we also have the right to sub-license these exclusive Content Copyrights to third parties.For non-exclusive Content Copyrights which only generates primarily indirect cash flows, the amortization method is based on the analysis ofhistorical viewership consumption patterns. We determine consumption patterns the number of viewers who watch the content throughout the estimateduseful life of the content. The information is then aggregated to come up with a viewership trend that can support an appropriate method to amortize non-exclusive Content Copyrights. We generally categorize our content in the Xunlei Kankan website into three broad categories, namely movies; TV series; andvariety shows and others, which include reality shows, talent shows, talk shows and entertainment news. Prior to April 1, 2011, we concluded that there wasinsufficient data to support a historical viewership demonstrative pattern in viewership of our licensed copyrights related to content. Therefore, we havedetermined that a straight-line basis of amortization over the shorter of the estimated useful lives of the related Content Copyright provides the right level ofexpenses attribution. Effective April 1, 2011, based on an accumulation of data gathered on historical viewing patterns of our non-exclusive ContentCopyrights, we revised the method to amortize non-exclusive Content Copyrights over their respective licensing periods using at an accelerated rate.Estimates of the consumption patterns for these non-exclusive Content Copyrights are reviewed periodically and revised, if necessary.Exclusive Content Copyrights generate both direct and indirect cash flows. For the portion of exclusive Content Copyright that generatesindirect cash flows, we use the amortization method based on the analysis of historical viewership consumption patterns, which is the same with that of non-exclusive Content Copyright as discussed above.For the portion of exclusive Content Copyrights that generates direct cash flows, we amortize the purchase costs using an individual-film-forecast-computation method, which amortizes such costs based on the ratio of sub-licensing revenue and barter transaction gain (details described in Note2(r) to our audited consolidated financial statements for the years ended December 31, 2012, 2013 and 2014) generated for the current period to the totalultimate direct revenues estimated to be generated by the exclusive Content Copyrights for their whole license period or estimated useful lives. We revisit theforecast at each quarter or year end and make adjustment, when appropriate.Impairment of long-lived assetsWe evaluate the program usefulness of licensed copyrights pursuant to the guidance in ASC 920-350 Intangibles—Goodwill and Other:Recognition, which provides that such rights be reported at the lower of unamortized cost or estimated net realizable value. 122Table of ContentsFor non-exclusive Content Copyrights which only generate indirect cash flows, we evaluate the net realizable value of our licensed copyrightsby three content categories (i.e. movies, TV series, variety shows and others), which are assessed to be the lowest level of precision for the purpose ofperforming such assessment. If our expectations of programming usefulness, which represents the expected revenues and related net cash flows derived fromthe content, are revised downward, we then assess whether it is necessary to write down the unamortized cost to the estimated net realizable value. Weevaluate programming usefulness by category on an annual basis by comparing the unamortized cost to our estimated net realizable value. On a quarterlybasis, we also monitors whether there are indicators of changes in our expected usage of program materials.We estimate net realizable value using expected net cash flows based on expected future levels of advertising revenues. Such estimates considerhistorical amounts and anticipated levels of demand. Expected future revenues are reduced by estimated direct costs to provide access to the website andgenerate the related revenues, including bandwidth costs and server costs. For purposes of estimating revenues for each category of the content, we considerboth expected future advertising revenues sold based on number of impressions delivered as well as advertising sold based on the period of time that it isdisplayed.For exclusive Content Copyrights that generate both direct and indirect cash flows, we evaluate the net realizable value of our licensedcopyright on a content by content basis. Impairment is assessed on an annual basis by comparing the unamortized cost to our estimated net realizable value.We estimate the net realizable value using expected net cash flows based on expected future levels of advertising and content sub-licensing revenues. Weestimated content sub-licensing revenue based on management’s expectation of the popularity of the content and we use pricing reference from other similarsub-licensing arrangements. For expected future levels of advertising revenue, we use the same estimation methodology used for the impairment assessmentof non-exclusive Content Copyrights.For both exclusive and non-exclusive Content Copyrights, there were no impairments for the years ended December 31, 2012, 2013, 2014because a significant portion of the content was related to movies and TV series, of which approximately 70% to 90% of the purchase costs of the ContentCopyrights had been amortized during the first year of the licensed period. As such, the unamortized carrying amounts were lower than the respective netrealizable values when the impairment assessment was performed.For other long-lived assets, we evaluate our long-lived assets for impairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may no longer be recoverable. We assess the recoverability of the long-lived assets by comparing the carrying value of the long-lived assets to the estimated undiscounted future cash flows we expect to receive from the use of the assets and their eventual disposition at the lowest levelof identifiable cash flows. Such assets are considered to be impaired if the sum of the expected undiscounted cash flows is less than the carrying amount ofthe assets. If we identify an impairment, the carrying value of the asset will be reduced to its estimated fair value based on a discounted cash flow approach or,when available and appropriate, to comparable market values.In 2013, indicator of possible impairment was triggered by the significant decline in the revenues generated by one online game. In the fourthquarter of 2013, this online game only generated US$27,000 as compared to US$303,000 generated in the third quarter of 2013, which was significantlylower than our expectation. The impairment test was performed using a discounted cash flow analysis that requires certain assumptions and estimatesregarding economic and future profitability. In 2013, this online game license had been provided for impairment of US$808,000. 123Table of ContentsImpairment of goodwillImpairment of goodwill assessment is performed on at least an annual basis on December 31 or whenever events or changes in circumstancesindicate that the carrying value of the asset may not be recoverable. According to ASC 350-20-35, an entity may assess qualitative factors to determinewhether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount,including goodwill. But we select to proceed directly to perform a two-step goodwill impairment test. The first step compares the fair values of a reportingunit to its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill is not considered impaired and thesecond step will not be required. If the carrying amount of a reporting unit exceeds its fair value, the second step compares the implied fair value of theaffected reporting unit’s goodwill to the carrying value of that goodwill. The implied fair value of goodwill is determined in a manner similar to accountingfor a business combination with the allocation of the assessed fair value determined in the first step to the assets and liabilities of the reporting unit. Theexcess of the fair value of the reporting unit over the amounts assigned to the assets and liabilities is the implied fair value of goodwill. This allocationprocess is only performed for purposes of evaluating goodwill impairment and does not result in an entry to adjust the value of any assets or liabilities. Animpairment loss is recognized for any excess in the carrying value of goodwill over the implied fair value of goodwill. The judgment in estimating the fairvalue of a reporting unit includes estimating future cash flows, determining appropriate discount rates and making other assumptions. Changes in theseestimates and assumptions could materially affect the determination of the fair value of a reporting unit. No goodwill impairment losses were recognized forthe year ended December 31, 2014.ConsolidationThe consolidated financial statements include the financial statements of Xunlei Limited, our subsidiaries and our VIE for which Xunlei Limitedis the primary beneficiary. All significant transactions and balances among our subsidiaries, our VIE and us have been eliminated upon consolidation.A subsidiary is an entity in which we, directly or indirectly, control more than one-half of the voting power, has the power to appoint or removethe majority of the members of the board of directors to cast a majority of the votes at meetings of the board of directors or to govern the financial andoperating policies of the investee under a statute or agreement among the shareholders or equity holders.An entity is considered to be a VIE if the entity’s equity holders do not have the characteristics of a controlling financial interest or do not havesufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties.We consolidate entities for which we are the primary beneficiary if the entity’s equity holders do not have the characteristics of a controllingfinancial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from otherparties.In determining whether Xunlei Limited or its subsidiary is the primary beneficiary of a VIE, we considered whether we have the power to directactivities that are significant to the VIE’s economic performance, including the power to appoint senior management, right to direct company strategy, powerto approve capital expenditure budgets, and power to establish and manage ordinary business operation procedures and internal regulations and systems. 124Table of ContentsManagement has evaluated the contractual arrangements among Giganology Shenzhen, Shenzhen Xunlei and its shareholders and concludedthat Giganology Shenzhen receives all of the economic benefits and absorbs all of the expected losses from Shenzhen Xunlei and has the power to direct theaforementioned activities that are significant to Shenzhen Xunlei’s economic performance, and is the primary beneficiary of Shenzhen Xunlei. Therefore,Shenzhen Xunlei and its subsidiaries’ results of operation, assets and liabilities have been included in our consolidated financial statements. We monitor theregulatory risk associated with these contractual arrangements. The details of how we manage the regulatory risk are described in “Certain risk andconcentration” in note 26 to our audited consolidated financial statements for the years ended December 31, 2012, 2013 and 2014.Business combinationsWe account for acquisitions of entities that include inputs and processes and have the ability to generate economic benefit as businesscombinations. We allocate the purchase price of the acquisition to the tangible assets and identifiable intangible assets acquired based on their estimated fairvalues. The excess of the purchase price over those fair values is recorded as goodwill. Acquisition-related costs are expensed as incurred.Accounts receivable, netAccounts receivable are presented net of allowance for doubtful accounts. We evaluate the creditworthiness of each customer at the time whenservices are rendered and continuously monitor the recoverability of the accounts receivable. We use specific identification method in providing for baddebts when facts and circumstances indicate that collection is doubtful and a loss is probable and estimable. If the financial conditions of our customers wereto deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. The allowance for doubtful accounts isbased on the best facts available and is re-evaluated and adjusted on a regular basis as additional information is received.Some of the factors that we consider in determining whether we record a bad debt allowance on an individual customer are: • the customer’s past payment history and whether it fails to comply with its payment schedule; • whether the customer is in financial difficulty due to economic or legal factors; • a significant dispute with the customer has occurred; • other objective evidence which indicates non-collectability of the accounts receivable.If we determine that an allowance is needed for a customer, we will discontinue business with them unless they start to resume payment. Theaccounts receivable is written-off when we cease pursuing collection. Any changes in our estimates may cause our operating results to fluctuate. The accountsreceivable that was fully reserved as of December 31, 2013 and 2014 was US$10.9 million, US$8.9 million, respectively.The allowances provided for accounts receivable as of December 31, 2013 and 2014 were US$12.1 million and US$9.4 million, respectively.As of December 31, 2014, we had accounts receivable net of allowances aged beyond one year from the date of invoice in the amount ofUS$4,763,737. Based on our assessment of the customer’s ability to pay, a bad debt allowance was not considered necessary for those amounts. As of the dateof this annual report, a majority of those balances have been collected and we continue to actively pursue collection of the remaining balance. 125Table of ContentsAlthough our general credit term for our customers is 90 days, we do not consider our receivables aged less than one year from the invoice dateto be past due given the general practices we have with our customers in the advertising industry. Typically we are willing to accept delayed repayment up toone year from invoice date if we have assurance that payment will be made as soon as practicable. Accordingly, we did not make significant provisions forbalances aged less than one year as of December 31, 2012, 2013 and 2014.Taxation and uncertain tax positionsIncome taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases andtax loss carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which the difference is expected to berecovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the consolidated statement of operations in theperiod that includes the enactment date. A valuation allowance is provided to reduce the carrying amount of deferred tax assets if it is considered more likelythan not that some portion, or all, of the deferred tax assets will not be realized.On January 1, 2008, we adopted the guidance regarding uncertain tax positions. Management evaluates our open tax positions that exist in eachjurisdiction for each reporting period. If an uncertain tax position is taken or expected to be taken in a tax return, the tax benefit from that uncertain positionis recognized in our consolidated financial statements if it is more likely than not that the position is sustainable upon examination by the relevant taxingauthority.We did not have any significant uncertain tax position and there was no effect on our financial position or results of operations as a result ofimplementing the new guidance. We recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense, ifany. No interest and penalties were recorded in the years ended December 31, 2012, 2013 and 2014.Commitments and contingenciesIn the normal course of business, we are subject to contingencies, such as legal proceedings and claims arising out of our business, that cover awide range of matters. Liabilities for such contingencies are recorded when it is probable that a liability has been incurred and the amount of the assessmentcan be reasonably estimated. In regards to legal cost, we recorded such costs as incurred.Certain conditions may exist as of the date of this annual report, which may result in a loss to us and such loss will only be resolved when one ormore future events occur or fail to occur. Our management and legal counsel assess such contingent liabilities, and such assessment inherently involve anexercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against us or unasserted claims that may result in suchproceedings, we will consult with our legal counsel and evaluate the perceived merits of any legal proceedings or unasserted claims as well as the perceivedmerits of the amount of relief sought or expected to be sought therein.If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can beestimated, then the estimated liability would be accrued in our financial statements. If the assessment indicates that a potentially material loss contingency isnot probable, but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of therange of possible loss, if determinable and material, would be disclosed. 126Table of ContentsRecent accounting pronouncementsIn March 2013, the FASB issued accounting guidance related to a parent’s accounting for the cumulative translation adjustment uponderecognition of certain subsidiaries or groups of assets within a foreign entity or of an investment in a foreign entity (ASC 830 Foreign Currency Matters).This guidance requires that the cumulative translation adjustment associated with a qualifying derecognized subsidiary or group of assets be immediatelyrecognized within the income statement by the parent company. The adoption of this guidance did not have an impact on our financial statements.In March 2013, the FASB also issued ASU 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, aSimilar Tax Loss, or a Tax Credit Carryforward Exists”, which is an update to provide guidance on the financial statements presentation of an unrecognizedtax benefit when a net operating loss carryforward exists. The guidance requires an entity to present an unrecognized tax benefit in the financial statements asa reduction to a deferred tax asset for a net operating loss carryforward, except for when a net operating loss carryforward is not available as of the reportingdate to settle taxes that would result from the disallowance of the tax position or when the entity does not intend to use the deferred tax asset for purposes ofreducing the net operating loss carryforward. The adoption of this guidance did not have an impact on our financial statements.In April 2014, the FASB issued ASU 2014-08, “Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity”,which changes the threshold for reporting discontinued operations and adds new disclosures. The new guidance defines a discontinued operation as adisposal that “represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results.” The standard is required to beadopted by public business entities in annual periods beginning on or after December 15, 2014, and interim periods within those annual periods. Entitiesmay “early adopt” the guidance for new disposals. We do not expect the adoption of this pronouncement to have a significant impact on our consolidatedfinancial statements.On May 28, 2014, the FASB and IASB issued their long-awaited converged standard on the recognition of revenue from contracts withcustomers. The standard will improve the financial reporting of revenue and improve comparability of the top line in financial statements globally. TheFASB is amending the FASB Accounting Standards Codification and creating a new Topic 606, Revenue from Contracts with Customers, to supersede therevenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance throughout the Industry Topics of theCodification. Additionally, the amendments supersede some cost guidance included in Subtopic 605-35, “Revenue Recognition—Construction-Type andProduction-Type Contracts”. For a public entity, the amendments are effective for annual reporting periods beginning after December 15, 2016, includinginterim periods within that reporting period. Early application is not permitted. We are currently evaluating the impact on our consolidated financialstatements of adopting this guidance.In June 2014, under ASC 718, “Compensation—Stock Compensation”, the FASB issued “Accounting for Share-Based Payments When theTerms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period”. These amendments apply to all reportingentities that grant their employees share-based payments in which the terms of the award provide that a performance target that affects vesting could beachieved after the requisite service period. That is the case when an employee is eligible to retire or otherwise terminate employment before the end of theperiod in which a performance target could be achieved and still be eligible to vest in the award if and when the performance target is achieved. For allentities, the amendments are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlieradoption is permitted. We do not expect the adoption of this pronouncement to have a significant impact on our consolidated financial statements. 127Table of ContentsIn August 2014, the FASB issued “Presentation of Financial Statements – Going Concern”. This standard requires management to evaluate foreach annual and interim reporting period whether it is probable that the reporting entity will not be able to meet its obligations as they become due withinone year after the date that the financial statements are issued. If the entity is in such a position, the standard provides for certain disclosures depending onwhether or not the entity will be able to successfully mitigate its going concern status. This guidance is effective for annual periods ending afterDecember 15, 2016 and interim periods within annual periods beginning after December 15, 2016. Early application is permitted. We do not expect theadoption of this pronouncement to have a significant impact on our consolidated financial statements.On February 18, 2015, the FASB issued Accounting Standards Update 2015-02, “Consolidation (Topic 810) –Amendments to the ConsolidationAnalysis”. The new guidance applies to entities in all industries and provides a new scope exception to registered money market funds and similarunregistered money market funds. It provide new guidance to companies in determining whether an entity is a variable interest entity, assessing fees paid to adecision maker or a service provider, and consideration of related parties in the economics test. The standard is effective for public business entities forannual periods beginning after December 15, 2015. We are in the process of assessing the impact of this new guidance. B.Liquidity and Capital ResourcesTo date, we have financed our operations primarily through cash generated from operations and, to a lesser extent, proceeds from privateplacements of preferred shares to investors, net proceeds received from our initial public offering and bank loans. As of December 31, 2014, we had US$404.3million in cash and cash equivalents. As of the same date, we did not have any outstanding bank loans.We historically generated a significant portion of our revenues from customers in the advertising industry. Although our general credit term forour customers is 90 days, we typically are willing to accept delayed repayment up to one year from the invoice date given the general practices we have withour customers in the advertising industry. Our practice and collection history may continue to have an impact on our liquidity.In the future, we may rely on dividends and other distributions on equity paid by our wholly-owned PRC subsidiaries for our cash and financingrequirements. There may be potential restrictions on the dividends and other distributions by our PRC subsidiaries. For instance, if Giganology Shenzhen,our PRC subsidiary, incurs debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make otherdistributions to us. The PRC tax authorities may require us to adjust our taxable income under the contractual arrangements Giganology Shenzhen currentlyhas in place with Shenzhen Xunlei in a way that would materially and adversely affect the latter’s ability to pay dividends and other distributions to us. Inaddition, under PRC laws and regulations, Giganology Shenzhen, as a wholly foreign-owned enterprise in the PRC, may pay dividends only out of itsaccumulated profits as determined in accordance with PRC accounting standards and regulations. Wholly foreign-owned enterprises such as GiganologyShenzhen are required to set aside at least 10% of their accumulated after-tax profits each year, if any, to fund a statutory reserve fund, until the aggregateamount of such fund reaches 50% of their respective registered capital. At their discretion, wholly foreign-owned enterprises may allocate a portion of theirafter-tax profits based on PRC accounting standards to staff welfare and bonus funds. These reserve funds and staff welfare and bonus funds are notdistributable as cash dividends. See “Item 3. Key Information—D. Risk factors—Risk related to our corporate structure—We may rely principally ondividends and other distributions on equity paid by our PRC subsidiaries to fund any cash and financing requirements we may have. Any limitation on theability of Giganology Shenzhen and Xunlei Computer to pay dividends to us could have a material adverse effect on our ability to conduct our business.” Inaddition, our investment made as registered capital and additional paid in capital of our subsidiaries, VIE and VIE’s subsidiaries are also subject torestrictions in their distribution and transfer according to the laws and regulations in China. Owing to the above, our subsidiaries, VIE and VIE’s subsidiariesin China are restricted in their ability to transfer their net assets to us in terms of cash dividends, loans or advances. As of December 31, 2012 and 2013, and2014, the amount of the restricted net assets, which represents registered capital and additional paid-in capital cumulative appropriations made to statutoryreserves, was US$45.0 million, US$49.2 million and US$59.8 million, respectively. 128Table of ContentsAs an offshore holding company, we are permitted, under PRC laws and regulations, to provide funding from the proceeds of our offshore fundraising activities to our PRC subsidiaries only through loans or capital contributions, and to our variable interest entity only through loans, subject to thesatisfaction of the applicable government registration and approval requirements. See “Item 3. Key Information—D. Risk factors—Risks related to ourcorporate structure—PRC regulation of loans to, and direct investment in, PRC entities by offshore holding companies and governmental control of currencyconversion may restrict or prevent us from using the proceeds of our initial public offering to make loans to our PRC subsidiaries and variable interest entityor to make additional capital contributions to our PRC subsidiaries, which may materially and adversely affect our liquidity and our ability to fund andexpand our business.” As a result, uncertainties exist as to our ability to provide prompt financial support to our PRC subsidiaries or variable interest entitywhen needed. Notwithstanding the forgoing, Giganology Shenzhen may use its own retained earnings (as opposed to RMB converted from foreign currencydenominated capital) to provide financial support to Shenzhen Xunlei either through extended payment terms on amounts due to Giganology Shenzhen fromShenzhen Xunlei, or via entrusted loans from Giganology Shenzhen to Shenzhen Xunlei, or direct loans to its nominee shareholders, which would becontributed to the variable interest entity as capital injection. Such direct loans to the nominee shareholders would be eliminated in the consolidatedfinancial statements against the VIE’s share capital.We believe that our current cash and cash equivalents and anticipated cash flow from operations will be sufficient to meet our anticipated cashneeds for the next 12 months. We may, however, need additional cash resources in the future if we experience changes in business conditions or otherdevelopments. We may also need additional cash resources in the future if we find and wish to pursue opportunities for investment, acquisition, capitalexpenditure or similar actions. If we determine that our cash requirements exceed the amount of cash and cash equivalents we have on hand, we may seek toissue debt or equity securities or obtain additional credit facilities.The following table sets forth a summary of our cash flows for the periods indicated: For the Year Ended December 31, (in thousands of US$) 2012 2013 2014 Net cash generated from operating activities 59,914 85,533 48,202 Net cash used in investing activities (49,490) (78,352) (70,546) Net cash generated from financing activities 17,692 2,487 333,268 Net increase in cash and cash equivalents 28,116 9,668 310,924 Cash and cash equivalents at the beginning of year 53,349 81,906 93,906 Effect of exchange rates on cash and cash equivalents 441 2,332 (555) Cash and cash equivalents at end of year 81,906 93,906 404,275 129Table of ContentsAs of December 31, 2014, we had cash or cash equivalents of approximately RMB516.4 million (US$83.2 million) and US$8.8 million locatedwithin the PRC, of which RMB268.3 million (US$43.2 million) was held by Shenzhen Xunlei and its subsidiaries. We also had cash or cash equivalents ofRMB157.6 million (US$25.4 million), US$285.3 million and 0.7 million Hong Kong dollars (US$0.1 million) located outside of the PRC as of December 31,2014.Operating activitiesNet cash generated from operating activities amounted to US$48.2 million in 2014, which was primarily attributable to a net income of US$9.9million, adjusted for certain non-cash expenses consisting principally of depreciation and amortization expenses of US$45.2 million, share-basedcompensation of US$7.6 million, a gain from warrants’ fair value change of US$8.1 million and a net change in working capital. The net change in workingcapital was primarily due to a decrease in accounts receivable amounting to US$4.7 million, which was in line with the decrease of our online advertisingrevenues, an increase in accrued liabilities and other payable of US$4.8 million mainly attributable to the increase in accrued payroll and employees benefitprovision, which was partially offset by an increase in prepayments and other current assets of US$9.2 million.Net cash generated from operating activities amounted to US$85.5 million in 2013, which was primarily attributable to a net income of US$10.4million, adjusted for certain non-cash expenses consisting principally of depreciation and amortization expenses of US$43.4 million, share-basedcompensation of US$2.1 million and a net change in working capital. The net change in working capital was primarily due to the decrease in accountsreceivable amounting to US$13.7 million, which was in line with the decrease of our advertising revenues, an increase in deferred revenue of US$12.6million as a result of increase in our subscription fees prepaid by our subscribers, and the increase in accounts payable of US$5.9 million primarilyattributable to the increased procurement of bandwidth.Net cash generated from operating activities amounted to US$59.9 million in 2012, which was primarily attributable to a net income of US$0.4million, adjusted for certain non-cash expenses consisting principally of depreciation and amortization expenses of US$54.3 million, share-basedcompensation of US$2.2 million and a net change in working capital. The net change in working capital was primarily due to the increase in accruedliabilities and other payable of US$10.9 million arising from an increase in accrual of sales rebates of online advertising and accrued payroll and employeesbenefit provision, and the increase in deferred revenue in the amount of US$8.5 million as our subscription revenues grew rapidly, partially offset by theincrease of accounts receivable of US$17.8 million as a result of the increase in online advertising revenues.Investing activitiesNet cash used in investing activities largely reflects purchases of property and equipment in connection with the expansion and upgrade of ourtechnology infrastructure, purchases of intangibles assets, and payments to purchase short-term investments such as equity interest in limited partnershipsthat make venture capital investments on companies with enterprise technologies, next generation hardware and related technologies.Net cash used in investing activities amounted to US$70.5 million in 2014, primarily attributable to the purchase of short-term investments, ofUS$330.5 million, purchase of intangible assets in the amount of US$38.1 million and payments for the acquisition of businesses amounting to US$33.0million, partially offset by proceeds from the sales and maturity of short-term investments, which amounted to US$341.8 million. Net cash used in investingactivities amounted to US$78.4 million in 2013, primarily attributable to the purchase of short-term investment of US$246.2 million, and purchase ofintangible assets in the amount of US$36.0 million, partially offset by proceeds from disposal of short-term investments of US$213.5 million. 130Table of ContentsNet cash used in investing activities amounted to US$49.5 million in 2012, mainly attributable to the purchase of intangible assets in theamount of US$32.6 million, the acquisition of property, plant and equipment in the amount of US$7.5 million and the purchase of short-term investment ofUS$6.5 million.Financing activitiesNet cash generated from financing activities amounted to US$333.3 million in 2014, primarily attributable to proceeds from our initial publicoffering in June 2014 of US$93.9 million and our issuance of series E preferred shares prior to the initial public offering in the amount of US$310.0 million,partially offset by payments for the repurchase of shares in the amount of US$69.3 million.Net cash generated from financing activities amounted to US$2.5 million in 2013 due to government grants received.Net cash provided by financing activities amounted to US$17.7 million in 2012 due to our proceeds from series D preferred share issuance andseries D warrants issuance of US$35.5 million and proceeds from bank borrowings of US$20.5 million, partially offset by repayment of bank borrowings ofUS$41.2 million.Capital ExpendituresWe made capital expenditures of US$7.4 million, US$7.4 million and US$7.8 million in the years ended December 31, 2012, 2013 and 2014,respectively. In the past, our capital expenditures were primarily used to purchase servers and other equipment for our business. Our capital expenditures mayincrease in the near term as our business continues to grow. C.Research and DevelopmentWe believe that our commitment to research and development is an important contributing factor in our success. As of December 31, 2014, wehad a team of 962 engineers. We provide our engineers with various continuing training programs and opportunities. To maintain and enhance our leadershipposition in the market, we will continue to compete for engineering talent and invest in research and development in order to provide better services to ourusers, subscribers and advertisers.Our research and development team is divided, according to focus areas, into core research and development, application engineering,subscription services engineering and wireless and embedded system engineering. The table below provides an outline of what each focus area entails: Core research and developmentPrimarily focuses on the development of our basic technologies to ensure that we use the mostadvanced transmission techniques to maintain our competitive advantage.Application EngineeringPrimarily focuses on continuous development of our resource discovery/distributed file locatingand bandwidth crowd-sourcing technologies to maintain the competitive advantages of our keyproducts such as Xunlei Accelerator, Project Crystal as well as the online games platform that weoperate.Subscription Services EngineeringPrimarily focuses on diversifying and refining the paid services we provide to our subscribers.Wireless and Embedded System EngineeringPrimarily focuses on expanding our services into other internet-enabled devices, such as tabletsand smartphones. 131Table of ContentsD.Trend InformationOther than as disclosed elsewhere in this annual report, we are not aware of any trends, uncertainties, demand, commitments or events for the yearended December 31, 2014 that are reasonably likely to have a material and adverse effect on our net revenues, income, profitability, liquidity or capitalresources, or that would cause the disclosed financial information to be not necessarily indicative of future results of operations or financial conditions. E.Off-Balance Sheet ArrangementsWe have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. In addition,we have not entered into any derivative contracts that are indexed to our own shares and classified as shareholder’s equity, or that are not reflected in ourconsolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that servesas credit, liquidity or market risk support to such entity. Moreover, we do not have any variable interest in any unconsolidated entity that provides financing,liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us. F.Contractual ObligationsThe following table sets forth our contractual obligations as of December 31, 2014: Payment due by period (in thousands of US$) Total Less than 1year 1-2years 2-3years Operating lease obligations(1) 3,538 2,203 1,329 6 Bandwidth lease obligations 15,661 15,053 608 — Total 19,199 17,256 1,937 6 (1)Operating lease obligations are primarily related to the lease of office space. These leases expire on different dates.As of December 31, 2014, we had irrevocable purchase obligations for certain copyrights and online game licenses that had not been recognizedin the amount of US$5.8 million and nil, respectively. G.Safe HarborSee “Forward-Looking Statements.” 132Table of ContentsItem 6.Directors, Senior Management and Employees A.Directors and Senior ManagementThe following table sets forth information regarding our executive officers and directors as of the date of this annual report. Directors and Executive Officers Age Position/TitleSean Shenglong Zou 43 Co-Founder, Chairman and Chief Executive OfficerHao Cheng 39 Co-Founder, Director and General Manager of Xunlei Kankan and Games Business UnitQin Liu 42 DirectorQuan Zhou 57 DirectorFeng Hong 38 DirectorChuan Wang 45 DirectorHongjiang Zhang 54 DirectorJenny Wenjie Wu 40 Independent DirectorYongfu Yu 38 Independent DirectorPeng Huang 47 Chief Operating OfficerTao Thomas Wu 49 Chief Financial OfficerLei Chen 42 Chief Technology OfficerMr. Sean Shenglong Zou is our co-founder and has been our chief executive officer and chairman since our inception in February 2005. Mr. Zouis an expert in distributed computing. Mr. Zou pioneered the theory of content-based multimedia indexing technology and resource discovery network thatprovides time-saving online experience for internet users and has led our company to revolutionize traditional internet acceleration by the technology andnetwork. Mr. Zou received a master’s degree in computer science from Duke University in the U.S. in 1998 and a bachelor’s degree in computer science fromUniversity of Wisconsin-Madison in 1997.Mr. Hao Cheng is our co-founder and has been our director since our inception in February 2005. Mr. Cheng is also currently the chief executiveofficer of Xunlei Games Development (Shenzhen) Co. Ltd. Prior to joining us, Mr. Cheng managed the products, services, marketing and sales of thecorporate search team at Baidu, Inc. Mr. Cheng received a master’s degree in computer science from Duke University in the U.S. in 1999 and a bachelor’sdegree in mathematics from Nankai University in China in 1997.Mr. Qin Liu has been a director of our company since September 2005. Mr. Liu is a director of the controlling general partner of MorningsideChina TMT Fund I, L.P., Morningside China TMT Fund II, L.P., Morningside China TMT Fund III, L.P., Morningside China TMT Special OpportunityFund, L.P. and Morningside China TMT Fund III Co-investment, L.P., which we refer to collectively as the Morningside Funds, and has been a director ofMorningside Venture Capital Limited, the investment manager of the Morningside Funds. Mr. Liu has served as a director in YY Inc., a Nasdaq-listedcompany since June 2008, and also serves as director in several non-public portfolio companies of the fund. From 2000 through 2008, Mr. Liu worked atMorningside IT Management Services (Shanghai) Co., Ltd. and established its print media business and served as publisher of The Bund, an upscale lifestyleweekly publication. Mr. Liu received a master’s degree in business administration, or MBA, from China Europe International Business School in 1999 and abachelor’s degree in electrical engineering from Beijing Science & Technology University in 1993. 133Table of ContentsMr. Quan Zhou has served as a director of our company since November 2006. Mr. Zhou is currently a managing member of the general partnerof IDG Technology Venture Investments, L.P. and its successor funds. Mr. Zhou is also serving as a director of the general partner of each of IDG-Accel ChinaGrowth Fund I and IDG-Accel China Capital Fund, and their respective successor funds. He currently serves on the board of SouFun Holdings Limited, aNYSE-listed company, and a number of non-public portfolio companies. Mr. Zhou received a Ph.D degree in fiber optics from Rutgers University in 1989, amaster’s degree in chemical physics from the Chinese Academy of Sciences in 1985 and a bachelor’s degree in chemistry from China Science andTechnology University in 1982.Mr. Feng Hong has been a director of our company since April 2014. Mr. Hong is a co-founder of Beijing Xiaomi Technology CompanyLimited, or Xiaomi Technology, and has been a vice president since its inception. From 2006 to 2010, Mr. Hong held various product and engineeringmanagement roles in Google. Prior to that, from 2001 to 2005, Mr. Hong worked at Siebel as a software engineer. Mr. Hong received his master’s degree incomputer science from Purdue University in 2001 and his bachelor’s degree in computer science and engineering from Shanghai Jiao Tong University inChina in 1999.Mr. Chuan Wang has been a director of our company since March 2014. Mr. Wang is a co-founder of Xiaomi Technology, where he has served asits vice president since 2012. He is also the founder of Beijing Duokan Technology Co., Ltd., where he has served as its chief executive officer since itsinception of business in 2010. Between 2005 and 2011, Mr. Wang was the general manager of Beijing Thunder Stone Century Technology Co., Ltd. Prior tothat, Mr. Wang was the general manager of Beijing Thunder Stone Digital Technology Co., Ltd. since 1997. Mr. Wang received his bachelor of sciencedegree from Beijing University of Technology in China in 1993.Dr. Hongjiang Zhang has been our director since April 2014. Dr. Zhang currently serves as an executive director and the chief executive officerof Kingsoft Corporation Limited, which is listed on the Hong Kong Stock Exchange (Stock Code: 3888). He also serves as a director and the chief executiveofficer of Kingsoft Cloud Holdings Limited. Dr. Zhang is a director of Cheetah Mobile Inc., which is listed on the New York Stock Exchange (NYSE:CMCM), as well as a director of 21Vianet Group, Inc. which is listed on the NASDAQ (NASDAQ: VNET). Prior to joining Kingsoft Corporation Limited inOctober 2011, Dr. Zhang was the chief technology officer of Microsoft Asia-Pacific Research and Development Group and the managing director of theMicrosoft Advanced Technology Center and a Distinguished Scientist. In his dual role, Dr. Zhang led Microsoft’s research and development initiatives inChina, including strategy and planning, research and development, as well as incubation of products, services and solutions. Dr. Zhang was also a member ofthe executive management committee of Microsoft (China) Limited. Dr. Zhang was the deputy managing director and a founding member of MicrosoftResearch Asia. Dr. Zhang has authored four books and over 400 scientific papers and holds approximately 200 US and international patents. Dr. Zhangreceived a Ph.D. in electrical engineering from the Technical University of Denmark in 1991, and a bachelor of science degree from Zhengzhou University,China, in 1982.Ms. Jenny Wenjie Wu has served as our independent director since June 2014. Ms. Wu has been the chief strategy officer of Ctrip.comInternational, Ltd. or Ctrip, a Nasdaq-listed company, since November 2013. Prior to that, she served as Ctrip’s chief financial officer between May 2012 andNovember 2013 and as a deputy chief financial officer between December 2011 and May 2012. Ms. Wu also serves as an independent director of KingsoftCorporation Limited from March 2013. Prior to joining Ctrip, Ms. Wu was an equity research analyst covering China Internet and Media industries inMorgan Stanley Asia Limited and in Citigroup Global Markets Asia Limited from 2005 to 2011. Prior to that, Ms. Wu worked in the Department ofEnterprises Operations and Management in China Merchants Holdings (International) Company Limited, a company listed on the Hong Kong StockExchange, from 2003 to 2005. Ms. Wu holds a Ph.D. degree in finance from the University of Hong Kong, a Master’s degree in philosophy in finance fromthe Hong Kong University of Science and Technology, and both a Master’s degree and a Bachelor’s degree in economics from Nan Kai University, China.Ms. Wu is a Chartered Financial Analyst (CFA). 134Table of ContentsMr. Yongfu Yu has served as our independent director since June 2014. Mr. Yu has been the chief executive officer of UCWeb Inc., a provider ofmobile internet software technology and services in China since the end of 2006. From 2001 to 2006, Mr. Yu worked at Legend Capital, a venture capitalinvestment fund, focusing on the TMT industry. He served as an investment manager between 2001 to 2004 and as a vice president between 2004 and 2006.Mr. Yu received his bachelor’s degree in business management from the College of International Business, Nankai University in China in 1999.Mr. Peng Huang has been our chief operating officer since September 2013, and currently oversees our business operation and strategiccooperation. Mr. Huang joined us in 2009 as a vice president, and also became the general manager of our member subscription department in 2011. From2006 to 2009, Mr. Peng worked as a general vice president for PPTV. From 1996 to 2001, Mr. Peng was the director of the Shanghai office of ShenzhenHuawei Technology Co., Ltd. and general manager of Shanghai Huawei Company. Mr. Huang received a master’s degree in communications and electronicsystem from the University of Electronic Science and Technology of China in 1992 and a bachelor’s degree in wireless engineering from NorthwesternPolytechnical University of China in 1987.Mr. Tao Thomas Wu has been our chief financial officer since November 2013. Prior to joining our company, Mr. Wu had served as the chieffinancial officer of Noah Holdings Limited, a U.S. listed company, since 2010. Prior to that, Mr. Wu spent nearly 20 years working in the financial servicessector. Most recently, Mr. Wu was a senior portfolio manager with AllianceBerstein L.P. in the United States and a senior analyst with Moody’s InvestorsServices in New York. Mr. Wu previously also worked in investment banks, primarily with JPMorgan Chase & Co. in New York and Singapore. Mr. Wureceived his master’s degree in public administration from Syracuse University in 1992 and his bachelor’s degree in mathematics from Grinnell College inMay 1987.Mr. Lei Chen has been our chief technology officer since November 2014. Prior to joining us, Mr. Chen was the chief executive officer ofTencent Cloud Computing (Beijing) Ltd., a wholly owned subsidiary of Tencent Holdings Limited, or Tencent, where he spearheaded Tencent’s cloudcomputing, open platform and social advertisement efforts. He joined Tencent in 2010. Before becoming the chief executive officer of Tencent CloudComputing (Beijing) Ltd., he served as manager of Tencent’s cloud platform division and deputy general manager of its open platform and social advertisingplatform divisions. Mr. Chen also worked at Google and Microsoft before joining Tencent, creating data storage and e-commerce applications. Mr. Chenholds a bachelor of science degree in computer science and technology from Tsinghua University, and a master’s degree in computer science from theUniversity of Texas at Austin. B.CompensationFor the fiscal year ended December 31, 2014, we paid an aggregate of approximately US$1.2 million in cash to our executive officers, and wepaid approximately US$32,000 in cash compensation to a non-executive director. In addition, we paid approximately US$67,027 in pension, housing funds,transportation subsidies and commercial insurance to our executive officers, and we did not set aside or accrued any amount to provide such benefits to ournon-executive directors. For share incentive grants to our officers and directors under our share incentive plan, see “—Share incentive plans.” For restrictedshare grants outside the share incentive plan, see “—Share Incentive Plans.” 135Table of ContentsShare Incentive PlansWe have adopted (i) a 2010 share incentive plan in December 2010, or the 2010 Plan, (ii) a 2013 share incentive plan in November 2013, assupplemented, or the 2013 Plan and (iii) a 2014 share incentive plan in April 2014, as supplemented, or the 2014 Plan. The purpose of the plans is to attractand retain the best available personnel by linking the personal interests of the members of the board, employees, and consultants to the success of ourbusiness and by providing such individuals with an incentive for outstanding performance to generate superior returns for our shareholders.2010 PlanUnder the 2010 Plan and the seventh amended and restated shareholders’ agreement dated as of April 24, 2014, the maximum number of sharesin respect of which options, restricted shares, or restricted share units that may be granted is 26,822,828 shares. As of March 31, 2015, options to purchase anaggregate number of 4,242,220 common shares were outstanding.The following paragraphs summarize the terms of the 2010 Plan.Types of awards. The following briefly describe the principal features of the various awards that may be granted under the 2010 Plan. • Options. Options provide for the right to purchase a specified number of our common shares at a specified price and usually will becomeexercisable in the discretion of our plan administrator in one or more installments after the grant date. The option exercise price may bepaid, subject to the discretion of the plan administrator, in cash or by check, in our common shares which have been held by the optionholder for such period of time as may be required to avoid adverse accounting treatment, in other property with value equal to theexercise price, through a broker-assisted cashless exercise, or by any combination of the foregoing. • Restricted Shares. A restricted share award is the grant of our common shares which are subject to certain restrictions and may be subjectto risk of forfeiture. Unless otherwise determined by our plan administrator, a restricted share is nontransferable and may be forfeited orrepurchased by us upon termination of employment or service during a restricted period. Our plan administrator may also impose otherrestrictions on the restricted shares, such as limitations on the right to vote or the right to receive dividends. • Restricted Share Units. Restricted share units represent the right to receive our common shares at a specified date in the future, subject toforfeiture of such right upon termination of employment or service during the applicable restriction period. If the restricted share unitshave not been forfeited, then we shall deliver to the holder unrestricted common shares that will be freely transferable after the last day ofthe restriction period as specified in the award agreement.Plan administration. Before our shares are listed on a stock exchange, the 2010 Plan shall be administered by our board of directors. After ourshares are listed on a stock exchange, the 2010 Plan shall be administered by our board of directors or the compensation committee of the board of directors(or a similar body) formed in accordance with applicable exchange rules. The plan administrator will determine the provisions and terms and conditions ofeach grant.Award agreement. Options, restricted shares, or restricted share units granted under the 2010 Plan are evidenced by an award agreement that setsforth the terms, conditions, and limitations for each grant. 136Table of ContentsOption exercise price. The exercise price subject to an option shall be determined by the plan administrators which may be a fixed or variableprice related to the fair market value of the subject of the grant. The exercise price may be amended or adjusted in the absolute discretion of the planadministrators, the determination of which shall be final, binding and conclusive. To the extent not prohibited by applicable laws or the rules of anyexchange on which our securities are listed, a downward adjustment of the exercise prices of options shall be effective without the approval of theshareholders or the approval of the affected participants.Eligibility. We may grant awards to our employees, consultants and all members of our board of directors, as determined by the boardof directors.Term of the awards. The term of each option grant shall be stated in the award agreement, provided that the term shall not exceed 10 years fromthe date of the grant. As for the restricted shares and restricted share units, the plan administrator shall determine and specify the period of restriction in theaward agreement.Vesting schedule. In general, the plan administrator determines the vesting schedule, which is set forth in the award agreement. Theadministrator, in its discretion, may accelerate the vesting schedule of an award.Transfer restrictions. Except as otherwise provided by the plan administrators, no option award shall be assigned, transferred, or otherwisedisposed of other than by will or the laws of descent and distribution.Termination. Unless terminated earlier, the 2010 Plan will expire automatically in December 2020. With the approval of our board of directors,the plan administrators may, at any time and from time to time, terminate, amend or modify the 2010 Plan. Our board of directors has the authority to amendor terminate the plan subject to shareholder approval to the extent necessary to comply with applicable law.The following table summarizes, as of March 31, 2015, the outstanding options granted to our executive officers, directors, and other individualsas a group under our 2010 Plan. Name Common sharesunderlyingoptions awarded Exercise price(US$/share) Date of grant Date of expiration Peng Huang * 2.40 June 3, 2009 June 2, 2016 Tao Thomas Wu * 2.11 November 18, 2013 November 17, 2020 Other Individuals as a Group (1) 3,900,459 Total 4,242,220 *Less than one percent of our total outstanding share capital.(1)As of March 31, 2015, the outstanding options held by other individuals as a group had exercise prices ranging from US$0.01 to US$3.97. Theseoptions were granted on various dates from April 1, 2003 through March 31, 2015. Each option that was granted before January 1, 2007 will expireafter ten years from the date of grant. Each option that was granted after January 1, 2007 will expire after seven years from the date of grant. 137Table of Contents2013 PlanUnder the 2013 Plan, the maximum number of share awards that may be granted is 9,073,732 restricted shares, which have been issued toLeading Advice Holdings Limited, or Leading Advice, for the purposes of administrating the awards according to the 2013 Plan. As of March 31, 2015,8,492,350 restricted shares (excluding those forfeited) have been granted to certain executive officers and other employees under the 2013 Plan.The following paragraphs summarize the terms of the 2013 Plan.Plan administration. Before our shares are listed on a stock exchange, the 2013 Plan shall be administered by Leading Advice Holdings Limitedor its designee. Leading Advice currently acts as an agent on behalf us to administer the 2013 Plan based on the instructions from us. The 2013 Plan isadministered by our board of directors or the compensation committee of the board of directors (or a similar body) formed in accordance with applicableexchange rules. The administrator determines the grantees under the 2013 Plan.Award agreement. Each award of restricted shares is evidenced by an award agreement that specifies the number of restricted shares so granted,the vesting schedule, the applicable provisions in the event the grantee’s employment or service terminates, and such other terms and conditions that theadministrator shall determine in its sole discretion.Eligibility. The restricted shares may be granted to members of our senior management, consisting of our chief operating officer, chief technicalofficer, vice presidents, or their equivalents, and counsel or consultant to our company.Vesting schedule. Each grant of restricted shares will be subject to a vesting schedule determined solely by the administrator. Once vested, therestricted shares will no longer be subject to forfeiture and other restrictions contained in the award agreement, unless otherwise specified therein.Shareholder rights. Grantees of restricted shares will not be entitled to any shareholder rights (including the right to dividends) on unvestedportions of the restricted shares. They will be entitled to dividends on the vested portions of the restricted shares. The administrator will hold all vestedportions of share awards for the benefit of the grantees and exercise the voting rights with respect of those shares. Currently, Leading Advice exercises thevoting power on behalf of the grantees regarding their vested restricted shares and it will solicit voting instruction from each grantee and vote in accordancewith such instruction.Forfeiture or repurchase of the awards. In the event that the award recipient ceases employment with us or ceases to provide services to usduring the applicable restriction period, restricted shares that are at that time subject to restrictions shall be forfeited or repurchased in accordance with theaward agreement, unless otherwise waived in whole or in part by the administrator.Acceleration. The administrator may accelerate the time at which any restrictions shall lapse or be removed.Transfer restrictions. Except as otherwise provided by the plan administrators or the applicable shareholders agreement, no share award shall beassigned, transferred, or otherwise disposed of other than by will or the laws of descent and distribution.Termination. Unless terminated earlier, the 2013 Plan will expire automatically in November 2023. With the approval of our board of directors,the plan administrators may, at any time and from time to time, terminate, amend or modify the 2013 Plan. Our board of directors has the authority to amendor terminate the plan subject to shareholder approval to the extent necessary to comply with applicable law. 138Table of Contents2014 PlanUnder the 2014 Plan, the maximum number of share awards that may be granted is 14,195,412 restricted shares, which are currently registeredunder the name of Leading Advice Holdings Limited for the purposes of administrating the awards according to the 2014 Plan. As of March 31, 2015,5,665,500 restricted shares (excluding those forfeited) have been granted to certain executive officers and other employees under the 2014 Plan.The following paragraphs summarize the terms of the 2014 Plan.Plan administration. Before our shares are listed on a stock exchange, the 2014 Plan shall be administered by Leading Advice Holdings Limitedor its designee. Leading Advice currently acts as an agent on behalf us to administer the 2014 Plan based on the instructions from us. The 2014 Plan isadministered by our board of directors or the compensation committee of the board of directors (or a similar body) formed in accordance with applicableexchange rules. The administrator determines the grantees under the 2014 Plan.Award agreement. Each award of restricted shares is evidenced by an award agreement that specifies the number of restricted shares so granted,the vesting schedule, the applicable provisions in the event the grantee’s employment or service terminates, and such other terms and conditions that theadministrator shall determine in its sole discretion.Eligibility. The restricted shares may be granted to members of our directors, senior management, employees, advisors and consultants ofour company.Vesting schedule. Each grant of restricted shares will be subject to a vesting schedule determined solely by the administrator. Once vested, therestricted shares will no longer be subject to forfeiture and other restrictions contained in the award agreement, unless otherwise specified therein.Shareholder rights. Grantees of restricted shares will not be entitled to any shareholder rights (including the right to dividends) on unvestedportions of the restricted shares. They will be entitled to dividends on the vested portions of the restricted shares. The administrator will hold all vestedportions of share awards for the benefit of the grantees and exercise the voting rights with respect of those shares. Currently, Leading Advice exercises thevoting power on behalf of the grantees regarding their vested restricted shares and it will solicit voting instruction from each grantee and vote in accordancewith such instruction.Forfeiture or repurchase of the awards. In the event that the award recipient ceases employment with us or ceases to provide services to usduring the applicable restriction period, restricted shares that are at that time subject to restrictions shall be forfeited or repurchased in accordance with theaward agreement, unless otherwise waived in whole or in part by the administrator.Acceleration. The administrator may accelerate the time at which any restrictions shall lapse or be removed.Transfer restrictions. Except as otherwise provided by the plan administrators or the applicable shareholders agreement, no share award shall beassigned, transferred, or otherwise disposed of other than by will or the laws of descent and distribution. 139Table of ContentsTermination. Unless terminated earlier, the 2014 Plan will expire automatically in April 2024. With the approval of our board of directors, theplan administrators may, at any time and from time to time, terminate, amend or modify the 2014 Plan. Our board of directors has the authority to amend orterminate the plan subject to shareholder approval to the extent necessary to comply with applicable law.The following table summarizes, as of March 31, 2015, the number of restricted shares granted to our officers and other individuals as a grouppursuant to our 2013 Plan and 2014 Plan. Name Number of restricted sharesgranted Date of grant Peng Huang * November 18, 2013 Tao Thomas Wu * November 18, 2013 Lei Chen * November 3, 2014 Other Individuals as a Group 8,940,230 Total 14,157,850 *Less than one percent of our total outstanding share capital.Employment AgreementsWe have entered into employment agreements with each of our senior executive officers. We may terminate a senior executive officer’semployment for cause at any time by giving written notice for certain acts of the officer, including: (i) conviction of a felony or act of fraud, misappropriationor embezzlement; (ii) gross negligence or dishonest to the detriment of our company; and (iii) material breach of the employment agreement. We may alsoterminate a senior executive officer’s employment upon at least two months’ prior written notice. A senior executive officer may terminate his or heremployment by giving two-months’ or three-months’ prior notice.Each senior executive officer has agreed that he or she shall not, at any time during the period of employment or after the termination of theperiod of employment, except for the benefit of our company, use or disclose any confidential information to any person, corporation or other entity withoutour written consent. Upon termination of the employment or at any other time when requested by us, the officer should promptly deliver to our company alldocuments and materials of any nature pertaining to his or her work with us and should provide written certification of his or her compliance with theemployment agreement. Under no circumstances can the officer, following his or her termination, in his or her possession any property of our company, orany documents or materials containing any confidential information. The officer should not, during the employment term, (i) improperly use or disclose anyproprietary information or trade secrets of any former employer or other person or entity with which the officer has a duty to keep in confidence informationacquired by such officer, if any, or (ii) bring into the premises of our company any document or confidential or proprietary information belonging to theformer employer unless consented to in writing by such employer. The officer will indemnify us and hold us harmless from and against all claims, liabilities,damages and expenses.Each officer also agrees that during the term of employment and within one year of termination of employment, he or she will not approachclients, customers or contacts of our company or other persons or entities introduced to such officer in the his/her capacity as a representative of our companyfor the purposes of doing business with such persons or entities which will harm the business relationship between our company and such persons or entities.Unless consented to by us, the officer should not assume employment with or provide services as a director or otherwise for any of our competitors, or engagein any competitor as a principal, partner, licensor or otherwise. The officer will not seek, directly or indirectly, by the offer of alternative employment or otherinducement whatsoever, to solicit the services of any of our employees as at or after the date of the termination of such officer’s employment, or in the yearpreceding such termination. 140Table of ContentsC.Board PracticesBoard of DirectorsOur board of directors consists of nine directors. A director is not required to hold any shares in our company to qualify to serve as a director. Allthe powers of our company to borrow money and to mortgage or charge its undertaking, property and uncalled capital, or any part thereof and to issuedebentures, debenture stock and other securities whenever money is borrowed or as a security for any debt, liability or obligation of our company or anythird party, may only be carried out jointly by our chief executive officer and chief financial officer.Committees of the Board of DirectorsWe have established an audit committee, a compensation committee and a nominating and corporate governance committee under the board ofdirectors. We have adopted a charter for each of the three committees. Each committee’s members and functions are described below.Audit CommitteeOur audit committee consists of Ms. Jenny Wenjie Wu, Mr. Yongfu Yu and Mr. Sean Shenglong Zou, and is chaired by Ms. Jenny Wenjie Wu.Our board of directors has determined that each of Ms. Jenny Wenjie Wu and Mr. Yongfu Yu satisfies the “independence” requirements of Rule 10A-3 underthe Securities Exchange Act of 1934, as amended, and Rule 5605(a)(2) of the NASDAQ Listing Rules. The audit committee will oversee our accounting andfinancial reporting processes and the audits of the financial statements of our company. The audit committee is responsible for, among other things: • selecting the independent registered public accounting firm and pre-approving all auditing and non-auditing services permitted to beperformed by the independent registered public accounting firm; • reviewing with the independent registered public accounting firm any significant matters or difficulties encountered by the externalauditors during the course of their audits and management’s response; • reviewing and approving all proposed related party transactions, as defined in Item 404 of Regulation S-K under the Securities Act; • discussing the annual audited financial statements with management and the independent registered public accounting firm; • reviewing significant matters as to the adequacy of our internal controls and any special procedures adopted by the external auditors inlight of material control deficiencies; • annually reviewing and reassessing the adequacy of our audit committee charter; • meeting separately and periodically with management and the independent registered public accounting firm; and • reporting regularly to the board. 141Table of ContentsCompensation CommitteeOur compensation committee consists of Ms. Jenny Wenjie Wu, Mr. Yongfu Yu and Mr. Chuan Wang, and is chaired by Mr. Chuan Wang. Ourboard of directors has determined that each of Ms. Jenny Wenjie Wu and Mr. Yongfu Yu satisfies the “independence” requirements of Rule 5605(a)(2) of theNASDAQ Listing Rules. The compensation committee assists the board in reviewing and approving the compensation structure, including all forms ofcompensation, relating to our directors and executive officers. Our chief executive officer may not be present at any committee meeting during which hiscompensation is deliberated upon. The compensation committee is responsible for, among other things: • reviewing the total compensation package for our three most senior executives and making recommendations to the board with respectto it; • approving and overseeing the total compensation package for our executives other than the three most senior executives; • reviewing the compensation of our directors and making recommendations to the board with respect to it; and • periodically reviewing and approving any long-term incentive compensation or equity plans, programs or similar arrangements, annualbonuses, and employee pension and welfare benefit plans.Corporate governance and nominating committeeOur corporate governance and nominating committee consists of Ms. Jenny Wenjie Wu, Mr. Yongfu Yu and Mr. Feng Hong, and is chaired byMr. Feng Hong. Our board of directors has determined that each of Ms. Jenny Wenjie Wu and Mr. Yongfu Yu satisfies the “independence” requirements ofRule 5605(a)(2) of the NASDAQ Listing Rules. The corporate governance and nominating committee assists the board in selecting individuals qualified tobecome our directors and in determining the composition of the board and its committees. The corporate governance and nominating committee isresponsible for, among other things: • recommending nominees to the board for election or re-election to the board, or for appointment to fill any vacancy on the board; • reviewing annually with the board the current composition of the board with regards to characteristics such as independence, age, skills,experience and availability of service to us; • selecting and recommending to the board the names of directors to serve as members of the audit committee and the compensationcommittee, as well as of the corporate governance and nominating committee itself; • advising the board periodically with regards to significant developments in the law and practice of corporate governance as well as ourcompliance with applicable laws and regulations, and making recommendations to the board on all matters of corporate governance andon any remedial action to be taken; and • monitoring compliance with our code of business conduct and ethics, including reviewing the adequacy and effectiveness of ourprocedures to ensure proper compliance. 142Table of ContentsDuties of DirectorsUnder Cayman Islands law, our directors have a fiduciary duty to act honestly, in good faith and with a view to our best interests. Our directorsalso have a duty to exercise the skill they actually possess and such care and diligence that a reasonably prudent person would exercise in comparablecircumstances. In fulfilling their duty of care to us, our directors must ensure compliance with our memorandum and articles of association, as amended fromtime to time. Our company may have the right to seek damages if a duty owed by our directors is breached.Terms of Directors and Executive OfficersOur directors may be elected by an ordinary resolution of our shareholders, or by the affirmative vote of a simple majority of our directors (whichshould include one non-independent director) present and voting at a meeting of our board of directors, and shall hold office until the expiration of his termand until his successor has been elected and qualified, or until such time as they are removed from office by ordinary resolution or the unanimous writtenresolution of all shareholders. A director will be removed from office automatically (1) if a simple majority of all directors determine at a duly called andconstituted board meeting that such director has been guilty of actual fraud or willful neglect in performing his duties as a director, or (2) if a director isnotified of, and fails to attend, an aggregate of three duly called and constituted board meetings within any 365-day period. In addition, the office of adirector will be vacated if such director (a) dies, becomes bankrupt or makes any arrangement or composition with his creditors, (b) is found to be or becomesof unsound mind, or (c) resigns his office by notice in writing to us. D.EmployeesWe had 1,362, 1,523 and 1,305 employees as of December 31, 2012, 2013 and 2014, respectively. As of December 31, 2014, we had 1,305employees, including 154 in general administration, 926 in research and development and 225 in sales and marketing. For 2012 and 2013, our employeeswere divided into five categories, including management, research and development, content procurement, sales and marketing and general administration.In 2014, however, we grouped our employees into three redefined categories—research and development, sales and marketing and general administration—and employees who were formerly in the management or content procurement categories were reassigned to one of the three redefined categories. As requiredby PRC regulations, we participate in employee benefit plans organized by government authorities, including pensions, work-related injury benefits, medicalbenefits, maternity benefits, unemployment benefit and housing fund plans. We have granted stock options and restricted shares to management and keyemployees in order to reward their services and provide them with equity incentives. We maintain good employee relations and have not experienced anymaterial labor disputes since our inception. E.Share OwnershipFor information regarding the share ownership of our directors and officers, see “Item 7. Major Shareholders and Related Party Transactions — A.Major Shareholders.” For information as to stock options granted to our directors, executive officers and other employees, see “Item 6. Directors, SeniorManagement and Employees—B. Compensation — Share Incentive Plans.” 143Table of ContentsItem 7.Major Shareholders and Related Party Transactions A.Major ShareholdersExcept as specifically noted, the following table sets forth information with respect to the beneficial ownership of our shares as of March 31,2015 held by: • each of our current directors and executive officers; and • each person known to us to beneficially own more than 5% of our common shares.Percentage of beneficial ownership is based on 335,073,840 total outstanding common shares as of March 31, 2015, excluding (ii) 21,269,144common shares issued to Leading Advice Holdings Limited for grants under our 2013 Plan and 2014 Plan that remained then unexercised or unvested, and(ii) 12,534,225 common shares issued to our depositary bank for bulk issuance of ADSs reserved for future issuances upon the exercise or vesting of awardsgranted under our share incentive plans.Beneficial ownership is determined in accordance with the rules and regulations of the SEC. These rules generally provide that a person is thebeneficial owner of securities if such person has or shares the power to vote or direct the voting of securities, or to dispose or direct the disposition ofsecurities or has the right to acquire such powers within 60 days. In computing the number of shares beneficially owned by a person and the percentageownership of that person, we have included shares that the person has the right to acquire within 60 days of March 31, 2015, including through the exerciseof any option, warrant or other right or the conversion of any other security, in both the numerator and the denominator. These shares, however, are notincluded in the computation of the percentage ownership of any other person. Common Shares Beneficially Owned Number %(1) Directors and executive officers**: Sean Shenglong Zou (2) 32,814,606 9.79% Hao Cheng(3) 13,133,952 3.92% Qin Liu(4) 4,166,667 1.24% Quan Zhou(5) 25,816,587 7.70% Feng Hong(6) — — Chuan Wang(7) — — Hongjiang Zhang(8) — — Peng Huang(9) * * Jenny Wenjie Wu(10) — — Yongfu Yu (11) * * Tao Thomas Wu * * Lei Chen — — All directors and executive officers as group 77,308,255 23.39% Principal Shareholders: Xiaomi Ventures Limited(12) 93,653,572 27.95% Morningside Technology Investments Limited(13) 37,787,909 11.28% King Venture Holdings Limited(14) 37,500,000 11.19% Vantage Point Global Limited(15) 32,814,606 9.79% IDG Funds(16) 25,816,587 7.70% Notes: *Less than 1% of the total outstanding common shares. 144Table of Contents**The business address of Messrs. Shenglong Zou, Hao Cheng, Tao Thomas Wu and Mr. Lei Chen is 4/F, Hans Innovation Mansion, North Ring Road,No. 9018 High-Tech Park, Nanshan District, Shenzhen, 518057, People’s Republic of China.(1)For each person and group included in this column, percentage ownership is calculated by dividing the number of common shares beneficially ownedby such person or group, including shares that such person or group has the right to acquire within 60 days of the date of this annual report, by335,073,840, being the sum of the total number of common shares, and the number of common shares underlying share options, restricted shares andwarrants held by such person or group that are exercisable within 60 days of the date of this annual report.(2)Represents 32,814,606 common shares held by Vantage Point Global Limited, a British Virgin Islands company which is 100% beneficially ownedby Mr. Sean Shenglong Zou through a family trust.(3)Represents 13,133,952 common shares held by Aiden & Jasmine Limited, a British Virgin Islands company which is 100% beneficially owned byMr. Hao Cheng through a family trust.(4)Represents (i) 3,796,296 common shares held by Morningside China TMT Special Opportunity Fund, L.P. and (ii) 370,371 common shares held byMorningside China TMT Fund III Co-Investment, L.P. Morningside China TMT Special Opportunity Fund, L.P. and Morningside China TMTFund III Co-Investment, L.P. are controlled by Morningside China TMT GP III, L.P., their general partner. Morningside China TMT GP III, L.P. is inturn controlled by TMT General Partner Ltd., its general partner. Mr. Liu is one of the directors of TMT General Partner Ltd. The business address ofMr. Liu is No. 380, Wu Yuan road, Xuhui District, Shanghai, China.(5)Represents (i) 19,635,416 common shares held by IDG Technology Venture Investment III, L.P., (ii) 2,014,504 common shares held by IDGTechnology Venture Investment IV, L.P., and (iii) 4,166,667 common shares held by IDG Technology Venture Investment V, L.P. We refer to IDGTechnology Venture Investment III, L.P., IDG Technology Venture Investment IV, L.P. and IDG Technology Venture Investment V, L.P. collectivelyas IDG Funds. IDG Technology Venture Investment III, L.P. is a limited partnership with IDG Technology Venture Investment III, LLC as its solegeneral partner. IDG Technology Venture Investment III, LLC is controlled by Mr. Quan Zhou and Mr. Chi Sing Ho, its two managing members. IDGTechnology Venture Investment IV, L.P. is a limited partnership with IDG Technology Venture Investment IV, LLC as its sole general partner. IDGTechnology Venture Investment IV, LLC is controlled by Mr. Quan Zhou and Mr. Chi Sing Ho, its two managing members. IDG Technology VentureInvestment V, L.P. is a limited partnership with IDG Technology Venture Investment V, LLC as its sole general partner. IDG Technology VentureInvestment V, LLC is a Delaware limited liability company controlled by Mr. Quan Zhou and Mr. Chi Sing Ho, its two managing members. Thebusiness address of Mr. Zhou is c/o IDG Capital Partners, 6/F, COFCO Plaza, No. 8 Jianguomennei Avenue, Beijing 100005, China.(6)The business address of Mr. Hong is Building E, Shunshijiaye Chuang Ye Yuan, No. 66 Zhufang Road, Qinghe, Haidian District, Beijing, China.(7)The business address of Mr. Wang is Building C, Shunshijiaye Chuang Ye Yuan, No. 66 Zhufang Road, Qinghe, Haidian District, Beijing, China.(8)The business address of Dr. Zhang is Kingsoft Tower, No.33 Xiaoying West Road, Haidian District, Beijing, China.(9)The business address of Mr. Huang is 7/F, Building 11, Tower 2, Kejizhonger Road, Ruanjiang Yuan, Nanshan District, Shenzhen, China.(10)The business address of Ms. Wu is No. 99, Fuquan Road, Shanghai, China.(11)The business address of Mr. Yu is F12, Tower A, U-Center, No. 28 Chengfu Road, Haidian District, Beijing 100083, China.(12)Represents 93,653,572 common shares held by Xiaomi Ventures Limited. Xiaomi Ventures Limited is wholly owned by Xiaomi Corporation, alimited liability company organized under the laws of the Cayman Islands. The business address of Xiaomi Ventures Limited is 68 Qinghe MiddleStreet WuCaiCheng Office Building, 12th Floor, Haidian District, Beijing, People’s Republic of China.(13)Represents 37,787,909 common shares held by Morningside Technology Investments Limited, a company incorporated in British Virgin Islands.Morningside Technology Investments Limited is ultimately indirectly held under a trust for the benefit of Madam Chan Tan Ching Fen. The addressof Morningside Technology Investments Limited is 2/F, Le Prince de Galles, 3-5 Avenue des Citronniers MC 98000.(14)Represents 37,500,000 common shares held by King Venture Holdings Limited. King Venture Holdings Limited is an exempted companyincorporated under the laws of the Cayman Islands, and is wholly owned by Kingsoft Corporation Limited, a Cayman Islands company with its shareslisted on the Hong Kong Stock Exchange (Stock Code: 3888). The business address of King Venture Holdings Limited is Kingsoft Tower,No. 33 Xiaoying West Road, Haidian District, Beijing, China.(15)Represents 32,814,606 common shares held by Vantage Point Global Limited, a British Virgin Islands company which is 100% beneficially ownedby Mr. Sean Shenglong Zou through a family trust. The registered address of Vantage Point Global Limited is P.O. Box 438, Palm Grove House, RoadTown, Tortola, British Virgin Islands. 145Table of Contents(16)Represents (i) 19,635,416 common shares held by IDG Technology Venture Investment III, L.P., (ii) 2,014,504 common shares held by IDGTechnology Venture Investment IV, L.P., and (iii) 4,166,667 common shares held by IDG Technology Venture Investment V, L.P. IDG TechnologyVenture Investment III, L.P. is a limited partnership with IDG Technology Venture Investment III, LLC as its sole general partner. IDG TechnologyVenture Investment III, LLC is controlled by Mr. Quan Zhou and Mr. Chi Sing Ho, its two managing members. IDG Technology Venture InvestmentIV, L.P. is a limited partnership with IDG Technology Venture Investment IV, LLC as its sole general partner. IDG Technology Venture InvestmentIV, LLC is controlled by Mr. Quan Zhou and Mr. Chi Sing Ho, its two managing members. IDG Technology Venture Investment V, L.P. is a limitedpartnership with IDG Technology Venture Investment V, LLC as its sole general partner. The sole general partner is a Delaware limited liabilitycompany controlled by Mr. Quan Zhou and Mr. Chi Sing Ho, its two managing members. The registered address of the IDG Funds is The CorporationTrust Company, 1209 Orange Street, Wilmington, Delaware 19801, United States.To our knowledge, as of March 31, 2015, 102,779,004 of our outstanding common shares are held by four record holders in the United States.This number includes 76,582,840 common shares held by The Bank of New York Mellon, the depositary of our ADS program, which represents 22.86% ofour total outstanding shares, and includes 12,534,225 common shares issued to the depositary bank for bulk issuance of ADSs reserved for future issuancesupon the exercise or vesting of awards granted under our share incentive plans. None of our shareholders has informed us that he or she is affiliated with aregistered broker-dealer or is in the business of underwriting securities. We are not aware of any arrangement that may, at a subsequent date, result in a changeof control of our company. B.Related Party TransactionsContractual arrangements with our PRC variable interest entity and its shareholdersDue to current legal restrictions on foreign ownership and investment in value-added telecommunications services in China, we conduct ouroperations in China principally through a series of contractual arrangements with our variable interest entity and its shareholders in China. For a descriptionof these contractual arrangements, see “Item 4. Information on the Company—C. Organizational Structure.”Repurchase of shares from existing shareholdersIn April 2014, we repurchased shares from several then shareholders as follows:Repurchase from Skyline. In connection with our series E preferred shares financing, on April 15, 2014, we repurchased from Skyline 469,225common shares, 27,180 series A preferred shares, 591,451 series A-1 preferred shares, 725,237 series B preferred shares and 3,808,943 series D preferred sharesfor a total consideration of US$24,275,665.3.Repurchase of shares from shareholders. On April 24, 2014, we repurchased from our existing shareholders a total of 17,676,240 common shareson an as-converted basis, including 10,334,679 common shares from Vantage Point Global Limited, 3,860,733 common shares from Aiden & JasmineLimited, 450,000 series A preferred shares from Bright Access International Limited, 2,921,868 series B preferred shares from Fidelity Asia VenturesFund L.P., and 108,960 series B preferred shares from Fidelity Asia Principals Fund L.P., for a total consideration of US$49,808,318.63. We transferred a totalof 14,195,412 repurchased common shares to Leading Advice Holdings Limited for future issuance of restricted shares under our 2014 Plan and cancelled theremaining repurchased shares on the same date. 146Table of ContentsShareholders agreementIn connection with the issuance of our series E preferred shares, we entered into a seventh amended and restated shareholders agreement inApril 2014 with our shareholders and relevant parties therein. Except for the registration rights, all preferred shareholders’ rights automatically terminatedupon the completion of our initial public offering. Additionally, the co-founders have agreed to the transfer restrictions imposed on an aggregate number of39,934,162 common shares beneficially owned by the co-founders. Accordingly, the co-founders are unable to transfer the relevant shares to any third partyuntil April 24, 2019 or April 24, 2018, as the case may be.Pursuant to our seventh amended and restated shareholders agreement, we have granted certain registration rights to our shareholders. Theregistration rights remain effective as of the date of this annual report. Set forth below is a description of the registration rights granted under the agreement.Demand registration rights. At any time following the completion of initial public offering, upon a written request from the holders of at least30% of the registrable securities then outstanding, we shall file a registration statement covering the offer and sale of the registrable securities. Registrablesecurities include our common shares issued or issuable upon conversion of the preferred shares provided that, with respect to demand registration right,registrable securities exclude common shares issued or issuable upon conversion of the series C preferred shares. However, we are not obligated to proceedwith a demand registration if (i) such registration is in any particular jurisdiction in which we would be required to execute a general consent to service ofprocess in effecting such registration, qualification or compliance, unless we already are subject to service in such jurisdiction and except as may be requiredby the Securities Act; (ii) we have already effected three demand registrations; (iii) such registration is during the period starting with the date 60 days priorto our good faith estimate of the date of filing of, and ending on a date 180 days after the effective date of a registration initiated by us, provided that we areactively employing in good faith all reasonable efforts to cause such registration statements to become effective; (iv) the initiating holders (defined in theshareholders agreement) propose to dispose of registrable securities which may be immediately registered on Form F-3 pursuant to a request from otherholders of registrable shares; (v) initiating holders do not request that such offering be firmly underwritten by underwriters selected by the initiating holdersor (vi) if we and the initiating holders are unable to obtain the commitment of the underwriter described in clause (v) above to firmly underwrite the offer. Wehave the right to defer filing of a registration statement for up to 120 days if our board of directors determines in good faith that the filing of a registrationstatement would be materially detrimental to us, but we cannot exercise the deferral right more than once in any 12-month period.Piggyback registration rights. If we propose to file a registration statement for a public offering of our securities other than pursuant toregistration statement relating to any employee benefit plan or a corporate reorganization, then we must offer holders of registrable securities an opportunityto include in that registration all or any part of their registrable securities. The underwriters of any underwritten offering have the right to limit the number ofshares with registration rights to be included in the registration statement, subject to certain limitations; for example, the number of shares that may beincluded in the registration and the underwriting shall be allocated first to us and then to the series E, series D, series C, series B and series A-1 preferredshareholders in turn.Form F-3 registration rights. When we are eligible for registration on Form F-3, holders of at least 30% of the registrable securities thenoutstanding will have the right to request that we file registration statements on Form F-3 covering the offer and sale of their securities. A Form F-3registration shall not be deemed to be a demand registration.We are not obligated to effect a Form F-3 registration, among other things, if (1) we have already effected a registration under the Securities Act within the sixmonths period preceding the date of such request, other than a registration from which the registrable securities of the holders have been excluded, or (2) thedollar amount of securities to be sold is of an aggregate price to the public of less than US$1.0 million. We have the right to defer filing of a registrationstatement for up to 90 days if our board of directors determines in good faith that the filing of a registration statement would be materially detrimental to us,but we cannot exercise the deferral right more than once in any 12-month period. 147Table of ContentsExpenses of registration. We will pay all expenses relating to any demand, piggyback, or Form F-3 registration, other than underwritingcommissions and discounts.Termination of obligations. Our obligations with respect to the piggyback registration rights shall terminate on the fifth anniversary of thecompletion of our initial public offering in June 2014. Our obligations with respect to the demand registration rights or the Form F-3 registration rights shallterminate on the fifth anniversary of the completion of our initial public offering. In addition, we shall have no obligation to effect any demand, or Form F-3registration if, in the opinion of our counsel, all registrable securities may be sold at that time without registration pursuant to Rule 144 under theSecurities Act.Employment agreementsSee “Item 6. Directors, Senior Management and Employees—B. Compensation—Employment agreements.”Share incentivesSee “Item 6. Directors, Senior Management and Employees—B. Compensation—Share incentive plans.”In relation to our 2013 Plan and 2014 Plan, we have appointed Leading Advice Holdings Limited, or Leading Advice, as the administer of bothplans. On behalf of us, Leading Advice executes actions based on our instruction to select the eligible grantees, to determine the number of awards and theconditions and provision of such awards, including but not limited to the vesting schedule and acceleration of the awards.Leading Advice is not entitled to the following rights in relation to the shares registered under its name: (i) dividends, (ii) voting powers prior tovesting of relevant shares and (ii) transfer of the unvested portion of the awards or awards that have not been granted. In addition, upon the liquidation or thedissolution of Leading Advice or the expiration of the relevant plan, common shares not granted as awards shall be transferred back to us at no consideration.For the awards that have been granted and become vested, Leading Advice will solicit voting instructions from each grantee, and vote inaccordance with such instructions. The grantees will be entitled to dividends and have the right to request Leading Advice to transfer vested awards to atransferee designated by the grantees.Advances extended to certain directorsWe extended advances amounting to US$85,000 to Mr. Hao Cheng in 2013 and US$10,000 to Mr. Shenglong Zou and US$7,000 to Mr. ChuanWang in 2014. These advances were used for general business purposes, to set up certain companies in the PRC which we plan to use to conduct a part of ourbusiness and consolidate into the financial statements of our company in the future. All the advances to Mr. Hao Cheng were unsecured, interest-free andhave no repayment terms. As of the December 31, 2014, all the advances to Mr. Hao Cheng have been fully repaid, although the advances to Mr. ShenglongZou and Mr. Chuan Wang remain outstanding. 148Table of ContentsGame sharing arrangement with Zhuhai Qianyou Technology, Co., Ltd.In November 2011, we obtained an exclusive game operation right from Zhuhai Qianyou Technology, Co., Ltd., or Zhuhai Qianyou, our equityinvestee, which is specialized in developing online games. According to the agreement in relation to such game operation right that we entered into withZhuhai Qianyou, we need to share revenues derived by the licensed games with Zhuhai Qianyou. In the years ended December 31, 2012, 2013 and 2014,game sharing cost paid and payable to Zhuhai Qianyou was US$1.0 million, US$1.8 million and US$0.4 million, respectively. As of December 31, 2012 and2013 and 2014, US$0.3 million, US$0.2 million and US$0.1 million, respectively, of the game sharing cost we owe to Zhuhai Qianyou remained unpaid andoutstanding.Intellectual property framework agreement between Shenzhen Xunlei and Xunlei ComputerOn December 24, 2013, Shenzhen Xunlei and Xunlei Computer entered into a technology development and software license frameworkagreement. The term of the agreement is two years from the date of its execution.Under this framework agreement, Xunlei Computer provides Shenzhen Xunlei with technology development services according to ShenzhenXunlei’s business needs. Any new intellectual property resulting from the technology development services is owned by Xunlei Computer, and cannot besubstituted or sub-licensed to any third party by Shenzhen Xunlei without the prior written consent of Xunlei Computer. During the term of the frameworkagreement, with respect to each technology development project, Shenzhen Xunlei and Xunlei Computer will separately sign technology development(services) agreements, which set out the specific terms and amount of consideration, all subject to the terms of the framework agreement.In addition, under the framework agreement, Xunlei Computer grants Shenzhen Xunlei a non-exclusive and limited right to use certain specifiedproprietary software that Xunlei Computer owns. With respect to the licensing of each software, Shenzhen Xunlei and Xunlei Computer will separately signsoftware licensing agreements, which will set out the specific terms and the amount of licensing fee, all subject to the terms of the framework agreement.In relation to cooperation under the framework agreement, Xunlei Computer and Shenzhen Xunlei entered into four agreements in 2013 forXunlei Computer’s technology development services and its software license and Giganology Shenzhen has agreed to the execution of these agreements andthe relevant services and licenses between Xunlei Computer and Shenzhen Xunlei.As of December 31, 2014, the aggregate amount of the fees that have been incurred by Shenzhen Xunlei for the technology developmentservices and the software license provided by Xunlei Computer under the framework agreement was RMB148.0 million (US$23.9 million).Pre-installing Services Agreements with XiaomiCooperation Framework Agreement. On August 1, 2013, we entered into a Cooperation Framework Agreement, or the Framework Agreement,with Xiaomi Technology to arrange for the pre-installation of our Xunlei Accelerator onto Xiaomi’s set-top boxes. The Framework Agreement has a term ofthree years and there is no fee charged for such cooperation. 149Table of ContentsXunlei Accelerator Mobile Pre-installing Services Agreement. On December 1, 2013, we entered into a Xunlei Accelerator Mobile Pre-installing Services Agreement, or the Pre-installing Services Agreement, with Beijing Xiaomi Mobile Software Company Limited, or Beijing Xiaomi, aXiaomi group company. Through such cooperation, Xiaomi phones will be pre-installed with our mobile acceleration applications and Xiaomi phone userswill have access to our acceleration services. The Pre-installing Services Agreement has a term of one year and there is no fee charged for the pre-installation.We have entered into other pre-installing agreements with other unrelated parties at no charge. Our mobile acceleration software has been officially adoptedby Xiaomi’s latest operating system, MIUI6, and installed on Xiaomi phones, including both pre-installations on new phone shipments and installations fromupgrades on existing Xiaomi phones. We received technology service revenue of US$0.3 million from Beijing Xiaomi in 2014.In 2014, we received sales orders from Xiaomi Technology to provide online advertising services on our website. Our total advertising revenuefrom the orders was US$0.9 million. As of December 31, 2014, we did not have any outstanding receivable from Xiaomi Technology.Acquisition of Business from a ShareholderIn September 2014, we, through Shenzhen Xunlei Network Technology Co., Ltd., acquired from subsidiaries of Kingsoft Corporation Limited,namely Beijing Kingsoft Cloud Network Technology Co., Ltd., Zhuhai Kingsoft Cloud Technology Co., Ltd., and Beijing Kingsoft Cloud Technology Co.,Ltd., Kuaipan Personal and Kansunzi, both software services in support of cloud-sourced storage and sharing, and their related business and assets, for anaggregate cash consideration of US$33 million. Kingsoft Corporation Limited, through its wholly owned subsidiary King Venture Holdings Limited, ownedapproximately 11.2% of our outstanding shares as of March 31, 2015. C.Interests of Experts and CounselNot applicable. Item 8.Financial Information A.Consolidated Statements and Other Financial InformationWe have appended consolidated financial statements filed as part of this annual report.Legal ProceedingsWe have been involved in legal proceedings related to our business from time to time and expect to continue to be involved in such proceedingsin the future. Internet services and content providers such as ours are frequently involved in litigation based on intellectual property-related claims. See “Item3. Key Information—D. Risk factors—Risks related to our business—We face and expect to continue to face copyright infringement claims and other relatedclaims, including claims based on content available through our services, which could be time-consuming and costly to defend and may result in damageawards, injunctive relief and/or court orders, divert our management’s attention and financial resources and adversely impact our business.”We were subject to a number of lawsuits in China for alleged copyright infringements over the years, a number of which are still outstanding asof the date of this annual report. Although legal proceedings are inherently uncertain and their results cannot be predicted, we have not been, nor are wecurrently a party to or aware of, any legal proceeding, investigation or claim that, in the view of our management, is likely to materially and adversely affectour business, financial position or results of operations. 150Table of ContentsDividend PolicyWe have not previously declared or paid cash dividends and we have no plan to declare or pay any dividends in the near future. We currentlyintend to retain most, if not all, of our available funds and any future earnings to operate and expand our business.We are a holding company incorporated in the Cayman Islands. We rely principally on dividends from our subsidiaries in China for our cashrequirements, including any payment of dividends to our shareholders. PRC regulations may restrict the ability of our PRC subsidiaries to pay dividends tous. See “Item 4. Information on the Company—B. Business Overview—Regulation—Regulation on dividend distributions.”Our board of directors has discretion as to whether to distribute dividends, subject to applicable laws. Our shareholders may by ordinaryresolution declare dividends, but no dividend may exceed the amount recommended by our board of directors. Even if our board of directors decides to paydividends, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financialcondition, contractual restrictions and other factors that the board of directors may deem relevant. Under Cayman Islands law, we may declare and paydividends on our shares only out of our profit or our share premium account, provided always that even if our company has sufficient profit or share premium,we may not pay a dividend if this would result in our company being unable to pay our debts as they fall due in the ordinary course of business. If we pay anydividends, we will pay our ADS holders to the same extent as holders of our common shares, subject to the terms of the deposit agreement, including the feesand expenses payable thereunder. See “Item 12. Description of Securities Other than Equity Securities—D. American Depositary Shares.” Cash dividends onour common shares, if any, will be paid in U.S. dollars. B.Significant ChangesExcept as disclosed elsewhere in this annual report, we have not experienced any significant changes since the date of our audited consolidatedfinancial statements included in this annual report. Item 9.The Offer and Listing A.Offering and Listing DetailsOur ADSs have been listed on The NASDAQ Global Select Market since June 24, 2014. Our ADSs currently trade on The NASDAQ Global SelectMarket under the symbol “XNET.” One ADS represented five common shares.The following table provides the high and low trading prices for our ADSs on NASDAQ for the time periods indicated. Trading Price High Low Annual Highs and Lows 2014 16.18 6.56 Quarterly Highs and Lows Second Quarter 2014 16.18 14.20 Third Quarter 2014 15.10 9.96 Fourth Quarter 2014 11.57 6.56 Monthly Highs and Lows October 2014 11.57 8.77 November 2014 10.99 8.28 December 2014 8.84 6.56 January 2015 8.50 7.32 February 2015 7.98 6.69 March 2015 7.10 5.93 April 2015 (through April 17, 2015) 7.62 6.25 151Table of ContentsB.Plan of DistributionNot applicable. C.MarketsOur ADSs have been listed on NASDAQ Global Select Market since June 24, 2014 under the symbol “XNET.” D.Selling ShareholdersNot applicable. E.DilutionNot applicable. F.Expenses of the IssueNot applicable. Item 10.Additional Information A.Share CapitalNot applicable. B.Memorandum and Articles of AssociationWe incorporate by reference into this annual report the description of our eighth amended and restated memorandum and seventh amended andrestated articles of association contained in our F-1 registration statement (File No. 333-196221), initially filed with the SEC on June 12, 2014. The eighthamended and restated memorandum and seventh amended and restated articles of association were adopted by our shareholders by special resolutions passedon June 11, 2014, and became effective upon completion of our initial public offering of our common shares represented by ADSs. C.Material ContractsWe have not entered into any material contracts other than in the ordinary course of business and other than those described in “Item 4.Information on the Company” or elsewhere in this annual report on Form 20-F. 152Table of ContentsD.Exchange ControlsSee “Item 4.B. Information on the Company—Business Overview—Regulation—Regulations Relating to Foreign Exchange.” E.TaxationCayman Islands TaxationAccording to Maples and Calder, our Cayman Islands legal counsel, the Cayman Islands currently levies no taxes on individuals or corporationsbased 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 bematerial to us levied by the Government of the Cayman Islands except for stamp duties which may be applicable on instruments executed in, or afterexecution brought within the jurisdiction of the Cayman Islands. The Cayman Islands is not party to any double tax treaties that are applicable to anypayments made to or by our company. There are no exchange control regulations or currency restrictions in the Cayman Islands.People’s Republic of China TaxationUnder the PRC EIT Law, an enterprise established outside the PRC with “de facto management bodies” within the PRC is considered a “residententerprise” of the PRC. A circular issued by the State Administration of Taxation on April 22, 2009 clarified that dividends and other income paid by suchresident enterprises will be considered PRC-source income and subject to PRC withholding tax, currently at a rate of 10%, when paid to non-PRC enterpriseshareholders. Under the implementation regulations to the EIT Law, a “de facto management body” is defined as a body that has material and overallmanagement and control over the manufacturing and business operations, personnel and human resources, finances and properties of an enterprise. Inaddition, the circular mentioned above specifies that certain offshore enterprises controlled by PRC resident enterprises will be classified as PRC residententerprises if the following are located or resident in the PRC: senior management personnel and departments that are responsible for daily production,operation and management; financial and personnel decision making bodies; key properties, accounting books, the company seal, and minutes of boardmeetings and shareholders’ meetings; and half or more of the senior management or directors having voting rights. We do not believe we would be treated asa “resident enterprise” for PRC tax purposes even if the criteria for “de facto management body” as set forth in the circular mentioned above were deemedapplicable to us. See “Item 3. Key Information—D. Risk factors—Risks related to doing business in China—Our global income may be subject to PRC taxesunder the PRC EIT Law, which may have a material adverse effect on our results of operations.” However, if the PRC tax authorities determine that we are aPRC resident enterprise for enterprise income tax purposes, we may be required to withhold a 10% withholding tax from dividends we pay to our non-resident enterprise shareholders, including the holders of our ADSs and non-resident enterprise holders may be subject to PRC tax on gains realized on thesale or other disposition of ADSs or common shares. It is unclear whether our non-PRC individual shareholders (including our ADS holders) would be subjectto any PRC tax on dividends or gains in the event we are determined to be a PRC resident enterprise. If any PRC tax were to apply to such dividends or gains,it would generally apply at a rate of 20% (unless a reduced rate is available under an applicable tax treaty). 153Table of ContentsIf we are deemed to be a PRC resident enterprise and our non-resident enterprise shareholders (including our ADS holders) are subject to PRC taxas described above, the withholding agent will be required to withhold enterprise income tax on payments of dividends to such investors. The withholdingagent must obtain a tax withholding registration and withhold the enterprise income tax from each payment made to non-resident enterprise shareholders andfile a report to the competent tax authorities. Where the withholding agent fails or is unable to perform its withholding obligation, the non-resident enterpriseshareholders must pay the tax due to the applicable tax authorities within seven days after the payment is made or due. We, as the withholding agent, will berequired to obtain a tax withholding registration and withhold the applicable enterprise income tax in order to comply with the above requirements. It is notclear who the withholding agent would be if tax is due on capital gains. In the event that we or our non-resident enterprise shareholders (including our ADSholders) fail to comply with the above procedures, we or our non-resident enterprise shareholders (including our ADS holders) may be ordered to rectify thenon-compliance or be subject to a fine of no more than RMB10,000. Failure by us to withhold the income tax fully and timely may result in a fine of 50% tothree times of the unpaid tax and failure by our ADS holders to pay the tax fully and timely may result in late payment penalties, or a fine of 50% to threetimes of the unpaid tax.In addition, if we are treated as a PRC resident enterprise for enterprise income tax purposes, we may be eligible for the benefits of the income taxtreaty between the PRC and other jurisdictions in which we may derive income, such as the United States. However, if we are treated as a PRC residententerprise, we do not expect to withhold at treaty rates if any withholding is required on dividends we pay to our non-resident shareholders (including ourADS holders) notwithstanding such holders may be eligible for the income tax treaty between their resident jurisdictions and the PRC. The United States—PRC tax treaty generally limits PRC withholding on dividends to a rate of 10%. Investors should consult their tax advisors regarding the availability of treatybenefits and the procedure for claiming a refund, if any.If we are not deemed a PRC resident enterprise, no PRC income tax will be withheld from dividends distributed by us and no PRC income taxwill be payable on gains realized from the sale or other disposition of our shares or ADSs by the non-resident holders of our shares or ADSs. SAT Circular 7further clarifies that, where a non-resident enterprise derives income by acquiring and selling shares in an offshore listed enterprise in the public market, suchincome shall not be subject to PRC tax. However, given the uncertainty concerning the application of SAT Circular 698 and SAT Circular 7, we and our non-PRC resident investors may be at risk of being required to file a return and being taxed under SAT Circular 698 and SAT Circular 7, and we may be requiredto expend valuable resources to comply with SAT Circular 698 and SAT Circular 7 or to establish that we should not be taxed under SAT Circular 698 andSAT Circular 7 in the future.United States Federal Income Tax ConsiderationsThe following discussion is a summary of the United States federal income tax considerations relating to the ownership and disposition of ourADSs or common shares by a U.S. Holder that holds our ADSs as “capital assets” (generally, property held for investment) under the United States InternalRevenue Code of 1986, as amended, or the Code. This discussion is based upon existing United States federal income tax law, which is subject to differinginterpretations or change, possibly with retroactive effect. No ruling has been sought from the Internal Revenue Service (the “IRS”) with respect to anyUnited States federal income tax consequences described below, and there can be no assurance that the IRS or a court will not take a contrary position. Thisdiscussion does not address all aspects of United States federal income taxation that may be important to particular investors in light of their individualinvestment circumstances, including investors subject to special tax rules (for example, certain financial institutions, banks, insurance companies, regulatedinvestment companies, real estate investment trusts, broker-dealers, traders in securities that elect mark-to-market treatment, partnerships and their partners,and tax-exempt organizations (including private foundations), holders who are not U.S. Holders, cooperatives, pension plans, U.S. expatriates, persons whoacquired ADSs or common shares pursuant to the exercise of any employee share option or otherwise as compensation, holders who own (directly, indirectlyor constructively) 10% or more of our voting stock, holders that hold their ADSs or common shares as part of a straddle, hedge, conversion, constructive saleor other integrated transaction, or holders that have a functional currency other than the United States dollar, all of whom may be subject to tax rules thatdiffer significantly from those summarized below). In addition, except to the extent described below, this discussion does not discuss any state, local,alternative minimum tax, non-United States tax, non-income tax (such as gift or estate tax), or the Medicare tax considerations. U.S. Holders are urged toconsult their tax advisors regarding the United States federal, state, local, and non-United States income and other tax considerations relating to theownership and disposition of our ADSs or common shares. 154Table of ContentsGeneralFor purposes of this discussion, a “U.S. Holder” is a beneficial owner of our ADSs or common shares that is, for United States federal income taxpurposes, (i) an individual who is a citizen or resident of the United States, (ii) a corporation (or other entity treated as a corporation for United States federalincome tax purposes) created in, or organized under the laws of, the United States or any state thereof or the District of Columbia, (iii) an estate the income ofwhich is includible in gross income for United States federal income tax purposes regardless of its source, or (iv) a trust (A) the administration of which issubject to the primary supervision of a United States court and which has one or more United States persons who have the authority to control all substantialdecisions of the trust or (B) that has otherwise elected to be treated as a United States person under the Code.If a partnership (or other entity treated as a partnership for United States federal income tax purposes) is a beneficial owner of our ADSs orcommon shares, the tax treatment of a partner in the partnership will generally depend upon the status of the partner and the activities of the partnership.Partnerships holding our ADSs or common shares and partners in such partnerships are urged to consult their tax advisors regarding the ownership anddisposition of our ADSs or common shares.It is generally expected that a holder of ADSs should be treated, for United States federal income tax purposes, as the beneficial owner of theunderlying shares represented by the ADSs. The remainder of this discussion assumes that a holder of ADSs will be treated in this manner. Accordingly,deposits or withdrawals of common shares for ADSs will generally not be subject to United States federal income tax.Passive Foreign Investment Company ConsiderationsBased on the market price of our ADSs and the composition of assets (in particular, the retention of a large amount of cash), we believe that it isvery likely that we were classified as a passive foreign investment company (“PFIC”) for United States federal income tax purposes for the taxable year endedDecember 31, 2014, and we will likely be classified as a PFIC for our current taxable year ending December 31, 2015 unless the market price of our ADSsincreases and/or we invest a substantial amount of the cash and other passive assets we hold in assets that produce or are held for the production of non-passive income. A non-United States corporation, such as our company, will be classified as a “passive foreign investment company”, or “PFIC”, forUnited States federal income tax purposes, if, in the case of any particular taxable year, either (i) 75% or more of its gross income for such year consists ofcertain types of “passive” income or (ii) 50% or more of the average quarterly value of its assets (as determined on the basis of fair market value) during suchyear produce or are held for the production of passive income. For this purpose, cash is categorized as a passive asset and the company’s unbookedintangibles associated with active business activities may generally be classified as non-passive assets. Passive income generally includes, among otherthings, dividends, interest, rents, royalties, and gains from the disposition of passive assets. We will be treated as owning a proportionate share of the assetsand earning a proportionate share of the income of any other corporation in which we own, directly or indirectly, more than 25% (by value) of the stock. 155Table of ContentsIf we are classified as a PFIC for any year during which a U.S. Holder holds our ADSs or common shares, we generally will continue to be treatedas a PFIC for all succeeding years during which such U.S. Holder holds our ADSs or common shares even if we cease to meet the threshold requirements forPFIC status, unless a U.S. Holder makes a taxable “deemed sale” election that may allow the U.S. Holder to eliminate the continuing PFIC status under certaincircumstances.The United States federal income tax rules that apply if we are classified as a PFIC for our current or future taxable years are generally discussedbelow under “Passive foreign investment company rules.”DividendsSubject to the discussion below under “Passive foreign investment company rules,” any cash distributions (including the amount of any PRC taxwithheld) paid on our ADSs or common shares out of our current or accumulated earnings and profits, as determined under United States federal income taxprinciples, will generally be includible in the gross income of a U.S. Holder as dividend income on the day actually or constructively received by theU.S. Holder, in the case of common shares, or by the depositary, in the case of ADSs. Because we do not intend to determine our earnings and profits on thebasis of United States federal income tax principles, any distribution paid will generally be treated as a “dividend” for United States federal income taxpurposes. A non-corporate recipient of dividend income will generally be subject to tax on dividend income from a “qualified foreign corporation” at a lowerapplicable capital gains rate rather than the marginal tax rates generally applicable to ordinary income provided that certain holding period requirements aremet. A non-United States corporation (other than a corporation that is classified as a PFIC for the taxable year in which the dividend is paid or the precedingtaxable year) generally will be considered to be a qualified foreign corporation (i) if it is eligible for the benefits of a comprehensive tax treaty with theUnited States which the Secretary of Treasury of the United States determines is satisfactory for purposes of this provision and which includes an exchange ofinformation program, or (ii) with respect to any dividend it pays on stock (or ADSs in respect of such stock) which is readily tradable on an establishedsecurities market in the United States. Our ADSs are currently listed on the NASDAQ Global Select Market. We believe that the ADSs will be readily tradableon an established securities market in the United States for so long as our ADSs continue to be listed on the NASDAQ Global Select Market. Since we do notexpect that our common shares will be listed on established securities markets, it is unclear whether dividends that we pay on our common shares that are notbacked by ADSs currently meet the conditions required for the reduced tax rate. There can be no assurance that our ADSs will continue to be consideredreadily tradable on an established securities market in later years. Furthermore, as mentioned above, it is very likely that we were classified as a PFIC for thetaxable year ended December 31, 2014, and we will likely be classified as a PFIC for our current taxable year ending December 31, 2015. Each non-corporateU.S. Holder is advised to consult their tax advisors regarding the availability of the lower capital gains rate applicable to qualified dividend income for anydividends we pay with respect to the common shares and ADSs. Dividends received on our ADSs or common shares will not be eligible for the dividendsreceived deduction allowed to corporations.Dividends will generally be treated as passive income from foreign sources for United States foreign tax credit purposes. A U.S. Holder may beeligible, subject to a number of complex limitations, to claim a foreign tax credit in respect of any foreign withholding taxes imposed on dividends receivedon our ADSs or common shares. The rules governing the foreign tax credit are complex. U.S. Holders are urged to consult their tax advisors regarding theavailability of the foreign tax credit under their particular circumstances. A U.S. Holder who does not elect to claim a foreign tax credit for foreign taxwithheld, may instead claim a deduction, for United States federal income tax purposes, in respect of such withholding, but only for a year in which suchholder elects to do so for all creditable foreign income taxes. 156Table of ContentsSale or Other Disposition of ADSs or Common SharesSubject to the discussion below under “Passive foreign investment company rules,” a U.S. Holder will generally recognize capital gain or lossupon the sale or other disposition of ADSs or common shares in an amount equal to the difference between the amount realized upon the disposition and theholder’s adjusted tax basis in such ADSs or common shares. Any capital gain or loss will be long-term if the ADSs or common shares have been held for morethan one year and will generally be United States source gain or loss for United States foreign tax credit purposes. Long-term capital gain of non-corporateU.S. Holders is generally eligible for a reduced rate of taxation. The deductibility of a capital loss is subject to limitations. In the event that gain from thedisposition of the ADSs or common shares is subject to tax in the PRC, a U.S. Holder that is eligible for the benefits of the income tax treaty between theUnited States and the PRC may elect to treat the gain as PRC source income. U.S. Holders are advised to consult its tax advisors regarding the taxconsequences if a PRC tax is imposed on a disposition of our ADSs or common shares, including the availability of the foreign tax credit under theirparticular circumstances.Passive Foreign Investment Company RulesAs mentioned above, it is very likely that we were classified as a PFIC for the taxable year ended December 31, 2014, and we will likely beclassified as a PFIC for our current taxable year ending December 31, 2015. If we are classified as a PFIC for any taxable year during which a U.S. Holderholds our ADSs or common shares, and unless the U.S. Holder makes a mark-to-market election (as described below), the U.S. Holder will generally be subjectto special United States federal income tax rules that have a penalizing effect, regardless of whether we remain a PFIC, on (i) any excess distribution that wemake to the U.S. Holder (which generally means any distribution paid during a taxable year to a U.S. Holder that is greater than 125 percent of the averageannual distributions paid in the three preceding taxable years or, if shorter, the U.S. Holder’s holding period for the ADSs or common shares), and (ii) any gainrealized on the sale or other disposition, including, under certain circumstance, a pledge, of ADSs or common shares. Under the PFIC rules: • the excess distribution and/or gain will be allocated ratably over the U.S. Holder’s holding period for the ADSs or common shares; • the amount allocated to the current taxable year and any taxable years in the U.S. Holder’s holding period prior to the first taxable year inwhich we are classified as a PFIC, or a pre-PFIC year, will be taxable as ordinary income; • the amount allocated to each prior taxable year, other than a pre-PFIC year, will be subject to tax at the highest tax rate in effectapplicable to the U.S. Holder for that year; and • an interest charge generally applicable to underpayments of tax will be imposed on the tax attributable to each prior taxable year, otherthan a pre-PFIC year.If we are a PFIC for any taxable year during which a U.S. Holder holds our ADSs or common shares and any of our non-United States subsidiariesor VIE entities is also a PFIC, such U.S. Holder would be treated as owning a proportionate amount (by value) of the shares of the lower-tier PFIC for purposesof the application of these rules. U.S. Holders are advised to consult their tax advisors regarding the application of the PFIC rules to any of our subsidiaries orVIE entities. 157Table of ContentsAs an alternative to the foregoing rules, a U.S. Holder of “marketable stock” in a PFIC may make a mark-to-market election with respect to ourADSs, provided that the ADSs are regularly traded on the NASDAQ Global Select Market. In addition, we do not expect that holders of common shares thatare not represented by ADSs will be eligible to make a mark-to-market election. Our ADSs may be regularly traded, but no assurances may be given in thisregard. If a mark-to-market election is made, the U.S. Holder will generally (i) include as ordinary income for each taxable year that we are a PFIC the excess,if any, of the fair market value of ADSs held at the end of the taxable year over the adjusted tax basis of such ADSs and (ii) deduct as an ordinary loss theexcess, if any, of the adjusted tax basis of the ADSs over the fair market value of such ADSs held at the end of the taxable year, but only to the extent of thenet amount previously included in income as a result of the mark-to-market election. The U.S. Holder’s adjusted tax basis in the ADSs would be adjusted toreflect any income or loss resulting from the mark-to-market election. If a U.S. Holder makes an effective mark-to-market election, in each year that we are aPFIC any gain recognized upon the sale or other disposition of the ADSs will be treated as ordinary income and loss will be treated as ordinary loss, but onlyto the extent of the net amount previously included in income as a result of the mark-to-market election.Because a mark-to-market election cannot be made for any lower-tier PFICs that we may own, a U.S. Holder that makes a mark-to-market electionwith respect to our ADSs may continue to be subject to the general PFIC rules with respect to such U.S. Holder’s indirect interest in any investments held byus that are treated as an equity interest in a PFIC for United States federal income tax purposes.We do not intend to provide information necessary for U.S. Holders to make qualified electing fund elections, which, if available, would result intax treatment different from (and generally less adverse than) the general tax treatment for PFICs described above.If a U.S. Holder owns our ADSs or common shares during any taxable year that we are a PFIC, the holder generally will be required to file annualreports with the IRS. U.S. Holders are advised to consult their tax advisors concerning the United States federal income tax consequences of purchasing,holding and disposing ADSs or common shares if we are or become classified as a PFIC, including the possibility of making a mark-to-market election.Information ReportingU.S. Holders may be subject to information reporting to the IRS with respect to dividends on and proceeds from the sale or other disposition ofour ADSs or common shares. Each U.S. Holder is advised to consult its tax advisors regarding the application of the United States information reporting rulesto its particular circumstances.Certain U.S. Holders who hold “specified foreign financial assets”, including stock of a non-U.S. corporation that is not held in an accountmaintained by a U.S. “financial institution,” whose aggregate value exceeds US$50,000 during the tax year, may be required to attach to their tax returns forthe year certain specified information. An individual who fails to timely furnish the required information may be subject to a penalty. U.S. Holders who areindividuals should consult their own tax advisors regarding their reporting obligations under this legislation. F.Dividends and Paying AgentsNot applicable. G.Statement by ExpertsNot applicable. 158Table of ContentsH.Documents on DisplayWe previously filed with the SEC our registration statement on Form F-1, as amended and prospectus under the Securities Act of 1933, withrespect to our common shares. We are subject to the periodic reporting and other informational requirements of the Exchange Act. Under the Exchange Act,we are required to file reports and other information with the SEC. Specifically, we are required to file annually a Form 20-F within four months after the endof each fiscal year, which is December 31. Copies of reports and other information, when so filed, may be inspected without charge and may be obtained atprescribed rates at the public reference facilities maintained by the SEC at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. The public may obtaininformation regarding the Washington, D.C. Public Reference Room by calling the Commission at 1-800-SEC-0330. The SEC also maintains a website atwww.sec.gov that contains reports, proxy and information statements, and other information regarding registrants that make electronic filings with the SECusing its EDGAR system. As a foreign private issuer, we are exempt from the rules under the Exchange Act prescribing the furnishing and content of quarterlyreports and proxy statements, and officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisionscontained in Section 16 of the Exchange Act.We will furnish The Bank of New York Mellon, the depositary of our ADSs, with our annual reports, which will include a review of operationsand annual audited consolidated financial statements prepared in conformity with U.S. GAAP, and all notices of shareholders’ meetings and other reports andcommunications that are made generally available to our shareholders. The depositary will make such notices, reports and communications available toholders of ADSs and, upon our request, will mail to all record holders of ADSs the information contained in any notice of a shareholders’ meeting received bythe depositary from us.In accordance with NASDAQ Stock Market Rule 5250(d), we will post this annual report on Form 20-F on our website at http://ir.xunlei.com. Inaddition, we will provide hardcopies of our annual report free of charge to shareholders and ADS holders upon request. I.Subsidiary InformationNot applicable. Item 11.Quantitative and Qualitative Disclosures about Market RiskForeign exchange riskOur financing activities are denominated mainly in U.S. dollars. The Renminbi, or RMB, is not freely convertible into foreign currencies.Remittances of foreign currencies into the PRC and conversion of foreign currencies into RMB require approval by foreign exchange administrativeauthorities and certain supporting documentation. The State Administration for Foreign Exchange, under the authority of the People’s Bank of China,controls the conversion of RMB into other currencies. The revenues and expenses of our subsidiaries, and the consolidated VIE and its subsidiaries aregenerally denominated in RMB and their assets and liabilities are denominated in RMB. We do not believe that we currently have any significant directforeign exchange risk and have not used any derivative financial instruments to hedge our exposure to such risk. Although in general, our exposure toforeign exchange risks should be limited, the value of your investment in our ADSs will be affected by the exchange rate between the U.S. dollar and theRMB because the value of our business is effectively denominated in RMB, while the ADSs will be traded in U.S. dollars. 159Table of ContentsThe value of the RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in China’spolitical and economic conditions. The conversion of RMB into foreign currencies, including U.S. dollars, has been based on rates set by the People’s Bankof China. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the RMB to the U.S. dollar. Under the revised policy,the RMB is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy resulted in a morethan 20% appreciation of the RMB against the U.S. dollar in the following three years. Since July 2008, however, the RMB has traded within a narrow rangeagainst the U.S. dollar. As a consequence, the RMB has fluctuated significantly since July 2008 against other freely traded currencies, in tandem with theU.S. dollar. In June 2010, the PRC government announced that it would increase Renminbi exchange rate flexibility and since that time the Renminbi hasgradually appreciated against the U.S. dollar, although there have been some periods when it has lost value against the U.S. dollar, as it did for exampleduring 2014. 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 we received from our initial public offering into RMB for our operations, appreciationof the RMB against the U.S. dollar would have an adverse effect on the RMB amount we receive from the conversion. Conversely, if we decide to convert theRMB into U.S. dollars for the purpose of making payments for dividends on our common shares or ADSs or for other business purposes, appreciation of theU.S. dollar against the Renminbi would have a negative effect on the U.S. dollar amounts available to us.Interest rate riskOur exposure to interest rate risk primarily relates to the interest income generated by excess cash, which is mostly held in interest-bearing bankdeposits. We have not used derivative financial instruments in our investment portfolio. Interest earning instruments carry a degree of interest rate risk. Wehave not been exposed to, nor do we anticipate being exposed to, material risks due to changes in market interest rates. However, our future interest incomemay fall short of expectations due to changes in market interest rates. Item 12.Description of Securities Other than Equity Securities A.Debt SecuritiesNot applicable. B.Warrants and RightsNot applicable. C.Other SecuritiesNot applicable. 160Table of ContentsD.American Depositary SharesFees and Charges Our ADS holders May Have to PayThe Bank of New York Mellon, the depositary of our ADS program, collects its fees for delivery and surrender of ADSs directly from investorsdepositing shares or surrendering ADSs for the purpose of withdrawal or from intermediaries acting for them. The depositary collects fees for makingdistributions to investors by deducting those fees from the amounts distributed or by selling a portion of distributable property to pay the fees. Thedepositary may collect its annual fee for depositary services by deduction from cash distributions or by directly billing investors or by charging the book-entry system accounts of participants acting for them. The depositary may collect any of its fees by deduction from any cash distribution payable to ADSholders that are obligated to pay those fees. The depositary may generally refuse to provide fee-attracting services until its fees for those services are paid.The depositary’s corporate trust office at which the ADSs will be administered is located at 101 Barclay Street, New York, New York 10286. The depositary’sprincipal executive office is located at One Wall Street, New York, New York 10286. Persons depositing or withdrawing shares must pay: For:$5.00 (or less) per 100 ADSs (or portion of 100 ADSs) • Issuance of ADSs, including issuances resulting from a distribution ofshares or rights or other property • Cancellation of ADSs for the purpose of withdrawal, including if thedeposit agreement terminates$.05 (or less) per ADS • Any cash distribution to ADS holdersA fee equivalent to the fee that would be payable if securities distributed to youhad been shares and the shares had been deposited for issuance of ADSs • Distribution of securities distributed to holders of deposited securitieswhich are distributed by the depositary to ADS holders$.05 (or less) per ADSs per calendar year • Depositary servicesRegistration or transfer fees • Transfer and registration of shares on our share register to or from thename of the depositary or its agent when you deposit or withdraw sharesExpenses of the depositary • Cable, telex and facsimile transmissions (when expressly provided inthe deposit agreement) • converting foreign currency to U.S. dollarsTaxes and other governmental charges the depositary or the custodian has topay on any ADSs or shares underlying ADSs, such as stock transfer taxes, stampduty or withholding taxes • As necessaryAny charges incurred by the depositary or its agents for servicing the depositedsecurities • As necessaryFees and Other Payments Made by the Depositary to UsThe depositary has agreed to reimburse us for our expenses incurred in connection with the establishment of our ADS facility including, investorrelations expenses, roadshow expenses, legal fees, stock exchange listing fees or any direct or indirect expenses incurred in connection with theestablishment of the facility. The depositary has also agreed to provide additional reimbursements to us based on the applicable performance indicatorsrelating to our ADS facility, including ADS issuance and cancellation fees, cash dividend fees and depositary servicing fees. For the year ended December 31,2014, we were entitled to receive approximately US$1.2 million (after withholding tax) from the depositary in connection with the establishment of our ADSfacility. This amount has been fully paid to us as of the date of this annual report. 161Table of ContentsPART II Item 13.Defaults, Dividend Arrearages and DelinquenciesNone. Item 14.Material Modifications to the Rights of Security Holders and Use of ProceedsThe following “Use of Proceeds” information relates to the registration statement on Form F-1, as amended (File Number: 333-196221) inrelation to our initial public offering of 7,315,000 ADSs representing 36,575,000 of our common shares, and the underwriters’ full exercise of their option topurchase from us an additional 1,097,250 ADSs representing 5,486,250 common shares, at an initial offering price of US$12.00 per ADS. Our initial publicoffering closed in June 2014. J.P. Morgan Securities LLC, Citigroup Global Markets Inc., and Oppenheimer & Co. Inc. were the representatives of theunderwriters for the offering.The total expenses incurred for our company’s account in connection with our initial public offering, including the over-allotment option, wereapproximately US$11.3 million, including underwriting discounts and commissions of approximately US$7.1 million, and other related costs of US$4.2million. None of the fees and expenses were directly or indirectly paid to the directors, officers, general partners of our company or their associates, personsowning 10% or more of our common shares, or our affiliates.After deducting the total expenses, we received net proceeds of approximately US$90.4 million from our initial public offering. For the periodfrom June 23, 2014, the date that the F-1 Registration Statement was declared effective by the SEC, to December 31, 2014, we have not used any of the netproceeds received from our initial public offering.None of the net proceeds from our initial public offering were directly or indirectly paid to the directors, officers, general partners of ourcompany or their associates, persons owning 10% or more of our common shares, or our affiliates. Item 15.Controls and ProceduresEvaluation of Disclosure Controls and ProceduresOur management, with the participation of our chief executive officer and chief financial officer, has performed an evaluation of the effectivenessof our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report, as requiredby Rule 13a-15(b) under the Exchange Act.Based upon that evaluation, our management has concluded that, due to the outstanding material weakness described below, as of December 31,2014, our disclosure controls and procedures were not effective in ensuring that the information required to be disclosed by us in the reports that we file andfurnish under the Exchange Act was recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and thatthe information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to ourmanagement, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. 162Table of ContentsManagement’s Annual Report on Internal Control over Financial ReportingThis annual report does not include a report of management’s assessment regarding internal control over financial reporting or an attestationreport of the company’s registered public accounting firm due to a transition period established by rules of the Securities and Exchange Commission fornewly public companies.Changes in Internal Control over Financial ReportingIn preparing our consolidated financial statements, we and our independent registered public accounting firm identified a material weakness, asignificant deficiency and other control deficiencies in our internal control over financial reporting as of December 31, 2013, which had not yet beenremediated as of December 31, 2014. As defined in standards established by the PCAOB, a “material weakness” is a deficiency, or combination ofdeficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interimfinancial statements will not be prevented or detected on a timely basis.The material weakness identified was related to a lack of accounting resources in U.S. GAAP and SEC reporting requirements, and the significantdeficiency identified was related to a lack of documented comprehensive U.S. GAAP accounting manuals and financial reporting procedures and lack ofrelated implementation controls.To remedy our identified material weakness, significant deficiency and other control deficiencies in connection with preparation of ourconsolidated financial statements, we have adopted several measures to improve our internal control over financial reporting. For example, we hired a chieffinancial officer and a senior financial officer, each of whom has a solid understanding of and extensive work experience involving U.S. GAAP and SECfinancial reporting. We engaged an external consulting firm to assist us to assess Sarbanes-Oxley compliance readiness and improve overall internal controls.In addition, we plan to further hire an additional number of employees with knowledge of U.S. GAAP and SEC regulations within our finance and accountingdepartments, implement a comprehensive ERP system and continue to provide our accounting and finance staff with U.S. GAAP training regularly. As suchremedial measures had not been fully implemented in the limited time that elapsed since our initial public offering, our management concluded that thematerial weakness had not been remediated as of December 31, 2014. We still lacked sufficient financial reporting and accounting personnel to formalize keycontrols over financial reporting and to timely and properly prepare and review financial statements and related footnote disclosures based on U.S. GAAP andSEC reporting requirements. We are fully committed to continue to implement measures to remediate our material weakness, significant deficiency and othercontrol deficiencies in our internal control over financial reporting. However, the implementation of these measures may not fully address the deficiencies inour internal control over financial reporting. We are not able to estimate with reasonable certainty the costs that we will need to incur to implement these andother measures designed to improve our internal control over financial reporting. See “Item 3. Key Information—D. Risk factors—Risks related to ourbusiness and industry—If we fail to implement and maintain an effective system of internal control over financial reporting, we may be unable to accuratelyreport our financial results or prevent fraud, and investor confidence in our company and the market price of our ADSs may be adversely affected.” 163Table of ContentsOther than as described above, no changes in our internal controls over financial reporting occurred during the period covered by this annualreport that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting. Item 16A.Audit Committee Financial ExpertOur board of directors has determined that Ms. Jenny Wenjie Wu, an independent director (under the standards set forth in Rule 5605(a)(2) of theNASDAQ Listing Rules and Rule 10A-3 under the Securities Exchange Act of 1934) and chairman of our audit committee, is an audit committee financialexpert. Item 16B.Code of EthicsOur board of directors has adopted a code of business conduct and ethics that applies to our directors, officers and employees, including certainprovisions that specifically apply to our chief executive officer, chief financial officer, other executive officers as defined under Rule 405 under the SecuritiesAct of 1933, as amended, senior finance officer, controller, senior vice presidents and any other persons who perform similar functions for us. We have filedour code of business conduct and ethics as Exhibit 99.1 to our registration statement on Form F-1 (File Number 333-196221), as amended, initially filed withthe SEC on May 23, 2014. The code is also available on our official website under the corporate governance section at our investor relations websitehttp://ir.xunlei.com.We hereby undertake to provide to any person without charge, a copy of our code of business conduct and ethics within ten working days afterwe receive such person’s written request. Item 16C.Principal Accountant Fees and ServicesThe following table sets forth the aggregate fees by categories specified below in connection with certain professional services rendered byPricewaterhouseCoopers and PricewaterhouseCoopers Zhong Tian LLP, our principal external auditors, for the periods indicated. 2013 2014 Audit fees(1) US$309,107 US$800,000 Audit-related fees(2) US$— US$1,046,002 All other fees(3) US$45,000 US$— (1)“Audit fees” represents the aggregate fees billed for each of the fiscal years listed for professional services rendered by our principal auditors for theaudit of our annual financial statements or services that are normally provided by the auditors in connection with statutory and regulatory filings orengagements.(2)“Audit-related fees” represents the aggregate fees billed for professional services rendered by our principal auditors in connection with our initialpublic offering in 2014, other than the underlying audit and review of financial statements.(3)“All other fees” means the aggregate fees for services rendered other than services reported under “Audit fees,” “Audit-related fees” and “Tax fees”provided by our principal auditors. 164Table of ContentsThe policy of our audit committee is to preapprove all audit and non-audit services provided by our independent auditors, including auditservices, audit-related services and tax services as described above, other than those for de minimis services which are approved by the audit committee priorto the completion of the audit. After our initial public offering, our audit committee has approved all of our audit fees, audit-related fees and tax fees for theyear ended December 31, 2014. Item 16D.Exemptions from the Listing Standards for Audit CommitteesNot applicable. Item 16E.Purchases of Equity Securities by the Issuer and Affiliated PurchasersIn December 2014, our board of directors authorized a share repurchase program, or the Repurchase Program, whereby our company mayrepurchase up to US$20 million of our common shares or ADSs from December 22, 2014 to December 31, 2015. The share repurchases may be made inaccordance with applicable laws and regulations through open market transactions, privately negotiated transactions or other legally permissible means asdetermined by our management, including through Rule 10b5-1 share repurchase plans. We publicly announced the Repurchase Program on December 22,2014.We did not make any repurchases during 2014, either pursuant to or outside of the Repurchase Program. Item 16F.Change in Registrant’s Certifying AccountantEffective as of October 30, 2014, we appointed PricewaterhouseCoopers Zhong Tian LLP, or PwC China, as our independent registered publicaccounting firm, and dismissed PricewaterhouseCoopers, Hong Kong, or PwC HK. The decision to change our independent registered public accounting firmfrom PwC HK to PwC China was made on August 18, 2014, after discussions with PwC HK. The decision was not made due to any disagreements, but solelyin order to further facilitate our audit process, since our core operations are conducted in China, where PwC China is based.Our Audit Committee participated in and approved the decision to change our independent registered public accounting firm.PwC HK’s reports on our consolidated financial statements as of and for the years ended December 31, 2012 and 2013 contained no adverseopinion or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles.During fiscal years ended December 31, 2012 and 2013 and the subsequent interim period through October 30, 2014, (i) there were nodisagreements with PwC HK on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, whichdisagreements, if not resolved to the satisfaction of PwC HK, would have caused PwC HK to make references thereto in their reports on the financialstatements for such periods and (ii) there were no “reportable events” requiring disclosure pursuant to Item 16F(a)(1)(v) of the instructions to Form 20-Fexcept for a lack of accounting resources in U.S. GAAP and SEC reporting requirements, which is a material weakness the details of which can be found in“Item 15. Control and Procedures—Changes in internal control over financial reporting.” 165Table of ContentsWe provided PwC HK with a copy of the foregoing disclosure, and requested that PwC HK furnish us with a letter addressed to the SEC statingwhether it agrees with the above statements, and if not, stating the respects in which it does not agree. We have received the requested letter from PwC HK, acopy of which is included as Exhibit 16.1 attached herein.During the fiscal years ended December 31, 2012 and 2013 and the subsequent interim period through October 30, 2014, we did not consultPwC China regarding either (i) the application of accounting principles to a specified transaction, either completed or proposed; or the type of audit opinionthat might be rendered on our financial statements (and no written report was provided to us or oral advice was provided that PwC China concluded was animportant factor considered by us in reaching a decision as to the accounting, auditing or financial reporting issue); or (ii) any matter that was either thesubject of a disagreement pursuant to Item 16F(a)(1)(iv) of the instructions to Form 20-F, or a reportable event pursuant to Item 16F(a)(1)(v) of theinstructions to Form 20-F. Item 16G.Corporate GovernanceAs a Cayman Islands company listed on the NASDAQ Global Select Market, we are subject to the corporate governance standards under theNASDAQ Stock Market Rules. However, the NASDAQ Stock Market Rules permit a foreign private issuer like us to follow the corporate governance practicesof its home country. Certain corporate governance practices in the Cayman Islands, which is our home country, may differ significantly from the corporategovernance standards under the NASDAQ Stock Market Rules. We have followed and intend to continue to follow the applicable corporate governancestandards under the NASDAQ Stock Market Rules, and currently do not plan to rely on the home country exemption for any corporate governance matters.However, if we choose to follow home country practice in any matters in the future, our shareholders may be afforded less protection than they otherwisewould under the NASDAQ Stock Market Rules’ corporate governance standards applicable to U.S. domestic issuers. Item 16H.Mine Safety DisclosureNot applicable.PART III Item 17.Financial StatementsWe have elected to provide financial statements pursuant to Item 18. Item 18.Financial StatementsThe consolidated financial statements of Xunlei Limited, its subsidiaries and its variable interest entity and its subsidiaries are included at theend of this annual report. 166Table of ContentsItem 19.Exhibits ExhibitNumber Description of Document 1.1 Eighth amended and restated memorandum and seventh amended and restated articles of association of the Registrant (incorporated by referenceto Exhibit 3.2 of our registration statement on Form F-1, as amended (file no. 333-196221), filed with the SEC on June 12, 2014) 2.1 Registrant’s specimen American depositary receipt (included in Exhibit 2.3) 2.2 Registrant’s specimen certificate for common shares (incorporated by reference to Exhibit 4.2 of our registration statement on Form F-1, asamended (file no. 333-196221), filed with the SEC on June 12, 2014) 2.3 Deposit agreement among the Registrant, the depositary and holders of American depositary receipts, dated June 23, 2014 (incorporated byreference to Exhibit 4.3 to the Registrant’s registration statement on Form F-1, as amended (File No. 333-196221), filed with the Securities andExchange Commission on June 12, 2014) 4.1 Seventh amended and restated shareholders agreement among the Registrant and its subsidiaries, Shenzhen Xunlei NetworkingTechnologies Co., Ltd. and its subsidiaries, shareholders of the Registrant and other parties thereto, dated April 24, 2014 (incorporated byreference to Exhibit 4.4 of our registration statement on Form F-1 (file no. 333-196221) filed with the SEC on June 12, 2014) 4.2 Series E preferred share purchase agreement, among the Registrant, Xiaomi Ventures Limited and other parties therein, dated as of February 13,2014 (incorporated by reference to Exhibit 4.6 of our registration statement on Form F-1 (file no. 333-196221) filed with the SEC on May 23,2014) 4.3 Warrant issued by the Registrant to Xiaomi Ventures Limited dated as of March 5, 2014 (incorporated by reference to Exhibit 4.7 of ourregistration statement on Form F-1 (file no. 333-196221) filed with the SEC on May 23, 2014) 4.4 Warrant issued by the Registrant to Skyline Global Company Holdings Limited, dated as of March 5, 2014 (incorporated by reference to Exhibit4.8 of our registration statement on Form F-1 (file no. 333-196221) filed with the SEC on May 23, 2014) 4.5 Supplemental agreement to Series E preferred share purchase agreement, among the Registrant, Xiaomi Ventures Limited and other partiestherein, dated as of March 20, 2014 (incorporated by reference to Exhibit 4.9 of our registration statement on Form F-1 (file no. 333-196221)filed with the SEC on May 23, 2014) 4.6 Series E preferred share purchase agreement, among the Registrant, King Venture Holdings Limited, Morningside China TMT SpecialOpportunity Fund, L.P., Morningside China TMT Fund III Co-Investment, L.P. and IDG Technology Venture Investment V, L.P., dated as ofApril 3, 2014 (incorporated by reference to Exhibit 4.10 of our registration statement on Form F-1 (file no. 333-196221) filed with the SEC onMay 23, 2014) 4.7 2010 share incentive plan (incorporated by reference to Exhibit 10.1 of our registration statement on Form F-1 (file no. 333-196221) filed withthe SEC on May 23, 2014) 4.8 2013 share incentive plan (incorporated by reference to Exhibit 10.2 of our registration statement on Form F-1 (file no. 333-196221) filed withthe SEC on May 23, 2014) 4.9 2014 share incentive plan (incorporated by reference to Exhibit 10.4 of our registration statement on Form F-1 (file no. 333-196221) filed withthe SEC on May 23, 2014) 167Table of ContentsExhibitNumber Description of Document 4.10 Letter agreement signed by Leading Advice Holdings Limited in relation to 2013 share incentive plan of the Registrant, dated March 20, 2014(incorporated by reference to Exhibit 10.3 of our registration statement on Form F-1 (file no. 333-196221) filed with the SEC on May 23, 2014) 4.11 Letter agreement signed by Leading Advice Holdings Limited in relation to 2014 share incentive plan of the Registrant, dated May 5, 2014(incorporated by reference to Exhibit 10.5 of our registration statement on Form F-1 (file no. 333-196221) filed with the SEC on May 23, 2014) 4.12 Letter agreement signed by Leading Advice Holdings Limited in relation to 2013 share incentive plan and 2014 share incentive plan of theRegistrant, dated May 19, 2014 (incorporated by reference to Exhibit 10.6 of our registration statement on Form F-1 (file no. 333-196221) filedwith the SEC on May 23, 2014) 4.13 Form of indemnification agreement with the Registrant’s directors and officers (incorporated by reference to Exhibit 10.7 of our registrationstatement on Form F-1 (file no. 333-196221) filed with the SEC on June 12, 2014) 4.14 Form of employment agreement between the Registrant and Executive Officers of the Registrant (incorporated by reference to Exhibit 10.8 ofour registration statement on Form F-1 (file no. 333-196221) filed with the SEC on June 12, 2014) 4.15 English translation of business operation agreement among Giganology Shenzhen, Shenzhen Xunlei and the shareholders of Shenzhen Xunlei,dated November 15, 2006, as amended on March 1, 2012, (incorporated by reference to Exhibit 10.9 of our registration statement on Form F-1(file no. 333-196221) filed with the SEC on May 23, 2014) 4.16 English translation of equity pledge agreement among Giganology Shenzhen and the shareholders of Shenzhen Xunlei dated November 15,2006, as amended on May 10, 2011, March 1, 2012 and March 10, 2014 (incorporated by reference to Exhibit 10.10 of our registration statementon Form F-1 (file no. 333-196221) filed with the SEC on May 23, 2014) 4.17 English translation of power of attorney between Giganology Shenzhen and Shenglong Zou, dated May 10, 2011 (incorporated by reference toExhibit 10.11 of our registration statement on Form F-1 (file no. 333-196221) filed with the SEC on May 23, 2014) 4.18 English translation of power of attorney between Giganology Shenzhen and Hao Cheng, dated May 10, 2011 (incorporated by reference toExhibit 10.12 of our registration statement on Form F-1 (file no. 333-196221) filed with the SEC on May 23, 2014) 4.19 English translation of power of attorney between Giganology Shenzhen and Fang Wang, dated May 10, 2011 (incorporated by reference toExhibit 10.13 of our registration statement on Form F-1 (file no. 333-196221) filed with the SEC on May 23, 2014) 168Table of ContentsExhibitNumber Description of Document 4.20 English translation of power of attorney between Giganology Shenzhen and Jianming Shi, dated May 10, 2011 (incorporated by reference toExhibit 10.14 of our registration statement on Form F-1 (file no. 333-196221) filed with the SEC on May 23, 2014) 4.21 English translation of power of attorney between Giganology Shenzhen and Guangzhou Shulian Information Investment Co., Ltd., dated May10, 2011 (incorporated by reference to Exhibit 10.15 of our registration statement on Form F-1 (file no. 333-196221) filed with the SEC on May23, 2014) 4.22 English translation of exclusive technical support and services agreement between Giganology Shenzhen and Shenzhen Xunlei, datedSeptember 16, 2005, as amended on November 15, 2006 and March 10, 2014 (incorporated by reference to Exhibit 10.16 of our registrationstatement on Form F-1 (file no. 333-196221) filed with the SEC on May 23, 2014) 4.23 English translation of exclusive technology consulting and training agreement between Giganology Shenzhen and Shenzhen Xunlei, datedSeptember 16, 2005, as amended on November 15, 2006 and March 10, 2014 (incorporated by reference to Exhibit 10.17 of our registrationstatement on Form F-1 (file no. 333-196221) filed with the SEC on May 23, 2014) 4.24 English translation of proprietary technology license contract between Giganology Shenzhen and Shenzhen Xunlei, dated March 1, 2012(incorporated by reference to Exhibit 10.18 of our registration statement on Form F-1 (file no. 333-196221) filed with the SEC on May 23, 2014) 4.25 English translation of intellectual properties purchase option agreement between Giganology Shenzhen and Shenzhen Xunlei dated March 1,2012, as amended on March 10, 2014 (incorporated by reference to Exhibit 10.19 of our registration statement on Form F-1 (file no. 333-196221) filed with the SEC on May 23, 2014) 4.26 English translation of loan agreement among Giganology Shenzhen, Guangzhou Shulian Information Investment Co., Ltd., Sean ShenglongZou, Hao Cheng, Fang Wang and Jianming Shi, dated December 22, 2010, as amended on March 1, 2012 and March 10, 2014 (incorporated byreference to Exhibit 10.20 of our registration statement on Form F-1 (file no. 333-196221) filed with the SEC on May 23, 2014) 4.27 English translation of loan agreement between Giganology Shenzhen and Sean Shenglong Zou, dated May 10, 2011, as amended on March 1,2012 (incorporated by reference to Exhibit 10.21 of our registration statement on Form F-1 (file no. 333-196221) filed with the SEC on May 23,2014) 4.28 English translation of equity interests disposal agreement between Giganology Shenzhen, Guangzhou Shulian Information Investment Co., Ltd.,Sean Shenglong Zou, Hao Cheng, Fang Wang and Jianming Shi, dated November 15, 2006, as amended on May 10, 2011 (incorporated byreference to Exhibit 10.22 of our registration statement on Form F-1 (file no. 333-196221) filed with the SEC on May 23, 2014) 169Table of ContentsExhibitNumber Description of Document 4.29 English translation of technology development and software license framework agreement between Shenzhen Xunlei and Xunlei Computerdated December 24, 2013 (incorporated by reference to Exhibit 10.23 of our registration statement on Form F-1 (file no. 333-196221) filedwith the SEC on May 23, 2014) 4.30 Content protection agreement by and between Shenzhen Xunlei Networking Technologies Co., Ltd. and other parties thereto dated May 22,2014 (incorporated by reference to Exhibit 10.24 of our registration statement on Form F-1 (file no. 333-196221) filed with the SEC on June12, 2014) 4.31* English summary of Assets and Business Transfer Agreement by and between Shenzhen Xunlei Networking Technologies Co., Ltd., BeijingKingsoft Cloud Network Technology Co., Ltd., Zhuhai Kingsoft Cloud Science and Technology Co., Ltd. and Beijing Kingsoft CloudScience and Technology Co., Ltd. dated September 2, 2014 8.1* List of significant subsidiaries and variable interest entity of the Registrant 11.1 Code of business conduct and ethics of the Registrant (incorporated by reference to Exhibit 99.1 of our Registration Statement on Form F-1(file no. 333-196221) filed with the Securities and Exchange Commission on June 12, 2014) 12.1* Certification by Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 12.2* Certification by Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 13.1** Certification by Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 13.2** Certification by Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 15.1* Consent of Maples and Calder 15.2* Consent of Zhong Lun Law Firm 15.3* Consent of PricewaterhouseCoopers Zhong Tian LLP, an independent registered public accounting firm 15.4* Consent of PricewaterhouseCoopers, an independent registered public accounting firm 16.1* Letter from PricewaterhouseCoopers to the SEC101.INS*** XBRL Instance Document101.SCH*** XBRL Taxonomy Extension Schema Document101.CAL*** XBRL Taxonomy Extension Calculation Linkbase Document101.DEF*** XBRL Taxonomy Extension Definition Linkbase Document101.LAB*** XBRL Taxonomy Extension Label Linkbase Document101.PRE*** XBRL Taxonomy Extension Presentation Linkbase Document *Filed herewith**Furnished herewith***To be filed by amendment 170Table of ContentsSIGNATURESThe registrant hereby certifies that it meets all of the requirements for filing its annual report on Form 20-F and that it has duly caused andauthorized the undersigned to sign this annual report on its behalf. Xunlei LimitedBy:/s/ Sean Shenglong ZouName:Sean Shenglong ZouTitle:Chairman and Chief Executive OfficerDate: April 20, 2015 171Table of ContentsIndex to consolidated financial statements Page Report of independent registered public accounting firm F-2 Report of independent registered public accounting firm F-3 Consolidated Balance Sheets as of December 31, 2013 and 2014 F-4 Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2012, 2013 and 2014 F-7 Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2012, 2013 and 2014 F-9 Consolidated Statement of Cash Flows for the Years ended December 31, 2012, 2013 and 2014 F-12 Notes to Consolidated Financial Statements F-14 Table of ContentsReport of independent registered public accounting firmTo the Board of Directors and Shareholders of Xunlei Limited:In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of comprehensive income, of changes in shareholders’equity and of cash flows present fairly, in all material respects, the financial position of Xunlei Limited and its subsidiaries (collectively, the “Group”) atDecember 31, 2013, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2013 in conformitywith accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Group’s management.Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance withthe standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management,and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. /s/ PricewaterhouseCoopersHong KongMarch 21, 2014 F- 2Table of ContentsReport of independent registered public accounting firmTo the Board of Directors and Shareholders of Xunlei Limited:In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of comprehensive income, of changes in shareholders’equity and of cash flows present fairly, in all material respects, the financial position of Xunlei Limited and its subsidiaries (collectively, the “Group”) atDecember 31, 2014, and the results of their operations and their cash flows for the year ended December 31, 2014 in conformity with accounting principlesgenerally accepted in the United States of America. These financial statements are the responsibility of the Group’s management. Our responsibility is toexpress an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with the standards of thePublic Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assuranceabout whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overallfinancial statement presentation. We believe that our audit provides a reasonable basis for our opinion.PricewaterhouseCoopers Zhong Tian LLPShenzhen, the People’s Republic of ChinaApril 20, 2015 F- 3Table of ContentsXunlei LimitedConsolidated Balance Sheets (Amounts expressed in thousands of United States dollars (“USD”), except for number of shares and per sharedata) Note December 31,2013 December 31,2014 Assets Current assets: Cash and cash equivalents 4 93,906 404,275 Short-term investments 5 40,993 29,427 Accounts receivable, net 6 35,275 28,921 Deferred tax assets 22 1,185 2,091 Due from related parties 21 85 22 Prepayments and other current assets 7 6,319 14,560 Content copyrights, current portion 9 16,018 16,013 Total current assets 193,781 495,309 Non-current assets:Long-term investments 10 2,949 5,498 Deferred tax assets 22 9,430 10,862 Property and equipment, net 8 20,208 17,519 Intangible assets, net 9 11,958 20,097 Goodwill 2(k), (l) — 23,237 Prepayments for content copyrights 7 3,149 1,988 Other long-term prepayments and receivables 7 2,928 5,852 Total assets 244,403 580,362 LiabilitiesCurrent liabilities:Accounts payable (including accounts payable of the consolidated variable interest entities and VIE’ssubsidiaries without recourse to the Company of USD 62,603 and USD 49,771 as of December 31,2013 and 2014, respectively) 39,820 40,204 Due to a related party (including due to a related party of the consolidated variable interest entities andVIE’s subsidiaries without recourse to the Company of USD 225 and USD 84 as of December 31, 2013and 2014, respectively) 21 225 84 Deferred revenue and income, current portion (including deferred revenue and income, current portion ofthe consolidated variable interest entities and VIE’s subsidiaries without recourse to the Company ofUSD 29,352 and USD 28,083 as of December 31, 2013 and 2014, respectively 11 29,352 28,294 Income tax payable (including income tax payable of the consolidated variable interest entities andVIE’s subsidiaries without recourse to the Company of USD 2,581 and USD 2,554 as of December 31,2013 and 2014, respectively) 2,581 2,554 F- 4Table of ContentsXunlei LimitedConsolidated Balance Sheets (Continued) (Amounts expressed in thousands of United States dollars (“USD”), except for number of shares and per sharedata) Note December 31,2013 December 31,2014 Accrued liabilities and other payables (including accrued liabilities and other payables of the consolidatedvariable interest entities and VIE’s subsidiaries without recourse to the Company of USD 49,265 and USD86,323 as of December 31, 2013 and 2014, respectively) 12 33,407 31,415 105,385 102,551 LiabilitiesNon-current liabilities:Deferred revenue and income, non-current portion (including deferred revenue and income, non-current portion of the consolidated variable interest entities and VIE’s subsidiaries withoutrecourse to the Company of USD 9,190 and USD 6,452 as of December 31, 2013 and 2014,respectively) 11 9,190 7,294 Deferred tax liability, non-current portion 22 8,074 8,552 Warrants liabilities 14 2,186 — Due to related parties, non-current portion 17, 21 — 4,137 Other long-term payable 17 — 807 Total liabilities 124,835 123,341 Commitments and contingencies 25 Mezzanine equitySeries D convertible redeemable preferred sharesUSD 0.00025 par value, 18,000,000 shares authorized, 10,580,397 shares issued and outstanding as atDecember 31, 2013 and nil as at December 31, 2014 14 40,290 — F- 5Table of ContentsXunlei LimitedConsolidated Balance Sheets (Continued) (Amounts expressed in thousands of USD, except for number of shares and per share data) Note December 31,2013 December 31,2014 Equity Series C convertible non-redeemable preferred sharesUSD0.00025 par value, 5,728,264 shares authorized, 5,728,264 shares issued and outstanding as atDecember 31, 2013 and nil as at December 31, 2014 15 1 — Series B convertible non-redeemable preferred sharesUSD0.00025 par value, 30,308,284 shares authorized, 30,308,284 shares issued and outstanding as atDecember 31, 2013 and nil as at December 31, 2014 15 8 — Series A-1 convertible non-redeemable preferred sharesUSD0.00025 par value, 36,400,000 shares authorized, 36,400,000 shares issued and outstanding as atDecember 31, 2013 and nil as at December 31, 2014 15 9 — Series A convertible non-redeemable preferred sharesUSD0.00025 par value, 27,932,000 shares authorized, 26,416,560 shares issued and outstanding as atDecember 31, 2013 and nil as at December 31, 2014 15 7 — Common sharesUSD0.00025 par value, 195,504,449 shares authorized, 70,521,104 shares issued and 61,447,372 sharesoutstanding as at December 31, 2013; 1,000,000,000 shares authorized, 357,886,089 shares issued and327,611,487 shares outstanding as at December 31, 2014 16 15 82 Additional paid-in-capital 61,634 446,202 Accumulated other comprehensive income 6,003 5,894 Statutory reserves 4,478 5,132 Treasury shares9,073,732 shares and 30,274,602 shares as at December 31, 2013 and 2014, respectively 16 2 7 Retained earnings 7,037 574 Total Xunlei Limited’s shareholders’ equity 79,194 457,891 Non-controlling interest 18 84 (870) Total liabilities, mezzanine equity and shareholders’ equity 244,403 580,362 The accompanying notes are an integral part of these consolidated financial statements. F- 6Table of ContentsXunlei LimitedConsolidated Statements of Comprehensive income (Amounts expressed in thousands of USD, except for number of shares and per sharedata) Years ended December 31, Note 2012 2013 2014 Revenues, net of rebates and discounts 2(q) 148,200 180,244 182,887 Business taxes and surcharges (7,679) (5,650) (3,358) Net revenues 140,521 174,594 179,529 Cost of revenues 13 (84,012) (93,260) (98,459) Gross profit 56,509 81,334 81,070 Operating expensesResearch and development expenses (20,357) (28,832) (35,287) Sales and marketing expenses (20,219) (26,610) (29,253) General and administrative expenses (18,474) (23,073) (29,960) Total operating expenses (59,050) (78,515) (94,500) Net gain from exchanges of content copyrights 2(r) 4,666 1,020 1,556 Operating income / (loss) 2,125 3,839 (11,874) Interest income 1,377 1,189 6,733 Interest expense (1,400) — (163) Other income, net 24 564 4,679 13,966 Share of (loss) / income from an equity investee (45) 25 (259) Income before income tax 2,621 9,732 8,403 Income tax benefit / (expense) 22 (2,239) 647 1,459 Net income 382 10,379 9,862 Less: net loss attributable to the non-controlling interest (121) (283) (950) Net income attributable to Xunlei Limited 503 10,662 10,812 Allocation of net income to participating preferred shareholders — (4,094) — Beneficial conversion feature of Series C convertible preferred shares from their modifications 15 (286) — — Deemed contribution from Series C preferred shareholders 15 2,979 — — Accretion of Series D to convertible redeemable preferred shares redemption value 14 (3,509) (4,300) (1,870) Contingent beneficial conversion feature of series C to one Series C shareholder 14 — — (57) Deemed dividend to Series D shareholder from its modification 14 — — (279) Accretion of Series E to convertible redeemable preferred shares redemption value 14 — — (12,754) Amortization of beneficial conversion feature of Series E 14 — — (4,139) Acceleration of amortization of beneficial conversion feature of Series E upon initial public offering — — (49,346) Deemed dividend to certain shareholders from repurchase of shares 17 — — (14,926) Deemed dividend to preferred shareholders upon initial public offering 14, 15 — — (32,807) Net (loss) / income attributable to Xunlei Limited’s common shareholders (313) 2,268 (105,366) Net income 382 10,379 9,862 Other comprehensive income / (loss): Foreign currency translation adjustment, net of tax 490 2,775 (114) Comprehensive income 872 13,154 9,748 Less: comprehensive income attributable to non-controlling interest shareholders (120) (276) (955) F- 7Table of ContentsXunlei LimitedConsolidated Statements of Comprehensive income (Continued) (Amounts expressed in thousands of USD, except for number of shares and per sharedata) Years ended December 31, Note 2012 2013 2014 Comprehensive income attributable to Xunlei Limited 992 13,430 10,703 Basic net (loss) / income per share attributable to Xunlei Limited 20 (0.01) 0.04 (0.54) Weighted average number of common shares outstanding—basic 20 61,447,372 61,447,372 194,711,227 Diluted net (loss) / income per share attributable to Xunlei Limited 20 (0.01) 0.01 (0.54) Weighted average number of common shares outstanding—diluted 20 61,447,372 76,065,898 194,711,227 The accompanying notes are an integral part of these consolidated financial statements. F- 8Table of ContentsXunlei LimitedConsolidated statements of changes in shareholders’ equity (Amounts expressed in thousands ofUSD, except for number of shares andper share data) Series Cconvertiblenon-redeemablepreferred share Series Bconvertiblenon-redeemablepreferred shares Series A-1convertiblenon-redeemablepreferred shares Series Aconvertiblenon-redeemablepreferred shares Common shares Treasury stock Additionalpaid-in Retained Statutory Accumulatedothercomprehensive Totalshareholders’ Non-controlling Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount capital earnings reserves income equity interest Balance at December 31,2011 5,728,264 1 30,308,284 8 36,400,000 9 26,416,560 7 61,447,372 15 — — 60,000 2,324 3,142 2,746 68,252 480 Share-based compensation — — — — — — — — — — — — 2,233 — — — 2,233 — Beneficial conversionfeature (“BCF”) ofSeries C convertiblepreferred shares from theirmodifications — — — — — — — — — — — — 286 (286) — — — — Deemed contribution fromSeries C preferredshareholders — — — — — — — — — — — — (2,979) 2,979 — — — — Series D preferred sharesaccretion — — — — — — — — — — — — — (3,509) — — (3,509) — Net income / (loss) — — — — — — — — — — — — — 503 — — 503 (121) Translation adjustments — — — — — — — — — — — — — — — 489 489 1 Balance at December 31,2012 5,728,264 1 30,308,284 8 36,400,000 9 26,416,560 7 61,447,372 15 — — 59,540 2,011 3,142 3,235 67,968 360 Issuance of common shares — — — — — — — — — — 9,073,732 2 (2) — — — — — Share-based compensation — — — — — — — — — — — — 2,096 — — — 2,096 — Series D preferred sharesaccretion — — — — — — — — — — — — — (4,300) — — (4,300) — Statutory reserves — — — — — — — — — — — — — (1,336) 1,336 — — — Net income / (loss) — — — — — — — — — — — — — 10,662 — — 10,662 (283) Translation adjustments — — — — — — — — — — — — — — — 2,768 2,768 7 Balance at December 31,2013 5,728,264 1 30,308,284 8 36,400,000 9 26,416,560 7 61,447,372 15 9,073,732 2 61,634 7,037 4,478 6,003 79,194 84 The accompanying notes are an integral part of these consolidated financial statements. F- 9Table of ContentsXunlei LimitedConsolidated statements of changes in shareholders’ equity (Continued) (Amounts expressed in thousands ofUSD, except for number of shares andper share data) Series Cconvertiblenon-redeemablepreferred share Series Bconvertiblenon-redeemablepreferred shares Series A-1convertiblenon-redeemablepreferred shares Series Aconvertiblenon-redeemablepreferred shares Common shares Treasury stock Additionalpaid-in Retained Statutory Accumulatedothercomprehensive Totalshareholders’ Non-controlling Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount capital earnings reserves income equity interest Balance at December 31,2013 5,728,264 1 30,308,284 8 36,400,000 9 26,416,560 7 61,447,372 15 9,073,732 2 61,634 7,037 4,478 6,003 79,194 84 Accretion of Series D toconvertible redeemablepreferred sharesredemption value — — — — — — — — — — — — (717) (1,153) — — (1,870) — BCF upon Series Etranche 1 — — — — — — — — — — — — 52,377 — — — 52,377 — BCF upon Series Etranche 2 — — — — — — — — — — — — 1,109 — — — 1,109 — Accretion of Series E toconvertible redeemablepreferred sharesredemption value — — — — — — — — — — — — (10,229) (2,525) — — (12,754) — Amortisation of BCF ofSeries E — — — — — — — — — — — — (3,206) (933) — — (4,139) — Contingent beneficialconversion feature ofseries C to one Series Cshareholder — — — — — — — — — — — — 57 (57) — — — — Deemed dividend ofSeries D convertiblepreferred shares fromtheir modifications — — — — — — — — — — — — — (279) — — (279) — Repurchase of preferredshares and commonshares — — (3,756,065) (1) (591,451) — (477,180) — (14,664,637) (4) — — (47,403) (11,674) — — (59,082) — Acceleration ofamortisation of BCF ofSeries E upon initialpublic offering (“IPO”) — — — — — — — — — — — — (49,346) — — — (49,346) — Deemed dividend topreferred shareholdersupon IPO — — — — — — — — — — — — (32,807) — — — (32,807) — F- 10Table of ContentsXunlei LimitedConsolidated statements of changes in shareholders’ equity (Continued) (Amountsexpressed inthousands ofUSD, exceptfor numberofshares andper sharedata) Series Cconvertiblenon-redeemablepreferred share Series Bconvertiblenon-redeemablepreferred shares Series A-1convertiblenon-redeemablepreferred shares Series Aconvertiblenon-redeemablepreferred shares Common shares Treasury stock Additionalpaid-in Retained Statutory Accumulatedothercomprehensive Totalshareholders’ Non-controlling Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount capital earnings reserves income equity interest Issuance ofcommon sharesand conversion ofpreferred sharesupon IPO (5,728,264) (1) (26,552,219) (7) (35,808,549) (9) (25,939,380) (7) 277,834,210 71 — — 470,712 — — — 470,759 — IPO expenses — — — — — — — — — — — — (4,216) — — — (4,216) — Issuance ofcommon sharesfor shareincentive plans — — — — — — — — — — 24,195,412 5 (5) — — — — — Exercised shareoptions — — — — — — — — 1,431,320 — (1,431,320) — 295 — — — 295 — Vested restrictedshares — — — — — — — — 1,563,222 — (1,563,222) — — — — — — — Share-basedcompensation -replacementawards in theacquisition ofKingsoft CloudStorage business — — — — — — — — — — — — 303 — — — 303 — Share-basedcompensation -others — — — — — — — — — — — — 7,644 — — — 7,532 — Statutory Reserve — — — — — — — — — — — — — (654) 654 — — — Components ofcomprehensiveincome: Net income / (loss) — — — — — — — — — — — — — 10,812 — — 10,924 (949) Translationadjustments — — — — — — — — — — — — — — — (109) (109) (5) Balance atDecember 31,2014 — — — — — — — — 327,611,487 82 30,274,602 7 446,202 574 5,132 5,894 457,891 (870) The accompanying notes are an integral part of these consolidated financial statements. F- 11Table of ContentsXunlei LimitedConsolidated Statement of Cash Flows (Amounts expressed in thousands of USD except for number of shares and per sharedata) Years ended December 31, 2012 2013 2014 Cash flows from operating activities Net income 382 10,379 9,862 Adjustments to reconcile net income to net cash generated from operating activities —Depreciation of property and equipment 3,994 5,112 6,500 —Amortization of intangible assets 50,578 38,314 38,741 —Allowance for doubtful accounts 3,700 4,921 1,767 —Loss on disposal of property and equipment 5 — — —Gain from barter transactions (7,472) (2,059) (4,428) —Share-based compensation 2,233 2,096 7,644 —Increase/(decrease) in fair value of warrants 710 (1,531) (8,054) —Share of loss / (income) from equity investee 45 (25) 259 —Investment income on short-term investments (2) (356) (317) —Impairment of intangible assets — 808 — —Loss on exchange of warrants — — 405 —Deemed disposal gain of long-term investments — — (449) —Interest expense accrued for long-term payable — — 163 —Deferred taxes (123) (822) (1,897) —Deferred government grants (1,363) (1,284) (2,059) Changes in operating assets and liabilities: —Accounts receivable (17,831) 13,655 4,699 —Prepayments and other assets (458) (333) (9,180) —Due from/to related parties 310 (96) (168) —Accounts payable 3,428 5,924 2,569 —Deferred revenue 8,543 12,630 (2,643) —Income tax payable 2,362 116 (5) —Accrued liabilities and other payables 10,873 (1,916) 4,793 Net cash generated from operating activities 59,914 85,533 48,202 Cash flows from investing activitiesAcquisition of property and equipment (7,447) (7,372) (7,770) Proceeds from disposal of fixed assets 5 — — Purchase of short-term investments (6,523) (246,153) (330,471) Proceeds from disposal of short-term investments 2 213,506 341,792 Purchase of intangible assets (32,554) (36,005) (38,056) Acquisition of long-term investments (952) (1,390) (2,359) Acquisition of Kingsoft Cloud Storage business — — (33,000) Loans to employees (2,021) (856) (767) Advance to or repayment of advance from a shareholder — (82) 85 Net cash used in investing activities (49,490) (78,352) (70,546) Cash flows from financing activitiesIssuance of Series D preferred shares 32,481 — — Issuance of Series D warrants 3,007 — — Issuance of Series E preferred shares — — 275,314 Issuance of Series E warrants — — 34,686 Payment of Series E financing expenses — — (343) Repurchase of shares — — (69,303) Proceeds from initial public offering (net of underwriters’ commissions of USD 7,066) — — 93,881 Payment of initial public offering expenses — — (3,504) Prepayment for share repurchase plan — — (1,000) Proceeds from bank borrowings 20,519 — — Repayment of bank borrowings (41,151) — — Governments grants received 2,836 2,487 856 Proceeds from exercise of vested share options — — 1,523 Initial public offering expenses reimbursement received — — 1,158 Net cash generated from financing activities 17,692 2,487 333,268 F- 12Table of ContentsXunlei LimitedConsolidated Statement of Cash Flows (Amounts expressed in thousands of USD except for number of shares and per sharedata) Years ended December 31, 2012 2013 2014 Net increase in cash and cash equivalents 28,116 9,668 310,924 Cash and cash equivalents at beginning of year 53,349 81,906 93,906 Effect of exchange rates on cash and cash equivalents 441 2,332 (555) Cash and cash equivalents at end of year 81,906 93,906 404,275 Supplemental disclosure of cash flow informationInterests paid 1,438 — — Income tax paid — — 241 Non cash investing and financing activities—Acquisition of property and equipment in form of other payables 1,344 4,157 240 —Initial public offering expenses in form of other payables — — 712 —Purchase of intangible assets in form of accounts payable 25,048 25,695 21,860 —Acquisition of intangible assets in form of barter transactions 6,650 4,058 4,030 —Beneficial Conversion Feature of Series C convertible preferred shares from their modifications 286 — — —Deemed contribution from Series C preferred shareholders (2,979) — — —Accretion to Series D preferred shares redemption value 3,509 4,300 1,870 —Contingent beneficial conversion feature of series C to one Series C shareholder — — 57 —Deemed dividend to Series D shareholder from its modification — — 279 —Accretion of Series E to convertible redeemable preferred shares redemption value — — 12,754 —Amortization of beneficial conversion feature of Series E — — 4,139 —Deemed dividend to certain shareholders from repurchase of shares — — 14,926 —Acceleration of amortization of beneficial conversion feature of Series E upon initial public offering 49,346 —Deemed dividend to preferred shareholders upon initial public offering 32,807 The accompanying notes are an integral part of these consolidated financial statements. F- 13Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 1.Organization and nature of operationsXunlei Limited, previously known as Giganology Limited, (the “Company”) was incorporated under the law of the Cayman Islands (“Cayman”) as a limitedliability company on February 3, 2005. The accompanying consolidated financial statements include the financial statements of the Company, itssubsidiaries, its variable interest entity (“VIE”) and the VIE’s subsidiaries (collectively referred to as the “Group”) as follows: Name of entities Place ofincorporation Date ofincorporation Relationship % of director indirecteconomicownership Principal activitiesShenzhen Xunlei NetworkingTechnologies, Co., Ltd (“ShenzhenXunlei”) China January 2003 VIE 100% Development of software, provisionof online and related advertising,membership subscription andonline game services; as well assales of software licensesGiganology (Shenzhen) Co. Ltd(“Giganology Shenzhen”) China June 2005 Subsidiary 100% Development of computer softwareand provision of informationtechnology services to relatedcompaniesShenzhen Fengdong NetworkingTechnologies, Co., Ltd. (“Fengdong”) China December 2005 VIE’ssubsidiary 100% Development of software for relatedcompaniesShenzhen Xunlei Kankan InformationTechnologies Co., Ltd (formerly known as“155 Networking (Shenzhen) Co., Ltd”) China August 2008 VIE’ssubsidiary 100% Development of software for relatedcompaniesXunlei Software (Beijing) Co., Ltd (“XunleiBeijing”) China June 2009 VIE’ssubsidiary 100% Development of software for relatedcompaniesXunlei Software (Shenzhen) Co., Ltd (“XunleiSoftware”) China January 2010 VIE’ssubsidiary 100% Provision of software technologydevelopment for related companies F- 14Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 1.Organization and nature of operations (Continued) Name of entities Place ofincorporation Date ofincorporation Relationship % of director indirecteconomicownership Principal activitiesXunlei Software (Nanjing) Co., Ltd. (“XunleiNanjing”) China January 2010 VIE’ssubsidiary 100% Development of computer softwareand online games for relatedcompanies and provision ofadvertising services (note a)Xunlei Games Development(Shenzhen) Co., Ltd. China February 2010 VIE’ssubsidiary 70% Development of online game andcomputer software for relatedcompanies and provision ofadvertising servicesXunlei Network Technologies Limited(“Xunlei BVI”) British VirginIslands February 2011 Subsidiary 100% Holding companyXunlei Network Technologies Limited(“Xunlei HK”) Hongkong March 2011 Subsidiary 100% Development computer software ofrelated companies and provision ofadvertising servicesXunlei Computer (Shenzhen) Co., Ltd(“Xunlei Computer”) China November 2011 Subsidiary 100% Development of computer softwareand provision of informationtechnology services to relatedcompaniesShenzhen Wangxin Technologies Co., Ltd(“Wangxin”) China September 2013 VIE’ssubsidiary 100% Development of computer softwareand provision of informationtechnology services to relatedcompanies Note a:In January 2011, the equity owners of Xunlei Nanjing resolved to liquidate the subsidiary. In May 2012, Xunlei Nanjing was approved to bede-registered by the relevant government authorities. There was no significant financial impact to the consolidated financial statements of theGroup.Note b:The English names of the PRC companies represent management’s translation of the Chinese names of these companies as these companies havenot adopted formal English names. F- 15Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 1.Organization and nature of operations (Continued) The Group engages primarily in the provision of online advertising services on its websites, premium downloading services to its members, online videosharing and distribution and online game platforms for game developers and users.To comply with PRC laws and regulations that prohibit or restrict foreign ownership of companies that provide online advertising services, operate onlinegames, and hold Internet Content Provider (“ICP”) license and the License for Transmission of Audio-Visual Programs through the internet (“the Licenses”),the company conducts its business through Shenzhen Xunlei, its consolidated VIE.Through the various agreements enacted among the Company, Giganology Shenzhen, a wholly owned subsidiary of the Company, Shenzhen Xunlei andlegal shareholders of Shenzhen Xunlei (the “Restructuring”), the Company received all of the economic benefits and residual interest and absorbed all of therisks and expected losses from Shenzhen Xunlei.Details of certain key agreements with the VIE are as follows:—Loan Agreements between Giganology Shenzhen and the shareholders of Shenzhen Xunlei—Giganology Shenzhen provided interest-free loans of RMB9 million to the shareholders of Shenzhen Xunlei for them to make contributions as registered capital into Shenzhen Xunlei. The term of these agreementslast for two years from the date it was signed, and will be automatically extended afterwards on a yearly basis until each shareholder of Shenzhen Xunlei hasrepaid the loans in its entirety in accordance with the loan agreement. The shareholders would not be allowed to transfer their interests in Shenzhen Xunleiwithout prior consent of Giganology Shenzhen. According to the loan agreements, the loans can only be repaid in the form of common shares of ShenzhenXunlei. At any time during the term of the loan agreements, Giganology Shenzhen may, at their sole discretion, requires any of the shareholders of ShenzhenXunlei to repay all or any portion of their outstanding loan under the agreement.Under a separate loan agreement between Giganology Shenzhen and Mr. Sean Shenglong Zou as a shareholder of Shenzhen Xunlei, Giganology Shenzhenmade an additional interest-free loan of RMB20 million to Mr. Sean Shenglong Zou, the entire amount of which was contributed to the registered capital ofShenzhen Xunlei, increasing the registered capital of Shenzhen Xunlei to RMB30 million. The term of this agreement last for two years from the date it wassigned, and will be automatically extended afterwards on a yearly basis until Mr. Zou has repaid the loan in its entirety in accordance with the loanagreement. This loan will be deemed to be repaid when all equity interest held by the shareholders in Shenzhen Xunlei has been transferred to GiganologyShenzhen or its designated parties. At any time during the term of this loan agreement, the Company may, at their sole discretion, require all or any portion ofthe outstanding loan under the agreement to be repaid.—Business Operation Agreements between Giganology Shenzhen and Shenzhen Xunlei—Under these agreements, Giganology Shenzhen has the rights todirect the operating activities of Shenzhen Xunlei, including the appointment of senior management. The shareholders of Shenzhen Xunlei also transferredall their shareholders’ rights to Giganology Shenzhen. The term of this agreement will expire in 2016 and may be extended with Giganology Shenzhen’sconfirmation prior to the expiration date. For instance, in May 2011, Shenzhen Xunlei sought and obtained consent from Giganology Shenzhen and theCompany to increase its registered capital by RMB20 million and to revise its articles of association accordingly. The term of this agreement will expire in2016 and may be extended with Giganology Shenzhen’s confirmation prior to the expiration date.—Equity Pledge Agreement between Giganology Shenzhen and the shareholders of Shenzhen Xunlei—Under this agreement, the shareholders of ShenzhenXunlei pledged all of their equity interests in Shenzhen Xunlei to Giganology Shenzhen. If Shenzhen Xunlei and/or its shareholders breach their contractualobligations under this agreement, Giganology Shenzhen, as pledgee, will be entitled to certain rights, including the right to sell the pledged equity interests. F- 16Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 1.Organization and nature of operations (Continued) —Power of Attorney—Each shareholder of Shenzhen Xunlei appointed Giganology Shenzhen as its attorney-in-fact to exercise their shareholders’ rights inShenzhen Xunlei, including shareholders’ voting rights. Each power of attorney will remain in force for 10 years unless the business operation agreementamong Giganology Shenzhen, Shenzhen Xunlei and the shareholders of Shenzhen Xunlei is terminated in advance. This period may be extended atGiganology Shenzhen’s discretion.—Service Agreements between Giganology Shenzhen and Shenzhen Xunlei—Under various service agreements, Giganology Shenzhen will provideservices including technical support, training, as well as consulting services to Shenzhen Xunlei in exchange for a service fee. These service agreementsinclude the Exclusive Technology Support and Services Agreement, the Exclusive Technology Consulting and Training Agreement and the Software andProprietary Technology License Contract. Giganology Shenzhen is entitled to service fees equal to 20%, 20% and 40% of the pre-tax operating profit ofShenzhen Xunlei according to the terms and provisions of these agreements, respectively (in aggregate 80% of pre-tax operating profit of Shenzhen Xunlei).In addition, these agreements also allow both parties to review and adjust the above mentioned percentage every six months according to the businessoperation and income of Shenzhen Xunlei so as to enable Giganology Shenzhen to extract substantially all the after tax operating profit of Shenzhen Xunlei.The amount of service fees payable from Shenzhen Xunlei to Giganology Shenzhen for the years ended December 31, 2012, 2013 and 2014 was USD1,494 thousand, USD nil and USD 1,228 thousand, respectively.For the Exclusive Technology Support and Services Agreement and the Exclusive Technology Consulting and Training Agreement, the term of theseagreements will expire in 2025 and may be extended with Giganology Shenzhen’s written confirmation prior to the expiration date. Giganology Shenzhen isentitled to terminate the agreement at any time by providing 30 days’ prior written notice to Shenzhen Xunlei.For the Proprietary Technology License Contract, the term of this contract will expire in 2022 and may be extended with Giganology Shenzhen’s writtenconfirmation prior to the expiration date. Giganology Shenzhen grants Shenzhen Xunlei a non-exclusive and non-transferable right to use GiganologyShenzhen’s proprietary technology. Shenzhen Xunlei can only use the proprietary technology to conduct business according to its authorized businessscope. Giganology Shenzhen or its designated representative(s) owns the rights to any new technology developed due to implementation of this contract.—Intellectual Properties Purchase Option Agreement between Giganology Shenzhen and Shenzhen Xunlei. Giganology Shenzhen has an option toacquire Shenzhen Xunlei’s intellectual properties at the lowest price permissible by the then-applicable PRC laws and regulation. The term of this contractwill expire in 2022 and may be automatically extended for an additional 10 years at Giganology Shenzhen’s discretion.—Call Option Agreement—Giganology Shenzhen has an option to acquire all of the outstanding shares of Shenzhen Xunlei at a purchase price equal toRMB 1 or the lowest price permissible by the then-applicable PRC laws and regulation. The term of the agreement will expire in 2022 and may be extendedat Giganology Shenzhen’s discretion.As a result of these agreements (collectively defined as “Structured Service Contracts”), Giganology Shenzhen can exercise effective control over ShenzhenXunlei, receives all of the economic benefits and residual interest and absorbs all of the risks and expected losses from Shenzhen Xunlei as if it were the soleshareholder, and has an exclusive option to purchase all of the equity interest in Shenzhen Xunlei at a minimal price. Therefore, Giganology Shenzhen isconsidered the primary beneficiary of Shenzhen Xunlei and accordingly Shenzhen Xunlei’s results of operations, assets and liabilities have beenconsolidated in the Company’s financial statements.On December 24, 2013, for purposes of developing the Group’s computer software and information technology capability, Shenzhen Xunlei and XunleiComputer entered into a technology development and software licenses framework agreement. The term of the agreement is two years from the date of itsexecution. Under this framework agreement, Xunlei Computer provides Shenzhen Xunlei with technology development services according to ShenzhenXunlei’s business needs. Any new intellectual property resulting from the technology development services is owned by Xunlei Computer, and cannot besubstituted or sub-licensed to any third party by Shenzhen Xunlei without the prior written consent of Xunlei Computer. The framework agreement signedbetween Shenzhen Xunlei and Xunlei Computers does not have an impact on the Structured Services Contracts with Shenzhen Xunlei. F- 17Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 1.Organization and nature of operations (Continued) VIE-Related RisksIt is possible that the Group’s operation of certain of its operations and businesses through VIEs could be found by PRC authorities to be in violation of PRClaw and regulations prohibiting or restricting foreign ownership of companies that engage in such operations and businesses. While the Group’s managementconsiders the possibility of such a finding by PRC regulatory authorities under current law and regulations to be remote, on January 19, 2015, the Ministry ofCommerce of the PRC, or (the “MOFCOM”) released on its Website for public comment a proposed PRC law (the “Draft FIE Law”) that appears to includeVIEs within the scope of entities that could be considered to be foreign invested enterprises (or “FIEs”) that would be subject to restrictions under existingPRC law on foreign investment in certain categories of industry. Specifically, the Draft FIE Law introduces the concept of “actual control” for determiningwhether an entity is considered to be an FIE. In addition to control through direct or indirect ownership or equity, the Draft FIE Law includes control throughcontractual arrangements within the definition of “actual control.” If the Draft FIE Law is passed by the People’s Congress of the PRC and goes into effect inits current form, these provisions regarding control through contractual arrangements could be construed to reach the Group’s VIE arrangements, and as aresult the Group’s VIEs could become explicitly subject to the current restrictions on foreign investment in certain categories of industry. The Draft FIE Lawincludes provisions that would exempt from the definition of foreign invested enterprises entities where the ultimate controlling shareholders are eitherentities organized under PRC law or individuals who are PRC citizens. The Draft FIE Law does not make clear how “control” would be determined for suchpurpose, and is silent as to what type of enforcement action might be taken against existing VIEs that operate in restricted industries and are not controlled byentities organized under PRC law or individuals who are PRC citizens. If a finding were made by PRC authorities, under existing law and regulations orunder the Draft FIE Law if it becomes effective, that the Group’s operation of certain of its operations and businesses through VIEs, regulatory authoritieswith jurisdiction over the licensing and operation of such operations and businesses would have broad discretion in dealing with such a violation, includinglevying fines, confiscating the Group’s income, revoking the business or operating licenses of the affected businesses, requiring the Group to restructure itsownership structure or operations, or requiring the Group to discontinue all or any portion of its operations. Any of these actions could cause significantdisruption to the Group’s business operations, and have a severe adverse impact on the Group’s cash flows, financial position and operating performance.In addition, it is possible that the contracts among the Group, the Group’s VIEs and shareholders of its VIEs would not be enforceable in China if PRCgovernment authorities or courts were to find that such contracts contravene PRC law and regulations or are otherwise not enforceable for public policyreasons. In the event that the Group was unable to enforce these contractual arrangements, the Group would not be able to exert effective control over theaffected VIEs. Consequently, such VIE’s results of operations, assets and liabilities would not be included in the Group’s consolidated financial statements. Ifsuch were the case, the Group’s cash flows, financial position and operating performance would be severely adversely affected. The Group’s contractualarrangements with respect to its consolidated VIEs are approved and in place. The Group’s management believes that such contracts are enforceable, andconsiders the possibility remote that PRC regulatory authorities with jurisdiction over the Group’s operations and contractual relationships would find thecontracts to be unenforceable. F- 18Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 1.Organization and nature of operations (Continued) Share splitOn January 21, 2011, the Company effected a 4 for 1 share split of all of its outstanding common shares and a proportional adjustment to the existingconversion ratios for preferred Series A, Series A-1 and Series B shares.Initial public offeringThe Company completed its initial public offering (“IPO”) on June 24, 2014 on the NASDAQ Global Market and the underwriters subsequently exercisedtheir over-allotment option on June 27, 2014. The Company issued and sold a total of 8,412,250 American Depositary Shares (“ADSs”) pursuant to thesetransactions. Each ADS represents five common shares. The net proceeds received by the Company, after deducting commissions and offering expenses,amounted to approximately US$ 89,665 thousand. Upon the completion of the IPO, all of the Company’s outstanding preferred shares were converted intocommon shares immediately as of the same date. 2.Summary of significant accounting policies (a)Basis of presentation and use of estimatesThe accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States ofAmerica (“U.S. GAAP”). Significant accounting policies followed by the Group in the preparation of the accompanying consolidated financial statements aresummarized below.The Restructuring was accounted for at historical costs. The assets and liabilities of Shenzhen Xunlei are consolidated in the Company’s financial statementsat carryover basis.The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amountsreported in the accompanying consolidated financial statements and related disclosures. Actual results could differ materially from these estimates.Significant accounting estimates reflected in the Group’s consolidated financial statements mainly include the useful lives of property and equipment,allowance for doubtful accounts, valuation allowance of deferred tax assets, sales rebate to advertising agencies, amortization period of online game revenue,amortization of content copyrights, fair value of content copyrights exchange, impairment assessment of goodwill and impairment assessment of long-livedassets. In addition, the Group uses assumptions in a valuation model to estimate the fair value of share options granted, warrants issued and underlyingcommon shares.Management bases the estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form thebasis for making judgments about the carrying values of assets and liabilities. Actual results could differ from these estimates. F- 19Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 2.Summary of significant accounting policies (Continued) (b)ConsolidationThe consolidated financial statements include the financial statements of the Company, its subsidiaries, VIE for which the Company is the primarybeneficiary and its subsidiaries. All significant transactions and balances among the Company, its subsidiaries, VIE and its subsidiaries have been eliminatedupon consolidation.A subsidiary is an entity in which the Company, directly or indirectly, controls more than one-half of the voting power, or has the power to appoint or removethe majority of the members of the board of directors to cast majority of votes at meetings of the board of directors or to govern the financial and operatingpolicies of the investee under a statute or agreement among the shareholders or equity holders.An entity is considered to be a VIE if the entity’s equity holders do not have the characteristics of a controlling financial interest or do not have sufficientequity at risk for the entity to finance its activities without additional subordinated financial support from other parties.The Group consolidates entities for which the Company is the primary beneficiary if the entity’s equity holders do not have the characteristics of acontrolling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial supportfrom other parties.In determining whether the Company or its subsidiary is the primary beneficiary of a VIE, the Company considered whether it has the power to directactivities that are significant to the VIE’s economic performance, including the power to appoint senior management, right to direct company strategy, powerto approve capital expenditure budgets, and power to establish and manage ordinary business operation procedures and internal regulations and systems.Management has evaluated the contractual arrangements among Giganology Shenzhen, Shenzhen Xunlei and its shareholders and concluded thatGiganology Shenzhen receives all of the economic benefits and absorbs all of the expected losses from Shenzhen Xunlei and has the power to direct theaforementioned activities that are significant to Shenzhen Xunlei’s economic performance, and is the primary beneficiary of Shenzhen Xunlei. Therefore,Shenzhen Xunlei and its subsidiaries’ results of operation, assets and liabilities have been included in the Group’s consolidated financial statements.Management monitors the regulatory risk associated with these contractual arrangements. See Note 26 for further discussion.Non-controlling interests represent the portion of the net assets of a subsidiary attributable to interests that are not owned by the Company. The non-controlling interests are presented in the consolidated balance sheets, separately from equity attributable to the shareholders of the Company. Non-controlling interests in the results of the Group is presented on the face of the consolidated statements of comprehensive income as an allocation of the totalincome or loss for the year/period between non-controlling shareholders and the shareholders of the Company. (c)Business combinationsThe Group accounts for acquisitions of entities that include inputs and processes and have the ability to generate economic benefit as business combinations.The Group allocates the purchase price of the acquisition to the tangible assets and identifiable intangible assets acquired based on their estimated fairvalues. The excess of the purchase price over those fair values is recorded as goodwill. Acquisition-related costs are expensed as incurred. F- 20Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 2.Summary of significant accounting policies (Continued) (d)Foreign currency translationThe Company’s reporting and functional currency is the United States Dollar (“USD”). Xunlei BVI and Xunlei HK’s functional currency is the USD. Thefunctional currency of other subsidiaries, VIE and its subsidiaries located in the PRC is the Renminbi (“RMB”), which is their respective local currency.Transactions denominated in foreign currencies are remeasured into the functional currency at the exchange rates prevailing on the transaction dates.Financial assets and liabilities denominated in foreign currencies are remeasured into the functional currency using the applicable exchange rates prevailingat the balance sheet date. The resulting exchange gains and losses from foreign currency transactions are included in other income (loss) within theconsolidated statements of comprehensive income.The Company uses the monthly average exchange rate for the year and the exchange rates at the balance sheet date to translate the operating results andfinancial position, respectively, of its subsidiaries whose functional currency is other than the USD. The resulting translation differences are recorded incumulated translation adjustments, a component of shareholders’ equity.The exchange rate used is released by Chinese State Administration of Foreign Exchange. (e)Cash and cash equivalentsCash and cash equivalents include cash on hand, cash in bank and time deposits placed with banks or other financial institutions, which have originalmaturities of three months or less and are readily convertible to known amounts of cash. (f)Short-term investmentsShort-term investments include deposits placed with banks with original maturities of more than three months but less than one year and investments infinancial instruments with a variable interest rate indexed to the performance of underlying assets. In accordance with ASC 825 Financial Instruments, forinvestments in financial instruments with a variable interest rate indexed to performance of underlying assets, the Group elected the fair value method at thedate of initial recognition and carried these investments subsequently at fair value. Changes in the fair value are reflected in the consolidated statements ofcomprehensive income. Interest generated from short term investments are recorded when interest payments are received at the maturity date. It is recorded as“other income” on the statement of comprehensive income and measured based on the actual amount of interest the Group received. (g)Fair value of financial instrumentsThe Group’s financial instruments consist principally of cash and cash equivalents, short-term investments, accounts receivable, other receivables, amountsdue from/(to) related parties, accounts payable, other payables and warrants liabilities. The carrying value of these balances, with the exception of short-terminvestments (see note 2 (e)), approximates their fair value due to the current and short term nature of these balances. (h)Accounts receivable, netAccounts receivable are presented net of allowance for doubtful accounts. The Group evaluates the creditworthiness of each customer at the time whenservices are rendered and continuously monitor the recoverability of the accounts receivable. F- 21Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 2.Summary of significant accounting policies (Continued) (h)Accounts receivable, net (Continued) The Group uses specific identification method in providing for bad debts when facts and circumstances indicate that collection is doubtful and a loss isprobable and estimable. If the financial conditions of its customers were to deteriorate, resulting in an impairment of their ability to make payments,additional allowances might be required. The allowance for doubtful accounts is based on the best facts available and is re-evaluated and adjusted on aregular basis as additional information is received.Some of the factors that the Group considers in determining whether a bad debt allowance is recorded on an individual customer are:1) the customer’s past payment history and whether it fails to comply with its payment schedule;2) whether the customer is in financial difficulty due to economic or legal factors;3) a significant dispute with the customer has occurred;4) the objective evidence which indicates non-collectability of the accounts receivable.The allowances provided for Accounts Receivable as of December 31, 2013 and 2014 were USD12.1 million and USD9.4 million, respectively.If the Group determines that an allowance is needed for a customer, the Group will discontinue business with them unless they start to resume payment. Theaccounts receivable is written-off when the Group ceases pursuing collection. Any changes in the estimates may cause the Group’s operating results tofluctuate. (i)Long-term investmentsThe Group holds investments in privately held companies. The Group accounts for these investments over which it has significant influence but does notown a majority equity interest or otherwise control using the equity method of accounting. For investments in an investee over which the Group does nothave significant influence and of which the investee has no readily determinable fair value, the Group carries the investment using the cost method. Underthe cost method, the investment is measured initially at cost. The investment carried at cost should recognize income when dividends are received from thedistribution of the investee’s earnings. The Group assesses its long-term investments for other-than-temporary impairment by considering factors including,but not limited to, current economic and market conditions, operating performance of the companies, including current earnings trends and undiscountedcash flows, and other company-specific information. The fair value determination, particularly for investments in privately-held companies, requiressignificant judgment to determine appropriate estimates and assumptions. Changes in these estimates and assumptions could affect the calculation of the fairvalue of the investments and determination of whether any identified impairment is other-than-temporary. During the years ended December 31, 2012, 2013and 2014, the Group did not impair any of its long-term investments. F- 22Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 2.Summary of significant accounting policies (Continued) (j)Property and equipmentProperty and equipment are stated at historical cost less accumulated depreciation and impairment loss, if any. Depreciation is calculated using the straight-line method over their estimated useful lives. Residual rate is determined based on the economic value of the asset at the end of the estimated useful life as apercentage of the original cost. Estimated useful lives Residual rate Servers and network equipment 5 years 5% Computer equipment 5 years 5% Furniture, fittings and office equipment 5 years 5% Motor vehicles 5 years 5% Leasehold improvements shorter of lease term or 3 years — Repair and maintenance costs are expensed as incurred. Expenditures that substantially increase an asset’s useful life are capitalized. Upon sale ordisposition, gain or loss on the disposal of property and equipment is the difference between the net sales proceeds and the carrying amount of the relevantassets and is recognized in the consolidated statements of operations. The cost and related accumulated depreciation are removed from the financialstatements. (k)GoodwillGoodwill represents the excess of the purchase price over the amounts assigned to the fair value of the assets acquired and the liabilities assumed of anacquired business. (l)Impairment of goodwillImpairment of goodwill assessment is performed on at least an annual basis on December 31 or whenever events or changes in circumstances indicate that thecarrying value of the asset may not be recoverable. According to ASC 350-20-35, an entity may assess qualitative factors to determine whether it is morelikely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount, including goodwill. Butthe Group selects proceed directly to perform a two-step goodwill impairment test. The first step compares the fair values of a reporting unit to its carryingamount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill is not considered impaired and the second step will notbe required. If the carrying amount of a reporting unit exceeds its fair value, the second step compares the implied fair value of the affected reporting unit’sgoodwill to the carrying value of that goodwill. The implied fair value of goodwill is determined in a manner similar to accounting for a businesscombination with the allocation of the assessed fair value determined in the first step to the assets and liabilities of the reporting unit. The excess of the fairvalue of the reporting unit over the amounts assigned to the assets and liabilities is the implied fair value of goodwill. This allocation process is onlyperformed for purposes of evaluating goodwill impairment and does not result in an entry to adjust the value of any assets or liabilities. An impairment loss isrecognized for any excess in the carrying value of goodwill over the implied fair value of goodwill. The judgment in estimating the fair value of a reportingunit includes estimating future cash flows, determining appropriate discount rates and making other assumptions. Changes in these estimates andassumptions could materially affect the determination of the fair value of a reporting unit.No goodwill impairment losses were recognized for the year ended December 31, 2014. F- 23Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 2.Summary of significant accounting policies (Continued) (m)Intangible assets I)Content copyrightsLicensed copyrights of movies, TV series and variety shows (collectively “Content Copyrights”) are capitalized when 1) the cost of the content is known 2)the content has been accepted by the Group in accordance with the conditions of the license agreement and 3) the content is available for its first showing onthe Group’s website. Content Copyrights are carried at cost less accumulated amortization and impairment loss, if any.The Group has two types of Content Copyrights, 1) non- exclusive Content Copyrights and 2) exclusive Content Copyrights. With non-exclusive ContentCopyrights, the Group has the right to broadcast the contents on its own websites. While, with exclusive Content Copyrights, besides the broadcasting right,the Group also has the right to sub-license these exclusive Content Copyrights to third parties.For non-exclusive Content Copyrights, which only generates primarily indirect cash flows, the amortization method is based on the analysis of historicalviewership consumption patterns. The Group determines consumption patterns by tracking the number of viewers watching the content throughout its lifecycle. This information is then aggregated to come up with a viewership trend that can support an appropriate method to amortize non-exclusive ContentCopyrights. The Group generally categorizes its contents in the Xunlei Kankan website into three broad categories, namely movies; TV series; and varietyshows and others, which include reality shows, talent shows, talk shows and entertainment news. Prior to April 1, 2011, the Group concluded there wasinsufficient historical viewership data to support a demonstrative pattern in viewership of the Group’s non-exclusive Content Copyrights. Therefore, theGroup has determined that a straight line method of amortization over the estimated useful lives of the related non-exclusive Content Copyright provides theright level of expenses attribution. Effective April 1, 2011, based on an accumulation of data gathered on historical viewing patterns of the non-exclusiveContent Copyrights, the Group revised the method to amortize new release of non-exclusive Content Copyrights over the shorter of estimated useful lives ortheir respective licensing periods using an accelerated method based on consumption patterns. Estimates of the consumption patterns for these non-exclusiveContent Copyrights are reviewed periodically and revised, if necessary.Exclusive Content Copyrights generate both direct and indirect cash flows. For the portion of exclusive Content Copyrights that generate indirect cash flows,the Group uses the amortization method based on the analysis of historical viewership consumption patterns, which is the same with that of non-exclusiveContent Copyright as discussed above.For the portion of exclusive Content Copyrights that generates direct cash flows, the Group amortizes the purchase costs using an individual-film-forecast-computation method, which amortizes such costs based on the ratio of sub-licensing revenue and barter transaction gain (details described in Note 2(r))generated for the current period to the total ultimate direct revenue estimated to be generated by the exclusive Content Copyrights for their whole licenseperiod or estimated useful lives. The Group revisits the forecast at each quarter or year end and makes adjustment, when appropriate. II)Other intangible assetsOther intangible assets, which include computer software, internal use software development costs, online game licenses, domain names, land use right,trademarks, technology (including right-to-use) and non-compete agreement, are carried at cost less accumulated amortization and impairment loss, if any.Exclusive game licenses are amortized using the straight-line method over their licensing period of three years. Computer software, internal use software anddomain name are amortized using the straight-line method over their estimated useful life of five years. Land use right is amortized using the straight-linemethod over their estimated useful life of thirty years. F- 24Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 2.Summary of significant accounting policies (Continued) (n)Impairment of long-lived assetsThe Group evaluates the program usefulness of non-exclusive Content Copyrights and exclusive Content Copyrights pursuant to the guidance in ASC 920-350 Intangible—Goodwill and Other: Recognition, which provides that such rights be reported at the lower of unamortized cost or estimated net realizablevalue.For non-exclusive Content Copyrights which only generate indirect cash flows, the Group evaluates the net realizable value of the content library by its threecontent categories (i.e. movies, TV series, variety shows and others). If management’s expectations of programming usefulness, which represents the expectedrevenues and related net cash flows derived from the contents, are revised downward, they assess whether it is necessary to write down the unamortized coststo estimated net realizable value. The Group evaluates programming usefulness by category on an annual basis by comparing the unamortized cost to theestimated net realizable value. On a quarterly basis, the Group also monitors whether there are indicators of changes in their expected usage of programmaterials.The Group estimates net realizable value using expected net cash flows of the content based on expected future levels of advertising revenues. Such estimatesconsider historical amounts and anticipated levels of demand. Expected future revenues are reduced by estimated direct costs to provide access to the websiteand generate the related revenue, including bandwidth costs and server costs. For purposes of estimating revenues for each category of content, the Groupconsiders both expected future advertising revenues sold based on number of impressions delivered as well as advertising sold based on the period of timethat it is displayed.For exclusive Content Copyrights that generate both direct and indirect cash flows, the Group evaluates the net realizable value of the Group’s licensedcopyright on a content by content basis. Impairment is assessed on an annual basis by comparing the unamortized cost to the Group’s estimated net realizablevalue. The Group estimates the net realizable value using expected net cash flows based on expected future levels of advertising and content sub-licensingrevenues. For expected future levels of advertising revenue, the Group uses the same estimation methodology used for the impairment assessment of non-exclusive Content Copyrights.For both exclusive and non-exclusive Content Copyrights, there were no impairments for the years ended December 31, 2012, 2013 and 2014 because asignificant portion of the contents was related to movies and TV series, of which approximately 70% to 90% of the purchase costs of the Content Copyrightshad already been amortized during the first year of the licensed period. As such, the unamortized carrying amounts were lower than the respective netrealizable values when the impairment assessment was performed.For other long-lived assets, the Group evaluates its long-lived assets for impairment whenever events or changes in circumstances indicate that the carryingamount of an asset may no longer be recoverable. The Group assesses the recoverability of the long-lived assets by comparing the carrying value of the long-lived assets to the estimated undiscounted future cash flows expected to be received from use of the assets and their eventual disposition at the lowest level ofidentifiable cash flows. Such assets are considered to be impaired if the sum of the expected undiscounted cash flows is less than the carrying amount of theassets. If the Group identifies an impairment, the carrying value of the asset will be reduced to its estimated fair value based on a discounted cash flowapproach or, when available and appropriate, to comparable market values. The impairment of online game license were USD nil, USD 808 thousand andUSD 808 as of December 31, 2012, 2013 and 2014, respectively. F- 25Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 2.Summary of significant accounting policies (Continued) (o)Commitments and contingenciesIn the normal course of business, the Group is subject to contingencies, such as legal proceedings and claims arising out of its business, that cover a widerange of matters. Liabilities for such contingencies are recorded when it is probable that a liability has been incurred and the amount of the assessment can bereasonably estimated. In regards to legal cost, the Group recorded such costs as incurred.Certain conditions may exist as of the date the financial statements are issued, which may result in a loss to the Group, but which will only be resolved whenone or more future events occur or fail to occur. The Group’s management and its legal counsel assess such contingent liabilities, and such assessmentinherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Group or unassertedclaims that may result in such proceedings, the Group, in consultation with its legal counsel, evaluates the perceived merits of any legal proceedings orunasserted claims as well as the perceived merits of the amount of relief sought or expected to be sought therein.If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then theestimated liability would be accrued in the Group’s financial statements. If the assessment indicates that a potentially material loss contingency is notprobable, but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the rangeof possible loss, if determinable and material, would be disclosed. (p)Operating leasesLeases in which a significant portion of the risks and rewards of ownership are retained by the lessor are classified as operating leases. Payments made underoperating lease are charged to the statements of comprehensive income on a straight-line basis over the period of the lease. (q)Revenue recognitionThe Group generates revenues from various streams. The Group operates a prepaid virtual items system, under which, prepaid virtual items at fixed face valueare sold to third parties. Virtual items purchased can be used to subscribe for membership or purchase of virtual items in online games, as discussed below.Virtual items sold but not yet consumed by the users are recorded as “Receipts in advance from customers” and upon consumption, they are recognized asmembership subscription and online game revenue according to the respective prescribed revenue recognition policies addressed below. F- 26Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 2.Summary of significant accounting policies (Continued) (q)Revenue recognition (Continued) I)Subscription revenuesThe Group operates a VIP membership program where VIP members can have access to high speed online acceleration services, online streaming and otheraccess privileges. The membership fee is time-based and is collected up-front from subscribers except in the cases when they elect to pay via their mobileoperators. The membership fee is collected when the subscribers pay for the monthly phone bills. The terms of time-based subscriptions range from onemonth to twelve months, with the subscribers having the option to renew the contract. The receipt of subscription fee is initially recorded as deferred revenueand revenue is recognized ratably over the period of subscription as services are rendered. Unrecognized portion beyond 12 months from balance sheet dateis classified as a long-term liability. The Group evaluated the principal versus agent criteria and determined that the Group is the principal in the transactionand accordingly record revenue on a gross basis. In determining whether to report revenues gross for the amount of subscription revenue, the Group assesseswhether it maintains the principal relationship with the VIP members, whether it bears the credit risk and whether it establishes prices for the end users.Service fees levied by online system, fixed phone line and mobile payment channels (“Payment Handling Fees”) are recorded as the cost of revenues in thesame period as the revenue for the membership fee is recognized. II)Advertising revenuesAdvertising revenues are derived principally from arrangements where the customers pay to place their advertisements on the Group’s platform in differentformats over a particular period of time. Such formats generally includes but not limited to videos, banners, links, logos and buttons. Advertisements on theGroup’s platform are generally charged on the basis of duration, and advertising contracts are signed to establish the fixed price and the advertising servicesto be provided. The Group enters into advertising contracts with third party advertising agencies that represents advertisers, as well as directly withadvertisers. A typical contract term would range from a few days to 3 months. Both third party advertising agencies and direct advertisers are generally billedat the end of the display period and payments are due usually within 3 months.Where the Group’s customers purchase multiple advertising spaces with different display periods in the same contract, the Group allocates the totalconsideration to the various advertising elements based on their relative fair values and recognizes revenue for the different elements over their respectivedisplay periods. The Group determines the fair values of different advertising elements based on the prices charged when these elements were sold on astandalone basis. The Group recognizes revenue on the elements delivered and defers the recognition of revenue for the fair value of the undeliveredelements until the remaining obligations have been satisfied. Where all of the elements within an arrangement are delivered uniformly over the agreementperiod, the revenue is recognized on a straight line basis over the contract period. F- 27Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 2.Summary of significant accounting policies (Continued) (q)Revenue recognition (Continued) II)Advertising revenues (Continued) Transactions with third party advertising agenciesFor contracts entered into with third party advertising agencies, the third party advertising agencies will in turn sell the advertising services to advertisers.Revenue is recognized ratably over the contract period of display based on the following criteria: • There is persuasive evidence that an arrangement exists—the Group will enter into framework and execution agreements with the advertising agencies,specifying price, advertising content, format and timing • Price is fixed and determinable—prices charged to the advertising agencies are specified in the agreements, including relevant discount andrebate rates • Services are rendered—the Group recognizes revenue ratably over the contract period of display • Collectability is reasonably assured—the Group assesses credit history of each advertising agency before entering into any framework and executionagreements. If the collectability from the agencies is assessed as not reasonably assured, the Group recognizes revenue only when the cash is receivedand all the other revenue criteria are met.The Group provides sales incentives in the forms of discounts and rebates to third party advertising agencies based on purchase volume. As the advertisingagencies are viewed as the customers in these transactions, revenue is recognized based on the price charged to the agencies, net of sales incentives providedto the agencies. Sales incentives are estimated and recorded at the time of revenue recognition based on the contracted rebate rates and estimated salesvolume based on historical experience.Transactions with advertisersThe Group also enters into advertisement contracts directly with advertisers. Under these contracts, similar to transactions with third party advertisingagencies, the Group recognizes revenue ratably over the contract period of display. The terms and conditions, including price, are fixed according to thecontract between the Group and the advertisers. The Group also performs credit assessment of all advertisers prior to entering into contracts. Revenue isrecognized based on the amount charged to the advertisers, net of discounts.The Group has estimated and recorded sales rebates provided to the agencies and advertisers of USD 7,414 thousand , USD 7,207 thousand and USD5,005 thousand for the years ended December 31, 2012, 2013 and 2014, respectively. III)Other internet value-added services i)Online game revenuesUsers play games through the Group’s platform free of charge and are charged for purchases of virtual items including consumable and perpetual items, whichcan be utilized in the online games to enhance their game-playing experience. Consumable items represent virtual items that can be consumed by a specificuser within a specified period of time. Perpetual items represent virtual items that are accessible to the users’ account over the life of the online game. F- 28Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 2.Summary of significant accounting policies (Continued) (q)Revenue recognition (Continued) III)Other internet value-added services (Continued) i)Online game revenues (Continued) Pursuant to contracts signed between the Group and game developers, revenue from the sale of virtual items are shared based on a pre-agreed ratio for eachgame. The Group enters into both non-exclusive and exclusive licensing contracts with game developers.Non-exclusive game licensed contractsThe games under non-exclusive licensed contracts are maintained, hosted and updated by the game developers. The Group mainly provides access to theplatform and limited after-sale services to the game players. The determination of whether to record these revenues using the gross or net method is based onan assessment of various factors; the primary factors are whether the Group acts as the principal in offering services to the game players or as agent in thetransaction, and the specific requirements of each contract. The Group determined that for non-exclusive game licensed arrangements, the third party gamedevelopers are the principal given that the game developers design and develop the game services offered, have reasonable latitude to establish prices ofgame virtual items, and are responsible for maintaining and upgrading the game content and virtual items. Accordingly, the Group records online gamerevenue, net of the portion remitted to the game developers.Given that online games are managed and administered by the game developers for non-exclusive licensed games, the Group does not have access to the dataon the consumption details and the types of virtual items purchased by the game players. The Group has adopted a policy to recognize revenues relating toboth consumable and perpetual items over the shorter of 1) estimated lives of the games and 2) the estimated lives of the user relationship with the Group,which were approximately two to six months for the periods presented.Adjustments arising from the changes of estimated lives of virtual items are applied prospectively as such changes are resulted from new informationindicating a change in the game player behavioral patterns.Exclusive licensing game contractsFor exclusive licensing contracts with game developers, the games are maintained and hosted by the Group. Accordingly, the Group is determined to be theprincipal, the Group records online game revenue on a gross basis, with the amount remitted to the game developers reported as cost of revenue. PaymentHandling Fees are recognized as cost of revenues when the related revenues are recognized.For exclusive licensed games which are maintained on the Group’s server, the Group has access to the data on the consumption details and types of virtualitems purchased by the game players. The Group does not maintain information on consumption details of virtual items, and only have limited informationrelated to the frequency of log-ons. Given that a substantial portion of the virtual items purchased by the game players in exclusive licensed games areperpetual items, management determined that it would be most appropriate to recognize revenue over the shorter of 1) estimated lives of the games and 2) theestimated lives of the user relationship with the Group, which were approximately one to three months for the periods presented. Revenues related toconsumable items are recognized immediately upon consumption. F- 29Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 2.Summary of significant accounting policies (Continued) (q)Revenue recognition (Continued) III)Other internet value-added services (Continued) i)Online game revenues (Continued) Exclusive licensing game contracts (Continued) Game players can purchase prepaid virtual items which can be used to purchase virtual items via online channels. The Group incurs service fees levied bythose payment channels, and such payment expenses are recorded as the cost of revenues when the related revenues are recognized.For both non-exclusive and exclusive licensed games, the Group estimates the life of virtual items to be the shorter of the estimated lives of the games and theestimated lives of the user relationship. The estimated user relationship period is based on data collected from those users who have purchased virtual items.To estimate the life of the user relationship, the Group maintains a software system that captures the following information for each user: the date of first log-in, the date of first purchase for a virtual item, the date of last purchase for a virtual item and the date the user ceases to play the game. The Group estimatesthe life of the user relationship to be the average period from the first purchase of a virtual item to the date the user ceases to play the game. The estimate ofthe life of the user relationship is based only on the data of those users who have purchased virtual items and is made on a game-by-game basis.To estimate the life of the games, the Group considers both games that they operate as well as games in the market that are of a similar nature. The Groupcategorizes these games by their nature, such as simulation games, role playing games and others, which appeal to players belonging to differentdemographics. The Group estimates that the life of each group of the games to be the average period from the date of launch for such games to the date thegames are expected to be removed from the website or terminated altogether. When the Group launches a new game, they estimate the life of the game anduser relationship based on lives of other similar games in the market until the new game establishes its own history. The Group also considers the game’sprofile, attributes, target audience, and its appeal to players of different demographic groups in estimating the user relationship period.The consideration of user relationship with each online game is based on the Group’s best estimate that takes into account all known and relevantinformation at the time of assessment. Adjustments arising from the changes of estimated lives of virtual items are applied prospectively as such changes areresulted from new information indicating a change in the game player behavioral patterns. Any changes in the estimates of lives of virtual items may result inthe Group’s revenues being recognized on a basis different from prior periods and may cause the Group’s operating result to fluctuate. The Group periodicallyassesses the estimated lives of the virtual items and any changes from prior estimates are accounted for prospectively. Any adjustments arising from changesin user relationship as a result of new information will be accounted as a change in accounting estimate in accordance with ASC 250 Accounting Changesand Error Corrections. F- 30Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 2.Summary of significant accounting policies (Continued) (q)Revenue recognition (Continued) III)Other internet value-added services (Continued) ii)Content sub-licensing revenueWith the exclusive Content Copyrights, the Group has the right to sub-license the broadcasting rights to third parties. The Group generates revenue fromsub-licensing these broadcasting rights on a recurring basis to third party customers for cash, mainly video streaming internet platforms, for cash payments ata fixed rate for a fixed period of time that falls within the original exclusive license period. Revenue is recognized in full at the later of the delivery of themaster copy of the content with acceptance acknowledged by the customers and the commencement of the license period, as the Group is not obliged toprovide any other services. The Group performs credit assessment of its customers prior to entering into contracts to ensure that collection of the arrangementfee is reasonably assured. There is no ongoing obligation of the Group after delivery of the master copy of the content. The Group recognized content sub-licensing revenue of USD 15,234 thousand, USD 7,369 thousand and USD 9,218 thousand for the years ended December 31, 2012, 2013 and 2014,respectively. iii)Pay per view subscription revenueThe Group operates a pay per view subscription program in which subscribers pay a monthly fee to watch and have access to a collection of movie contents.The subscription fee is time-based and is collected up-front from subscribers except in the cases where they elect to pay via their mobile operators. Thesubscription fee is collected when the subscribers pay for their monthly phone fees. The terms of time-based subscriptions range from one month to twelvemonths, with the subscribers having the option to renew the contract. The receipt of revenue is initially recorded as deferred revenue and revenue isrecognized ratably over the period of subscription as services are rendered.Viewers can also pay to watch individual movies for an unlimited number of times. Revenue is recognized when the movie is broadcasted to the viewer. iv)Revenues from traffic referral programsThe Group enters into contracts with certain third party portals/websites to earn revenue by referencing online traffic to these third party portals/websites. Ona monthly basis, the Group receives data on the user traffic and the related monthly revenue from these third party portals/ websites. Under these programs,the Group recognizes its share of revenues based on contractual rates applied to user traffic referred to the advertisements of the third parties. (r)Barter transactionsThe Group also enters into agreements with third parties (mainly video streaming internet platform) to exchange content. The exchanged content providesrights for each respective party only to broadcast the content received on its own website; though, each party retains the right to continue broadcasting and orsub-license the rights to the content it surrendered in the exchange. These transactions are non-monetary transactions similar to barter transactions, and theGroup follows ASC 845, Non-Monetary Transactions and ASC 360-10, Property, Plant, and Equipment. F- 31Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 2.Summary of significant accounting policies (Continued) (r)Barter transactions (Continued) Such barter transactions should be recorded at fair value of the surrendered assets in the transaction unless such fair value are not determinable withinreasonable limits. The Group estimated the fair value of the content by gathering “price reference” of cash sub-licensing transactions of each exclusivecontent right and categorizing it into two buckets (1) cash transaction prices with established counterparties and (2) cash transaction prices with lessestablished counterparties. With this information, the Group calculates an “average cash transaction price” for each category to be used as a reference for thenon-monetary transaction. The attributable cost of the related exclusive Content Copyright surrendered is released and recorded as the cost of the bartertransaction using the individual-film-forecast computation method. This method calculates such cost based on the ratio of the estimated fair value of theexchanged content over the aggregated estimated fair value to be generated by the exclusive Content Copyrights for their whole license period or estimateuseful lives. The Group revisits the forecast at each quarter or year end and make adjustment, when appropriate.The Group generated net gains amounted to USD1,556 thousand (2012:USD4,666 thousand, 2013: USD1,020 thousand) from barter transactions, which isthe net amount of proceeds of USD4,428 thousand (2012:USD7,472 thousand, 2013: USD2,059 thousand), after deducting related allocation of cost ofUSD2,606 thousand (2012:USD2,380 thousand, 2013: USD915 thousand) and business tax and surcharge of USD266 thousand (2012:USD426 thousand,2013: USD124 thousand). (s)Sales and marketing expensesSales and marketing expenses comprise primarily of salary, commission and benefits of sales and marketing personnel and external advertising and marketpromotion expenses. The external advertising and market promotion expenses amounted to approximately USD 7,951 thousand, USD 12,247 thousand andUSD 13,957 thousand for the years ended December 31, 2012, 2013 and 2014, respectively. (t)General and administrative expensesGeneral and administrative expenses consist primarily of salary and benefits, professional service fees, legal expenses and other administrative expenses. (u)Research and development costsThe Group incurred research and development costs to develop its downloading software. Costs incurred during the research phase are expensed as incurred.Costs incurred for the development of the downloading software prior to the establishment of technological feasibility, which is when a working model isavailable, are expensed when incurred. The development costs qualified for capitalization have been immaterial for the periods presented.The Group also incurred development costs in connection with an internal-use ERP software to further enhance management to monitor the business. Whileinternal and external costs incurred during the preliminary project stage are expensed as incurred, costs relating to activities during the applicationdevelopment stages have been capitalized. During each of the three years ended December 31, 2014, nil software development costs were capitalized asintangible assets, respectively.In addition, the Group incurred other research and development costs in relation to software used to support its operations. Any development costs qualifiedfor capitalization have been immaterial for the periods presented. F- 32Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 2.Summary of significant accounting policies (Continued) (v)Taxation and uncertain tax positionsIncome taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequencesattributable to differences between the financial statements’ carrying amounts of existing assets and liabilities and their respective tax bases and tax loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which the difference is expected to be recovered orsettled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the consolidated statement of operations in the period thatincludes the enactment date. A valuation allowance is provided to reduce the carrying amount of deferred tax assets if it is considered more likely than notthat some portion, or all, of the deferred tax assets will not be realized. On January 1, 2007, the Group adopted the guidance regarding uncertain tax positionsand evaluated its open tax positions that exist in each jurisdiction for each reporting period. If an uncertain tax position is taken or expected to be taken in atax return, the tax benefit from that uncertain position is recognized in the Group’s consolidated financial statements if it is more likely than not that theposition is sustainable upon examination by the relevant taxing authority. The Group did not have any significant uncertain tax position and there was noeffect on its financial condition or results of operations as a result of implementing the new guidance. The Group recognizes interest and penalties accrued onany unrecognized tax benefits as a component of income tax expense, if any. Nevertheless, no significant interest and penalties were recorded in the yearsended December 31, 2012, 2013 and 2014.Transition from PRC Business Tax to PRC Value Added TaxEffective September 1, 2012, the Chinese government has begun a pilot program (the “Pilot Program”) for transition from imposing business tax to imposingof value added tax (“VAT”) for revenues generated in certain industries. The Pilot Program has been expanded from Shanghai to eight other cities andprovinces in China, including Beijing and Shenzhen. The Group’s advertising and content sub-licensing revenues are subject to the Pilot Program sinceNovember 1, 2012, and its subscription revenue, online game revenue and pay per view subscription revenue are subject to the Pilot Program since June 1,2014. Business Tax has been imposed primarily on revenues from the provision of taxable services, assignments of intangible assets and transfers of realestate. Prior to the implementation of the pilot program, the Group’s Business Tax rate, which varies depending upon the nature of the revenues being taxed,generally ranged from 3% to 5%.VAT payable on goods sold or taxable labor services provided by a general VAT taxpayer for a taxable period is the net balance of the output VAT for theperiod after crediting the input VAT for the period. Before the implementation of the Pilot Program, the Group was mainly subject to a small amount of VATmainly for revenues of the sale of software. VAT has been imposed on those revenues at a rate of 17%. With the implementation of the Pilot Program, inaddition to the revenues currently subject to VAT, the Group’s advertising and content sub-licensing revenues, subscription revenue, online game revenueand pay per view subscription revenue are in the scope of the Pilot Program and are now subject to VAT at a rate of 6%. (w)Retirement benefitsFull-time employees of the Company’s subsidiaries, consolidated VIE and its subsidiaries in the PRC participate in a government mandated multi-employerdefined contribution plan pursuant to which certain pension benefits, medical care, unemployment insurance, employee housing fund and other welfarebenefits are provided to employees. Chinese labor regulations require that the subsidiaries and VIEs of the Company make contributions to the governmentfor these benefits based on certain percentages of the employees’ salaries. The Group has no legal obligation for the benefits beyond the contributions made.The total amounts for such employee benefits, which are expensed as incurred, were USD1,930 thousand, USD3,243 thousand and USD 3,818 for the yearsended December 31, 2012, 2013 and 2014, respectively. F- 33Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 2.Summary of significant accounting policies (Continued) (x)Share-based compensationThe Group measures share-based compensation at the grant date based on the fair value of the award determined using the Black-Scholes option pricingmodel. As the Group has granted share options and restricted shares with service-only condition, the Group elected to recognize compensation costs net ofestimated forfeitures on a straight line basis over the requisite service period, which is generally the same as the vesting period. The amount of compensationcost recognized at any date is at least equal to the portion of the grant-date value of the award that is vested at that date. (y)Government subsidiesThe Group receives subsidies from the local PRC government for general use or purchase of equipment. General-use subsidies which are not subject to anyconditions or specific use requirements are recorded as subsidy income in the consolidated statements of operations. Subsidies for purchase of equipment arerecorded as deferred government grant when received, and are recorded as other income over the expected useful life of the assets after the related equipmenthas been purchased. (z)Segment reportingThe Group’s Chief Executive Officer has been identified as the chief operating decision maker (“CODM”), who reviews consolidated operating results of theGroup when making decisions about allocating resources and assessing performance of the Group as a whole. The Group has internal reporting of revenue,cost and expenses that does not distinguish between segments, and reports costs and expense by nature as a whole. The Group does not distinguish betweenmarkets or segments for the purpose of internal reporting. Management has determined that the Group operates and manages its business as a single segmentwhich is the operation of its online media platform. All revenues of the Group are derived from mainland China.An analysis of the different types of revenues for the years ended December 31, 2012, 2013 and 2014 are summarized as follows: Years ended December 31, (In thousands) 2012 2013 2014 Subscription revenue 51,055 86,733 98,189 Advertising revenue 61,795 48,028 38,378 Other internet value-added services (note a) 35,350 45,483 46,320 Total 148,200 180,244 182,887 note a:Other internet value-added services mainly comprise online game revenue, content sub-licensing revenue, pay per view subscription revenue,revenue from traffic referral programs, technical services regarding online acceleration, online sales revenue, online game subscription revenue andsales of software licenses. (aa)Net income / (loss) per shareBasic income / (loss) per share is computed by dividing net income / (loss) attributable to holders of common shares by the weighted-average number ofcommon shares outstanding during the year using the two class method. Using the two class method, net income / (loss) is allocated between common sharesand other participating securities based on their participating rights. F- 34Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 2.Summary of significant accounting policies (Continued) (aa)Net income / (loss) per share (Continued) Diluted income / (loss) per share is calculated by dividing net income / (loss) attributable to common shareholders as adjusted for the effect of dilutivecommon equivalent shares, if any, by the weighted-average number of common and dilutive common equivalents shares outstanding during the year.Dilutive equivalent shares are excluded from the computation of diluted income / (loss) per share if their effects would be anti-dilutive. Common shareequivalents consist of the common shares issuable in connection with the Group’s convertible non-redeemable and redeemable preferred shares using the if-converted method, and common shares issuable upon the conversion of the stock options, using the treasury stock method. (bb)Comprehensive incomeComprehensive income is defined as the change in equity of a Group during the period from transactions and other events and circumstances excludingtransactions resulting from investments from shareholders and distributions to shareholders. Accumulated other comprehensive income, as presented on theaccompanying consolidated balance sheets, consists of cumulative translation adjustment. (cc)Profit appropriation and statutory reservesThe Group’s subsidiaries, consolidated VIE and its subsidiaries incorporated in the PRC are required on an annual basis to make appropriations of retainedearnings set at certain percentage of after-tax profit determined in accordance with PRC accounting standards and regulations (“PRC GAAP”). Appropriationto the statutory general reserve should be at least 10% of the after-tax net income determined in accordance with the legal requirements in the PRC until thereserve is equal to 50% of the entities’ registered capital. The Group is not required to make appropriation to other reserve funds and the Group does not haveany intentions to make appropriations to any other reserve funds.The general reserve fund can only be used for specific purposes, such as setting off the accumulated losses, enterprise expansion or increasing the registeredcapital. Appropriations to the general reserve funds are classified in the consolidated balance sheets as statutory reserves.There are no legal requirements in the PRC to fund these reserves by transfer of cash to restricted accounts, and the Group does not do so.The following table presents the balances of registered capital, additional paid-in-capital and statutory reserves of entities within the Group incorporated inChina as of December 31, 2013 and 2014 for the Group’s reporting purpose in China as determined under generally accepted accounting principles in China: (In thousands) December 31,2013 December 31,2014 Registered capital 44,532 54,467 Additional paid-in capital 161 161 Statutory reserves 4,478 5,132 Total 49,171 59,760 F- 35Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 2.Summary of significant accounting policies (Continued) (cc)Profit appropriation and statutory reserves (Continued) Relevant laws and regulations permit payments of dividends by the PRC subsidiaries and affiliated companies only out of their retained earnings, if any, asdetermined in accordance with respective accounting standards and regulations. Accordingly, the above balances are not allowed to be transferred to theCompany in terms of cash dividends, loans or advances (See also Note 26). (dd)DividendsDividends are recognized when declared. No dividends were declared for the years ended December 31, 2012, 2013 and 2014, respectively. The Group doesnot have any present plan to pay any dividends on common shares in the foreseeable future. The Group currently intends to retain the available funds andany future earnings to operate and expand its business. (ee)Recent accounting pronouncementsIn March 2013, the FASB issued guidance on “Foreign Currency Matters, Parent’s Accounting for the Cumulative Translation Adjustment uponDerecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity.” The amendments clarify theapplicable guidance for the de-recognition of all or a portion of a cumulative translation adjustment when an entity ceases to have a controlling financialinterest in a subsidiary or group of assets that is a non-profit activity or a business (other than a sale of in substance real estate or conveyance of oil and gasmineral rights) within a foreign entity or when other changes stipulated occur and involve a foreign entity. The amendments are effective prospectively forfiscal years (and interim reporting periods within those years) beginning after December 15, 2013. The adoption of this Accounting Standard Update (ASU)did not have a material impact on the Company’s consolidated financial statements.In March 2013, the FASB also issued guidance on “Income Taxes—Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, aSimilar Tax Loss, or a Tax Credit Carryforward Exists.” The amendments clarify that an unrecognized tax benefit, or a portion of an unrecognized tax benefit,should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss, similar tax loss, or tax credit carryforward, exceptas noted in the following sentence. To the extent a net operating loss, similar tax loss, or tax credit carryforward is not available at the reporting date underthe tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of theapplicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such a purpose, then under thisexception the unrecognized tax benefit is to be presented in the financial statements as a liability and should not be combined with (netted with) the deferredtax asset(s). The assessment of whether a deferred tax asset is “available” is based on the unrecognized tax benefit and deferred tax asset amounts that exist atthe reporting date and should be made presuming disallowance of the tax position at the reporting date. The amendments are effective for fiscal years, andinterim periods within those years, beginning after December 15, 2013. The adoption of this ASU did not have a material impact on the Company’sconsolidated financial statements.In April 2014, the FASB issued Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, which changes the thresholdfor reporting discontinued operations and adds new disclosures. The new guidance defines a discontinued operation as a disposal that “represents a strategicshift that has (or will have) a major effect on an entity’s operations and financial results.” The standard is required to be adopted by public business entities inannual periods beginning on or after December 15, 2014, and interim periods within those annual periods. Entities may “early adopt” the guidance for newdisposals. The Company does not expect the adoption of this pronouncement to have a significant impact on its consolidated financial statements. F- 36Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 2.Summary of significant accounting policies (Continued) (ee)Recent accounting pronouncements (Continued) On May 28, 2014, the FASB and IASB issued their long-awaited converged standard on the recognition of revenue from contracts with customers. Thestandard will improve the financial reporting of revenue and improve comparability of the top line in financial statements globally. The FASB is amendingthe FASB Accounting Standards Codification and creating a new Topic 606, Revenue from Contracts with Customers, to supersede the revenue recognitionrequirements in Topic 605, Revenue Recognition, and most industry-specific guidance throughout the Industry Topics of the Codification. Additionally, theamendments supersede some cost guidance included in Subtopic 605-35, Revenue Recognition—Construction-Type and Production-Type Contracts. For apublic entity, the amendments are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reportingperiod. Early application is not permitted. The Company is currently evaluating the impact on its consolidated financial statements of adopting thisguidance.In June 2014, under ASC 718, Compensation—Stock Compensation, the FASB issued Accounting for Share-Based Payments When the Terms of an AwardProvide That a Performance Target Could Be Achieved after the Requisite Service Period. These amendments apply to all reporting entities that grant theiremployees share-based payments in which the terms of the award provide that a performance target that affects vesting could be achieved after the requisiteservice period. That is the case when an employee is eligible to retire or otherwise terminate employment before the end of the period in which a performancetarget could be achieved and still be eligible to vest in the award if and when the performance target is achieved. For all entities, the amendments are effectivefor annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. The Company does notexpect the adoption of this pronouncement to have a significant impact on its consolidated financial statements.In August 2014, the FASB issued Presentation of Financial Statements – Going Concern. This standard requires management to evaluate for each annual andinterim reporting period whether it is probable that the reporting entity will not be able to meet its obligations as they become due within one year after thedate that the financial statements are issued. If the entity is in such a position, the standard provides for certain disclosures depending on whether or not theentity will be able to successfully mitigate its going concern status. This guidance is effective for annual periods ending after December 15, 2016 and interimperiods within annual periods beginning after December 15, 2016. Early application is permitted. The Company does not expect the adoption of thispronouncement to have a significant impact on its consolidated financial statements.On February 18, 2015, the FASB issued Accounting Standards Update 2015-02, Consolidation (Topic 810) –Amendments to the Consolidation Analysis.The new guidance applies to entities in all industries and provides a new scope exception to registered money market funds and similar unregistered moneymarket funds. It provide new guidance to companies in determining whether an entity is a variable interest entity (VIE), assessing fees paid to a decisionmaker or a service provider, and consideration of related parties in the economics test. The standard is effective for public business entities for annual periodsbeginning after December 15, 2015. The company is in the process of assessing the impact of this new guidance. F- 37Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 3.Business combinationIn September 2014, the Group acquired assets relating to a personal cloud storage business from Kingsoft Corporation Limited, for cash consideration of USD33 million plus the portion of the fair value of replacement share-based awards allocated to consideration for the acquisition of USD 0.3 million. As a result ofthe acquisition, the Group obtained the key intellectual property to develop and expand the personal cloud storage business. The assets acquired constitute abusiness and the acquisition was recorded as a business combination. The allocation of the purchase price at the date of acquisition is as follows: (In thousands) Property and equipment 255 Intangible assets —Trademarks 6,120 —Technology (including right-to-use) 2,381 —Non-compete agreement 1,490 Goodwill 23,057 33,303 The business combination was completed on 5 September 2014 and the company has finalised the purchase price allocation. The excess of purchase priceover tangible assets and identifiable intangible assets acquired was recorded as goodwill. There was no liability assumed arising from the acquisition. Inconnection with this acquisition, the Group is obligated to issue share options to replace the unvested awards owned by the employees who are transferred tothe Group, the portion of the fair-value-based measure of the replacement award attribute to pre-combination service of USD 303 thousand was allocated tothe consideration, while the portion attribute to post-combination service of USD44 thousand was recorded to as share based compensation expense over theremaining vesting period. The acquired goodwill is not deductible for tax purposes. Acquisition related costs were immaterial and were included in generaland administrative expenses for the year ended December 31, 2014.Pro forma revenue data was not disclosed because the impact was immaterial. Pro forma earnings data was not disclosed because the personal cloud storagebusiness was previously operated by the seller as an integral part of its cloud storage business, and it was impracticable to determine the expenses attributableto the personal cloud storage business. F- 38Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 4.Cash and cash equivalentsCash and cash equivalents represent cash on hand, cash held at bank, and time deposits placed with banks or other financial institutions, which have originalmaturities of three months or less. Cash on hand and cash held at bank balance as of December 31, 2013 and 2014 primarily consist of the followingcurrencies: December 31, 2013 December 31, 2014 (In thousands) Amount USDequivalent Amount USDequivalent RMB 499,034 81,851 674,001 110,149 USD 11,959 11,959 294,036 294,036 HKD 749 96 697 90 Total 93,906 404,275 Time deposits with original maturities of three months or less as of December 31, 2013 and 2014 primarily consist of the following currencies: December 31, 2013 December 31, 2014 (In thousands) Amount USDequivalent Amount USDequivalent RMB 157,860 25,892 156,749 25,617 USD 5,000 5,000 5,500 5,500 Total 30,892 31,117 5.Short-term investments (In thousands) December 31,2013 December 31,2014 Time deposits 9,695 — Investments in financial instruments (note) 31,298 29,427 Total 40,993 29,427 Note:the investments were issued by commercial banks in China with a variable interest rate indexed to performance of underlying assets. Since theseinvestments’ maturity dates are within one year, they are classified as short-term investments.Time deposits and investments in financial instruments are stated on the balance sheet at the principal amount plus accrued interest. Interest income isrecorded in “other income” in the statement of comprehensive income. F- 39Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 6.Accounts receivable, net (In thousands) December 31,2013 December 31,2014 Accounts receivable 47,386 38,273 Less: Allowance for doubtful accounts (12,111) (9,352) Accounts receivable, net 35,275 28,921 The accounts receivable that was fully reserved as of December 31, 2013 and 2014 was USD 10.9 million and USD 8.9 million, respectively.The following table presents movement in the allowance for doubtful accounts: (In thousands) December 31,2012 December 31,2013 December 31,2014 Balance at beginning of the year 4,150 7,875 12,111 Additions 3,840 4,308 2,633 Reversals (140) (373) (1,176) Write-off — — (4,161) Exchange difference 25 301 (55) Balance at end of the year 7,875 12,111 9,352 The top 10 customers accounted for about 40% and 37% of accounts receivable as of December 31, 2013 and 2014, respectively. 7.Prepayments and other assets (In thousands) December 31,2013 December 31,2014 Current portion: Advance to suppliers 717 520 Interest-free loans to employees (note a) 3,578 3,998 Low-interest loans to employees, current portion (note c) — 64 Advance to employees for business purposes 316 585 Content copyrights prepaid assets (note b) 830 297 Interest receivable 118 5,380 Rental and other deposits 596 774 Prepayment for share repurchase plan (note d) — 1,000 Prepaid game sharing costs — 458 Prepaid professional fees — 900 Prepaid management insurance — 179 Others 164 405 Total of prepayments and other current assets 6,319 14,560 Non-current portion:Prepayments for content copyrights 3,149 1,988 Prepayments for online game licenses 2,358 5,346 Deferred initial public offering costs 374 — Low-interest loans to employees, non-current portion (note c) 196 506 Total of long-term prepayments and other assets 6,077 7,840 F- 40Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 7.Prepayments and other assets (Continued) Note a:The Group had entered into loan contracts with certain employees as at December 31, 2013 and 2014, under which the Group provided interest-free loans to these employees. The loan amounts vary amongst different employees and are repayable on demand.Note b:Content copyrights prepaid assets represent content copyright that the Group has yet to receive from the counterparty under a barter transactionbut the counterparty has already received the content copyrights from the Group.Note c:The Group had entered into loan contracts with certain employees as at December 31, 2013 and 2014, under which the Group provided low-interest loans to these employees. The loan amounts vary amongst different employees and are repayable in equal instalments on a monthly basisover the term of 10 years.Note d:In December 2014, the Company announced a share repurchase program to purchase up to USD 20 million shares and prepaid USD 1 million to asecurity broker for this program. 8.Property and equipmentProperty and equipment consist of the following: (In thousands) December 31,2013 December 31,2014 Servers and network equipment 32,108 35,256 Computer equipment 2,097 2,123 Furniture, fixtures and office equipment 889 903 Motor vehicles 340 339 Leasehold improvements 2,177 2,169 Total original costs 37,611 40,790 Less: Accumulated depreciation (17,403) (23,271) 20,208 17,519 Depreciation expense recognized for the years ended December 31, 2012, 2013 and 2014 are summarized as follows: Years ended December 31 (In thousands) 2012 2013 2014 Cost of revenues 3,271 4,317 5,652 General and administrative expenses 594 690 715 Sales and marketing expenses 129 105 133 Total 3,994 5,112 6,500 No impairment loss had been recognized for the years ended December 31, 2012, 2013 and 2014. F- 41Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 9.Intangible assets, netThe following table presents the movement in intangible assets: December 31, 2013 December 31, 2014 (In thousands) Cost Amortization Impairment Net bookvalue Cost Amortization Impairment Net bookvalue Content copyrights 110,346 (89,396) — 20,950 137,470 (116,511) — 20,959 —Exclusive 84,313 (67,487) — 16,826 106,942 (93,172) — 13,770 —Non-exclusive (note a) 26,033 (21,909) — 4,124 30,528 (23,339) — 7,189 Land use rights 5,298 (78) — 5,220 5,279 (253) — 5,026 Trademarks — — — — 6,168 (167) — 6,001 Non-compete agreement — — — — 1,502 (252) — 1,250 Technology (including right-to-use) — — — — 2,399 (100) — 2,299 Acquired computer software 1,284 (1,061) — 223 1,468 (1,141) — 327 Internal use software development costs 718 (395) — 323 716 (537) — 179 Online game licenses (note b) 5,321 (3,343) (808) 1,170 5,304 (4,478) (808) 18 Domain name 200 (110) — 90 200 (149) — 51 123,167 (94,383) (808) 27,976 160,506 (123,588) (808) 36,110 Less: Content copyrights, current portion (16,018) (16,013) 11,958 20,097 Note a:Included in non-exclusive content copyrights are net book values of USD 1,987 thousand and USD 1,401 thousand of rights that were acquiredfrom barter transactions as of December 31, 2013 and 2014, respectively. These assets were initially recorded at their respective fair valuesdetermined at the time of exchange.Note b:In 2013, indicator of possible impairment triggered the Group to perform an impairment test for one online game license. The impairment test wastriggered by the significant decline in the revenue generated by the one online game. For the quarter ended December 31, 2013, this online gameonly generated revenue amounted to USD 27 thousand as compared to USD 303 thousand for the quarter ended September 30, 2013, which wassignificantly lower than the Group’s expectation. The impairment test was performed using a discounted cash flow analysis that requires certainassumptions and estimates regarding economics and future profitability. As of December 31, 2014, full provision for impairment has beenprovided for this online game license. F- 42Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 9.Intangible assets, net (Continued) Amortization expense recognized for the years ended December 31, 2012, 2013 and 2014 are summarized as follows: Years ended December 31 (In thousands) 2012 2013 2014 Cost of revenues 47,810 36,980 35,181 Cost of barter transactions (note 2(r)) 2,380 916 2,606 General and administrative expenses 388 418 412 Research and development expenses — — 542 Total 50,578 38,314 38,741 The estimated aggregate amortization expense for each of the next five years as of December 31, 2014 is: (In thousands) ContentCopyrights Others 2015 15,780 2,052 2016 4,421 1,897 2017 758 1,815 2018 — 1,614 2019 and thereafter — 7,773 The weighted average amortization periods of intangible assets as at December 31, 2013 and 2014 are as below: (In year) December 31,2013 December 31,2014 Copyrights related to content 2.83 2.78 Land use right 30 30 Trademarks — 7 Non-compete agreement — 4 Technology (including right-to-use) — 8 Acquired computer software 5 5 Internal use software development costs 5 5 Online game licenses 3 3 Domain name 5 5 Total 4.04 3.97 F- 43Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 10.Long-term investments (In thousands) December 31,2013 December 31,2014 Equity method investments: Balance at beginning of the year 1,488 2,785 Additions 1,214 — Share of income / (loss) from equity investees 25 (259) Dilution gains arising from deemed disposal of investments (ii) (iii) — 449 Exchange differences 58 (10) Balance at end of the year 2,785 2,965 Cost method investments:Balance at beginning of the year — 164 Additions (i) 162 2,359 Exchange difference 2 10 Balance at end of the year 164 2,533 Total long-term investments 2,949 5,498 Details of the Group’s ownership are as follows: Investee Percentage of ownership of sharesas of December 31, 2013 2014 Equity method investments: Zhuhai Qianyou Technology, Co., Ltd. (“Zhuhai Qianyou”), 19% 19% Guangzhou Yuechuan Network Technology, Co., Ltd. (“GuangzhouYuechuan”) (ii) 23.44% 19.13% Chengdu Diting Technology, Co., Ltd. (“Chengdu Diting”) (iii) 19.9% 16.58% Cost method investments: Shenzhen Kushiduo Network Science and Technology Co., Ltd.(“Shenzhen Kushiduo”) 10% 10% Shanghai Guozhi Electronic Technology Co., Ltd. (“ShanghaiGuozhi”) (i) — 21% Guangzhou Wucai Information Technology Co., Ltd. (“GuangzhouWucai”) (i) — 10% Guangzhou Hongsi Network Technology Co., Ltd. (“GuangzhouHongsi”) (i) — 19.9% Tianjin Kunzhiyi Network Technology Co., Ltd. (“Tianjin Kunzhiyi”)(i) — 19.99% (i)In 2014, the Group made equity investments in four unrelated privately-held companies. The shares held by the Group are not in-substance commonstock and therefore the Group accounted for these investments according to ASC 320 as equity activities using the cost method. F- 44Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 10.Long-term investments (Continued) (ii)In April of 2014, Guangzhou Yuechuan, an equity method investee held by the Group, issued new shares to a number of third parties for a totalconsideration of RMB 18 million (USD 2,928 thousand). As a result of the transaction, the Group’s ownership interest in Guangzhou Yuechuan wasdiluted from 23.44% to 19.13%. The Group recorded a dilution gain of RMB 1.8 million (USD 298 thousand) arising from the sale of shares by theinvestee to third parties at a price in excess of the per share carrying value of the shares owned by the Group in 2014. The Group continued to classifyGuangzhou Yuechuan as an equity method investment because it retained significant influence through its one out of four seats on the board ofdirectors.In May of 2014, Chengdu Diting, an equity method investee held by the Group, issued new shares to a third party for a total consideration of RMB10 million (USD 1,627 thousand). As a result of the transaction, the Group’s ownership interest in Chengdu Diting decreased from 19.9% to 16.58%.The Group recorded a dilution gain of RMB 0.9 million (USD 151 thousand) arising from the sale of shares by the investee to third parties at a price inexcess of the per share carrying value of the shares owned by the Group in 2014. (iii)As of December 31, 2013, the investment in Chengdu Diting was accounted for under the cost method due to the fact that the Group did not havesignificant influence in this company. In May of 2014, the Group obtained the right to appoint a director to Chengdu Diting and thus had one out offive seats on the board of directors of this investee. Given the existence of significant influence; the Group started to apply equity method in May2014. The investment, results of operations (current and prior periods presented), and retained earnings of the Group have been adjusted retroactivelyon a step-by-step basis as if the equity method had been in effect during all previous periods in which the investment was held. 11.Deferred revenue and income (In thousands) December 31,2013 December 31,2014 Deferred revenue Membership subscription revenues 30,051 27,543 Online game revenues 1,650 1,111 Pay per view subscription revenues 261 550 Deferred income Government grants 6,580 5,331 Reimbursement from the depository (i) — 1,053 Total 38,542 35,588 Less: non-current portion (ii) (9,190) (7,294) Deferred revenue and income, current portion 29,352 28,294 (i)In December of 2014, the Company received from its depositary a reimbursement of USD 1.2 million, net of withholding tax of USD0.3 million. Thisreimbursement was recognized as deferred income and amortized over the depositary service period of 5 years.(ii)As of December 31, 2014, the non-current portion included Membership subscription revenues of USD 1,121 thousand (2013: USD 2,610 thousand),Government grants of USD 5,331 thousand (2013: USD 6,580 thousand), and Reimbursement from the depository of USD 842 thousand (2013: nil). F- 45Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 12.Accrued liabilities and other payables (In thousands) December 31,2013 December 31,2014 Payroll and welfare 8,784 12,260 Agency commissions and rebates—online advertising 9,745 8,017 Payables for advertisement on exclusive online games 2,797 2,515 Receipts in advance from customers 2,211 1,133 Tax levies 1,198 556 Payables for purchase of equipment 4,157 240 Legal and litigation related expenses (Note 25) 288 451 Professional fees 574 2,460 Staff reimbursements 1,228 440 Content copyrights deposits (note a) 1,555 622 Rental expense 70 382 Payables for proceeds from selling exercised stock options — 872 Advance for exercise of stock options — 356 Others 800 1,111 Total 33,407 31,415 Note a:Content copyrights deposits are recognized under a barter transaction when the Group has yet to provide the content copyrights to thecounterparty while the Group has received the content copyrights from the counterparty. 13.Cost of revenues (In thousands) Years ended December 31, 2012 2013 2014 Bandwidth costs 22,211 35,454 40,373 Content costs, including amortization 46,671 35,964 34,671 Payment handling fees 8,505 12,401 11,961 Depreciation of servers and other equipment 3,271 4,317 5,652 Games revenue sharing costs and others 3,354 5,124 5,802 Total 84,012 93,260 98,459 14.Redeemable convertible preferred sharesSeries D convertible redeemable preferred sharesOn January 31, 2012, the Company entered into an agreement to issue Series D preferred shares and warrants to a third-party investor for a total considerationof USD37,500 thousand. Pursuant to the agreement, the company issued 10,580,397 series D preferred shares at USD 3.544 per share; and warrants topurchase 2,218,935 Series D preferred shares at USD 3.38 per share at the option of the holders. In addition, the third-party investor also purchased a total of5,036,367 existing shares directly from other then existing shareholders and they were entitled to the same rights as attached to the respective classes ofexisting shares. F- 46Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 14.Redeemable convertible preferred shares (Continued) Series D convertible redeemable preferred shares (Continued) The key terms of the Series D preferred shares were as follows:Dividend rightsThe holders of the Series D preferred shares were entitled to participate in any dividend pari passu with common shareholders of the Company on an as-converted basis.Liquidation preferencesAmount shall be paid to Series D holders before any distribution or payment shall be made to the holders of Series A, Series A-1, Series B and C PreferredShares. If asset for distribution is insufficient to pay off Series D holders, the assets shall be distributed among the holders of Series D in proportion to the fullamounts to which they would otherwise be respectively entitled thereon on an as-converted basis.Upon issuance of Series E preferred shares, the liquidation preference of Series D preferred shares was amended. Before any distribution or payment shall bemade to the Series A, A-1, B and C shareholders (for the purpose of this clause, such holders did not include Skyline Global Company Holdings Limited(“Skyline Holdings”, or “Series D Investor”), the Series D holder, who also held any Series A, A-1, B and any other Junior Securities) an amount shall be paidwith respect to each share held by Skyline Holdings equal to original issue price.Voting rightsThe holders of the Series D preferred shares shall be entitled to such number of votes equal to the whole number of common shares into which such Series Dpreferred shares are convertible.Conversion rightsEach share of the Series D preferred shares was convertible at the option of the holder, at any time after the issuance of such shares, and each share can beconverted into one common share of the Company. The conversion was subject to adjustments for certain events, including but not limited to additionalequity securities issuance, reorganization, mergers, share dividends, distribution, subdivisions, redemptions, combinations, or consolidation of commonshares. The conversion price was also subject to adjustment in the event the Company issues additional common shares at a price per share that is less thansuch conversion price. In such case, the conversion price shall be reduced to adjust for dilution on a weighted average basis.In addition, each share of the Series D preferred shares would automatically be converted into common shares of the Company (i) upon the closing of aninitial public offering of the Company’s shares or (ii) upon written notice to convert given to the Company by the holders of a majority of Series D preferredshareholders. F- 47Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 14.Redeemable convertible preferred shares (Continued) Series D convertible redeemable preferred shares (Continued) Redemption RightThe Series D preferred shares were redeemable at any time after the 4th anniversary of the initial closing of February 6, 2012 to request the Company topurchase all Series D preferred shares and shares issuable upon the conversion or exercise of the Series D warrants if an initial public offering is notconsummated. This redemption right expires after the 5th anniversary of the initial closing of the transaction. The redemption price shall be equal to theaggregate amount of price paid at USD3.544, plus all declared but unpaid dividends up to the date of redemption plus interest of 8% per annum compoundedannually from the closing of the Series D preferred shares investment(“Initial Closing”) up to and including the date of redemption.The Company had determined that the Series D preferred shares should be classified as mezzanine equity. The Series D warrant is initially measured at its fairvalue and the initial carrying value for Series D preference shares is allocated on a residual basis as it was liability classified. The initial carrying value forSeries D preference shares was USD 32,481 thousand, and the related capitalized expense was USD2,012 thousand. There were no beneficial conversionfeatures for the Series D preferred shares.The carrying value of the preferred shares was accreted from its carrying value on the date of issuance to the redemption value using effective interest methodfrom date of issuance to the earliest redemption date. The accretion was recorded against retained earnings, or in the absence of retained earnings, by chargingagainst additional paid-in capital. Once additional paid-in capital had been exhausted, additional charges were recorded by increasing the accumulateddeficit. The Company had determined that conversion and redemption features embedded in the Series D convertible redeemable preferred shares were notrequired to be bifurcated and accounted for as a derivative.Series D WarrantsThe holder of Series D warrants had the right to exercise the warrants at the earlier of (i) 24 months from date of Initial Closing or (ii) automatically exercisedimmediately prior to the closing of the following transactions: (a) mergers or consolidation of the Company, b) initial public offering, c) transaction in whichin excess of 50% of the Company’s equity is transferred to any person, d) sale, transfer, lease, assignment conveyance, exchange, mortgage, or otherdisposition of all or substantially all of the assets of the Company. The warrants were not entitled to dividend rights nor to vote until the warrants wereexercised and shares became issuable. Series D warrants was classified as a liability and initially measured at their fair value at USD 3,007 thousand. As ofDecember 31, 2013, the fair value of Series D warrants was USD 2,186 thousand. For the year ended on December 31, 2012 and 2013, the fair value (loss) /gain recorded were USD 710 thousand and USD 1,531 thousand, respectively.Exchange of Series D warrants and the issuance of Series E warrantsThe warrants to purchase 1,952,663 and 266,272 Series D preferred shares at USD3.38 per share expired on February 6, 2014 and March 1, 2014, respectively.On the date of the expiration, the warrant was measured at a fair value of USD2,414 thousand. It was agreed that upon issuance of the Series E preferred shareson March 5, 2014, the Company would issue to the Series D investor warrants to purchase 3,406,824 Series E preferred shares with an exercise price ofUSD2.82. These warrants are exercisable at the option of the holder, at any time, no later than the earlier of (1) the pricing date of the initial public offering ofthe Company or (2) March 1, 2015. As the warrants were exercised into mezzanine equity, the warrants are classified as a liability and were initially measuredat a fair value of USD2,819 thousand. F- 48Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 14.Redeemable convertible preferred shares (Continued) Series D convertible redeemable preferred shares (Continued) Exchange of Series D warrants and the issuance of Series E warrants (Continued) The exchange of the Series D warrants and the issuance of the Series E warrants were considered to be a related transaction and are accounted for as a singletransaction because the holder was willing to allow the Series D warrants to expire in contemplation that they would be issued Series E warrants. A loss ofUSD405 thousand, which was the difference in value of the Series D warrants on the expiration date and the value of the Series E warrants on the issuancedate was charged to the income statement in quarter one of 2014.The fair value of the Series D warrants and the Series E warrants was estimated by the Company with the assistance of an independent valuation firm based onthe Company’s estimates and assumptions. The valuation report provided the Group with guidelines in determining the fair value, but the determination wasmade by the Group. The Group applied the Black-Scholes Option Pricing Model to calculate the fair value of the Series D warrant on the valuation date.The major assumptions used in calculating the fair value of the Series D warrants include: December 31,2013 February 6,2014 Spot price(1) 4.36 4.47 Risk-free interest rate(2) 0.05% 0%* Volatility rate(3) 30.33% 0%* Dividend yield(4) — — *Given that the maturity date of Series D warrant was February 6, 2014, the volatility rate and risk-free interest rate did not affect the valuation of thewarrant on February 6, 2014.The major assumptions used in calculating the fair value of the Series E warrants include: March 5, 2014 Spot price(1) 3.31 - 4.65 Risk-free interest rate(2) 0.04% - 0.12% Volatility rate(3) 38.39% - 38.81% Dividend yield(4) — (1)Spot price – based on the fair value of 100 percent equity interest of the Company which was allocated to preferred shares and common shares of theCompany as at the valuation date under different scenarios. For the valuation on March 5, 2014 and March 31, 2014, the probability of the occurrenceof an IPO is assumed to be 80%, the probability of the occurrence of a liquidation event is assumed to be 10% and the probability of the occurrence ofa redemption event is assumed to be 10%(2)Risk-free interest rate – based on the US Treasury Bond & Notes BFV curve from Bloomberg as at the valuation date.(3)Volatility – based on the average historical volatility of the comparable companies from Bloomberg as at the valuation date.(4)The Company has no history or expectation of paying dividends on its common shares. F- 49Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 14.Redeemable convertible preferred shares (Continued) Series D convertible redeemable preferred shares (Continued) Exchange of Series D warrants and the issuance of Series E warrants (Continued) Triggering of the anti-dilution clauseUpon issuance of Series E preferred shares in March and April 2014, the Company adjusted the Series D conversion price from USD3.5 to USD2.86 per sharefor 6,771,454 Series D preferred shares held by the Series D Investor. The Company concluded that the downward conversion price adjustment is inaccordance with the anti-dilution clause in the original Series D financing agreement. As a result of this anti-dilution, the Company would issue a total of8,391,850 common shares on a fully-converted basis of the original 6,771,454 Series D preferred shares when the conversion right is exercised by the holder.The downward adjustment of the conversion price did not contain a contingent beneficial conversion feature.For the remaining 3,808,943 Series D preferred shares held by the Series D Investor, the Series D investor agreed to waive the anti-dilution clause as the SeriesD Investor has planned to sell these shares to the Company upon the issuance of Series E preferred shares in March 2014. The waiver of this anti-dilutionclause was accounted for as a modification of the terms of the Series D preferred shares. However, it was determined that the incremental value contributed bythe Series D Investor was deemed to be a transfer of value between the preferred shareholders because 1) the change in value of the common shares before andafter the modification was deemed to be negligible and 2) the modification of the Series D preferred shares were also made concurrent with the sale of theSeries E preferred shares. The Company concluded that this was evidence to suggest that most of the value was transferred from the Series D preferredshareholder to the other existing preferred shareholders. Therefore, no accounting charge was recorded.Upon the completion of the IPO on 24 June 2014, the Company adjusted the Series D conversion price from USD2.86 to USD2.27 per share relating to6,771,454 Series D preferred shares held by the Series D Investor. The Company concluded that the downward conversion price adjustment is in accordancewith the anti-dilution clause in the latest shareholders agreement. As a result of this anti-dilution, the Company would issue a total of 10,581,726 commonshares on a fully-converted basis of the original 6,771,454 Series D preferred shares when the conversion right is exercised by the holder. At the time of thisanti-dilution, the Series D preferred shares anti-diluted contained a beneficial conversion feature of USD4,008 thousand as a deemed dividend to Series DInvestor and charged against retained earnings, and in the absence of retained earnings, a charge to additional paid-in capital.Modification of redemption rightsUpon issuance of the Series E preferred shares in March 2014, the Company amended the redemption rights of 6,771,454 Series D preferred shares. The SeriesD investor shall have the right to request the Company to purchase its shares after February 28, 2017 but no later than February 28, 2018. Prior to themodification, the holder had the right to request the Company to purchase its shares after February 6, 2016 but no later than February 6, 2017. Theamendment of the redemption date was accounted for as modification of the terms of Series D preferred shares. The incremental value received by the Series Dpreferred shareholder amounted to USD279 thousand and was deemed to be a transfer of value between the preferred shareholder and common shareholdersand the amount was charged to retained earnings.In determining the accounting for the modification of the Series D preferred shares, the Company estimated the valuation of the Series D preferred shares withthe assistance of an independent valuation firm based on the Company’s estimates and assumptions. Option-pricing method was used to allocate enterprisevalue to preferred and ordinary shares, taking into account the guidance prescribed by the AICPA Audit and Accounting Practice Aid, “Valuation ofPrivately-Held Company Equity Securities Issued as Compensation”. The method treats common stock and preferred stock as call options on the enterprise’svalue, with exercise prices determined based on the liquidation preference of the preferred stock. The option-pricing method involves making estimates ofthe anticipated timing of a potential liquidity event, such as a sale of the Company or an initial public offering, and estimates of the volatility of theCompany’s equity securities. F- 50Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 14.Redeemable convertible preferred shares (Continued) Series D convertible redeemable preferred shares (Continued) Modification of redemption rights (Continued) The anticipated timing was based on the plans of management. Estimating the volatility of the share price of a privately held company was complex becausethere is no readily available market for the shares. The Company estimated the volatility of its shares to range from 38.39% to 43.40% based on the historicalvolatility of comparable publicly traded shares of companies engaged in similar lines of business.Modification of liquidation rightsUpon issuance of the Series E preferred shares, the Company amended the liquidation rights of Skyline Holdings’ common shares, Series A preferred shares,Series A-1 preferred shares, and Series B preferred shares (collectively, the “Series D Investor Shares”). As a result of this amendment, the Series D InvestorShares had priority to receive proceeds from the Company upon liquidation over the common shares, Series A preferred shares, Series A-1 preferred shares,Series B preferred shares and Series C preferred shares held by other investors. This right given to the Skyline Holdings was non-transferable to a third party.The amendment of the liquidation rights was accounted for as modification of the terms of Series D Investor Shares. However, the incremental value receivedby Skyline Holdings is deemed to be negligible. No accounting charge was recorded by the Company. Similar to the modification of the Series D preferredshares as stated above, the fair value of the Series D preferred shares was estimated by the Company with the assistance of an independent valuation firmbased on the Company’s estimates and assumptions. The Option-pricing method as described above, was also used to account for this modification. TheCompany estimated the volatility of its shares to range from 38.39% to 43.40% based on the historical volatility of comparable publicly traded shares ofcompanies engaged in similar lines of business.The Group had determined that there was no beneficial conversion feature attributable to the Series D preferred shares because the initial and adjustedeffective conversion prices of these preferred shares were higher than the fair value of the Company’s common shares determined by the Group with theassistance from an independent valuation firm.Initial public offeringUpon the completion of the IPO on 24 June 2014, the Series D Investor did not exercise Series E warrants, and the fair value of Series E warrants was nil. Thefair value gain of USD2,922 thousand was recorded for the year ended December 31, 2014 as other income. As a result, 10,581,726 common shares wereissued, and the balance of Series D preferred shares was transferred to common shares and additional paid-in capital on that date. Years ended December 31, (In thousands) 2013 2014 Beginning balance 35,990 40,290 Deemed dividend to Series D shareholder from its modification — 279 Accretion of Series D to convertible redeemable preferred shares redemption value 4,300 1,870 Repurchase of preferred shares — (15,003) Deemed dividend to preferred shareholders upon IPO — 4,008 Converted to common shares upon IPO — (31,444) Ending balance 40,290 — F- 51Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 14.Redeemable convertible preferred shares (Continued) Series E convertible redeemable preferred sharesOn March 5, 2014, the Company entered into an agreement to issue Series E preferred shares (the “Series E Tranche 1 Preferred Shares”) and warrants to athird-party investor (“Series E Tranche 1 Investor”) for a total consideration of USD 200 million. Pursuant to the agreement, the Company issued 70,975,491Series E Tranche 1 Preferred Shares at USD 2.82 per share; and warrants to purchase 17,743,873 Series E preferred shares at USD 2.82 per share at the optionof the holders. In addition, within 3 months after the closing, the Series E Tranche 1 Investor shall have the right (“Subscription Rights”) to purchase, ordesignate any other person/party to purchase from the Company an additional 35,487,746 Series E preferred shares, at a price equal to USD 2.82 per share.The key terms of the Series E preferred shares were as follows:Dividend rightsThe holders of the Series E preferred shares were entitled to participate in any dividend pari passu with common shareholders of the Company on an as-converted basis.Liquidation preferencesBefore any distribution or payment shall be made to the holders of Series A, Series A-1, Series B, Series C and D preferred shares, an amount shall be paid toSeries E holders with respect to each Series E preferred share held by the Series E holder equal to 100% of the applicable original issue price.Voting rightsThe holders of the Series E preferred shares shall be entitled to such number of votes equal to the whole number of common shares into which such Series Epreferred shares are convertible.Conversion rightsEach of the Series E preferred shares was convertible at the option of the holder, at any time after the issuance of such shares, and each share could beconverted into one common share of the Company. The conversion was subject to adjustments for certain events, including but not limited to additionalequity securities issuance, reorganization, mergers, share dividends, distribution, subdivisions, redemptions, combinations, or consolidation of commonshares. The conversion price was also subject to adjustment in the event the Company issues additional common shares at a price per share that was less thansuch conversion price. In such case, the conversion price shall be reduced to adjust for dilution on a weighted average basis.In addition, each of the Series E preferred shares would automatically be converted into common shares of the Company (i) upon the closing of an initialpublic offering of the Company’s shares or (ii) upon written notice to convert given to the Company by the holders of a majority of Series E preferredshareholders. F- 52Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 14.Redeemable convertible preferred shares (Continued) Series E convertible redeemable preferred shares (Continued) Redemption rightThe Series E preferred shares were redeemable at the option of the investor any time after March 1, 2018 but not later than March 1, 2019.The redemption price shall be equal to the aggregate amount of price paid per such share pursuant to the share purchase agreement (i.e. USD 2.82), plusinterest on the original issue price applicable to each Series E convertible redeemable preferred share at a rate of 15% per annum compounded annually fromthe issuance date up to and including the date of redemption, plus all declared but unpaid dividends and distributions on any such Shares; If the Companydid not have sufficient funds to redeem all of the redeemable shares, the Company shall redeem a pro rata portion of each holder’s redeemable shares out offunds legally available; and redeem the remaining shares as soon as practically after the Company had funds legally available therefor.The Company had determined that the Series E preferred shares should be classified as mezzanine equity in the unaudited condensed consolidated balancesheets because the preferred shares are only contingently redeemable by the holder four years after the issuance date. The carrying value of the preferredshares is accreted from its carrying value on the date of issuance to the redemption value using the effective interest method from date of issuance to theearliest redemption date. The accretion was recorded against retained earnings, or in the absence of retained earnings, by charging against additional paid-incapital. Once additional paid-in capital has been exhausted, additional charges should be recorded by increasing the accumulated deficit.The Company assessed beneficial conversion feature attributable to the Series E Tranche 1 Preferred Shares and determined that there was a beneficialconversion feature with an amount of USD52,377 thousand, which was bifurcated from the carrying value of Series E Tranche 1 Preferred Shares as acontribution to additional paid-in capital upon issuance of Series E Tranche 1 Preferred Shares. The discount of USD52,377 thousand resulting from therecognition of the beneficial conversion feature were amortized from the date of the issuance to the first redemption date of the Series E Tranche 1 PreferredShares as a deemed dividend to preferred shareholders and charged against retained earnings, and in the absence of retained earnings, a charge to additionalpaid-in capital. The beneficial conversion feature is calculated based on the difference between an adjusted conversion price of USD2.31 and the Company’scommon share fair value of USD3.05 multiplied by the number of shares into which the preferred shares are convertible into. The conversion price wasadjusted from USD2.82 to USD2.31 principally because liability classified instruments, such as the warrants and the subscription rights (see below for furtherinformation) were issued with the Series E Tranche 1 Preferred Shares. Since the warrants and the subscription rights are classified as liability, the salesproceeds are first allocated to the warrants and the subscription rights’ full fair value (not relative fair value) and the residual amount of the sales process isallocated to the Series E Tranche 1 Preferred Shares to calculate the beneficial conversion feature. (In thousands) December 31,2014 Beginning balance — Addition 275,314 Exercise of Series E subsequent sale rights 28,568 BCF upon Series E (53,486) Amortisation of BCF of Series E 4,139 Accretion of Series E to convertible redeemable preferred shares redemption value 12,754 Acceleration of amortization of BCF of Series E upon IPO 49,346 Deemed dividend to preferred shareholders upon IPO 27,396 Converted to common shares upon IPO (344,031) Ending balance — F- 53Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 14.Redeemable convertible preferred shares (Continued) Series E convertible redeemable preferred shares (Continued) Exchange of Series E Tranche 1 Investor options for transfer restrictionsAs part of the issuance of the Series E Tranche 1 Preferred Shares, the Series E Tranche 1 Investor and the Company’s founders (who are also employees) andtwo employees (collectively the “Grantees”) of the Company agreed that (i) Series E Tranche 1 Investor will grant to the Grantees the right to purchase certainnumber of restricted shares of the Series E Tranche 1 Investor’s own shares with a total subscription consideration of not more than USD20 million at asubscription price subscription price per share that reflects the valuation of the Series E Tranche 1 Investor being USD10 billion (the “Series E Tranche 1Investor Options”); and (ii) the Grantees agreed to impose a transfer restriction (the “Transfer Restrictions”) on 39,934,162 common shares, 3,394,564unvested restricted shares, 180,000 unvested options and 180,000 vested options (the “Shares”) owned by the Grantees. The Transfer Restrictions prohibitthe Grantees from transferring their shares to another person/party until April 24, 2018 or April 24, 2019 as appropriate without the prior written consent ofthe holders of at least 75% of the Series E Tranche 1 Preferred Shares holders The Series E Tranche 1 Investor Options and the Transfer Restrictions are nottied to the Grantees’ future employment with the Company.The value of the Transfer Restrictions was determined to be significantly greater than the value of Series E Tranche 1 Investor Options. In determining thevalue of the Transfer Restrictions, the Company was assisted by an independent valuation firm based on data provided by the Company. The valuation of theTransfer Restrictions is estimated to be USD43.3 million (refer to the valuation methodology below). For the valuation of the Series E Tranche 1 InvestorOptions, the Company was only able to obtain limited financial information from the Series E Tranche 1 Investor, a private company, to perform a valuationanalysis. This information includes high level 2013 revenue data and information of a third party investment transaction that valued the Series E Tranche 1Investor at USD10 billion in August of 2013. Given the lack of financial information, the Company is unable to determine a more precise estimate of the fairvalue of the Series E Tranche 1 Investor Options on the exchange date. If the fair value of the Series E Tranche 1 Investor Options were worth USD43.3million, the estimated value of the Transfer Restrictions, the Series E Tranche 1 Investor itself would need to be estimated at a valuation in excess of USD30billion on March 5, 2014. The Company does not expect the valuation of the Series E Tranche 1 Investor to increase by 200% from USD 10 billion in August2013 to USD 30 billion in March 2014. Hence, no incremental benefit was given to the Grantees and no compensation expense was recognized.To determine the fair value of the Transfer Restrictions, the Company valued the common shares with the Transfer Restrictions and compared this value tothe value of the common shares without the restriction. The difference was determined to be the value of the Transfer Restrictions. A put option pricing modelwas used to determine the discount to be applied to the common shares to arrive at the value of common shares with the Transfer Restrictions. Pursuant to thatmodel, the Company used the cost of a put option, which can be used to hedge the price change before a share subject to transfer restriction can be sold, asthe basis to determine the discount for transfer restrictions. A put option was used because it incorporates certain company-specific factors, including timingof the expected initial public offering or duration of the Transfer Restriction and the volatility of the share price companies engaged in the same industry.Series E WarrantsThe Series E warrants (“Series E warrants”) granted to the Series E Tranche 1 Investor is exercisable at the option of the Series E Tranche 1 Investor, at anytime, on or after January 1, 2015 and no later than March 1, 2015. The warrants are not exercisable if the Company has completed the initial public offeringin the United States by December 31, 2014. The exercise price shall be adjusted from time to time as provided below: proportionate adjustment for issuanceof additional common shares, share split and combination, dividend and distributions, reclassification, reorganization, merger, and consolidations. F- 54Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 14.Redeemable convertible preferred shares (Continued) Series E convertible redeemable preferred shares (Continued) Series E Warrants (Continued) The warrants are not entitled to dividend rights nor to vote until the warrants are exercised and shares become issuable. The Series E warrants are initiallymeasured at its fair value and the initial carrying value for Series E Tranche 1 Preferred Shares is allocated on a residual basis as the warrant is liabilityclassified. The Series E warrants are initially measured at their fair value of USD 6,477 thousand.The fair value of the Series E warrants were estimated by the Company with the assistance from an independent valuation firm based on data provided by theCompany. The valuation report provided by the Company with guidelines in determining the fair value, but the determination was made by the Company.The Company applied the Black-Scholes Option Pricing Model to calculate the fair value of the Series E warrants on the valuation date.The major assumptions used in calculating the fair value of the Series E warrants include: March 5,2014Spot price(1) 4.50 - 4.65Risk-free interest rate(2) 0.12%Volatility rate(3) 38.81%Dividend yield(4) — (1)Spot price – based on the fair value of 100 percent equity interest of the Company which is allocated to preferred shares and common shares of theCompany as at the valuation date under different scenarios. The probability of the occurrence of an IPO is assumed to be 80%, the probability of theoccurrence of a liquidation event is assumed to be 10% and the probability of the occurrence of a redemption event is assumed to be 10%.(2)Risk-free interest rate – based on the US Treasury Bond & Notes BFV curve from Bloomberg as at the valuation date.(3)Volatility – based on the average historical volatility of the comparable companies from Bloomberg as at the valuation date.(4)The Company has no history or expectation of paying dividends on its common shares.Subscription RightsWithin 3 months after March 5, 2014, the Series E Tranche 1 Investor shall have Subscription Rights to purchase, or designate any other person/party topurchase from the Company an additional number of 35,487,746 Series E preferred shares, at a price equal to the purchase price per share (USD 2.82) of theSeries E issuance. The exercise price shall be adjusted from time to time as provided below: proportionate adjustment for issuance of additional commonshares, share split and combination, dividend and distributions, reclassification, reorganization, merger, and consolidations. The Subscription Rights are notentitled to dividend rights nor to vote until the Subscription Rights have been exercised and shares are issuable.On April 24, 2014, two of the three Series E Tranche 2 Investors exercised the Subscription Rights assigned to them by the Series E Tranche 1 Investor topurchase USD100 million while the third Series E Tranche 2 investor purchased the remaining USD10 million. Upon the exercise of the Subscription Rights,the fair value of the warrant liability of USD 29,223 thousand was derecognized and credited to carrying amount of the Series E Tranche 2 Preferred Shares. F- 55Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 14.Redeemable convertible preferred shares (Continued) Series E convertible redeemable preferred shares (Continued) Subscription Rights (Continued) The fair value of the Subscription Rights was estimated by the Company with the assistance from an independent valuation firm based on data provided bythe Company. The valuation report provided by the Company with guidelines in determining the fair value, but the determination was made by theCompany. The Company applied the Black-Scholes Option Pricing Model to calculate the fair value of the Subscription Rights on the valuation date. TheSubscription Rights are initially measured at their fair value of USD 28,208 thousand. As of April 24, 2014, the fair value of Subscription Rights was USD29,223 thousand.The major assumptions used in calculating the fair value of the Subscription Rights include: March 5,2014 April 24,2014 Spot price(1) 3.31 - 4.65 3.39 - 4.64 Risk-free interest rate(2) 0.04% 0.02% Volatility rate(3) 38.12% 42.74% Dividend yield(4) — — (1)Spot price – based on the fair value of 100 percent equity interest of the Company which is allocated to preferred shares and common shares of theCompany as at the valuation date under different scenarios. The probability of the occurrence of an IPO is assumed to be 80%, the probability of theoccurrence of a liquidation event is assumed to be 10% and the probability of the occurrence of a redemption event is assumed to be 10%.(2)Risk-free interest rate – based on the US Treasury Bond & Notes BFV curve from Bloomberg as at the valuation date.(3)Volatility – based on the average historical volatility of the comparable companies from Bloomberg as at the valuation date.(4)The Company has no history or expectation of paying dividends on its common shares.Issuance of Series E Tranche 2 Preferred SharesOn April 24, 2014, the Company issued Series E convertible redeemable preferred shares (the “Series E Tranche 2 Preferred Shares”) to three investors (the“Series E Tranche 2 Investors”) to subscribe 39,037,382 Series E Tranche 2 Preferred Shares for a total consideration of USD110 million.The Company assessed the beneficial conversion feature attributable to the Series E Tranche 2 Preferred Shares and determined that there was a beneficialconversion feature with an amount of USD1,109 thousand for the Series E Tranche 2 Preferred Shares of USD10 million issued to one investor. For theremaining Series E Tranche 2 Preferred Shares of USD100 million issued to another two investors, there was no beneficial conversion feature attributable tothem. F- 56Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 14.Redeemable convertible preferred shares (Continued) Series E convertible redeemable preferred shares (Continued) Initial public offeringUpon the completion of the IPO on 24 June 2014, the Company adjusted the Series E conversion price from USD2.82 to USD2.4 per share relating to110,014,440 Series E preferred shares held by the Series E investors. The Company concluded that the downward conversion price adjustment is inaccordance with the anti-dilution clause in the latest shareholders agreement. As a result of this anti-dilution, the Company issued a total of 129,166,667common shares on a fully-converted basis when the conversion right is exercised by the Series E shareholders. The triggering of the anti-dilution clauseresulted in a beneficial conversion feature amounted to USD 27,396 thousand which was charged to retained earnings in 2014 as a deemed dividend to SeriesE shareholders. And the unamortized beneficial conversion features of Series E preferred shares of USD49,346 thousand were recognized upon thecompletion of the IPO as a deemed dividend to Series E investors and charged against retained earnings, and in the absence of retained earnings, a charge toadditional paid-in capital.Upon the completion of the IPO on 24 June 2014, the Series E warrants are not exercisable in future. As a result, the fair value of Series E warrants liability ofUSD6,381 thousand was derecognized and the related fair value gain was recognized as other income. 15.Convertible preferred sharesThe key terms of the Series A, Series A-1, Series B and Series C preferred shares are as follows:Dividend rightsThe holders of the Series A, Series A-1, Series B and Series C preferred shares are entitled to participate in any dividend pari passu with common shareholdersof the Company on an as-converted basis.Liquidation preferencesIn the event of a liquidation, dissolution or winding up of the Company, available assets and funds of the Company are distributed to the holders of thepreferred shares in order of 1) Series C and Series B which are grouped as one class for the purpose of liquidation preference, 2) Series A-1 and then 3)Series A, at their respective original issuance price per share plus any declared but unpaid dividends adjusted for share splits, share dividends,recapitalizations, and other adjustments. In the event that available assets and funds are insufficient to permit payment to the holders of the less senior classof preferred shares, the assets and funds will be distributed ratably to that class of preferred shareholders based on their proportional share ownership. After thedistribution to the holders of Series C and Series B, Series A-1, Series A preferred shares and common shares are made, any remaining legally available assetsand funds shall be distributed to the holders of common shares and Series C and Series B, Series A-1 and Series A preferred shares pro rata on an as-convertedbasis.In addition, the following events are deemed liquidation events in which case any proceeds derived from such deemed liquidation events will be distributedin the order discussed above. If no proceeds are derived from such deemed liquidation events, the Series B preferred shareholders shall have the right torequire the Company to repurchase all or any of the outstanding Series B preferred shares at the original issue price. F- 57Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 15.Convertible preferred shares (Continued) Liquidation preferences (Continued) 1)Any consolidation or merger of the Company or other corporate reorganization, in which the shareholders of Company own less than a majority of thevoting power of the Company or surviving company, after such consolidation, merger or reorganization 2)A sale of other disposition of all or substantially all of the assets of the Company or the Group 3)A transfer or an exclusive licensing of all or substantially all of the intellectual property of the CompanyHowever, all liquidation events or deemed liquidation event have to be approved by a special resolution passed by a duly convened general meeting of theCompany, which require presence of a representative from the common shareholders, a representative from Series A-1 preferred shareholders and arepresentative from Series B preferred shareholders. Accordingly, the Company determined that the deemed liquidation events are within the control of theCompany and the Series B preferred shareholders do not have control of the Company. Therefore, the deemed liquidation events do not preclude the Series Bpreferred shares from being classified within permanent equity.Voting rightsThe holders of the Series A, Series A-1, Series B and Series C preferred shares shall be entitled to such number of votes equal to the whole number of commonshares into which such Series A, Series A-1, Series B and Series C preferred shares are convertible.Conversion rightsEach share of the Series A, Series A-1, Series B and Series C preferred shares is convertible at the option of the holder, at any time after the issuance of suchshares, and each share can be converted into one common share of the Company. In addition, each share of the Series A, Series A-1, Series B and Series Cpreferred shares would automatically be converted into common shares of the Company upon (i) an underwritten public offering of the company’s shares onmajor stock exchanges, including Nasdaq Global Market that results in proceeds to the Company of at least USD 50 million (“QIPO”) or (ii) upon writtennotice to convert given to the Company by the holders of a majority of such class or series of preferred shares in issue, in each case voting as a separate classon an as converted basis, as applicable.At the time of issuance, the Series A preferred shares issued to one of the shareholders in 2005 contained a beneficial conversion feature of USD 54 thousandand the amount was charged to retained earnings in 2005 as a deemed dividend.At the time of anti-dilution, the Series C preferred shares anti-diluted in 2012 contained a beneficial conversion feature of USD 286 thousand and the amountwas charged to retained earnings in 2012 as a deemed dividend. There were no beneficial conversion features for the other issuance.In April, 2011, the Company removed the USD 50 million threshold from the definition of QIPO. The removal of the threshold is not expected to have asignificant impact to the financial statements of the Company.None of the preferred shares are redeemable at the holders’ option. F- 58Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 15.Convertible preferred shares (Continued) Modification in 2012Upon issuance of Series D preferred shares in January 2012 as discussed in note 13, the Company adjusted the Series C conversion price from USD5.24 toUSD4.14 per share; and obtained an exclusive option to purchase at any time within 12 months after the date of the conversion for all, but not less than all, ofSeries C preferred shares at the purchase price of USD4.607 per common share. The Series C conversion price could be adjusted for any share dividends, sub-division and consolidation, and unpaid dividend. As a result of this modification, the Company would issue a total of 7,248,293 common shares on a fully-converted basis of the original 5,728,264 Series C preferred shares when the conversion right is exercised by the holder. Other terms of the Series C preferredshares including the original liquidation rights remained unchanged.The Company concluded that the downward conversion price adjustment from USD 5.24 to USD 5.13 is in accordance with the anti-dilution clause in theoriginal Series C financing agreement. The incremental downward price adjustment from USD 5.13 to USD 4.14 and the right to an exclusive purchase optionare accounted for as modifications of the terms of Series C preferred shares. The incremental value contributed by the Series C preferred shareholder amountedto USD 2,905 thousand and was deemed to be a wealth transfer between the preferred shareholder and common shareholders and the amount was charged toadditional paid-in capital.In determining the accounting for the modification of the Series C preferred shares, the Group also relied on, in part, a valuation report retrospectivelyprepared by an independent valuer based on data provided by the Group. The valuation report provided the Group with guidelines in determining the fairvalue, but the determination was made by the Group. Option-pricing method was used to allocate enterprise value to preferred and ordinary shares, takinginto account the guidance prescribed by the AICPA Audit and Accounting Practice Aid, “Valuation of Privately-Held Company Equity Securities Issued asCompensation”. The method treats common stock and preferred stock as call options on the enterprise’s value, with exercise prices determined based on theliquidation preference of the preferred stock.The option-pricing method involves making estimates of the anticipated timing of a potential liquidity event, such as a sale of the Company or an initialpublic offering, and estimates of the volatility of the Group’s equity securities. The anticipated timing is based on the plans of management. Estimating thevolatility of the share price of a privately held company is complex because there is no readily available market for the shares. The Group estimated thevolatility of its shares to range from 55.36% to 59.91% based on the historical volatility of comparable publicly traded shares of companies engaged insimilar lines of business.Modification in 2014In January of 2014, the Company modified the anti-dilution terms relating to 5,613,699 Series C preferred shares held by one investor (“Series C Investor 1”).The modification effectively amended the anti-dilution triggering price from USD4.14 to USD2.81 per share. The incremental downward trigger priceadjustment from USD 4.14 to USD 2.81 is accounted for as modifications of the terms of Series C preferred shares. The incremental value contributed by theSeries C preferred shareholder was deemed to be a transfer of value between the preferred shareholders because the change in the value of the common sharesbefore and after the modification was deemed to be negligible. The Company concluded that this was evidence to suggest that most of the value wastransferred from this Series C preferred shareholder to the other existing preferred shareholders. No accounting charge was recorded by the Company. F- 59Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 15.Convertible preferred shares (Continued) Triggering of the anti-dilution clauseUpon issuance of Series E preferred shares in March and April 2014, the Company adjusted the Series C conversion price from USD4.14 to USD3.64 and fromUSD3.64 to USD3.63 per share relating to 114,565 Series C preferred shares held by one investor (“Series C Investor 2”), respectively. The Companyconcluded that the downward conversion price adjustment is in accordance with the anti-dilution clause in the original Series C financing agreement. As aresult of this anti-dilution, the Company would issue a total of 165,236 common shares on a fully-converted basis of the original 114,565 Series C preferredshares when the conversion right is exercised by the holder. At the time of this anti-dilution, the Series C preferred shares anti-diluted in 2014 contained abeneficial conversion feature of USD 58 thousand and the amount was charged to retained earnings in 2014 as a deemed dividend. The issuance of the SeriesE Tranche 1 Preferred Shares did not triggered the anti-dilution term of Series C Investor 1 as their shares were modified as described above.Upon the completion of the IPO on 24 June 2014, the Company adjusted the Series C conversion price from USD4.14 to USD3.89 and from USD3.63 toUSD3.45 per share relating to 5,613,699 Series C preferred shares held by Series C Investor 1 and 114,565 Series C preferred shares held by Series C Investor2, respectively. The Company concluded that the downward conversion price adjustment is in accordance with the anti-dilution clause in the latestshareholders agreement. As a result of this anti-dilution, the Company issued a total of 7,724,419 common shares on a fully-converted basis when theconversion right is exercised by the Series C shareholders. The triggering of the anti-dilution clause resulted in a beneficial conversion feature amounted toUSD 1,403 thousand as a deemed dividend to Series C shareholders and charged against retained earnings, and in the absence of retained earnings, a chargeto additional paid-in capital.As a result, 96,024,567 common shares were issued, and the balance of Series A, Series A-1, Series B and Series C preferred shares was transferred to commonshares and additional paid-in capital on the same date. 16.Common sharesThe Company’s Memorandum and Articles of Association authorizes the Company to issue 1,000,000,000 shares of USD0.00025 par value per commonshare as of December 31, 2014. Each common share is entitled to one vote. The holders of common shares are also entitled to receive dividends wheneverfunds are legally available and when declared by the Board of Directors, which is subject to the approval by the holders of the common shares representing amajority of the aggregate voting power of all outstanding shares. As of December 31, 2013 and 2014, there were 61,447,372 and 327,611,487 common sharesoutstanding, respectively. In November 2013 and April 2014, 9,073,732 shares and 14,195,412 shares of USD0.00025 par value per common share wereissued to Leading Advice Holdings Limited, a BVI Company owned by the Group’s chairman and chief executive officer for no consideration, respectively.While the common shares have been legally issued, the common shares issued to Leading Advice do not have the attributes of unrestricted, issued andoutstanding shares. Therefore, these shares issued to Leading Advice are accounted as treasury shares. F- 60Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 17.Repurchase of sharesOn April 15, 2014, the Company repurchased from Skyline 469,225 common shares, 27,180 Series A preferred shares, 591,451 Series A-1 preferred shares,725,237 Series B preferred shares and 3,808,943 Series D convertible redeemable preferred shares at a consideration of approximately USD24,276 thousand.On April 24, 2014, the Company repurchased from a number of existing shareholders the following common and preferred shares for a total consideration ofUSD49,809 thousand. The Company repurchased the following common and preferred shares at a per share price of USD2.82, equal to the issuance price ofthe Series E preferred shares: • 10,334,679 common shares from Vantage Point Global Limited (Founder’s company) for USD29,121 thousand; • 3,860,733 common shares from Aiden & Jasmine Limited (Co founder’s company) for USD10,879 thousand; • 450,000 Series A preferred shares from Bright Access International Limited for USD1,268 thousand; • 2,921,868 Series B preferred shares from Fidelity Asia Ventures Fund L.P. for USD8,233 thousand; • 108,960 Series B preferred shares from Fidelity Asia Principals Fund L.P. for USD308 thousand;For accounting purposes, the Company determined the per share fair value of the common shares, Series A preferred shares, and Series B preferred shares to beUSD3.13, USD3.13, and USD3.19, respectively, on April 24, 2014, the date of repurchase. The repurchase price of USD2.82 was mutually negotiated at thetime of the repurchase transactions. There were no other arrangements with the selling shareholders other than the exchange of Xiaomi options for transferrestrictions as described above. The selling shareholders were willing to sell its common and preferred shares at the USD2.82 per share price as it wouldprovide them with as a form of liquidity. For the common shares repurchased, the Company charged the excess of the purchased price over the par value toadditional paid in capital. For the preferred shares repurchased, the Company charged the excess of the purchase price over the carrying value to retainearnings or to additional paid in capital if retained earnings is zero.On the same day, April 24, 2014, the Company transferred a total of 14,195,412 repurchased common shares to Leading Advice for future issuance ofrestricted shares under the Company’s 2014 Plan and cancelled the remaining repurchased shares. While the common shares have been transferred to LeadingAdvice, the common shares issued to Leading Advice do not have the attributes of unrestricted, issued and outstanding shares. Therefore, these shares issuedto Leading Advice are accounted as treasury shares.According to the repurchase contract, the Company was entitled to an amount (the “Withheld Price”) to withhold any taxes with respect to this repurchase asrequired under the applicable laws. If the Seller has not been specifically required by the applicable governmental or regulatory authority to pay any taxes asrequired under the applicable laws in connection with the repurchase, after the fifth anniversary of the Closing Date, the Company will pay to the Seller theWithheld Price with a simple interest thereon at the rate of five percent (5%) per annum (the “repayment price”) from the Closing Date. Therefore, theWithheld Price was recognized as long-term payable of USD4,782 thousand including due to related parties, non-current portion in the financial statements. 18.Non-controlling interestNon-controlling interest includes the interest owned by a shareholder of the Company in a subsidiary of the consolidated VIE.In February 2010, Shenzhen Xunlei set up a new subsidiary named Xunlei Games Development (Shenzhen) Co., Ltd (“Xunlei Games”) and holds 70% of itsequity interest. A shareholder of the Company contributed RMB 3,000 thousand (equivalent to USD439 thousand) and holds 30% equity interest in XunleiGames, which was accounted for as a non-controlling interest of the Group. F- 61Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 19.Share-based compensation2010 share incentive planDuring the years presented, the Company granted share options to employees, officers and directors of the Group. There were no options granted to non-employees as of December 31, 2012, 2013 and 2014.These options were granted with exercise prices denominated in the USD, which is the functional currency of the Company. The maximum term of any issuedstock option is seven or ten years from the grant date. Stock options granted to employees and officers vest over a four-year schedule as stated below: (1)One-fourth of the options shall be vested upon the first anniversary of the grant date; (2)The remaining three quarters of the options shall be vested on monthly basis over the next thirty-six months. (1/48 of options shall be vested permonth subsequently)Stock options granted to directors were subject to a vesting schedule of approximately 32 months.All share-based payments to employees are measured based on their grant-date fair values. Compensation expense is recognized on a straight-line basis overthe requisite service period.In December 2010, the Group adopted a share incentive plan, which is referred to as the 2010 Share Option Plan (“the 2010 Plan”). The purpose of the plan isto attract and retain the best available personnel by linking the personal interests of the members of the board, employees, and consultants to the success ofthe Group’s business and by providing such individuals with an incentive for outstanding performance to generate superior returns for our shareholders.Under the 2010 Plan, the maximum number of shares in respect of which options, restricted shares, or restricted share units may be granted is 26,822,828shares (excluding the share options previously granted to the directors who are the founders of the Company). The amount of shares available for such grantsas of December 31, 2014 is 8,043,115.On June 11, 2014, board of directors of the Group decided to extended the contractual life for certain vested share options to June 11, 2015, because thematurity date of these options was from June to December in 2014, whereas, the lock-up period for the shares was 6 months from the IPO closing date, i.e.June 24, 2014, which would result in the expiration of these options before the exercise. The incremental share-based compensation of USD768 is recognizedat the time of modification.In the business combination of personal cloud storage business completed on September 5, 2014, the Group granted share options under the 2010 Plan toreplace the unvested awards owned by the employees who are transferred to the Group, the portion of the fair-value-based measure of the replacement awardattribute to pre-combination service of USD 303 thousand was allocated to the consideration, while the portion attribute to post-combination service ofUSD44 thousand was recorded as share based compensation expense over the remaining vesting period (See Note 3).On December 1, 2014, board of directors of the Group approved the conversion of certain vested and unvested share options with relatively high exerciseprice into restricted shares. In this conversion, 3,776,711 share options were cancelled and 1,505,787 restricted shares were granted. The incremental share-based compensation of USD 2,214 thousand is recorded over the remaining vesting period of 2 to 4.5 years.In November 2014, the Company issued to a depositary bank for American Depositary Shares, 10,000,000 common shares, which were reserved for the futureexercise of share options or vesting of restricted shares. F- 62Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 19.Share-based compensation (Continued) 2010 share incentive plan (Continued) The following table summarizes the share option activity for the years ended December 31, 2012, 2013 and 2014: Number ofshare options Weightedaverageexerciseprice (USD) Weighted-averagegrant-datefairvalue (USD) Weightedaverageremainingcontractuallife(years) Aggregateintrinsicvalue (inthousands) Outstanding, December 31, 2011 20,891,782 1.30 3.87 43,068 Granted 320,000 2.73 1.59 Forfeited (989,120) 1.72 Outstanding, December 31, 2012 20,222,662 1.30 2.82 40,788 Granted 1,076,761 3.33 1.27 Forfeited (326,647) 3.32 Outstanding, December 31, 2013 20,972,776 1.37 — 2.03 39,420 Vested and expected to vest at December 31, 2013 20,701,286 1.32 0.40 1.89 41,014 Exercisable at December 31, 2013 19,382,156 1.17 0.31 1.67 40,771 Granted 1,566,381 3.23 1.01 Forfeited (371,989) 3.96 Expired (1,116,531) 0.26 Converted to restricted shares (3,776,711) 3.14 Exercised (note a) (7,333,641) 0.18 Outstanding, December 31, 2014 9,940,285 1.88 1.95 3,067 Vested and expected to vest at December 31, 2014 9,642,307 1.86 0.49 1.87 3,057 Exercisable at December 31, 2014 9,129,958 1.81 0.41 1.49 3,042 Note a: Of which 1,431,320 shares had been settled as of December 31, 2014.A summary of the restricted shares activities under the 2010 Plan for the years ended December 31, 2014 is presented below: (In thousands) Number ofrestrictedshares Weighted-AverageGrant-Date FairValue Unvested at January 1, 2014: — Converted from share options 1,505,787 1.71 Vested — Forfeited — Unvested at December 31, 2014 1,505,787 Vested and expected to vest at December 31, 2014 1,279,919 Forfeitures are estimated at the time of grant. If necessary, forfeitures are revised in subsequent periods if actual forfeitures differ from those estimates. Basedupon the Company’s historical and expected forfeitures for stock options granted, the directors of the Company estimated that its future forfeiture rate wouldbe 20% for employees and nil for directors and advisors. F- 63Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 19.Share-based compensation (Continued) 2010 share incentive plan (Continued) The aggregate intrinsic value in the table above represents the difference between the estimated fair value of the Company’s common shares as ofDecember 31, 2013 and 2014 and the exercise price.Total fair values of share options vested as of December 31, 2013 and 2014 were USD 6,271 thousand and USD 7,923 thousand, respectively.As of December 31, 2013 and 2014, there were USD 2,803 thousand and USD 1,462 thousand of unrecognized share-based compensation costs related toshare options, which were expected to be recognized over a weighted-average vesting period of 2.66 and 2.84 years, respectively. To the extent the actualforfeiture rate is different from the Company’s estimate, the actual share-based compensation related to these awards may be different from the expectation.The Black-Scholes option pricing model is used to determine the fair value of the stock options granted to employees. The fair values of stock optionsgranted during the years ended December 31, 2012, 2013 and 2014 were estimated using the following assumptions:Options granted to employees Years ended December 31, 2012 2013 2014 Risk-free interest rate(1) 0.67% to 0.92% 0.77% to 1.76% 0.77% to 1.76% Dividend yield(2) — — — Volatility rate(3) 53.9% to 54.5% 43.8% to 51.3% 40.07% to 43.3% Expected term (in years)(4) 4.58 4.58 4.13 to 4.58 (1)The risk-free interest rate of periods within the contractual life of the share option is based on the USD denominated China Government Bond yield asat the valuation dates.(2)The Company has no history or expectation of paying dividends on its common shares.(3)Expected volatility is estimated based on the average of historical volatilities of the comparable companies in the same industry as at the valuationdates.(4)The expected term is developed by assuming the share options will be exercised in the middle point between the vesting dates and maturity dates.2013 share incentive planIn November 2013, the Group adopted a share incentive plan, which is referred to as the 2013 Share Incentive Plan (“the 2013 Plan”). The purpose of the planis to motivate, attract and retain the best available personnel by linking the personal interests of senior management to the success of the Group’s business.The group appointed Leading Advice Holdings Limited (“Leading Advice”), a BVI company owned by the Group’s chairman and chief executive officer forno consideration, to administer the plan and is the Administrator. Leading Advice has no activities other than administering the plan and does not haveemployees. The Group has considered whether Leading Advice is a variable interest entity and, if so, whether the Group is the primary beneficiary. The Groupconcluded that it is not the primary beneficial of Leading Advice. F- 64Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 19.Share-based compensation (Continued) 2013 share incentive plan (Continued) On behalf of the Group, the Administrator has the authority to select the eligible participants to whom awards will be granted: determine the types of awardsand the number of shares covered: establish the terms, conditions and provisions of such awards; cancel or suspend awards; and, under certain conditions toaccelerate the exercisability of awards. The Administrator is authorized to interpret the 2013 Plan; to establish, amend, and rescind any rules and regulationsrelating to the 2013 Plan; to determine the terms of agreements entered into with recipients under the 2013 Plan; and, to make all other determinations thatmay be necessary or advisable for the administration of the 2013 Plan. In the event of any disagreement between the Group and Leading Advice, the Group’sdecision shall be final and binding.In November 2013, the Company issued 9,073,732 common shares to Leading Advice. Although the shares were legally issued to Leading Advice, LeadingAdvice does not have any of the rights of a typical common share holder. Leading Advice 1) is not entitled to dividends 2) does not have the right to voteprior to vesting and 3) does not have the right to sell the unvested portion of the awards or awards that have not been granted. In addition, upon 1) theliquidation of Leading Advice 2) the dissolution of Leading Advice and 3) the expiration of the 2013 Plan, common shares not granted as awards shall betransferred back to the Group at no consideration. Given the structure of this arrangement, while the common shares have been legally issued, the commonshares issued to Leading Advice do not have the attributes of unrestricted, issued and outstanding shares. Therefore, the 9,073,732 common shares issued toLeading Advice are accounted as treasury shares until these common shares are earned by the senior management or employees for service provided to theGroup.For the awards that have been granted and become vested, Leading Advice held shares for the grantees’ benefit and exercise the voting rights on their behalf.The grantees will be entitled to dividends and have the right to request Leading Advice to transfer vested award to a transferee designated by the grantees.Shares that have been granted and vested continued to be held by and voting rights exercised by Leading Advice on behalf of the grantee at the closing of aQIPO.Before the closing of a QIPO, the Company would have a “right of first refusal” with respect to any proposed transfer of vested restricted shares. After theclosing of a QIPO, vested restricted shares may not be sold or transferred for a period of six months or a period of time determined by the underwriter (the“lock up period”). If the grantee terminates its employment prior to the closing date of a QIPO and a trade sale, the Group would have the right to acquire thevested restricted shares from the senior officer at a market price as determined by third-party valuation experts.Upon the closing of IPO, the administrator of the 2013 Plan was changed from Leading Advice to the Company’s compensation committee.Under the 2013 Plan, the maximum number of restricted shares that may be granted is 9,073,732 shares.As of December 31, 2014, 8,764,000 restricted shares were granted to a few senior officers. F- 65Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 19.Share-based compensation (Continued) 2013 share incentive plan (Continued) (1)6,285,737 of these restricted shares will vest over a four-year schedule in which one-fourth of the restricted shares shall be vested upon the first, second,third, and fourth anniversary of the grant date, respectively. (2)1,383,858 of these restricted shares will vest over a five-year schedule in which one-fifth of the restricted shares shall be vested upon the first, second,third, fourth and fifth anniversary of the grant date, respectively. (3)60,000 of these restricted shares will vest over one year schedule in which one-fourth of the restricted shares shall be vested upon the end of eachquarter since the grant date. (4)180,000 of these restricted shares will vest in one month since the grant date. (5)The remaining 854,405 restricted shares granted will vest over a four-year schedule as stated below: (i)One-fourth of the restricted shares shall vest on the earlier of: (i) the first anniversary of the grant date, or (ii) upon a QIPO; and (ii)The remainder three quarters of the restricted shares shall vest in equal instalments on a monthly basis over a thirty-six month vesting periodafterwards.A summary of the restricted shares activities under the 2013 Plan for the years ended December 31, 2012, 2013 and 2014 is presented below: (In thousands) Number ofrestrictedshares Weighted-AverageGrant-Date FairValue Unvested at January 1, 2013: — Granted 8,095,238 3.15 Unvested at December 31, 2013 8,095,238 Granted 4,233,558 2.89 Vested (1,563,222) Forfeited (3,564,796) Unvested at December 31, 2014 7,200,778 Vested and expected to vest at December 31, 2014 7,683,884 Forfeitures are estimated at the time of grant. If necessary, forfeitures are revised in subsequent periods if actual forfeitures differ from those estimates.All restricted shares granted to senior officers are measured based on their grant-date fair values. Compensation expense is recognized on a straight-line basisover the requisite service period. As of December 31, 2014, total unrecognized compensation expense relating to the restricted shares was USD 20,058thousand. No restricted shares were issued to non-employees. F- 66Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 19.Share-based compensation (Continued) 2014 share incentive planIn April 2014, the Group adopted a share incentive plan, which is referred to as the 2014 Share Incentive Plan (“the 2014 Plan”). The purpose of the plan is tomotivate, attract and retain the best available personnel by linking the personal interests of senior management to the success of the Group’s business. Underthe 2014 Plan, the maximum number of restricted shares that may be granted is 14,195,412 shares to certain officers, directors or employees of, or advisors orconsultants to the Company and its subsidiaries and consolidated affiliated entities. The company issued 14,195,412 common shares to Leading Advice, acompany owned by the Group’s chairman and chief executive officer. The issuance of common shares was to facilitate the administration of the 2014 plan.The 2014 Plan was administered by the Company’s compensation committee.As of December 31, 2014, 3,896,500 restricted shares were granted to certain officers and employees of the Group: (1)2,096,500 of these restricted shares will vest over a five-year schedule in which one-fifth of the restricted shares shall be vested upon the first, second,third, fourth and fifth anniversary of the grant date, respectively. (2)The remaining 1,800,000 restricted shares will vest over a four-year schedule in which one-fourth of the restricted shares shall be vested upon the first,second, third and fourth anniversary of the grant date, respectively.A summary of the restricted shares activities under the 2014 Plan for the years ended December 31, 2014 is presented below: (In thousands) Number ofrestrictedshares Weighted-AverageGrant-Date FairValue Unvested at January 1, 2014 — Granted 3,896,500 1.77 Unvested at December 31, 2014 3,896,500 Vested and expected to vest at December 31, 2014 3,312,025 Forfeitures are estimated at the time of grant. If necessary, forfeitures are revised in subsequent periods if actual forfeitures differ from those estimates.All restricted shares granted are measured based on their grant-date fair values. Compensation expense is recognized on a straight-line basis over the requisiteservice period. As of December 31, 2014, total unrecognized compensation expense relating to the restricted shares was USD 6,713 thousand. No restrictedshares were issued to non-employees.Total compensation costs recognized for the years ended December 31, 2012, 2013 and 2014 are as follows: Years ended December 31, (In thousands) 2012 2013 2014 Sales and marketing expenses 46 43 66 General and administrative expenses 1,102 1,080 6,407 Research and development expenses 1,085 973 1,171 Total 2,233 2,096 7,644 F- 67Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 20.Basic and diluted net (loss) / income per shareBasic and diluted net (loss) / income per share for the years ended December 31, 2012, 2013 and 2014 are calculated as follows: (Amounts expressed in thousands of United States dollars (“USD”), except fornumber of shares and per share data) Years ended December 31, 2012 2013 2014 Numerator: Net (loss) / income attributable to Xunlei Limited 503 10,662 10,812 Beneficial Conversion Feature of Series C convertible preferred shares from theirmodifications (286) — — Deemed contribution from Series C preferred shareholders 2,979 — — Accretion of Series D to convertible redeemable preferred shares redemption value (3,509) (4,300) (1,870) Contingent beneficial conversion feature of series C to one Series C shareholder — — (57) Deemed dividend to Series D shareholder from its modification — — (279) Accretion of Series E to convertible redeemable preferred shares redemption value — — (12,754) Amortization of beneficial conversion feature of Series E — — (4,139) Deemed dividend to certain shareholders from repurchase of shares — — (14,926) Acceleration of amortization of beneficial conversion feature of Series E uponinitial public offering — — (49,346) Deemed dividend to preferred shareholders upon IPO — — (32,807) Allocation of net income to participating preferred shareholders — (4,094) — Numerator of basic net (loss) / income per share (313) 2,268 (105,366) Dilutive effect of warrant — (1,531) — Numerator for diluted (loss) / income per share (313) 737 (105,366) Denominator:Denominator for basic net (loss) / income per share-weighted average sharesoutstanding 61,447,372 61,447,372 194,711,227 Dilutive effect of warrants — 2,218,935 — Dilutive effect of share options and restricted shares — 12,399,591 — Denominator for diluted net (loss) / income per share 61,447,372 76,065,898 194,711,227 Basic net (loss) / income per share (0.01) 0.04 (0.54) Diluted net (loss) / income per share (0.01) 0.01 (0.54) F- 68Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 20.Basic and diluted net (loss) / income per share (Continued) The following common shares equivalent were excluded from the computation of diluted net income per common share for the periods presented becauseincluding them would have had an anti-dilutive effect: Years ended December 31, 2012 2013 2014 Preferred shares—weighted average 110,083,912 110,953,534 93,213,683 Share options and restricted shares —weighted average 2,240,681 2,513,017 9,041,434 21.Related party transactionsThe table below sets forth the related parties and their relationships with the Group: Related Party Relationship with the GroupZhuhai Qianyou Equity investment of the GroupHao Cheng Co-founder and shareholder of the GroupChuan Wang Director of the CompanyShenglong Zou Co-founder and shareholder of the GroupBeijing Millet technology Co., LTD (“Beijing Xiaomi”) Company owned by a shareholder of the GroupLeading Advice Holdings Limited Company owned by a Co-founder and shareholder of the GroupVantage Point Global Limited Shareholder of the CompanyAiden & Lasmine Limited Shareholder of the CompanyKingsoft Corporation Limited Shareholder of the CompanyDuring the years ended December 31, 2012, 2013 and 2014, significant related party transactions were as follows: Years ended December 31, (In thousands) 2012 2013 2014 Game sharing costs paid and payable to Zhuhai Qianyou (note a) 1,041 1,760 402 Advance to Hao Cheng — 85 — Repayment from Hao Cheng — — 85 Technology service revenue from Beijing Xiaomi — — 303 Advertisement revenue from Beijing Xiaomi — — 871 Advance to Shenglong Zou — — 10 Advance to Chuan Wang — — 7 note a – The Company obtained an exclusive game operation right from Zhuhai Qianyou, which is specialized in developing online games. According to theagreement, the Company will share revenues derived by the licensed games with Zhuhai Qianyou.In April 2014, the company issued 14,195,412 common shares to Leading Advice, a company owned by the Group’s chairman and chief executive officer.The issuance of common shares was to facilitate the administration of the 2014 plan.As mentioned in note 3, the Group acquired assets relating to a personal cloud storage business from certain PRC subsidiaries of Kingsoft CorporationLimited for an aggregate cash consideration of USD33 million. Kingsoft Corporation Limited, through its wholly owned subsidiary King Venture HoldingsLimited, owned approximately 11.4% of our outstanding shares as of the closing of the transaction. F- 69Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 21.Related party transactions (Continued) As of December 31, 2012, 2013 and 2014, the amounts due to / from related parties were as follows: (In thousands) December 31,2012 December 31,2013 December 31,2014 Amounts due to related parties Accounts payable to Zhuhai Qianyou 313 225 84 Long-term payable to Aiden & Lasmine Limited (note 17) — — 1,125 Long-term payable to Vantage Point Global Limited (note 17) — — 3,012 (In thousands) December 31,2012 December 31,2013 December 31,2014 Amounts due from related parties Accounts receivable from Beijing Xiaomi — — 5 Other receivable from Hao Cheng — 85 — Other receivable from Shenglong Zou — — 10 Other receivable from Chuan Wang — — 7 22.Taxation (i)Cayman IslandsUnder the current laws of the Cayman Islands, the Company is not subject to tax on income or capital gains. Additionally, upon payment of dividends by theCompany to its shareholders, no Cayman Islands withholding tax will be imposed. (ii)PRC Enterprise Income Tax (“EIT”)Giganology Shenzhen, the VIE and its subsidiaries which were established in the Shenzhen Special Economic Zone of the PRC were all subject to EIT at arate of 15% before 2008. On March 16, 2007, the PRC National People’s Congress promulgated the New Enterprise Income Tax Law (the “New EIT Law”),which became effective on January 1, 2008, adopting a unified EIT rate of 25%. In addition, the New EIT Law also provides a five-year transitional periodstarting from its effective date for those enterprises that were established before the date of promulgation of the New EIT Law and that were entitled topreferential income tax rates under the then effective tax laws or regulations. On December 26, 2007, the State Council issued the “Circular toImplementation of the Transitional Preferential Policies for the Enterprise Income Tax”. Pursuant to this Circular, the transitional income tax rates forenterprises established in the Shenzhen Special Economic Zone before March 16, 2007 were 18%, 20%, 22%, 24% and 25% for 2008, 2009, 2010, 2011 and2012, respectively. Thus, the applicable EIT rate for Giganology Shenzhen, the VIE and its subsidiaries, which were established in the Shenzhen SpecialEconomic Zone before March 16, 2007, was 25%, 25% and 25% for the years 2012, 2013 and 2014, respectively.As approved by the local tax authority, Giganology Shenzhen was further exempt from EIT for two years commencing from its first year of profitableoperation after offsetting prior years’ tax losses, followed by a 50% reduction for the next three years (“2-year Exemption and 3-year 50% Reduction”) as asoftware enterprise. The first year of profit operation of Giganology Shenzhen was 2006. According to new EIT Law, Giganology Shenzhen could still enjoythe tax holidays which were grandfathered by the New EIT Law. F- 70Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 22.Taxation (Continued) (ii)PRC Enterprise Income Tax (“EIT”) (Continued) Accordingly, the applicable EIT rates for Giganology Shenzhen were 25%, 25% and 25% for the years ended December 31, 2012, 2013 and 2014,respectively.On April 14, 2008, relevant governmental regulatory authorities released further qualification criteria, application procedures and assessment processes formeeting the High and New Technology Enterprise (“HNTE”) status under the New EIT Law which would entitle qualified and approved entities to afavorable statutory tax rate of 15%.In April 2009, the State Administration for Taxation (“SAT”) issued Circular Guoshuihan [2009] No. 203 (“Circular 203”) stipulating that entities whichqualified for the HNTE status should apply with in-charge tax authorities to enjoy the reduced EIT rate of 15% provided under the New EIT Law starting fromthe year when the new HNTE certificate becomes effective. In addition, an entity which qualified for the HNTE status can continue to enjoy its remaining taxholiday from January 1, 2008 provided that it has obtained the HNTE certificate according to the new recognition criteria set by the New EIT Law and therelevant regulations.In February 2011, Shenzhen Xunlei obtained the HNTE certificate with effect from January 1, 2011.According to a policy promulgated by the State tax bureau of the PRC and effective from 2008 onwards, enterprises engage in research and developmentactivities are entitled to claim 150% of the research and development expenses so incurred in a year as tax deductible expenses in determining its taxassessable profits for that year (“Super Deduction”). Shenzhen Xunlei has been claiming such Super Deduction in ascertaining its tax assessable profits from2009 onwards. In addition, approved by the relevant local tax authority in July 2010, Shenzhen Xunlei was recognized as an enterprise engaged in softwaredevelopment activities, accordingly, it is entitled to a tax holiday of 2-year Exemption and 3-year 50% Reduction from 2010 onwards.In December 2013, Shenzhen Xunlei obtained the certificate of Key Software Enterprise for the years ended December 31, 2013 and 2014, which enabledShenzhen Xunlei to enjoy the preferential tax rate of 10% for the year 2013. As a result, the applicable tax rate of Shenzhen Xunlei for the years endedDecember 31, 2012, 2013 and 2014 were 12.5%, 10% and 10% respectively.The subsidiaries and VIE’s subsidiaries, which were established after January 1, 2008, were subject to EIT at a rate of 25%.Xunlei Computer was established in 2011 in the Shenzhen Special Economic Zone, the PRC. As approved by the relevant tax authority in June 2013, XunleiComputer was further exempt from EIT for two years commencing from its first year of profitable operation after offsetting prior years’ tax losses, followed bya 50% reduction for the next three years (“2-year Exemption and 3-year 50% Reduction”). The first year of profit operation of Xunlei Computer is 2013. F- 71Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 22.Taxation (Continued) (ii)PRC Enterprise Income Tax (“EIT”) (Continued) Dividends paid by the PRC subsidiaries of the Group out of the profits earned after December 31, 2007 to non-PRC tax resident investors are subject to PRCwithholding tax. The withholding tax (“WHT”) on dividends is 10%, unless a foreign investor’s tax jurisdiction has a tax treaty with the PRC that providesfor a lower withholding tax rate and the foreign investor is recognized as the beneficial owner of the income under the relevant tax rules. The 10% WHT isapplicable to any dividends to be distributed from Giganology Shenzhen and Xunlei Computer to the Company out of any profits of these two companiesderived after January 1, 2008. Up to December 31, 2014, both Giganology Shenzhen and Xunlei Computer did not declare any dividend to the parentcompany and have determined that it has no present plan to declare and pay any dividends. The Group currently plans to continue to reinvest its subsidiaries’undistributed earnings, if any, in its operations in China indefinitely. Accordingly, no withholding income tax was accrued or required to be accrued as ofDecember 31, 2013 and 2014. The undistributed earnings from the Group’s PRC entities as of December 31, 2013 and 2014 amounted to USD31,385 thousand and USD 38,393, respectively. An estimated foreign withholding taxes of USD 3,138 thousand and USD 3,839 would be due if theseearnings were remitted as dividends as of December 31, 2013 and 2014, respectively.Moreover, the current EIT Law treats enterprises established outside of China with “effective management and control” located in the PRC as PRC residententerprises for tax purposes. The term “effective management and control” is generally defined as exercising overall management and control over thebusiness, personnel, accounting, properties, etc. of an enterprise. The Company, if considered a PRC resident enterprise for tax purposes, would be subject tothe PRC Enterprise Income Tax at the rate of 25% on its worldwide income for the period after January 1, 2008. As of December 31, 2014, the Company hasnot accrued for PRC tax on such basis. The Company will continue to monitor its tax status.The current and deferred portions of income tax expense included in the consolidated statements of operations are as follows: Years ended December 31, (In thousands) 2012 2013 2014 Current income tax expenses 2,362 175 397 Deferred income tax benefits (123) (822) (1,856) Taxation for the year 2,239 (647) (1,459) The aggregate amount and per share effect of the tax holiday are as follows: Years ended December 31, 2012 2013 2014 Aggregate dollar effect (in thousands) 2,073 4,638 2,784 Per share effect—basic 0.03 0.08 0.01 Per share effect—diluted 0.03 0.06 0.01 F- 72Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 22.Taxation (Continued) (ii)PRC Enterprise Income Tax (“EIT”) (Continued) The reconciliation of total tax (benefit) / expense computed by applying the respective statutory income tax rates to pre-tax (loss) / income is as follows: Years ended December 31, (In thousands) 2012 2013 2014 Income tax (benefit) / expense at PRC statutory rate (based on statutory tax rate applicable toenterprises in Shenzhen, China) 655 2,433 2,129 Effects of differences in tax rates in different jurisdictions applicable to entities of the Groupoutside of the PRC 2,074 667 (838) Non-deductible expenses 53 102 714 Effect of Super Deduction available to Shenzhen Xunlei (2,274) (1,763) (1,365) Effect of tax holiday (2,073) (4,638) (2,784) Change in valuation allowance of deferred tax assets 6 — 291 Effect on deferred tax assets due to change in tax rates (437) 1,764 (103) Outside basis difference arising from VIE and its subsidiaries in the PRC 4,217 713 478 Expiration of tax loss — 31 51 Others 18 44 (32) Income tax expense / (benefit) 2,239 (647) (1,459) The tax effects of temporary differences that give rise to the deferred tax asset and liability balances at December 31, 2013 and 2014 are as follows: (In thousands) December 31,2013 December 31,2014 Deferred tax assets, current portion: Net operating loss carried forward (Note a) 50 315 Amortization of intangible assets arising from intragroup transactions(Note b) 69 69 Amortization of content copyrights (Note c) 1,033 1,675 Impairment of online game licenses 33 32 Deferred tax assets, current portion, net 1,185 2,091 Deferred tax assets, non-current portion:Net operating loss carried forward (Note a) 3,676 6,103 Allowance for doubtful accounts 1,311 796 Amortization of intangible assets arising from intragroup transactions(Note b) 175 105 Impairment of online game licenses 49 16 Amortization of Content Copyrights (Note c) 4,219 4,133 Valuation allowance — (291) Deferred tax assets, non-current portion, net 9,430 10,862 Deferred tax liability, non-current portion:Outside basis difference (Note d) (8,074) (8,552) F- 73Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 22.Taxation (Continued) (ii)PRC Enterprise Income Tax (“EIT”) (Continued) Note a:As of December 31, 2014, the Group had tax loss carryforwards of USD 24,509 thousand, which can be carried forward to offset future taxableincome. The net operating tax loss carryforwards will begin to expire as follows: (In thousands) 2015 1,259 2016 1,784 2017 1,971 2018 9,638 2019 and thereafter 9,857 24,509 Note b:Before 2008, Giganology Shenzhen sold several self-developed software at a market valuation of approximately RMB42 million to ShenzhenXunlei. Shenzhen Xunlei was entitled to capitalize the amounts as intangible assets for tax purposes and the respective amortization charges couldbe entitled to claim tax deduction. As a result, this transaction had created a temporary difference between the accounting base (on a group basis)and the tax base (on Shenzhen Xunlei standalone basis) and led to origination of a deferred tax asset.Note c:As mentioned in Note 2(m), the Group adopts certain accelerated amortization methods for amortization of certain Content Copyrights foraccounting purposes, while straight- line method is adopted for PRC tax reporting. Accordingly, the differences have led to origination oftemporary differences.Note d:The deferred tax liabilities arising from the aggregate retained earnings and reserves of the VIE and its subsidiaries that are expected to berecovered by Giganology Shenzhen and other affiliates of the Group in the future periods, amounted to USD 32,296 thousand and USD 34,210 asof December 31, 2013 and 2014, respectively.Movement of valuation allowance is as follows: Years ended December 31, (In thousands) 2012 2013 2014 Beginning balance (37) (43) — Additions (6) — (291) Write-off — 43 — Ending balance (43) — (291) Valuation allowances had been provided against the net deferred tax assets because it is more likely than not that all of the deferred tax asset will not berealized. In 2013, valuation allowance was written off due to the termination of the business of Xunlei Nanjing. In 2014, valuation allowance was providedfor net operating loss carry forward of Wangxin because it was more likely than not that such deferred tax assets will not be realized based on the Group’sestimate of Wangxin’s future taxable income. F- 74Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 22.Taxation (Continued) (ii)PRC Enterprise Income Tax (“EIT”) (Continued) As of December 31, 2014, the tax returns of the Group’s subsidiaries, VIE and its subsidiaries since their respective dates of incorporation are still opento examination. 23.Fair value measurementsEffective January 1, 2008, the Group adopted ASC 820-10, Fair Value Measurements and Disclosures, which defines fair value, establishes a framework formeasuring fair value and expands financial statement disclosures about fair value measurements. Although adoption did not impact the Group’s consolidatedfinancial statements, ASC 820-10 requires additional disclosures to be provided on fair value measurements.ASC 820-10 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:Level 1—Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active marketsLevel 2—Include other inputs that are directly or indirectly observable in the marketplace or based on quoted price in markets that are not activeLevel 3—Unobservable inputs which are supported by little or no market activity and are significant to the overall fair value measurementASC 820-10 describes three main approaches to measuring the fair value of assets and liabilities: (1) market approach; (2) income approach and (3) costapproach. The market approach uses prices and other relevant information generated from market transactions involving identical or comparable assets orliabilities. The income approach uses valuation techniques to convert future amounts to a single present value amount. The measurement is based on thevalue indicated by current market expectations about those future amounts. The cost approach is based on the amount that would currently be required toreplace an asset. F- 75Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 23.Fair value measurements (Continued) The following table sets forth the financial instruments, measured at fair value, by level within the fair value hierarchy as of December 31, 2013 and 2014. Fair value measurements as at December 31, 2013 (In thousands) Total Quoted pricesin active marketfor indentificalassets(Level 1) Significantotherobservableinputs(Level 2) Significantobservableinputs(Level 3) Cash equivalent: time deposits with original maturities less than threemonths 30,892 — 30,892 — Short term investments: Time deposits 9,695 — 9,695 — Investments in financial instruments 31,298 — 31,298 — Warrant liabilities (2,186) — (2,186) — 69,699 — 69,699 — Fair value measurements as at December 31, 2014 (In thousands) Total Quoted pricesin active marketfor indentificalassets(Level 1) Significantotherobservableinputs(Level 2) Significantobservableinputs(Level 3) Cash equivalent: time deposits with original maturities less than threemonths 31,117 — 31,117 — Short term investments: Investments in financial instruments 29,426 — 29,426 — 60,543 — 60,543 — 24.Other income, net Years ended December 31, (In thousands) 2012 2013 2014 Subsidy income 1,621 1,393 2,236 Fair value changes of warrants liabilities (note 14) (710) 1,531 8,054 Investment income from short-term investments 2 1,847 3,471 Dilution gains arising from deemed disposal of investment (Note 10) — — 449 Exchange losses (351) (252) (176) Others 2 160 (68) 564 4,679 13,966 F- 76Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 25.Commitments and contingenciesRental commitmentsThe Group leases facilities in the PRC under non-cancellable operating leases expiring on different dates. Payments under operating leases are expensed on astraight-line basis over the periods of the respective leases, including any free rental periods.Total office rental expenses under all operating leases were USD 2,390 thousand, USD 2,786 thousand and USD 3,068 thousand for the years endedDecember 31, 2012, 2013 and 2014, respectively.Future minimum payments under non-cancellable operating leases of office rental consist of the following as of December 31, 2014: (In thousands) 2015 2,203 2016 1,329 2017 6 3,538 Bandwidth lease commitmentsThe Group leases bandwidth in the PRC under non-cancellable operating leases expiring on different dates. Payments under bandwidth leases are expensedon a straight-line basis over the duration of the respective lease periods, including any lease free periods.Total bandwidth leasing costs under all operating leases were USD 22,211 thousand, USD 35,454 thousand and USD 40,373 thousand for the years endedDecember 31, 2012, 2013 and 2014.Future minimum payments under non-cancellable bandwidth leases consist of the following as of December 31, 2014: (In thousands) 2015 15,053 2016 608 15,661 Capital commitmentsAs at December 31, 2014, the Group had irrevocable purchase obligations for certain copyrights and online game licenses that had not been recognized in theamount of USD 5,789,600 and USD nil, respectively.LitigationThe Group is involved in a number of cases pending in various courts. These cases are substantially related to alleged copyright infringement as well asroutine and incidental matters to its business, among others. Adverse results in these lawsuits may include awards of damages and may also result in, or evencompel, a change in the Group’s business practices, which could impact the Group’s future financial results. The Group had incurred USD 760 thousand, USD263 thousand and USD 1,073 thousand legal and litigation related expenses for the years ended December 31, 2012, 2013 and 2014, respectively. F- 77Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 25.Commitments and contingencies (Continued) Litigation (Continued) Up to April 20, 2015, which is the date when the consolidated financial statements were issued, the Group had 24 lawsuits pending against the Group with anaggregate amount of claimed damages of approximately RMB 1.88 million (USD 0.31 million) which occurred before December 31, 2014. Of the 24 pendinglawsuits, 22 lawsuits were relating to the alleged copyright infringement in the PRC and the remaining 2 were relating to the Xunlei Kankan and online gamebusiness which is not related with copyright infringement. The Group had accrued for USD 451 thousand litigation related expenses in “Accrued expensesand other liabilities” in the consolidated balance sheet as of December 31, 2014.Out of the 22 lawsuits for the alleged copyright infringement, 12 lawsuits involved Xunlei Kankan, an online video website owned by the Group. Theremaining 10 lawsuits were relating to online services the Group provided on the Xunlei download accelerator tool, cloud subscription and Gougou, a digitalmedia content search engine previously owned by the Group.The Group estimated the litigation compensation based on judgments handed down by the court, out-of-court settlements of similar cases as well as advicesfrom the Group’s legal counsel. The Group is in the process of appealing certain judgments for which the losses had been accrued. Although the results ofunsettled litigation and claims cannot be predicted with certainty, the Group does not expect that the outcome of the 24 lawsuits will result in the amountsaccrued materially different from the range of reasonably possible losses.In May 2014, the Group entered into a content protection agreement with the Motion Picture Association of America, Inc., or MPAA, and six major U.S.entertainment content providers, which are the members of MPAA. In January 2015, a number of MPAA member studios filed copyright infringementlawsuits against the Group with an aggregate amount of claimed damages of RMB 8.40 million (USD 1.37 million), and the cases are awaiting trial as of April20, 2015. As the litigations remain in their preliminary stages, the Group is unable to express any opinion on the likelihood of an unfavorable outcome orany estimate of the amount or range of any potential loss. Further, subsequent to December 31, 2014, there were additional claims mainly with an aggregateamount of claimed damages of approximately RMB 2.17 million (USD 0.35 million) related to alleged copyright infringement made in the ordinary course ofbusiness against the Group. The Group has assessed that none of these claims that occurred between January 1, 2015 to April 20, 2015 will result in theamount accrued materially different from the range of reasonably possible losses in the consolidated financial statements of the Group. F- 78Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 26.Certain risks and concentrationPRC regulationsCurrent PRC laws and regulations place certain restrictions on foreign ownership of companies that engage in internet businesses, including the provision ofonline video and online advertising services. Specifically, foreign ownership in an internet content provider or other value-added telecommunication serviceproviders may not exceed 50%. The Group conducts its operations in China principally through contractual arrangements among Giganology Shenzhen, itswholly-owned PRC subsidiary, and Shenzhen Xunlei and its shareholders. Shenzhen Xunlei holds the licenses and permits necessary to conduct its resourcediscovery network, online video, online advertising, online games and related businesses in China and hold various operating subsidiaries that conduct amajority of its operations in China. The Company conducts all of its operations in China through, Shenzhen Xunlei, a variable interest entity, which itconsolidates as a result of a series contractual arrangements enacted. If the Company had direct ownership of Shenzhen Xunlei, it would be able to exercise itsrights as a shareholder to effect changes in the board of directors of Shenzhen Xunlei, which in turn could effect changes at the management level, subject toany applicable fiduciary obligations. However, under the current contractual arrangements, it relies on Shenzhen Xunlei and its shareholders’ performance oftheir contractual obligations to exercise effective control. In addition, its operating contract with Shenzhen Xunlei has a term of ten years, which is subject toGiganology Shenzhen’s unilateral termination right. None of Shenzhen Xunlei or its shareholders may terminate the contracts prior to the expiration date.Further, the Group believes that the contractual arrangements among Giganology Shenzhen, Shenzhen Xunlei and its shareholders are in compliance withPRC law and are legally enforceable. However, the Chinese government may issue from time to time new laws or new interpretations on existing laws toregulate this industry. Regulatory risk also encompasses the interpretation by the tax authorities of current tax laws, and the Group’s legal structure and scopeof operations in the PRC, which could be subject to further restrictions resulting in limitations on the Company’s ability to conduct business in the PRC. ThePRC government may also require the Company to restructure the Group’s operations entirely if it finds that its contractual arrangements do not comply withapplicable laws and regulations. Furthermore, it could revoke the Group’s business and operating licenses, require it to discontinue or restrict its operations,restrict its right to collect revenues, block its website, require it to restructure its operations, impose additional conditions or requirements with which theGroup may not be able to comply, or take other regulatory or enforcement actions against the Group that could be harmful to its business. The imposition ofany of these penalties may result in a material and adverse effect on the Group’s ability to conduct the Group’s business. In addition, if the imposition of anyof these penalties causes the Group to lose the rights to direct the activities of the VIE and its subsidiaries or the right to receive their economic benefits, theGroup would no longer be able to consolidate the VIE. The Group does not believe that any penalties imposed or actions taken by the PRC Governmentwould result in the liquidation of the Company, Giganology Shenzhen or Shenzhen Xunlei.As of December 31, 2014, the aggregate retained earnings and distributable reserves of VIE and VIE’s subsidiaries amounted to approximately USD 34,211(2013: USD 32,296 thousand), which has been included in the consolidated financial statements.As stated above, Shenzhen Xunlei holds assets that are important to the operation of the Group’s business, including patents for proprietary technology,related domain names and trademarks. If Shenzhen Xunlei or its subsidiaries falls into bankruptcy and all or part of its assets become subject to liens or rightsof third-party creditors, the Group may be unable to conduct its business activities in China, which could have a material adverse effect on the Group’s futurefinancial position, results of operations or cash flows. However, the Group believes this is a normal business risk many companies face. The Group willcontinue to closely monitor the financial conditions of Shenzhen Xunlei and its subsidiaries. F- 79Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 26.Certain risks and concentration (Continued) PRC regulations (Continued) Shenzhen Xunlei and its subsidiaries’ assets comprise both recognized and unrecognized revenue-producing assets. The recognized revenue-producing assetsinclude intangible assets, purchased property and equipment. The balances of these assets held by the VIE and its subsidiaries are included in “copyrightsrelated to content, current portion”, “property and equipment, net” and “intangible assets, net” in the consolidated balance sheet and specifically in the VIEtable on the following page. The unrecognized revenue-producing assets mainly consist of license, patents, trademarks, and domain names which are notrecorded in the financial statement as they didn’t meet the recognition criteria set in ASC 350-30-25. The licenses stated above primarily consist of licensesthat grant the VIE and its subsidiaries the right to produce and broadcast internet, radio, and television programs. One of them is the ICP licenses as describedin note 1.As of December 31, 2014, Shenzhen Xunlei and its subsidiaries held patents granted in the PRC and in the United States. Presently, patent applications arebeing examined by the State Intellectual Property Office of the PRC and also patent application is being reviewed by the United States Patent and TrademarkOffice.As of December 31, 2014, Shenzhen Xunlei and its subsidiaries have applied to register trademarks, of which the Company has received registered trademarksin different applicable trademark categories including trademark registered with the United States Patent and Trademark Office and trademark registered withWorld Intellectual Property Organization.As of December 31, 2014, Shenzhen Xunlei held one domain name that was recognized as an intangible asset and other domain names that are not recordedin the financial statements. F- 80Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 26.Certain risks and concentration (Continued) PRC regulations (Continued) The following consolidated financial information of the Group’s VIE and its subsidiaries was included in the accompanying consolidated financialstatements as of and for the years ended: As of December 31, (In thousands) 2013 2014 Current assets: Cash and cash equivalents 50,663 43,849 Short-term investments 31,298 28,575 Accounts receivable, net 35,592 29,248 Due from related parties 85 6 Deferred tax assets 750 1,358 Prepayments and other current assets 11,403 10,819 Copyrights related to content, current portion 14,230 15,333 Total current assets 144,021 129,188 Non-current assets:Equity method investments 2,949 5,498 Deferred tax assets 6,756 8,262 Property and equipment, net 20,116 17,481 Intangible assets, net 13,083 21,632 Goodwill — 23,237 Prepayments for content copyrights 2,483 1,694 Other long-term prepayments 2,554 5,852 Total non-current assets 47,941 83,656 Total assets 191,962 212,844 Current liabilities:Accounts payables 62,603 49,771 Due to a related party 225 84 Deferred revenue and income, current portion 29,352 28,083 Income tax payable 2,581 2,554 Accrued liabilities and other payables 49,265 86,323 Total current liabilities 144,026 166,815 Non-current liabilities:Deferred revenue and income, non-current portion 9,190 6,452 Total non-current liabilities 9,190 6,452 Total liabilities 153,216 173,267 Years ended December 31, (In thousands) 2012 2013 2014 Net revenue 140,532 174,594 179,590 Net income / (loss) attributable to Xunlei Limited 14,637 1,368 (5,730) F- 81Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 26.Certain risks and concentration (Continued) PRC regulations (Continued) Years ended December 31, (In thousands) 2012 2013 2014 Net cash provided by operating activities 59,379 92,580 70,822 Net cash used in investing activities (33,675) (66,243) (78,335) Net cash (used in) / provided by financing activities (20,632) 2,487 856 5,072 28,824 (6,657) Foreign exchange riskThe Group’s financing activities are denominated mainly in the USD. The RMB is not freely convertible into foreign currencies. Remittances of foreigncurrencies into the PRC and exchange of foreign currencies into the RMB require approval by foreign exchange administrative authorities and certainsupporting documentation. The State Administration for Foreign Exchange, under the authority of the People’s Bank of China, controls the conversion of theRMB into other currencies. The revenues and expenses of the Company’s subsidiaries, consolidated VIE and its subsidiaries are generally denominated in theRMB and their assets and liabilities are denominated in the RMB.Concentration of customer riskThe top 10 customers accounted for 20%, 14% and 16% of the net revenues for the years ended December 31, 2012, 2013 and 2014, respectively. Prior toentering into sales agreements, the Group performs credit assessments of its customers to assess the credit history of its customers. Further, the Group has notexperienced any significant bad debts with respect to its accounts receivable.Credit riskAs of December 31, 2013 and 2014, substantially all of the Group’s cash and cash equivalents were held at reputable financial institutions in the jurisdictionswhere the Group and its subsidiaries are located. The Group believes that it is not exposed to unusual risks as these financial institutions have high creditquality. The Group has not experienced any losses on its deposits of cash and cash equivalents.Prior to entering into sales agreements, the Group performs credit assessments of its customers to assess the credit history of its customers. Further, the Grouphas not experienced any significant bad debts with respect to its accounts receivable. 27.Subsequent eventsRestricted shares grantIn March 2015, 1,769,000 restricted shares had been granted to certain executive officers or employees of the Group.Issuance of common sharesIn January 2015, the Company issued to a depositary bank for American Depositary Shares, 10,991,120 common shares, which were reserved for the futureexercise of share options or vesting of restricted shares. F- 82Table of ContentsXunlei LimitedNotes to consolidated financial statements(Amounts in US dollars unless otherwise stated) 27.Subsequent events (Continued) InvestmentsIn January 2015, the Group paid USD 1 million as the consideration to acquired 2.24% equity interests in 11.2 Capital I, L.P., a limited partnership whichmakes venture capital investments, principally by investing in and holding equity and equity-oriented securities of privately held companies, with a focus oncompanies that are primarily focused on enterprise technologies, next generation hardware and related technologies. This acquisition was closed onJanuary 15, 2015.In February 2015, the Group paid USD 647 thousand as the consideration to acquire 19.9% equity interests in Suzhou Heidisi Network Technology Co., Ltd.,a company which develops and operates mobile game in the PRC. This acquisition was closed on March 11, 2015.In March 2015, the Group paid USD 1.2 million as part of the consideration (total consideration was 2 million) for acquiring 15% equity interests in XiamenDiensi Network Technology Co., Ltd., a company which provides domain name analysis services in the PRC. This acquisition was still in the process as ofApril 20, 2015.Proposed disposal of business and assets in relation to Xunlei KankanOn March 31, 2015, the Group entered into a legally binding framework agreement with Beijing Nesound International Media Corp., Ltd. (“Nesound”), anindependent third party, to sell the Group’s online video streaming platform, Xunlei Kankan. Pursuant to the framework agreement, the Group agreed todispose and Nesound agreed to acquire the business and assets in relation to Xunlei Kankan, together with 100% of equity interest of Shenzhen XunleiKankan Information Technologies Co., Ltd, for an aggregate cash consideration of RMB 130 million. Nesound has paid a deposit of RMB26 million as of thedate of April 20, 2015. The completion of the transaction is subject to the signing of a definitive purchase agreement and fulfilling closing conditionscontained therein, which may include the completion of a specific research and development project, the transfer of domain name, other assets and certainliabilities and businesses of Xunlei Kankan, and the application for the transfer of permits and licenses required for Xunlei Kankan’s operations. If thetransaction fails to close due to the fault of either Xunlei or Nesound, including the failure to meet closing conditions, the responsible party shall be liable topay a penalty of RMB52 million in addition to returning the deposit of RMB26 million. 28.Restricted net assetsRelevant PRC laws and regulations permit payments of dividends by the Company’s subsidiaries, VIE and VIE’s subsidiaries in China only out of theirretained earnings, if any, as determined in accordance with PRC accounting standards and regulations. In addition, the Company’s subsidiaries, VIE andVIE’s subsidiaries in China are required to make certain appropriation of net after-tax profits or increase in net assets to the statutory surplus fund(see Note 2(cc)) prior to payment of any dividends. As a result of these and other restrictions under PRC laws and regulations, the Company’s subsidiaries,VIE and VIE’s subsidiaries in China are restricted in their ability to transfer their net assets to the Company in terms of cash dividends, loans or advances,which restricted portion amounted to USD 49,171 thousand and USD 59,760 as of December 31, 2013 and 2014, respectively. Even though the Companycurrently does not require any such dividends, loans or advances from the PRC subsidiaries, VIE and VIE’s subsidiaries for working capital and other fundingpurposes, the Company may in the future require additional cash resources from the Company’s subsidiaries, VIE and a VIE’s subsidiaries in China due tochanges in business conditions, to fund future acquisitions and development, or merely to declare and pay dividends to make distributions to shareholders. F- 83Table of Contents29.Additional information: condensed financial statements of the CompanyRegulation S-X require condensed financial information as to financial position, changes in financial position and results of operations of a parent companyas of the same dates and for the same periods for which audited consolidated financial statements have been presented when the restricted net assets ofconsolidated and unconsolidated subsidiaries together exceed 25 percent of consolidated net assets as of the end of the most recently completed fiscal year.The Company records its investment in its subsidiaries, VIE and VIE’s subsidiaries under the equity method of accounting.Such investments are presented on the separate condensed balance sheets of the Company as “Long-term investments”.The subsidiaries did not pay any dividends to the Company for the periods presented. Certain information and footnote disclosures generally included infinancial statements prepared in accordance with U.S. GAAP have been condensed and omitted. The footnote disclosures represent supplemental informationrelating to the operations of the Company, as such, these statements should be read in conjunction with the notes to the consolidated financial statements ofthe Group.The Company did not have significant other commitments, long-term obligations, or guarantees as of December 31, 2014. F- 84Table of ContentsCondensed balance sheets (In thousands) December 31,2013 December 31,2014 Assets Current assets: Cash and cash equivalents 28,863 309,457 Due from subsidiaries and consolidated VIEs 25,859 67,397 Prepayments and other current assets 653 6,709 Total current assets 55,375 383,563 Non-current assets:Intangible assets, net 1,017 394 Investments in subsidiaries and consolidated VIEs 67,009 82,360 Total assets 123,401 466,317 LiabilitiesCurrent liabilities:Accounts payable 807 101 Deferred revenue and income, current portion — 211 Accrued liabilities and other payables 924 2,328 Total current liabilities 1,731 2,640 Non-current liabilities:Deferred revenue and income, non-current — 842 Warrants liabilities 2,186 — Due to related parties, non-current portion — 4,137 Other long-term payable — 807 Total liabilities 3,917 8,426 Commitments and contingenciesMezzanine equity 40,290 — Shareholders’ equitySeries C convertible non-redeemable preferred shares 1 — Series B convertible non-redeemable preferred shares 8 — Series A-1 convertible non-redeemable preferred shares 9 — Series A convertible non-redeemable preferred shares 7 — Common shares 15 82 Treasury shares 9,073,732 shares as at December 31, 2013 and 30,274,602 shares as atDecember 31, 2014 2 7 Other shareholders’ equity 79,152 457,802 Total Xunlei Limited’s shareholders’ equity 79,194 457,891 Total liabilities, mezzanine equity and shareholders’ equity 123,401 466,317 F- 85Table of ContentsCondensed statements of operations Years ended December 31, (In thousands) 2012 2013 2014 Revenues — — — Cost of revenues (3,075) (2,264) (1,673) Gross profit (3,075) (2,264) (1,673) Operating expensesResearch and development expenses (1,369) — — Sales and marketing expenses (489) (241) — General and administrative expenses (1,315) (972) (996) Total operating expenses (3,173) (1,213) (996) Operating loss (6,248) (3,477) (2,669) Interest income 1,089 706 6,171 Interest expense — — (163) Other (loss) / income, net (885) 1,651 7,602 Income from subsidiaries and consolidated VIEs 6,547 11,782 (129) Income before income tax 503 10,662 10,812 Income tax — — — Net income 503 10,662 10,812 Net income attributable to the non-controlling interest — — — Net income attributable to Xunlei Limited’s common shareholders 503 10,662 10,812 Condensed statement of cash flows Years ended December 31, (In thousands) 2012 2013 2014 Cash flows from operating activities Net cash generated from / (used in) operating activities 695 4,708 (41,485) Cash flows from investing activities Net cash used in investing activities (37,302) (3,843) (10,333) Cash flows from financing activities Net cash generated from / (used in) financing activities 35,488 (2,242) 332,412 Net (decrease) / increase in cash and cash equivalents (1,119) (1,377) 280,594 Cash and cash equivalents at beginning of year 31,359 30,240 28,863 Effect of exchange rates on cash and cash equivalents — — — Cash and cash equivalents at end of year 30,240 28,863 309,457 F- 86Exhibit 4.31English Summary*ofAssets and Business Transfer AgreementBy and betweenBeijing Kingsoft Cloud Network Technology Co., Ltd.Zhuhai Kingsoft Cloud Science and Technology Co., Ltd.Beijing Kingsoft Cloud Science and Technology Co., Ltd.AndShenzhen Xunlei Networking Technologies Co., Ltd.September 2, 2014 *The original contract is in Chinese; this is an English summary of the original contract.Table of Contents Article 1 Definition 3 Article 2 Transfer of Assets 6 Article 3 Consideration 8 Article 4 Delivery 9 Article 5 Conditions for Performance of Obligations 9 Article 6 Representations and Warranties 12 Article 7 Taxes and Fees 16 Article 8 Commitments 16 Article 9 Liabilities for Breach of Contract and Termination of Agreement 21 Article 10 Confidentiality 23 Article 11 Force Majeure 23 Article 12 Miscellaneous 23 Annex I: List of Contacts to be TransferredAnnex II: List of Fixed Assets to be TransferredAnnex III (A): List of Intangible Assets to be TransferredAnnex III (B): List of Intangible Assets to be LicensedAnnex IV: List of Employees to be TransferredAnnex V: Tripartite AgreementAnnex VI: Labor ContractAnnex VII: Confidentiality and Non-competition AgreementAnnex VIII: List of Documents Relating to Assets to be TransferredAnnex IX: List of Documents Relating to Business to be TransferredAnnex X: List of Documents Relating to Employees to be TransferredAnnex XI: Disclosure LetterAnnex XII: Confidentiality AgreementAnnex XIII: PatentsAssets and Business Transfer AgreementThis Assets and Business Transfer Agreement (“This Agreement”) is signed by the following parties on September 2, 2014 (“Date of Signing”) in Beijing,the People’s Republic of China (“China”): 1.Transferor:Beijing Kingsoft Cloud Network Technology Co., Ltd. (Company Registration No.:110108013708507)Zhuhai Kingsoft Cloud Science and Technology Co., Ltd. (Company Registration No.:440400000183128)Beijing Kingsoft Cloud Science and Technology Co., Ltd. (Company Registration No.:110000450202564) 2.Transferee:Shenzhen Xunlei Networking Technologies Co., Ltd. (Company Registration No.:440301103773964)For the purposes of this Agreement, the aforesaid parties are referred to individually as “one Party” and collectively as “the Parties”.Whereas: (1).Members of the Transferor are the companies lawfully established in China. The business in which the Transferor is currently engaged includes thebusiness to be transferred (as defined below), and the Transferor intends to transfer the business to be transferred (as defined below) to the Transferee foroperation in whole. (2).Subject to the terms and conditions of this Agreement, the Transferor agrees to transfer, and the Transferee agrees to accept, its business to betransferred (as defined below, assets to be transferred (as defined below) and employees to be transferred (as defined below).The parties hereby agree as follows with respect to the aforesaid matters under applicable PRC laws and regulations:Article 1 Definitions 1.1Definition. For the purposes of this Agreement, unless the context otherwise requires, the following terms shall have the following meanings: (1)“Trade Secrets” means technical information and commercial information contained in business to be transferred and/or assets to be transferredas well as all information contained in this Agreement, including but not limited to, research and development, proprietary information,technical data, technical solutions, designs, specifications, list of customers and suppliers, financial data, pricing and cost data, as well asbusiness and marketing plans and proposals. (2)“Contract to be Transferred” means the contract as listed in Annex I hereto and relating to the business to be transferred, which is notperformed completely as of the date of signing hereof and is not terminated prior to the date of delivery. 3 (3)“Newly Signed Contract” means the Contract (if any) relating to the business to be transferred that the Transferor and the customer have theintention to sign or have begun to perform but fail to formally sign. (4)“Fixed Assets to be Transferred” means the fixed assets as listed in Annex II hereto that the Transferor transfers to the Transferee in accordancewith the terms and conditions of this Agreement. (5)“Intangible Assets to be Transferred” means all registered and unregistered intellectual property rights and other intangible assets as listed inAnnex III (A) hereto and relating to the business to be transferred, which the Transferor or the Transferor’s affiliates own and may transfer or useduring the process of operating the business to be transferred, provided that the intellectual property rights as listed in Annex III (B) that theTransferor intends to grant or the Transferor’s affiliates must grant to the Transferee for use do not belong to intangible assets. (6)“Assets to be Transferred” means (a) contracts to be transferred as contained in the business to be transferred; (b) fixed assets to be transferred ascontained in the business to be transferred; (c) intangible assets to be transferred as contained in the business to be transferred; (d) any tradesecret relating to the aforesaid three items and the business to be transferred, which the Transferor or the Transferor’s affiliates own and maytransfer. For avoidance of doubt, assets to be transferred do not include excluded assets as specified in Article 2.6 hereof. (7)“Business to be Transferred” means online storage service provided by using personal edition of Kuaipan and Kansunzi software, service ofpublishing and using digital works, operating the website www.kuaipan.cn, cloud albums and any service provided by using the data cumulatedby personal edition of Kuaipan client and Kansunzi software. For avoidance of doubt, business to be transferred do not include excluded assetsand business as specified in Article 2.6 hereof. (8)“Personal Edition of Kuaipan” refers to free synchronous online disk of individual based on cloud storage. (9)“Kansunzi Software” means for photo storage and sharing service software targeted to family and friends circle. (10)“Intellectual Property Rights” means all patents registered in China of, patent application rights, trademarks, trademark application rights,copyrights, software copyrights, domain names, trade names, logo, trade secrets, etc. , whether registered or unregistered, including, but notlimited to, intellectual property rights as listed in the list of intangible assets to be transferred under Annex III (A) hereto. (11)“Employees to be Transferred” means the existing employees as set out in Annex IV currently employed by the Transferor or the Transferor’saffiliates and engaged in the business to be transferred that the Transferee requires and agrees to employ. 4 (12)“Core Personnel” means the candidates marked as the core personnel for the business to be transferred under Annex IV hereto. (13)“Tripartite Agreement” means the tripartite novation agreement signed by the Transferor, the Transferee and the counterparts to the contract tobe transferred (including one party and multiple parties, hereinafter referred to as “the Customer”) to transfer the contract to be transferred to theTransferee in the template as detailed in Annex V hereto. (14)“Labor Contract” means the labor contract signed by the employees to be transferred and the Transferee in the template as detailed in Annex VIhereto. The employment conditions for employees to be transferred under such labor contract shall not be less than the employment conditionsgiven by the Transferee to other employees. (15)“Confidentiality and Non-competition Agreement” means the confidentiality and non-competition agreement signed by the employee to betransferred and the Transferee prior to or on the date of delivery in the template as detailed in Annex VII hereto. (16)“Date of Delivery” has the meaning as prescribed in Article 4 hereof. (17)“Delivery” has the meaning as prescribed in Article 4 hereof. (18)“Remuneration Treatments” means all statutory and agreed remuneration, overtime pay, labor protection, insurance premium, provident fund,compensation for unused annual leave, reimbursement, statutory economic compensation (if any), and other benefits prescribed by relevant PRClaws and regulations enjoyed by the employees to be transferred with the Transferor prior to signing of labor contract by and between theemployees to be transferred and the Transferee. (19)“Security Interest” means any mortgage, pledge, lien, right to limit, priority, preemptive rights, third party rights or interests, any other securityor security interest, and any other form of similar priority arrangements. (20)“Force Majeure” means the events that cannot be predicted by the parties hereto and occurrence and consequences of which cannot beprevented and avoided, thereby resulting in that this Agreement cannot be performed in whole or in part or cannot be performed under the termsand conditions hereof, including but not limited to earthquakes, typhoons, floods, fires, war, or other events deemed as force majeure under theinternational business practices. (21)“Affiliates” means any individual, partnership, organization or entity that is relating to one party and directly or indirectly (through one or moreintermediaries) controls such party, is controlled by such party or with such party. The term “control” means the right to direct one party or causeone party to be directed obtained by the other party for having an absolute majority of equity of stake of fifty percent (50%) or more, or having arelative majority of equity of less than fifty percent (50%), or by adopting the manner of control through agreement, or adopting the mannerother than control through agreement, such as dispatching directors, etc. 5 (22)“Material Adverse Effect” means any material adverse change or effect on the assets to be transferred or business to be transferred or theemployees to be transferred as initiated by the Transferor that causes the whole transaction proposed hereunder not to be conducted in a lawfulmanner in whole or frustrates the loss of basis for transaction or results in fundamental changes.Article 2 Transfer of Assets 2.1Transfer of Assets. Under the prerequisite that the conditions under Article 5.1 hereof are met or waived on the date of delivery, the Transferor herebyagrees to transfer, assign and deliver and cause the Transferor’s affiliates to transfer, assign and deliver at the time of delivery, and the Transferee agreesto from the Transferor and the Transferor’s affiliates at time of delivery receive, obtain and accept, the business to be transferred, assets to be transferredand employees to be transferred as defined in Article 1 hereof on which there are no significant right flaws and no significant security interest isimposed (“Transfer of Assets”) . 2.2Risk and ownership transfer. Unless otherwise agreed in this Agreement, (1) prior to the date of delivery, the Transferor shall have all the rights andinterests in the business to be transferred and assets to be transferred, and assume all risks relating to business to be transferred, assets to be transferredand employees to be transferred; (2) as from the date of delivery, the Transferee shall have all the rights and interests conferred by this Agreement andassume all risks relating to business to be transferred, assets to be transferred and employees to be transferred. However, for avoidance of doubt, in thecase of intellectual property rights registered and applied for registration, all the rights and interests thereon and relevant risks shall pass to theTransferee as from the date on which registration of transfer of ownership of relevant intellectual property rights is completed. (3) subsequent to thedate of delivery, the Transferor shall continue to perform and complete the responsibilities and obligations relating to business to be transferred andassets to be transferred to be performed and completed by the Transferor, including but not limited to, completion of registration of transfer of relevantintellectual property rights with relevant sector, cooperation with relevant assets that are owned by the Transferor or the Transferor’s affiliates and mustbe used in the process of operating the business to be transferred on the date of delivery as found by the transferee subsequent to the date of delivery, aswell as the completion of the procedures for registration of transfer or authorization relating to such assets. 62.3No liability. Without prior express written consent of the Transferee or unless otherwise expressly stipulated in this Agreement, subject to Article 2.2hereof, the Transferee is not liable for any debt and liability relating to the business to be transferred, contract to be transferred and assets to betransferred that exists or occurs to the Transferor or the Transferor’s affiliates prior to the date of delivery, and the Transferor or the Transferor’s affiliatesshall continue to bear any debt and liability relating to the business to be transferred, contract to be transferred and assets to be transferred that exists oroccurs to the Transferor or the Transferor’s affiliates prior to the date of delivery, including but not limited to (1) any liability, debt or taxes payable;(2) any pending litigation, arbitration, administrative punishment or other legal proceedings relating to business to be transferred, contract to betransferred and assets to be transferred that exist or occur prior to the date of delivery. Where the Transferee or the Transferee’s affiliates enter into anylitigation, arbitration, administrative punishment or other legal proceedings, or sustain any loss due to any claim made by any third party, theTransferee shall promptly notify the Transferor and shall make every effort to provide assistance to avoid further losses that may be sustained by theTransferor. In this context, the Transferor shall be responsible for responding to the litigation or deal with punishment and legal proceedings, and makecompensation for all losses sustained by the Transferee as a result. 2.4Update of annexes. Where relevant annexes regarding the assets to be transferred and employees to be transferred attached to this Agreement at thetime of signing hereof have change as of the date of delivery, the Transferor shall be responsible for updating such annexes to reflect the actual statethereof as of the date of delivery, and the updated annexes are confirmed and consented to by the Transferee, the parties shall continue to perform thisAgreement in accordance with the updated annexes. 2.5Taking further necessary action. Notwithstanding the foregoing, at any time subsequent to the date of delivery, the Transferor agrees to take alllawful, reasonably necessary and reasonably required action to ensure that the Transferee enjoys relevant interests relating to assets to be transferred,business to be transferred and employees to be transferred in accordance with this Agreement subsequent to the date of delivery. Where the Transfereefinds upon the date of delivery that the assets to be transferred and employees to be transferred that are delivered are inconsistent with this Agreementor the Transferor actually fails to meet the conditions under Article 5 hereof, the Transferee is entitled to notify the Transferor to make rectification tothe aforesaid issues without prejudice to the right enjoyed by the Transferee to claim damages in accordance with this Agreement. For avoidance ofdoubt, it is hereby indicated that in respect of the application for relevant rights on the assets to be transferred (including but not limited to trademarkapplication right and patent application right), etc. the Transferor is not obligated to ensure that such applications are approved, provided that suchclause does not relieve the Transferor from being liable for breach of contract when the Transferor delays in performing the obligation of transfer,thereby resulting in that transfer of patent application cannot be completed. 72.6Excluded assets and business. Regardless of this Article 2.1 hereof or other provisions, the parties hereby make clear that all the technical facilities,software and hardware involved in the technologies and services relating to cloud storage service currently used in the personal edition of Kuaipanoperated by the Transferor, commercial edition of Kuaipan, cloud storage (KS3) service, EC2 virtual host ( Cloud Hosting) business, private cloudservices and load balancing services, database services and caching services, as well as assets and business such as trade secrets, information, data, etc.relating to the aforesaid technologies, services and software and hardware do not belong to the scope of assets to be transferred or business to betransferred, and the Transferor shall own all rights and interests in such assets and business. Commercial edition of Kuaipan is hereby defined as afacility to provide the organizational users with the business based on cloud storage and derived technologies on cloud storage through online service;cloud storage (KS3) service is hereby defined as: the network online storage service to be accessed to through a standard interface; EC2 virtual Hosting(Cloud Hosting) business is hereby defined: to provide users with an elastically scalable computing resources services; private cloud service is definedto provide the organizational users (including internal and external ones) with cloud storage and cloud calculation service through deployment servicein the private network; load balancing service means the service to provide users with to traffic distribution between (virtual) hosts; database servicemeans the service to provide users with self-operating and extended relational database service through a Web interface; caching storage service meansthe service to provide users with self-operating and extended caching storage service through a Web interface. For the purposes of Article 2.6, the term“network” includes computer Internet, radio and television networks, fixed communication network, mobile communications network and otherinformation networks taking computers, televisions, fixed telephones, mobile telephones and other electronic equipment as the terminal, as well as toLAN open to the public. “Organizational users” includes corporate legal person, institutions, government agencies; for the purposes of this Article 2.6,the term “private network” refers to network ownership or control of which is attributable to such organizational user.Article 3 Consideration 3.1Consideration. The total consideration payable by the Transferee in respect of completion of transactions under this Agreement shall be RMB amountequivalent of USD 33 million (“Transaction Consideration”), and the Transferee shall pay transaction consideration in RMB, and exchange rate ofRMB against USD shall be calculated by using the middle rate against USD announced by the Bank of China at 10:00 am on one (1) working day priorto the date of delivery. For avoidance of ambiguity, it is hereby indicated that transaction consideration does not include VAT involved by theproposed transactions hereunder, and the Transferee shall actually pay and assume such VAT. 3.2The Transferee shall pay the Transferor the transaction consideration at the time and in the manner as prescribed under this Paragraph. (1)Since the provisions of Article 5.1 are met, and on the Date of Delivery, the Transferee shall pay the transaction consideration in full to theaccount designated by the Transferor in RMB. 8 (2)The payment as specified in this Article shall be remitted to the bank account(s) designated by the Transferor, and division of amount ofpayments in the specific collection account shall be otherwise determined by the Transferor in the payment instructions submitted to theTransferee, and the Transferor shall provide The Transferee with the payment instructions 2 working days prior to the date of delivery. (3)After receiving the transaction consideration and going through relevant procedures for tax filing, the Transferor shall issue to the Transferee thelawful and valid special VAT invoice or receipt. Where such special VAT invoice or receipt is required to be itemized or has its own amount tobe determined, such items or amounts shall be jointly confirmed by the Transferor and the Transferee based on the principle of friendlycooperation subject to applicable PRC tax laws. The parties shall make their commercially reasonable efforts to enable the Transferee to receiveall of the foresaid lawful and valid notes within three (3) months of payment of transaction consideration and corresponding VAT. (4)Where the matters as specified in this Article 3.2 cannot be completed for the reasons attributable to the Transferor or the Transferor fails toprovide the Transferee with notes in full on time in accordance with this Article 3.2, thereby resulting in losses sustained by the Transferee, theTransferor shall be liable.Article 4 Delivery 4.1Delivery. Within three (3) working days after the prerequisites as set forth in Article 5.1 and Article 5.2 are met or exempted or at any time agreed bythe parties (“Date of Delivery”), the parties shall make delivery (“Delivery”) in respect of transactions hereunder. Delivery shall be made at the officeof Beijing Kingsoft Cloud Network Technology Co., Ltd. or other location as agreed by the parties. 4.2Delivery of assets to be transferred and business to be transferred. The Transferor shall, on the date of delivery, submit and deliver to the Transferee: (1)Documents as set out in Annex VIII hereto and relating to assets to be transferred; (2)Documents as set out in Annex IX hereto and relating to business to be transferred; (3)Documents as set out in Annex X hereto and relating to business to be transferred.Article 5 Conditions for Performance of Obligations 5.1Conditions for performance of obligations by the Transferee. Unless a written waive is given by the Transferee, performance of its obligations fortransaction hereunder by the Transferee shall be subject to the prerequisite that all the following conditions are met prior to or on the date of delivery: (1)Representations and warranties by the Transferor under Article 6.1 below shall always be true, complete and accurate in all respects from thecurrent date when such representations and warranties are made to the date of delivery. 9 (2)Commitments by the Transferor prior to delivery under Article 8 below shall always be true, complete and accurate in all respects from thecurrent date when such commitments are made to the date of delivery. (3)The Transferor has signed this Agreement as well as all agreements and documents to be signed by the Transferor under its commitmenthereunder prior to or on the date of delivery, and this Agreement has taken effect. (4)There is no litigation, arbitration or governmental proceedings in respect of assets to be transferred, business to be transferred or arising betweenthe Transferor and the employee to be transferred that are pending or any person threatens to institute, and there have been no effective ruling,judgment or administrative punishment prohibiting or restricting transfer of assets to be transferred, which will result in that transfer of assets willbe prohibited, restricted or otherwise prejudiced in all or main respects at the time of delivery. (5)There is no effective act, decision, ruling, judgment and other instrument prohibiting or restricting transfer of assets, which will result in thattransfer of assets will be prohibited, restricted or otherwise prejudiced in all or main respects at the time of delivery. (6)There is no material adverse change in the assets to be transferred, business to be transferred and employees to be transferred upon date of signinghereof. (7)Prior to the date of delivery, the Transferor shall normally carry out business to be transferred in the manner acceptable the parties based on thegood faith and reasonable commercial considerations and related market practices, and there is no material adverse effects, thereby frustrating thepurpose of the transactions hereunder. (8)The Transferor has obtained all internal approvals required by completion of this Agreement and transactions hereunder, including but notlimited to, approval by the resolution of the shareholders’ meeting of the Transferor. (9)The fixed assets as listed in the list of fixed assets to be transferred under Annex II themselves as well as the specific documents and informationas listed in Annex II and required to be delivered prior to the date of delivery shall be delivered to the Transferee on or prior to the date ofdelivery hereunder, and the Transferee shall carry out acceptance of and inspection of the fixed assets and relevant supporting documentsdelivered by the Transferor, and when they are inspected to be correct, the Transferee shall sign the letter on handover of fixed assets to confirmcompletion of delivery. (10)Transfer of employees: in respect of the specific program on transfer of employees and sharing of relevant cost, the matters to be completed priorto the date of delivery have been completed in accordance with the program otherwise determined by the Transferor and the Transferee throughconsultation. (11)The Transferor has delivered to the Transferee the originals of the documents as set out in Annex VIII and relating to the assets to be transferredand intellectual property rights thereon. 10 (12)Prior to or on the date of delivery, The Transferee and the Transferor or the Transferor’s affiliates shall sign the agreement on transfer of patentapplication right in respect of patent application as set out in Annex III (A) (“Agreement on Transfer of Patent Application Right”). (13)Prior to or on the date of delivery, the Transferee or the Transferor and the Transferor’s affiliates (including but not limited to, Beijing KingsoftSoftware Co., Ltd., Zhuhai Kingsoft Software Co., Ltd., Beijing Kingsoft Digital Entertainment Technology Co., Ltd. and Zhuhai Kingsoft OfficeSoftware Co., Ltd.) shall sign the Patent Licensing Agreement in respect of the patent and patent application as set out in Annex III (B) (“PatentLicensing Agreement”). (14)Prior to or on the date of delivery, the Transferee or the Transferor and the Transferor’s affiliates shall sign the Agreement on Transfer ofRegistered Trademark in respect of the registered trademark and trademark application as set out in Annex III (A) (“Agreement on Transfer ofRegistered Trademark”). (15)Prior to or on the date of delivery, the Transferee or the Transferor and the Transferor’s affiliates shall sign the Agreement on Transfer of SoftwareCopyright in respect of software copyright as set out in Annex III (A) (“Agreement on Transfer of Software Trademark”). (16)Prior to or on the date of delivery, the Transferee or the Transferor and the Transferor’s affiliates shall sign the Domain Name Transfer Agreementin respect of domain name as set out in Annex III (A) (“Domain Name Transfer Agreement”). (17)In respect of relevant annexes regarding assets to be transferred and employees to be transferred attached to this Agreement at time of signinghereof, the Transferor shall timely update such annexes to reflect actual state thereof as of the date of delivery, and if updates of such annexes bythe Transferor include the material adverse change in the assets to be transferred and the business to be transferred, the Transferor shall obtainconfirmation and approval from the Transferee. (18)The Transferor provides the Transferee with its audit report of 2013. (19)Upon confirmation by the business teams of the Transferor and the Transferee through e-mail, as of December 31, 2013, the total number of usersregistering with the Persona Edition of Kuaipan and the number of active users both reached desired thresholds. On April 30, 2014 or the date ofdelivery (whichever occurs earlier), the reduction rate of the aforesaid data about number of users shall be capped. 5.2Conditions for performance of obligations by the Transferor. Unless a written waive is given by the Transferor, performance of its obligations fortransaction hereunder by the Transferor shall be subject to the prerequisite that all the following conditions are met prior to or on the date of delivery: (1)Representations and warranties by the Transferee under Article 6.2 below shall always be true, complete and accurate in all respects from thecurrent date when such representations and warranties are made to the date of delivery. (2)The Transferee has signed this Agreement as well as all agreements and documents to be signed by the Transferor under its commitmenthereunder prior to or on the date of delivery, and this Agreement has taken effect. 11 (3)The relevant authority of the Transferee approved this Agreement and the transactions hereunder, and adopted the corresponding resolution ofthe shareholders’ meeting.Article 6 Representations and Warranties 6.1Representations and Warranties by the Transferor. In addition to those disclosed under Disclosure Letter as Annex XI hereto, the Transferor makesthe following representations and warranties to the Transferee on the date of signing and the date of delivery: (1)All members of the Transferor are an independent legal persons officially organized, lawfully existing and in good standing under the PRC laws,and the Transferor will obtain all internal approvals required by completion of this Agreement and transactions hereunder prior to the date ofdelivery, including but not limited to the approval by the resolution of the shareholders’ meeting of the Transferor. The Transferor is entitled tosign this Agreement and perform its obligations hereunder, and this Agreement is fully legally binding upon the Transferor upon its signing. (2)Signing of this Agreement by the Transferor or performance of its obligations hereunder will not violate the Transferor’s articles of association orother company organization documents or any laws, regulations, rules and authorization or approval by any government agency or department,nor will said signing or performance violate or be in conflicts with any provisions of any contract or agreement to which the Transferor is a party. (3)The Transferor or its affiliates shall enjoy full ownership of the assets to be transferred and business to be transferred as transferred to theTransferee in accordance with the this Agreement (except where the intellectual property rights disclosed to the Transferee as listed in Annex IIIare granted to other parties for use under the contract to be transferred, provided that authorization of such disclosure does not affect the abilityby the Transferor to perform its obligations hereunder), and there is no license granted to any third party in respect of the assets to be transferred,pledge on the assets to be transferred, the right to purchase the assets to be transferred or any other security interest as granted to any other party;for the intellectual property rights as listed in Annex III (A), there is no pending and ongoing or potential (as deemed by the Transferor withcause) objection, dispute, request for revocation, request for declaration of invalidation, etc. proposed by the government agency or any thirdparty; (4)There is no event or circumstance that has occurred or is reasonably expected to occur, and will have significant adverse impact any part of assetsto be transferred, transfer of the employees to be transferred or the transaction hereunder; 12 (5)The Transferor (or its affiliates) has all license, permits, approval, registration, qualification, certificate or other government authorization, etc.required to operate its business to be transferred, and such documents are lawfully obtained and during the valid term; the Transferor (or itsaffiliates) lawfully operates its business to be transferred; (6)All the documents, representations and information owned by the Transferor and relating to transactions hereunder have been disclosed to theTransferee in a complete, true and effective manner, and the documents provided by the Transferor to the Transferee do not contain anymisrepresentation or omission in any significant aspects; (7)Assets to be transferred and business to be transferred that the Transferor intends to transfer (excluding authorization) to the Transferee do nothave any significant defects in right or security interest and other restrictions at the time of being transferred to the Transferee, and in respect ofthe assets to be transferred that the Transferor intends to authorize the Transferee to use, the Transferor is entitled to lawfully authorize theTransferee to use, and any data transferred by the Transferor to the Transferee, including, but not limited to, data stored at the server, do not havesignificant omissions; (8)As of the date of delivery, each copy of contract to be transferred: (i) in the case of the Transferor and other parties thereto, is legal, valid, bindingand enforceable; (ii) to the knowledge of the Transferor, the Transferor and the other parties thereto do not seriously default, nor shall theyinfringe upon the title, intellectual property rights or other legitimate interests of any third party; and (iii) to the knowledge of the Transferor,neither party advocates the abolition or cancellation of any of the terms of such contract; (9)Employees to be transferred and the Transferor or its affiliates lawfully signed the labor contract, and all the employees to be transferred are theemployees lawfully employed by the Transferor or its affiliates, and there is no significant labor dispute between the employees to be transferredand the Transferor; (10)The Transferor undertakes, as from the effective date of this Agreement, to do its utmost to contact and negotiate with the Customer to cause theCustomer to agree to transfer or terminate relevant contract to be transferred in the agreed specific applicable manner, thereby transferring thecontract to be transferred to the Transferee. In respect of the contract the contract to be transferred that the Customer agrees to transfer and theTransferee recognizes in writing, the Transferor shall arrange the parties to sign relevant agreement, contract and/or other documents respectivelyin the shortest practicable time; (11)Intellectual Property Rights (a)All intellectual property rights contained in the intangible assets to be transferred or authorized hereunder are lawfully owned by thesubjects as listed in Annex III, and to the knowledge of the Transferor, the intellectual property rights do not constitute interference,infringement, misappropriation or otherwise conflict with the intellectual property rights of any third party, and there are no securityinterests or other restrictions on each of the intellectual property rights, and the Transferor has taken necessary action to maintain andprotect the intellectual property rights; 13 (b)To the knowledge of the Transferor, the aforementioned intellectual property rights are not subject to any judgment, order or ruling;there is no pending litigation, arbitration or other claim or assertion against legality, validity, enforceability, use or ownership of suchintellectual property rights; (c)All intellectual property rights are legally registered or applied for registration under PRC laws, and the registration obtained orapplication for registration made is not revoked or dismissed or declared invalid, and the Transferor shall pay annual fee for patent onschedule. (12)The Transferor has disclosed to the Transferee all material facts relating to the assets to be transferred, business to be transferred and employees tobe transferred, and all relevant information given by the Transferor or the representative thereof to the Transferee prior to or during negotiationshall be true, complete, accurate and not misleading in all material respects; (13)Information under the annexes hereto is true, complete and accurate, without any concealment and material omissions; (14)Except for those disclosed to the Transferee, the assets to be transferred constitute the main and necessary assets required by the Transferee toengage in the business to be transferred, and the operation of business to be transferred has no need to take any other assets currently owned bythe Transferor or its affiliates or any third party (including, but not limited to, fixed assets, patents, patent applications, trademarks, trademarkapplications, software copyright, domain names), personnel or technology as basis or premise, and business to be transferred does not involveillegal use of the assets currently owned by any third party (including, but not limited to, fixed assets, patents, patent applications, trademarks,trademark applications, software copyrights, domain) or technology or personnel, except for the assets of the Transferor or its affiliates used asagreed by the Transferee and the Transferor or its affiliates; (15)Prior to or on the date of delivery, both the assets to be transferred and business to be transferred are in the normal operating state; (16)Except as otherwise agreed herein, the assets to be transferred, the employees to be transferred and the business to be transferred have includedrelevant rights and interests on all the resources used by the Transferor for operating the assets to be transferred and business to be transferredprior to the date of delivery, and required to enable the Transferee to normally operate the assets to be transferred and the business to betransferred in the manner substantially the same as the manner adopted by the Transferor prior to transfer subsequent to the date of delivery; 14 (17)The Transferor does infringe upon the rights of any third party or is subject to any penalties imposed by relevant government departments due toits engagement in the business to be transferred. To the knowledge of the Transferor, there is no legal action that is ongoing or involves thebusiness to be transferred or assets to be transferred or employees to be transferred, nor there is any ongoing administrative proceedings,litigation or arbitration imposed by the administrative department, court or arbitration institution or involving business to be transferred or assetsto be transferred or employees to be transferred, nor there is any labor dispute between the Transferor and the employees to be transferred, exceptwhere the aforesaid penalty, administrative procedures, litigation, arbitration or dispute will not have significant adverse impact on the proposedtransactions hereunder. The Transferor is lawfully entitled to transfer the assets to be transferred or business to be transferred in accordance withthis Agreement, and may lawfully transfer said assets or business; (18)There is no insurable interest and/or insurance contract that is still valid on any assets to be transferred. 6.2Representations and warranties by the Transferee. The Transferee makes the following representations and warranties to the Transferor: (1)The Transferee is a limited liability company validly established under PRC laws, which is s officially organized, lawfully existing and in goodstanding under the PRC laws, and the Transferee is entitled to sign this Agreement and perform its obligations hereunder, and this Agreement isfully legally binding upon the Transferee upon its signing. The Transferee will obtain all internal approvals required by completion of thisAgreement and transactions hereunder prior to the date of delivery, including but not limited to the resolution of the shareholders’ meeting ofthe Transferee. (2)Signing of this Agreement by the Transferee or performance of its obligations hereunder will not violate the Transferee’s articles of association orother company organization documents or any laws, regulations, rules and authorization or approval by any government agency or department,nor will said signing or performance violate or be in conflicts with any provisions of any contract or agreement to which the Transferee is a party.Where signing of this Agreement or performance its obligations hereunder by the Transferee requires authorization or approval from anygovernment agency or department under any laws, regulations and rules, the Transferee undertakes to obtain such authorization or approval, ifand the Transferee fails to obtain said authorization or approval, the parties agree that termination of such transaction by either party is notdeemed as default. Where the signing of this Agreement or performance its obligations hereunder by the Transferor requires authorization orapproval by any government agency or department and needs assistance from the Transferee under any laws, regulations and rules, the Transfereeundertakes to cooperate. 15Article 7 Taxes and Fees 7.1The parties shall bear the taxes and fees relating to the transactions hereunder respectively under applicable laws and regulations. VAT resulting fromtransactions hereunder shall be borne by the Transferee. 7.2The costs and expenses relating to negotiation, preparation, signing of this Agreement and incurred by the parties to obtain necessary approvals, shallbe borne by the Transferor, subject to an agreed upper limit.Article 8 Commitments 8.1Commitments by the parties. As from the date of the signing of this Agreement, either party shall: (1)not engage in or allow any act or omission that may be in violation of any representations and warranties as specified in Article 6 hereof and thecommitments as specified in Article 8 hereof; (2)Once such party is aware of any act or omission in violation of any representation and warranty hereunder, it shall immediately make disclosureto the other party in writing. Especially once the Transferor or the Transferee finds any asset to be included but not included in the scope ofassets to be transferred hereunder, the Transferor shall immediately transfer such asset to the Transferee free of charge in accordance with thisAgreement, and complete the corresponding registration of change (if required). 8.2As from the date of signing of this Agreement, the Transferor undertakes: (1)to take all necessary action and sign all necessary documents to cause ownership of the assets to be transferred and any right in connectiontherewith be full given to the transferee and/or registered under the Transferee’s name, and smoothly complete delivery; (2)to take effective measures to facilitate a smooth transition of the employees to be transferred to the Transferee, and assist the Transferee in goingthrough all the procedures for personnel employment of the employees to be transferred to make such employees be lawfully employed by theTransferee; the Transferor and the Transferee shall otherwise sign the employee relocation and cost-sharing agreement at the same time assigning this Agreement to expressly agree the specific program on transfer of employees. 16 (3)from the date of signing of this Agreement to the date of delivery (in the case of intellectual property rights involved in the intangible assets tobe transferred registration of which is completed) or date of actual transfer of intellectual property right, except for the performance ofobligations hereunder or with the prior written consent of the Transferee or as otherwise agreed herein, the Transferor may not: (1) use, license,sell, lease, copy, pledge or dispose of the assets to be transferred or any part thereof or relevant intellectual property rights; (2) advocate forownership or intellectual property rights of the assets to be transferred (or any updated, upgraded or developed part thereof); (3) apply forregistering name or similar name or the contained intellectual property rights of the assets to be transferred (including, but not limited to, anyupdated, upgraded or developed part thereof) as trademarks, domain names, trade names, etc., or registered copyright, or make unauthorized usethereof; (4) disclose trade secrets related to assets to be transfer to a third party; (5) in respect of the patent or trademark being applied for as listedin Annex III (A), cancel application or is overdue to make a reply when the relevant government department requires the Transferor to modify ortake any action on such application within the prescribed time. For avoidance of ambiguity, it is hereby indicated that in no case may use by theTransferor or its affiliates of the excluded asses as mentioned in Article 2.6 hereof or operation by the Transferor or its affiliates of the excludedbusiness as mentioned in Article 2.6 be deemed as violation of this Article 8.2(3) or other provisions hereof. (4)Within six (6) months of the date of delivery, the Transferee and the Transferor or its affiliates shall submit the application materials concerningtransfer of the patent as listed in Annex III (A) to relevant authority in charge of patent, and finally complete the filing of patent transfer, andobtain the Notice of Going through Procedures issued by the authority in charge of patent. (5)Within six (6) months of the date of delivery, the Transferee and the Transferor or its affiliates shall submit the application materials concerningtransfer of the patent application as listed in Annex III (A) to relevant authority in charge of patent, and finally complete the filing of patenttransfer, and obtain the Notice of Going through Procedures issued by the authority in charge of patent. (6)Within eighteen (18) months of the date of the delivery, the Transferee and the Transferor or its affiliates shall submit to relevant authority incharge of trademark the application materials regarding the registered trademark as listed in Annex III (A) hereto (other than Kuaipan trademarkunder Items 1-6, Section (I) and Items 8-14, Section (II) of Annex III (A), obtain the Certificate on Approval of Transfer of Trademark issued bythe relevant authority in charge of trademark or the filing document issued by other authority in charge of trademark indicating that registrationof transfer of the registered trademark belonging to the scope of assets to be transferred and to be transferred to the Transferee has beencompleted. For avoidance of ambiguity, it is hereby indicated that transfer of Kuaipan trademark under Items 1-6, Section (I) and Items 8-14,Section (II) of Annex III (A) shall be completed within eighteen (18) months upon deregistration of trademark under Article 8.10 hereof. 17 (7)Within eighteen (18) months of the date of delivery, the Transferee and the Transferor or its affiliates shall submit to relevant authority in chargeof trademark the application materials regarding the trademark applications as listed in Annex III (A) hereto and obtain the Acceptance Noticeissued by the authority in charge of trademark. (8)Prior to completion of transfer of registered trademark and patent as listed in Annex III (A), the Transferor shall maintain validity of the patentand registered trademark, including, but not limited to timely payment of the annual fee in full and dealing with the administrative procedures,disputes, litigation, arbitration or other proceedings concerning trademark and patent with due diligence an, provided that all the costs arisingfrom registration of change for transfer of registered trademark and patent relating to the aforesaid matters shall be borne by the Transferee; (9)Within six (6) months of the date of delivery, the Transferee and the Transferor or its affiliates shall apply to the copyright administrationdepartment under the State Council for going through the procedures for registration of transfer of software copyright as listed in Annex III (A),and provide the Transferee with the Software Copyright Registration Certificate with the Transferee registered as the owner. (10)Within six (6) months of the date of delivery, the Transferee and the Transferor or its affiliates shall apply to the relevant domain nameadministrative authority for going through the procedures for registration of change for the transfer of domain name as listed in Annex III (A),and provide the Transferee with the Domain Name Certificate with the Transferee registered as the owner. (11)Within six (6) months of the date of delivery, Beijing Kingsoft Cloud Network Technology Co., Ltd. shall change the Telecommunications andInformation Services Business License of the People’s Republic of China numbered Jing ICP Zheng 120829 held by it. (12)Within six (6) months of the date of delivery, the Transferor shall make every effort to contact and negotiate with the Customer to cause theCustomer to agree to transfer the contract to be transferred in the special applicable manner, thereby transferring the contract to be transferred tothe Transferee. In respect of the contract to be transferred that the Customer agrees to transfer and is recognized by the Transferee in writing, theTransferor shall arrange them to sign relevant agreement, contract and/or other documents respectively in the practicable shortest time. TheTransferor will endeavor to require the Customer to sign the relevant form and content of the tripartite agreement in the format and contents asdetailed in Annex V, and submit the signed the tripartite agreement to the Transferee; (13)As from date of signing of this Agreement without the prior consent of the Transferee, the Transferor shall not sign any new contract in respect ofthe business to be transferred; all newly signed contract as from the date of delivery shall be directly signed by the Transferee and the Customer,and the Transferor shall not sign and enter into any new contract or agreement in respect of the business to be transferred (except for signing fortransferring the contract to be transferred), except where the prior consent is obtained from the Transferee; 18 (14)The Transferor guarantees to normally operate the assets to be transferred and the business to be transferred during the period commencing on thedate of signing hereof and ending on the date of delivery, and will not establish or allow to have any security or other encumbrance that mayaffect the rights of and interests in the assets to be transferred or business to be transferred, except where the prior consent is obtained from theTransferee. (15)After the assets to be transferred hereunder are transferred to the Transferee, the Transferor will not commit any act that may prejudice legitimacy,effectiveness and value of such assets to be transferred, or hinder the Transferee to make full use of such assets to be transferred; (16)The Transferor will not engage in or permit any act or omission that may be in violation of representations and warranties under Article 6 hereofprior to the date of delivery; (17)After the business to be transferred hereunder is transferred to the Transferee, the Transferor will not commit any act that may be detrimental tothe smooth operation of such business to be transferred, or impede the Transferee to operate such business to be transferred; (18)The Transferor shall bear the obligation of confidentiality under the confidentiality agreements as listed in Annex XII hereto and other relatedagreements containing confidentiality provisions, unless the Transferee and the counterpart thereto otherwise sign an agreement, or theTransferee has no need to perform the obligations under the confidentiality agreements as listed in Annex XII hereto and other relatedagreements containing confidentiality provisions and to be liable for damages; (19)Within twelve (12) months of the date of delivery, where the Transferee needs to use the patents as listed in Annex XIII hereto at the time ofoperating the business to be transferred, the Transferor shall assist the Transferee in obtaining the authorization of free use of such patent. 8.3Upon the date of delivery, the Transferor shall do its utmost commercially to assist the Transferee in operating the business transferred in accordancewith this Agreement and give necessary support and cooperation to the Transferee to ensure that such business to be transferred is operated smoothly. 8.4Business operation by the Transferee upon delivery. The Transferee undertakes to do their utmost commercially upon the date of delivery to operatethe business to be transferred and provide the user with relevant service to ensure that no adverse effects will be imposed on the Transferor, its affiliatesand its business due to the operation by the Transferee of the business to be transferred. 198.5Authorized use of intellectual property rights. (1) Upon the date of delivery and prior to completion of procedures for registration of transfer of theassets to be transferred, the Transferor agrees to authorize the Transferee to use relevant assets to be transferred without compensation, including butnot limited to trademarks, patents, domain name and software copyrights and other intangible assets as listed in Annex III (A); (2) Upon the date ofdelivery, the Transferor agrees to license without compensation or cause the its affiliates to license without compensation the Transferee to use thetrademark and patent as listed in Annex III (B) on the premise that the Transferee only continues to use such trademark and patent within the scope ofbusiness to be transferred on the date of delivery; (3) upon completion of the procedures for registration of transfer of patent as listed in Annex III (A),the Transferee agrees to authorizes to use such patent without compensation, and in case the Transferee transfers such patent, it shall continue to ensurethat the Transferor uses such patent without compensation; (4) within 18 months of the date of delivery, the Transferor may continue to use thetrademarks as listed in Annex III (A) without compensation to facilitate the Transferor to continue to use such trademark while adjustment otherrelevant product business, provided that the Transferor is not obligated to take any further action in the previous use of such trademark (including, butnot limited to, requiring the ads placed to stop using such trademark). 8.6Non-competition agreement. Except where the prior written consent is obtained from the Transferee, the Transferor undertakes: within three (3) yearsupon delivery, the Transferor and the company in which the Transferor holds 50% or more of the equity or the company holding 50% or more of equityin the Transferor (hereinafter collectively referred to as “the Party Making Non-competition Commitment”) shall adhere to standard non-competeprovisions agreed upon between the parties. 8.7The Transferee undertakes that without written permission of the Transferor, the Transferee shall not use or disclose the trade secrets of the Transferorobtained by the Transferee under this Agreement and the transactions proposed hereunder that have nothing to do with the business to be transferred. 8.8The Transferee undertakes not to instigate any personnel to leave the Transferor or not joint the Transferor or not serve the Transferor, nor will theTransferee instigate any personnel to leave the Transferor or join the Transferee or its affiliate or other party’s enterprise, institution or entity; withinthree (3) years as from the date of delivery, the Transferee and the companies in which the Transferee holds 50% or more of equity or the companiesholding 50% or more of equity in the Transferee will not hire the personnel as determined in the list of the employees the Transferor submits to theTransferee in writing each year. 8.9The parties hereto agree and acknowledge that, except as otherwise agreed herein, the transaction consideration constitutes the reasonable andsufficient consideration of the assets to be transferred and business to be transferred hereunder, and except for transaction consideration, the Transferorhas need to make any payment to the Transferee or other parties under the agreement on transfer of patent right, agreement on transfer of the patentapplication right, patent licensing agreement, trademark authorization agreement, agreement on transfer of registered trademark, agreement on transferof software copyright or agreement on transfer of domain name. 208.10Deregistration of trademark. In respect of the registered trademarks involving word “KingSoft” as listed in Annex III (B), the Transferor shallimmediately carry out deregistration with the assistance of the Transferee upon the date of delivery, and shall submit the application materials forderegistration of trademark within ten (10) working days of the date of delivery. The Transferee may continue to use the registered trademarksinvolving word “KingSoft” as listed in Annex III (B) prior to completion of procedures for deregistration. 8.11Renaming software copyright. In respect of the name of software copyright as listed in Annex III (A) involving word “kingSoft”, upon registration ofchange in the ownership of software copyright, the Transferee shall change and delete the word “kingSoft” involved in its name within two (2) monthsupon completion of registration of change in ownership of such software copyright. 8.12The parties shall make best efforts on business to cooperate with cutting and data migration for all the servers required and used by completion ofbusiness to be transferred, including but not limited to, the servers as listed in Annex II hereto, and ensure that no significant loss is caused to relevantdata.Article 9 Liability for Breach of Contract and Termination of Agreement 9.1Liability for Breach of Contract. (1)Where either party violates any of its representation, warranties, undertakings hereunder or any other provisions hereof, including thecircumstance under which either party makes any untrue representation or warranty hereunder, thereby resulting in the other party assumes anycosts, liability or sustains any loss (Including but not limited to, any loss of profits expected to be available to the other party for which the otherparty has a specific and reasonable evidence), the defaulting party shall be liable to the other party for any of the aforesaid costs, liabilities orloss (including but not limited to any interest and attorney fees paid or lost by the other party due to default by the defaulting party). Suchdamages shall be equivalent to the actual losses incurred by the non-defaulting party due to default. Where the parties default, they shall beliable correspondingly in corresponding proportion based on actual situation. (2)The defaulting party shall take corrective action as soon as possible, continue to fulfill its obligations under this agreement and makecompensation for direct loss sustained by the non-defaulting party, provided that the cumulative damages payable by the defaulting party asagreed by the parties shall not exceed 100% of transaction consideration. (3)Where the cumulative damages exceed an agreed threshold due to subsequent breach by the defaulting party, the defaulting party shall be liablefor all losses sustained by the other party. 21 (4)Subject to relevant provisions of this Article 9.1, after delivery is made, where the Transferee finds that the Transferor violates the representationsand warranties under Article 6.1 hereof and/or commitments by the Transferor under Article 8, the Transferee is entitled to require the Transferorto take corrective measures as soon as possible and be liable for losses sustained by the Transferee, provided that the Transferee shall hold theTransferor liable for such breach within eighteen (18) months subsequent to the date of delivery; where the Transferor finds that the Transfereeviolates the representations and warranties under Article 6.2 hereof and/or commitments by the Transferee under Article 8, the Transferor isentitled to require the Transferee to take corrective measures as soon as possible and be liable for losses sustained by the Transferor, providedthat the Transferor shall hold the Transferee liable for such breach within eighteen (18) months subsequent to the date of delivery. (5)Notwithstanding the provisions of this Article 9.1, where the party making non-competition commitment violates the provisions on non-competition under Article 8.6, the Transferor shall pay the Transferee liquidated damages, the amount of which would be determined in line withthe amount of time passed since the closing of this transaction. (6)Where closing is delayed for the reasons attributable to the Transferee or the Transferee delays in paying part or all of transaction considerationfor more than five (5) working days, the Transferee shall pay the Transferor the liquidated damages equivalent to one-thousandth (0.1%) of thetransaction consideration per day of delay, and bear the costs incurred and involved by the Transferor in respect of the assets to be transferredand business to be transferred as from the date of delay in delivery or the date of delay in payment. Where such transferee defaults for more thanthirty (30) working days, the Transferee shall pay the Transferor the amount equivalent to one point five thousandth (0.15%) of the transactionconsideration as the liquidated damages per day of delay, and bear one hundred and fifty percent (150%) of the costs incurred and involved bythe Transferor in respect of the assets to be transferred and business to be transferred as from the date of delay in delivery or the date of delay inpayment. Where completion of one more or more matters under Items (4), (5), (6), (7), (9), (10), (11) and (12) (a total of eight items) of Article 8.2is delayed for more than five (5) working days for the reasons attributable to the Transferor, the Transferor shall pay the Transferee one-ten-thousandth (0.01%) of the transaction consideration as the liquidated damages on the daily basis in respect of each of said items, and bear thecosts incurred by the Transferee as a result. Where such transferor defaults for more than thirty (30) working days, the Transferor shall pay theTransferee one point five ten-thousandth (0.015%) of the transaction consideration as the liquidated damages on the daily basis, and bear onehundred fifty percent (150%) of the costs incurred by the Transferee as a result. (7)Members of the Transferor shall be jointly and severally liable for damages in respect of the liability for breach of contract as set out in thisArticle 9.1. 9.2Termination of Agreement. (1)The parties hereto may terminate this Agreement at any time if they have so agreed through friendly consultation. 22 (2)Where either party seriously violates or fails to perform any provisions hereof, other non-defaulting party is entitled to immediately terminatethis Agreement, and the defaulting party shall bear any liability arising therefrom. (3)Upon termination of this Agreement, the parties shall work together to make the assets to be transferred and employees to be transferred to berestored to the state at the time prior to signing hereof, and shall fully return any and all consideration paid by the Transferee. All the costsarising from or in connection with such return procedures shall be borne by the party at fault in the fault principle. Where either party is not atany fault for failure to delivery, the party proposing for termination shall be liable for the costs in respect of such return procedures. (4)Any liability for damages in respect of any breach hereunder shall not be rescinded due to termination hereof.Article 10 Confidentiality 10.1The Parties acknowledge and confirm that the existence and terms of this Agreement and any oral or written information exchanged by the parties inrespect of this Agreement are confidential information (“Confidential Information”), and the parties shall maintain confidentiality of all suchinformation. Without the prior written consent of the other party, neither party shall disclose to any third party any Confidential Information, except forthe following circumstances: (1) such information has entered the public domain for the reasons other than unauthorized disclosure by the partyaccepting such information to the public; (2) disclosure is required by applicable laws, including, but not limited to disclosure either party or affiliatesthereof is required to make due to listing or listing regulation; or (3) either party needs to make disclose to its legal or financial adviser in respect of thetransaction hereunder, provided that such legal or financial advisors also needs to perform the obligation of confidentiality similar to this clause. Anydisclosure made by working personnel or an institution hired by either party shall be deemed to have been made by such party, and such party is liablefor breach of contract in accordance with this Agreement. This clause survives termination of this Agreement for whatever reason.Article 11 Force Majeure 11.1Where either party hereto delays in performing its obligations hereunder due to force majeure, thereby resulting in any loss sustained by the otherparty, such party is not liable for such losses. The party encountering event of force majeure shall take active effective measures to minimize the losssustained by the other party due to its delay in performing contractual obligations, or such party shall be liable for the further losses on its own.Article 12 Miscellaneous 12.1Effectiveness of this Agreement. This Agreement takes effect upon signing by the parties. 12.2Governing Law. Signing, effectiveness, performance, interpretation, termination of this Agreement and dispute resolution shall be governed by thelaws of the People’s Republic of China. 2312.3Dispute Resolution. All disputes relating to this Agreement and arising out of performance of this Agreement shall be resolved by the parties throughfriendly consultation. Where such dispute is not resolved within thirty (30) days after one party issues the written notice to the other party, requiringresolution of the dispute through consultation, either party may submit such dispute to China International Economic and Trade ArbitrationCommission for arbitration, which shall be conducted under the then effective arbitration rules in Guangzhou. The arbitral award is final and bindingon the parties hereto. 12.4Modifications and Supplements to this Agreement. Any modification or supplement to this Agreement shall be made by the parties hereto in writing.Any modification and supplement hereto signed by the parties in writing constitute an integral part of this Agreement and are equally authentic as thisAgreement. 12.5Waiver. Failure or delay by either party in exercising any right or remedy as set forth in this Agreement and modifications or supplements hereto shallnot constitute or be deemed as a waiver; nor shall any single or partial exercise of the aforesaid rights and remedies impede further exercise of suchrights and remedies. 12.6Severability. If any provision of this Agreement becomes invalid or unenforceable for any reason, legality, validity and enforceability of otherprovisions of this Agreement will not be affected. 12.7Annexes. Any annex hereto constitutes an integral part of this Agreement and is equally authentic as this Agreement. 12.8Survival. Article 6, Article 8 to Article 10 and Article 12 hereof survive termination hereof. 24The following annexes constitute an integral part of this Agreement:Annex I: List of Contacts to be TransferredAnnex II: List of Fixed Assets to be TransferredAnnex III (A): List of Intangible Assets to be TransferredAnnex III (B): List of Intangible Assets to be LicensedAnnex IV: List of Employees to be TransferredAnnex V: Tripartite AgreementAnnex VI: Labor ContractAnnex VII: Confidentiality and Non-competition AgreementAnnex VIII: List of Documents Relating to Assets to be TransferredAnnex IX: List of Documents Relating to Business to be TransferredAnnex X: List of Documents Relating to Employees to be TransferredAnnex XI: Disclosure LetterAnnex XII: Confidentiality AgreementAnnex XIII: Patents(The remainder of this page is intentionally left blank) 25(This is the signature page of Assets and Business Transfer Agreement, and the remainder of this page is intentionally left blank)In witness whereof, the parties hereto have caused this Agreement to be signed by their respective authorized representative on the date written above.Transferor: Beijing Kingsoft Cloud Network Technology Co., Ltd.Seal of Beijing Kingsoft Cloud Network Technology Co., LTD.Signature of Authorized Representative: /s/ WANG YulinName of Authorized Representative: WANG YulinTitle of Authorized Representative: Legal Representative[Corporate Seal]Signature page 26(This is the signature page of Assets and Business Transfer Agreement, and the remainder of this page is intentionally left blank)In witness whereof, the parties hereto have caused this Agreement to be signed by their respective authorized representative on the date written above.Transferor: Zhuhai Kingsoft Cloud Science and Technology Co., Ltd.Seal of Zhuhai Kingsoft Cloud Science and Technology Co., Ltd.Signature of Authorized Representative: /s/ ZHANG HongjiangName of Authorized Representative: ZHANG HongjiangTitle of Authorized Representative: Legal Representative[Corporate Seal]Signature page 27(This is the signature page of Assets and Business Transfer Agreement, and the remainder of this page is intentionally left blank)In witness whereof, the parties hereto have caused this Agreement to be signed by their respective authorized representative on the date written above.Transferor: Beijing Kingsoft Cloud Science and Technology Co., Ltd.Seal of Beijing Kingsoft Cloud Science and Technology Co., Ltd.Signature of Authorized Representative: /s/ ZHANG HongjiangName of Authorized Representative: ZHANG HongjiangTitle of Authorized Representative: Legal Representative[Corporate Seal]Signature page 28(This is the signature page of Assets and Business Transfer Agreement, and the remainder of this page is intentionally left blank)In witness whereof, the parties hereto have caused this Agreement to be signed by their respective authorized representative on the date written above.Transferee: Shenzhen Xunlei Networking Technologies Co., Ltd.Seal of Shenzhen Xunlei Networking Technologies Co., Ltd.Signature of Authorized Representative: /s/ WU JiangName of Authorized Representative: WU JiangTitle of Authorized Representative: Authorized Signatory[Corporate Seal]Signature page 29Annex 1List of Contracts to be Transferred(not applicable)Annex 2List of Fixed Assets to be TransferredAnnex 3(A)List of Intangible Assets to be TransferredI. Trademarks and Trademark ApplicationsA. Trademarks 1.2.3.B. Trademark Applications 1.2.3.4.5.II. Domain Names1.Kuaipan.cnIII. Software Copyrights 1.2.3.4.5.T PanV1.0.0.289KingsoftKuaipan V1.0Kuaipan V1.0KingsoftKuaipan V2.0KingsoftKuaipan 1.0 6.7.8.9.10.KingsoftKuaipan 2.0XiaomiWungpan V1.0KingsoftYunqiangceV1.0Kansunzi IV1.0Kansunzi AV1.011.12.13.14.Kuaipan PCV1.21.0.1590Kuaipan AndroidV1.9.5Kuaipan iPadV3.8Kuaipan iPhoneV2.6IV. Patent Application1.Device to sharesourcesAnnex 3(B)I. Patents and Patent ApplicationsA. Patent 1.Client andmethod to showfile status oncloudB. Patent Applications 1.2.3.4.5.Means, deviceand terminalequipment totransfer filesbetweenterminalequipment andserverMeans,terminalequipment,cloud serverand system to recommendthe installation ofsoftwareMeans, client,server,terminal andsystem to syncdataMeans, server,client andterminalequipment tosync filesSystem andmeans toprioritize theupdate ofcertain files6.7.8.9.10.Means andsystem to logon real timeonline storageservice viainstantmessengersoftwareSystem andmeans totransfer filesSystem andmeans totransfer filesSystem andmeans totransfer filesSystem andmeans totransfer files11.12.13.14.15.Means andsetup of linkto jump to thecontent fromthe table ofcontentMeans, client,server andequipment tosync filesMeans, client,server andequipment toprocess dataMeans, device,client, serverand equipmentto sync filesMeans, device,client, serverand equipmentto sync files16.17.18.Two-dimensionalcode process,client, electronicsequipment,server terminaland server.Means, device,system, mobileand registrationserver toexpedite theregistrationMulti-languagemeans andsystem of sourcecodeII. Trademark1. Annex 4List of Employees to be TransferredAnnex 5Three Parties Agreement TemplateAnnex 6Template Labor Contract(issued by the Shenzhen Bureau of Labor and Social Security)Annex 7Template Employee Confidentiality and Non-Compete AgreementsAnnex 8List of Documents Related to Asset TransferAnnex 9List of Documents Related to Transfer of BusinessAnnex 10List of Documents Related to the Employees Being TransferredAnnex 11Disclosure LetterAnnex 12List of Confidentiality Agreements and Related ContractsAnnex 13Patents 1.2.3.4.5.Means andsystem toencrypt anddecrypt theencoded filesMeans andsystem tomanage user’sreceiving filesMeans andsystem toautomaticallytag filesaccording to the filesignaturesMeans andsystem toshare databased onlocationserviceMeans, systemand device toshare files toother clientsoutside thecircle 6.7.8.9.10.Means, system,cloud serverand terminal todownload filescross terminalsMeans, deviceand clientequipment todownloadmedia filesMeans anddevice toprocess dataMeans toidentifyInternet userFile processingmeans and dataprocessingdevice 11.12.13.14.15.Means andsystem todownload filesMeans, clientequipment andserver toprocess dataMeans anddevice tomanageAndroid filesMeans andsystem totransfer andopen filesamongmulti-devicesIdentificationmeans betweenserver andclient 16.17.18.19.20.Means, serverand clientequipment toupdate theprocessMeans andsystem torestore thedeleted filesMeans anddevice ofrollbackMeans andsystem toobtain theprototypenumber of anAndroidmobile phoneMeans anddevice toobtain specificsource on theInternet 21.22.2324.25.Means andsystem to syncfiles on theonline storageMeans, deviceand mobileequipment tointeractMeans andsystem totransfer datainstantlyMeans andsystem ofsmooth flowcontrolSystem andmeans torealize singlesign-on.26.27.28.29.30.Means toupdate thewirelessterminalprogramMeans anddevice tobackup dataMeans anddevice todownload dataMeans andsystem to synconline storagevia authorizedmanagementMeans andsystem of cachesynchronizationof online storage 31.32.33.34.35.Means andsystem to synconline storageSystem, deviceand means toshare filesMeans andsystem tomanage datasecurityMeans andsystem toinstantlytransfer dataamong mobiledevicesMeans anddevice toprotect user’sdata 36.37.38.39.40.Means andsystem toresolveconflictsamong files inthe cloudstorage systemMeans to syncfiles on themobiledevicesMeans anddevice tomanage mobileapplicationconfigurationinformationMeans andsystem toswitchbetween fileson the mobileterminalMeans, deviceand mobileterminal tomove data onthe mobileterminal41.42.43.Means, deviceand client to startthe applicationMeans and cloudstorage system toshow theselectivelysynced files atthe clientMeans andsystem to encryptthe accountinformationExhibit 8.1List of Significant Subsidiaries and Variable Interest Entity Place of IncorporationSubsidiaries Giganology (Shenzhen) Co. Ltd. PRCXunlei Network Technologies Limited British Virgin IslandsXunlei Network Technologies Limited Hong KongXunlei Computer (Shenzhen) Co., Ltd. PRCVariable Interest Entity Shenzhen Xunlei Networking Technologies, Co., Ltd. PRCExhibit 12.1Certification by the Principal Executive OfficerPursuant to Section 302 of the Sarbanes-Oxley Act of 2002I, Sean Shenglong Zou, certify that:1. I have reviewed this annual report on Form 20-F of Xunlei Limited;2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the company as of, and for, the periods presented in this report;4. The company’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) for the company and have:(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, toensure that material information relating to the company, including its consolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this report is being prepared;(b) [Intentionally omitted];(c) Evaluated the effectiveness of the company’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and(d) Disclosed in this report any change in the company’s internal control over financial reporting that occurred during the period covered by the annualreport that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting; and5. The company’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to thecompany’s auditors and the audit committee of the company’s board of directors (or persons performing the equivalent functions):(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonablylikely to adversely affect the company’s ability to record, process, summarize and report financial information; and(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the company’s internal controlover financial reporting.Date: April 20, 2015 By:/s/ Sean Shenglong ZouName:Sean Shenglong ZouTitle:Chairman and Chief Executive OfficerExhibit 12.2Certification by the Principal Financial OfficerPursuant to Section 302 of the Sarbanes-Oxley Act of 2002I, Tao Thomas Wu, certify that:1. I have reviewed this annual report on Form 20-F of Xunlei Limited;2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the company as of, and for, the periods presented in this report;4. The company’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) for the company and have:(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, toensure that material information relating to the company, including its consolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this report is being prepared;(b) [Intentionally omitted];(c) Evaluated the effectiveness of the company’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and(d) Disclosed in this report any change in the company’s internal control over financial reporting that occurred during the period covered by the annualreport that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting; and5. The company’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to thecompany’s auditors and the audit committee of the company’s board of directors (or persons performing the equivalent functions):(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonablylikely to adversely affect the company’s ability to record, process, summarize and report financial information; and(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the company’s internal controlover financial reporting.Date: April 20, 2015 By:/s/ Tao Thomas WuName:Tao Thomas WuTitle:Chief Financial OfficerExhibit 13.1Certification by the Principal Executive OfficerPursuant to Section 906 of the Sarbanes-Oxley Act of 2002In connection with the Annual Report of Xunlei Limited (the “Company”) on Form 20-F for the year ended December 31, 2014 as filed with theSecurities and Exchange Commission on the date hereof (the “Report”), I, Sean Shenglong Zou, Chairman and Chief Executive Officer of the Company,certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.Date: April 20, 2015 By:/s/ Sean Shenglong ZouName:Sean Shenglong ZouTitle:Chairman and Chief Executive OfficerExhibit 13.2Certification by the Principal Financial OfficerPursuant to Section 906 of the Sarbanes-Oxley Act of 2002In connection with the Annual Report of Xunlei Limited (the “Company”) on Form 20-F for the year ended December 31, 2014 as filed with theSecurities and Exchange Commission on the date hereof (the “Report”), I, Tao Thomas Wu, Chief Financial Officer of the Company, certify, pursuant to18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.Date: April 20, 2015 By:/s/ Tao Thomas WuName:Tao Thomas WuTitle:Chief Financial OfficerExhibit 15.1Consent of Maples and CalderApril 20, 2015Dear SirsWe have acted as legal advisers as to the laws of the Cayman Islands to Xunlei Limited, an exempted limited liability company incorporated in the CaymanIslands (the “Company”), in connection with the filing by the Company with the United States Securities and Exchange Commission (the “SEC”) of anannual report on Form 20-F for the year ended 31 December 2014 (“Form 20-F”).We hereby consent to the reference of our name under the heading “Item 10. Additional Information – E. Taxation – Cayman Islands Taxation” in the Form20-F, and further consent to the incorporation by reference of the summary of our opinion under this heading into Xunlei Limited’s registration statement onForm S-8 (File No. 333—200633) that was filed on November 28, 2014. Yours faithfully/s/ Maples and CalderMaples and CalderExhibit 15.2April 20, 2015Consent of Zhong Lun Law FirmDear Sirs:We consent to the reference to our firm under the headings “Item 3. Key Information—D. Risk Factors” and “Item 4. Information on the Company—C.Organizational Structure” in Xunlei Limited’s Annual Report on Form 20-F for the year ended December 31, 2014, which will be filed with the Securities andExchange Commission (hereinafter the “SEC”) in April 2015, and further consent to the incorporation by reference of the summaries of our opinions underthese headings into Xunlei Limited’s registration statement on Form S-8 (File No. 333—200633) that was filed on November 28, 2014. We also consent tothe filing with the SEC of this consent as an exhibit to the Annual Report on Form 20-F for the year ended December 31, 2014. Yours faithfully,/s/ Zhong Lun Law FirmZhong Lun Law FirmExhibit 15.3Consent of Independent Registered Public Accounting FirmWe hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 333-200633) of Xunlei Limited of our report datedApril 20, 2015 relating to the consolidated financial statements as of December 31, 2014 and for the year ended December 31, 2014, which appears in thisForm 20-F./s/ PricewaterhouseCoopers Zhong Tian LLPPricewaterhouseCoopers Zhong Tian LLPShenzhen, the People’s Republic of ChinaApril 20, 2015Exhibit 15.4Consent of Independent Registered Public Accounting FirmWe hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 333-200633) of Xunlei Limited of our report datedMarch 21, 2014 relating to the consolidated financial statements as of December 31, 2013 and for each of the two years in the period ended December 31,2013, which appears in this Form 20-F./s/ PricewaterhouseCoopersPricewaterhouseCoopersHong KongApril 20, 2015Exhibit 16.1[PricewaterhouseCoopers letterhead]April 20, 2015Securities and Exchange Commission100 F Street, N.E.Washington, DC20549Commissioners:We have read the statements made by Xunlei Limited (copy attached), which we understand will be filed with the Securities and Exchange Commission,pursuant to Item 16F of Form 20-F, as part of the Form 20-F of Xunlei Limited, dated April 20, 2015. We agree with the statements concerning our Firm insuch Form 20-F. Very truly yours,/s/ PricewaterhouseCoopersHong KongAttachment A Item 16F.Change in Registrant’s Certifying AccountantEffective as of October 30, 2014, we appointed PricewaterhouseCoopers Zhong Tian LLP, or PwC China, as our independent registered publicaccounting firm, and dismissed PricewaterhouseCoopers, Hong Kong, or PwC HK. The decision to change our independent registered public accounting firmfrom PwC HK to PwC China was made on August 18, 2014, after discussions with PwC HK. The decision was not made due to any disagreements, but solelyin order to further facilitate our audit process, since our core operations are conducted in China, where PwC China is based.Our Audit Committee participated in and approved the decision to change our independent registered public accounting firm.PwC HK’s reports on our consolidated financial statements as of and for the years ended December 31, 2012 and 2013 contained no adverseopinion or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles.During fiscal years ended December 31, 2012 and 2013 and the subsequent interim period through October 30, 2014, (i) there were nodisagreements with PwC HK on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, whichdisagreements, if not resolved to the satisfaction of PwC HK, would have caused PwC HK to make references thereto in their reports on the financialstatements for such periods and (ii) there were no “reportable events” requiring disclosure pursuant to Item 16F(a)(1)(v) of the instructions to Form 20-Fexcept for a lack of accounting resources in U.S. GAAP and SEC reporting requirements, which is a material weakness the details of which can be found in“Item 15. Control and Procedures—Changes in internal control over financial reporting.”We provided PwC HK with a copy of the foregoing disclosure, and requested that PwC HK furnish us with a letter addressed to the SEC statingwhether it agrees with the above statements, and if not, stating the respects in which it does not agree. We have received the requested letter from PwC HK, acopy of which is included as Exhibit 16.1 attached herein.During the fiscal years ended December 31, 2012 and 2013 and the subsequent interim period through October 30, 2014, we did not consultPwC China regarding either (i) the application of accounting principles to a specified transaction, either completed or proposed; or the type of audit opinionthat might be rendered on our financial statements (and no written report was provided to us or oral advice was provided that PwC China concluded was animportant factor considered by us in reaching a decision as to the accounting, auditing or financial reporting issue); or (ii) any matter that was either thesubject of a disagreement pursuant to Item 16F(a)(1)(iv) of the instructions to Form 20-F, or a reportable event pursuant to Item 16F(a)(1)(v) of theinstructions to Form 20-F. 1

Continue reading text version or see original annual report in PDF format above