1.                          ORGANIZATION

 

ChinaCache International Holdings Ltd. (the ‘‘Company’’) was incorporated under the laws of the Cayman Islands on June 29, 2005. Upon incorporation, the Company was 99% owned by Consolidated Capital Holdings Ltd (‘‘CCH’’) which was under the control of Mr. Wang Song and his spouse Ms. Kou Xiaohong, (collectively known as the ‘‘Founders’’). Subsequently on April 12, 2007, CCH transferred 15% of its interest in the Company to Harvest Century International Limited (‘‘HCI’’), a company which is 100% owned by Ms. Kou Xiaohong.

 

The Company through its subsidiaries and variable interest entities noted below are principally engaged in the provision of Content and Application Delivery services in the People’s Republic of China (the “PRC”).

 

As of December 31, 2013, subsidiaries of the Company and variable interest entities (“VIEs”) where the Company is the primary beneficiary include the following:

 

		Date of incorporation		Place of incorporation		Percentage of ownership		Principal activities
Subsidiaries
ChinaCache Network Technology (Beijing) Ltd. (“ChinaCache Beijing”)		August 25, 2005		The PRC		100	%	Provision of Technical Consultation services
ChinaCache North America Inc. (“ChinaCache US”)		August 16, 2007		United States of America		100	%	Provision of Content and Application Delivery services
ChinaCache Ireland Limited (“ChinaCache IE”)		November 18, 2013		Ireland		100	%	Provision of Content and Application Delivery services
ChinaCache Networks Hong Kong Ltd. (“ChinaCache HK”)		April 7, 2008		Hong Kong		100	%	Provision of Content and Application Delivery services
JNet Holdings Limited (“JNet Holdings”)		September 27, 2007		British Virgin Islands		100	%	Investment holding
ChinaCache Xin Run Technology (Beijing) Co., Ltd. (“Xin Run”)		July 18, 2011		The PRC		100	%	Research & Development center
Metasequoia Investment Inc. (“Metasequoia”)		March 28, 2012		British Virgin Islands		100	%	Investment holding
VIEs
Beijing Blue I.T. Technologies Co., Ltd. (“Beijing Blue IT”)*		June 7, 1998		The PRC		—		Provision of Content and Application Delivery services
Beijing Jingtian Technology Limited (“Beijing Jingtian”) *		September 1, 2005		The PRC		—		Provision of Content and Application Delivery services

 

*                     The equity interest of Beijing Blue IT and Beijing Jingtian are held by the Founders and two employees of the Company, respectively (collectively the “Nominee Shareholders”).

 

The following is a summary of the various VIE agreements:

 

Exclusive option agreement

 

Pursuant to the exclusive option agreement amongst the Company and the Nominee Shareholders, the Nominee Shareholders irrevocably granted the Company or its designated party, an exclusive option to purchase all or part of the equity interests held by the Nominee Shareholders in Beijing Blue IT, when and to the extent permitted under PRC law, at an amount equal to either a) the outstanding loan amount pursuant to the loan agreement owed by the Nominee Shareholders or b) the lowest permissible purchase price as set by PRC law. Such consideration, if in excess of the outstanding loan amount, when received by the Nominee Shareholders upon the exercise of the exclusive option is required to be remitted in full to ChinaCache Beijing. Beijing Blue IT cannot declare any profit distributions or grant loans in any form without the prior written consent of the Company. The Nominee Shareholders must remit in full any funds received from Beijing Blue IT to ChinaCache Beijing, in the event any distributions are made by the VIEs pursuant to any written consents of the Company. This agreement is valid for ten years and expires on September 23, 2015. Such agreement can be renewed for an additional ten years at the sole discretion of the Company, and the times of such renewals are unlimited.

 

Similar exclusive option agreements were signed by ChinaCache Beijing with the VIEs, Shanghai JNet (Note 4(b)) and Beijing Jingtian, respectively.

 

Exclusive business cooperation agreement

 

Pursuant to the exclusive business cooperation agreement between ChinaCache Beijing and the VIEs, ChinaCache Beijing is to provide exclusive business support, technical and consulting services including technical services, business consultations, access to intellectual property licenses, equipment or property leasing, marketing consultancy, system integration, product research and development and system maintenance in return for fees in an amount as determined and adjustable at the sole discretion of ChinaCache Beijing. The service fees charged to Beijing Blue IT are based on methods set forth in the technical support and service agreement and technical consultation and training agreement, as further discussed below. The service fees charged to Beijing Jingtian is based on 100% of Beijing Jingtian’s net income.

 

This agreement is valid for ten years and expires on September 23, 2015. Prior to this agreement’s and subsequent agreements’ expiration dates, ChinaCache Beijing can at its sole discretion renew at a term of its choice through written confirmation.

 

Exclusive technical support and service agreement/Exclusive technical consultation and training agreement/Equipment leasing agreement

 

Pursuant to these agreements between ChinaCache Beijing and Beijing Blue IT, ChinaCache Beijing is to provide research and development, technical support, consulting, training and equipment leasing services in return for fees, which is adjustable at the sole discretion of ChinaCache Beijing. The fees charged to Blue IT include an annual fixed amount and a variable quarterly amount which is determined based on the following factors:

 

·                  the number of ChinaCache Beijing’s employees who provided the services pursuant to the business cooperation agreement to Beijing Blue IT during the quarter (the “Quarterly Services”) and the qualifications of the employees;

·                  the number of hours ChinaCache Beijing’s employees spent to provide the Quarterly Services;

·                  operating expenses incurred by ChinaCache Beijing to provide the Quarterly Services;

·                  nature and value of the Quarterly Services; and

·                  Beijing Blue IT’s operating revenue for the quarter.

 

The original term of each of these three agreements was five years running from September 23, 2005, and each of the agreements was renewed in September 2010 for a five year term which expires on September 23, 2015. The term of the equipment leasing agreement can be extended solely by ChinaCache Beijing by written notice prior to the expiration of the term, and the extended term shall be determined by ChinaCache Beijing.

 

The exclusive business cooperation agreement, exclusive technical support and service agreement, exclusive technical consultation and training agreement, and equipment leasing agreement are collectively referred to as “Service Agreements”.

 

Loan agreement

 

The Company provided a loan facility of RMB10,000,000 to the Nominee Shareholders of Beijing Blue IT for the purpose of providing capital to Beijing Blue IT to develop its business. In addition, the Company also agreed to provide unlimited financial support to Beijing Blue IT for its operations and agree to forego the right to seek repayment in the event Beijing Blue IT is unable to repay such funding. The loan agreement between the Company and the Nominee Shareholders of Beijing Blue IT is valid for ten years and expires on September 23, 2015. Such agreement can be extended upon mutual written consent of the Company and the Nominee Shareholders of Beijing Blue IT.

 

ChinaCache Beijing also provided a loan of RMB8,500,000 to the Nominee Shareholders of Beijing Jingtian for their investment in the registered share capital. In addition, the Company, through ChinaCache Beijing, agreed to provide unlimited financial support to Beijing Jingtian for their operations and agree to forego the right to seek repayment in the event this VIE are unable to repay such funding. The loan agreement between ChinaCache Beijing and the Nominee Shareholders of Beijing Jingtian is valid for ten years and expires on December 3, 2022. Such agreement can be extended upon mutual written consent of ChinaCache Beijing and the Nominee Shareholders of Beijing Jingtian.

 

Power of attorney agreement

 

The Nominee Shareholders entered into the power of attorney agreement whereby they granted an irrevocable proxy of the voting rights underlying their respective equity interests in the VIEs to ChinaCache Beijing, which includes, but are not limited to, all the shareholders’ rights and voting rights empowered to the Nominee Shareholders by the company law and the Company’s Article of Association. This agreement remains continuously valid, as long as the Nominee Shareholders continue to be the shareholders of the VIEs.

 

Subsequently, ChinaCache Beijing assigned the power of attorney agreement to ChinaCache Beijing’s shareholders or a party designated by ChinaCache Beijing’s shareholders, to whom it granted an irrevocable proxy of the voting rights underlying their respective equity interests in the VIEs, which includes, but are not limited to, all the shareholders’ rights and voting rights empowered to the Nominee Shareholders by the company law and the Company’s Article of Association.

 

Share pledge agreement

 

Pursuant to the share pledge agreement between ChinaCache Beijing and the Nominee Shareholders, the Nominee Shareholders have pledged all their equity interests in the VIEs to guarantee the performance of the VIEs’ obligations under the Service Agreements.

 

If the VIEs breach their respective contractual obligations under the business cooperation agreements, ChinaCache Beijing, as pledgee, will be entitled to certain rights, including the right to sell the pledged equity interests. The Nominee Shareholders agreed not to transfer, sell, pledge, dispose of or otherwise create any new encumbrance on their equity interests in the VIEs without the prior written consent of ChinaCache Beijing. This agreement is continuously valid until all payments due under the above VIE agreements have been fulfilled by the VIEs.

 

Despite the lack of technical majority ownership, there exists a parent-subsidiary relationship between the Company and the VIEs through the irrevocable powers of attorney agreement, whereby the Nominee Shareholders effectively assigned all of their voting rights underlying their equity interest in the VIEs to the Company. In addition, the Company, either directly or through ChinaCache Beijing, obtained effective control over the VIEs through the ability to exercise all the rights of the VIEs’ shareholders pursuant to the share pledge agreement and the exclusive option agreements. The Company demonstrates its ability and intention to continue to exercise the ability to absorb substantially all of the expected losses directly through the loan agreements. In addition, the Company also demonstrates its ability to receive substantially all of the economic benefits of the VIEs through ChinaCache Beijing using the Service Agreements. Thus, the Company is the primary beneficiary of the VIEs and consolidates the VIEs under by Accounting Standards Codification (“ASC”) Subtopic 810-10 (“ASC 810-10”) “Consolidation: Overall”.

 

Legal compliance

 

Assessing the legal validity and compliance of these above noted arrangements are a precursor to the Company’s ability to consolidate the results of operations and financial condition of its VIEs. In the opinion of the Company’s management and PRC counsel, (i) the ownership structure of the VIEs are in compliance with existing PRC laws and regulations; (ii) the contractual arrangements with the VIEs and their shareholders are valid, binding and enforceable, and will not result in any violation of PRC laws or regulations currently in effect; and (iii) the Company’s business operations are in compliance with existing PRC laws and regulations in all material respects.

 

However, there is significant consolidation judgment due to the existence of substantial uncertainties regarding the interpretation and application of current and future PRC laws and regulations. Accordingly, the Company cannot be assured that PRC regulatory authorities will not ultimately take a contrary view to its opinion. If the current ownership structure of the Company and its contractual arrangements with its VIEs is found to be in violation of any existing or future PRC laws and regulations, the Company may be required to restructure its ownership structure and operations in the PRC. To the extent that changes to and new PRC laws and regulations prohibit the Company’s VIE arrangements from also complying with the principles of consolidation, then the Company would no longer be able to consolidate and therefore would have to deconsolidate the financial position and results of operations of its VIEs. In the opinion of management, the likelihood of loss and deconsolidation in respect of the Company’s current ownership structure or the contractual arrangements with its VIEs is remote based on current facts and circumstances.

 

There was no pledge or collateralization of the VIEs’ assets. Creditors of the VIEs have no recourse to the general credit of the Company, who is the primary beneficiary of the VIEs, and such amounts have been parenthetically presented on the face of the consolidated balance sheets. The Company has not provided any financial or other support that it was not previously contractually required to provide to the VIEs during the periods presented.

 

The following tables represent the financial information of the consolidated VIEs as of December 31, 2012 and 2013 and for the years ended December 31, 2011, 2012 and 2013 before eliminating the intercompany balances and transactions between the consolidated VIEs and other entities within the Group:

 

		As of December 31,
		2012		2013
		RMB		RMB		US$
ASSETS:
Current assets:
Cash and cash equivalents		69,503		77,400		12,786
Accounts receivable (net of allowance for doubtful accounts of RMB 24,369 and RMB 11,894 (US$1,965) as of December 31, 2012 and 2013, respectively)		219,324		297,947		49,217
Prepaid expenses and other current assets		23,393		25,871		4,274
Deferred tax assets		12,878		6,546		1,081
Amounts due from inter-companies(1)		—		6,300		1,041
Amounts due from a related party(2)		—		141		23
Total current assets		325,098		414,205		68,422
Non-current assets:
Property and equipment, net		123,877		185,107		30,577
Cloud infrastructure construction in progress		—		5,705		942
Intangible assets, net		—		4,702		777
Long term investments		6,103		7,603		1,256
Deferred tax assets		4,602		602		99
Long term deposits and other non-current assets		3,676		4,458		736
Total non-current assets		138,258		208,177		34,387
TOTAL ASSETS		463,356		622,382		102,809

 

		As of December 31,
		2012		2013
		RMB		RMB		US$
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Current liabilities:
Accounts payable		103,261		200,483		33,117
Accrued employee benefits		26,441		33,448		5,525
Accrued expenses and other payables		48,776		71,095		11,745
Income tax payable		15,200		5,777		954
Liabilities for uncertain tax positions		4,050		6,296		1,040
Amounts due to inter-companies(1)		208,743		236,584		39,081
Amounts due to a related party (2)		1,044		844		139
Deferred government grant		—		24,360		4,024
Total current liabilities		407,515		578,887		95,625
Non-current liabilities:
Deferred government grant		3,360		—		—
Total non-current liabilities		3,360		—		—
Total liabilities		410,875		578,887		95,625

 

(1)         Amount due from/to inter-companies consist of intercompany receivables/payables to the other companies within the Group.

(2)         Information with respect to related parties is discussed in Note 19.

 

		For the Years Ended December 31,
		2011		2012		2013
		RMB’000		RMB’000		RMB’000		US$’000
Net revenues
-Third party customers		600,203		745,835		910,757		150,446
-Inter-companies		2,353		12,588		146,640		24,223
-A related party customer		—		12,543		—		—
Net profit/ (loss)		43,723		20,406		(12,761	)	(2,108	)
Income from discontinued operations (including gain on disposal of Shanghai JNet (Note 4(b)))		31,977		—		—		—

 

Income from discontinued operations relates to the operations of Shanghai JNet that has been classified as discontinued operations upon the disposal of Shanghai JNet and the concurrent termination of the VIE Agreements (Note 4(b)).

 

		For the Years Ended December 31,
		2011		2012		2013
		RMB’000		RMB’000		RMB’000		US$’000
Net cash provided by operating activities		94,710		51,059		97,554		16,114
Net cash used in investing activities		(73,873		(49,933	)	(89,657	)	(14,810	)
Net cash used in financing activities		—		—		—		—