Business Context and Reporting Period
The filing is ChinaNet Online Holdings, Inc.’s unaudited Form 10-Q for the quarter and nine months ended September 30, 2018. The company provides advertising, precision marketing, online-to-offline channel expansion, search-engine marketing and related data services to small and medium-sized enterprises in China. In January 2018, it announced an expansion into blockchain technology and began developing related applications. The filing identifies the registrant as ChinaNet Online Holdings, Inc., not ZW Data Action Technologies Inc.
Financial Results and Key Metrics
All amounts below are in thousands of U.S. dollars unless otherwise noted.
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $17,042 | $13,523 | $47,822 | $31,287 |
| Gross profit | $393 | $1,360 | $1,962 | $4,332 |
| Gross margin | 2% | 10% | 4% | 14% |
| Operating loss | $(3,350) | $(2,010) | $(13,092) | $(3,481) |
| Net loss attributable to shareholders | $(2,953) | $(2,087) | $(12,888) | $(3,963) |
| Loss per share, basic and diluted | $(0.19) | $(0.17) | $(0.82) | $(0.33) |
| Cash used in operating activities | Not separately provided | Not separately provided | $(3,693) | $(2,654) |
- Search-engine marketing and data-service revenue was $40.38 million for the nine months and $14.53 million for Q3, representing approximately 84% and 85% of total revenue, respectively.
- Revenue growth was driven primarily by search-engine marketing and data services. Internet advertising and data-service revenue was $7.34 million for the nine months and $2.51 million in Q3.
- Operating expenses were $15.05 million for the nine months, including $3.38 million of intangible-asset impairment and $5.29 million of goodwill impairment. Q3 operating expenses were $3.74 million, including $1.50 million of intangible-asset impairment.
- A $1.45 million gain from the change in fair value of warrant liabilities partially offset operating losses for the nine months; the Q3 gain was $0.50 million.
- Cash and cash equivalents were $5.92 million at September 30, 2018, compared with $2.95 million at December 31, 2017. Current assets were $15.87 million and current liabilities were $10.63 million.
- Total liabilities were $11.59 million, including $1.16 million of short-term bank loans, $0.83 million of warrant liabilities and $0.13 million of long-term borrowing from a director.
- Total equity declined to $8.76 million from $15.46 million at December 31, 2017. Accumulated deficit increased to $33.38 million.
Material Changes Versus the Prior Comparable Period
- Nine-month revenue increased approximately 53% year over year, while Q3 revenue increased approximately 26%.
- Gross margin fell from 14% to 4% for the nine months and from 10% to 2% for Q3. Management attributed the deterioration to a greater mix of lower-margin search-engine marketing services, intensified competition and increased investment in internet resources.
- Internet advertising and data-service gross margin fell to 9% for the nine months and 1% for Q3, from 45% and 42%, respectively, in the prior-year periods. Search-engine marketing gross margin fell to 3% and 2%, from 5% and 4%.
- The nine-month operating loss expanded to $13.09 million from $3.48 million, primarily because of the impairment charges and lower gross margins.
- The company raised approximately $10.26 million net through a January 2018 registered direct offering of 2.15 million shares and warrants covering 774,000 shares. Shares outstanding increased to 16.13 million at September 30, 2018 from 13.98 million at year-end 2017.
- Investing cash flow changed from $0.76 million provided in the prior-year period to $2.81 million used, reflecting blockchain development spending, acquisition of a noncontrolling interest and other investments.
- The company completed its acquisition of the remaining 49% of Chuang Fu Tian Xia for revised total consideration of RMB12.5 million, including cash payments and a remaining $0.22 million payable at September 30, 2018.
Outlook, Risks, Contingencies and Unusual Items
- Going concern: Management stated that substantial doubt exists about the company’s ability to continue as a going concern within one year after issuance of the financial statements. The company does not currently have sufficient cash or financing commitments to sustain operations for the next twelve months.
- Management plans to improve liquidity by optimizing internet-resource spending, increasing gross margins, strengthening receivables collection and negotiating more favorable vendor terms. Additional equity or debt financing may be required, but availability and terms are uncertain.
- The company capitalized $3.38 million of blockchain software development costs under a $4.5 million contract and prepaid approximately $0.37 million for a WeChat-based marketing application. The blockchain project was expected to be completed before June 2019.
- Accounts receivable were $7.52 million net of a $3.38 million allowance. One customer represented 66% of accounts receivable and 17% of nine-month revenue and 22% of Q3 revenue.
- Two suppliers represented 96% of nine-month cost of revenue, creating significant supplier concentration.
- Approximately $12.0 million of net assets of PRC subsidiaries and VIEs were restricted from transfer as of September 30, 2018. PRC foreign-exchange controls, dividend restrictions, taxation changes and regulatory developments may limit access to operating cash.
- The company operates through PRC subsidiaries and variable interest entities. VIE assets and liabilities are consolidated, but the VIE liabilities do not represent additional claims on the company’s general assets according to the filing.
- The company issued warrants with a $6.60 exercise price and accounted for them as derivative liabilities. Their $0.83 million fair value at September 30, 2018 is subject to changes in earnings based on market and valuation assumptions.
- Remaining disclosed commitments included approximately $0.17 million of office lease obligations, approximately $1.12 million payable for blockchain development, and approximately RMB0.6 million payable for the WeChat application.
- No material legal or administrative proceedings were reported. The company reported effective disclosure controls and no material change in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether management can achieve the planned gross-margin improvement and positive operating cash flow before available cash is depleted.
- The timing, cost and commercial viability of the blockchain and related software projects.
- The collectability of the $7.52 million net receivables balance, particularly the customer representing 66% of receivables.
- The sustainability of revenue growth given the shift toward low-margin search-engine marketing services and high supplier concentration.
- The potential dilution from 774,000 outstanding warrants, 835,216 options and future financing needs.
- The effect of PRC VIE structures, foreign-exchange controls and restrictions on transferring funds from PRC operating entities.
- The accounting and valuation assumptions supporting the intangible-asset, goodwill and warrant-liability measurements.