Microalgo Inc. annual report, FY2022

MicroAlgo Inc. Form 10-K Summary

Business context and reporting period

MicroAlgo Inc. is a Cayman Islands holding company with substantially all operations in China. It provides bespoke central processing algorithm solutions for internet advertising, gaming and intelligent-chip applications, and operates two reportable segments: central processing algorithm services and intelligent chips and services.

This filing reports the fiscal year ended December 31, 2022, rather than a standalone fourth quarter. The company completed its business combination with VIYI Algorithm Inc. on December 9, 2022, in a reverse recapitalization. The company trades on Nasdaq under the symbol MLGO.

Financial results and key metrics

Metric	2021	2022	Change
Revenue	$82.0 million	$87.1 million	Up 6.2%
Gross profit	$33.1 million	$19.0 million	Down 42.8%
Gross margin	40.4%	21.8%	Down 18.6 percentage points
Operating income (loss)	$8.0 million	$(7.9) million	Declined to loss
Net income (loss)	$8.5 million	$(6.9) million	Declined to loss
Net loss attributable to MicroAlgo	$8.6 million income	$(7.0) million	Declined to loss
Operating cash flow	$15.3 million	$2.0 million	Down substantially
Cash and cash equivalents	$42.7 million	$42.7 million	Essentially unchanged

• Central processing algorithm revenue increased 57.3% to $66.6 million, while intelligent-chip and services revenue decreased 48.2% to $20.6 million.
• Central processing algorithm gross margin fell from 64.5% to 27.6%, primarily because of higher advertising-channel costs and weaker advertising growth.
• Intelligent-chip and services gross margin fell from 14.6% to 2.8%, reflecting lower software-development revenue and reduced chip sales volume.
• Operating expenses were $26.8 million, including $5.3 million of goodwill impairment and $2.0 million of intangible-asset impairment. Research and development expense was $13.9 million.
• Basic and diluted loss per share was $0.17 for 2022, compared with earnings per share of $0.22 in 2021.
• Total assets were $72.1 million and total liabilities were $5.1 million at December 31, 2022. No significant conventional bank debt was reported at year-end.
• Working capital was approximately $51.6 million. Current assets were $55.2 million versus current liabilities of $4.8 million.

Cash flow, liquidity and capital structure

• Operating cash flow declined to $2.0 million from $15.3 million, primarily reflecting the net loss, higher non-cash impairment charges and working-capital movements.
• Investing activities generated $2.8 million, principally from net short-term investment activity and collection of a third-party loan.
• Financing activities used $2.4 million. The company received $20.7 million from the recapitalization, repaid approximately $29.9 million to its parent and received approximately $12.5 million from its parent.
• Cash included approximately $23.1 million held at the Cayman Islands level and approximately $18.9 million held by China subsidiaries, based on the filing’s currency presentation.
• PRC restrictions limit the transfer of cash from subsidiaries through dividends, loans or advances. Approximately $28.9 million of PRC subsidiary paid-in capital and statutory reserves was restricted at year-end.
• Management stated that existing working capital is sufficient for operations for the next twelve months, but additional financing may be required for acquisitions, capital expenditures or changing business conditions.
• Operating lease commitments totaled approximately $0.3 million, primarily due within one year.

Material changes versus the prior comparable period

• Revenue grew modestly, but the revenue mix shifted substantially toward algorithm services and away from intelligent-chip sales and software development.
• Cost of revenue increased 39.4% to $68.2 million, substantially faster than revenue, causing gross margin to contract sharply.
• The company moved from operating and net profitability in 2021 to operating and net losses in 2022.
• Customer retention declined in both reported segments: algorithm services retention fell from 82.8% to 66.5%, and intelligent-chip and services retention fell from 100% to 63.3%.
• The company recorded a $5.3 million impairment of goodwill related to Fe-da Electronics and approximately $2.0 million of semiconductor-related intangible-asset impairment, reflecting reduced demand for consumer electronics and communications devices.
• Foreign-currency translation changed from a $1.1 million gain to a $4.6 million loss, contributing to a comprehensive loss attributable to MicroAlgo of $11.5 million.
• The former VIE structure for Shenzhen Yitian was terminated on April 1, 2022 after the related restricted Internet activities ceased; the company obtained direct equity control.
• The December 2022 business combination increased shares outstanding from 39.6 million to 43.9 million and added approximately $19.8 million of additional paid-in capital.

Guidance, outlook, commentary and risks

The filing does not provide specific revenue, earnings or margin guidance. Management expects to continue investing in algorithm technology, artificial intelligence, intelligent chips and cloud-based applications, expand into industries such as finance, government, manufacturing and healthcare, and selectively pursue acquisitions and strategic partnerships.

• Management attributed weaker margins and operating results partly to COVID-19-related disruptions, reduced advertising spending and higher channel costs. The filing states that future effects of COVID-19 remain uncertain.
• The company expects continued significant research and development investment and may need additional equity or debt financing, which could dilute shareholders or impose restrictive covenants.
• Customer concentration remains material: one customer represented 18.5% of 2022 revenue, and two customers represented 57.8% of year-end accounts receivable.
• PRC regulatory, cybersecurity, data-protection and cross-border data-transfer requirements may increase compliance costs, restrict operations or affect the company’s U.S. listing.
• WiMi controlled 65.9% of voting power, making MicroAlgo a Nasdaq “controlled company” eligible for exemptions from certain corporate-governance requirements.
• The company relies heavily on China-based operations and faces risks relating to foreign-exchange controls, limitations on cash transfers, geopolitical tensions, enforcement of foreign judgments and changing PRC policies.
• The company maintains limited insurance and does not carry business interruption, general third-party liability or information-technology systems damage coverage.
• Management reported effective disclosure controls and internal control over financial reporting as of December 31, 2022. The auditor was not required to provide an internal-control attestation because the company was a non-accelerated filer.
• On January 13, 2023, the company entered into a proposed private placement of up to 2,666,667 units at $1.20 per unit, potentially generating approximately $3.2 million gross proceeds. Each unit includes one ordinary share and one warrant exercisable at $1.35; closing remained subject to customary conditions.
• Marcum LLP ceased serving as auditor on March 16, 2023, and OneStop Assurance PAC was engaged. The filing reports no disagreements with Marcum.

Most important facts for investors to verify

• Whether the sharp decline in segment and consolidated gross margins is temporary or reflects a structurally higher cost of acquiring advertising traffic.
• The sustainability and quality of the 57.3% growth in algorithm-services revenue, including customer retention, channel economics and accounts-receivable collections.
• The recovery prospects of the intelligent-chip business after the 2022 revenue decline and goodwill and intangible-asset impairments.
• Cash availability at the parent level versus cash restricted or held in PRC subsidiaries, including the ability to upstream funds under PRC foreign-exchange rules.
• The terms, completion status and dilution effects of the proposed January 2023 private placement and associated warrants.
• Potential effects of evolving PRC cybersecurity, data, overseas-listing and audit-inspection regulations on operations and Nasdaq listing status.
• The impact of customer and vendor concentration, foreign-exchange movements and COVID-19 or other macroeconomic disruptions on future cash flow.