ZW Data Action Technologies Inc. annual report, FY2019

ChinaNet Online Holdings, Inc. — FY2019 Form 10-K Summary

Reporting period: Fiscal year ended December 31, 2019, compared with fiscal year ended December 31, 2018. The filing identifies the registrant as ChinaNet Online Holdings, Inc. (Nasdaq: CNET), although the request metadata refers to ZW Data Action Technologies Inc. This is an annual filing, not a standalone fourth-quarter report.

Business context

The company is a Nevada holding company conducting substantially all operations through PRC subsidiaries and variable interest entities. Its principal business is Internet advertising, precision marketing, search-engine marketing resource distribution, sales-lead information, data and technical services for Chinese small and medium-sized enterprises. It is also developing blockchain-based applications, including BO!News and OMG, but those applications had not generated revenue and were not commercially available as of the filing date.

The company reported approximately 1,100 advertising, marketing and data-service clients in 2019, compared with approximately 800 in 2018. Substantially all operations are conducted in China and are consolidated through contractual VIE arrangements.

Key financial metrics

US$ in thousands, except per-share data	2019	2018	Change
Total revenue	58,080	57,146	Up 1.6%
Cost of revenue	52,582	54,728	Down 3.9%
Gross profit	5,498	2,418	Up 127.4%
Gross margin	9%	4%	Improved
Operating loss	(1,688)	(14,512)	Improved
Net loss	(1,270)	(14,127)	Improved
Net loss attributable to stockholders	(1,261)	(14,025)	Improved
Basic and diluted loss per share	(0.07)	(0.88)	Improved
Net cash used in operating activities	(4,311)	(5,389)	Improved, still negative
Net cash used in investing activities	(2,158)	(3,047)	Improved
Net cash provided by financing activities	4,352	9,492	Down 54.1%
Cash and cash equivalents at year-end	1,603	3,742	Down 57.2%

Revenue and margin detail

Internet advertising and related data and technical services generated $56.878 million, or 97.9% of total revenue, versus $57.025 million, or 99.8%, in 2018.
Search-engine marketing resource distribution revenue declined 13% to $41.361 million from $47.423 million, primarily because suppliers tightened credit terms and required more working capital.
Internet advertising and data-service revenue increased approximately 54% to $14.807 million from $9.588 million.
Software sales contributed $1.202 million in 2019, compared with none in 2018. Technical-service revenue was $0.710 million versus $0.014 million.
Television advertising revenue was zero, compared with $0.121 million in 2018.
Gross margins improved for Internet advertising and data services to 7% from 5%, and for search-engine marketing distribution to 6% from 4%. The aggregate margin for Internet advertising and related services increased to 8% from 4%.

Profitability and unusual items

Operating expenses fell to $7.186 million from $16.930 million. The 2018 amount included $3.330 million of intangible-asset impairment and $5.211 million of goodwill impairment; no comparable impairment was recorded in 2019.
Sales and marketing expense declined to $0.540 million from $1.970 million, while general and administrative expense increased to $5.777 million from $5.486 million.
The company recorded a $0.499 million gain from the change in fair value of warrant liabilities, compared with a $1.669 million gain in 2018. Interest expense, net, was $0.035 million.
Allowance for doubtful accounts was approximately $2.335 million in 2019. The company also charged off approximately $2.5 million of receivables deemed unlikely to be collected.

Liquidity, debt and cash flow

Year-end current assets were $11.935 million and current liabilities were $7.013 million. Total liabilities were $7.138 million and total equity was $11.413 million.
Debt included a $0.430 million short-term bank loan and $0.125 million of long-term borrowing from a director. The short-term loan matured and was repaid in January 2020. The company’s approximately $0.72 million revolving credit facility expired on January 2, 2020.
Operating cash outflow remained significant at $4.311 million. A major use of working capital was a $5.221 million increase in prepayments and deposits to suppliers, while accounts payable declined $2.441 million.
Financing cash inflow included approximately $4.787 million of net proceeds from a private placement of 3.21686 million shares at $1.4927 per share. The company also repaid $0.870 million of short-term bank loans and re-borrowed $0.435 million.
Approximately $2.158 million was used in investing activities, including $1.962 million for software technology and other intangible assets and $0.160 million for blockchain application development.
The auditor and 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. Management expects to improve margins and collections, negotiate better vendor terms and obtain additional financing, but the filing states that financing may not be available on acceptable terms or at all.

Material changes versus 2018

Revenue was broadly stable in U.S. dollars, while gross profit more than doubled because of lower direct costs, improved pricing and mix, and new technical-service and software revenue.
Net loss attributable to stockholders narrowed from $14.025 million to $1.261 million, principally because 2018 included major impairment charges and higher sales and marketing costs.
Cash declined by $2.139 million during 2019, compared with a $0.790 million increase in 2018, despite the 2019 equity financing.
Shares outstanding increased to 19.629 million at December 31, 2019 from 16.383 million, reflecting the 2019 private placement. Weighted-average shares increased to 17.130 million from 15.864 million.
Supplier concentration increased: two major search-engine suppliers represented approximately 89% and less than 10% of search-engine resource costs in 2019, compared with 85% and 11% in 2018.
Related-party advertising and marketing revenue was $0.899 million in 2019, or approximately 1.5% of total revenue; there was no related-party revenue in 2018.

Guidance, outlook, risks and contingencies

Management expected Internet advertising margins to improve gradually through better data analysis and cost control, and expected search-engine marketing revenue to recover as working-capital conditions improved. These are expectations, not formal financial guidance.
COVID-19 caused PRC offices, particularly the Hubei operation, to close for approximately one to two months in early 2020. Management stated that the pandemic materially adversely affected first-quarter 2020 operations and financial performance, but the amount was not quantifiable as of filing.
COVID-19 was expected to delay the OMG and BO!News release schedule by one to two months. Remaining development costs under the two contracts were approximately $1.050 million at December 31, 2019, with approximately $0.300 million paid in the first quarter of 2020 and the balance expected during 2020.
The blockchain applications had aggregate contract amounts of approximately $4.93 million, of which approximately $3.88 million had been paid by December 31, 2019. Capitalized blockchain development costs were $3.879 million at year-end.
The company’s VIE structure depends on contractual arrangements rather than direct ownership. The PRC Foreign Investment Law became effective January 1, 2020, and its future interpretation could affect the enforceability of the structure and the company’s ability to operate or consolidate the VIEs.
Other material risks include dependence on Chinese advertising spending, customer and supplier concentration, receivables collectability, currency controls, PRC regulatory changes, cybersecurity and blockchain risks, and difficulty transferring cash from China.
On April 21, 2020, Nasdaq notified the company that its common stock did not meet the $1.00 minimum bid-price requirement. The filing stated that the compliance deadline was extended to December 28, 2020; failure to regain compliance could result in delisting.
The auditor was located in China and was not subject to PCAOB inspection at the time of filing. The audit report included a going-concern explanatory paragraph.

Most important facts for investors to verify

Going concern: Confirm current cash, operating cash burn, working-capital deficiency and the availability of financing after December 31, 2019.
COVID-19 impact: Review subsequent quarterly filings for actual revenue, collections, margins and operating losses during 2020.
VIE enforceability: Assess developments under the PRC Foreign Investment Law and any effect on contractual control, consolidation and cash transfers.
Receivables: Verify aging, subsequent collections, charge-offs and the adequacy of the $3.148 million allowance at year-end.
Supplier dependence: Verify credit terms and availability of search-engine resources, particularly given the concentration of costs with major suppliers.
Blockchain investment: Determine whether OMG and BO!News launched commercially, generated revenue, or required additional spending beyond the disclosed commitments.
Capital structure: Consider dilution from the 2019 equity issuance, 774,000 outstanding warrants, 755,216 options and subsequent 2020 restricted-stock grants of approximately 1.60 million shares.
Nasdaq status: Verify whether the company regained minimum-bid-price compliance or was delisted after the stated December 28, 2020 deadline.