Newegg Commerce, Inc. annual report, Q4 FY2018

Business context and reporting period

Important filing-identity mismatch: The supplied filing is Lianluo Smart Limited’s Form 20-F, not a filing by Newegg Commerce, Inc. It reports the fiscal year ended December 31, 2018, not 2018 Q4 alone. Newegg is mentioned only in an executive biography.

Lianluo was a China-focused medical-device and wearable-health company, shifting toward wearable sleep-apnea diagnosis and related services (OSAS). Its statements are audited under U.S. GAAP; the auditor gave an unqualified opinion on the financial statements.

Key financial metrics

Amounts below are U.S. dollars unless stated otherwise.

2018 revenue comprised $342,344 of product sales and $217,042 of OSAS diagnostic services. The company reported a $3.28 million impairment of sleep-respiratory software copyrights, patents and other intangible assets after lower-than-expected revenue; this was a major contributor to the larger operating loss. Selling expenses rose 78% to $2.08 million, and general and administrative expenses rose 15% to $3.68 million. A $599,865 warrant fair-value gain partly offset expenses.

Debt and liquidity: The balance sheet reported no short-term borrowings or amounts due to related parties at December 31, 2018, following a $5.38 million offset involving HLI and DGHKT. It did report a $1.13 million warrant liability, with one million warrants outstanding at a $2.20 exercise price. The company said available cash and expected operating cash flows would cover the next 12 months, while also noting possible additional financing needs. It obtained about $3.7 million of short-term loans from major shareholder HLI during 2018. Lease obligations were $104,706, due within one year.

Material changes versus the prior comparable period

• Revenue declined as Lianluo reduced unprofitable product sales and redirected resources toward OSAS diagnosis services. New OSAS service revenue partly offset a $0.54 million reduction in product sales.
• Gross loss improved to $0.20 million from $0.77 million, but the company remained gross-loss-making.
• Operating and net losses worsened, principally reflecting the $3.28 million intangible-asset impairment and higher selling and administrative costs.
• Cash fell from $6.81 million to $0.48 million, reflecting operating cash use and investing outflows, including the related-party loan.
• Two largest customers accounted for about 29% of 2018 revenue, versus 56% in 2017; two largest suppliers accounted for about 48% of purchases, versus 63%.

Outlook, risks, contingencies and unusual items

No quantified revenue or earnings guidance is provided. Management described OSAS services and wearable sleep products as potential growth drivers, reported partnerships with hospitals and examination centers, and expected general and administrative expenses to decline. Management also acknowledged that the service business remains early-stage and may require further marketing investment; margins in sleep-respiratory solutions were loss-making.

• Controls: Management concluded internal control over financial reporting and disclosure controls were ineffective at year-end due to a material weakness: insufficient qualified accounting personnel with U.S. GAAP and SEC-reporting expertise and inadequate review capacity. Planned remediation included hiring and training staff. The auditor did not attest to internal controls.
• Related parties: HLI was a major shareholder and the principal 2018 financing source. Lianluo also lent $6 million to DGHKT during 2018; the remaining balance was offset against amounts owed to HLI. Review the terms, approvals and cash movements underlying these arrangements.
• Contingency: A supplier initiated arbitration in January 2019 seeking RMB513,684 plus interest. The company disputed the claim and estimated the payable at RMB235,524; it had recorded a $36,387 payable at year-end.
• Other exposures: Management estimated possible employee severance payments of approximately $886,049 but did not accrue them, judging payment unlikely. The filing also highlights China regulatory and currency controls, customer and supplier concentration, competition, early-stage service adoption, and the absence of product-liability and business-interruption insurance.
• Post-year-end financing: The company borrowed an aggregate RMB1.17 million (about $0.18 million) from HLI in February–April 2019 at 8% annual interest; it also made a $0.06 million loan to DGHKT at 3.5%.

Most important facts for investors to verify

1. Confirm the issuer and period: this is Lianluo Smart’s FY2018 20-F, not Newegg Commerce’s filing or a quarterly report.
2. Assess whether the sharply reduced cash balance and recurring operating losses can be funded, and verify repayment terms and subsequent related-party borrowing.
3. Track OSAS service revenue, customer usage, unit economics and margins to test management’s growth case.
4. Review the $3.28 million impairment, remaining asset values and the basis for future product investment.
5. Monitor remediation of the material weakness and the quality of subsequent financial reporting.
6. Check the arbitration outcome, unrecorded severance estimate, related-party transactions and customer/supplier concentration.