ZW Data Action Technologies Inc. quarterly report, Q2 FY2013

Business Context and Reporting Period

ChinaNet Online Holdings, Inc. filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2013. The filing identifies the registrant as ChinaNet Online Holdings, Inc., although the request metadata refers to ZW Data Action Technologies Inc. The company provides internet and television advertising, technical services, brand management, and sales-channel-building services to small and medium-sized businesses in China, primarily through PRC subsidiaries and variable interest entities (VIEs).

The company consolidated its VIEs under contractual arrangements because PRC regulations restrict foreign ownership of internet-content and advertising businesses. The company reported 22,226,540 common shares outstanding as of August 14, 2013.

Financial Highlights

Metric	Six months ended June 30, 2013	Six months ended June 30, 2012	Three months ended June 30, 2013	Three months ended June 30, 2012
Revenue	$15.941 million	$28.062 million	$8.892 million	$13.127 million
Gross profit	$6.184 million	$6.160 million	$3.602 million	$3.763 million
Gross margin	39%	22%	41%	29%
Operating income	$0.736 million	$0.942 million	$0.793 million	$0.808 million
Net income	$0.405 million	$0.752 million	$0.416 million	$1.043 million
Net income attributable to company	$0.464 million	$0.529 million	$0.434 million	$0.895 million
Basic and diluted EPS	$0.02	$0.02	$0.02	$0.04

Revenue declined 43.2% year over year for the six-month period and 32.3% for the second quarter.
Gross profit was broadly stable for the six-month period despite lower revenue because the company reduced low-margin television advertising activity.
Operating expenses were $5.448 million for the six months, compared with $5.218 million in the prior-year period. Research and development increased to $0.912 million from $0.756 million, while selling expense was essentially unchanged.
Income tax expense was $0.268 million for the six months and $0.354 million for the quarter. The quarter included a $0.131 million adjustment related to the tax rate applicable to Business Opportunity Online Hubei.

Cash Flow, Liquidity, Debt and Balance Sheet

Cash and cash equivalents were $3.392 million at June 30, 2013, down from $5.483 million at December 31, 2012. The company also held a $3.426 million term deposit, bearing 3.5% annual interest; it matured on July 5, 2013 and was extended to July 5, 2014.
Net cash used in operating activities was $0.020 million for the six months, compared with $1.092 million provided in the prior-year period. Working-capital uses included a $1.781 million increase in accounts receivable and a $0.701 million increase in other receivables.
Net cash used in investing activities was $2.140 million, including an $0.800 million software-technology deposit, $1.280 million paid for the remaining acquisition consideration for Sou Yi Lian Mei, and $0.060 million of equipment purchases.
Financing activities generated or used no cash during the period. Long-term borrowing from a director was $0.141 million and was non-interest bearing. The filing reports no material conventional debt.
Total assets were $57.689 million and total liabilities were $11.590 million at June 30, 2013. Current assets were $35.496 million versus current liabilities of $9.837 million.
Accounts receivable, net, increased to $10.460 million from $8.486 million. The allowance for doubtful accounts was $3.704 million, and overdue advertising contract deposits carried a $0.956 million allowance.
Prepayments and supplier deposits totaled $14.636 million, including $8.044 million of contract-execution guarantees and $6.529 million of advertising-resource prepayments.
Management stated that existing cash was adequate to fund operations for the next 12 months.

Material Changes Versus the Prior Comparable Period

Television advertising revenue fell to $5.127 million for the six months from $16.513 million and to $2.489 million for the quarter from $6.144 million. TV advertising minutes sold declined to approximately 3,532 from 15,300 for the six-month comparison.
Internet advertising revenue was $9.046 million for the six months versus $9.619 million in 2012, but quarterly internet advertising revenue increased to $5.335 million from $5.313 million. Management attributed the improvement to customer growth and greater use of mobile marketing tools, although spending per customer remained weak.
Brand management and sales-channel-building revenue declined to $1.427 million from $1.704 million for the six months and to $0.896 million from $1.554 million for the quarter.
TV advertising gross margin improved to 7% for the six months and 10% for the quarter, compared with 1% and 2%, respectively, in the prior-year periods. Overall gross margin benefited from the reduced mix of low-margin TV advertising.
Net income attributable to the company declined 12.3% for the six months and 51.5% for the quarter, despite the improved gross margin, primarily because of lower revenue, higher tax expense, and equity-method losses.
Accumulated other comprehensive income increased, including a $0.828 million foreign-currency translation gain for the six months.

Guidance, Outlook, Risks and Unusual Items

No formal numerical revenue or earnings guidance was provided.
Management plans to emphasize internet advertising, maintain rather than expand the bank-kiosk business, pursue cost-effective brand-building activities, and continue development of cloud-based and mobile advertising applications.
The company deposited $0.808 million for potential software technology acquisitions or purchases while the target applications remained in preliminary selection and valuation.
A $2.262 million marketing-related loan remained outstanding at June 30, 2013. The repayment term was extended to December 31, 2013, and management stated that collectability would continue to be assessed.
PRC tax authorities were reviewing the first profitable year and applicable preferential tax treatment of Business Opportunity Online Hubei. A favorable determination could reverse some 2013 tax expense; an unfavorable determination could increase taxes.
Approximately $5.8 million of net assets held by the PRC subsidiary and VIEs were restricted from transfer under PRC statutory-reserve and capital regulations. Approximately $39.6 million of retained earnings were generated in RMB and may be affected by foreign-exchange restrictions.
Material risks include VIE enforceability and regulatory restrictions in China, currency-convertibility limits, changing PRC tax policies, customer and supplier concentration, collectability of receivables and deposits, and economic weakness affecting SME advertising budgets.
Three suppliers represented 34%, 29%, and 14% of six-month cost of sales. One customer represented 11% of accounts receivable at June 30, 2013.
The company reported no material litigation, no off-balance-sheet arrangements, and effective disclosure controls as of June 30, 2013. The risk-factor section was omitted because the company qualified as a smaller reporting company.

Facts Investors Should Verify

Confirm the registrant identity because the filing names ChinaNet Online Holdings, Inc., while the request metadata names ZW Data Action Technologies Inc.
Assess whether the decline in TV advertising revenue is offset by sustainable growth and margins in internet advertising.
Review the aging and collectability of the $10.460 million accounts receivable, $3.704 million doubtful-debt allowance, and $2.262 million marketing loan.
Monitor operating cash conversion, given positive net income but slightly negative operating cash flow in the first half of 2013.
Evaluate the effect of the Business Opportunity Online Hubei tax review and the scheduled expiration of certain preferential PRC tax rates after 2013.
Review the contractual basis, enforceability, and cash-transfer limitations associated with the PRC VIE structure.
Consider dilution from 2,363,456 outstanding warrants and 939,440 outstanding options, which were excluded from diluted EPS because they were anti-dilutive.