ZW Data Action Technologies Inc. quarterly report, Q3 FY2021

ZW Data Action Technologies Inc. — Form 10-Q Summary

Business Context and Reporting Period

ZW Data Action Technologies Inc. provides Internet advertising, precision marketing, search-engine marketing-resource distribution, e-commerce O2O advertising and marketing, and related data and technical services to small and medium-sized enterprises in China through PRC subsidiaries and contractual variable-interest entities. The filing covers the unaudited quarter and nine months ended September 30, 2021, filed November 15, 2021. The company was a non-accelerated filer and smaller reporting company; its common stock trades on Nasdaq under CNET.

Financial Performance and Position

Metric	Q3 2021	Q3 2020	First Nine Months 2021	First Nine Months 2020
Revenue	$11.90 million	$12.30 million	$34.85 million	$27.10 million
Gross profit/(loss)	$0.04 million	$(0.64) million	$(0.89) million	$0.56 million
Gross margin	0.4%	(5.0%)	(3.0%)	2.0%
Operating loss	$(1.57) million	$(1.40) million	$(11.67) million	$(4.70) million
Net income/(loss) attributable to ZW Data	$1.38 million	$(1.33) million	$(1.59) million	$(4.61) million
Basic and diluted EPS	$0.04	$(0.06)	$(0.05)	$(0.22)
Operating cash flow	Not separately provided for the quarter	Not separately provided	$(6.60) million	$0.60 million

Q3 revenue was substantially generated by Internet advertising and related services, including $9.65 million from distributing search-engine marketing rights, $2.13 million from Internet advertising and related data services, and $0.13 million from e-commerce O2O services.
Operating expenses were $1.62 million in Q3 and $10.78 million for the nine-month period. Nine-month general and administrative expense rose to $10.37 million, primarily because of approximately $6.95 million of share-based compensation and higher Guangzhou office and administrative costs.
The nine-month net loss included a $9.68 million gain from changes in the fair value of warrant liabilities. The Q3 gain was $2.85 million. These non-cash gains materially affected reported earnings.
At September 30, 2021, cash and cash equivalents were $8.73 million, compared with $4.30 million at December 31, 2020. Total current assets were $21.83 million and total current liabilities were $9.99 million.
The company reported total liabilities of $12.05 million, including $3.69 million of warrant liabilities, $2.12 million of operating lease liabilities, $3.41 million of taxes payable, and $0.14 million of long-term related-party borrowing.
Investing cash outflows were $6.10 million, including investments in investee entities, a $1.16 million software purchase, short-term loans, and $2.50 million of deposits and prepayments. Financing cash inflows were $17.11 million after cash offering costs.
The February 2021 registered direct offering issued 5.21 million shares at $3.59 per share and warrants for up to approximately 2.97 million shares, generating gross proceeds of approximately $18.7 million and net proceeds of approximately $17.1 million.

Material Changes Versus the Prior Comparable Period

First-nine-month revenue increased 28.6%, but Q3 revenue decreased 3.3% year over year.
Revenue growth was concentrated in search-engine marketing-resource distribution, which increased to $28.61 million from $18.00 million for the nine-month period. This service represented 82.1% of nine-month revenue.
Overall nine-month gross margin declined to negative 3% from positive 2%, although Q3 gross margin improved to 0.4% from negative 5%. Management attributed the quarterly improvement mainly to better supplier discounts.
Operating loss widened substantially for the nine-month period because of higher general and administrative costs, particularly share-based compensation.
Cash flow from operations deteriorated from $0.60 million provided in the prior-year period to $6.60 million used, partly because of increased supplier prepayments and other working-capital requirements.
Accounts receivable, net, increased to $2.67 million from $2.41 million despite a reduction in the allowance for doubtful accounts from $4.25 million to $2.20 million. Approximately $2.08 million of receivables was charged off during the nine months after collection efforts were exhausted.
Shares outstanding increased to 35.33 million at September 30, 2021 from 26.06 million at December 31, 2020, reflecting the February financing, share-based awards, and warrant exercises.

Guidance, Outlook, Risks and Unusual Items

Management expected search-engine marketing-resource distribution revenue to continue growing in Q4 2021 and expected gross margins for Internet advertising and search-engine marketing services to improve. No formal full-year revenue or earnings guidance was provided.
The company expected to fully launch its Blockchain Integrated Framework and related NFT, digital franchise-management, smart-retail, and blockchain SaaS applications during Q4 2021 after testing.
The company canceled a $1.50 million cryptocurrency-mining-machine purchase agreement because of PRC policies banning cryptocurrency mining and expected the prepayment to be refunded before fiscal year-end. A separate $1.00 million refundable deposit related to a potential merger or acquisition was expected to be refunded if no definitive agreement was reached by December 31, 2021.
Approximately $4.41 million had been capitalized for blockchain platform development, with approximately $0.55 million of the related contract amount remaining unpaid and expected to be paid during 2021.
COVID-19-related restrictions and possible future outbreaks could reduce advertising spending and delay revenue growth. The company also faces concentration risk: one supplier represented 77% of nine-month cost of revenues and 85% of Q3 cost of revenues.
Customer concentration remained material. One customer represented 13% of nine-month revenue and 26% of Q3 revenue; four customers collectively represented 79% of accounts receivable at September 30, 2021, based on the disclosed concentration percentages.
Substantially all operations are in China and conducted through PRC subsidiaries and VIEs. Approximately $13.2 million of net assets were restricted from transfer as of September 30, 2021, and currency-conversion, dividend, PRC regulatory, and VIE-structure risks may limit access to operating cash.
The company had approximately $30.7 million of U.S. net operating loss carryforwards and approximately $24.9 million of PRC subsidiary and VIE loss carryforwards. Valuation allowances totaled approximately $12.0 million against deferred tax assets, reflecting uncertainty regarding future utilization.
No material legal or administrative proceedings were reported. Management stated that disclosure controls were effective and that no material change in internal control over financial reporting occurred during the quarter.

Key Facts Investors Should Verify

Whether the expected Q4 blockchain/NFT platform launch occurred and generated material revenue.
Whether the $1.50 million cryptocurrency-mining prepayment and the $1.00 million potential-M&A deposit were recovered on the stated timetable.
Whether search-engine marketing margins continue to improve, given the business’s dependence on a single major supplier and its negative nine-month gross margin.
The sustainability of earnings excluding the $9.68 million non-cash warrant fair-value gain and the impact of future warrant revaluations.
Whether operating cash burn, supplier prepayments, receivable recoverability, and customer concentration create additional liquidity pressure.
The potential dilution from 5.00 million outstanding warrants, 0.28 million options, and other equity awards, as well as the effect of the enlarged share count.
Restrictions on transferring cash from PRC subsidiaries and VIEs, foreign-exchange approvals, and developments affecting the company’s VIE arrangements and PRC regulatory environment.