Item 2 Management’s Discussion
and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
You should read the following
discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements
and the related notes included elsewhere in this interim report. Our consolidated financial statements have been prepared in accordance
with U.S. GAAP. The following discussion and analysis contains forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including, without limitation, statements regarding
our expectations, beliefs, intentions or future strategies that are signified by the words “expect,” “anticipate,”
“intend,” “believe,” or similar language. All forward-looking statements included in this document are
based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements.
Our business and financial performance are subject to substantial risks and uncertainties. Actual results could differ materially
from those projected in the forward-looking statements. In evaluating our business, you should carefully consider the information
set forth under the heading “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31,
2016. Readers are cautioned not to place undue reliance on these forward-looking statements.
Overview
We were incorporated in the State
of Texas in April 2006 and re-domiciled to become a Nevada corporation in October 2006. On June 26, 2009, we consummated a share
exchange transaction with China Net Online Media Group Limited (the “Share Exchange”), a company organized under the
laws of British Virgin Islands (“China Net BVI”). As a result of the Share Exchange, China Net BVI became a wholly
owned subsidiary of us and we are now a holding company, which, through certain contractual arrangements with operating entities
in the PRC, is engaged in providing advertising, precision marketing, online-to-offline (O2O) sales channel expansion and the related
data services to SMEs in China and entrepreneurial management and networking services for entrepreneurs in the PRC.
Through our PRC operating subsidiaries and VIEs, we primarily operate a one-stop services for our clients on our
integrated service platform, primarily including Omni-channel precision advertising and marketing system, CloudX and data analysis
management system. Our Omni-channel precision advertising and marketing system, primarily consists of digital advertising and marketing
portals, include internet and mobile, and our other non-digital advertising units, such as TV. We provide and monitor varieties
of advertising and marketing campaigns through this service system which generates effective sales leads through the combination
of the Internet, mobile, content and others, including TV and schemes, we also provide search engine marketing services through
this system to maximize market exposure and effectiveness for our clients. Our data analysis management system is an information
and data analysis portal for SMEs or entrepreneurs who plans to start their own business, helping them for a higher survival and
faster deal closing rate. It is built to further expand our service and data-link to assist our clients in developing their sales
both online and offline, so that the overall service platform can create a traceable looped online to offline (O2O) ecosystem for
our clients in their ground sales expansion throughout the cities in the PRC. During the past few years, we have been developing
our SMEs intelligent operation and marketing data service applications, which consists of several online cloud technology based
advertising and marketing, lead management, elite store management, client membership management and other administrative operational
management tools specifically designed for small business in China to match their simplicity. We are intending to use these applications
to create social community-based consumption ecosystem, by deploying our Big Data technologies and analyze both online and offline
businesses’ operational and customers’ consumption data to help the SMEs improve their marketing efficiency and sales
effectiveness with their target customers.
Basis of presentation, management
estimates and critical accounting policies
Our unaudited condensed consolidated
interim financial statements have been prepared in accordance with U.S. GAAP for interim financial information and with the instructions
to Form 10-Q and Article 10 of Regulation S-X, as promulgated by the SEC, and include the accounts of our Company, and all of our
subsidiaries and VIEs. We prepare financial statements in conformity with U.S. GAAP, which requires us to make estimates and assumptions
that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities on the date of the
financial statements and the reported amounts of revenues and expenses during the financial reporting period. We continually evaluate
these estimates and assumptions based on the most recently available information, our own historical experience and various other
assumptions that we believe to be reasonable under the circumstances. Since the use of estimates is an integral component of the
financial reporting process, actual results could differ from those estimates. Some of our accounting policies require higher degrees
of judgment than others in their application. In order to understand the significant accounting policies that we adopted for the
preparation of our condensed consolidated interim financial statements, you should refer to the information set forth in Note 3
“Summary of significant accounting policies” to our audited financial statements in our 2016 Form 10-K.
A. RESULTS
OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2017 AND 2016
The following table sets forth
a summary, for the periods indicated, of our consolidated results of operations. Our historical results presented below are not
necessarily indicative of the results that may be expected for any future period. All amounts, except number of shares and per
share data, are presented in thousands of U.S. dollars.
|
|
Three Months Ended March 31,
|
|
|
2017
|
|
2016
|
|
|
(US $)
|
|
(US $)
|
|
|
(Unaudited)
|
|
(Unaudited)
|
Revenues
|
|
|
|
|
|
|
|
|
From unrelated parties
|
|
|
7,245
|
|
|
|
5,012
|
|
From related parties
|
|
|
19
|
|
|
|
48
|
|
Total revenues
|
|
|
7,264
|
|
|
|
5,060
|
|
Cost of revenues
|
|
|
5,992
|
|
|
|
3,456
|
|
Gross profit
|
|
|
1,272
|
|
|
|
1,604
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
Sales and marketing expenses
|
|
|
834
|
|
|
|
880
|
|
General and administrative expenses
|
|
|
1,092
|
|
|
|
1,706
|
|
Research and development expenses
|
|
|
395
|
|
|
|
426
|
|
Total operating expenses
|
|
|
2,321
|
|
|
|
3,012
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
|
(1,049
|
)
|
|
|
(1,408
|
)
|
|
|
|
|
|
|
|
|
|
Other income/(expenses)
|
|
|
|
|
|
|
|
|
Interest income
|
|
|
19
|
|
|
|
27
|
|
Interest expense
|
|
|
(36
|
)
|
|
|
-
|
|
Other expenses
|
|
|
(3
|
)
|
|
|
(12
|
)
|
Total other (expense)/income
|
|
|
(20
|
)
|
|
|
15
|
|
Loss before income tax benefit, noncontrolling interests and discontinued operation
|
|
|
(1,069
|
)
|
|
|
(1,393
|
)
|
Income tax benefit
|
|
|
-
|
|
|
|
28
|
|
Loss from continuing operation
|
|
|
(1,069
|
)
|
|
|
(1,365
|
)
|
Loss from discontinued operation, net of income tax
|
|
|
-
|
|
|
|
(46
|
)
|
Net loss
|
|
|
(1,069
|
)
|
|
|
(1,411
|
)
|
Net income attributable to noncontrolling interests from continuing operations
|
|
|
(18
|
)
|
|
|
-
|
|
Net loss attributable to ChinaNet Online Holdings, Inc.
|
|
|
(1,087
|
)
|
|
|
(1,411
|
)
|
Revenues
The following tables set forth a breakdown
of our total revenues, divided into three segments for the periods indicated, with inter-segment transactions eliminated:
|
|
Three Months Ended March 31,
|
|
|
2017
|
|
2016
|
Revenue type
|
|
(Amounts
expressed in thousands of US dollars, except percentages)
|
-Internet advertisement and data service
|
|
$
|
2,292
|
|
|
|
31.6
|
%
|
|
$
|
3,627
|
|
|
|
71.7
|
%
|
-Technical services
|
|
|
-
|
|
|
|
-
|
|
|
|
21
|
|
|
|
0.4
|
%
|
-Search engine marketing service
|
|
|
4,972
|
|
|
|
68.4
|
%
|
|
|
1,412
|
|
|
|
27.9
|
%
|
Internet advertisement and related services
|
|
$
|
7,264
|
|
|
|
100
|
%
|
|
$
|
5,060
|
|
|
|
100
|
%
|
Total Revenues:
Our total revenues increased
to US$7.26 million for the three months ended March 31, 2017 from US$5.06 million for the same period last year, which was primarily
due to increase in revenues from search engine marketing service during the periods.
We derive the majority of our advertising
and data service revenues from the sale of advertising space on our internet portals, sales of effective sales lead information,
providing search engine marketing (“SEM”) service and other related value added services, and content management services
to unrelated third parties and to certain related parties. Our advertising, marketing and data services to related parties were
provided in the ordinary course of business on the same terms as those provided to our unrelated customers. For the three months
ended March 31, 2017 and 2016, our service revenues from related parties in the aggregate was less than 1% of the total revenues
for each respective reporting period.
The tables below summarize the
revenues, cost of revenues, gross profit and net loss generated from each of our VIEs and subsidiaries for the three months ended
March 31, 2017 and 2016, respectively, with inter-company transactions eliminated:
For the three months ended March 31, 2017:
Name of subsidiary or VIE
|
|
Revenue from
unrelated parties
|
|
Revenue from
related parties
|
|
Total
|
|
|
($’000)
|
|
($’000)
|
|
($’000)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Business Opportunity Online and subsidiaries
|
|
|
7,245
|
|
|
|
19
|
|
|
|
7,264
|
|
Total revenues
|
|
|
7,245
|
|
|
|
19
|
|
|
|
7,264
|
|
Name of subsidiary or VIE
|
|
Cost of Revenues
|
|
Gross Profit/(Loss)
|
|
|
($’000)
|
|
($’000)
|
|
|
|
|
|
|
|
|
|
Business Opportunity Online and subsidiaries
|
|
|
5,992
|
|
|
|
1,272
|
|
Total cost of revenues
|
|
|
5,992
|
|
|
|
1,272
|
|
Name of subsidiary or VIE
|
|
Net Loss
|
|
|
($’000)
|
|
|
|
|
|
Rise King WFOE and subsidiaries
|
|
|
(501
|
)
|
Business Opportunity Online and subsidiaries
|
|
|
(326
|
)
|
Beijing CNET Online and subsidiaries
|
|
|
(28
|
)
|
ChinaNet Online Holdings, Inc.
|
|
|
(214
|
)
|
Total net loss from continuing operations before allocation to the noncontrolling interest
|
|
|
(1,069
|
)
|
Loss from discontinued operations
|
|
|
-
|
|
Total net loss before allocation to the noncontrolling interest
|
|
|
(1,069
|
)
|
For the three months ended March 31, 2016:
Name of subsidiary or VIE
|
|
Revenue from
unrelated parties
|
|
Revenue from
related parties
|
|
Total
|
|
|
($’000)
|
|
($’000)
|
|
($’000)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rise King WFOE and subsidiaries
|
|
|
21
|
|
|
|
-
|
|
|
|
21
|
|
Business Opportunity Online and subsidiaries
|
|
|
4,991
|
|
|
|
48
|
|
|
|
5,039
|
|
Total revenues
|
|
|
5,012
|
|
|
|
48
|
|
|
|
5,060
|
|
Name of subsidiary or VIE
|
|
Cost of Revenues
|
|
Gross Profit
|
|
|
($’000)
|
|
($’000)
|
|
|
|
|
|
|
|
|
|
Rise King WFOE and subsidiaries
|
|
|
1
|
|
|
|
20
|
|
Business Opportunity Online and subsidiaries
|
|
|
3,455
|
|
|
|
1,584
|
|
Total cost of revenues
|
|
|
3,456
|
|
|
|
1,604
|
|
Name of subsidiary or VIE
|
|
Net Loss
|
|
|
($’000)
|
|
|
|
|
|
Rise King WFOE and subsidiaries
|
|
|
(491
|
)
|
Business Opportunity Online and subsidiaries
|
|
|
(246
|
)
|
Beijing CNET Online and subsidiaries
|
|
|
(43
|
)
|
ChinaNet Online Holdings, Inc.
|
|
|
(585
|
)
|
Total net loss from continuing operations before allocation to the noncontrolling interest
|
|
|
(1,365
|
)
|
Loss from discontinued operations
|
|
|
(46
|
)
|
Total net loss before allocation to the noncontrolling interest
|
|
|
(1,411
|
)
|
Management considers revenues generated
from internet advertising and data service, SEM services and other related technical services as one aggregate business operation
and relies upon the consolidated results of all the operations in this business unit to make decisions about allocating resources
and evaluating performance.
|
l
|
Internet advertising and data service revenues for the three months ended March 31, 2017 were approximately
US$2.29 million, compared with US$3.63 million for the same period in 2016. We believe that the temporary decrease in our internet
advertising and data service revenues during the period reflected our strategy to further upgrading our internet advertising, marketing
and data services to our larger SME clients and eliminating smaller and non-profitable clients. During the past few years, we optimized
our online promotion analysis and cost control system to provide more data and feedback to our users, which is especially helpful
to our larger clients, we also optimized our online promotion tactics to improve cost efficiency, which helped the Company and
our clients achieve more accurate promotion and placement effects with acceptable costs, thereby increasing sales lead conversion
rate and overall client satisfaction with our services. As a result, along with eliminating smaller and non-profitable clients,
revenues contributed by larger customers served by us continued to increase, we believe that upgrading existing services and launching
new services will help increase our market penetration in the SME segment, thereby continuing to increase our recurring revenues
in future periods.
|
|
l
|
Revenue generated from search engine marketing service for the three months ended March 31, 2017 and 2016 was
approximately US$4.97 million and US$1.41 million, respectively. The relative lower level of this type of revenues achieved for
the three months ended March 31, 2016 was primarily due to the delay of finalizing the 2016 framework purchase contract with our
key search engine suppliers in the first quarter of 2016, which temporarily limited the supply of this service during the period.
This enhanced third-party search engine marketing service is designed to help our clients select the most effective key words and
to prioritize the ranking of the anticipated search engine results on selected key words in order to increase the sales lead conversion
rate for our clients’ business promotion on both mobile and PC searches. Management believes this service will be an effective
supplement to the internet advertising and data service provided to our clients, and will help increase the overall satisfaction
with our services, thereby increasing recurring revenues and the number of clients in the future.
|
Cost of revenues
Our cost of revenues consisted
of costs directly related to the offering of our advertising, marketing and data services and technical services. The following
table sets forth our cost of revenues, divided into three segments, by amount and gross profit ratio for the periods indicated,
with inter-segment transactions eliminated:
|
|
Three Months Ended March 31,
|
|
|
2017
|
|
2016
|
|
|
(Amounts expressed in thousands of US dollars, except percentages)
|
|
|
Revenue
|
|
Cost
|
|
GP ratio
|
|
Revenue
|
|
Cost
|
|
GP ratio
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-Internet advertisement and data service
|
|
$
|
2,292
|
|
|
$
|
1,178
|
|
|
|
49
|
%
|
|
$
|
3,627
|
|
|
$
|
2,085
|
|
|
|
43
|
%
|
-Technical services
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
21
|
|
|
|
1
|
|
|
|
95
|
%
|
-Search engine marketing service
|
|
|
4,972
|
|
|
|
4,814
|
|
|
|
3
|
%
|
|
|
1,412
|
|
|
|
1,370
|
|
|
|
3
|
%
|
Internet advertisement and related services
|
|
$
|
7,264
|
|
|
$
|
5,992
|
|
|
|
18
|
%
|
|
$
|
5,060
|
|
|
$
|
3,456
|
|
|
|
32
|
%
|
Cost of revenues:
Our total cost of revenues
increased to US$5.99 million for the three months ended March 31, 2017, compared with US$3.46 million for the same period in 2016.
The increase in our total cost of revenues was primarily due to the increase in costs associated with providing search engine marketing
service during the period, which was in line with the increase in the related revenues as discussed above. Our cost of revenues
related to our advertising, marketing and data services primarily consists of internet resources purchased from key search engines
and technical services providers related to lead generation, sponsored search and other direct cost associated with providing services.
|
l
|
For internet advertising and data service, cost associated with obtaining internet resources was
the largest component of our cost of revenues, accounting for over 80% of our total internet advertising and data service cost
of revenues. We purchased these internet resources from other well-known search engines and portal websites in China, such as:
Baidu, Qihu 360 and Sohu (Sogou). The purchase of these internet resources in large volumes allowed us to negotiate discounts with
our suppliers. For the three months ended March 31, 2017 and 2016, our total cost of revenues for internet advertising and data
service was US$1.18 million and US$2.09 million, respectively. During the past few years, we continued developing our precision
advertising and marketing system, CloudX and optimized our digital marketing tactics by conglomerating different products of a
single large customer and relatively increasing our classified segment and industry level marketing scheme to improve cost efficiency,
which helped us and our clients achieve lead results and effects with acceptable or lower costs. As a result, the gross margin
rate for our internet advertising and data service revenues increased to 49% for the three months ended March 31, 2017, compared
with 43% for the three months ended March 31, 2016.
|
|
l
|
Costs for search engine marketing services were direct internet resource costs consumed for search
engine marketing services provided to clients as described above. We normally charge our clients service fees for this service
as a certain percentage of the related direct cost consumed, which is normally 2%-3%. Gross margin rate of this service for the
three months ended March 31, 2017 and 2016 was both approximately 3%.
|
Gross Profit
As a result of the foregoing, our
gross profit was US$1.27 million and US$1.60 million for the three months ended March 31, 2017 and 2016, respectively. Our
overall gross margin decreased to 18% for the three months ended March 31, 2017, compared with 32% for the same period last year.
The decrease in our overall gross margin rate was a direct result of the increase of revenues from the relative lower margin search
engine marketing service for the three months ended March 31, 2017, compared with that in the same period last year, which constituted
approximately 68.4% of our total revenues for the three months ended March 31, 2017, compared with 27.9% of the total revenues
in the same period last year.
Operating Expenses and Net Loss
Our operating expenses consist
of sales and marketing expenses, general and administrative expenses and research and development expenses. The following
tables set forth our operating expenses, divided into their major categories by amount and as a percentage of our total revenues
for the periods indicated.
|
|
Three Months Ended March 31,
|
|
|
2017
|
|
2016
|
|
|
(Amounts expressed in thousands of US dollars, except percentages)
|
|
|
Amount
|
|
% of total
revenue
|
|
Amount
|
|
% of total
revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Revenues
|
|
$
|
7,264
|
|
|
|
100
|
%
|
|
$
|
5,060
|
|
|
|
100
|
%
|
Gross Profit
|
|
|
1,272
|
|
|
|
18
|
%
|
|
|
1,604
|
|
|
|
32
|
%
|
Sales and marketing expenses
|
|
|
834
|
|
|
|
11
|
%
|
|
|
880
|
|
|
|
17
|
%
|
General and administrative expenses
|
|
|
1,092
|
|
|
|
15
|
%
|
|
|
1,706
|
|
|
|
34
|
%
|
Research and development expenses
|
|
|
395
|
|
|
|
5
|
%
|
|
|
426
|
|
|
|
8
|
%
|
Total operating expenses
|
|
$
|
2,321
|
|
|
|
32
|
%
|
|
$
|
3,012
|
|
|
|
59
|
%
|
Operating Expenses:
Our total operating
expenses decreased to US$2.32 million for the three months ended March 31, 2017 from US$3.01 million for the same period of
2016.
|
l
|
Sales and marketing expenses: Sales and marketing expenses decreased to US$0.83 million for the
three months ended March 31, 2017 from US$0.88 million for the same period of 2016. Our sales and marketing expenses primarily
consist of advertising expenses for brand development that we pay to different media outlets for the promotion and marketing of
our advertising web portals, other advertising and promotional expenses, staff salaries, staff benefits, performance bonuses, travelling
expenses, communication expenses and other general office expenses of our sales department. For the three months ended March 31,
2017, the change in our sales and marketing expenses was primarily due to the following reasons: (1) the increase in advertising
expenses for brand development of approximately US$0.09 million; and (2) the decrease in general expenses of our sales department
of approximately US$0.13 million due to cost reduction plan executed by management.
|
|
l
|
General and administrative expenses: General and administrative expenses decreased to US$1.09 million
for the three months ended March 31, 2017 from US$1.71 million for the same period in 2016. Our general and administrative
expenses primarily consist of salaries and benefits for management, accounting and administrative personnel, office rentals, depreciation
and amortization, professional service fees, maintenance, utilities and other office expenses. For the three months ended March
31, 2017, the change in our general and administrative expenses was primarily due to the following reasons: (1) the decrease in
general administrative expenses, such as: professional service expenses, salary and benefit expenses and other general office expenses
of approximately US$0.18 million, due to cost reduction plan executed by management; (2) the decrease in rental expenses of approximately
US$0.07 million, due to less office space rented during the three months ended March 31, 2017, compared with the same period in
2016; and (3) the decrease in share-based compensation expenses of approximately US$0.39 million related to restricted shares awarded
to management in 2014, which had been fully vested by the end of 2016.
|
|
l
|
Research and development expenses: Research and development expenses were US$0.40 million and US$0.43
million for the three months ended March 31, 2017 and 2016, respectively. Our research and development expenses primarily
consist of salaries and benefits for the research and development staff, equipment depreciation expenses, and office utilities
and supplies allocated to our research and development department.
|
Loss from operations:
As a result of the foregoing, we incurred a loss from operations of approximately US$1.05 million and US$1.41 million for the three
months ended March 31, 2017 and 2016, respectively.
Interest income:
For
the three months ended March 31, 2017 and 2016, interest income we earned was primarily contributed from the approximately US$3
million of term deposit we placed in one of the major financial institutions in the PRC.
Interest expense:
For
the three months ended March 31, 2017, interest expense incurred were primarily related to the short-term
bank loan we borrowed from major financial institutions in the PRC to supplement our short-term working capital needs and amounts
due from new investors related to terminated security purchase agreements as discussed in Note 14.
Loss before income tax benefit,
noncontrolling interests and discontinued operation:
As a result of the foregoing, our loss before income tax benefit,
noncontrolling interest and discontinued operation was approximately US$1.07 million and US$1.39 million for the three months ended
March 31, 2017 and 2016, respectively.
Income Tax benefit:
For
the three months ended March 31, 2017, we recognized an approximately US$0.01 million deferred tax benefit in relation to the net
operating loss incurred by our PRC operating VIEs for the period, which we consider likely to be able to utilized with respect
to future earnings of the entities to which the operating losses relate. We also incurred an approximately US$0.01 million income
tax expenses by utilizing deferred tax assets recognized in previous years due to earnings generated during the period. For the
three months ended March 31, 2016, we recognized an approximately US$0.03 million net income tax benefit, of which approximately
US$0.029 million of our income tax benefit was in relation to the amortization of the intangible assets identified in the acquisition
transactions consummated in previous years and approximately US$0.034 million of our income tax benefit was in relation to the
net operating loss incurred by our PRC operating VIEs for the period, which we consider likely to be able to utilized with respect
to future earnings of the entities to which the operating losses relate; and we also incurred approximately US$0.035 million income
tax expenses by utilizing deferred tax assets recognized in previous years due to earnings generated during the period.
Loss from continuing operations:
As a result of the foregoing, we incurred a loss from continuing operations of approximately US$1.07 million and US$1.37
million for the three months ended March 31, 2017 and 2016, respectively.
Loss from discontinued operation,
net of income tax:
We exited our brand management and sales channel building business segment in the fourth fiscal quarter
of 2015, operated by a former VIE of ours, Quanzhou City Zhilang Network Technology Co., Ltd. (“Quanzhou Zhi Lang”),
which qualified for presentation as a discontinued operation. In June 2016, we disposed Quanzhou Zhi Lang to an unaffiliated third-party.
The results of operations of discontinued operation was presented as a separate component in the condensed consolidated statements
of operations and comprehensive loss, which was approximately US$0.05 million for the three months ended March 31, 2016.
Net loss:
As a result
of the foregoing, for the three months ended March 31, 2017 and 2016, we incurred a total net loss from continuing and discontinued
operations of approximately US$1.07 million and US$1.41 million, respectively.
Net income attributable to noncontrolling
interest from continuing operations:
Beijing Chuang Fu Tian Xia was 51% owned by Business Opportunity Online upon incorporation.
For the three months ended March 31 2017 and 2016, net income allocated to the noncontrolling interests of Beijing Chuang Fu Tian
Xia was approximately US$0.02 million and US$nil, respectively.
Net loss attributable to ChinaNet
Online Holdings, Inc.:
Total net loss as adjusted by net income attributable to the noncontrolling interest shareholders
as discussed above yields the net loss attributable to ChinaNet Online Holdings, Inc. Net loss attributable to ChinaNet Online
Holdings, Inc. was US$1.09 million and US$1.41 million for the three months ended March 31, 2017 and 2016, respectively.
B. LIQUIDITY
AND CAPITAL RESOURCES
Cash and cash equivalents represent
cash on hand and deposits held at call with banks. We consider all highly liquid investments with original maturities of three
months or less at the time of purchase to be cash equivalents. As of March 31, 2017, we had cash and cash equivalents of approximately
US$1.05 million. We also had approximately US$3.1 million of term deposit placed in one of the major financial institutions in
China which will mature in July 2017.
Our liquidity needs include (i)
net cash used in operating activities that consists of (a) cash required to fund the initial build-out, continued expansion of
our network and new services and (b) our working capital needs, which include deposits and advance payments to internet resource
and technical services providers, payment of our operating expenses and financing of our accounts receivable; and (ii) net cash
used in investing activities that consist of the payment for acquisitions to further expand our business and client base, investment
in software technologies to enhance the functionality of the management tools for providing our advertising, marketing and data
services and to secure the safety of our general network, and investment in other general office equipment. To date, we have financed
our liquidity need primarily through proceeds from operating activities we generated. Our existing cash is adequate to fund operations
for the next twelve months.
The following table provides detailed
information about our net cash flow for the periods indicated:
|
|
Three Months Ended March 31,
|
|
|
2017
|
|
2016
|
|
|
Amounts in thousands of US dollars
|
Net cash (used in)/provided by operating activities
|
|
$
|
(2,007
|
)
|
|
$
|
443
|
|
Net cash used in investing activities
|
|
|
-
|
|
|
|
(2,204
|
)
|
Net cash provided by/(used in) financing activities
|
|
|
-
|
|
|
|
-
|
|
Changes in cash and cash equivalents included in assets held for sale
|
|
|
-
|
|
|
|
(6
|
)
|
Effect of foreign currency exchange rate changes on cash
|
|
|
19
|
|
|
|
8
|
|
Net decrease in cash and cash equivalents
|
|
$
|
(1,988
|
)
|
|
$
|
(1,759
|
)
|
Net cash (used in)/provided by operating
activities
For the three months ended March
31, 2017, our net cash used in operating activities of approximately US$2.0 million were primarily attributable to:
|
(1)
|
net loss excluding approximately US$0.35 million of non-cash expenses
of depreciation and amortizations; approximately US$0.21 million share-based compensation; approximately US$0.03 million reversal
of allowance for doubtful accounts of approximately US$0.54 million;
|
|
(2)
|
the receipt of cash from operations from changes in operating
assets and liabilities such as:
|
|
-
|
accounts payable increased by approximately US$0.3 million;
|
|
-
|
advance from customers increased by approximately US$3.2 million,
which we collected for the advance payment required by one of our largest internet resources suppliers;
|
|
-
|
other receivables decreased by approximately US$0.02 million;
and
|
|
-
|
other current liabilities increased by approximately US$0.08 million.
|
|
(3)
|
offset by the use from operations from changes in operating assets
and liabilities such as:
|
|
-
|
accounts receivable and due from related parties increased by
approximately US$1.77 million;
|
|
-
|
deposit and prepayment to suppliers increased by approximately
US$3.15 million, due to additional advance payment required by one of our largest internet resources suppliers;
|
|
-
|
other current assets increased by approximately US$0.04 million;
and
|
|
-
|
accruals decreased by approximately US$0.09 million.
|
For the three months ended March
31, 2016, our net cash provided by operating activities of approximately US$0.44 million were primarily attributable to:
|
(1)
|
net loss excluding approximately US$0.38 million of non-cash expenses
of depreciation and amortizations; approximately US$0.56 million share-based compensation; approximately US$0.02 million of loss
on disposal of fixed assets and approximately US$0.03 million of net deferred income tax benefit of approximately US$0.47 million;
|
|
(2)
|
the receipt of cash from operations from changes in operating assets
and liabilities such as:
|
|
-
|
other receivable decreased by approximately US$1.46 million, primarily
due to subsequent collection of TV advertising deposit and prepayment receivable related to a contract expired on December 31,
2014;
|
|
-
|
accounts payable increased by approximately US$0.19 million;
|
|
-
|
advance from customers increased by approximately US$0.06 million;
|
|
-
|
other current assets decreased by approximately US$0.03 million;
and
|
|
-
|
taxes payable increased by approximately US$0.05 million.
|
|
(3)
|
offset by the use from operations from changes in operating assets
and liabilities such as:
|
|
-
|
accounts receivable and due from related parties for advertising
services provided increased by approximately US$0.53 million;
|
|
-
|
prepayment to suppliers increased by approximately US$0.15 million;
and
|
|
-
|
accruals and other payables decreased by approximately US$0.2
million.
|
Net cash used in investing activities
For the three months ended March
31, 2017, there was no cash provided by or used in investing activities.
For the three months ended March
31, 2016, our cash used in investing activities included the following transactions: (1) we spent approximately US$0.12 million
for the purchase of general office equipment and expenditures on leasehold improvements; (2) we paid approximately US$1.39 million
to purchase software technology related to Internet operation safety, information exchange security and data encryption and management;
and (3) we made additional investments and advances to our unconsolidated investee companies of approximately US$0.69 million during
the period. In the aggregate, these transactions resulted in a net cash outflow from investing activities of approximately US$2.2
million for the three months ended March 31, 2016.
Net cash provided by/used in financing
activities
For the three months ended March
31, 2017 and 2016, there was no cash provided by or used in financing activities.
Restricted Net Assets
As most of our operations are conducted
through our PRC subsidiaries and VIEs, our ability to pay dividends is primarily dependent on receiving distributions of funds
from our PRC subsidiaries and VIEs. Relevant PRC statutory laws and regulations permit payments of dividends by our PRC subsidiaries
and VIEs only out of their retained earnings, if any, as determined in accordance with PRC accounting standards and regulations
and after it has met the PRC requirements for appropriation to statutory reserves. Paid in capital of the PRC subsidiaries and
VIEs included in our consolidated net assets are also not distributable for dividend purposes.
In accordance with the PRC regulations
on Enterprises with Foreign Investment, a WFOE established in the PRC is required to provide certain statutory reserves, namely
general reserve fund, the enterprise expansion fund and staff welfare and bonus fund which are appropriated from net profit as
reported in the enterprise’s PRC statutory accounts. A WFOE is required to allocate at least 10% of its annual after-tax
profit to the general reserve until such reserve has reached 50% of its registered capital based on the enterprise’s PRC
statutory accounts. Appropriations to the enterprise expansion fund and staff welfare and bonus fund are at the discretion of the
board of directors. The aforementioned reserves can only be used for specific purposes and are not distributable as cash dividends.
Rise King WFOE is subject to the above mandated restrictions on distributable profits. Additionally, in accordance with the Company
Law of the PRC, a domestic enterprise is required to provide a statutory common reserve of at least 10% of its annual after-tax
profit until such reserve has reached 50% of its registered capital based on the enterprise’s PRC statutory accounts. A domestic
enterprise is also required to provide for a discretionary surplus reserve, at the discretion of the board of directors. The aforementioned
reserves can only be used for specific purposes and are not distributable as cash dividends. All of our PRC VIEs are subject to
the above mandated restrictions on distributable profits.
As a result of these PRC laws and
regulations, our PRC subsidiaries and VIEs are restricted in their ability to transfer a portion of their net assets to us.
As of March 31, 2017 and December 31, 2016, net assets restricted in the aggregate, which includes paid-in capital and statutory
reserve funds of our PRC subsidiaries and VIEs that are included in our consolidated net assets, was both approximately US$7.8
million.
The New PRC Enterprise Income Tax
(“EIT”) Law, which was effected on January 1, 2008, also imposed a 10% withholding income tax for dividends distributed
by a foreign invested enterprise to its immediate holding company outside China, which were exempted under the previous EIT law.
A lower withholding tax rate will be applied if there is a tax treaty arrangement between mainland China and the jurisdiction of
the foreign holding company. Holding companies in Hong Kong, for example, will be subject to a 5% rate.
The ability of our PRC subsidiaries
to make dividends and other payments to us may also be restricted by changes in applicable foreign exchange and other laws and
regulations.
Foreign currency exchange regulation
in China is primarily governed by the following rules:
|
l
|
Foreign Exchange Administration Rules (1996), as amended in August 2008, or the Exchange Rules;
|
|
l
|
Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996), or the Administration
Rules.
|
Currently, under the Administration
Rules, Renminbi is freely convertible for current account items, including the distribution of dividends, interest payments, trade
and service related foreign exchange transactions, but not for capital account items, such as direct investments, loans, repatriation
of investments and investments in securities outside of China, unless the prior approval of the State Administration of Foreign
Exchange (the “SAFE”) is obtained and prior registration with the SAFE is made. Foreign-invested enterprises like Rise
King WFOE that need foreign exchange for the distribution of profits to its shareholders may effect payment from their foreign
exchange accounts or purchase and pay foreign exchange rates at the designated foreign exchange banks to their foreign shareholders
by producing board resolutions for such profit distribution. Based on their needs, foreign-invested enterprises are permitted to
open foreign exchange settlement accounts for current account receipts and payments of foreign exchange along with specialized
accounts for capital account receipts and payments of foreign exchange at certain designated foreign exchange banks.
Although the current Exchange Rules
allow the convertibility of Chinese Renminbi into foreign currency for current account items, conversion of Chinese Renminbi into
foreign exchange for capital items, such as foreign direct investment, loans or securities, requires the approval of SAFE, which
is under the authority of the People’s Bank of China. These approvals, however, do not guarantee the availability of foreign
currency conversion. We cannot be sure that it will be able to obtain all required conversion approvals for our operations or the
Chinese regulatory authorities will not impose greater restrictions on the convertibility of Chinese Renminbi in the future. Currently,
most of our retained earnings are generated in Renminbi. Any future restrictions on currency exchanges may limit our ability to
use retained earnings generated in Renminbi to make dividends or other payments in U.S. dollars or fund possible business activities
outside China.
As of March 31, 2017 and December
31, 2016, there was approximately US$16.7 million and US$17.6 million retained earnings in the aggregate, respectively, which was
generated by our PRC subsidiaries and VIEs in Renminbi included in our consolidated net assets, aside from US$2.5 million statutory
reserve funds as of March 31, 2017 and December 31, 2016, respectively, that may be affected by increased restrictions on currency
exchanges in the future and accordingly may further limit our PRC subsidiaries’ or VIEs’ ability to make dividends
or other payments in U.S. dollars to us, in addition to the approximately US$7.8 million restricted net assets as of March 31,
2017 and December 31, 2016, respectively, as discussed above.
C. OFF-BALANCE
SHEET ARRANGEMENTS
None.