ZW Data Action Technologies Inc.: Form 10-Q for the period ended Mar 31, 2014

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, 2013. 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, marketing, communication and brand management and sales channel building services to SMEs in China.

Through our PRC operating subsidiary and VIEs, we primarily operate an one-stop services for our clients on four major service platforms, including social networking service information platform, multi-channel advertising and promotion platform, brand management and sales channel building platform and management tools platform. Our social networking service information platform primarily consists of www. chuangye.com, an information and service portal for entrepreneurs or any individual who plans to start their own business. Our multi-channel advertising and promotion platform primarily consists of internet advertising and marketing portals, including www.28.com (http://www.28.com) (“28.com”), www.liansuo.com (http://www.liansuo.com) (“liansuo.com”) and www.sooe.cn (http://www.sooe.cn) (“sooe.cn”), ChinaNet TV as our TV production and advertising unit and the bank kiosk advertising unit. We provide varieties of marketing campaigns through this platform by the combination of the Internet, mobile, television, bank kiosks and printed-medias to maximize market exposure and effectiveness for our clients. Our band management and sales channel expansion platform consists of our brand consulting and management service and offline sales channel expansion service, which is to physically help small businesses to recruit dealers, wholesalers, partners or franchisees based on their business needs. Management tools platform consists of a mobile-based sales and administrative management tools specifically designed for small business in China to match their simplicity.

Basis of presentation, management estimates and critical accounting policies

Our unaudited interim consolidated 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 interim consolidated 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 2013 Form 10-K.

Recent Accounting Standards

In April 2014, the Financial Accounting Standard Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” This ASU changes the threshold for reporting discontinued operations and adds new disclosures. The new guidance defines a discontinued operation as a disposal that “represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results.” The standard is required to be adopted by public business entities in annual periods beginning on or after December 15, 2014, and interim periods within those annual periods. Early adoption is permitted, but only for disposals (or classifications as held for sale) that have not been reported in financial statements previously issued or available for issuance. The adoption of this standard is not expected to have a material impact on our consolidated financial position or results of operations.

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)”. This ASU supercedes the revenue recognition requirements in Accounting Standards Codification (“ASC”) 605-Revenue Recognition and most industry-specific guidance throughout the Codification. The standard requires that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. This ASU should be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the ASU recognized at the date of initial application. For a public entity, the amendments in this ASU are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early application is not permitted. For all other entities (nonpublic entities), the amendments in this ASU are effective for annual reporting periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018. A nonpublic entity may elect to apply this guidance earlier, however, only as prescribed in this ASU. The adoption of this standard is not expected to have a material impact on our consolidated financial position and results of operations.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on our consolidated financial statements upon adoption.

A. RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2014 AND 2013

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 US dollars.

(Unaudited)

(Unaudited)

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Revenue

The following tables set forth a breakdown of our total revenue, divided into five segments for the periods indicated, with inter-segment transactions eliminated:

(Amounts expressed in thousands of US dollars, except percentages)

Total Revenues: Our total revenues decreased to US$5.18 million for the three months ended March 31, 2014 from US$7.05 million for the three months ended March 31, 2013, representing a 26% decrease. This decrease is primarily due to the decrease in internet advertising and related technical service revenue and TV advertising revenue of approximately 6% and 55%, respectively, during the three months ended March 31, 2014 as compared to the same period of last year.

We derive the majority of our advertising service revenues from the sale of advertising space on our internet portals and from providing the related technical support and services, internet marketing service and content management services to unrelated third parties and to certain related parties. We also derive revenue from the sale of advertising time purchased from different TV programs. Our advertising services to related parties were provided in the ordinary course of business on the same terms as those provided to our unrelated advertising clients. For the three months ended March 31, 2014 and 2013, our service revenue from related parties in the aggregate was less than 1% of the total revenue we achieved for each respective reporting period.

Our advertising service revenues are recorded net of any sales discounts. Sales discounts include volume discounts and other customary incentives offered to our small and medium-sized franchise and merchant clients, including providing them with additional advertising time for their advertisements if we have unused space available on our websites and represent the difference between our official list price and the amount we actually charge our clients. We typically sign service contracts with our small and medium-sized franchisor and other clients that require us to place the advertisements on our portal websites in specified locations on the sites and for agreed periods; and/or place the advertisements onto our purchased advertisement time during specific TV programs for agreed periods. We recognize revenues as the advertisement airs over the contractual term based on the schedule agreed upon with our clients.

The tables below summarize the revenues, cost of sales, gross margin and net income/(loss) generated from each of our VIEs and subsidiaries for the three months ended March 31, 2014 and 2013, respectively.

For the three months ended March 31, 2014:

For the three months ended March 31, 2014:

For the three months ended March 31, 2014:

For the three months ended March 31, 2013:

For the three months ended March 31, 2013:

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For the three months ended March 31, 2013:

Management considers revenues generated from internet advertising and the 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 revenues for the three months ended March 31, 2014 were approximately US$3.50 million as compared to US$3.71 million for the same period in 2013, representing a decrease of approximately 6%, which resulted from a decrease in number of customers during the period as compared to the same period of last year. The decrease in number of customers in the first fiscal quarter of 2014 was primarily due to that in the fourth fiscal quarter of 2013, one of the technical staff was detected from stole and intercepted our websites visitors’ message and information from our database for his own benefit, which damaged the effectiveness of our online advertising platform and its ability to satisfy the overall advertising effects expected by our clients for a certain time of period. As a result, the confidence of our customers to the effectiveness of our online advertising portals was also harmed. Management had taken immediate remedial measures once this incident was detected, including reassessing of our server security and monitoring processes, upgrading firewalls and security procedures, communicating and comforting our customers and increasing the cost on direct search engine marketing to regain and strengthen their confidence. Management believes that this is an infrequent event in our ordinary course of business and our sales performance will be able to gradually recover in further periods of the year.

l Revenues generated from technical services offered by Rise King WFOE were US$0.08 million for the three months ended March 31, 2014 as compared to US$0.10 million for the same period in 2013. Due to unexpectedly economic difficulties and overall economic downturn in China from the second half of 2011, with no significant improvement afterwards, many of our clients, including our branded clients, who are mostly SMEs, reduced their advertising spending significantly, majority of our clients cancelled the subscription of these services and only continued their basic internet advertising service, which was recorded in as our internet advertising revenue discussed above. As there was no significant improvement in the overall economic in China for the past two years, our technical services revenue generated by Rise King WFOE was insignificant for both the three months ended March 31, 2014 and 2013.

l Our TV advertising revenue decreased to US$1.18 million for the three months ended March 31, 2014 from US$2.64 million for the same period in 2013, representing a 55% decrease. We generated this US$1.18 million in TV advertising revenue by selling approximately 1,180 minutes of advertising time that we purchased from one provincial TV stations as compared with approximately 1,864 minutes we sold in the same period of 2013. The decrease in TV advertising revenue was primarily due to the adoption of a restrictions notice to TV shopping infomercials broadcasted in provincial satellite television station, issued by the State Administration of Press, Publication, Radio, Film and Television of the People’s Republic of China (the “SARFT”) in October 2013, which further restricts the contents, air time and duration of these infomercials. This restriction notice has had and may continue to have adverse impacts on the demands of our TV advertising service. In response to these restrictions, management plans to cooperate with the television stations to develop and produce new form of TV program which will replace TV shopping infomercials to help our client to raise their brand and product awareness, and to develop of non-TV shopping advertising customers. We will continue to monitor our customers’ needs of the TV advertising services and improve the profitability of this business segment in future periods.

l For the three months ended March 31, 2014 and 2013, we earned both approximately US$0.07 million of revenue from the bank kiosk business segment. The bank kiosk advertising business is not intended to expand at the moment as management’s primary focus is on expanding internet business. The kiosk business’ many details still need to be further analyzed and confirmed before allocating more capital to this business unit. Therefore, it was not a significant contributor to revenue for either the three months ended March 31, 2014 or 2013. Management currently maintains this business without any expansion plans and some of the technology used in this business unit will be fully integrated into the overall advertising and marketing platform.

l For the three months ended March 31, 2014, we generated approximately US$0.35 million service revenue from our brand management and sales channel building segment as compared to US$0.53 million service revenue generated in the same period of 2013. Due to the estimated slow recovery of economy in 2014 and in consideration of the fact that our customers who had made large spending to use our services in previous years and intent to tighten their advertising budget, we do not expect growth in this business segment in 2014.

Cost of revenues

Our cost of revenue consisted of costs directly related to the offering of our advertising services, technical services, marketing services and brand management and sales channel building services. The following table sets forth our cost of revenues, divided into five segments, by amount and gross profit ratio for the periods indicated, with inter-segment transactions eliminated:

(Amounts expressed in thousands of US dollars, except percentages)

Cost of revenues: Our total cost of revenues decreased to US$3.82 million for the three months ended March 31, 2014 from US$4.47 million for the same period in 2013. This was primarily due to the decrease in costs associated with our TV advertisement business segment, which was in line with the decrease in our TV advertisement revenue as discussed above. Our cost of revenues related to the offering of our advertising and marketing services primarily consists of internet resources purchased from key search engines and other portal websites, TV advertisement time costs purchased from TV stations and direct labor cost associated with providing services.

l Cost associated with obtaining internet resources was the largest component of our cost of revenue for internet advertisement, accounting for over 80% of our total internet advertisement cost of sales. We purchased these internet resources from other well-known search engines and portal websites in China, such as: Baidu, Qihu 360 and Sohu (Sogou). Our purchasing of these internet resources in large volumes for ultimate use by our customers allowed us to negotiate discounts with our suppliers. The majority of the resources purchased were used by the internet advertising unit to attract more internet traffic to our advertising portals, assist our internet advertisement clients to obtain more diversified exposure and to generate more visits and sales leads to their advertisements and mini-sites placed on our portal websites. For the three months ended March 31, 2014 and 2013, our total cost of sales for internet advertising was US$2.54 million and US$1.64 million, respectively. The increase in our internet advertising cost was primarily due to (1) continuously increase in internet advertising resources cost at a rate of 5%-15% per annual due to the overall decrease in demands of TV advertising and other traditional advertising media and stronger bargaining power of key search engines in China; (2) intensified competition in the industry, which resulted in the increase in cost related to constantly improving the internet advertising effect for customer satisfaction; and (3) we increased the cost on direct search engine marketing during the period to regain and strengthen the confidence of our customers as a remedial measure to the incident incurred in the fourth fiscal quarter of 2013, which harmed the effectiveness of our online advertising platform, as discussed above. As a result, our gross profit ratio for internet advertising revenue decreased to 27% for the three months ended March 31, 2014 from 56% for the same period of last year.

l TV advertisement time cost is the largest component of cost of revenue for TV advertisement revenue. We purchase TV advertisement time from provincial satellite TV stations in China and resell it to our TV advertisement clients. Our TV advertisement time cost was approximately US$1.1 million and US$2.5 million for the three months ended March 31, 2014 and 2013, respectively. The decrease in our total TV advertisement time cost was in line with the decrease in TV advertising revenue for the three months ended March 31, 2014 as compared to that in the same period of 2013, as discussed above. Gross margin of this business segment was 7% and 5% for the three months ended March 31, 2014 and 2013, respectively.

l Cost recognized for Brand management and sales channel building business segment primarily consisted of director labor cost for providing these services to our customers.

Gross Profit

As a result of the foregoing, our gross profit was US$1.4 million for the three months ended March 31, 2014 as compared to US$2.6 million for the same period in 2013. Our overall gross margin decreased to 26% for the three months ended March 31, 2014 as compared with 37% for the same period in 2013. This decrease is a direct result of the decrease in the gross margin of our internet advertising segment to 27% from 56% for the same period of last year, which was primarily due to the decrease in sales and increase in the related cost of sales of this segment during the period, as discussed above. Our internet advertising revenue and the related technical service revenue in the aggregate accounted for approximately 69% of our total revenue for the three months ended March 31, 2014 as compared to 54% in the same period of 2013.

Operating Expenses and Net Income

Our operating expenses consist of selling 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.

(Amounts expressed in thousands of US dollars, except percentages)

Operating Expenses: Our operating expenses decreased to US$2.03 million for the three months ended March 31, 2014 from US$2.64 million for the same period of 2013.

l Selling expenses: Selling expenses decreased to US$0.59 million for the three months ended March 31, 2014 from US$0.79 million for the same period of 2013. Our selling expenses primarily consist of advertising expenses for brand development that we pay to TV stations and other media outlets for the promotion and marketing of our advertising web portals, other advertising and promotional expenses, website server hosting and broadband leasing 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, 2014, the change in our selling expenses was primarily due to the following reasons: (1) the decrease in staff salary, bonus, employee related benefit expenses of approximately US$0.14 million resulted from decrease in sales performance during the period as compared with the same period of last year; (2) the decrease in general selling expenses, such as travelling expenses, business and entertainment expenses and communication expenses of approximately US$0.07 million due to the same reason discussed above; and (3) the slightly increase in our brand development advertising expenses for our advertising web portals of approximately US$0.01 million.

l General and administrative expenses: General and administrative expenses decreased to US$0.99 million for the three months ended March 31, 2014 from US$1.40 million for the same period in 2013. Our general and administrative expenses primarily consist of salaries and benefits for management, accounting and administrative personnel, office rentals, depreciation of office equipment, professional service fees, maintenance, utilities and other office expenses. For the three months ended March 31, 2014, the change in our general and administrative expenses was primarily due to the following reasons: (1) the decrease in general administrative expenses, such as: salary and staff benefits, office supplies, travelling expenses and entertainment expenses of approximately US$0.13 million, due to the cost reduction plan executed by management; (2) the decrease in allowances for doubtful debts of approximately US$0.26 million; and (3) the decrease in professional service (such as: investor relations, legal, etc.) charges of approximately US$0.03 million, primarily due to decrease in the related services required from these parties as compared to the same period of last year.

l Research and development expenses: Research and development expenses were US$0.45 million for both the three months ended March 31, 2014 and 2013. 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$0.67 million and US$0.06 million for the three months ended March 31, 2014 and 2013, respectively.

Interest income: For the three months ended March 31, 2014 and 2013, interests income we earned was primarily contributed from the approximately US$3.4 million of term deposit we placed in one of the major financial institutions in the PRC.

Loss before income tax expense, equity method investments and noncontrolling interests: As a result of the foregoing, we incurred a loss before income tax expense, equity method investment and noncontrolling interest of approximately US$0.65 million and US$0.03 million for the three months ended March 31, 2014 and 2013, respectively.

Income Tax (expenses)/benefit: We recognized a net income tax expense of approximately US$0.05 million and a net income tax benefit of approximately US$0.09 million and for the three months ended March 31, 2014 and 2013, respectively. For the three months ended March 31, 2014 and 2013, current income tax expense was approximately US$0.18 million and US$0.10 million, respectively. The increase in the current income tax expense was primarily due to the increase in the effective income tax rates of Business Opportunity Online Hubei for the three months ended March 31, 2014. For the three months ended March 31, 2014, our income tax benefit was approximately US$0.13 million, of which approximately US$0.06 million was in relation to the amortization of the intangible assets identified in the acquisition transactions consummated in 2011 and approximately US$0.07 million 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 be utilized with respect to future earnings of the entities to which the operating losses relate. For the three months ended March 31, 2013, our net income tax benefit was approximately US$0.19 million, of which approximately US$0.06 million was in relation to the amortization expenses of the intangible assets identified in the acquisition transactions consummated in 2011 and approximately US$0.13 million 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 be utilized with respect to future earnings of the entities to which the operating losses relate.

(Loss)/income before equity method investments and noncontrolling interests: As a result of the foregoing, for the three months ended March 31, 2014, our loss before equity method investments and noncontrolling interests was approximately US$0.70 million as compared to a income before equity method investments and noncontrolling interests of approximately US$0.06 million for the three months ended March 31, 2013.

Share of losses in equity investment affiliates: For the three months ended March 31, 2014 and 2013, we beneficially own 23.18% and 25.5% equity interest in Shenzhen Mingshan and Zhao Shang Ke Hubei, respectively. Accordingly, for the three months ended March 31, 2014, we recognized our pro-rata share of losses in Shenzhen Mingshan and Zhao Shang Ke Hubei of approximately US$0.002 million and US$0.013 million, respectively. For the three months ended March 31, 2013, we recognized our pro-rata share of losses in Shenzhen Mingshan and Zhao Shang Ke Hubei of approximately US$0.026 million and US$0.045 million, respectively.

Net loss: As a result of the foregoing, our net loss incurred for the three months ended March 31, 2014 and 2013 was approximately US$0.71 million and US$0.01 million, respectively.

Loss attributable to noncontrolling interest: Beijing Chuang Fu Tian Xia and Sheng Tian Hubei were 51% owned by Business Opportunity Online and Business Opportunity Online Hubei, respectively, upon incorporation. In September 2013, we acquired the remaining 49% equity interest in Sheng Tian Hubei and Sheng Tian Hubei became a wholly-owned VIE of ours accordingly. For the three months ended March 31, 2014, the net losses allocated to the noncontrolling interests of Beijing Chuang Fu Tian Xia was approximately US$0.05 million. For the three months ended March 31, 2013 the aggregate net losses allocated to the noncontrolling interest of Beijing Chuang Fu Tian Xia and Sheng Tian Hubei was approximately US$0.04 million.

Net (loss)/income attributable to ChinaNet Online Holdings, Inc.: Total net loss as adjusted by the net loss attributable to the noncontrolling interest shareholders as discussed above yields the net (loss)/income attributable to ChinaNet Online Holdings, Inc. Our net loss attributable to ChinaNet Online Holdigs, Inc. was approximately US$0.67 million for the three months ended March 31, 2014 as compared to a net income attributable to ChinaNet Online Holdings, Inc. of approximately US$0.03 million for the three months ended March 31, 2013.

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, 2014, we had cash and cash equivalents of approximately US$1.66 million and we also have approximately US$3.44 million of term deposit placed in one of the major financial institutions in China which will expire in July 2014.

Our liquidity needs include (i) net cash used in operating activities that consists of (a) cash required to fund the initial build-out and continued expansion of our network and (b) our working capital needs, which include deposits and advance payments to TV advertising slots and internet resource 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 provided by our advertising portals and our general network securities, and investment in other general office equipment. To date, we have financed our liquidity need primarily through proceeds from operating activities we generated in prior years. Our existing cash is adequate to fund operations for the next 12 months.

The following table provides detailed information about our net cash flow for the periods indicated:

Amounts in thousands of US dollars

Net cash used in operating activities:

For the three months ended March 31, 2014, our net cash used in operating activities of approximately US$1.35 million were primarily attributable to:

(1) net loss excluding an approximately US$0.13 million net deferred income tax benefit, a US$0.38 million and non-cash expenses of depreciation, amortizations, share-based compensation and our share of losses in equity investment affiliates of approximately US$0.46 million;

(2) the receipt of cash from operations from changes in operating assets and liabilities such as:

• accounts receivable and due from related parties for the advertising services provided decreased by approximately US$0.64 million;
• other receivable decreased by approximately US$0.15 million, primarily due to the partial collection of the marketing-related loan made for the production of the TV series “Xiao Zhan Feng Yun”;
• accounts payable increased by approximately US$0.17 million;
• advances from customers increased by approximately US$0.13 million;
• other payable increased by approximately US$0.07 million; and
• taxes payable increased by approximately US$0.15 million.

(3) offset by the use from operations from changes in operating assets and liabilities such as:

• prepayment to suppliers increased by approximately US$2.09 million for the purchasing of internet resources and TV advertising slots; and
• aggregate of increase in other current assets and decease in other current liabilities of approximately US$0.11 million.

For the three months ended March 31, 2013, our net cash used in operating activities of approximately US$0.43 million were primarily attributable to:

(1) net income excluding an approximately US$0.19 million net deferred income tax benefit, a US$0.50 million non-cash expenses of depreciation, amortizations, share-based compensation and our share of losses in equity investment affiliates, and a US$0.26 million of allowances for doubtful debts of approximately US$0.56 million;

(2) the receipt of cash from operations from changes in operating assets and liabilities such as:

• accounts payable increased by approximately US$0.11 million;
• advances from customers increased by approximately US$0.56 million; and
• taxes payable increased by approximately US$0.13 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 the advertising services provided increased by approximately US$1.35 million;
• prepayment to suppliers increased by approximately US$0.41 million; and
• net increase in other current assets and decease in other current liabilities of approximately US$0.04 million.

Net cash used in investing activities:

For the three months ended March 31, 2014, our cash used in investing activities included the following transactions: (1) we spent approximately US$0.01 million for purchasing of general office equipments; (2) we prepaid approximately US$0.85 million for the develop of software systems related to internet environment monitoring and system optimization to enhance the overall safety and efficiency of our network system; and (3) we collected approximately US$0.25 million of short-term loan that we lent to an unrelated entity in last year. In the aggregate, these transactions resulted in a net cash outflow from investing activities of approximately US$0.61 million for the three months ended March 31, 2014.

For the three months ended March 31, 2013, our cash used in investing activities included the following transactions: (1) we spent approximately US$0.01 million for purchasing of general office equipments; and (2) we paid approximately US$1.27 million to settle the outstanding payment for the acquisition of the 49% equity interest in Sou Yi Lian Mei. In the aggregate, these transactions resulted in a net cash outflow from investing activities of approximately US$1.28 million for the three months ended March 31, 2013.

Net cash provided by financing activities:

For the three months ended March 31, 2014, we borrowed approximately US$0.20 million from the noncontrolling interest of one of our VIEs to supplement the short-term working capital needs of this VIE.

For the three months ended March 31, 2013, no cash generated from financing activities or spent for financing activities.

Restricted Net Assets

As most of our operations are conducted through our PRC subsidiary and VIEs, our ability to pay dividends is primarily dependent on receiving distributions of funds from our PRC subsidiary and VIEs. Relevant PRC statutory laws and regulations permit payments of dividends by our PRC subsidiary 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 subsidiary 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 subsidiary and VIEs are restricted in their ability to transfer a portion of their net assets to us. As of March 31, 2014 and December 31, 2013, net assets restricted in the aggregate, which includes paid-in capital and statutory reserve funds of our PRC subsidiary and VIEs that are included in our consolidated net assets, was both approximately US$7.3 million.

The current PRC Enterprise Income Tax (“EIT”) Law also imposed a 10% withholding income tax for dividends distributed by a foreign invested enterprise to its immediate holding company outside China. 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. Rise King WFOE is invested by its immediate holding company in Hong Kong and will be entitled to the 5% preferential withholding tax rate upon distribution of the dividends to its immediate holding company.

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, 2014 and December 31, 2013, there were approximately US$38.3 million and US$39.3 million retained earnings in the aggregate, respectively, which were generated by our PRC subsidiary and VIEs in Renminbi included in our consolidated net assets, aside from US$2.8 million statutory reserve funds as of March 31, 2014 and December 31, 2013, that may be affected by increased restrictions on currency exchanges in the future and accordingly may further limit our PRC subsidiary’s or VIEs’ ability to make dividends or other payments in U.S. dollars to us, in addition to the approximately US$7.3 million restricted net assets as of March 31, 2014 and December 31, 2013, as discussed above.

C. OFF-BALANCE SHEET ARRANGEMENTS

None.

Evaluation of Disclosure Controls and Procedures

Our chief executive officer and chief financial officer, with the participation of other members of management, evaluated the effectiveness of our disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e), as of the end of the fiscal quarter ended March 31, 2014. Based on this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were ineffective as of March 31, 2014, due to our inability to timely file our periodic reports with the SEC. The fact that we failed to maintain a well-established contingency plan to promptly react to the absence of a primary member of management responsible for the organization, coordination and supervision of our external reporting processes was a major reason that resulted in the delinquency in filing of this quarterly report.

Changes in Internal Control over Financial Reporting

Other than the disclosure contained in the Evaluation of Disclosure Controls and Procedures discussed above, there was no change in our internal control over financial reporting that occurred during the first fiscal quarter of 2014 covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.