ZW Data Action Technologies Inc.: Form 10-Q for the period ended Mar 31, 2016

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, 2015. 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, online-to-offline (O2O) sales channel expansion and the related data services to SMEs in China 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 platforms, primarily including multi-channel advertising and promotion platform and social networking and services distribution platform. Our multi-channel advertising and promotion platform primarily consists of internet advertising and marketing portals and our TV production and advertising unit. We provide varieties of marketing campaigns through this platform by the combination of the Internet, mobile and TV, we also generate effective sales leads and provide search engine marketing services through this platform to maximize market exposure and effectiveness for our clients. Our social networking and services distribution platform is an information and service portal for entrepreneurs or any individual who plans to start their own business. It is built to serve the community of entrepreneurs to assist them with developing their business, as well as sharing their resources. We also use this platform to develop the distribution channels for our online to offline (O2O) sales channel expansion services in different cities in the PRC. During the past two years, we developed our SMEs intelligent operation and marketing data service applications, which consists of several online cloud technology based sales, client membership management and other administrative operational management tools specifically designed for small business in China to match their simplicity. We intend to use these applications to create community-based consumption ecosystem, deploy our Big Data technologies and analyze offline businesses’ operational data and customers’ consumption data to help the SMEs improve the conversion rate of the purchase from their clients and provide them with related data services.

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 2015 Form 10-K.

A. RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2016 AND 2015

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.

(Unaudited)

(Unaudited)

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Revenues

The following tables set forth a breakdown of our total revenues, 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$5.06 million for the three months ended March 31, 2016 from US$5.72 million for the three months ended March 31, 2015. The decrease was primarily due to decrease in revenues from search engine marketing service during the period.

We derive the majority of our service revenues from the sale of advertising space on our internet portals and providing the related data service, sales of effective sales lead information, providing search engine marketing (“SEM”) service and other related value added technical support and services and content management services to unrelated third parties and to certain related parties. Our advertising and marketing 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, 2016 and 2015, our service revenues from related parties in the aggregate was less than 1.2% 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, 2016 and 2015, respectively, with inter-company transactions eliminated:

For the three months ended March 31, 2016:

For the three months ended March 31, 2016:

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For the three months ended March 31, 2016:

For the three months ended March 31, 2015:

For the three months ended March 31, 2015:

For the three months ended March 31, 2015:

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, 2016 increased to approximately US$3.63 million compared to US$2.45 million for the same period in 2015, representing a 48% increase. During 2015, we continued to place persistent effort in integrating and upgrading our internet advertising, marketing and data services to our SME clients. We optimized our online promotion tactics by conglomerating different products of a single large customer and relatively increasing input on segment and industry level online promotions 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. We also 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, and helpful to the Company to achieve a dynamic control on its internet resources costs. As a result, along with eliminating smaller and non-profitable clients, the number of larger customers served by us continued to increase, and our client’s average consumption amount for our internet advertising and data service also increased compared with the same period last year, which led the increase in revenues from this business for the three months ended March 31, 2016. We will continue to invest in developing new service modules for our clients. We believe that launch of new services in future periods will help increase our market penetration in the SME segment, thereby continuing to increase our recurring revenues in the future.

l Revenues generated from technical services offered by Rise King WFOE were US$0.02 million for the three months ended March 31, 2016 compared to US$0.10 million for the same period in 2015.

l Revenue generated from search engine marketing services for the three months ended March 31, 2016 and 2015 was approximately US$1.41 million and US$3.05 million, respectively. 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. The decrease in this revenues 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. 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. Due to the relative low gross margin of this service as compares to the internet advertising and data service, management does not expect further expansion of this service in the future.

l As discussed in our 2015 Form 10-K, we exited our bank kiosk advertisement business segment in the fourth fiscal quarter of 2015. We did not generate any TV advertisement revenues for the three months ended March 31, 2016, since we did not finalize any TV advertisement resources contracts with suppliers during the period. For the three months ended March 31, 2015, our total revenues generated from TV and bank kiosk advertisement was approximately US$0.13 million, of which approximately US$0.06 million was generated form TV advertisement and US$0.07 million was generated from bank kiosk advertisement.

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 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$3.46 million for the three months ended March 31, 2016 from US$4.87 million for the same period in 2015. This was primarily due to the decrease in costs associated with our search engine marketing service, which was in line with the decrease 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, 2016 and 2015, our total cost of revenues for internet advertising and data service was approximately US$2.09 million and US$1.80 million, respectively. The gross margin for our internet advertising and data service revenues increased to 43% for the three months ended March 31, 2016, compared to 27% for the three months ended March 31, 2015, which was primarily due to the measures we took to increase the cost efficiency and enhance the cost control, as discussed above.

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. Gross margin of this service for the three months ended March 31, 2016 and 2015 was both approximately 3%.

Gross Profit

As a result of the foregoing, our gross profit was US$1.60 million for the three months ended March 31, 2016 compared to US$0.86 million for the same period in 2015. Our overall gross margin increased to 32% for the three months ended March 31, 2016, compared to 15% for the same period in 2015. The increase in our gross profit and gross margin for the three months ended March 31, 2016 was primarily due to (1) the improvement in gross margin of our internet advertising and data service business, which was 43% and 27% for the three months ended March 31, 2016 and 2015, respectively, and (2) the decrease in lower margin revenues from search engine marketing service, which constituted 28% and 53% of our total revenues for the three months ended March 31, 2016 and 2015, respectively.

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.

We exited our brand management and sales channel building business segment in the fourth fiscal quarter of 2015, which qualified for presentation as a discontinued operation. The results of operation of this business was reported in discontinued operation as a separate component in the consolidated statements of operations and comprehensive loss for all periods presented. As a result, operating expenses amounts in the consolidated statements of operations and comprehensive loss for the three months ended March 31, 2015 have been retrospectively adjusted to reflect the effect of reclassification of results of operations reported in discontinued operation as a separate component.

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

Operating Expenses: Our operating expenses increased slightly to US$3.01 million for the three months ended March 31, 2016 from US$2.92 million for the same period of 2015.

l Sales and marketing expenses: Sales and marketing expenses decreased to US$0.88 million for the three months ended March 31, 2016 from US$1.19 million for the same period of 2015. 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, 2016, the decrease in our sales and marketing expenses was primarily due to the decrease in our brand marketing expenses of approximately US$0.23 million, which we spent through key search engines to promote our brand, websites and services.

l General and administrative expenses: General and administrative expenses increased to US$1.71 million for the three months ended March 31, 2016 from US$1.25 million for the same period in 2015. 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, 2016, the change in our general and administrative expenses was primarily due to the following reasons: (1) the increase in general administrative expenses, such as: professional service expenses, salary and benefit expenses, office rental and other general office expenses of approximately US$0.12 million; (2) the net effect of increase in allowances for doubtful accounts, due to reversal of allowance for doubtful accounts of approximately US$0.22 million during the first quarter of 2015; and (3) the increase in share-based compensation expense of approximately US$0.12 million.

l Research and development expenses: Research and development expenses were US$0.43 million and US$0.49 million for the three months ended March 31, 2016 and 2015, 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$1.41 million and US$2.06 million for the three months ended March 31, 2016 and 2015, respectively.

Interest income: For the three months ended March 31, 2016 and 2015, interest income we earned was primarily contributed from the approximately US$3.3 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, 2015, interest expense we paid were primarily related to the approximately US$0.8 million of short-term bank loan we borrowed from a major financial institution in the PRC to supplement our short-term working capital needs, which was matured in July 2015 with no further extension.

Loss before income tax benefit, equity method investments, noncontrolling interests and discontinued operation: As a result of the foregoing, our loss before income tax benefit, equity method investment, noncontrolling interest and discontinued operation was approximately US$1.39 million and US$2.02 million for the three months ended March 31, 2016 and 2015, respectively.

Income Tax benefit: We recognized a net income tax benefit of approximately US$0.03 million and US$0.22 million for the three months ended March 31, 2016 and 2015, respectively. For the three months ended March 31, 2016, 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; 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. For the three months ended March 31, 2015, approximately US$0.04 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$0.19 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 utilized with respect to future earnings of the entities to which the operating losses relate.

Loss before equity method investments, noncontrolling interests and discontinued operation: As a result of the foregoing, our loss before equity method investment, noncontrolling interest and discontinued operation was approximately US$1.37 million and US$1.80 million for the three months ended March 31, 2016 and 2015, respectively.

Share of income in equity investment affiliates: For the three months ended March 31, 2016 and 2015, we beneficially owned 23.18% and 25.5% equity interest in Shenzhen Mingshan and Zhao Shang Ke Hubei, respectively. Accordingly, for the three months ended March 31, 2015, we recognized our pro-rata share of income in Shenzhen Mingshan and Zhao Shang Ke Hubei of approximately US$0.001 million and US$nil, respectively. For the three months ended March 31, 2016, we did not recognize any pro-rata share of loss in these equity investment affiliates, since the amount was immaterial.

Loss from continuing operations: As a result of the foregoing, we incurred a net loss from continuing operations of US$1.37 million and US$1.80 million for the three months ended March 31, 2016 and 2015, respectively.

Loss from discontinued operation, net of income tax: Since we exited our brand management and sales channel building business segment in the fourth fiscal quarter of 2015, which qualified for presentation as a discontinued operation, the results of operations of this segment was reported as loss from discontinued operations as a separate component in our statements of operations and comprehensive loss for the three months ended March 31, 2016 and 2015, respectively. Major line items constituting pre-tax net loss and net loss of the discontinued operation are as follows:

(Unaudited)

(Unaudited)

Net loss: As a result of the foregoing, for the three months ended March 31, 2016 and 2015, we incurred a total net loss from continuing and discontinued operations of approximately US$1.41 million and US$1.82 million, respectively.

Net loss 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, 2016 and 2015, net loss allocated to the noncontrolling interests of Beijing Chuang Fu Tian Xia was approximately US$nil million and US$0.03 million, respectively.

Net loss attributable to ChinaNet Online Holdings, Inc.: Total net loss as adjusted by net loss 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$1.41 million and US$1.79 million for the three months ended March 31, 2016 and 2015, 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, 2016, we had cash and cash equivalents of approximately US$3.7 million. We also had approximately US$3.3 million of term deposit placed in one of the major financial institutions in China which will mature in July 2016.

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:

Amounts in thousands of US dollars

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Net cash provided by/(used in) operating activities

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 advertisement 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;
• 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;
• accruals and other payables decreased by approximately US$0.2 million.

For the three months ended March 31, 2015, our net cash used in operating activities of approximately US$2.33 million were primarily attributable to:

(1) net loss of US$1.82 million, adjusted by excluding an approximately US$0.23 million net deferred income tax benefit, an US$0.90 million non-cash expenses of depreciation, amortization, and share-based compensation and an US$0.22 million of reversal of bad debts provisions, yielded the non-cash items excluded net loss of approximately US$1.37 million;

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

• other receivable decreased by approximately US$0.20 million, primarily due to the partial collection of the TV advertisement deposit and prepayment receivable related to a contract expired on December 31, 2014;
• advances from customers increased by approximately US$1.3 million; and
• other payable increased by approximately US$0.04 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$0.05 million;
• deposit and prepayment to suppliers increased by approximately US$2.2 million for the purchasing of internet resources and TV advertising slots; and
• aggregate of increase in other current assets and decrease in accounts payable and other current liabilities of approximately US$0.25 million.

Net cash 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; (3) we lent two of our cost method investees an aggregate of approximately US$0.26 million of short-term working capital loans during the period; and (4) we made additional investments to an investee of the Company of approximately US$0.43 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.

For the three months ended March 31, 2015, our cash used in investing activities included the following transactions: (1) we paid approximately US$0.33 million to settle the remaining balance related to the purchasing of software technology, which was consummated in December 2014; and (2) we made investments of approximately US$0.18 million in the aggregate to our cost/equity method investees during the period. In the aggregate, these transactions resulted in a net cash outflow from investing activities of approximately US$0.51 million for the three months ended March 31, 2015.

Net cash provided by/(used in) financing activities

For the three months ended March 31, 2016 and 2015, there was no cash provided by or used in 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, 2016 and December 31, 2015, 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$8.5 and US$6.7 million, respectively.

The current PRC Enterprise Income Tax 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.

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, 2016 and December 31, 2015, there were approximately US$22.2 million and US$22.9 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 of statutory reserve funds as of March 31, 2016 and December 31, 2015, 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$8.5 million and US$6.7 million of restricted net assets as of March 31, 2016 and December 31, 2015, as discussed above.

C. OFF-BALANCE SHEET ARRANGEMENTS

None.

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal accounting and financial officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures as of the end of the fiscal quarter ended March 31, 2016, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based on this evaluation, our principal executive officer and principal financial officer have concluded that during the period covered by this report, the Company’s disclosure controls and procedures were effective as of such date to ensure that information required to be disclosed by us in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the first fiscal quarter of 2016 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.