Datasea Inc. — Form 10-Q Summary
Reporting period: Three and six months ended December 31, 2017, the company’s fiscal second quarter and first half of fiscal 2018. Financial statements are unaudited. Amounts are in U.S. dollars unless stated otherwise.
Business context
Datasea provides internet security products, new-media advertising, micro-marketing, and data-analysis services in China. It shifted resources away from marketing its cybersecurity program toward its “Safe Campus” and “Smart Elevator” programs. For Safe Campus, it reported agreements with 30 schools across 10 provinces, covering approximately 3,000 students. The company provides equipment and services to participating schools for free and expects to monetize the program through advertising, online shopping, and data use; the filing does not report revenue from this strategy.
Financial performance
| Metric | Three months ended Dec. 31, 2017 | Three months ended Dec. 31, 2016 | Six months ended Dec. 31, 2017 | Six months ended Dec. 31, 2016 |
|---|---|---|---|---|
| Revenue | $0 | $132,964 | $9,034 | $132,964 |
| Gross profit (loss) | $0 | $(6,054) | $9,013 | $(6,054) |
| Operating expenses | $398,960 | $217,916 | $840,451 | $487,810 |
| Operating loss | $(398,960) | $(223,970) | $(831,438) | $(493,864) |
| Net loss | $(391,501) | $(212,573) | $(799,998) | $(479,408) |
Quarterly revenue fell to zero from $132,964; first-half revenue declined to $9,034 from $132,964. First-half selling expenses were $65,661, up from $55,092, and general and administrative expenses were $774,790, up from $432,718. Management attributed expense increases mainly to advertising and hiring, including personnel for the new programs. Basic and diluted loss per share was $0.01 for the six-month period in both years; the quarterly 2017 loss per share was $0.01 versus $0.00 in 2016.
Cash flow, liquidity, and balance sheet
- At December 31, 2017, cash was $1,899,723, current assets $2,184,328, and current liabilities $201,111; reported working capital was $1,983,217.
- For the six months, operating cash outflow was $856,123, investing cash outflow $13,301, and financing cash inflow $1,331,246. Cash increased by $724,773 to $1,899,723, including a positive $262,951 foreign-exchange effect.
- Financing included $1,429,534 net proceeds from common-stock sales and $72,682 of deferred financing costs. Common shares issued and outstanding increased from 56,610,271 at June 30 to 57,511,771 at December 31; 57,511,771 were outstanding as of February 13, 2018.
- Current liabilities included a $109,136 interest-free, unsecured, on-demand loan payable to the president, down from $129,874 at June 30. The company reported no other long-term debt.
- Deferred financing costs of $74,192 related to a proposed common-stock offering. The filing does not state that the offering was completed.
Outlook, risks, and other notable matters
- Going concern: The company reported substantial doubt about its ability to continue as a going concern, citing recurring losses, minimal revenue, and the need for additional funding. Management estimated current resources would fund operations through May 2018 and said it needed RMB 50–80 million (approximately $8.5–$12 million) for June–December 2018. It intended to seek debt or equity financing, but gave no assurance funding would be available.
- Management outlook: Management expected revenue to increase during 2018, citing demand for internet services in China, but provided no quantified revenue or earnings guidance. It said additional government procurement revenue from the cybersecurity program was unlikely until marketing resumed.
- Concentration and execution: One customer accounted for 100% of sales in each six-month period presented. Safe Campus depends on building users and developing future monetization from advertising and related activities.
- Controls: Management concluded disclosure controls were ineffective due to material weaknesses involving segregation of duties and risk assessment, U.S. GAAP expertise, and written accounting and reporting procedures. Planned remediation depended substantially on obtaining financing; the weaknesses had not been remediated during the period.
- Related parties and other disclosures: The company disclosed vehicle and apartment rentals from its president and a second-hand car purchase from an entity owned by the president’s father. It reported no contingencies, pending legal proceedings, or off-balance-sheet arrangements. Cash is held at state-owned Chinese banks and is not insured.
Important facts for investors to verify
- Whether the company obtained financing sufficient to meet the stated $8.5–$12 million funding need and address the going-concern uncertainty.
- Whether Safe Campus and Smart Elevator achieved adoption and generated revenue after the reporting date, and the costs and economics of providing equipment for free.
- The status and terms of the proposed equity offering associated with the $74,192 deferred financing costs, and the resulting dilution.
- Customer concentration and the sustainability of revenue given the reported single-customer dependence and minimal current-period sales.
- Reconciliation of filing inconsistencies: the cash-flow statement reports prior-year six-month net loss of $479,408, while the MD&A cash-flow discussion states $497,408; financing cash-flow presentation shows a net $25,606 shareholder-loan payment, while MD&A describes $25,606 of loan proceeds.
- The MD&A says there were no material internal-control changes during the quarter ended September 30, 2017, although this report covers the quarter ended December 31, 2017; confirm the intended period.