Datasea Inc. — Form 10-Q summary
Reporting period: Quarter and six months ended December 31, 2019. This is the company’s fiscal second quarter of fiscal 2020, despite the request metadata describing it as “2019 Q2.” Amounts are U.S. dollars; statements are unaudited.
Business context
Datasea provides smart-security products and services, primarily for schools, tourist attractions, and public communities in China. The company reported no revenue in either the quarter or the six-month period. Its consolidated structure includes a China-based variable interest entity (VIE) controlled through contractual arrangements.
Financial performance and position
| Metric | Three months ended Dec. 31, 2019 | Six months ended Dec. 31, 2019 | Prior-year comparison |
|---|---|---|---|
| Revenue | $0 | $0 | $0 in both comparable 2018 periods |
| Cost of goods sold / gross loss | $194 / $194 loss | $194 / $194 loss | No cost or gross loss reported in 2018 |
| Operating expenses | $765,460 | $1,175,102 | $388,669 / $754,890 in 2018 |
| Operating loss | $765,654 | $1,175,296 | $388,669 / $754,890 in 2018 |
| Net loss | $751,032 | $1,148,018 | $379,712 / $743,937 in 2018 |
| Net loss per share, basic and diluted | $0.04 | $0.05 | $0.02 / $0.04 in 2018 |
Gross margin is not meaningful because the company had no revenue. General and administrative expense rose 132% for the quarter and 88% for six months year over year; management cited higher rent, other costs, and approximately $285,000 of technology costs expensed in the quarter. Selling expense declined, while research and development expense increased, which management attributed to hiring additional R&D staff.
Cash flow: Six-month operating cash use was $1.572 million, versus $795,000 in 2018; investing cash use was $1.609 million, primarily for $1.4 million of intangible assets and $209,000 of equipment. Financing cash use was $84,227, mainly repayment of a shareholder loan. Cash fell $3.268 million to $2.805 million.
Liquidity and liabilities: Working capital was $1.106 million at December 31, down from $4.568 million at June 30, 2019. Current assets were $3.133 million and current liabilities $2.027 million. Total liabilities were $2.562 million. No shareholder loan was outstanding at quarter-end; operating lease liabilities totaled about $1.115 million, of which $579,475 was current. Customer advances of $1.301 million remain a current liability. Stockholders’ equity was $4.606 million.
Material changes, outlook, and risks
- The company paid approximately $1.9 million to two third-party agencies for product development during the six months. A $1.2 million SDT development agreement had not begun because specifications were not finalized; $1.0 million had been paid and recorded as a prepayment. A separate $1.2 million eye-protection technology project was in process, with $900,000 paid.
- Datasea adopted lease accounting on July 1, 2019, recording $1.115 million of right-of-use assets and corresponding lease liabilities. It also entered into a new Beijing office lease and related service agreement.
- Management said existing cash and its operating cash-flow forecast should fund operations through December 2020. It expects revenue from expansion of its Safe Campus business and new products, but gave no quantified revenue or earnings guidance. If revenue falls short, it may seek support from majority stockholders or issue securities; financing may not be available on acceptable terms or at all.
- The filing warns that the COVID-19 outbreak could delay school activity and product sales, weaken demand, create liquidity shortfalls, and raise substantial doubt about the company’s ability to continue as a going concern if prolonged. Management also said it was seeking to adapt products and software to the outbreak, with no assurance of success.
- Disclosure controls and procedures were deemed ineffective because of material weaknesses involving segregation of duties and risk assessment, U.S. GAAP expertise, and written accounting and reporting procedures. Remediation depends partly on obtaining financing and generating more revenue.
- Cash exposure includes approximately $2.207 million held at Hong Kong financial institutions, of which about $2.143 million was uninsured, and approximately $529,000 held at U.S. institutions, of which about $280,000 was uninsured. Some RMB cash in China is not freely convertible.
- The VIE disclosure reports $515,764 of assets and $5.940 million of liabilities at December 31, 2019. The filing states that VIE creditors have no recourse to the parent’s general credit. The company also notes that its control rests on contractual arrangements rather than direct ownership of the VIE.
- No legal proceedings or material contingencies were reported. The company reported no subsequent events requiring adjustment or disclosure. In January 2020, management transferred ownership of three entities to the VIE for no consideration.
Important facts for investors to verify
- Whether and when the company can begin generating revenue, convert customer advances into sales, and achieve commercial adoption of its products.
- Cash burn, remaining cash runway, and the availability and terms of any additional financing or shareholder support.
- Progress, deliverables, remaining payments, and recoverability of the technology-development prepayments and intangible assets.
- The impact of COVID-19 on customers, product development, operations, and the company’s stated ability to fund operations through December 2020.
- Remediation of the disclosed material weaknesses and continued reliability of financial reporting.
- Risks relating to uninsured and restricted cash, the VIE contractual structure, and the reported VIE liabilities.