DataSea Inc. — Form 10-Q Summary
Reporting period: Three months ended September 30, 2018, the company’s fiscal first quarter of fiscal 2019. The filing was signed November 14, 2018. DataSea provides internet security, advertising, micro-marketing and data-analysis services in China through subsidiaries and a contractual variable-interest entity (VIE).
Financial performance and position
| Metric | Quarter ended Sep. 30, 2018 | Prior-year quarter |
|---|---|---|
| Revenue | $0 | $8,994 |
| Cost of goods sold / gross profit (loss) | $7,434 / $(7,434) | $21 / $8,973 |
| Operating expenses | $366,221 | $441,491 |
| Operating loss | $(373,655) | $(432,518) |
| Net loss | $(371,659) | $(408,537) |
| Basic and diluted loss per share | $(0.02) | $(0.01) |
| Net cash used in operating activities | $(435,390) | $(458,861) |
Gross margin was negative in the current quarter because the company reported costs of goods sold despite no revenue. Cash decreased by $199,408 to $832,078. Investing activities used $19,584; financing provided $220,473, including approximately $246,944 of net stock proceeds and a net shareholder-loan payment of $26,471. At quarter-end, current assets were $1,024,093, current liabilities $78,076 and working capital $946,017. Total assets were $1,168,776; reported total stockholders’ equity was $1,090,700. The balance sheet reports no shareholder loan payable, while a related-party note reports $35,110 due to the president.
Changes and business developments
- Revenue fell from $8,994 to zero. Management said it had suspended marketing of its cybersecurity program and was focusing on Safe Campus and Smart Elevator.
- Operating expenses declined year over year, mainly because prior-year staffing costs for Safe Campus and Smart Elevator were higher. Selling expense increased as the company hired employees to market products; research and development expense decreased to $62,771 from $94,560.
- Safe Campus agreements covered 30 schools in ten provinces and approximately 9,000 students. Equipment and services are provided free; the company expects to monetize the platform through advertising, online shopping and data use.
- The company reported a two-year cooperation agreement with China Minsheng Bank to offer financial products through its Xin Platform, with service fees tied to products held by users. In September, it sold 84,000 shares for approximately $246,946.
- The board adopted a 2018 equity incentive plan authorizing up to 4,000,000 shares; no awards had been granted as of the filing.
Outlook, risks and other matters
Management expected available resources to fund operations only through December 2018 and estimated a need to raise RMB 50–80 million (approximately $8.5–12 million) for January–June 2019. It expected revenue during fiscal 2019 but gave no quantified revenue guidance. Management said additional debt or equity financing was needed, with no assurance it could be obtained. The filing states that recurring losses and the absence of current-quarter revenue raise substantial doubt about the company’s ability to continue as a going concern.
- Controls: Management concluded disclosure controls were ineffective, citing inadequate segregation of duties and risk assessment, insufficient U.S. GAAP expertise, and inadequate written accounting and reporting procedures. Remediation depends partly on obtaining financing.
- Risks: The filing identifies uncertainty around financing, Chinese economic and regulatory conditions, customer demand and order timing, product acceptance, suppliers and the company’s ability to establish and operate its business. Cash is held at PRC state-owned banks and is uninsured.
- Commitments and contingencies: No contingencies or pending legal proceedings were reported. The company disclosed future office rent of approximately $41,383 and property-management fees of approximately $82,766 under agreements ending February 2019.
- VIE structure: The company consolidates Shuhai Beijing through contractual arrangements rather than direct ownership; the filing notes that VIE creditors have no recourse to the company’s general credit.
Important facts for investors to verify
- Reconcile the financial statements: the equity roll-forward reports ending stockholders’ equity of $1,462,359 and leaves the deficit unchanged from June, while the balance sheet reports equity of $1,090,700 and a deficit of $(4,496,606). The roll-forward also does not show the quarter’s net loss.
- Clarify the shareholder-related balance: the September 30 balance sheet shows no shareholder loan, but the related-party note reports $35,110 due to the president.
- Confirm the exact proceeds and accounting for the September share sale: the filing cites approximately $246,946 net cash proceeds, while the equity roll-forward records $244,665 for the issuance.
- Assess financing availability, cash runway and progress toward revenue generation, given the going-concern warning and management’s stated funding requirement.
- Monitor remediation of ineffective controls and the potential dilution from the 4,000,000-share incentive plan.