Datasea Inc. — Form 10-Q Summary
Reporting period: Three months ended September 30, 2021, the company’s fiscal first quarter. Financial statements are unaudited; comparisons are with the three months ended September 30, 2020 unless noted. Datasea is a Nevada holding company whose China-based operations are conducted primarily through a variable interest entity (VIE) and contractual arrangements.
Business context and financial performance
The company operates in smart-city and security solutions, acoustic intelligence, 5G messaging, and smart payment services. In the quarter, recognized revenue came primarily from 5G SMS/messaging services provided to one large internet-services customer.
| Metric | Quarter ended Sep. 30, 2021 | Prior-year quarter |
|---|---|---|
| Revenue | $671,130 | $9,055 |
| Cost of goods sold | $607,535 | $16,899 |
| Gross profit (loss) | $63,595 | $(7,844) |
| Gross margin | About 9% | Not meaningful; gross loss |
| Operating expenses | $1,637,486 | $868,227 |
| Operating loss | $(1,573,891) | $(876,071) |
| Net loss attributable to Datasea | $(1,441,234) | $(866,823) |
| Basic and diluted loss per share | $(0.06) | $(0.04) |
| Net cash used in operations | $(1,399,969) | $(909,530) |
Liquidity, debt, and financing
- Cash was $5.81 million at September 30, up from $49,676 at June 30, 2021. Approximately $5.44 million was held in RMB at PRC financial institutions and is not freely convertible into foreign currencies.
- Current assets were $7.39 million and current liabilities were $3.46 million, yielding reported working capital of $3.93 million and a current ratio of 2.14, compared with a $2.37 million working-capital deficit and 0.27 ratio at June 30.
- Loans payable were $984,519, down from $1.49 million; the remaining loans bear no interest and are due on demand before December 31, 2021. Operating lease liabilities totaled $1.10 million.
- Financing activities provided $7.17 million net cash, mainly from the July equity financing, partly offset by debt repayment and payments to related parties. The company sold 2,436,904 shares at $3.48 per share and warrants; it reported approximately $7.64 million net proceeds. Cash used in investing was $9,156.
Changes and management commentary
- Revenue increased substantially from a very low prior-year base as Datasea expanded into 5G messaging. Gross profit turned positive, but the approximately 9% gross margin remained insufficient to cover operating costs.
- Operating expenses rose about 88%. General and administrative expense increased by $500,035, including higher professional fees, rent, payroll, and meal and entertainment costs. Selling expense increased by $176,734; research and development expense rose to $287,216 from $194,726.
- Management says it intends to invest approximately $10 million in technology product development over the next three years and aims to achieve annual profit in the new fiscal year. No quantified earnings or revenue guidance is provided.
- Management cited September 2021 SMS agreements with stated contract values of approximately $4.33 million and $3.87 million, and an October agreement with a stated value of approximately $4.67 million. A separate October 9 agreement calls for 5G messaging services with revenue of at least RMB 30 million (about $4.63 million). These contract values are not equivalent to revenue recognized in the reported quarter.
- A subsequent strategic agreement for smart systems and services at at least 200 schools and institutions was described as having a total value of not less than approximately $14.76 million over two years. The filing also describes a small October school purchase order of approximately $2,900.
Risks, contingencies, and unusual items
- Going concern: The company reported recurring operating losses, a $13.50 million accumulated deficit, and negative operating cash flow. Management says the equity financing mitigated liquidity concerns, but states there is no assurance of profitability, further financing, or continued operations.
- VIE and China exposure: Datasea has no equity ownership in its VIE and relies on contractual arrangements to control and consolidate it. The filing identifies uncertainty around PRC laws, foreign-ownership restrictions, overseas-listing review, and enforceability of the VIE agreements.
- Customer and collection risk: Quarterly revenue was concentrated in one customer. The company also reported a $567,428 receivable from Heqin, with a $283,714 allowance; Heqin had made no repayment as of the report date, despite a revised repayment schedule beginning in October 2021.
- Internal controls: Management concluded disclosure controls and procedures were not effective, citing inadequate segregation of duties and risk assessment, insufficient U.S. GAAP training, and inadequate written accounting and reporting procedures. Remediation efforts are underway.
- The filing reports no pending legal proceedings and no material contingencies as of September 30, 2021. Management did not expect COVID-19 to have a significant impact on the rest of fiscal 2022, based on information then available.
Important facts for investors to verify
- Whether reported 5G messaging contracts convert into delivered services, collected cash, and sustainable revenue—and how much revenue depends on the principal customer.
- Cash accessibility and transferability, particularly the RMB funds held in China, alongside near-term loan maturities and continuing operating cash burn.
- The status and collectability of the Heqin receivable and the adequacy of its allowance.
- Progress in remediating the disclosed material weaknesses and whether subsequent filings report effective controls.
- The terms, enforceability, and regulatory exposure of the VIE arrangements, and the dilution and potential share issuance associated with outstanding warrants.