Datasea Inc. — Form 10-Q Summary
Reporting period: The filing covers the quarter and nine months ended March 31, 2020, the company’s fiscal third quarter of 2020. This differs from the request metadata of “2019 Q3.” The financial statements are unaudited; the report was signed May 14, 2020.
Business context
Datasea develops smart security and education-related technology in China, including systems for schools, scenic areas and public communities. It reported no revenue for either the three or nine months ended March 31, 2020 or the comparable 2019 periods. The company was developing epidemic-prevention systems, among other products, and reported 33 related purchase orders totaling $84,000; these orders had not resulted in reported revenue in the periods presented.
Financial results and position
| Metric | Three months ended March 31, 2020 | Nine months ended March 31, 2020 | Comparable 2019 period |
|---|---|---|---|
| Revenue | $0 | $0 | $0 |
| Operating expenses | $570,657 | $1,745,953 | $574,589; $1,329,479 |
| Operating loss | $570,657 | $1,745,953 | $574,589; $1,329,479 |
| Net loss | $557,739 | $1,705,757 | $540,999; $1,284,936 |
| Basic and diluted loss per share | $0.03 | $0.08 | $0.03; $0.06 |
| Net cash used in operating activities | Not separately stated | $2,285,214 | $1,289,063 |
Gross profit was zero in both current and comparable periods; gross margin is not meaningful with no revenue. Nine-month selling expense fell 22% to $142,605, while research and development expense rose 72% to $229,511 and general and administrative expense rose 36% to $1,373,837. Management attributed G&A growth mainly to higher rent and professional fees. Quarterly net loss increased slightly, principally because non-operating income declined.
At March 31, 2020, total assets were $6.41 million, including cash of $2.01 million and restricted cash of $600,000. Current liabilities were $1.94 million and reported working capital was $1.51 million; management gave a current ratio of 1.78:1. Total liabilities were $2.36 million, including $769,956 in operating lease liabilities. The shareholder loan outstanding at June 30, 2019 had been repaid. Stockholders’ equity was $4.05 million and accumulated deficit was $7.26 million.
Nine-month investing cash outflow was $1.65 million, mainly $1.40 million for intangible assets and $248,333 for fixed assets. Financing cash outflow was $85,091, primarily repayment of a shareholder loan; there were no equity proceeds in the period. Cash and restricted cash together declined $4.06 million to $2.61 million. Cash flow from operations and investing materially exceeded cash provided by financing.
Changes, outlook and risks
- Material year-over-year change: Nine-month net loss increased by about $421,000 as operating expenses rose, despite the continued absence of revenue. Cash used in operations increased by about $996,000.
- COVID-19: The company said marketing and business development were materially affected from January through March 2020, with operations resuming in April. Management cited product adaptation, online research and development, and government support as factors that may aid recovery, but warned that the pandemic could disrupt operations and reduce demand.
- Going concern: The filing states that recurring losses and the $7.26 million accumulated deficit raise substantial doubt about the company’s ability to continue as a going concern. Management expected available resources and anticipated revenue to support operations for the next 12 months, but also said it may seek financing through securities offerings or loans and gave no assurance that funding or profitability would be achieved.
- Commercial execution: The safe-campus system was in the market; scenic-area and public-community systems were in testing. The company described epidemic-prevention installations and purchase orders, but had not recognized revenue. It held $1.36 million in customer advances, including about $1.28 million from sales agents, subject to revenue recognition as agents sell to end customers.
- Unusual transactions and commitments: Three entities were transferred to the company’s VIE for no consideration from management and other individuals; some had not begun operations. A newly formed subsidiary reported a $197,598 interest-free receivable from Heqin under a marketing arrangement, secured by Heqin assets and shareholder guarantees. The company also reported $1.4 million of intangible-asset cash spending; development under one $1.2 million agreement had not commenced because specifications were not finalized, while another technology project was in process.
- Controls and corporate matters: Management concluded disclosure controls were not effective, citing material weaknesses in segregation of duties and risk assessment, U.S. GAAP expertise, and written accounting and reporting procedures. Remediation was underway but partly dependent on additional revenue or financing. The prior auditor resigned in January 2020 and Morison Cogen LLP was appointed as successor; the filing reported no disagreements or reportable events with the former auditor. The VIE structure, China-based operations and limits on currency convertibility are additional considerations.
Key facts for investors to verify
- Confirm the intended reporting period: this filing is for the quarter ended March 31, 2020, not 2019 Q3.
- Track whether purchase orders and installations convert into recognized revenue, and how customer advances are fulfilled or otherwise accounted for.
- Assess cash burn, available unrestricted cash, restricted escrow funds, and the company’s ability to obtain financing in light of the going-concern warning.
- Monitor collection of the Heqin receivable, the remaining commitments and progress under technology-development agreements, and the commercial performance of new products.
- Review progress in remediating the disclosed internal-control weaknesses and the practical enforceability and risks of the VIE arrangements.