Datasea(DTSS) - 2020 Q2 - Quarterly Report

FORM 10-Q General Information Company Identification and Filing Details Datasea Inc.'s 10-Q report details company identification, filing status, incorporation, principal offices, stock ticker, and company type - Datasea Inc. filed its 10-Q quarterly report for the period ended December 31, 2019[1] - The company is incorporated in Nevada with its principal executive offices located in Beijing, China[2] Company Stock Information and Filing Status | Metric | Details | | :--- | :--- | | Ticker Symbol | DTSS | | Registered Exchange | NASDAQ Capital Market | | Filing Company Type | Smaller reporting company | | Filing Company Type | Emerging growth company | | Common Stock Outstanding (as of Feb 14, 2020) | 20,943,846 shares | TABLE OF CONTENTS Report Structure Overview This section outlines the 10-Q report's official table of contents, detailing its two main parts: financial information and other information - The report is divided into two main parts: Part I for financial information and Part II for other information[6] - Part I, Financial Information, includes financial statements, management's discussion and analysis of financial condition and results of operations, market risk disclosures, and controls and procedures[6] - Part II, Other Information, covers legal proceedings, risk factors, unregistered sales of equity securities, defaults on senior securities, mine safety disclosures, other information, and exhibits[6] PART I – FINANCIAL INFORMATION Item 1. Financial Statements This chapter presents Datasea Inc.'s unaudited condensed consolidated financial statements for the quarter ended December 31, 2019, along with their detailed notes Condensed Consolidated Balance Sheets Total assets and stockholders' equity decreased as of December 31, 2019, driven by reduced cash and increased operating lease and intangible asset liabilities Total Assets Change | Date | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 7,168,043 | | June 30, 2019 | 7,448,790 | | Change | (280,747) | | Percentage Change | -3.77% | Cash Change | Date | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 2,804,740 | | June 30, 2019 | 6,072,637 | | Change | (3,267,897) | | Percentage Change | -53.81% | Total Liabilities Change | Date | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 2,562,297 | | June 30, 2019 | 1,683,402 | | Change | 878,895 | | Percentage Change | 52.21% | Stockholders' Equity Change | Date | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 4,605,746 | | June 30, 2019 | 5,765,388 | | Change | (1,159,642) | | Percentage Change | -20.11% | - Net intangible assets significantly increased from $555,811 as of June 30, 2019, to $1,951,504 as of December 31, 2019[11] - Operating lease liabilities of $579,475 (current) and $535,417 (non-current) were added as of December 31, 2019, due to the adoption of ASU 2016-02[11] Condensed Consolidated Statements of Operations and Comprehensive Loss The company generated no revenue, resulting in a gross loss, with net loss significantly increasing due to higher operating expenses, particularly general and administrative costs - For the three and six months ended December 31, 2019, the company reported $0 in revenue[13] Net Loss (Three Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | (751,032) | | December 31, 2018 | (379,712) | | Change | (371,320) | | Loss Increase Percentage | 97.79% | Net Loss (Six Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | (1,148,018) | | December 31, 2018 | (743,937) | | Change | (404,081) | | Loss Increase Percentage | 54.32% | - General and administrative expenses increased by 131.6% from $275,582 in 2018 to $638,157 for the three months ended December 31, 2019[13] - Research and development expenses increased by 68.2% from $41,114 in 2018 to $69,158 for the three months ended December 31, 2019[13] - Basic and diluted net loss per share increased from ($0.02) in 2018 to ($0.04) for the three months ended December 31, 2019[13] Condensed Consolidated Statements of Changes In Stockholders' Equity Total stockholders' equity decreased from $5,765,388 on June 30, 2019, to $4,605,746 on December 31, 2019, primarily due to net loss and foreign currency translation adjustments Total Stockholders' Equity Change | Date | Amount ($) | | :------------- | :--------- | | June 30, 2019 | 5,765,388 | | December 31, 2019 | 4,605,746 | | Change | (1,159,642) | | Percentage Change | -20.11% | - Accumulated deficit increased from ($5,550,128) on June 30, 2019, to ($6,698,145) on December 31, 2019, reflecting accumulated net losses[14] - Foreign currency translation adjustments resulted in a ($18,238) loss for the three months ended December 31, 2019, reducing comprehensive income[14] Condensed Consolidated Statements of Cash Flows Net cash significantly decreased for the six months ended December 31, 2019, primarily due to increased outflows from operating and investing activities, contrasting with prior year's net inflows from financing Net Cash Outflow from Operating Activities (Six Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | (1,572,243) | | December 31, 2018 | (794,846) | | Change | (777,397) | | Cash Outflow Increase Percentage | 97.81% | Net Cash Outflow from Investing Activities (Six Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | (1,608,538) | | December 31, 2018 | (30,337) | | Change | (1,578,201) | | Cash Outflow Increase Percentage | 5202.2% | Net Cash from Financing Activities (Six Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | (84,227) | | December 31, 2018 | 5,038,638 | | Trend | Shift from cash inflow to outflow | Net (Decrease) Increase in Cash (Six Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | (3,267,897) | | December 31, 2018 | 4,242,022 | | Trend | Shift from significant cash increase to decrease | - The ending cash balance decreased from $5,273,508 on December 31, 2018, to $2,804,740 on December 31, 2019[16] Notes to Condensed Consolidated Financial Statements This section provides detailed disclosures and explanations for the condensed consolidated financial statements, covering organization, accounting policies, asset and liability details, related party transactions, income taxes, commitments, and subsequent events NOTE 1 – ORGANIZATION AND DESCRIPTION OF BUSINESS Datasea Inc., incorporated in Nevada in 2014, underwent a reverse merger in 2015 with Shuhai Skill (HK) becoming the accounting survivor, and now primarily provides smart security solutions in China, recently expanding with new subsidiaries for technology development and market growth - Datasea Inc. was incorporated in Nevada on September 26, 2014[17] - On October 29, 2015, the company acquired Shuhai Skill (HK) and its subsidiaries, including its VIE Shuhai Beijing, through a share exchange agreement, treated as a reverse merger[18] - The company primarily provides smart security solutions for schools, tourist attractions, and public communities in China[19] - On October 16, 2019, Shuhai Beijing established a wholly-owned subsidiary, Heilongjiang Xunrui Technology Co., Ltd., to focus on developing and marketing smart security system products[20] - On December 3, 2019, Shuhai Beijing established Nanjing Shuhai Equity Investment Fund Management Co., Ltd., a 99% owned joint venture, to secure government and private funding for new technology development and project incubation[20] NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES This note details the accounting principles and methods used for financial statement preparation, including consolidation, VIE treatment, estimates, cash, inventory, property, intangibles, revenue recognition, income tax policies, and recent accounting updates BASIS OF PRESENTATION AND CONSOLIDATION The unaudited financial statements are prepared according to SEC regulations and consolidate the company, its wholly-owned subsidiaries (Shuhai Skill (HK), Tianjin Information), and its Variable Interest Entity (Shuhai Beijing) and its subsidiaries - The consolidated financial statements include the company and its 100% owned subsidiaries Shuhai Skill (HK), Tianjin Information, and its VIE Shuhai Beijing and its subsidiaries[21] - The financial statements are unaudited, prepared in accordance with SEC rules and regulations, and reflect all adjustments management deems necessary for a fair presentation of operating results[22] VARIABLE INTEREST ENTITY (VIE) The company consolidates Shuhai Beijing as a Variable Interest Entity (VIE) because it is deemed the primary beneficiary, holding the ability to direct its activities and the right to absorb losses or receive benefits through various contractual agreements - The company is required to consolidate Shuhai Beijing as a VIE in its financial statements under FASB ASC Section 810, "Consolidation"[23] - The company is considered the primary beneficiary of Shuhai Beijing, possessing the ability to direct its economic performance activities and the obligation to absorb losses or receive benefits[24][25] - Operating and Intellectual Property Service Agreement: Allows Tianjin Information to manage and operate Shuhai Beijing and collect 100% of its net profits[26] - Shareholder Voting Rights Proxy Agreement: Shuhai Beijing shareholders (Zhixin Liu and Fu Liu) irrevocably delegated their voting rights to Tianjin Information, with no expiration date[27] - Equity Option Agreement: Shuhai Beijing shareholders granted Tianjin Information an irrevocable right to acquire all or part of Shuhai Beijing's equity at a nominal price[33] - Equity Pledge Agreement: Shuhai Beijing shareholders pledged all their equity in Shuhai Beijing to Tianjin Information to secure their performance under other agreements[34] VIE Financial Data (as of December 31, 2019) | Metric | Amount ($) | | :---------------- | :--------- | | Current Assets | 209,493 | | Non-Current Assets | 306,270 | | Total Assets | 515,764 | | Current Liabilities | 5,940,253 | | Non-Current Liabilities | - | | Total Liabilities | 5,940,253 | USE OF ESTIMATES Financial statement preparation requires management estimates and assumptions, particularly for asset useful lives, employee benefits, deferred income taxes, and valuation allowances, where actual results may differ significantly - Management must make estimates and assumptions in preparing financial statements, particularly regarding the estimated useful lives and salvage values of property, plant, and equipment, employee benefit provisions, recognition and measurement of deferred income taxes, and valuation allowances for deferred tax assets[37] - Actual results may differ from these estimates, and such differences could materially impact the condensed consolidated financial statements[37] CONTINGENCIES The company assesses potential losses from legal proceedings or unasserted claims, and as of December 31, 2019, and June 30, 2019, no material contingencies were identified - Company management and legal counsel assess contingent liabilities related to legal proceedings or unasserted claims[38] - If an assessment indicates a high probability of material loss and the amount can be estimated, an estimated liability is accrued; if not probable but reasonably possible, or probable but not estimable, its nature and possible loss range are disclosed[38][39] - As of December 31, 2019, and June 30, 2019, the company had no such contingencies[39] CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash on hand, demand deposits, and highly liquid short-term cash investments with original maturities of three months or less - Cash and cash equivalents include cash on hand, demand deposits, and highly liquid short-term cash investments with original maturities of three months or less[40] INVENTORY Inventory, primarily smart student ID cards and routers for "Safe Campus" products, is valued at the lower of cost or net realizable value using the first-in, first-out method, with no impairment recorded as of December 31, 2019, and June 30, 2019 - Inventory primarily consists of smart student ID cards and routers for installation, related to the company's "Safe Campus" security products[41] - Inventory is valued at the lower of cost or net realizable value, using the first-in, first-out method[41] - No inventory impairment was recorded as of December 31, 2019, and June 30, 2019[41] ESCROW A $600,000 cash amount in escrow serves as an indemnification escrow account, required by the company's IPO underwriter's financing agreement, for a term of 18 months or longer following the IPO's closing on December 21, 2018 - An escrow account holds $600,000 in cash[42] - These funds are an indemnification escrow account required by the company's IPO underwriter's financing agreement[42] - The escrow term is 18 months or longer following the IPO's closing on December 21, 2018[42] PROPERTY AND EQUIPMENT Property and equipment are stated at cost less accumulated depreciation, with depreciation calculated using the straight-line method over estimated useful lives of 3 to 10 years, and leasehold improvements depreciated over their estimated useful lives or the shorter remaining lease term - Property and equipment are stated at cost less accumulated depreciation[43] - Depreciation is calculated using the straight-line method over estimated useful lives[43] Estimated Useful Lives for Property and Equipment | Asset Type | Useful Life | | :------------- | :--------- | | Furniture and Fixtures | 5-10 years | | Office Equipment | 3-5 years | | Vehicles | 5 years | | Leasehold Improvements | 3 years | - Leasehold improvements are depreciated using the straight-line method over their estimated useful lives or the shorter remaining lease term[46] INTANGIBLE ASSETS Intangible assets with finite useful lives, including licenses, certificates, patents, and other technologies, are amortized using the straight-line method over their estimated benefit periods of five to ten years, with no impairment identified as of the balance sheet date - Intangible assets with finite useful lives are amortized using the straight-line method over their estimated benefit periods[47] - The estimated useful lives for intangible assets range from five to ten years[47] - Intangible assets include licenses, certificates, patents, and other technologies[47] - No impairment of intangible assets was identified as of the balance sheet date[47] FAIR VALUE MEASUREMENTS AND DISCLOSURES The company applies FASB ASC Topic 820, "Fair Value Measurement," which establishes a three-level valuation hierarchy, and due to the short-term nature of financial instruments, their carrying values approximate fair values, with no assets or liabilities requiring recurring fair value presentation identified as of December 31, 2019, and June 30, 2019 - The company follows FASB ASC Topic 820, "Fair Value Measurement," which defines fair value and establishes a three-level valuation hierarchy[48] - Level 1 inputs: Quoted prices (unadjusted) in active markets for identical assets or liabilities[48] - Level 2 inputs: Quoted prices for similar assets and liabilities in active markets, and inputs that are observable, either directly or indirectly, for substantially the full term of the financial instrument[48] - Level 3 inputs: Unobservable inputs that are significant to the fair value measurement[48] - As of December 31, 2019, and June 30, 2019, the company did not identify any assets or liabilities that are required to be presented at fair value on a recurring basis[49] IMPAIRMENT OF LONG-LIVED ASSETS The company reviews long-lived assets for impairment when events or circumstances indicate that the carrying amount may not be recoverable, measuring impairment as the excess of the asset's carrying amount over its fair value, with no impairment losses recognized during the reporting period - In accordance with FASB ASC 360-10, the company reviews long-lived assets for impairment when events or circumstances indicate that the carrying amount of an asset may not be recoverable[50] - The impairment amount is measured as the excess of the asset's carrying amount over its fair value[50] - No impairment losses on long-lived assets were recognized during the reporting period[50] REVENUE RECOGNITION The company adopted ASC 606 on July 1, 2018, recognizing revenue when control of goods and services transfers to customers, typically at a point in time upon delivery, with no significant change in revenue recognition patterns compared to previous standards - The company adopted Accounting Standards Update (ASU) 2014-09, "Revenue from Contracts with Customers" (ASC 606), on July 1, 2018[52] - The core principle is to recognize revenue when control of promised goods or services is transferred to customers, in an amount that reflects the consideration the company expects to be entitled to[53] - The company's revenue streams are recognized at a point in time when all performance obligations are satisfied and collection is reasonably assured[53][55] - The adoption of ASC 606 did not result in a significant change in the company's revenue recognition patterns[54] INCOME TAXES (Accounting Policy) The company accounts for income taxes using the balance sheet method under ASC Topic 740, recognizing current and deferred tax effects, with a valuation allowance provided for deferred tax assets if realization is unlikely, and no significant uncertain tax positions identified - The company accounts for income taxes using the balance sheet method under ASC Topic 740, "Income Taxes"[56] - Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income, and a valuation allowance is provided for deferred tax assets if their realization is not probable[56] - The company had no significant uncertain tax positions for all periods presented[57] RESEARCH AND DEVELOPMENT EXPENSES (Accounting Policy) Research and development expenses are recognized as incurred, increasing for both the three and six months ended December 31, 2019, compared to the prior year periods - Research and development expenses are recognized as incurred[59] Research and Development Expenses (Three Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 69,158 | | December 31, 2018 | 41,114 | | Change | 28,044 | | Percentage Change | 68.21% | Research and Development Expenses (Six Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 120,365 | | December 31, 2018 | 103,885 | | Change | 16,480 | | Percentage Change | 15.86% | CONCENTRATION OF CREDIT RISK The company holds cash in Chinese state-owned banks with limited insurance coverage, and a significant portion of cash held in US and Hong Kong financial institutions is also uninsured - The company holds cash in Chinese state-owned banks, with amounts below RMB 500,000 (approximately $71,806) covered by insurance[60] - As of December 31, 2019, $67,806 in RMB cash held in Chinese financial institutions and approximately $279,500 in cash held in US financial institutions were uninsured[61] - As of December 31, 2019, approximately $2,143,000 in cash held in Hong Kong financial institutions was uninsured (Hong Kong Deposit Protection Board limit is HK$500,000, approximately $64,000)[61] FOREIGN CURRENCY TRANSLATION AND COMPREHENSIVE INCOME (LOSS) Financial statements are prepared by converting Chinese entity accounts (RMB) to USD, with assets and liabilities translated at period-end rates, equity at historical rates, and operations and cash flows at weighted-average rates, with translation adjustments reported in other comprehensive income (loss) - Chinese entity accounts (RMB) are translated into USD, with assets and liabilities translated at the balance sheet date exchange rate, stockholders' equity at historical rates, and operations and cash flows at the weighted-average exchange rate for the period[62] - Resulting translation adjustments are reported in other comprehensive income (loss)[62] USD to RMB Exchange Rates | Date | Period-End Rate | Average Rate | | :------------- | :--------- | :--------- | | December 31, 2019 | 6.9632 | 7.0711 | | December 31, 2018 | 6.8764 | 6.8587 | | June 30, 2019 | 6.8668 | 6.8263 | RECENT ACCOUNTING PRONOUNCEMENTS The company adopted ASU 2016-02 (Leases) on July 1, 2019, recognizing right-of-use assets and operating lease liabilities, and is evaluating the impact of ASU 2018-13 (Fair Value Measurement) and ASU 2019-05 (Credit Losses), both effective August 1, 2020, while other recent pronouncements are not expected to materially impact consolidated financial statements - The company adopted ASU 2016-02, "Leases," on July 1, 2019, resulting in the recording of right-of-use assets and operating lease liabilities[64] - The company is evaluating the impact of ASU 2018-13, "Fair Value Measurement," and ASU 2019-05, "Financial Instruments—Credit Losses," both effective August 1, 2020[67][68] - Management believes other recently issued accounting pronouncements not yet effective, if currently adopted, would not have a material impact on the consolidated financial statements[69] NOTE 3 – PROPERTY AND EQUIPMENT (Details) Net property and equipment significantly increased from $41,116 on June 30, 2019, to $242,458 on December 31, 2019, primarily due to additions in leasehold improvements and office equipment, with depreciation expenses of $4,490 and $9,707 for the three and six months ended December 31, 2019, respectively Net Property and Equipment Change | Date | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 242,458 | | June 30, 2019 | 41,116 | | Change | 201,342 | | Percentage Change | 489.69% | - Leasehold improvements increased from $0 to $126,607[72] - Office equipment increased from $54,641 to $129,795[72] Depreciation Expense (Three Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 4,490 | | December 31, 2018 | 6,186 | | Change | (1,696) | | Percentage Change | -27.42% | Depreciation Expense (Six Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 9,707 | | December 31, 2018 | 17,631 | | Change | (7,924) | | Percentage Change | -44.94% | NOTE 4 – INTANGIBLE ASSETS (Details) Net intangible assets significantly increased from $555,811 on June 30, 2019, to $1,951,504 on December 31, 2019, primarily due to substantial investments in technology development, including $1,000,000 for security software (not yet started) and $900,000 for eye protection technology (ongoing) Net Intangible Assets Change | Date | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 1,951,504 | | June 30, 2019 | 555,811 | | Change | 1,395,693 | | Percentage Change | 251.19% | - Technology development expenditures increased from $500,000 on June 30, 2019, to $1,900,000 on December 31, 2019[74] - $1,000,000 was paid to SDT Trade Co., Ltd. for security-related software and system development, which has not yet commenced[74] - $900,000 was paid to HW (HK) Limited for eye protection technology system development, which is currently in progress[75] Amortization Expense (Three Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 1,726 | | December 31, 2018 | 806 | | Change | 920 | | Percentage Change | 114.14% | Amortization Expense (Six Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 3,479 | | December 31, 2018 | 1,618 | | Change | 1,861 | | Percentage Change | 115.02% | NOTE 5 – PREPAID EXPENSES AND OTHER CURRENT ASSETS Prepaid expenses and other current assets significantly increased from $105,932 on June 30, 2019, to $253,621 on December 31, 2019, primarily due to higher prepaid expenses and advances Total Prepaid Expenses and Other Current Assets Change | Date | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 253,621 | | June 30, 2019 | 105,932 | | Change | 147,689 | | Percentage Change | 139.42% | - Prepaid expenses and advances increased from $34,181 to $194,027[78] NOTE 6 – ACCRUED EXPENSES AND OTHER PAYABLES Accrued expenses and other payables significantly decreased from $264,684 on June 30, 2019, to $93,996 on December 31, 2019, mainly due to reduced payroll and other payables, and the elimination of deposits Total Accrued Expenses and Other Payables Change | Date | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 93,996 | | June 30, 2019 | 264,684 | | Change | (170,688) | | Percentage Change | -64.49% | - Payroll and other payables decreased from $234,159 to $93,996[80] - Deposits decreased from $30,525 to $0[80] NOTE 7 – ADVANCES FROM CUSTOMERS As of December 31, 2019, the company recorded $1,300,638 in advances from customers, a slight decrease from $1,318,897 on June 30, 2019, related to payments from sales agents for the "Safe Campus Management System," with revenue to be recognized upon product and service sales to third parties Advances from Customers Change | Date | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 1,300,638 | | June 30, 2019 | 1,318,897 | | Change | (18,259) | | Percentage Change | -1.38% | - Advances are from two sales agents for marketing the company's "Safe Campus Management System"[81] - Revenue will be recognized when sales agents sell products and services to third parties[81] NOTE 8 – RELATED PARTY TRANSACTIONS The company engaged in several related party transactions with President Zhixin Liu and his father Fu Liu, including repayment of shareholder loans, car and apartment lease agreements, and a short-term interest-free loan - Shareholder loans payable (President Zhixin Liu) decreased from $86,733 on June 30, 2019, to $0 on December 31, 2019, having been repaid[82] - A car lease agreement with the President, with monthly rent of approximately $707, was renewed until December 31, 2020[82] - An apartment lease agreement with the President, with annual rent of approximately $2,828, was renewed until April 30, 2020[83] - An interest-free loan of RMB 400,000 (approximately $57,000) was borrowed from the President in April 2019 for operating expenses and repaid in July 2019[83] NOTE 9 – INCOME TAXES (Details) The company incurred Net Operating Losses (NOLs) in both reporting periods, resulting in no US federal income tax provision, and despite enjoying a 15% corporate income tax rate in China as a high-tech enterprise, a full valuation allowance has been recorded against deferred tax assets due to significant uncertainty regarding future NOL realization - No US federal income tax provision was recorded for the three and six months ended December 31, 2019, due to losses incurred by US entities[84] - The company, as a high-tech enterprise, enjoys a 15% corporate income tax rate in China[84] Net Operating Losses (NOLs) | Period | Amount ($) | | :------------- | :--------- | | Three months ended December 31, 2019 | 751,032 | | Three months ended December 31, 2018 | 379,712 | | Six months ended December 31, 2019 | 1,148,018 | | Six months ended December 31, 2018 | 743,937 | - As of December 31, 2019, the company had NOLs of approximately $860,820 related to its Chinese subsidiaries and VIE, expiring between 2019 and 2023[85] - Due to significant uncertainty regarding the future realization of deferred tax assets, the company has recorded a full valuation allowance, resulting in $0 net deferred tax assets as of December 31, 2019, and 2018[85][91] - The effective tax rate for all periods presented is 0% due to the valuation allowance[87] NOTE 10 – COMMIMENTS (Lease Agreement Details) The company entered new operating lease agreements in 2019, including a one-year dormitory lease and a three-year Beijing office lease, resulting in the recognition of $1,114,892 in right-of-use assets and corresponding operating lease liabilities, with total future minimum lease payments of $1,114,892, a weighted-average remaining lease term of 2.33 years, and a discount rate of 4.75% - A one-year operating lease agreement for senior management dormitory was signed on March 20, 2019, with monthly rent of approximately $735[92] - A three-year operating lease agreement for Beijing office space (October 2019 to October 2022) was signed on July 30, 2019, with monthly rent of approximately $32,000, requiring a three-month rent deposit and including a six-month rent-free period[93] - A property service agreement for the Beijing office was signed on July 30, 2019, with quarterly fees of approximately $29,000, for a term until October 2022[93] Impact of Operating Leases on Balance Sheet (as of December 31, 2019) | Metric | Amount ($) | | :---------------- | :--------- | | Right-of-Use Assets | 1,114,892 | | Lease Liabilities (Current) | 579,475 | | Lease Liabilities (Non-Current) | 535,417 | - Weighted-average remaining lease term: 2.33 years[95] - Weighted-average discount rate: 4.75%[95] Total Future Minimum Lease Payments (as of December 31, 2019) | Period | Minimum Lease Payments ($) | | :---------------- | :--------- | | Twelve months ending December 31, 2020 | 465,868 | | 2021 | 485,669 | | 2022 | 163,355 | | Total Minimum Payments | 1,114,892 | NOTE 11 – SUBSEQUENT EVENTS The company evaluated subsequent events and transactions up to the financial statement issuance date and found no items requiring adjustment or disclosure - The company evaluated subsequent events up to the financial statement issuance date and found no items requiring adjustment or disclosure[98] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation This section provides management's perspective on the company's financial performance and condition, including forward-looking statements, business overview, recent developments, detailed analysis of operating results, and a discussion of liquidity and capital resources Cautionary Note Regarding Forward-Looking Statements This section warns readers that the report contains forward-looking statements subject to known and unknown risks and uncertainties that could cause actual results to differ materially from projections, advising against undue reliance on these statements based on current management expectations and assumptions - The report contains forward-looking statements, including projections regarding earnings, revenue, future operations, new services, economic conditions, and beliefs[101] - Actual results may differ materially from forward-looking statements due to known and unknown risks, uncertainties, and other factors[101] - The company undertakes no obligation to update any forward-looking statements, except as required by federal securities laws[102] - Factors influencing actual results include: ability to establish and operate businesses and generate revenue, uncertainties in China's economic/political and business conditions, changes in industry trends and product/service demand, timing of customer plans and orders, changes in advertising patterns and pricing policies, unexpected delays in product/service development/market acceptance/installation, changes in Chinese government regulations, and capital availability/terms and deployment, and relationships with third-party equipment suppliers[103] Overview (Business Description) Datasea Inc., founded in 2014 and reverse-merged with Shuhai Skill (HK) in 2015, primarily offers internet security products, new media advertising, micro-marketing, and data analysis services in China, completed its IPO in 2018 raising $5.7 million, and sees attractive growth opportunities in the Chinese security equipment market - Datasea Inc. was incorporated in Nevada on September 26, 2014, and changed its name to Datasea Inc. on May 27, 2015[104] - On October 29, 2015, the company acquired Shuhai Skill (HK) and its subsidiaries and VIE through a share exchange agreement, with Shuhai Skill (HK) becoming the accounting survivor[106] - The company primarily engages in internet security products and equipment, new media advertising, micro-marketing, and data analysis services in China[107] - On December 21, 2018, the company completed its IPO, listing on the NASDAQ Capital Market and raising approximately $5.7 million in net proceeds[110] - The company believes the growing demand for security equipment and related products in China offers attractive opportunities for its business development[112] Recent Developments Datasea Inc. expanded its operations through the establishment of Heilongjiang Xunrui Technology for R&D, a joint venture (Nanjing Shuhai) for new technology funding, and the gratuitous acquisition of three entities (Guozhong Shidai, Guohao Shiji, Guozhong Heze) to broaden business, explore acquisitions, and further develop smart security products, while also noting the potential adverse impact of the Wuhan coronavirus outbreak on its business and liquidity - On October 16, 2019, Shuhai Beijing established a wholly-owned subsidiary, Heilongjiang Xunrui Technology Co., Ltd., focusing on R&D of new technologies and products[113] - On December 3, 2019, Shuhai Beijing established Nanjing Shuhai Equity Investment Fund Management Co., Ltd., a 99% owned joint venture, to secure government and private funding for new technology development and project incubation[113] - In January 2020, the company gratuitously acquired three entities established by management for the company: Guozhong Shidai (to expand business), Guohao Shiji (to explore potential acquisition targets), and Guozhong Heze (to further develop and market smart security system products)[114][115] - The company noted that the Wuhan coronavirus outbreak could lead to a prolonged economic slowdown in China, significantly impacting its business and revenue, and potentially raising substantial doubt about its ability to continue as a going concern[116] Results of Operations The company generated no revenue for the three and six months ended December 31, 2019, leading to a significant increase in net loss due to rising operating expenses, particularly a 131.6% increase in general and administrative expenses and a 68.2% increase in R&D expenses for the three-month period Revenue The company generated no revenue for the three and six months ended December 31, 2019, or for the corresponding periods in 2018 - For the three and six months ended December 31, 2019, and December 31, 2018, the company's revenue was $0[117] Cost of Goods and Gross Profit For the three and six months ended December 31, 2019, the company recorded $194 in cost of goods sold and a $194 gross loss, compared to $0 for the prior year periods - For the three and six months ended December 31, 2019, cost of goods sold was $194, compared to $0 for the corresponding periods in 2018[117] - For the three and six months ended December 31, 2019, gross loss was $194, compared to $0 for the corresponding periods in 2018[117] Selling, General and Administrative Expenses Selling expenses decreased for both three and six-month periods due to lower payroll, while general and administrative expenses significantly increased by 131.6% and 88.2% respectively, driven by higher rent and the expensing of approximately $285,000 in capitalized technology Selling Expenses (Three Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 58,146 | | December 31, 2018 | 71,973 | | Change | (13,827) | | Percentage Change | -19.21% | Selling Expenses (Six Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 109,321 | | December 31, 2018 | 148,852 | | Change | (39,531) | | Percentage Change | -26.56% | General and Administrative Expenses (Three Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 638,157 | | December 31, 2018 | 275,582 | | Change | 362,575 | | Percentage Change | 131.56% | General and Administrative Expenses (Six Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 945,416 | | December 31, 2018 | 502,153 | | Change | 443,263 | | Percentage Change | 88.27% | - The increase in general and administrative expenses was primarily due to higher rent expenses and the expensing of approximately $285,000 in capitalized technology for the three months ended December 31, 2019[118] Research and Development Expenses Research and development expenses increased for both the three and six months ended December 31, 2019, compared to the prior year periods, primarily due to increased staffing in the R&D department Research and Development Expenses (Three Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 69,158 | | December 31, 2018 | 41,114 | | Change | 28,044 | | Percentage Change | 68.21% | Research and Development Expenses (Six Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 120,365 | | December 31, 2018 | 103,885 | | Change | 16,480 | | Percentage Change | 15.86% | - The increase in research and development expenses was due to hiring more employees in the R&D department, leading to higher payroll expenses[120] Net Loss Due to a lack of recurring revenue and increased operating expenses, the company reported net losses of $751,032 and $1,148,018 for the three and six months ended December 31, 2019, respectively, exceeding the $379,712 and $743,937 losses from the prior year periods Net Loss (Three Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | (751,032) | | December 31, 2018 | (379,712) | | Change | (371,320) | | Loss Increase Percentage | 97.79% | Net Loss (Six Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | (1,148,018) | | December 31, 2018 | (743,937) | | Change | (404,081) | | Loss Increase Percentage | 54.32% | - The net loss was primarily due to a lack of recurring revenue[121] Liquidity and Capital Resources For the six months ended December 31, 2019, the company's liquidity declined due to $1.9 million in R&D expenditures, and while management expects existing cash and projected operating cash flows to support operations through December 2020, additional funding may be required through major shareholder support or public/private securities offerings if revenue falls short of expectations - The company's working capital is primarily sourced from common stock sales and shareholder loans[122] - For the six months ended December 31, 2019, the company paid $1.9 million to two third-party entities for new product R&D, leading to a decrease in liquidity[122] - Management anticipates that, based on current cash levels and projected operating cash flows, the company has sufficient resources to support operations through December 2020[122] - If revenue does not meet anticipated levels, the company expects to cover cash flow shortfalls through financial support from major shareholders and public or private offerings of securities[124] Working Capital Change | Date | Amount ($) | | :------------- | :--------- | | December 31, 2019 | 1,105,913 | | June 30, 2019 | 4,568,461 | | Change | (3,462,548) | | Percentage Change | -75.80% | - As of December 31, 2019, current assets were $3,132,793, primarily comprising $2,804,740 in cash, $74,432 in inventory, and $253,621 in prepaid expenses and other current assets[125] - As of December 31, 2019, current liabilities were $2,026,880, primarily comprising $52,771 in accounts payable, $93,996 in accrued expenses and other payables, $579,475 in operating lease liabilities, and $1,300,638 in advances from customers[125] Cash Flow from Operating Activities Net cash outflow from operating activities significantly increased to $1,572,243 for the six months ended December 31, 2019, compared to $794,846 in the prior year, primarily due to increased net loss and changes in prepaid expenses and accrued liabilities Net Cash Outflow from Operating Activities (Six Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | (1,572,243) | | December 31, 2018 | (794,846) | | Change | (777,397) | | Cash Outflow Increase Percentage | 97.81% | - Key factors for the six months ended December 31, 2019, included a net loss of ($1,148,018), changes in prepaid expenses and other current assets of ($271,654), and changes in accrued expenses and other payables of ($163,636)[126] Cash Flow from Investing Activities Net cash outflow from investing activities sharply increased to $1,608,538 for the six months ended December 31, 2019, compared to $30,337 in the prior year, primarily due to substantial acquisitions of intangible assets ($1,400,000) and office equipment ($208,538) Net Cash Outflow from Investing Activities (Six Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | (1,608,538) | | December 31, 2018 | (30,337) | | Change | (1,578,201) | | Cash Outflow Increase Percentage | 5202.2% | - Primarily used for the acquisition of $1,400,000 in intangible assets[128] - Primarily used for the acquisition of $208,538 in office equipment[128] Cash Flow from Financing Activities For the six months ended December 31, 2019, the company generated a net cash outflow of $84,227 from financing activities, mainly due to shareholder loan repayments, a stark contrast to the $5,038,638 net cash inflow from common stock sales and issuances in the prior year period Net Cash from Financing Activities (Six Months Ended December 31) | Period | Amount ($) | | :------------- | :--------- | | December 31, 2019 | (84,227) | | December 31, 2018 | 5,038,638 | | Trend | Shift from significant cash inflow to outflow | - For the six months ended December 31, 2019, the primary activity was the net repayment of shareholder loans totaling $84,227[128] - For the six months ended December 31, 2018, primary activities included net proceeds from common stock sales of $5,748,422 and common stock issuance of $307,724, partially offset by shareholder loan repayments of $17,508 and escrow funds of $1,000,000[129] Off-Balance Sheet Arrangements The company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on its financial condition, changes in financial condition, revenues, expenses, results of operations, liquidity, capital expenditures, or capital resources - The company has no off-balance sheet arrangements[130] Item 3. Quantitative and Qualitative Disclosures about Market Risk As a smaller reporting company, Datasea Inc. is not required to provide quantitative and qualitative disclosures about market risk - As a smaller reporting company, the company is not required to provide quantitative and qualitative disclosures about market risk[132] Item 4. Controls and Procedures The CEO and CFO deemed the company's disclosure controls and procedures ineffective as of December 31, 2019, due to significant deficiencies including inadequate segregation of duties, lack of GAAP-familiar personnel, and insufficient written policies; the company has initiated corrective actions, such as appointing a CFO, establishing an audit committee, and adopting internal control policies, with further measures planned upon securing additional financing Disclosure Controls and Procedures As of December 31, 2019, the company's disclosure controls and procedures were deemed ineffective due to significant deficiencies, including inadequate segregation of duties, weak risk assessment, lack of GAAP-familiar personnel, and insufficient written accounting and financial reporting policies; remedial actions include appointing a CFO, establishing an audit committee, and adopting internal control policies, with further staffing and policy implementation planned upon securing additional financing - As of December 31, 2019, the company's disclosure controls and procedures were deemed ineffective[133] - Significant deficiencies include: inadequate segregation of duties and weak risk assessment[133] - Lack of qualified personnel familiar with US GAAP[133] - Insufficient written policies and procedures for accounting and financial reporting[133] - Remedial actions taken include: appointing a CFO, establishing an audit committee, adopting internal control policies (e.g., cash flow control, budget approval, reimbursement policies), and establishing an internal audit department and legal team[134] - Planned remedial actions include: appointing more qualified personnel to address inadequate segregation of duties and risk management issues, and adopting sufficient written accounting and financial reporting policies, upon securing additional financing[134] Changes in Internal Control over Financial Reporting No changes in the company's internal control over financial reporting occurred during the quarter ended December 31, 2019, that materially affected or are reasonably likely to materially affect its internal control - No material changes in the company's internal control over financial reporting occurred during the quarter ended December 31, 2019[136] PART II – OTHER INFORMATION Item 1. Legal Proceedings The company is not currently involved in any pending legal proceedings, nor is it aware of any such proceedings being contemplated, and no directors, officers, affiliates, or 5%+ shareholders are adverse parties or hold material interests against the company - The company is not currently involved in any pending legal proceedings, nor is it aware of any such proceedings being contemplated[137] - No director, officer, affiliate, or shareholder holding more than 5% of the company's securities is an adverse party or has a material interest adverse to the company[137] Item 1A. Risk Factors As a smaller reporting company, Datasea Inc. is not required to provide the risk factor information requested under this item - As a smaller reporting company, the company is not required to provide the risk factor information requested under this item[138] Item 2. Unregistered Sales Of Equity Securities And Use Of Proceeds No unregistered sales of equity securities occurred during the reporting period - No unregistered sales of equity securities occurred during the reporting period[138] Item 3. Defaults Upon Senior Securities This item is not applicable to the company - This item is not applicable to the company[138] Item 4. Mine Safety Disclosures This item is not applicable to the company - This item is not applicable to the company[138] Item 5. Other Information No other information requiring disclosure was reported during the period - No other information requiring disclosure was reported during the period[138] Item 6. Exhibits This section lists the exhibits filed as part of the 10-Q report, including certifications from the CEO and CFO under Sections 302 and 1350 of the Sarbanes-Oxley Act, and various XBRL taxonomy documents - Exhibits include certifications from the Chief Executive Officer and Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act and 18 U.S.C. Section 1350[139] - Exhibits also include XBRL Instance Document, XBRL Taxonomy Extension Schema Document, XBRL Taxonomy Extension Calculation Linkbase Document, XBRL Taxonomy Extension Definition Linkbase Document, XBRL Taxonomy Extension Label Linkbase Document, and XBRL Taxonomy Extension Presentation Linkbase Document[139] SIGNATURES Report Signatures This report was formally signed by CEO Zhixin Liu and CFO Jijin Zhang on February 14, 2020, certifying its submission under the Exchange Act - The report was signed by Chief Executive Officer Zhixin Liu and Chief Financial Officer Jijin Zhang[141][142] - The signing date was February 14, 2020[141][142]