Dogness (International) Corp annual report, Q4 FY2019

Dogness (International) Corp. — Form 20-F Summary

Reporting period: Fiscal year ended June 30, 2019, with comparisons to fiscal 2018 and 2017. Although the request identifies “2018 Q4,” this filing is an annual report for fiscal 2019, not a standalone quarterly filing. Figures are in U.S. dollars unless stated otherwise. The company designs and manufactures pet products, including traditional leashes, collars and harnesses, as well as newer connected pet products; it also sells lanyards and related products. Its operations are principally in China.

Key financial results

Metric	FY2019	FY2018	Change
Total revenue	$26.22 million	$30.14 million	Down 13.0%
Gross profit / margin	$9.43 million / 36.0%	$12.13 million / 40.3%	Profit down 22.3%; margin down 4.3 percentage points
Operating expenses	$8.79 million	$6.19 million	Up 41.9%
Operating income / margin	$0.64 million / 2.4%	$5.94 million / 19.8%	Down 89.2%
Net income attributable to Dogness	$1.42 million	$4.60 million	Down 69.1%; basic and diluted EPS $0.05 vs. $0.22
Operating cash flow	$(1.27) million	$3.51 million	Turned negative
Cash at year-end	$2.55 million	$7.09 million	Down $4.54 million
Short-term investments	$11.07 million	$28.23 million	Down $17.16 million
Short-term bank loans	$2.91 million	$4.84 million	Down $1.92 million

Business and material changes

• Sales volume fell 24.1%. Management attributed the decline principally to U.S.–China trade tensions and higher U.S. tariffs, which reduced orders from U.S. customers. U.S. revenue fell 45.7%, from $10.17 million to $5.52 million.
• China domestic revenue increased 1.5% to $15.08 million; European revenue rose 25.9% to $2.51 million and Canadian revenue rose to $0.95 million. International sales overall declined 27.1% to $11.13 million.
• Traditional product categories weakened, especially collars, down 42.1%, and harnesses, down 28.0%. Intelligent pet-product revenue rose from $59,719 to $2.10 million, but remained a new and relatively unproven business. Climbing hooks contributed $215,464 in their first reported year.
• Gross margin declined as the product mix used more costly leather and labor costs increased. Operating expenses rose substantially, including higher general and administrative costs associated with public-company expenses, facility investment depreciation, bad debt, share-based compensation and leases.
• Net income included $1.14 million of other income, including $616,878 of net interest income and a $503,528 foreign-exchange gain. This offset part of the decline in operating income and should not be assumed to recur at the same level.

Cash, liquidity, debt and commitments

• At June 30, 2019, current assets were $25.92 million and current liabilities were $8.07 million, yielding reported working capital of approximately $17.9 million and a current ratio of 3.2:1. Current assets included $11.07 million of short-term bank wealth-management investments, generally with short maturities, and approximately $5.41 million of net receivables.
• Operating cash use reflected working-capital movements, notably a $4.48 million increase in prepayments and other current assets, primarily connected to a planned warehouse site, and a $1.36 million increase in inventories. The company reported that a substantial portion of year-end receivables was collected after year-end.
• Investing cash use was $1.62 million, including substantial construction and equipment spending, partly offset by proceeds from maturing short-term investments. Financing cash use was $1.65 million.
• The $2.91 million bank loan outstanding at year-end was repaid at maturity in August 2019. Subsequently, the company entered new one-year borrowing agreements for approximately $1.8 million with ICBC and $2.6 million with Bank of Communications. Loans are secured by company property and supported by guarantees from the CEO and family members.
• Construction-in-progress commitments for the Meijia plant and Dongguan warehouse were $11.7 million at June 30, 2019; after approximately $4.4 million of subsequent spending, management estimated remaining commitments at about $7.3 million. The Meijia facility was in test operation and expected to be ready for production before December 31, 2019, subject to final government inspection; the warehouse was expected to be completed by fiscal 2020.
• The company also disclosed approximately $0.79 million of remaining equity-investment commitments at June 30, 2019 and a $6.8 million capital contribution obligation for its 58%-owned Guangzhou intelligent-products venture, due by May 2038. Management stated that it expects available resources and financing to meet liquidity needs for at least 12 months from the filing date.

Outlook, risks and unusual items

• No formal quantitative revenue or earnings guidance is provided. Management expected further uncertainty and possible export-sales pressure from trade tariffs, while aiming to grow domestic China, European, Canadian and other markets and sell smart products through retail-chain agreements. It expects intelligent-product sales to increase, but notes the products have only recently entered distribution and consumer acceptance is uncertain.
• Customer concentration is significant: the three largest customers represented approximately 47.2% of FY2019 revenue, and one customer represented about 28.1%. Loss or reduced orders from major accounts could be difficult to replace.
• Accrued tax liabilities were approximately $2.91 million at June 30, 2019, mostly relating to unpaid PRC taxes. Management was negotiating a settlement and believed settlement in fiscal 2020 was likely, but gave no assurance. PRC authorities could assess additional tax, interest or penalties.
• Management identified material weaknesses in internal control over financial reporting, including inadequate accounting and U.S. GAAP/SEC reporting staffing and insufficient documented closing procedures. Management concluded internal controls and disclosure controls were ineffective; remediation was underway. The auditor did not audit internal controls.
• Other notable risks include raw-material price volatility, foreign-exchange exposure (the company does not hedge), uninsurable PRC bank deposits, potential social-insurance and housing-fund underpayments, facility and land-use issues, and dependence on third-party logistics and software/app providers. The company reported no material legal proceedings and no material off-balance-sheet arrangements.
• The company reported no cash dividends in FY2019 or FY2018 and said it does not expect to pay dividends in the foreseeable future. CEO Silong Chen controls the Class B shares, which carry three votes each, and approximately 62.3% of voting power as disclosed in the ownership section.
• The independent auditor issued an unqualified opinion on the consolidated financial statements. The company adopted ASC 606 in FY2019 and reported no material effect on its revenue recognition or financial statements.

Most important facts for investors to verify

1. Reconcile reported revenue: the consolidated statements report total FY2019 revenue of $26.22 million, including $328,567 of related-party sales, while selected financial data presents $25.89 million. Also reconcile the filing’s differing descriptions of export-sales share.
2. Track U.S. tariffs, major-customer orders and concentration, and whether growth in China and other markets actually offsets reduced U.S. sales.
3. Verify cash conversion, the liquidity and risk profile of the $11.07 million short-term investments, subsequent receivable collections, and the company’s actual post-year-end debt balance and refinancing terms.
4. Monitor completion, remaining cost and production ramp of the Meijia plant and Dongguan warehouse, alongside the related-party-supported borrowing and capital commitments.
5. Check resolution of the approximately $2.91 million accrued tax liability and progress in remediating the disclosed material weaknesses in financial reporting controls.
6. Assess smart-product sales, margins and customer adoption independently of management’s expectations, given the short sales history and reliance on third-party app and cellular services.