ZK International Group Co., Ltd. — FY2018 Form 20-F
Reporting period: Fiscal year ended September 30, 2018, with comparisons to FY2017 and FY2016. Although the request refers to 2018 Q4, this filing is an annual report and does not provide standalone quarterly results. Financial statements are prepared under U.S. GAAP; amounts below are U.S. dollars unless noted.
Business context
ZK International manufactures and sells steel pipes, strips, fittings and related products, primarily through its PRC operating subsidiaries. Products serve water and gas transmission and construction/infrastructure markets. Management attributed growth to increased market share and customer projects replacing underground pipes and improving local water systems.
Key financial metrics
| Metric | FY2018 | FY2017 | Change |
|---|---|---|---|
| Revenue | $54.88 million | $44.95 million | +22.1% |
| Gross profit / margin | $18.29 million / 33.3% | $13.11 million / 29.2% | Margin +4.1 percentage points |
| Operating income / margin | $9.62 million / 17.5% | $8.08 million / 18.0% | Income +19.0% |
| Net income | $7.10 million | $5.93 million | +19.7% |
| Net income attributable to ZK International | $7.02 million | $5.87 million | — |
| Basic / diluted EPS | $0.52 / $0.51 | $0.56 / $0.56 | Lower despite higher net income |
| Operating cash flow | $(2.23) million | $1.15 million | Turned negative |
| Cash and cash equivalents | $7.68 million | $11.28 million | Down $3.60 million |
| Short-term bank borrowings | $19.27 million | $21.34 million | Down $2.07 million |
| Total assets / total liabilities | $76.40 million / $39.13 million | $61.17 million / $39.81 million | Equity increased to $37.27 million |
Current assets were $64.35 million and current liabilities $39.13 million at year-end, implying working capital of approximately $25.22 million and a current ratio of about 1.64. Accounts receivable, net, was $27.13 million, inventories were $17.79 million, and advances to suppliers were $7.83 million. The filing reports 180 days sales outstanding, versus 193 days in FY2017. Gross-margin improvement was attributed to manufacturing improvements and a lower defect rate; operating expenses rose 72.5%, led by higher G&A, selling and marketing costs.
Material changes and unusual items
- Operating cash flow deteriorated as receivables increased approximately $7.15 million and inventory increased approximately $9.07 million. Management also reported about $4 million of inventory held at outsourcing facilities.
- G&A expense rose 128.4% to $4.07 million, attributed mainly to SEC-compliance legal and other costs and expansion-related payroll, welfare and travel. Selling and marketing expense rose 54.0% to $2.95 million; R&D expense rose 24.2% to $1.65 million.
- FY2018 included an $818,468 foreign-currency translation loss, compared with a $272,237 gain in FY2017, primarily due to RMB depreciation against the U.S. dollar. The company reports no currency hedging.
- In August 2018, the company settled approximately $9.24 million of CEO Jiancong Huang’s working-capital advances by issuing 3,280,525 restricted shares at $2.82 per share. The filing reports $9.84 million of noncash financing activity; confirm the relationship between this amount and the settlement terms. Shares outstanding increased to 16,528,037 from 13,068,346.
- The company placed $4.23 million in long-term deposits for two proposed acquisitions. At September 30, 2018, both remained subject to legal and financial due diligence and neither had been approved or rejected; the deposits are stated to be refundable if an acquisition does not proceed.
Liquidity, debt and risks
Management said cash, expected operating cash generation and capital-market access should meet working-capital needs for at least 12 months, and that the company was not dependent on future financing for that period. However, FY2018 operating cash flow was negative, and the company relies on short-term revolving bank loans: $19.27 million outstanding across 23 loans at year-end, generally due within six months to one year. The weighted-average annual rate was 6.12%. Loans are secured by assets with reported carrying values totaling $7.57 million and guaranteed by shareholders, family members and third parties; management expects renewals but gives no assurance of refinancing.
- Tax exposure: The filing reports a potential tax liability of $8.23 million for FY2018, mostly related to income and VAT, excluding possible interest and penalties. Management was negotiating with local tax authorities and expected a possible reduction, but no settlement was assured. The balance sheet separately reports income tax payable of $4.26 million; investors should reconcile these disclosures.
- Customer and supplier concentration: One customer represented 21.1% of FY2018 sales, with $9.51 million due from that customer at year-end. Three suppliers accounted for 62.4% of purchases.
- Receivable and credit risk: Receivables are largely unsecured; the allowance for doubtful accounts was $2.00 million. Some receivables have reportedly remained outstanding for more than three years. Cash held in PRC financial institutions is not insured against bank failure.
- China-related risks: The company cites PRC foreign-exchange restrictions, currency volatility, regulatory and tax uncertainty, and possible limits on moving funds or dividends offshore. It also states that beneficial owners who are PRC residents had not completed required SAFE registrations as of the filing.
- Controls: Management concluded disclosure controls and internal control over financial reporting were ineffective at September 30, 2018 because of inadequate segregation of duties and insufficient U.S.-GAAP-experienced accounting personnel. Management planned remediation for FY2019. The auditor’s report gave an unqualified opinion on the financial statements but did not express an opinion on internal-control effectiveness.
- Other: Management reported no off-balance-sheet arrangements and no material purchase commitments, significant leases or unused letters of credit. The company does not expect to pay dividends in the foreseeable future.
Outlook and management commentary
Management plans to expand production capacity, develop products and engineering solutions, and pursue water-supply and infrastructure opportunities, including exports and potential acquisitions. It identified potential demand from municipal pipeline replacement and water-system upgrades, but provided no quantified revenue, earnings or cash-flow guidance. The filing cautions that actual results may differ materially from forward-looking statements.
Important facts for investors to verify
- Whether the $8.23 million potential tax liability is covered by reported tax-payable balances, and the status and possible cost of any tax settlement.
- Collection progress on the $27.13 million net receivables balance, especially the $9.51 million due from the largest customer, and the adequacy of the doubtful-account allowance.
- Cash conversion and inventory quality, including the outsourced inventory, as well as the reasons for the FY2018 operating cash outflow.
- Renewal and repayment terms for short-term bank loans, collateral exposure, guarantees and any changes in borrowing costs.
- Final outcome of the two proposed acquisitions and recoverability of the $4.23 million deposits if transactions do not close.
- Share-count and related-party disclosures surrounding the CEO debt settlement, including the $9.84 million noncash financing figure.
- Progress on remediation of the disclosed material weaknesses and the effectiveness of financial reporting controls.