Business context and reporting period
Addentax Group Corp. is a China-based garment manufacturer and logistics provider. This Form 10-Q covers the three and six months ended September 30, 2019, with comparisons to the corresponding 2018 periods; the balance sheet compares September 30, 2019 with March 31, 2019. The filing describes the September quarter as the second quarter of its fiscal year.
Financial performance and position
| Metric | Three months ended Sep. 30, 2019 | Six months ended Sep. 30, 2019 | Comparable 2018 period |
|---|---|---|---|
| Revenue | $1.945 million | $4.154 million | $2.835 million; $5.567 million |
| Gross profit / margin | $321,000 / 16.5% | $679,000 / 16.3% | $682,000 / 24.0%; $976,000 / 17.5% |
| Operating income (loss) | $(309,000) | $(663,000) | $137,000; $(37,000) |
| Net income (loss) | $(322,000) | $(689,000) | $136,000; $(25,000) |
| Operating cash flow | $(882,000) for six months | $934,000 for six months |
At September 30, cash was $268,000; current assets were $2.737 million and current liabilities $6.628 million, a $3.891 million working-capital deficit. Total liabilities were $8.162 million and shareholders’ deficit was $2.283 million. Related-party payables were $4.882 million, unsecured, non-interest-bearing and due on demand. Bank loans totaled $350,000, bearing stated rates of 4.84%–6.96% and due in 2020. The company also recorded $1.989 million of operating lease right-of-use assets and matching current and non-current lease liabilities.
Material changes versus the prior comparable periods
- Revenue fell 31.4% in the quarter and 25.4% for the six months. Management attributed the decline to fewer orders amid market weakness in both businesses, the absence of consulting income, and a factory move that reduced garment orders.
- Quarterly gross margin declined to 16.5% from 24.0%; six-month gross margin was 16.3% versus 17.5%. Logistics margins weakened, with increased fuel and subcontracting costs and costs associated with empty return trucks and containers. Garment margins improved in percentage terms for the six months, but manufacturing revenue fell sharply.
- Operating expenses increased 15.7% for the quarter and 32.4% for the six months, mainly from higher legal and professional fees, new office rent, overseas travel and general-meeting costs. The company moved from quarterly operating income to a loss; its six-month operating loss widened substantially.
- Operating cash flow turned negative from positive $934,000 in the prior six-month period. Financing provided $969,000, including related-party borrowing proceeds; cash declined by $8,000 to $268,000.
Outlook, risks and unusual items
- Going concern: Management disclosed substantial doubt about the company’s ability to continue as a going concern, citing recurring losses, negative working capital, a shareholders’ deficit and the need for additional financing. It expects to rely on operating cash flow and CEO support; the CEO indicated intent and ability to provide further equity financing, but the filing gives no assurance funding will be available or sufficient.
- Business plans: Management aims to expand garment customers and improve profitability. Logistics operated in over 79 cities across approximately nine provinces and two municipalities; the company expected to develop 20 additional logistics points in existing cities and improve profit in 2020. No quantified financial guidance is provided.
- Risks: Management cited continued pricing pressure and economic uncertainty in China, potential effects on sales, margins, liquidity and receivable collections, foreign-exchange exposure, and dependence on suppliers and logistics subcontractors. Five largest suppliers accounted for approximately 88% of inventory purchases in the quarter. Accounts receivable totaled $1.656 million, with several customers individually representing more than 10%; no doubtful-account allowance was recorded.
- Controls and contingencies: Management concluded disclosure controls and internal control over financial reporting were ineffective due to a material weakness: insufficient personnel with appropriate accounting knowledge, experience and training. The company reported no material pending legal proceedings, defaults on senior securities, or off-balance-sheet arrangements. Adoption of lease accounting resulted in recognition of significant lease assets and liabilities.
Important facts for investors to verify
- Whether the company can secure ongoing funding and meet obligations, particularly the large on-demand related-party balances and near-term liquidity needs.
- Whether revenue stabilizes and logistics and garment margins recover as order volumes, fuel costs and subcontracting needs change.
- Receivable collectability, customer concentration, and the basis for recording no credit-loss allowance.
- Progress in addressing the disclosed material weakness and restoring effective financial-reporting controls.
- The lease-liability terms and the company’s capacity to meet lease, bank-loan and other obligations.