ZK International Group Co., Ltd. annual report, Q4 FY2021

ZK International Group Co., Ltd. — FY2021 Form 20-F

Reporting period: Fiscal year ended September 30, 2021. This is an annual report, not a standalone 2021 Q4 filing. Financial statements are prepared under U.S. GAAP; amounts below are U.S. dollars.

Business context

The company’s core business is manufacturing and selling steel pipe, fittings, strip and related products, principally in China. During the year it also expanded into digital-asset and entertainment ventures: xSigma’s stablecoin exchange, an investment in sports betting and casino operator CG Malta, and development of trading and NFT platforms. The company owns 51% of xSigma Corporation and invested $25 million in CG Malta, holding 15.73% at fiscal year-end.

Key financial metrics

Current assets exceeded current liabilities by approximately $34.19 million (current ratio about 1.77). Cash flow from investing was $(27.15) million, principally reflecting the $25 million CG Malta investment. Financing provided $40.24 million, including stock and convertible-note proceeds and bank borrowing. In addition to bank loans, the balance sheet reported $2.82 million of convertible debentures at carrying value; the related disclosed outstanding principal was $4.12 million.

Changes versus FY2020

• Revenue rose 14.5%, which management attributed chiefly to higher average selling prices as construction-material demand recovered and to international sales growth. International sales were $2.71 million, up 162.7%.
• Gross profit increased 64.1% and gross margin improved from 4.54% to 6.51%, but remained well below FY2019’s 24.49% margin.
• Operating loss widened by $1.77 million. General and administrative expense rose 132.5%, primarily due to stock-based compensation and costs associated with new ventures; selling and marketing expense also increased.
• Net loss widened to $3.80 million. Revenue growth and improved gross margin did not offset operating expenses and interest costs.
• Operating cash flow moved from positive $0.46 million to negative $3.48 million. The company cited higher supplier advances and lower accounts payable amid raw-material shortages, partly offset by collections of receivables.
• Year-end shares outstanding increased about 74.6%, reflecting equity offerings, conversion of debentures, warrant exercises and share-based compensation.

Outlook, risks and unusual items

• Management said existing cash, expected operating cash generation and capital-market access should meet working-capital needs for at least 12 months, while noting that growth plans may require additional equity capital. No quantified earnings or revenue guidance was provided.
• Raw-material availability and pricing, supplier concentration, competitive pricing, customer collections and the weak operating cash flow are significant business and liquidity considerations. Three suppliers represented 72.52% of purchases.
• Net accounts receivable was $27.12 million; $7.86 million was aged over two years, including $1.44 million over three years. Management also disclosed a $2.22 million allowance for doubtful accounts.
• Short-term bank loans are secured by company assets and supported by guarantees from shareholders, relatives and third parties. The company depends on renewal of revolving loans, most of which mature within a year.
• The company recorded a potential tax liability of $2.35 million for uncertain PRC tax positions; additional taxes, interest or penalties could be assessed. The filing says no tax authority examination had begun for the years discussed.
• Of $12.47 million in long-term acquisition deposits, a target associated with $11.53 million was acquired by a state-owned enterprise after year-end; management reported an oral agreement to convert that deposit into a loan or apply it to future outsourced production fees. Recovery and terms warrant attention.
• The $25 million CG Malta investment is carried at cost, with no impairment recorded in FY2021. Further investment commitments were amended after year-end, including scheduled $5 million installments and a remaining subscription amount. The filing flags investment-company and PFIC classification risks if the investment expands.
• Digital-asset, gaming, CFD and NFT businesses are early-stage and exposed to regulatory, licensing, custody, cybersecurity, market-liquidity and adoption risks. The company did not recognize revenue on its SIG tokens because of low trading volume and unstable market price.
• COVID-19 disrupted production, customer demand and supply chains, though the company reported reopening and recovering operations. Currency translation generated a $2.42 million gain in FY2021, recorded in other comprehensive income rather than net income.
• Management concluded disclosure controls and internal control over financial reporting were ineffective, citing insufficient accounting and finance personnel with U.S. GAAP experience. Management described plans to hire experienced personnel; the auditor did not express an opinion on internal-control effectiveness. The financial-statement audit opinion was unqualified.

Most important facts for investors to verify

1. Reconcile the filing’s conflicting selected-financial-data presentation: detailed audited statements report FY2021 operating loss of $3.65 million, while an earlier selected-data table contains an inconsistent operating-income figure.
2. Track subsequent collection of aged receivables, supplier advances, and the status and recoverability of acquisition deposits, particularly the $11.53 million deposit.
3. Confirm bank-loan renewals, repayment schedules, collateral and guarantees, and the conversion or maturity of remaining debentures and potential dilution.
4. Review CG Malta’s performance, the terms and funding of remaining investment commitments, and the accounting and regulatory implications of the investment.
5. Assess whether internal-control remediation is implemented and whether future reports demonstrate reliable U.S. GAAP financial reporting.