Hello everyone! I’ve been mostly doing YouTube videos lately, but I’ve had some articles cooking in the background… and here is one of them. Today, we’ll go through my review of the QIND FY 2022 10k along with my thoughts and issues with QIND.
This was originally going to be ILUS and QIND together in one article, but my notes got so long on QIND that I figured I’d break it up. I’ll try to get a YouTube video out on all of this with more commentary, so hopefully I can explain some more of this better.
DISCLAIMER – READ FIRST!
Before anyone gets any wrong ideas based on what I say below, I wanted to get a few things out of the way early.
First – I don’t think QIND is a fraud. I just found several issues which make me think their financial reports are quite poor. I personally won’t consider investing until I see better reports, but you can do whatever you want. You might make a lot of money still, you might not, who knows?
Second – I’m doing this for the benefit of QIND’s and (by extension) ILUS’ shareholders. I don’t have a financial position in QIND or ILUS, long or short. I do this for shareholders and prospective investors so that they can better understand their investments.
Now then, let’s get right to it!
General Impressions on Business / Direction
Note – QI = Quality Industrial, the subsidiary of $QIND.
I’m not going to regurgitate what QIND does, so please read the 10k for that. But QIND is clearly a very ambitious company and by extension so is ILUS. They are taking a big step, and also a big risk, in acquiring QI and hoping that they can earn a healthy rate of return on the business to justify the large 100m plus purchase price.
I’m not going to lie; I think this is a very risky company. But high risk, high reward.
The company has promise, but QI was a massive acquisition, and they are rolling the dice in being able to make the required payments. I think a lot of the success of this company hinges on their ability to raise financing over the next 6-12 months, either via debt or via a stock offering once on NASDAQ. Why is that?
At a basic level, they have a very low cash balance and have took out a small loan since the 10k came out. So they appeared to be cash strapped on a day-to-day in early 2023 too. So why are they so cash strapped? Look at all those profits!!
While the company is growing significantly, they haven’t collected much of their revenue yet and have quite a large cash shortfall they need to close in the next 12 months. I could write a whole article on this, so I’ll keep it short. But it will be CRUCIAL for them to shorten their collection cycle as much as possible to service future debt and be more attractive to lenders.
But if they can pull it off and also manage to find funding in these tricky times, then QIND shareholders may be rewarded. This is clearly a profitable business and everything tells me they will be cash flow positive eventually. But right now it’s a timing thing and if they can get it done in time.
Initial Notes on Consolidations and US GAAP
This will sort of form the basis for the rest of my analyses. Under US GAAP (which QIND says is their accounting method for this report), there is only one way to consolidate subsidiaries if you own more than 50% of the company.
The method is simple, you consolidate 100% of the subsidiary’s financials with yours (revenue, costs, assets, liabilities, etc.). HOWEVER, you then must include after net income (in the income statement) or equity (on the balance sheet) the value of that respective amount for the portion you don’t control.
Let’s give an example. Say I have a shell company parent and a subsidiary I own 51% of. Say the subsidiary has 100 dollars in revenue and 10 dollars in profit. So I consolidate up all 100 of revenue and 10 of profit and call my net income 10.
Then, I need to state that 4.9 dollars (49%) of net income is attributable to a non-controlling interest. So in reality, the net income of my shareholders is only 5.1, or 51% of net income.
The same thing happens on the balance sheet – 100% of the assets and liabilities go up, but equity is reduced by 49%.
Simple enough, hopefully!
Now let’s apply to QIND. It owns 52% of QI and 51% of Petro Line. So while 100% of the revenue, assets, liabilities, etc. are counted as 100% to QIND, they need to be reduced by the minority interest.
See below as an example with QIND and its balance sheet…
Notice how it isn’t there with the income statement… we’ll get to that.
But please keep this in mind as I go through everything below!! I will be referring to the whole consolidation up (100% of revenue, etc.), but recall that QIND shareholders only get 52% of that from QI, for example.
Red Flags and Issues Identified
Let me reiterate my second point above, I don’t have some weird ulterior motive with this article. I’m just doing this to give perspective to current or prospective shareholders.
In addition, I’m not proclaiming to be some 10k expert who knows every SEC rule to ever exist.
But the issues I’m bringing up below are considered red flags for my own personal investments, and I give them weight for good reason. Whether or not QIND should be reissuing or amending things is completely up to them, and I don’t really care what they do.
I broke this up into a couple of sections:
- General Issues
- Minority Interest and Consolidations
- Lack of Debt Detail
- Cash Flow Statement
- Audit Process and Level of Detail
This is probably better said at the end once you see my points. It’s also very petty, but I have to say it! But in general I thought this 10k was a little amateurish and I’ve seen non-audited annual reports on OTCMarkets from other companies of higher quality.
A few examples:
They use puzzling groupings of line items – like lumping all of current assets or current liabilities together and then breaking it out down below in the notes. Why not just do it in the actual financial statements? There weren’t that many different line items!
There were quite a few times where they made up line items or used strange nomenclature. Like how can you have a Cash Flow from Financing Activities line item just say “Subsidiary”? I know it’s debt issued at the subsidiary level… but that’s a dumb way to say it.
I am also a little bit of a formatting junky in my work (I try to take it easy on the blog) so seeing random changes in formatting, line spacing, font, etc. didn’t scream “quality” to me. Especially once you get to the auditor’s report section which they presumably didn’t write. But again, nit-picky and I put low weight here 🙂
All in all, it didn’t exude quality or reassurance to me right off the bat. But let’s get into the less petty things!
Minority Interest and Consolidations
QIND and ILUS have previously stated that they like the idea of majority stakes in acquisitions, but not full ownership. ILUS’ 77% ownership of QIND and QIND’s 52% ownership of QI are good examples. Like I said above, you get to consolidate up 100% of their financials and you only have to reduce net income and equity by the non-controlling stake.
(Sorry if I switch between using “non-controlling interest” and “minority interest”, people use it interchangeably. It’s the same thing!)
HOWEVER, the first thing I checked was how those reductions in net income and equity were treated. For the balance sheet, it’s clear as day and I’ve demonstrated above.
But they didn’t do it for the income statement.
That’s right, for some reason they are not showing the reduced stake of net income for the 48% minority owners of QI, for example. Why are they doing that? I have no clue. They don’t do it for ILUS either, but that’s for another article.
***(NOTE – I have emailed ILUS twice about this, but they have not responded to me as of writing this article.)***
So the way the income statement is written, it is OVERSTATING net income by 48% of QI’s net income.
To clarify one thing… it’s not as simple as just taking 52% of QIND’s net income and getting the “real” number as QIND has other things like debt, etc. running through QIND, that’s not in QI. But all you need to know is that QIND’s net income is greatly overstated. I don’t know how material it is, but I suspect it is material enough to be a red flag in my opinion.
So when you calculate your PE ratios, etc. you need to take out the minority interest, which is currently impossible.
This is by far my biggest red flag. If the company is reading this, can you please clarify? I sincerely hope I am wrong and am missing something.
I won’t dwell on this; you get the point.
Lack of Debt Detail
The company has a very poor description of the terms of its debt within QIND and its subsidiaries. Remember, 100% of QI’s and Petro’s debt have to come up into the balance sheet and be described.
However, we get a frankly pitiful description of their debt facilities in the 10k. First off, they go into great detail to describe all of the dinky loans left behind from the pre-QIND days, like 15k loans and whatnot. Which is probably them just rolling forward old language.
But for all of the substantive debt, they just slap on a short sentence saying “oh yea btw we have 27.8m in long-term debt too” without any additional detail… okay that’s not exactly what it says… It just says:
As of December 31, 2022, and December 31, 2021, the Company had loans payable of $27,898,630 and $63,090, respectively.
So we’re just supposed to go along with that? 27.89m is a lot of debt vs. their market cap! When does the debt mature? What is the rate? Is it fixed or variable? Can it be prepaid? Does it convert? That was one of the laziest descriptions of such a large amount of debt I’ve ever seen in a 10k.
And it gets worse.
We then get to see current liabilities of 100m. Most of this is the 81m in payments they absolutely have to make to QI’s sellers (not contingent on EBITDA), so that’s clear. But there’s 18.2m of short-term debt with no description at all. Again, this tells us nothing! Insert same rant from above.
The only bright side is we can see their interest expense in the income statement, so we can sort of guess the general rates they’re getting. But that is nowhere near perfect and it’s honestly disappointing that this was the best they could roll out into a 10k.
So to wrap up, there’s 46m in debt that we have basically no detail on. Yep.
Cash Flow Statement Error
Cash flow from operations should be a positive value, not negative. Whatever, it’s a typo I guess. The numbers will add up correctly then. But again, this is the easy stuff!
Second, regarding QI and acquisition payments. I don’t know if this is technically how you’re supposed to do this, so this is more of an explanation if you’re confused. But they account for the QI acquisition like this….
Remember they haven’t really paid much of the QI acquisition price in 2022. However, they have recorded the corresponding liability already. So they say a liability increased by 99m (includes other stuff), and then they paid 88.8m for investing (mostly QI). But they haven’t paid anything to QI yet… it’s kind of weird, but I’m not necessarily saying it’s wrong.
Audit Process and Level of Detail
Normally I don’t even read this section, but I decided to on a whim as they are newly audited. What first stuck out to me was that their auditor fees were only 25k? That is so extremely low. For example, AITX, which is smaller than QIND, paid 290k in 2022.
That raised my red flag meter, so I read the section in detail.
It looks like for QI specifically, their auditors didn’t actually perform an audit themselves. They relied on a third-party audit report which they are “comfortable” with. I’ll paste the whole section below (underlines added by me):
Quality International Co. Ltd FZC (QI) is a subsidiary of Quality Industrial Corp (QIND), and its financial statements are audited by an independent auditor. As QIND’s auditors, we have relied on the audit report issued by QI’s independent auditor. Additionally, we have only reviewed the audit report of QI provided to us by QIND’s management as an alternative procedure. QI’s financial statement was prepared in accordance with US GAAP, and an independent auditor issued an unmodified opinion based on US GAAP. The independent auditor also evaluated the adequacy of QI’s accounting and internal control systems. Based on this information, we are comfortable with the consolidated financial statement of QIND provided to us by QIND’s management, which includes QI’s financial information.
So some mystery third party thought QI was good, and QIND’s auditors thought their report was sufficient.
Honestly, this is a red flag in my book. This doesn’t give me much of a level of comfort as to the weight of their audit opinion if they didn’t really audit QI themselves.
But I’m giving them the benefit of the doubt as it was probably difficult to do one consolidated audit for the whole group due to QI being so new to the company. If they do it again for 2023, it will be an even bigger red flag. So I’ll let this slide.
Let’s summarize quickly here…
QIND is clearly very ambitious but they have a tough task ahead of them to not only collect cash as quickly as possible, but also to raise necessary financing. Not impossible, but it’s risky.
More importantly, my issues were as follows:
- General Issues – kind of a junky report with errors, etc.
- Minority Interest and Consolidations – HUGE red flag that they aren’t removing minority interest from net income. I hope I’m missing something here.
- Lack of Debt Detail – another HUGE red flag. We need to know these things in order to make an informed decision.
- Cash Flow Statement – just an error, but it’s a very bizarre layout in general and sort of goes to my above point of grouping things in weird ways.
- Audit Process and Level of Detail – not a big deal YET. I want to see one consolidated auditor next year.
For me, the red flags were too much so I won’t be investing personally. However, I might be more conservative than other investors so if you have a different opinion/risk tolerance, do whatever you please!
So there may be a play here, but it’s not a play for me right now.
Anyways – thanks for reading and I hope to get more QIND and ILUS articles out in the future!
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DISCLAIMER – AT THE TIME OF WRITING THIS ARTICLE I DO NOT HAVE A POSITION, LONG OR SHORT, IN QIND or ILUS. THIS ARTICLE IS NOT FINANCIAL ADVICE AND IS INTENDED ONLY FOR EDUCATIONAL PURPOSES. I AM NOT A FINANCIAL ADVISOR. DO YOUR OWN RESEARCH.