HIGHWAY HOLDINGS LTD annual report, Q4 FY2015

Business context and reporting period

Highway Holdings Limited filed this Form 20-F for the fiscal year ended March 31, 2015. Although the request refers to 2014 Q4, this filing reports annual results; it does not provide a clear standalone fourth-quarter financial result. The company manufactures metal, plastic, electrical and electronic products for OEM customers, primarily in China, with administrative and sales operations in Hong Kong. Its shares trade on Nasdaq under HIHO.

Financial performance and position

Amounts below are in U.S. dollars; financial statement figures are in millions unless otherwise noted.

Gross margin improved as lower-margin European orders declined, automation reduced staffing needs, and some assembly work shifted to Myanmar. SG&A fell 4.6% to $4.446 million. The FY2015 income tax expense was $134,000, with a reported effective tax rate of 10.4%. Cash generation included a $1.539 million inventory reduction; year-end inventory was $2.081 million, down from $3.700 million. Investing activities provided net cash of $815,000, including release of $643,000 of pledged deposits. Financing activities used $728,000, including $758,000 of dividends paid, partly offset by $30,000 from option exercises. The company declared $1.138 million of dividends for FY2015 ($0.30 per share), of which $380,000 remained payable at year-end.

Material changes versus the prior year

• Sales decreased $563,000, principally after two major European customers reduced orders following price increases; higher orders from other customers and pricing partly offset the decline.
• Metal stamping and mechanical OEM sales fell $1.300 million to $12.520 million; electric OEM sales rose $737,000 to $9.853 million. Segment operating income was $745,000 and $605,000, respectively.
• Operating income rose $478,000, supported by higher gross profit and lower SG&A. A $125,000 foreign-exchange loss (versus $31,000 in FY2014) was partly offset by a $110,000 gain on disposal of equipment.
• The company acquired a 75% interest in Kayser Myanmar for total consideration of $75,000 and consolidated the business. The acquisition generated provisional goodwill of $77,000; the valuation remained subject to finalization.
• Hi-Lite stopped operating under the BFDC arrangement in April 2015 and was being dissolved. Future China operations were to be conducted through the PRC-registered Nissin subsidiary, with greater regulatory, tax and administrative obligations.

Outlook, risks and unusual items

Management expected to shift more labor-intensive assembly to Myanmar during FY2016 to offset rising China costs. It reported that about half of assembly operations had been shifted, but further relocation depended on facility expansion and customer approval; only two customers had approved some Myanmar subcontracting. Management expected available cash and internally generated funds to cover planned equipment and Myanmar investment and the next 12 months’ needs. It also disclosed a requirement to contribute approximately $200,000 of additional capital to the Myanmar subsidiary.

• Customer concentration: Two customers represented 51.4% of FY2015 sales; the three largest represented 60.7%. The three largest year-end receivables represented 66.6% of total receivables. Purchase orders are generally short-term and may be changed or cancelled.
• Operating costs and regulation: Labor costs, mandatory benefits, environmental and safety rules, VAT and other requirements have increased costs in China. The company said actual labor costs had risen more than 19% over two years and noted that customers may reject further price increases.
• Facilities: Shenzhen leases run through February 28, 2017. Metal stamping operations were temporarily relocated during landlord reconstruction; a return to the rebuilt site was expected in mid-2016. The cost and operational impact of the move-back could be material but were not estimable.
• Myanmar execution: Risks include infrastructure and utility constraints, uncertain regulations, currency fluctuations and customer resistance to manufacturing there. Kayser Myanmar also depends on the company as its sole customer.
• Foreign exchange: The company does not hedge. It reported $125,000 of exchange losses in FY2015 and remains exposed to RMB, euro and Myanmar kyat movements.
• Liquidity and commitments: China customs deposits were $229,000 at year-end and can tie up cash. Contractual obligations totaled $4.685 million, including $1.792 million of operating leases, $115,000 of equipment commitments and $2.778 million of purchase obligations.
• Other disclosures: No material pending legal proceedings or off-balance-sheet arrangements were reported. Management concluded disclosure controls and internal control over financial reporting were effective; the auditor did not attest to internal control. The filing highlights limits on PCAOB inspection of audit work relating to China operations.

Key facts for investors to verify

• Whether customer approvals and Myanmar capacity allow further assembly transfers, and whether the expected savings offset added costs and capital needs.
• Current orders, customer retention and receivable collection, given sales and receivable concentration and the loss of some customers after price increases.
• Lease renewal or relocation plans for the Shenzhen facility, including the cost and disruption of moving metal stamping back to the rebuilt site.
• Cash-flow quality and working-capital trends, particularly the extent to which FY2015 operating cash flow benefited from inventory reduction and liability accruals.
• Final purchase-accounting values for Kayser Myanmar, the additional capital contribution, and the subsidiary’s operating performance.
• Dividend capacity and timing: the filing reports $1.138 million declared for FY2015, $758,000 paid during the year and $380,000 payable at year-end.