Trio-Tech International Shifts Capital Expenditures from East China to Southeast Asia.

Trio-Tech International (AMEX: TRT) is engaged in testing services, equipment manufacturing, and distribution for the semiconductor industry (SIC: 3559). The company generated global sales of US$38.5 million in the year ended June 30, 2017, up 11.8% over the previous year. Net income for the year was US$1.4 million, up 37.1% from the prior year. Free cash flow was 120.5% of net income for the year, whereas free cash flow was negative in the previous fiscal year. Although the company seems to have turned around its operations, events in China that were outside of the company’s control drove these results. At the same time, there are significant opportunities within China to improve future free cash flow.

To support an 11.9% increase in revenue, the company’s cost of goods sold increased 13.2%. The company was not able to control costs. Only the testing segment was able to both grow sales and increase gross margin year-over-year.

The company increased income from continuing operations before income taxes by US$499K year-over-year. However, almost all of that came from a US$467K favorable increase in foreign exchange transactions. The company transacts in the Singapore dollar, Malaysian Ringgit, Thai baht, Chinese renminbi, and Indonesian rupiah. According to the Monetary Authority of Singapore, the renminbi devalued against the U.S. dollar more than the four other currencies during the relevant period. This positively impacted the company’s cross-currency invoicing, but was completely out of the company’s control.

Globally, the company increased additions to property, plant, and equipment by 52.5% year-over-year. However, all of this increase occurred in Southeast Asia. Capital expenditures declined year-over-year at the Tianjin facility, but specific amounts were not disclosed. Although the company had overall decent execution on accounts receivables, the Tianjin subsidiary signed an agreement with a bank for an Accounts Receivable Financing facility for approximately US$871K. This would indicate the company is having cash flow issues in China.

Despite the fact that the company is engaged in the semiconductor industry, about 7.3% of the company’s total non-current assets as of June 30, 2017 were composed of depreciated investment properties in Chongqing, China that were acquired in 2008 and 2010. The current market value of these properties is likely much higher than the book value. The proceeds from these sales, as well as the $4.0 million in cash the company had on its balance sheet, could be deployed elsewhere. If this capital is taken out of China, the company could expand its geographic or product diversification. If this capital is kept in China, the company could expand the testing segment’s capabilities at the Suzhou facility or reduce the need for bank credit at the Tianjin facility.

Lightpath’s Operating Cash Flow Suffers in China During FY2017.

Lightpath Technologies, Inc. (Nasdaq:  LPTH), a manufacturer of optical components (SIC:  3674), generated US$28.3 million globally in the year ended June 30, 2017, growing 64.2% over the prior year. The company earned US$7.7 million in net income, compared to US$1.4 million in the prior year, an increase of 450%. Despite this increase, cash flow from operations in the fiscal year ended June 30, 2017 was only 64.8% of net income, compared to 107.8% in the previous year.  Based on statements made in the company's annual report, activities in China are driving down operating cash flow.

The company did not provide revenue information specific to China, but it did state that it extinguished all net operating loss carryforwards in China during fiscal 2016 and did not accrue any in fiscal 2017. It did mention, "Revenue from our [high volume precision molded optics] product group had been derived from the industrial tool market in China, which had experienced six years of declining growth."  Even though the company is in a declining market, it was profitable this year.

Lightpath Technologies, Inc. did mention China-specific issues related to its operating cash flow. Net assets in China increased from US$9.9 million as of June 30, 2016 to US$12.3 million as of June 30, 2017.  The company begins to calculate allowance for accounts receivables starting at the 60-day mark in the United States, but waits until the 120-day mark in China. This implies the company's China-based customers have extended payment terms.

On a global basis, Lightpath Technologies, Inc. is growing revenue and net income, but has poor operating cash flow performance. Much of that seems to stem from China operations, where taxes are being incurred on operations in a declining market, supported by higher net assets, and repaid at extended payment terms.