Hollysys Automation Technologies Ltd (HOLI) 2011 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the HollySys Automation fiscal 2011 first-quarter ended September 30, 2010 earnings conference call. At this time all participants are in a listen-only mode. There will be a presentation followed by a question and answer session (Operator Instructions). Please be advised that this conference is being recorded today, November 8, 2010.

I would now like to hand the conference over to Miss. Jennifer Zhang, the Investor Relations Manager of HollySys Automation Technology. Thank you. Please go ahead, Miss. Zhang.

Good day to everyone, and thank you for joining us. Our speakers today will be Dr. Changli Wang, CEO and Chairman at HollySys Automation Technology, Mr. Peter Li, CFO of HollySys, and myself, the IR Manager at HollySys.

Before we get started I would like to remind everyone that this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation and Reform Act of 1995. Forward-looking statements are statements that are not historical facts, including statements relating to the expected growth of HollySys' future product introductions, the mix of product in future periods and future operating results. Such forward-looking statements, based upon the current beliefs and expectations of HollySys management, are subject to risks and uncertainties which could cause actual results to differ from the forward-looking statements.

The following factors, among others, could cause actual results to differ from those set forth in these statements; the business conditions in China and in South East Asia; continued compliance with government regulations; legislation or regulatory environment, requirement for changes adversely affecting the businesses in which HollySys is engaged; decisions or changes in government incentive programs; potential trade barriers affecting international expansion; fluctuations in customer demand; management of [debt growth] and transition to new markets; intensity of competition from or introduction of new and superior products by other providers of automation and control system technology; timing, approval and market acceptance of new product introductions; general economic conditions, geopolitical events and regulatory changes, as well as other relevant risks detailed in HollySys' filings with the Securities and Exchange Commission.

The information set forth herein should be read in light of such risks. HollySys does not assume any obligation to update the information discussed in this conference call or in the filings.

On today's call the CEO and Chairman of HollySys, Dr. Changli Wang, will provide a general overview of our business, including some highlights of the quarter. And then the CFO of HollySys, Mr. Peter Li, will discuss our quarterly performance from a financial perspective and the financial outlook for the rest of fiscal year 2011. Both Changli and Peter will be available for the Q&A session afterwards.

Please note that all amounts noted in this conference call will be in US dollars unless otherwise noted. And now I'd like to turn the call over to Dr. Changli Wang. Please go ahead, Dr. Wang.

Okay. Thank you, Jennifer, and greetings to everyone. We are pleased to report the fiscal 2011 first quarter with solid operational performance. I would like to discuss some of the key wins that took place during this quarter.

In this quarter we continued to make strides in Industrial Automation, especially in PLC business expansion and DCS application. By working more closely with power equipment suppliers, HollySys is winning more contracts from international market through EPC. We are seeing tangible financial and operation results of increased R&D investment by pushing our newly-developed products to the market, which in turn enhances HollySys' marketing capability and brand-name recognition as a total solution provider.

During this quarter we announced contracts and bidding wins of four high-speed rail lines, with an aggregated contract value of $32.6m and a total length of 1,290 kilometers. It is the quality of our products, brand-name recognition and speed to deliver under a tight schedule that played an important role in winning these projects. As China's twelfth five-year plan is being formulated with much more expedited high-speed Rail rollout plan by the end of 2015, HollySys will continue to leverage on its core competency to take its leading share in China's high-speed Rail build-out.

I would like to take note of the exciting Nuclear Automation breakthrough achieved by our Nuclear joint venture with Guangdong Nuclear Power Holding Co. Ltd. Our Nuclear JV has successfully completed the development of proprietary reactor protection system, which is scheduled to be commercialized within the next two to three years. This achievement is another testament of our leading position in China's Nuclear Automation and Control market. HollySys, together with its Nuclear JV, will take their leading share in China's aggressive Nuclear build-out.

With that, I would like to turn the call over to our CFO, Peter Li, who will discuss in greater detail our financial results. Hi, Peter.

Thank you, Dr. Wang, and hello to everyone. In a nutshell, HollySys' financial and operational results for the fiscal 2011 first quarter ended September 30, 2010, the Company recorded a solid quarterly result.

The quarterly revenue increased by 59.3%, to $60.8m, from $38.2m in the prior-year period. The quarterly revenue of $60.8m is a record-breaking quarter in HollySys' history. Of the total revenues, revenue from integrated contracts increased by 59.9% to $57.4m compared to $35.9m for the same period of the prior year.

The segment breakdown of the Company's integrated Contract revenues was as follows; $31m, or 54%, from Industrial Automation, representing a 27.8% segment revenue growth year over year; Rail and Subway was $25.3m, or 44.1%, representing a 186.2% increase year over year; of which $10.3m, or 18%, from High-Speed Rail and $15m, or 26.1%, from Subway; $1.1m, or 1.9%, from Nuclear and Miscellaneous compared to $2.8m year over year.

It's worth noting that our Industrial Automation revenue for the quarter is a record-breaking number in HollySys' corporate history. The second highest quarterly Industrial Automation revenue was reported at $29.6m for December quarter in 2009. The healthy growth of our Industrial Automation would indicate our strong competitiveness from both technology and supply chain perspective.

The quarterly gross margin was 34.8%, as compared to 37.2% for the same period of last year. The gross margin for integrated Contract and Product sales were 33.6% and 55.6% for the period, as compared to 34.3% and 82.8% for the same period of last year respectively.

The quarterly selling expenses were $3.6m compared to $2.7m year over year, increased by $0.9m, or 31%, which was mainly due the Company's expanded sales network and increased selling expenses. As a result, as a percentage of total revenue, selling expense were 5.9% or (sic) 7.1% for the quarter ended September 30, 2010 and 2009 respectively.

G&A expenses excluding non-cash stock-based compensation expenses were $3.8m for the quarter, representing an increase of $1.4m, or 55.4%, as compared to $2.4m for the prior-year period, mainly due to an increase of $0.6m in bad debt allowance and other expenses. As a percentage of total revenue, G&A expenses were 6.2% and 6.4% for the quarter ended September 30, 2010 and 2009 respectively. Including the non-cash stock-based compensation cost of $131,000, G&A expenses were $3.9m and $2.6m for the quarter ended September 30, 2010 and 2009 respectively.

R&D expenses were $4.3m for the quarter, compared to $2.9m for the same period of last year, increased by $1.4m, or 51.6%, mainly due to the Company's increased R&D activities. As a percentage of total revenue R&D expenses were 7.1% and 7.5% for the quarter ended September 30, 2010 and 2009 respectively. The quarterly other revenue amounted to $1.5m, of which $1.4m was contributed by the gain on disposal of 29% interest in HollySys Information Technology Limited, which HollySys will continue to own 20% after the transaction.

The share of net losses from equity investees was $0.4m for the quarter, of which a loss of $0.7m from Beijing Techenergy Limited, the 50/50 joint venture between HollySys and China Guangdong Nuclear Power Corp. that mainly engages in providing Automation and Control products and services to China's Nuclear industry.

The quarterly non-GAAP net income, excluding non-cash stock compensation costs, was $10.4m, or $0.19 per diluted share, based on 55m shares outstanding. This represents an increase of $3.8m, or 56.7%, over the $6.6m or $0.13 per share based on 50m shares outstanding reported in the prior-year period. On a GAAP basis, net income was $10.3m, or $0.19 per diluted share, representing an increase of $3.8m, or 57.9%, over the $6.5m or $0.13 per share reported in the prior-year period.

HollySys' backlog balance record got broken again this quarter, reported at $255.3m. To put this number in perspective we have broken our Company's backlog record for four quarters in a row now, since September quarter last year, when we reported our backlog balance at $187.5m. The Company reported a record-breaking backlog at $219.6m for December quarter the same year, and then followed by a string of record-breaking backlog balances reported at $242.3m for March quarter and $252.9m for June quarter this year.

Like I illustrated at the earnings call for September quarter last year, on November 12, 2009, quote, our backlog balance is affected by the timing of signing these contracts, given the nature of our businesses, with various levels of government in China, which could have made our backlog business lumpy quarter to quarter. If you really want to gauge our backlog I would encourage you to draw a trend line of our backlog level over a four-quarter or five-quarter time span and you will get a much more accurate picture of our backlog, unquote. I think our continuous backlog record-breaking is a strong sign of our business trend going forward.

The net cash used operating activities was $1.8m for the quarter, mainly due to increased non-billable accounts receivables. Including investing and financing activities the total net cash outflow for this quarter was $9.3m. The majority of the fixed asset purchases were related to the new facility. As of September 30, 2010 HollySys' cash and cash equivalents were $110.2m compared to $119.5m on June 30, 2010.

DSO for the quarter is 111 days, as compared to 157 days year over year and 140 days quarter over quarter. Inventory turnover is 65 days for the quarter, as compared to 75 days in the prior-year period.

Given another record-breaking backlog balance and a strong pipeline across all of our business segments, we are reiterating our fiscal 2011 revenue and net income guidance of $233m to $237m, and $38m to $39m respectively.

Thank you, Peter. At this time we'd like to open up the Q&A session. Please note that for Chinese-speaking participants we can also do the Q&A in Mandarin and we will provide translation.

(Spoken in Chinese). Operator, please.

(Operator Instructions). Your first question comes from the line of Ole Hui. Sir, your line is open.

Hello.

Hello, Ole.

Hello. Yes, I have a couple of questions. The first question, you mentioned international EPC. How much is that of your revenues in the first quarter?

And also can you give us some color on the end-user/end-market breakdown for your Industrial Automation. So how much is power equipment, how much is other type of equipment?

And lastly, on PLC, how much is that in the first quarter?

Yes, sure, Ole. As you noticed, in this quarterly in Industrial Automation businesses we made a couple of significant strides compared to previous quarters. One of the highlights we achieved during the quarter was we did make significant achievements in obtaining international sales through working power equipment manufacturers in China via EPC.

But in terms of the EPC percentage in our Industrial Automation revenue, we have not disclosed that. And I think EPC phenomenon is one of the ways we try to play, to leverage on domestic power equipment producers to go international, as China currently is cooling down the low-scale of thermal power stations' construction and building going forward. So I think this trend will continue for us. But in terms of revenue contribution from this area, unless it's getting more significant we're not going to disclose it separately.

In terms of the end-user/end-market breakdown for Industrial revenue, we will provide more detailed, more accurate breakdown going forward for the investors.

PLC, we are continuously making great progresses in this area. We are putting more and more sales efforts in this area. We think currently its revenue contribution is not significant enough to separately disclosing this segment. Going forward, we think in the near future we might feel obligated to do so. Thank you.

Thank you. I have one more question regarding the High-Speed Rail business. I know that you had a very large revenue increase in this quarter year on year and I think most of your revenue today comes from the TCC. So can we expect more ATP Contract wins and more ATP revenues in your revenue mix?

Absolutely. I think the revenue mix between TCC and ATP is largely driven by the characteristics of Chinese High-Speed Rail build-out. As you would appreciate, you need to put in the lines operational first as China's Ministry of Rail is scrambling to build the most ambitious High-Speed Rail plan in the world.

I think the first phase -- until probably 2012 or 2013 I think the main focus of Ministry of Rail will be focused on building up lines and putting them into operational. And then the need for the High-Speed Rail trains will come into play. By that time the need for our ATP will be largely driven by the number of High-Speed Railway trains put into operation.

Having said that, I think you've seen our Contract wins and announcements over the past few months mainly concentrated in TCC segment. I think going forward ATP Contract wins definitely will come and to be announced down the road. It's just a matter of time. We will do that in due time. Thank you.

Thank you.

Your next question comes from the line of Mark Tobin of Roth Capital Partners.

Wang, Peter, good evening.

Hi, Mark.

A question on your Rail pipeline; obviously very strong order volume during the quarter. Can you give us some insight into what you're seeing over the next couple of quarters and what your expectations are from an order standpoint?

Absolutely. I think for High-Speed Rail, what we're seeing now as we're moving along this unprecedented High-Speed Rail build-out in China, and the whole process is governed and administered by Ministry of Rail, we are seeing the High-Speed Rail projects is expedited going forward. We are seeing our High-Speed rail projects, in terms of implementation cycle, is getting shorter and shorter.

So I think going into the next few quarters we will continuously work with the sales pipeline we currently have, which we see very promising. We will closely working with Ministry of Rail to help them react as we can.

Okay. But as far as bidding activity, I guess on a relative basis, you're just as busy now as you were three or six months ago.

Busier.

Okay.

Mark, okay. Peter, I will add one or two things, if that's okay. Mark, hi, it's Changli.

Hello, Changli.

Yes, hi. In fact, we are working very busily now for the High-Speed Rail. If you can see that for the couple of months before most of the Contracts we are winning is from the TCC and the systems from the lines. In fact, that kind of systems was issued to us by the constructors. But the ATP systems was decided -- has been decided by the Ministry of China Rail. So they are [really] in a big crisis and they have been holding this for quite a long time. And we are expecting more to coming, because with this construction of these lines they need more trains to put into operation. And without the ATP systems they cannot put them under operation. So we are expecting more. Okay, Mark?

Okay, that's helpful. Thank you very much. And then one housekeeping question, Peter. On your tax rate for the last couple of quarters you've been at the 15% to 16% range. What do you expect for tax going forward?

As I communicated with you before, we expect the coming [months] the income tax rate will continue to be at 9% to 10% of the range. For the current quarter's income tax rate, due to our Hangzhou subsidiary's tax certificate timing issue, we will have to recognize the income tax by the standard rate. And then at the end of the year we will recoup back the income tax expenses.

Okay. So is that -- so is it safe to assume that for fiscal Q2 and Q3 you're also going to be at that 15% range?

Well, for now I think it's -- anywhere could be between 10% to 13%, 14%, but only temporarily. It will be recouped towards the end of the fiscal year.

Okay, that's helpful. Thank you. I'll jump back in the queue.

Thanks, Mark.

Your next question comes from the line of Anderson Chow of Macquarie Capital.

Good evening, Peter and good evening, Dr. Wang. I'd just have a question on the accounting numbers. The cash flow from operating activities was negative. In fact, at the same time I think your accounts receivable days reduced quite significantly. And also you mentioned something about a significant increase in the -- [cost and] estimated earnings in excess of billings. Can you just explain how should we reconcile that? It seems to be going in different directions.

And what's the non -- the excess billings non-receivables? What's that related to? Is it Industrial Automation Systems or Railway Systems? Or what part of the sales is it generating from? Thank you.

Sure, Anderson, that's a very good question. Cost and estimated earnings in excess of billings is under the current assets section of balance, in essence, that account should be called non-billed receivable. Okay? It's basically a temporary parking account for the revenue we recognized in the P&L, but yet according to the legal terms of the contract for that project it's not billable yet, so it's not legally belong to accounts receivable yet.

So that's why, for this quarter specifically, we have -- the majority of the increase in this non-billed receivable comes from High-Speed Rail and Subway. So as the revenue been recognized in these two segments and corresponding entry from the accounting perspective would be booked into this non-billed receivables. So even though our DSO for accounts receivable reduced significantly, but for the non-billed receivables balance continue to go up. That's why actually, because of this largely increased non-billed receivables, it causes our operating cash flow in the negative neighborhood. Does that answer your question?

Yes. So do we expect the situation to reverse in the coming quarter or two?

Depends, depends. If for the project we happen to recognize revenue, if it's billable, then it should go to the accounts receivable section, so it depends on how the payment -- on the timing of the payment terms of the contract and the timing of the revenue recognition under US GAAP. So I cannot really comment the trend line for this non-billed receivable going forward. It's really driven by the difference of the timing of the invoice and the timing of revenue recognition for each specific project.

Okay, thank you.

Thanks, Anderson.

(Operator Instructions). You have a follow-up question from the line of Anderson Chow of Macquarie Capital.

Thank you, Peter, just one last question. Obviously the Company still has a very, very strong balance sheet and net cash position. Should investors expect the Company to be utilizing that cash in the coming year or two, or, alternatively, will the Company consider starting dividends at some point? Thank you.

Yes, Anderson. That's a typical hard question we would be asked by a lot of investors. From a management perspective, paying dividends, we regard ourselves still as a high-growth Company. We believe we have better ways to put the cash in use to generate more returns than paying out the dividends to investors. Having said that, merger and acquisition is always our plate. The Company is always seeking M&A target both domestically and internationally.

Our M&A criteria would be couple folded. Firstly, it has to be highly complementary either in technology or product or market. Secondly, the M&A has to be accretive to current investors. Thirdly, the management style and philosophy of the acquired company has to be similar to ours so that the future integration will be as smooth as possible.

So to sum it up, yes, we do have a significant amount of cash on the balance sheet. Going forward, we'll continue to seek ways to better utilize this amount of cash to return higher profit to our shareholders. Thank you.

Thank you, everyone, for joining us on the call today. If you haven't got a chance to raise your questions, we'll be pleased to answer them through follow-up contact. We look forward to speaking with you again in the near future. Thank you.

Thank you, goodbye.

That does conclude our conference for today. Thank you for participating. You may all disconnect.