Hollysys Automation Technologies Ltd (HOLI) 2012 Q1 法說會逐字稿

Thank you ladies and gentlemen for standing by and welcome to the Hollysys Automation fiscal 2012 first quarter ended September 30, 2011 earnings conference call. (Operator Instructions). Please be advised that this conference is being recorded today November 15, 2011. I would now like to hand the conference over to Ms. Jennifer Zhang, the Investor Relations Manager of Hollysys Automation Technologies. 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 of Hollysys Automations Technologies, Mr. Peter Li, CFO of Hollysys, and myself, the IR Manager of Hollysys.

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

The following factors among others could cause actual results to differ from those set forth in this statement.

Business conditions in China and in Southeast Asia, continued compliance with government regulations, legislation or regulatory environment, requirements or changes adversely affecting the businesses in which is Hollysys is engaged, decision or tenders in government incentive programs, potential trade barriers affecting international expansion, fluctuations in customer demand, management of (inaudible) and transitions to new markets, intensity of competition from or introduction of new and superior products by other providers for 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 see to the Hollysys filings with Securities and Exchange Commission. The information set forth herein is to be read in light of such risks. Hollysys does not assume any obligation to update the information discusses in this conference call or its filings.

After this call the CEO and Chairman of Hollysys, Dr. Changli Wang, will provide a general overview of our business including some highlights for the quarter. And then the CFO of Hollysys, Mr. Peter Li, will discuss our performance from financial perspective and the financial outlook for fiscal 2012. Both Changli and Peter will be available for the QA 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 greeting to everyone. We are very please to report another stellar quarter with solid financial and operational performance.

Here I would like to take this opportunity to discuss some key events that took place in this quarter. In our Industrial Automation businesses we are very glad to see some our strategic measures we put in one year or two years ago starting to pay off, evidenced by unprecedented quarterly growth at 65% on year over year basis. In was our strategic decision of increasing R&D investment back to January 2009 amidst the height of financial crisis that a series of our proprietary products have been churned out and are pushed to the market. That rounded out our industrial products portfolio and also enabled Hollysys to position itself as a total solution provider.

Envisioning this secular trend of a dramatic increased adoption of industrial automation in China we are aggressively expanded our industrial sales force and the service network between July and December 2010 resulting in sales force growing from 150 to 500 and the geographic coverage expanded from 21 to 40 cities around China.

Hollysys as been a foreign system substitute in this sector, leveraging on its better value for money proposition to a wide array of industrial clients, ranging from state owned enterprises, multinational corporations and the local small and medium sized companies. Over the past 18 years we have been successfully entered, penetrated and took leadership from low-end to mid-end market segments. And we are now chasing our multinational peers to the high-end segment, while we still continue to expand our sales force and network coverage, consolidating low- and mid-end markets in order to become the absolute leader in China industrial automation market.

In our Rail Transportation segment there has been some encouraging news over the past months for China's high-speed rail segment which may have indicated a new page has been turned in the sector. With the government coming up to support MOR, Ministry of China Rail, debt insurance --- issuance, MOR has successfully reached the CNY40b and there is another CNY200b financing believed to be in the works, which means MOR's financing issue is largely resolved for now.

There is 13,000 kilometers of high-speed rail tracks currently under construction, which will require signaling system to be installed prior to commercial operations. We are cautiously optimistic on continuous revenue generation from China's high-speed rail segment for the next few years. Hollysys was blessed to have a playing a leading role in China's high-speed rail signaling market in which we obtain the key capability in signal technology and know-how.

To be determined to become one of the leading international signal players Hollysys now has been investing significant resources in developing and designing the whole set of signal products for both high-speed rail and subway according to the European safety standard. We have obtained European safety standard certification level 4, SIL4, for our proprietary signaling products such ATP to 200 and 250 kilometers per hour segment, Balise transmission model, that's BTM, line-side electronic unit, LEU, temporary train control systems, TSRS, and vital computer platform, HVC, enabling where the signal-related applications to be developed in the scalable and swift manner.

We have also completed development our train control center and interlocking systems based on our proprietary HVC and will receive SIL 4 certification for these pertaining product in the next few months. We are working on propelling our high-speed signal business on dual engines of both Chinese and international market going forward.

From this point on our financial reporting will include the financial performance of Concord Corporation Pte Ltd, CCPL, on consolidated basis. We are satisfied with its quarterly result given the delay of some of the sizable contracts in subway and industrial sectors totally to more $10m.

During this quarter we make substantial progress in integrating our businesses and product lines for international market, which is spearheaded by Casey Liu, CCPL CEO, and Jay Naidu, CCPL Executive VP. Casey has been working, experience with technical and corporation management experience of GE Industrial Automation, Thales transportation etc., and Jay with been working with Bombardier Transportation and Land Transportation Authority of Singapore.

Hollysys and CCPL have already been working together on some of the signal and the SCADA opportunities in Southeast Asian market which we believe would prelude Hollysys entry into international market with its proprietary products.

It's worth mentioning that Hollysys management completed a staff purchase plan of $7.5m with 1.26m shares purchased on open market this quarter, which was a strong indication of our collective confidence in Hollysys' business fundamentals and growth perspectives -- prospects.

With that I would like to turn the call to our CFO, Peter Li, who will discuss at great detail of our financial results. Okay, Peter.

Thank you Dr. Wang and hello to everyone. In a nutshell, Hollysys financial and operational results for the fiscal year 2012 first quarter ended September 30, 2011, the Company reported robust financial results. Total revenues increased by 43.3% to $87.2m from $60.8m in the prior year period. Of the total revenues, integrated contract revenue increased by 45.5% to $83.5m as compared to $57.4m for the same period of the prior year. The segment breakdown of integrated contract revenue is as following, $53m or 63.5% from Industrial, $25.4m or 30.4% from Rail, and $5.1m or 6.1% from Overseas.

Starting from this quarter the integrated revenue is presented in slightly different breakdown manner from the previous earnings release to better reflect our business model and strategy going forward, in which the previously segregated category of nuclear is lumped together with Industrial Automation, and that the categories rail automation and software automation previously reported separately are lumped together under Rail Transportation. The Overseas category reflects the revenue from newly acquired Singaporean company.

The Industrial Automation revenue of $53m is consists of industrial automation revenues of $51.8m and the nuclear revenue of $1.2m in previous breakdown categories. And the Rail Transportation revenue of $25.4m is consists of high-speed rail revenue of $16.4m and subway automation revenue of $9m.

The quarterly gross margin was 37.8% as compared to 34.8% for the same period last year. The gross margin increase was mainly due to high year gross margin in rail businesses as a result of a few higher margin projects, or portion of projects of high-speed rail being recognized in the quarter.

The quarterly selling expenses were $7m compared to $6.2m quarter over quarter and $3.6m year over year. The increase was mainly due to the Company's expanded sales network and increased selling staff. As a percentage of total revenues selling expenses were 8% compared to 8.6% quarter over quarter and 5.9% year over year.

The quarterly G&A expenses excluding non-cash stock-based compensation expenses were $4.9m representing an increase $1.1m or 27.8% as compared to $3.8m for the same period of prior year. The increase was mainly contributed by newly acquired Singaporean company. As a percentage of total revenues G&A expenses were 5.6% in this quarter compared to 6.2% year on year basis. Including non-cash stock-based compensation cost recorded on a GAAP basis, G&A expenses were $5m for the quarter.

The quarterly R&D expenses $6.1m compared to $4.3m for the same period of last year, increased by $1.7m or 40.3% mainly due to the Company's increased R&D activities. As a percentage of total revenue R&D expenses were 7% for the quarter compared to 7.1% for the same period of last year.

The quarterly VAT refunds on government subsidy were reported as $0.4m representing an 80.1% decrease compared to $2m reported in the prior year period. The decrease was due to the delayed release of pertaining VAT refund guidelines by the government resulting in none of the VAT refund applications being submitted. With this VAT refund guideline release on October 13 we believe VAT refunds will gradually be caught up over the next few quarters. VAT refunds is a refund on value added tax levied on corporate internally developed software components, which in essence is R&D tax credit.

The quarterly income tax expense were $1.9m, unchanged compared to the prior year period.

For the quarter the non-GAAP net income excluding non-cash stock compensation cost was $12.8m of $0.23 per diluted share based on 55m shares outstanding. This represents an increase of $2.4m or 23.6% over the $10.4m or $0.19 per share based on 55m shares outstanding reported in the prior year period. On GAAP basis net income to Hollysys was $12.7m or $0.23 per diluted share.

Hollysys' backlog as of September 30, 2011 were $301m (sic -- see press release) compared to June's $296.4m and $255.3m September last year. It's worth noting the Industrial Automation backlog set another historical high at $128.7m.

The net cash used in operating activities was $2.6m for the quarter mainly due to increased accounts receivable. Including investing and financing activities the total net cash outflow for this quarter $13.2m mainly due to a cash outflow of $5.4m for acquisition of Concord and a cash outflow of $8.3m dividend paid to ex-shareholders of Concord.

Due to much improved payment practice for Ministry of Rail over the past few weeks supported by successful financing we belief our operating cash flow and DSO will be improved in the next quarter or two. As of September 30, 2011 Hollysys's cash and cash equivalents were $75.5m compared to $90.7m quarter on quarter basis. DSO were 138 days as compared to 111 days year over year and 129 days quarter over quarter. And the inventory turnover was 51 days as compared to 65 days year over year and 63 days quarter over quarter.

Given our strong backlog currently on hand and sales pipeline we are reiterating our annual guideline of revenue in the range of between $354m and $356m and non GAAP net income in the range between $57m an $58m on consolidated basis.

Thank you.

Thank you Peter. At this time we would like to open up for the Q&A question. Please note that for Chinese speaking participants we can also give a Q&A in Mandarin and we'll provide translation. Operator please.

We will now begin the question and answer session. (Operator Instructions). Your first question comes from the line of Jacob Schori of Credit Suisse.

Good afternoon Dr. Wang. A question for you. Congratulations on management buying the $7.5m of shares. What I'd like to know, is the source of funds in there anyway comes as a loan from the Company or is it all money that you guys took out of your personal funds and bought shares in the open market? Thank you.

Okay, first of all it's nothing to do with the Company. It's our personal money and we just, we fund ourselves. Nothing to do with the Company.

Okay. So there is no loan or anything to purchase these?

No. No loan from the Company, no.

Okay, great. That's makes it even better.

It's our personal money.

Thank you very much.

Your next question comes from the line Paul Gong of Citigroup.

Hello Dr. Wang. Hello Peter, Jennifer. Congratulations for the great quarter. Actually I have two questions. The first question is regarding your PLC, which you are expanding on your Industrial Automation line. Are these PLC projects, are they project basis or OEM basis? The customers, are they equipment users or equipment makers?

And what types of machines are you now mainly focused on or concentrated in? Do you see any cannibalization with your traditional DCS markets?

And recently I also read a little bit about the SoftPLC, the PC-based SoftPLC. How do you foresee this a threat for SoftPLC and how do you prepare for that?

The second question is on your development strategy. From history we can see a lot of foreign automation companies get acquired when their revenues are below $1b. So when Hollysys is trying to expand towards this (inaudible), how do you keep the same quality, to maintain the same quality when you are expanding your sales force, your engineering team and so on? I stop here.

Okay. Peter, I answer this question. Okay, for the PLC products, now our PLC application now is mainly can be categorized in two parts. One is related to the factory automation. It's not machinery. Like some of the process, for example like the mining process and also the water processing process, and like maybe some of the paper and pulp process. The customers used to use PLC as a controller rather than DCS. This in fact is kind of transition-based.

It's a small part of our PLC products now is placed on the machineries. Some of the machineries like the packaging machines and some of them are the, we designed some (inaudible) systems for the mining systems, some of the mining equipment in the core mining etc. But now mainly it's kind of working on the factory automation and also the water processing process.

For the second question, for the R&D part and also the process of operations, I think Hollysys now is mainly it's working on our own strategy quite healthily so far. And we are being, first of all, study the customer requirements all over China and also cover all the market segments from the power plants, from chemical process and also from the Siemens etc. etc. And by evaluating the customers' detailed requirements we designed, we're operating our systems or tailor our systems to meet their requirements perfectly in a way, so encourage our competitive edge in this way.

The second is we are trying to penetrate into new areas. Like for example, Hollysys originally we only do industrial automation, but later on in the year 2000 around we found that high-speed rail might be another big market for us and also it has a very high entry barrier. But with our kernel technology cumulated for so many years and also we've studied the requirements of the high-speed rail, and then we designed our systems and then we successfully penetrated the market. So in this way, we now start in this way. We are still evaluating the other markets as well in this way and we're trying to enlarge the market share and also we try to gain the new areas.

As for the question you just ask, a lot of companies below $1b market value can be easily acquired by some of the competitors, multinational competitors, but for Hollysys it's our dream to build up a long-lasting sustainable company in the long term so we invest very heavily in our R&D. You can see we invest 7% of our revenue totally on R&D. And if you can see the high effectiveness and also the high efficiency of our R&D, in fact we invest much higher percentage compared with our multinational competitors in a way.

So in order to do that -- in fact why we do this? Because we want to try to build our Company to create value for investors in the long term in a way, and also for ourselves. And also Hollysys shareholders are long term mainly, and also me and our colleagues own quite a part of share and we are not intend to fail. So I think it's not that easy to be taken over in a way. Okay.

So how about the PC-based SoftPLC?

PC-based PLC, okay, it's a good question. In fact the PC-based PLC nowadays become more and more popular because first of all they have the very powerful computation capability in a way. But in a lot of applications the PC-based is not so rugged in a way, not so solid. It's not appropriate for a lot of applications. For example in a lot of areas like the machinery control they need the system to be embedded inside the system with the tolerance capability for high vibration and shocking etc. in a way. And the second is also the reliability of PC-based is not that sound in a way. So I think the application, certainly we can find some applications in some areas but still in a lot of areas they still require the solid PLC I think.

When PLC is becoming more and more affordable and the reliability improve, does Hollysys prepare anything for expanding in the SoftPLC as well or what's your thinking on that?

For that technically there's no barrier for us. We have all the knowledge of designing the PC-based but so far it totally depends on our market strategy. If, for example, later on our customers still require these kinds of applications, if we found that, it's a very big segment in a way, we can do that. But it's not -- technically there's no barrier for Hollysys. But now I think, I'm sure because Hollysys has been trying to do something specific and unique in a way -- not unique but very special or differentiated from the popular PC application users because in that area there are much more companies can do work, but in this kind of embedded or solid systems Hollysys has a lot of experience and also we have a lot of knowledge in this.

Great, that's helpful. Thank you.

Thank you.

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

Thanks for taking my questions. I guess looking at the shift in your business where your core Industrial Automation business has become a bigger mix, can you take some time to walk through comparing and contrasting Industrial Automation projects with your Rail projects as far as what's a typical size, what's a typical period of performance, margins, cash flow, so forth? Thank you.

Sure Mark. This is Peter. Industrial Automation normally has a much smaller contract size compared to Rail. And normally for Rail business, especially for high-speed rail, in any given year we will not do as many as 30 projects on a calendar-year basis. But on a calendar year basis we can do Industrial Automation for as many as 1,500 or even more project-based implementations.

In terms of implementation cycle, Industrial Automation projects normally takes much less time, normally ranging from three to nine months on average. For Rail businesses, regardless signaling or SCADA, it's normally around six to 18 or even 24 months.

In terms of payment cycles there's normally a cash advance at the time of contract signing. And it's also, comparatively speaking, it's more on actually guided basis. With Rail business, especially in high-speed rail doing business with MOR, their financing capabilities are largely [in tact] our payment collection cycle.

Okay. And how about margins, comparing the two?

Industrial Automation still in same margin profile as we communicate with the investor community. It's roughly about 30% to 35%. For Rail, signaling, for high-speed rail, it's roughly about 40%. For the subway SCADA business it's normally around 15% to 20%.

Okay. So going forward I guess looking at Q1 with the margins somewhat elevated, would you expect those to tick downward as we continue to have a higher mix of Industrial Automation business?

As I've said before in the previous earnings calls, we encourage investors to gauge our gross margin from a trend line perspective instead of on a segregated quarterly basis because our gross margin could be lumpy from quarter-to-quarter due to some of the higher margin projects or higher margin portion of a specific project being recognized, especially from high-speed rail or subway. So, for example, last quarter, for June quarter, we reported a quarterly gross margin roughly around 28% to 29%. In the March quarter this year the gross margin was probably at the highest I remember at 40% to 41%. So definitely the lumpiness is there. You really need to gauge our fundamental from a trend line perspective, Mark.

Okay. Thank you. Then finally can you provide some commentary as far as what you're seeing on a Company basis as far as rail contract awards resuming and how much of your guidance, or I guess what kind of rail contribution is assumed within your guidance?

We provided annual guidance back to around mid of August. That's when the, already the high-speed rail in China was significantly slowed down due to the traffic --- due to the accident occurred in the late July. And as of now I think the whole market including the high-speed rail players like Hollysys are waiting for the official release of the investigation report from the Government. And we believe once that report is being released and we can start to gain some visibility towards the new contract rampings and bidding situations from that point on.

In terms of the high-speed rail consideration contained in annual guidance, we definitely consider high-speed rail in a conservative manner given the high-speed rail accident. So our gauge or our estimate of high-speed rail business for the year is unchanged for now.

That's helpful. I'll jump back in the queue. Thanks again for taking my questions.

Thank you.

Thanks Mark.

And there are no further questions at this time.

Hello. Peter?

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

Thank you.

Thanks everyone.

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