Hollysys Automation Technologies Ltd (HOLI) 2012 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Hollysys Automation fiscal 2012 second quarter ended December 31, 2011 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, February 21, 2012.

I would now like to hand the conference over to Miss Jennifer Zhang, the Investor Relations Director 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 of Hollysys Automation Technology; Miss Herriet Qu, CFO of Hollysys, and myself, the IR Director of 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 risk 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; business conditions in China and in Southeast Asia; continued compliance with government regulation; legislation or regulatory environment, requirements 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 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 its 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 for the quarter. And then the CFO of Hollysys, Miss Herriet Qu will discuss our performance from a financial perspective and the financial outlook for fiscal year 2012. Both Changli and Herriet 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.

Thank you, Jennifer and greetings to everyone.

We're very pleased to report another stellar quarter with solid financial and operational performance amidst unfavorable external economic conditions and we feel excited about our achievements and the breakthroughs in several sectors. Here I would like to take this opportunity to discuss some key events that took place in this quarter.

Industrial Automation business (inaudible) continues its strong growth momentum thanks to our strategic change of total solution proposition and sales force and sales network expansion. We are pleased that we won six 660 megawatt ultra supercritical thermal power generating units in aggregate in 2011 in high end thermal power automation and control markets which were used to be dominated by multinational corporations. We will continue to leverage on our proprietary technology and total solution approach to further penetrate into high end segments of industrial automation and consolidate low end to mid end markets through expanded sales and service network in the country.

In our high speed rail segment, we delivered satisfying financial results despite a mixed high speed rail environment in China for this quarter which demonstrates the strength and the breadth of our high speed rail businesses. We signed a contract of approximately $4.2m to supply our 200-250 kilometer per hour high speed rail ATP equipment to the Ministry of Railways of China while the new contract tender of China's high speed rail was considered to be quiet at the time.

Given the intense demand for high speed rail build out with China's large population transportation demand and limited land use resources together with approximately 15,000 kilometers of high speed rail tracks currently in construction in China which will require signaling systems to be installed prior to commercial operations, we believe there is a huge market potential in high speed rail signaling market for leading players like Hollysys to realize and capture.

Besides, we have obtained European Safety Standard Certification Level 4, the SIL4 for our proprietary signaling products such as Automatic Train Protection ATP, Balise Transmission Module BTM, Line-side Electronic Unit LEU, Temporary Train Control System TSRS, Vital Computer Platform HVC, Train Control Center, TCC and interlocking system. With this whole product suite, our proprietary high speed rail signaling system is development completed and received European Safety Standards certification, Hollysys is poised to explore the vast international railway market and achieve fruitful results to further create value for our shareholders.

In our subway business segment we're excited to winning the competitive bid to supply our Main Control Systems, MCS to Hong Kong MTR Corporation for Hong Kong section of the Guangzhou-Shenzhen-Hong Kong Express Rail Link, the XRL, valued at approximately HKD65.6m, approximately $8.4m. This is the first international bid of our proprietary SCADA system with the MTR Corporation against other multinational companies which is a strong validation of our proprietary technology and implementation capabilities and remarkable milestone of distributing our footprint in the international subway arena.

We have achieved the breakthrough of international market and have laid a solid technology foundation and accumulated in-depth implementation knowledge and experiences. We are expecting more international contracts in pipeline.

In addition to the Hong Kong MTR contract we are also excited about the contract win with Beijing Metro Construction and Administration Corporation to supply the integrated surveillance control and data acquisition system, the SCADA to Beijing Subway Line 14 at $18.8m. We attribute this important record to the numerous successful applications, such as Beijing Subway Line and our strong technology capability which has been able to stay ahead of our competition while developing along with the industry.

We are also very pleased to see continued smooth integration with our wholly owned subsidiary Concord Corporation Pte Limited. In this quarter, Concord successfully signed a contract with Sendan International Co Ltd to provide electrical instrumentation and control installation works for Rabigh Power Plant II in Rabigh, Saudi Arabia at approximately $16.9m. This is the first sizeable contract win by Concord after the acquisition and we are glad to see no surprise that Concord is continuously winning new business while its integration into Hollysys has been well underway in both new product development and business development. We believe the combination of Concord's customer base and the industrial know-how with Hollysys' proprietary technology and products will pave our way to broader market space of rail and industrial automation sectors in Southeast Asia and the Middle East.

Another major event that took place in this quarter is that we announced the CFO's departure and the appointment of CFO's replacement. We sincerely appreciate our former CFO Mr. Peter Li for his contributions as Hollysys's CFO and extend our best wishes to his new endeavors. Meanwhile, we are very pleased to see Miss Herriet Qu, our former Financial Controller, is internally promoted to Chief Financial Officer of Hollysys, overseeing the overall corporate financial management who has been with the Company for more than four years with MBA degree from Oklahoma City University.

After this smooth transition of CFO -- the transition of the CFO together with the appointment of corporate senior executives COO, Mr. Jianfeng He and Senior VP Business Development Mr. Baiqing Shao, our senior management team will remain on a strategic vision and continuously devote ourselves into Hollysys's future development and growth to better serve our clients and the shareholders' best interests.

With that I would like to turn the call over to [Miss Ashley Chan], our Investor Relations Manager, who will read the financial results analysis for this quarter on behalf of our CFO, Ms Herriet Qu.

Thank you Dr. Wang and hello to everyone. In a nutshell of Hollysys financial and operational results, for the fiscal year 2012, second quarter ended December 31, 2012, the Company reported robust financial results.

Total revenue increased by 8% to $80.3m from $74.4m in the prior year period. Among total revenues, revenues from integrated contracts increased by 6.6% to $75.9m as compared to $71.2m for the same period of prior year.

The Company's integrated contract revenue by segments were $44.5m or 58.6% from Industrial, $24.3m or 32% from Rail and $7.1m or 9.4% from Overseas.

The Industrial Automation revenue of $44.5m for the three months ended September 31, 2011 (sic) has consisted of Industrial Automation revenue of $41.5m and nuclear revenue of $3m in the previous breakdown categories. And the Rail Transportation revenue of $24.3m for the three months ended December 31, 2011 has consisted of high speed rail revenue of $17.5m and subway automation revenue of $6.8m.

As a percentage of total revenues, overall gross margin was 38.5% for the three months ended December 31, 2011 as compared to 36% for the same period of last year.

The gross margin for integrated contracts and product sales were 36.4% and 73.4% for the three months ended December 31, 2011 as compared to 35.7% and 42.1% for the same period of last year respectively. The gross margin increase was mainly due to a few higher margin projects and portion of projects of high speed rail being recognized in this quarter.

For the three months ended December 31, 2011, selling expenses were $8.1m, compared to $7m quarter over quarter, and $5.4m year over year. The increase was mainly due to the Company's expanded sales network and increased selling stocks.

As a percentage of total revenue, selling expenses were 10% as compared to 8.0% quarter over quarter, and 7.2% year over year.

G&A expenses, excluding non-cash stock-based compensation expenses, G&A expenses were $7.4m for the quarter ended December 31, 2011, representing an increase of $2.7m or 56.7%, as compared to $4.7m for the same period of prior year. The increase was mainly consisted of an increase of $1.9m contributed by the newly acquired or set up subsidiaries, and an increase of $0.5m in allowance for doubtful accounts.

As a percentage of total revenues, G&A expenses were 9.2% and 6.3% for the three months ended December 31, 2011 and 2010 respectively. Including the non-cash stock compensation cost recorded on a GAAP basis, G&A expenses were $7.5m and $4.8m for three months ended December 31, 2011 and 2010, respectively.

R&D expenses were $6.8m for the three months ended December 31, 2011, compared to $6.4m for the same period of last year. As a percentage of total revenue, R&D expenses were 8.6% and 8.7% for three months ended December 31, 2011 and 2010, respectively.

The VAT refunds on government subsidy amounted to $13.5m for three months ended December 31, 2011, as compared to $5.2m for the prior year period, representing an increase of $8.3m, or 159.4%.

According to the accounting policy, the Company only recognizes the VAT refunds upon the completion of government approval process.

In this quarter, the PRC government approved and granted total VAT refunds of $11.8m to the Company, of which $5.3m was related to the sales during January to June 2011, and the remaining $6.5m was related to sales during July to December 2011.

The income tax expenses were $1.3m for the three months ended December 31, 2011, compared to $1.7m for the prior year period.

The effective tax rate was 6.2% and 10.3% for the quarter ended December 31, 2011 and 2010, respectively. The low tax rate for this quarter is mainly due to the large sum of VAT refunds recognized, which was a non-taxable income.

For the three months ended December 31, 2011, the non-GAAP net income to Hollysys excluding non-cash stock compensation cost was $20.4m or $0.37 per diluted share based on 55m shares outstanding. This represents an increase of $5.4m or 36.4%, over the $15m or $0.27 per share based on 54m shares outstanding, reported in the prior year period.

On a GAAP basis, net income attributable to Hollysys was $20.3m or $0.36 per diluted share representing an increase of $0.09, or 33.3%, over the $14.9m or $0.27 per share reported in the prior year period.

Hollysys' backlog as of December 31, 2011 was $332.1m compared to $300.1m on September 30, 2011 and $288.5m on December 31, 2010. The detailed breakdown of this backlog by segments are $124.4m or 37.5% from Industrial Automation, $170.4m or 51.3% from Rail Transportation, $37.3m or 11.2% from Overseas.

The net cash provided by operating activities was $57.8m for the three months ended December 31, 2011 achieving the historical high mainly due to the accounts receivable collection of $37.2m and VAT refunds of $11.8m received in this quarter. Including investing and financing activities, the net -- total net cash inflow for this quarter was $54.4m mainly due to a cash outflow of $6.9m for the repayment of short-term loans and a cash inflow of $44m (sic - see press release) for the advance receipt of disposal of 10% equity interest in Beijing Techenergy.

As of December 31, 2011, Hollysys' cash and cash equivalents were $130m, compared to $75.5m on September 30, 2011. For the three months ended December 31, 2011, days sales outstanding is 150 days as compared to 104 days year over year and 138 days quarter over quarter. And the inventory turnover was 54 days as compared to 60 days year over year and 51 days quarter over quarter.

And that's for the financials, thanks you.

Thank you Ashley. At this time we would 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.

We will now begin the question and answer session. (Operator Instructions). And you have a question from the line of Saiyi He of Macquarie Capital.

Hello, good evening. This is Saiyi from Macquarie. I have two questions. (Spoken in Chinese)

The first question is I have noticed a significant increase in our Company's gross profit margin and also a significant reduction in our revenue exposure to high speed rail. And we all know historically you were able to generate higher gross profit margins from high speed rail revenue sales. And has there been a significant increase in gross profit margin from the Industrial Automation segment that caused the expansion in gross profit margins? That's my first question.

My second question I would like to know if you can provide more detailed breakdown of your order backlog, especially in what percentage of that currently comes from the Overseas or the Concord exposure. Thank you.

Thank you, Saiyi. Okay, for the first question, the gross margin -- you know the gross margin of our Hollysys business is [evaluate] because of the business structure. And this is just to mention, usually our Railway business has higher margin and nuclear has the highest, railway has the second highest and Industrial Automation is on the average and Subways business is at the lowest.

But this quarter we have created a very high gross margin because first of all the business structure is very good and second, we have increased the Subway margin before as I mentioned many times because we did not -- winning all the contracts because these had contracts. But we have to evaluate each contract so that guaranteed the margin is appropriate.

And the second is we have been working very hard to maintain our Industrial Automation segment, the gross margin stable at least. And for this quarter some of the contracts, it's very good. So in that case the overall gross margin is higher than the previous times. But this does need stating that in the future we will maintain the 38.8%, 38.9% because it will evaluate a little bit up and down. But we are trying and trying to maintain the gross margin on average about 35% at least. That's our target.

And about the backlog breakdown, we can see that the Industrial part, the Industrial Automation part is $124.4m for this quarter and the Rail Transportation is $170m and Overseas in $37.3m for this quarter. So the Overseas is -- comprised of 11.2% of the whole backlog. Is that okay, Saiyi?

Hello, can you hear me? Hello?

Hello?

Hi. If you don't mind me I just summarize the answer you gave. So basically the Railway margin was significantly higher. Even though the revenue exposure was lower and it was able to help lift the overall margin and our Industrial Automation margin was stable.

For the second part, the reason I asked about overseas exposure, I want to ask is all of our overseas exposure from Concord right?

Yes mainly.

Yes, okay.

Mainly. Almost all from Concord.

Okay, understand. Thank you.

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

Hello Dr. Wang. Hello Ashley. Hello Miss Qu and Jennifer. Thanks for taking my call. Actually I have two questions.

The first question is about the competitive landscape of metro [SIG] markets as well as start up markets. Could you please give us some color on how many players are there in Chinese markets for metro SIG loading and metro SCADA and who are the strongest?

Also previously we heard Unisys has formed a JV with CSR, China Sovereign Locomotive and Rolling Stock. They want to enter this market and what's the latest update? Do you feel any competition from them as well? This is the first question.

And the second question is on your overseas opportunities. We have noticed that you have been working hard to try to explore the overseas market. Could you please give us some color on where you start in terms of the products and the geographic locations? Where do you target? I stop here.

Thank you very much Paul. And for the first question about the metro market, in China the metro market is very promising and I think at times it's very confusing. So we have been very hard at the beginning.

You know first of all, the first SCADA system what's happening in the automation control systems and now signal systems was designed by Hollysys in the year 2000. And we delivered that and we created that market in China almost. And after that a lot of competitors joining in and we have been improving our systems. At the same time we're trying to enlarge our percentage of proprietary systems.

First of all now the total platform was designed by Hollysys. It's 100% owned by Hollysys. And the second part is for the Beijing Line 14, we have replaced the original PLC with our own proprietary PLC systems which composes quite a big part of the contract and will help to increase the order. And also, some other small competition components we have also trying very hard to replace them with our local products now.

And about the competition scenario in this area in China, there are a quite a few players including (technical difficulty), who's very strong and also very good. We respect that competitor very well. And also there are some others, I think around five of them come. But most of the others they do not win a lot of contracts per year and I'm sure they will be our very strong competitor for us in the future in this area.

And for the signal part of subway systems, so far most -- the majority of the products were dominated still by the multinational companies like Siemens, like Alstom and the other I think it's [ACAS] now belong to [Tellus] and a few others.

Now the Beijing Jiaotong University has created a company doing these local signal systems. They have started a few lines, a couple of lines and we are going to see their results as well.

And so the signal competition now is not that fierce as the SCADA systems. And there's no so far fully proved local product, proprietary product yet and we still have opportunity.

And as you mentioned, Unisys has set up a joint JV with Nanshou and I'm sure there are some opportunities for them. And -- but it's still too early to see how competitive they will be in the market because it depends what the products level of Unisys and also it depends on the experiences Nanshou can deliver in this area. But still as I said they are going to be our competitor in this field.

And for Hollysys, we have -- first of all we have transferred our technology from our high speed rail systems which has been fully demonstrated in the real field. And also we have designed a system so that we fully proved that the European safety standard so that our system cannot only working for the Chinese market but also for the international markets.

Our first target, since you mentioned, I'm trying very hard with our Concord and also with our local team, with our Chinese team, that we are capturing the overseas market. First of all, there are quite a few market opportunities for us in the Asian area and we do not want -- I do not want to mention now because we are working on them and it is quite sensitive at this time. I do not want to speak that -- to say that now.

And also, in the future, we are working some of the upgrading systems. You know so far there are many, many subway systems in the world, in the developed world that have been in operation for many decades. And most of the systems they need to be updated and redesigned with the new systems. We are quite confident that our signal systems will be designed with the most modern technology available now. So I'm sure in the future our systems will be -- after they finish all the [HOLI] certifications. We haven't done it yet. We are planning to finish that by the end of this year, this calendar year.

And after that that I'm sure our system technically and in the price level are quite competitive in the international market. And we will find -- we will see then, but it's still too early to say too much about it now. But first of all as I said we are targeting the Asian market first and then we will explore the other developing, route systems markets. Okay Paul?

Thank you very much. Just a quick follow up. I recall you have won the metro signaling system on Beijing-Changchun line. Hello?

Yes.

What's the latest progress there and what percentage of the work has been finished? Could you please give a bit of idea on that?

Okay. For the Beijing Changchun line, we supplied part of the systems, the signal systems only because at that time most of the -- our platforms hadn't proved yet. So we integrated some systems platforms from Hitachi and some from other partners. And we do the system integration and also we did the systems designing and also the installation testing for the operation of the whole system. So by that we gained a lot of experience. We, by that project, after that project, our engineers, almost fully understand the real vision requirements. So that a very, an invaluable experience for us.

So that project has been fully completed right?

Yes, it's already in operation now.

Okay, thank you very much.

Your next question comes from the line of Chapman Deng of JP Morgan.

Hi, thank you Dr. Wang. Congratulations on a set of very solid results. I've just got two questions.

The first one is I would like to get your view on China overall industrial automation market outlook, and in particular what kind of revenue growth do you expect for Hollysys over the next two to three years? That's my first question.

And the second question, I would like to get some update on China high speed rail new order? What's your revenue growth guidance for that segment for 2012 and 2013? Thank you.

Okay. For the first question I'm very excited about it because today I had a whole day meeting, our COO and me had a whole day meeting with our regional managers about the industrial automation. Although -- we have because we made up our business development plan of this year before the start of this year and we have been examining the results from the market for these couple of -- more than one month time and after this time I think it starts with all the original. We evaluate each regional manager about their market.

And so far, although on the general, the Chinese industrial automation market is not growing at a very satisfactory growth rate, but we are very confident -- our confidence from our regional managers because they are controlling the operations of each of the business segments and upon their response that they are very confident still to maintain our sustainable growth of industrial automation.

If -- we have all agreed that if the market growth rate, the general market growth rate is very satisfactory and very optimistic and we are going to make a bigger progress. But if the market is not that optimistic, then we are trying very hard to gain market share in a way to maintain our business growth and also to improve the scope of our suppliers and customers. That's our strategy on Industrial Automation. So still after today I'm still very confident about the future development of this business segment.

Now your second question about Chinese high speed rail, I feel so sorry that we still haven't got any new contract yet, although I -- we keep very optimistic about the long-term market, because in China as you know that and during this spring festival time I -- also I saw some of the people from the MOR and they still encourage me to keep okay because they are still working on more projects in the future because this is the Chinese situation that the requirement for the large scale high speed rail network is very necessary because especially for this film festival you can see that it's very difficult to get tickets, railway tickets for the traffic. So the requirement is still there. And also it's our stated policy in the future to construct a very sophisticated high speed rail network to guarantee the high speed transportation.

So in the long-term there is no problem for that. We are confident and for the short-term that's a problem because, as I mentioned, as I told you Chapman, I'm sorry to say that a couple of months -- a month ago you asked me about this question. I told you that we have to wait until the end of this rush transportation period of the spring festival. And now it's finished but still we haven't got contract awarded yet. They consolidate the people from the high speed rail and although, as I said, they told us they encourage us to keep our confidence in the construction and also for Hollysys after the July 23 accident, Hollysys is free of anything wrong.

So the people there have more confidence in our (technical difficulty) and they are pleased with our quality control and safety manual procedure. But for them now, you know first of all, after the impaction, they have removed some of the personnel from some of the positions so they need to adjust some of the personnel of the positions especially who's taking care of the signaling segments.

The second is after the inspection of this critical accident, the authorities they have found that they need to improve the safety guarantee procedure in a way how to evaluate the ability, for example, to guarantee --- to make sure that in the future all the signal systems are safe, so that I'm sure they are working very hard right on this now. But still, as I said, I cannot see too much in a couple of weeks, but as I said in the long run we are still confident of the market. Okay Chapman.

Oh thank you Dr. Wang.

Thank you.

And your final question comes from the line of Mark Tobin of Roth Capital Partners.

Hi Dr. Wong, Herriet, Jennifer thanks for taking my questions. First looking at the guidance and I guess also looking at the VAT refunds that you had during this quarter, can you give us a sense of what level of VAT refunds you expect for the full year or what's assumed within your guidance?

Okay Mark, I would like Herriet to answer your questions okay?

Okay, thank you.

(Interpreted). Hi Mark, to answer your question, you should understand the VAT refund we booked this quarter, it takes about 30% of our total net income guidance which is $57m to $58m.

And for the full year VAT refund guidance is around $90m which includes $11.8m which we already booked in this quarter, and of which $5.3m was related to the sales during January to June. And the remaining $6.5m was related to the sales of the first quarter of 2012. And there's about approximately $7m to $8m of the VAT refund coming in the second half of this fiscal year. Thank you.

Okay, thank you, and then one follow up. Looking I guess excluding the VAT refund, the government subsidies that you have, can you discuss your target operating margins? In particular we saw SG&A as well as R&D expenses go up and understandably so because you're investing in your business. But I guess can you discuss what your target margin profile is excluding the refunds and subsidies? Thank you.

(Interpreted). Hi Mark. Our G&A and sales and R&D expenses for the second half of this fiscal year are going to stay at probably the same level as the first half year's. And because our gross margin has increased significantly than the other previous periods, so exclude the VAT refund and government subsidies. We expect there's still 12% margins -- more than 12% margins for this year.

Okay. And when you say stay at the same level do you mean on percentage of revenue terms or in dollar terms?

(Interpreted). Both.

Okay. That's helpful, 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.

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

Portions of this transcript that are noted interpreted were interpreted on the conference call by an Interpreter present on the live call. The interpreter was provided by the Company sponsoring this Event.