Hollysys Automation Technologies Ltd (HOLI) 2012 Q3 法說會逐字稿

Thank you for standing by and welcome to the Hollysys Automation Technologies fiscal 2012 third quarter ended March 31, 2012 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 at which time, if you wish to ask a question (Operator Instructions). Please be advised that this conference is being recorded today, May 15, 2012.

I would now like to hand the conference over to Miss Jennifer Zhang, the Investor Relations Director 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. Chang Li Wang, CEO and Chairman of Hollysys Automation Technologies, and Ms. Herriet Qu, CFO of Hollysys, and myself, the IR Director for Hollysys.

Before we get started, I want to warn you 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 facts including statements relating to the expected growth of Hollysys' future product introduction, the mix of products in futures 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 results to differ from the forward looking statements.

The following factors, among others, could cause the actual result to differ from such forward-looking statements. Business conditions in China and in southeast Asia; continue the compliance with the government's regulations; legislation or regulatory environment; requirements or changes adversely affecting the businesses in which Hollysys is engaged; decision or changes in government incentive programs; potential trade barriers affecting international expansion; fluctuations in customer demand; management of Company growth and transition to new market; 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 detailed in the 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 obligations to update the information discussed in this conference call or its filing.

Under 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, Ms. Herriet Qu, will discuss our performance from financial perspective and the financial outlook for fiscal year 2012.

Both Changli and Peter will be available for the QA session afterwards.

Please note that all amounts noted for this conference call will be in US dollars unless otherwise noted. I would now 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 another quarter with solid operating and financial results. Here I would like to give -- to take this opportunity to discuss some key events that took place in the quarter.

Industrial automation is continuously growing towards the top position in domestic market and is starting to build its brand power globally. We keep seeing strong business demands across all of our products and industry verticals. The significant growth we reported in this quarter clearly validates our dedicated industry expert total solution and sales network expansion strategies.

Our established brand recognition, strong track record of customization, quality and service, efficient R&D and implementation, together with customer-orientated flexibility give us a significant competitive advantage over domestic and international competitors. We believe Hollysys is in an excellent position as we pursue future growth in industrial automation markets.

In our high-speed rail segment, we successfully won the international bid and signed a contract of approximately $63.15m with MTR Corporation Ltd to provide the complete suite of high-speed rail signaling systems to Guangzhou-Shenzhen-Hong Kong Express Rail Hong Kong Section. As this first ever international contract for our high-speed rail signaling system, amid the stiff competition from other world class signaling system providers, this contract is of paramount importance and a remarkable milestone in steering our business to the next level in the global arena.

On the domestic side, we believe we will continue to benefit from the continuous construction of high-speed rail called by the huge demand for rail transportation across the country. With the successful Safety certification in accordance with international standards for our signaling products and system, we will continue to leverage our strong commitment to R&D, quality and service to further explore business opportunities in both China and abroad.

In subway business, in addition to the Hong Kong MTR contract and the Beijing Subway Line 14 contract of supplying the integrated SCADA system this quarter, we are expecting our self-developed proprietary subway signaling system to obtain SIL 4 by the end of this year.

We are excited about the subway signaling system because it clearly differentiates Hollysys and will bring us to a higher level in competing with other players, to propel our subway business in both Chinese and international market.

Furthermore, we made substantial progress in our strategy of international market expansion through our successfully acquired company, Concord. In this quarter, Concord successfully signed a retrofit project of $14.02m with Shaw Brothers Limited, to supply and provide installation and the electrification services for the Shaw Centre in Singapore.

We are seeing building automation is becoming a big market given that increasing high-end commercial buildings and a growing demand for retrofit projects are increasing commercial buildings in many markets. Meanwhile, Concord has been actively working on a few international biddings and projects in rail and industrial automation segment.

The acquisition of Concord has been proved to be a good synergy and successful by combining our proprietary technology and Concord's international team. We will continue to leverage the core capabilities to further penetrate into the international arena and building Hollysys into a world leading automation and control technology and product provider.

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

Thank you Dr. Wang and hello to everyone. In a nutshell, Hollysys financial and operational results for the fiscal year 2012, third quarter ended March 31, 2012.

The Company reported robust financial results. Total revenues increased by 18.6% to $66.01m, (sic -- see press release) from $55.8m in the prior year period. Among total revenues, revenue from integrated contracts increased by 17.8% to $61.8m, as compared to $52.4m for the same period of the prior year.

The Company's integrated contract revenue by segment was shown as following. $35.7m or 57.7% from industrial, $21.1m or 34.2% from Rail, and $5m or 8.1% from Overseas.

The industrial automation revenue of $35.7m for the three months ended March 31, 2012 is consisted of industrial automation revenue of $35.6m and nuclear revenue of $0.1m in the previous breakdown categories. And the rail transportation revenue of $21.1m for the three months ended March 31, 2012 is consisted of high-speed rail revenue of $13.2m and subway automation revenue of $7.9m.

As a percentage of total revenues, overall gross margin was 39.3% for the three months ended March 31, 2012 as compared to 40.3% for the same period of last year.

The gross margin for integrated contracts and product sales was 37.9% and 59.9% for the three months ended March 31, 2012 as compared to 38.8% and 65.1% for the same period of last year, respectively.

The gross margin fluctuation was mainly due to the different revenue mix with different margins.

For the three months ended March 31, 2012 selling expenses were $6.1m, compared to $5.3m last year, in year over year, and $8.1m quarter over quarter. Compared to the same period of prior 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 9.2% compared to 9.5% year over year and 10% quarter over quarter.

G&A expenses, excluding non-cash stock-based compensation expenses, were $4.9m for the quarter ended March 31, 2012, representing an increase of $0.1m, or 1%, as compared to $4.8m for the same period of prior year.

As a percentage of total revenues, G&A expenses were 7.5% and 8.8% for the three months ended March 31, 2012 and 2011, respectively.

Including the non-cash stock compensation cost recorded on a GAAP basis, G&A expenses were both $5m for three months ended March 31, 2012 and 2011, respectively.

R&D expenses were $5.6m for the three months ended March 31, 2012 compared to the $3.9m year over year and the $6.9m quarter over quarter. Compared to the same period of prior year, the increase was mainly due to the Company's increased R&D activities. As a percentage of total revenues, R&D expenses were 8.4% compared to 6.9% year over year, and 8.6% quarter over quarter.

The VAT refunds and a government subsidy amounted to $2.5m for the three months ended March 31, 2012 as compared to $1.3m for the prior year period, representing an increase of $1.2m, or 85.9%, mainly due to Hangzhou Hollysys, the Company's wholly-owned subsidiary, recognized a subsidy of $0.9m during this quarter, which was granted to encourage the Company's R&D activities in DCS field.

The gains on disposal of long-term investments amounted to $2m for the quarter ended March 31, 2012 which Beijing Hollysys, the Company's wholly-owned subsidiary, disposed 10% equity interest in China Techenergy Corporation Ltd by consideration of CNY27.8m, approximately $4.4m, and recognized a disposal gain of $2m during this quarter. After this transaction, Beijing Hollysys continues to hold 40% equity interest in China Techenergy.

The income tax expenses were $2.5m for the three months ended March 31, 2012, compared to $0.2m year over year, and $1.3m quarter over quarter. The effective tax rate was 18.0% compared to 1.8% year over year, and 6.2% quarter over quarter.

The large increase of tax expenses was mainly due to an income expense of $1m related to VAT refunds was recognized by Beijing Hollysys during this quarter as the Beijing Tax Bureau specified that VAT refunds to be taxable. For the nine months ended March 31, 2012 the effective tax rate was 11.4% as compared to 9.9% for the prior year period.

For the three months ended March 31, 2012, the non-GAAP net income to Hollysys excluding non-cash stock compensation cost was $11.6m, or $0.21 per diluted share based on 56m shares outstanding. This represents an increase of $2m, or 20.8% over the $9.6m, or $0.17 per share based on 55m shares outstanding reported in the prior year period.

On a GAAP basis, net income attributable to Hollysys was $11.5m, or $0.21 per diluted share representing an increase of $2m, or 21.4%, over the $9.5m, or $0.17 per diluted share reported in the prior year period.

Hollysys' backlog as of March 31, 2012 was $401.8m compared to $332.1m on December 31, 2011, and $280.9m on March 31, 2011. The large increase was mainly contributed by a backlog of $63.2m brought by contracts with Hong Kong MTR Corporation to provide high-speed rail signaling systems. The detailed breakdown of the backlog by segment is as following.

$144.8m or 36% is from Industrial Automation, $208.4m or 51.9% is from Rail Transportation, $48.6m or 12.1% from overseas.

The net cash provided by operating activities was $1.5m for the three months ended March 31, 2012. Including investing and financing activities, the total net cash outflow for this quarter was $3.7m, mainly due to a cash outflow of $2m for the repayment of long-term loans, and $3.7m used for purchases of property, plant and equipment.

As of March 31, 2012 Hollysys' cash and cash equivalents were $126.2m compared to $130m on December 31, 2011. For the three months ended March 31, 2012 days' sales outstanding is 160 days as compared to 156 days year over year, and 150 days quarter over quarter. And inventory turnover was 68 days as compared to 101 days year over year and 54 days quarter over quarter.

Due to severe slowdown of China's high-speed rail development, as well as overseas projects delayed because of the mixed international environment, we are revising the previous announcement for full year 2012 revenue guidance between $354m and $356m, down to between $310m and $320m. But we are confidently reiterating our fiscal year 2012 net income guidance between $57m and the $58m unchanged.

We are still confident of the steady and sustainable growth of industrial automation segments based on the strong backlog and feedback from the market team.

That's for the financials, Thank you.

Thank you Ashley. At this time I would like to open up the QA session. Please note that for Chinese speaking participants, there will also be a Q&A in Mandarin and we will provide a translation.

Operator, please.

We will now begin the question and answer session. If you wish to ask a question (Operator Instructions). And your first question comes from the line of Paul Gong.

Hello Dr. Wang. Hello Herriet, Jennifer and Ashley. Congratulations for a another strong quarter. Hello, Dr. Wang, can you hear me?

Hi, hi, hi Paul.

Okay, basically I have three questions. The first question is regarding your industrial automation. Are we still seeing strong growth on the new orders. I just was want to -- wondering which downstream demand do you particularly see the orders coming from? Is that from chemical or thermal power or -- and which segment? And also, do you see this as new capacity demand, or more like a replacement demand?

My second question is on your cash. Now you have almost like $100m left cash, do you have like a dividend or share repurchase program given you do not have too much CapEx at this moment?

And my third question is on Metro SIG loading and what is the latest progress on that? I stop here. Thank you.

Paul, could you repeat the third question?

The third question is on the metro signaling system, which you are still on development at this moment. Do you have a latest update on that? How is the latest progress on the R&D?

Okay, thank you. Thank you Paul. For the first question about the industrial growth, as you know, Hollysys has been starting this new strategy. We set out in expanding the sales networks and also we are trying to promote our solution and scope of the system. So in both directions but in a large part of the business.

As for the vertical segments, you know Paul, it's, I think Hollysys will not give very clear clarification about this, because a lot of competitors are watching us very carefully. They are seeing which segments, for example, we are growing and I do not want to attract the press. So, but anyway we have a few segments growing very fast. One is the chemical process and also the new energy process for this.

For the new projects and the updating old projects, it seems mainly, still, quite a lot from new projects, although our subways part is growing very fast. But due to the historical small percentage of this part of the business, although it's growing fast but still it's not very big compared with the whole industrial automation segments.

Okay, your second question about the cash, although we have quite a lot of cash now at hand, but still because we cannot see clearly what the future environment will be, especially at this time, it seems that the European issue is also pending and also in China, although we are quite confident from our market feedback that the market is okay for us, and we can manage growth and also we are quite confident for this part.

But still Hollysys' [trend] has been and will be converted in a way that we have to guarantee that Hollysys can tolerate and can survive any harsh environment just like the environment of last year, for example. Hollysys has successfully cut through and we have made quite a good progress even in a very disadvantaged environment.

So in that case, for this time, we still haven't decided whether we pay dividends or not yet because we will wait until, for example, after the world environment becomes clearer and also the Chinese environment becomes much better and then we will decide on this. Also, we will check what the market will be in that case.

About the metro system development, so far it's very normal and we have got a few product 35 and also our development and designing of some of the critical parts for the subway system signal systems is going through very well. And we still keep the timeline that we have got for 35 at the end of this year. Okay Paul. Hello.

Thank you very much.

Okay, thank you.

Thank you.

Your next question comes from the line of Saiyi He.

Good evening Qu, Wong and Jennifer. First of all congratulations. I have three questions. (Spoken in Chinese) First is about your guidance for Industrial Automation margin in the fourth quarter FY12, especially given that we have lowered our full year revenue guidance but maintaining our bottom line. So can you just give us a rough guidance on what we should expect on Industrial Automation margins, and why we think you should hold up?

Also on overseas revenue, given the euro issue and falling raw material prices, the Middle East investment is also slowing down. Are you still maintaining what should we expect from the overseas revenue contribution in the fourth quarter FY12 and what is your -- are you still maintaining your overseas revenue and net profit contribution for FY13?

In terms of Railway segment we just want to find out can you just give us a color for the fourth quarter again? I know you probably don't have much outlook yet.

My second question, this is more for Qu. We want to understand in terms of VAT refund, how is it currently dealing with the Beijing Tax Bureau? Are you receiving cash tax refunds from now on a monthly basis? And what have you budgeted for the VAT refund and tax paid on that for the fourth quarter?

Finally is on sales network expansion. Previously you informed me that it's still ongoing. So should we expect, and given that you probably need to penetrate more industrial areas and markets, should we expect SG&A costs to go up in the next year.

Okay, I will answer the first question okay. For the industrial market you ask first, so far we still maintain that margin. On average quite stable, although some of the projects may be lower, but some of the projects are higher. So the mix of the general industrial automation path will be maintaining quite stable for the margin part.

And for the overseas projects, although we have met some difficulties because at the beginning when we acquired Concord the team there was too optimistic. They had quite a few big projects at hand almost signed but due to the international situation some of the projects delayed and some of the projects stopped. So they got some of the -- they didn't finish their part of the business as we planned before. But this couple of months -- these few months I have been working with the team there and we are trying to get more project opportunities, bidding on more project opportunities.

So we have just showed that. Last month we announced one project. And later we are quite confident that in the later part of this year we still have a few good projects -- well in the bidding process and some of them we are quite confident to win them okay.

And for the Railway -- for the railway part, now, although it's not very clear when -- which day we are going to sign some of the projects, but during this time, during these few weeks, the Railway business has already started recovered in a way that some of the projects have been discussing and negotiating between the MOR and our team. So hopefully, some of the projects will settle down very soon and we've got some of them. Anyway, we are quite optimistic in the way that in the later part of this year, definitely we are going to have more projects, much better than last year's situation.

Now I will turn to Qu.

I want to thank you for the answers.

Thank you.

We just want to understand, so in terms of fourth quarter FY12, so in terms of bottom line contributions from the three main areas, we should expect the majority of it comes from Industrial Automation?

Industrial Automation and OSE. OSE I mean Railways. Railways we still have some projects ongoing.

For the fourth quarter?

For the fourth quarter yes. We still have some projects yes. We haven't finished the backlog yet.

All right, okay thank you.

We have some old projects ongoing and also we are going to sign some new projects, hopefully. So for the next quarter, although Industrial Automation will maintain the momentum and the OSE will catch up a little bit more I hope and we can see that.

Sure. Thank you.

Thank you.

Your next question comes from the line of Mark Tobin.

No, I haven't finished yet. Okay. Go ahead. Hello.

Hi Mark. Hello.

Hello?

Hi. Okay, I guess the one -- I've got a couple of questions. First, your backlog has grown very impressively. Can you give us a sense of what, I guess the period of performance and the duration of that backlog? Has it grown longer than say the backlog that you had a year ago? In particular I look at the most recent rail announcement, the $63m announcement deliverable through 2015. Can you give us a sense of the length of your current backlog versus a year ago?

Okay, the backlog now is growing and especially all the segments are growing, especially the high-speed rail with big projects from the Hong Kong project

The other segments, like the Industrial Automation, compared to the previous years, it's only a little bit longer than before. For example, before the Industrial Automation part, it's six months on average. But now maybe it's a little bit longer than six months. Maybe, for example on average, although some of them are still very short, but on average maybe its nine months or something a bit longer than before.

For the high-speed rail part, the Hong Kong project is not a typical. It's much longer than our traditional Chinese market railway business. This one project is going to be lasted for three years in the future. It's going to finish by the end of 2014 or early 2015.

So the other part is just like before.

Okay, and how about Concord?

Concord, the backlog still we cannot see very clearly so far because we need more time to get on average because in Concord some of the projects are very quick. For example, some of them are going to be finished within three to six months. But some projects are a little bit longer like for example, can last 12 months. But on the detailed calculation how much, I mean on average, we haven't computed that yet. We are going to give that data later as more projects are building up okay Mark?

Okay that's helpful. Then a follow up on Concord. Based on the revenue that they've reported so far this year, it would be my best guess that they will probably not hit the $10m net income earn-out that was there. Is that safe to assume? I guess when we're looking at share count for fiscal '13 there is the 750,000 shares. Should we probably not think about those being added at this point?

Okay, good, Mark that's a good question. It seems, it looks like that they are very difficult to finish the target, and also when they issue reiterating our guidance, we assume that we are not going to be the target. They made some discount on that. So -- but if they cannot beat the market, that's the rule. They have signed with them in a contract. So they will not earn the award bonus shares.

Okay that's helpful. Then the final question, for your guidance for fiscal '12, what is your VAT, your subsidy and rebate assumption for Q4?

I will let Miss. Qu answer that question.

(Interpreted) Thank you. The VAT response in the fourth quarter will be at the same level as previous as well $4m. Thank you.

Okay Mark.

That was $4m? I just couldn't hear I'm sorry.

You couldn't hear?

It was $4m?

Yes.

Okay, thank you.

And did you want to finish answering Saiyi? Your next question comes from Chapman Deng.

(Spoken in Chinese). I've got a few questions. The first question is actually I want to talk about gross margin -- quarter three gross margin over the past couple of quarters. If you look at year-on-year comparison we actually had achieved much higher gross margin in FY12 versus that in last year. But may I know the reason behind? Also I want to know gross margin for the fourth quarter. That's the first question.

The second question is actually regarding your metro signaling system. You expect to obey the safety certificate by the end of this year. So may I know when do you expect the revenue from the subway signaling system should come in? And what kind of gross margin do you expect from these signaling orders? That's the second question.

Yes, and lastly I want to know, I mean for the Concord, other than the subcontracted business they are working on, actually do you see business opportunity between Hollysys and Concord especially in the Industrial Automation DCS area? Thank you.

Okay Chapman. I would like Qu to answer the first question. I will answer the last two okay.

Thank you, sure.

(Interpreted). Our gross margin is impacted by the mix of our products. So the current quarter's gross margin cannot represent our long-term and sustainable gross margin level. And this quarter, the reason for the high gross margin as Miss Qu explained, that's the change of the mix of the products we sold.

And the reason actually is in two sides. For the PCS our gross margin, Industrial Automation stays quite stable and on the rail side, because we previously implement our strategy choosing the good quality programs, so that has actually increased our gross margin for those projects.

And for the fourth quarter expectation, we expect the gross margin will maintain at the similar level as before between 30% to 35%. But at our Hong Kong contract NCR contract that we served that contract as a system integrator, we will purchase some products or systems from the outside suppliers. That maybe lower our margin a little bit.

I would like to add a couple of details on this Chapman. As I told you before, our Industrial Automation part, we have a very good mix of business products so we maintain a very good stable margin.

We do not want to sacrifice our margin to grow the market share okay. And for the Rail business, as I said several time before, Rail being lower the subway SCADA system percentage because some of the projects are very, very low margin we give up that part of the business. We only choose very good projects.

In that case, on the general, summing up, the margin has been going up a little bit. Okay?

Now I answer your second question. For the metro signal part, as I have just mentioned when I answered Paul's question, we carry out the R&D very smoothly now and everything is on time. So we're planning to finish the R&D and got certified by the end of this year. And after we got certified by the end of this year, we are capable of bidding projects internationally and now we have found quite a few opportunities outside China.

As for the margin of the metro signal systems, that will be the same level as high-speed rail signal systems. So it's much higher than the SCADA systems.

The first question is for the Industrial--.

Now, Chapman, for the Concord part now I've been working with them for a few months and now we can work in together first of all to explore the subway systems internationally and for example, when we bidding the Hong Kong project and their team has contributed some -- a lot in negotiating and also enjoying the bidding documentation etc. And also now we also have a few other projects undergoing a bidding process and hopefully we are going to win them from the Concord side.

As for the industrial part, we are working together now. We are trying to find some big opportunities there. For example, now we found that just as I mentioned on the previous page, that we found that in the Southeast Asia areas energy conservation is a very critical issue now and a lot of governments, especially the Singaporean government, has a very strong emphasis to save energy, especially for the building energy consumption. So we are encouraged to do something.

So we utilize our industrial automation technologies in the building automation so that we can -- because we have done a lot in China for the energy conservation and also to reduce the energy consumption in a lot of segments so we are now trying to working with the Concord team to build up a solution for the building automation systems in the future. And we are trying to explore some of the opportunities there together. Okay Chapman?

Sure. Thank you Dr. Wang. Can I ask one quick follow up question actually on the Hong Kong high-speed rail order? Basically what kind of gross margin do you expect for the whole contract? So you mentioned that you expect lower gross margin from the contract. Is it just at the beginning of the project or for the overall project? Thank you.

For the overall project. Because we are quite conversant in this announcement, so maybe they are going to be a little lower than our signal, pure signal high-speed rail projects because, for example, even for the high-speed rail products, different products with the different margin. So overall, we enjoy a very high margin for the high-speed signal system.

But for the Hong Kong high-speed signal systems, the gross margin may be just now they still cannot get a very detailed data yet, but maybe a little bit lower, but not on a large scale. We're confident of that.

Thank you.

Your final question comes from the line of Saiyi He.

Hi Wang and Qu. (Spoken in Chinese). You already answered part. I would just understand it better. Just now Qu mentioned that every quarter you're budgeting $4m VAT refund. Is this going forward in this calendar year every quarter as well? Or this is $4m just for fourth quarter FY12?

Also I want to understand how is the VAT refund will be carried out going forward with Beijing Tax Bureau. Will they be giving us literally cash refunds every month? Or this is just planning?

(Spoken in Chinese).

(Spoken in Chinese).

(Spoken in Chinese).

(Spoken in Chinese). SG&A costs, do you think it will continue to go up?

No, not really. You know the sales team expand very fast last year and now the team is almost stable and now although we are still growing the sales team, but not in that speed. We are going to use the capabilities of each member so that we are going to fully explore their power to get more contracts.

And also, maybe we still enroll some new employees just to replace some of the not qualified candidates in a way. And we were going to enlarge in some rural areas, a few numbers, but not too rapidly this year.

Okay.

Okay, take care thank you.

Okay. Thank you everyone for joining us on the call today. If we haven't had any chance to read your questions, we will be pleased to answer them for [us to contact]. We look forward to speaking with you in the near future.

Thank you.

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.