Hollysys Automation Technologies Ltd (HOLI) 2014 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Hollysys Automation Technologies Fiscal Year 2014 Fourth Quarter and Fiscal Year 2014 ended on June 30, 2014 Earnings Conference Call. (Operator instructions). Please be advised this conference is being recorded today, August 13, 2014.

I would now like to hand the conference over to Ms. Jennifer Zhang, the Investor Relations Director of Hollysys Automation Technologies. Thank you. Please go ahead, Ms. Zhang.

Hello everyone and thank you for joining us. Today our speakers will be Dr. Jianfeng He, Chairman of Hollysys Automation Technologies, Mr. Baiqing Shao, CEO and Ms. Herriet Qu, CFO, and myself, IR Director of Hollysys.

Today's call, Mr. Shao will provide a general overview of our business, including some highlights for the quarter and Ms. Qu will discuss our performance from a financial perspective and financial outlooks for fiscal year 2015 and the whole senior management will answer questions afterwards.

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 reform act of 1995. Forward-looking statements are statements that are not historical facts, including statements relating to the expected growth of Hollysys's future product introductions, the mix of products in future periods and future operating results.

Such forward-looking statements based upon the current beliefs and expectations of Hollysys's 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 the statements. Business conditions in China and South-East Asia; continued compliance with government regulations; legislation or regulatory environments, requirements or changes adversely affecting the businesses in which Hollysys is engaged; cessation or changes in government incentive programs; potential trade barriers affecting the international expansion; fluctuation in customer demands; measurement of rapid 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 (inaudible) events and [regulatory] changes, as well as other relevant risks detailed in Hollysys's [filing] 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 filings. Please note that all amounts noted in this conference call will be in US dollars, unless otherwise noted. I'd now like to turn the call over to Mr. Baiqing Shao. Please go ahead, Mr. Shao.

Thank you Jennifer, and greetings to everyone. In fiscal year 2014 we made a solid achievement and delivered robust fiscal growth in several areas in terms of financial performance and business operation and outperformed the challenging earnings guidance we announced previously.

When we enjoy the exciting moment, we also calmly evaluate the future opportunities and the challenges and carefully plan for the future growth. Here we would like to discuss the achievements in the past fiscal year and strategies in the future in respective segments.

The industrial automation delivered solid growth during fiscal year 2014. The actual growth rate was not as fast as we previously expected, mainly because of the influence by the general economic environment. During the past fiscal year, China began to adjust its industry structure and reducing the capacity, in some industries such as metallurgy, building materials, paper mill and coal fire power.

But we gained more market share from rising industries to make up the loss from the decreasing industries. We were doing well in chemical which took up the largest portion of our revenue in industrial automation and we were doing better in the food and beverage industry and the medical industry.

In order to better cope with such situation, firstly, we have been continuously improving our industry solution capability and the competition capability to strengthen industry marketing and influence on the base of regional network construction few years ago and to focus more on larger projects with more total solution supply.

Secondly, we increased the higher gross margin products provided, including Distributed Control System, Safety Instrumentation System and advanced control software and reduced the lower gross margin instrumentation business, to improve operation quality and profitability.

Thirdly, we continued to provide a quality service and maintenance to our customers, to set up long term working relationship with our older customers and to provide more value adding technologies to improve their operation. Fourthly, capture the new growth opportunities of energy conservation and emission reduction and pursue the new business opportunities driven by intelligent automated product and working.

The factory automation, which is categorized in the industrial automation is relatively a new business but with strong potential. In this area we provide proprietary Programming Logic Controller, PLC, and develop our proprietary solution and equipment to the industries such as coal mining, waste water treatment and Traditional Chinese Medicine, TCM. We have built up vast technology platform, mature products and the successful application track record in the above areas and we'd like to seek more opportunities to replace labor and improve the production efficiency for our customers.

Besides, we are expecting another strong growth driver of industrial automation from overseas markets. We have established subsidiary companies and offices in India, Malaysia and Singapore to provide our industrial automation products. We are currently enhancing the localization, such as recruiting local talents and establishing local partnership.

We believe that we will have the same strong advantages as in China, like the quality products, better service, better value for money, which will enable us to win more customers and enlarge overseas business scale.

Nuclear power business was gradually recovering since the second half of the calendar year 2013, and we successfully provided and installed our proprietary HOLLiAS-N Distributed Control System, HOLLiAS-N DCS in the Unit 1 and the Unit 2 of Hongyanhe Nuclear Power Plant, Unit 1 and Unit 2 of Ningde Nuclear Power Plant, and Unit 1 of Yangjiang Nuclear Power Plant and assist these units' successful commercial operation and delivered outstanding performance.

In high-speed rail sector, we made remarkable achievements in fiscal year 2014. The revenue in rail transportation sector in fiscal year 2014 was doubled compared with fiscal year 2013, mainly because of the strong rail industry recovery in the second half of the last year after China Railway Corporation, CRC, was established.

In fiscal year 2014 we signed several sizable ground-based high-speed rail signaling system contracts to provide the Train Control Centers, TCC and other related products consecutively including the Lanzhou-Xinjiang high-speed rail line Xinjiang section, Mudanjiang-Suifenhe high-speed rail line, Qingdao-Rongcheng high-speed rail line, Jilin-huichun high-speed rail line, Guiyang-Guangzhou high-speed rail line, Guizhou section, and Shenyang-Dandong high speed rail line; and several batches of significant Automatic Train Protection, ATP, equipment providing contracts.

The strong backlog and a booming order pipeline make certain for another strong year ahead. We believe with our key position in China's high-speed rail signaling system providing, superior products performance and well-reputed track record, we are well-prepared to make more market share in the high-speed rail signaling in the near future.

In subway sector we signed the contract with Land Transport Authority, LTA, to provide a Supervisory Control and Data Acquisition System, SCADA, for the Thomson Line and Eastern Region Line in Singapore in June this year, which was a major breakthrough for us to provide our proprietary SCADA system to the international market. In the future, we will closely work with international local rail authorities to explore the SCADA and subway signaling business opportunity.

Overseas, we were excited of Bond Group's solid financial and operational performance and strong orders backlog. We were pleased to see that Concord Group worked together with our domestic team to provide Integrated Supervisory Control System for Thomson & Eastern Region Lines in Singapore.

In the next phase we will accelerate the overseas business expansion, ensure the healthy development of Bond and Concord's original business, and increase our proprietary products and system providing leveraging their market resources and improve our overseas business gross margin.

In addition, analysts and investors are invited to attend our Annual Investment Day around mid-October in our Beijing premises, which will be filled with showcasing our whole executive team, insightful presentations from various corporate executives and facility tour, to further enhance our transparency, corporate investor relations and communication. Our shareholders who would like to participate in this annual event should contact their brokerage firms or contact us directly to arrange the reservation. We are looking forward to meeting with you in October at our premises.

With that I'd like to turn the call over to Jennifer Zhang who will read through the financial results unaudited on behalf of CFO Ms. Herriet Qu. Jennifer.

Thank you, Mr. Shao. (Inaudible) Hollysys financial and operational results for fiscal year 2014 ended June 30, 2014 the Company reported solid financial results. For the fiscal year 2014 total revenues increased by 49.4% to $521.3 million from $349.1 million of the prior year.

Of the total revenues -- revenue from integrated contracts increased by 45.6% to $478.3 million as compared to $328.6 million of the prior year. Revenue from prior sales increased by 55.7% to $31.9 million as compared to $20.5 million for the prior year.

The revenue from services was $11.1 million for the current year. The Company's total revenue by segment was as follows -- industrial automation, $224.4 million; rail transportation, $178.1 million; mechanical and electrical solutions, $108.8 million; miscellaneous, $10 million. As a percentage of total revenues, overall gross margin excluding non-cash amortization of acquired intangibles was 34.7% for fiscal year 2014 as compared to 36.2% for the prior year.

The non-GAAP growth margin for integrated contracts, part sales and service excluding non-cash amortization of acquired intangibles was 32.1%, 63.7% and 63.3% for fiscal year 2014 as compared to 34.3%, 66.8% and nil for the prior year respectively. The gross margin fluctuation was mainly due to the different revenue mix with different margins. Including non-cash amortization of acquired intangibles recorded on a GAAP basis, overall gross margin was 33.7% for the fiscal year 2014 as compared to 35.4% for the prior year.

The gross margin for integrated contracts, product sales and services including non-cash amortization of acquired intangibles was 31%, 63.7% and 63.3% for the year ending June 30, 2014 as compared to 33.5%, 66.8% and nil for the prior year respectively. For fiscal year 2014, selling expenses were $28.3 million representing a slight increase of $1.5 million or 5.5% as compared to $26.8 million year-over-year. As a percentage of total revenues, selling expenses were 5.4% and 7.7% for fiscal year 2014 and 2013 respectively.

General and administrative expenses excluding non-cash share based compensation expenses was $36.7 million for the fiscal year 2014 representing an increase of $8.7 million or 31% as compared to $28 million year-over-year. The increase was mainly due to an increase of $3.7 million incurred by the newly-acquired company Bond as well as an increase of $4.2 million in bad debt allowance.

As a percentage of total revenues, G&A expenses were 7% and 8% for fiscal year 2014 and 2013 respectively. Including the non-cash share-based compensation expenses recorded on a GAAP basis, G&A expenses was $39.7 million and $29.6 million for the fiscal year 2014 and 2013 respectively.

Research and development expenses were $36.5 million for the fiscal year 2014, as compared to $32.5 million of the prior year representing an increase of $4 million or 12.2%. As a percentage of total revenues, R&D expenses were 7% and 9.3% for the year ended June 30, 2014 and 2013 respectively.

The VAT refunds and government subsidies amounted to $25.9 million for the year ended June 30, 2014 as compared to $23 million for the prior year representing an increase of $2.9 million or 12.9%. The increase was consisted of an increase of $4 million in VAT refunds, which was partially offset by a decrease of $1.1 million in government subsidies.

The income tax expenses and the effective tax rate was $19.5 million and 21.7% for the fiscal year 2014 as compared to $8.1 million and 13.4% for the prior year. Of the $19.9 million expenses for the current year, $1.4 million was accrued and withheld for the potential profits distribution from PRC to overseas.

Excluding the withholding tax impact, the effective tax rate for the current year is 20.2%. Beijing Hollysys and HangZhou Hollysys are now in the process of renewing their High-tech certification, which will grant the Company a preferential tax rate of 15% for calendar year 2014 to 2016 and expected to get the renewed certificate in late 2014. For the January to June 2014, the Company used statutory tax rate of 25% to calculate the current and deferred tax from a conservative standpoint.

For the fiscal year 2014, the non-GAAP net income attributable to Hollysys excluding non-cash share-based compensation expenses, amortization of acquired intangibles and acquisition-related consideration fair value adjustment was $87.2 million or $1.49 per diluted share based on 58.4 million shares outstanding. This represents an increase of $29.6 million or 51.3% over the $57.6 million or $1.02 per diluted share based on 56.4 million shares outstanding reported in the prior year period. On a GAAP basis, net income attributable to Hollysys was $69.9 million or $1.20 per diluted share, representing an increase of $17.9 million or 34.3% over the $52 million or $0.92 per diluted share reported in the prior year period.

Hollysys backlog as of June 30, 2014 was $556 million, representing a decrease of 7.8% compared to $602.9 million as of March 31, 2014 and an increase of 13.8% compared to $488.7 million as of June 30, 2013. The detailed breakdown of backlog per segment was as follows. Industrial automation, $178.7 million; rail transportation, $262.1 million; mechanical and electrical solution, $115.2 million.

For the fiscal year ended June 30, 2014 the net cash provided by operating activities was $84.8 million; including investing and financing activities the total net cash inflow for this year was $49.9 million. During this year, the net cash used in investing activities was $25.2 million, majorly consisted of $18.9 million placed with banks as [time] deposits, $8.4 million used in purchase of property, plant and equipment, $5.5 million paid for the second batch of share consideration for Bond acquisition and partially offset by $11.6 million proceeds from maturity of [time] deposits.

The net cash used in financing activities was $8.3 million, majorly consisted of $13.8 million used in repayment of short-term bank loans, $9.2 million used in repayment of long-term bank loans and partially offset by $14.6 million proceeds from short-term bank loans.

The total amount of cash and cash equivalents and [time] deposits with original maturities over three months were $190.5 million, $150.5 million and $133.1 million as of June 30, March 31, 2014 and June 30, 2013 respectively. Of the total $190.5 million as of June 30, 2014 cash and cash equivalents were $162.2 million and [time] deposits with original maturities over three months were $28.3 million.

For the fiscal year 2014, DSO is 150 days as compared to 180 days for the prior year and inventory turnover is 36 days as compared to 52 days for the prior year. Given our strong backlog currently on-hand and sales pipeline envisioned so far, we set our guidance for fiscal year 2015 with revenue in the range of $565 million to $600 million and non-GAAP net income in the range of $94 million to $98 million.

At this time we would like to open up for 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 foreign language).

We will now begin the question and answer session. (Operator instructions) Baiding Rong, Credit Suisse.

(interpreted) Okay thank you Baiding. Mr. Baiding Rong has four questions. The first question regarding the guidance (inaudible) the management give a breakdown of the guidance in terms of revenue and net income by different segments? Second question is regarding the ATP and he wants to know how many sets of ATPs due upon delivery? Thirdly, he asked about the gross margins and the breakdown in different segments like IA, Rail and M&E? The fourth question is regarding the IA growth into the 2015 and he wants to know the growth rate of the profit automation -- factory automation growth of the IA in 2015? Thanks.

(interpreted) The first question, we have three major businesses, industrial automation, rail and M&E. For the Industrial Automation we expect to have 8% to 15% growth rate going into the next fiscal year and with high expectation to achieve 10% to 15%. For the rail because this year we achieved a very high gross because of the backlog execution and the new orders pipeline. So this gives us a very high pressure going into next fiscal year. So we expect the next fiscal year to maintain a stable performance as compared to this fiscal year. For the M&E we expect to have around 15% growth rate.

So for the ATPs it's not appropriate to disclose the exact numbers of the [set] of the ATP upon delivery but according to the contract we are ordered to deliver [all the] ATPs by July 30 but we still have some sets of ATPs due upon delivery. So by the end of September 30 -- the September quarter we will finish the whole contract. We still maintained a stable growth margin performance for the industrial automation -- that is 30% to 35%, rail is 40% and the mechanical and electrical solutions 15%.

(interpreted) Okay, I'll translate for Mr. Shao, CEO, for the growth of the process automation, factory automation going into the next fiscal year. Firstly, for the process automation, this is where we originate from. Even though because of the current economic situation to cause the metallurgy and building materials industry has slowed down, but we have stable growth from the food and beverage industry, [thermo] power and the medical industries.

So in 2015, we feel confident to achieve about 10% to 15% growth in this segment. For the factory automation, this area is -- we emphasis very much and invested a lot of resources. We have the mature products, like the PLC and motion control products, and especially for the traditional Chinese medicine, we have the packaging machines and dispensing equipment and have done a lot of research and have established successful track record.

So in the future, we will continue with research and development in terms of the automated production line development in this area. So overall, speaking for the factory automation, because this [low] base, we expect this area to grow faster compared with process automation.

Okay, for the specific measures, we have successfully released our DCS K series products and have successfully applied the K series DCS in the large products, like the very large, super critical, super power plant. Also, we have strengthened our industry solutions improvement and established or strengthened our relationship with large customers and enhanced our after sales to maintain work. So in the future, (technical difficulty) improve the quality and the win-rate of the (technical difficulty) and improve the overall revenue performance of this area.

For the factory automation, we are (inaudible) technology corporation. We introduced more advanced technology or products to improve our solutions. So we will have further improvement and we will announce when we got more progress in this area.

[Because the] factory automation currently in China is in the process of fast growth, the [performance is] because of very big knowledge and the solid accumulation of technology such that we will also invest more in this area.

(interpreted) Okay, Baiding has two more questions. First he wants to know the orders pipeline for the rail and M&E for the future, and second, he wants to know the jobs market performance of the different segments. So (inaudible) that there is not too much difference of growth margin of the individual segment. (Inaudible).

(interpreted) For the orders of the rail, firstly in the (inaudible) segment, our ATPs can be applied in the four types of the high-speed trains of A, B, C, D and for the (inaudible), for the rail TCC supplying, we have won quite a large order as you have seen, because of the strong performance of rail in the last fiscal year. So in next fiscal year, we expect to have a similar or the stable performance in this sector.

Besides, we are also expanding and doing more research in the related areas, such as we are doing more maintenance and also we have developed our ATP products equipped in the track trains. Besides we also have designed and developed our track circuit product and have passed the related tests or examination by the local authorities.

Also for the [city stage one], we are developing the related technology and laying some foundation for the future reconstruction market opportunities. Also we are expanding our market share in the (inaudible) and TCC market. We have got our track circuit and interlocking system for the preparation to be certified by the local authorities to expand our product lines in this area. The last one is for the inter-city high-speed trains, we have formed a dual technology solution, one in C2 and the second one in C2+ATO, so we are well-prepared in both technology paths into the future and enhance the (inaudible) and we have now a competitive (inaudible).

In terms of the overall investment scale in China and China's going to invest more than RMB800 billion in the rail construction in 2014 and no less than RMB600 billion or RMB700 billion in the next year, 2015. So we are still confident the (inaudible) environment will present us some more opportunities for a continuous development.

Besides, we have successfully signed our SCADA contract with LTA for the Thomson line in Singapore. So that's [really] good, so we have our brand name recognition in the international market. So we continue to work globally with such large end customers in the international market and to improve our international presence.

Thank you.

Your next question comes from the line of Frank Xu of Goldman Sachs. Please go ahead.

Hi. Can you hear me?

Hello?

Hi, can you hear me?

Yes.

Hi, this Frank Xu from Goldman Sachs. So I have some very quick questions. First of all, can you talk about the new motion controlled products outlook? How much factory automation revenue is there going to be in the sector in financial year 2014 and what about the forecast of this sector in financial year 2015 and 2016? Also, I see there's a new revenue item called service rendered for this year's financial reports. So I was just wondering if you can give some color on what exactly is this item? Thank you very much.

(interpreted) For the motion control we have developed our products and successfully applied in the (inaudible). We don't want to disclose too much details about this product, but this will be like the PLC work as core products we will provide into this market in the future.

For the factory automation, percentage revenue, sorry we don't disclose details separate of the factory automation versus product automation (technical difficulty) in a relatively small scale, so in the future because of the labor cost increase in this [area of growth] we think it will gradually take a lot of percentage, and in the future we may consider to disclose the detailed breakdown of our IA and give you the detailed revenue performance of this area in the factory automation.

Thank you very much.

(interpreted) Hello, hi. Because of the increase in the service performance, so after discussed with our auditor we separated the service in our revenue to better illustrate our nature in terms of the products providing, service providing in the whole segment.

Okay, thank you Mr. Shao, [Ms. Xi], and Ms. Jennifer for translation. Thank you very much.

Thank you friend. Next question please.

Lingxin Kong, CICC.

(interpreted) First a question regarding the subway as we are developing the CBTC and also developing the ATO and track circuit product. So we want to know the market fill of the different products and also we want to know how much revenue we can earn, but [as far as] in 2015 and 2016.

Second question, we have noticed these orders decrease in the M&E segment in the last quarter. The other -- the [measurement explain].

Third question is about the revenue and the income performance -- the guidance in 2015. They want to know how much ATP and TCC contracts have been included in our guidance and if there's any opportunity that we can outperform the guidance we announced. Thank you.

(interpreted) Okay, for the CBTC and other related products are categorized in the signaling field and also can be named as the safety system. So we are very cautious and careful in the product development and also we [constantly] do a lot of testing of our products.

In future we will increase our investment and development into these two areas and explore more opportunities in the market so we can [not give you] guidance of how much revenue we can earn from this segment in the next two years.

For the second question about the (technical difficulty) because it's (inaudible) in this quarter, and our strong delivery of the orders. So in the future into the [M&E] segment, we will strengthen our investment and investment in the marketing.

Also we have established a lot of strategic [operation] relations in Singapore and in Malaysia and work closely with the customers in the local area. Also we have a lot of EPC customers so we'll also [leverage] customer resources in the local area to strengthen our IA marketing and sales. [Similarly] we will build ourselves into this to do more total solutions products and more turnkey solution providing.

So for the guidance for the 2015, we made that guidance based on our current background and our new order pipeline [division]. But maybe there's some uncertainty in terms of that new order signing and [the ability] to outperform our guidance in the rail. It's really hard to say, just like investors, it's very much beyond our expectations originally. So in this area (inaudible) we give such guidance but it really depends on the market.

(Spoken in a foreign language).

Thank you, Lingxin. Next question? Hello operator, our next question please?

Alex Chang, Citi.

(interpreted) Firstly, for the VAT and government subsidy in this fiscal year, he would like to know the split of the two segments and the future trend of the VAT and government subsidy. Second question is regarding one sentence written in our earnings report that is $1.4 million was accrued and withheld for potential profits distribution from PRC to overseas. He wants the management to explain.

Similarly, wanted to know the market share change in the [C3] and [C2] in our rail. He said that we have a very high market share in the [C2] but our market share in the C3 is relatively low, around 30%.

Is there any potential to increase our market share in this area and what is the reason for the low market share in this area? Thank you.

(interpreted) For the first question we have $22 million for the VAT refund and $3 million for the government subsidy. In the future there will be no policy change in these two areas. For the VAT refund we need to first pay the tax to the government first and then to claim back the (inaudible) from the government.

But I want to tell you that there's no linear relationship between the VAT and the revenue, so you [can largely] relate it with your proprietary software portions in our products providing. For your information for both IA and rail we can claim the VAT refund. For the M&E there's no way to refund.

Secondly for your question about the second, if -- because we have been considering to pay the dividend. If we want to pay it we need to accrue and withhold the potential tax first according to the accounting (technical difficulty).

But whether we will pay the dividend it will largely depend on the management decisions and the consideration about operation. Definitely we need to seek the Board approval for this proposal.

Thirdly, we definitely want to unite our shares in the C3 segment but firstly we need to do and perform well in the current C2 and C3 projects and try to enlarge our market share in the C3 in the future maybe potentially.

(spoken in a foreign language).

Thank you Alex. Okay, thank you everyone for joining us on the call today. If you haven't got a chance to make your question we'll be pleased to answer them (inaudible) through our contacts. We look to forward to speaking with you again in the near future. Thank you, take care.