Hollysys Automation Technologies Ltd (HOLI) 2015 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Hollysys Automation Technologies fiscal year 2015 first quarter ended on September 30, 2014 earnings conference call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. (Operator Instructions) Please be advised that this conference is being recorded today, November 14, 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 of Hollysys; Ms. Herriet Qu, CFO of Hollysys; and myself, IR Director of Hollysys. On 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 financial perspective and the financial outlook 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' 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 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 the forward-looking statements.

Business conditions in China and in Southeast 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 international expansion; fluctuations in customer demand; management 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; geopolitical events and regulatory changes; as well as other relevant risks detailed in Hollysys' filings with the Securities and Exchange Commission.

The information set forth herein should be read in light of such risks. Hollysys does not assume any obligation to update the information discussed in this conference call or in its filings. Please note that all amounts noted in this conference call will be in US dollars unless otherwise noted. I now like to turn the call over to Mr. Baiqing Shao. Please go ahead, Mr. Shao.

Thank you, Jennifer, and greetings to everyone. During this quarter, we continuously insisted in executing our strategies to vertically penetrate in the high-end industrial automation market and we have won several high-end projects in chemical, thermal, food and beverage, and new energy industries. We were also focusing on building strong after-sales department and set long-term goals on improving after-sale services. Our solutions in reducing waste emission and environmental protection proved successful. In the recent operations, we have won a significant bidding to provide our proprietary DCS for 1 gigawatt Guangdong Yuedian Bohe thermal power plant. We also had a contract win of 2X800 megawatt thermal power plant DCS reconstruction project for Liaoning Suizhong Power Plant, which marks our footstep on largest scale of power plant reconstruction area in China, proved that our leading technology and total solution has won the trust of our client to replace the foreign players' control technology and products.

While China is going into aging society and the labor shortage tends to be a big problem, China is putting more efforts in automation to replace labor and improve efficiency to reduce emission and protect environment. We believe we will financially benefit more in the long run. Going forward, we will continue to expand our sales forces and allocate more resources to high-growth industries, penetrate further into high-end market, increase market share in the low to mid-end market, expand our products supply such as software and safety protection solutions, increase our overall market share; and grow the business in the industrial automation leveraging our advanced technologies, experienced professionals, profound industry expertise, and customization and innovation capability.

In rail transportation during this quarter, we feel excited of the significant subway supervisory control and data acquisition system (SCADA) bidding win in Tianjin Subway Line 5, which is scheduled to be in operation by the end of 2017, leveraging our previous successful subway SCADA experience in Beijing, Guangzhou, Shenzhen subway lines. We will continue to deliver quality works and work closer with the subway authorities in the future to promote our SCADA and future subway signaling technologies. Besides in the high-speed railway, we continuously make remarkable achievements and market share increase. Currently, we are tightly executing quite a few railway lines, including Qingdao-Rongcheng Line, Guiyang-Guangzhou Line, Shenyang-Dandong Line, and bidding for new projects.

We also work to expand our rail products supply such as track circuit. We have finished one year testing of this product on the line authorized by the Beijing Railway Bureau and soon we are going to finish the official admission progress. With China's tremendous rail and subway construction nationwide, there is going to be an exciting prospect for Hollysys. As a well-recognized rail signaling system provider, we are confident that with our strong R&D capability, solid execution, and reliable products; Hollysys will continue to penetrate China's vast rail and subway construction market and achieve significant results. In the mechanical and electrical solution segment, Bond and Concord, delivered solid growth during this quarter given their solid local market position, abundant customer resources, and strong execution in Southeast Asia.

For the overseas industrial automation and railway transportation expansion, we are sending qualified and experienced engineers from China to overseas and recruiting local engineers to expand our overseas team. With our proprietary technology and products, industry expertise and strong competitive advantages, together with our expanded local channels through Bond and Concord; we will continue to make exciting achievements in the international market in both industrial and rail transportation fields, and creating value for our shareholders.

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

Thank you, Mr. Shao. In a nutshell, Hollysys' financial and operational results for the fiscal year 2015 first quarter ended September 30, 2014, the Company reported solid financial results. Comparing to the first quarter of the prior fiscal year, the total revenues for this quarter increased from $113.2 million to $140.7 million representing an increase of 24.2%. Broken down by the revenue types; integrated contracts revenue increased by 21.8% to $128.5 million, products sales revenue increased by 27.8% to $8.9 million, and services revenue increased by 332.6% to $3.3 million. The Company's total revenue in segments are as follows. Industrial automation, $57.1 million; rail transportation, $40.8 million; mechanical and electrical solution, $40.1 million; miscellaneous, $2.7 million.

Overall gross margin, excluding non-cash amortization of acquired intangibles, was 39.6% for the three months ended September 30, 2014 as compared with 36.6% for the same quarter last year. The non-GAAP gross margin for integrated contracts, product sales, and services rendered were 36.3%., 79.2%, and 61.6% for the three months ended September 30, 2014 as compared to 34.8%, 62.3%, and 49.5% for the same period of the prior year respectively. The gross margin fluctuation was mainly due to the different revenue mix with different margin. The GAAP overall gross margin, which includes non-cash amortization of acquired intangibles, was 38.2% for the three months ended September 30, 2014 as compared with 35.7% for the same quarter last year.

The GAAP gross margin for integrated contracts, product sales, and service rendered were 34.8%, 79.2%, and 61.6% for the three months ended September 30, 2014 as compared with 33.9%, 62.3%, and 49.5% for the same quarter last year respectively. Selling expenses were $6.8 million for this quarter representing an increase of $0.2 million or 2.6% compared to $6.6 million for the same quarter last year. As a percentage of total revenues, selling expenses were 4.8% and 5.8% for the three months ended September 30, 2014 and 2013 respectively. For this quarter, the G&A expenses was $9.3 million representing an increase of $1.1 million or 13.7% as compared to $8.2 million for the same quarter last year. As a percentage of total revenues, non-GAAP G&A expenses were 6.6% and 7.2% for the quarters ended September 30, 2014 and 2013 respectively.

The GAAP G&A expenses, which include the non-cash share-based compensation expenses, were $9.8 million and $8.6 million for the three months ended September 30, 2014 and 2013 respectively. Research and development expenses were $8.8 million for this quarter representing an increase of $0.8 million or 10.5% compared to $7.9 million for the same quarter last year, mainly due to the increased R&D activities. Represented as a percentage of total revenues, R&D expenses were 6.2% and 7% for the quarter ended September 30, 2014 and 2013 respectively. The VAT refunds and government subsidies were $6.4 million for this quarter as compared to $4.5 million for the same quarter last year representing $1.8 million or 40.6% increase, which primarily due to the increase of VAT refunds of $1.9 million.

The income tax expenses and the effective tax rate were $7.4 million and 21.2% for the three months ended September 30, 2014 as compared to $3.8 million and 15.7% for the comparable prior year period. For the first quarter of fiscal year 2015, the Company adopted the statutory tax rate of 25% to calculate the current and deferred tax for Beijing Hollysys & Hangzhou Hollysys as opposed to 15% used in the first quarter of fiscal year 2014. These two entities are in the process of reapplying their High and New Technology Enterprise certification. Upon reapplication, Beijing and Hangzhou Hollysys will be qualified for the preferential enterprise income tax rate of 15% for calendar years ended December 31, 2014 to December 31, 2016.

The non-GAAP net income attributable to Hollysys; which excludes non-cash share-based compensation expenses, amortization of acquired intangibles, and acquisition-related consideration fair value adjustments; was $27.2 million or $0.46 per diluted share based on 59.1 million shares outstanding for the three months ended September 30, 2014. This represents a 33.4% increase over the $20.4 million or $0.35 per share based on 58 million shares outstanding reported in the comparable prior year period. On a GAAP basis, net income attributable to Hollysys was $27.1 million or $0.46 per diluted share representing an increase of 35.3% over the $20 million or $0.35 per diluted share reported in the comparable prior year period. Hollysys' backlog for integrated contracts as of September 30, 2014 was $495.7 million representing a decrease of 10.8% compared to $555.5 million as of June 30, 2014 and a decrease of 3.9% compared to $515.9 million as of September 30, 2013.

The detailed breakdown of the backlog for integrated contracts by segment is industrial automation $161.9 million, rail transportation $244.4 million, mechanical and electrical solutions $89.4 million. For the three months ended September 30, 2014 the total net cash inflow was $0.7 million and net cash used by operating activities was $0.8 million and net cash used by investing activities was $15.8 million, out of which $14.6 million was used to settle the third cash consideration in connection to the acquisition of Bond Group. The net cash provided by financing activities was $17.3 million, which primarily made up by the $20 million convertible loan received from International Finance Corporation. The total amount of cash and cash equivalents and time deposits with original maturities over three months were $191.1 million, $190.5 million, and $129.4 million as of September 30, 2014; June 30, 2014; and September 30, 2013 respectively.

As of September 30, 2014 the Company held $162.9 million in cash and cash equivalents and $28.2 million in time deposits with original maturities over three months. For the three months ended September 30, 2014 days sales outstanding was 176 days as compared to 175 days from the comparable prior year period and 148 days from last quarter and inventory turnover was 41 days as compared to 44 days from the comparable prior year period and 31 days from last quarter. Given our strong backlog currently on-hand and sales pipeline envisioned so far, we reiterate 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'd like to open up for the Q&A. Please note that for Chinese speaking participants, we can also do the Q&A in Mandarin and we will provide translation. (spoken in Mandarin) Operator, please.

(Operator Instructions) David Jin, Goldman Sachs.

Congratulations on a solid quarter last quarter. The first question is regarding gross margin and I saw a pretty strong gross margin this quarter. However, if you look at revenue breakdown, actually M&E contributed a higher portion compared to last year. Can you elaborate more on why margin came out so fast and is it sustainable? That's my first question. And second question is on automation, it seems that new orders is relatively weak this quarter and when does the management expect to see the pickup in new orders and do you think your full-year 8% to 15% revenue growth is achievable? That's my second question. And third question is on rail. It seems that rail was pretty strong and considering the acceleration of high speed rail buildout and mounted unit tendering, do you think your flattish railway revenue is too conservative at this moment? Thank you very much.

For the first question for the gross margin, even though M&E takes about a percentage of our revenue, but the M&E segment also had higher gross margin. The gross margin of the M&E segment used to be 15% to 16%, but in this quarter it reached to 20% in gross margin. In fact IA and rail also had very good gross margin performance through our effort in the better control of taking more quality contracts and better cost control and implementation in the cost, we also had a higher gross margin in IA. In fact in rail because the rail is always a high gross margin business, we also believe that our efforts in the next one to two years, the rail also has a better gross margin.

(interpreted) For the second question, yes, indeed we have the new orders decrease in IA in the past quarter. Well, actually that is within our expectation. The first reason is because of the external environment, which caused a delay of the implementations here with our projects. Secondly, because of the industry restructure of the whole society two years ago, we are also focusing and spending more efforts in the new growth industry such as the environment protection related industries and also we have a better growth from the medical industry as well. And certainly because also ultimate solution providing in IA will provide more higher gross margin businesses such as service, such as the software, such as the safety protection solutions. And also in the meantime we controlled our low gross margin businesses, which also caused the new order decrease in last quarter, but it actually benefited the long-term growth of the whole business.

We still maintain our full-year guidance in fiscal year 2015 for the whole Company, that is around 8% to 15% growth; in number that is $565 million to $600 million in revenue for fiscal year 2015. And for the IA , we are still working hard to achieve our original guidance for 8% to 15% growth in this fiscal year. [Have to grow] given China is investing more in the rail construction and given the new orders tendering in the multiple builders and the (inaudible) construction; after two to three months, we will sign the contract for the signaling system providing. So, we expect that we are going to have good new orders taken in the near future. So overall thinking, we expect we will have relatively flat revenue performance in the rail transportation in this fiscal year. Thanks.

Saiyi He, Macquarie Capital.

The first question is about the VAT refund. If we exclude the overseas and the new business, the proportion of VAT refund in terms of our China related business is significantly increased compared to previous years and previous quarters. And I just want to check if in this quarter we have included some new rebates, the delayed rebates from the previous quarters and if in terms of the China's VAT refund that we are receiving this year should remain in line as the previous year? So, that's my first question. My second question is continue to be about our industrial automation segment and Mr. Shao just now have given quite a detailed explanation on your confidence of maintaining the 8% to 15% original full-year guidance.

Could you just share some light with us where you get the confidence from? Are there some potential big contracts in the pipeline from some customers that we have tried to establish over the past couple of years? And also can you give us some update on the Company's commercial launch of the PLC business and if we do expect some revenue contribution albeit how small it is toward the end of this fiscal 2015 year? And lastly, my question is about the Company's SG&A cost, especially the selling expense this quarter is significantly low. I want to ask is this going to be one-off for this quarter or we should actually forecast SG&A cost at a similar percentage of sales as the previous years or we do have a trend of reducing those expenses? Thank you.

(interpreted) For the first question on VAT refunds. Because it's little bit difficult for us to project how much VAT refund we are going to take in this fiscal year, we think it will be more than $20 million. Of course yearly we take a rebate for the cash we recognize the VAT refund. So for the third question, the G&A expense percentage decreased in this fiscal year compared to last year. We think we are going to maintain the similar percentage in the full fiscal year. And also for the selling expenses, it is about 5% and the same considerations going to maintain that 5% in this fiscal year and going forward. Just to reconfirm that, we are going to have more than $20 million VAT refund in the full fiscal year in 2015, including four quarters.

(interpreted) In fact the chemical and the petrochemical takes a large percentage of revenue in the process automation within the whole IA. Two years ago we started invest more resources and grow our business in the industries such as medical industry, food beverage, new energy, and thermal power, et cetera. So by our efforts, we have a significant growth from the above mentioned industries. We will continue to see our results after our investment in the new growth industries and benefit from the trends long term. And also, the after-sales service is going to be another significant driver of our whole IA growth. Probably it takes about 5% to 8% of our revenue, probably it's going to increase in the future. We not only increased our market share in the mid-to-low end market, but also recruited the industry experts to provide total solutions targeting to the high-end customers.

The total solutions will include DCS, the advanced software solutions, safety instrumentation systems, et cetera. It is going to increase the single contract value from the single customer and to increase our efficiency of the whole Company. Besides since our K-series, our new generation DCS, was launched in the market; we have won the full recognition from our customers because we also provide more products and solutions to the customer, which are also going to benefit for the rapid growth in the long term. For the PLC business, we are spending more energy in doing the research and the development in the [factory] automation area. So in the future, we think the PLC or the factory automation is going to take a lot of percentage in the whole IA business. In the next stage, we are not to provide the product in the factory automation, but also to provide the total solutions and service to our customers in this industry to increase (inaudible) influence and the revenue growth.

Thank you.

Nick Zhang, JP Morgan.

(interpreted) The first question regarding railway transportation, if only the (inaudible) for the high-speed trains in the C2 and C3 segment so revenue in the Hollysys SCADA order for the signaling providing for [Tianjin] high-speed trains. And the second question is regarding the gross margin, we have noticed that the M&E takes a nice percentage in the revenue this quarter. So for the gross margin increase in the M&E segment, is that temporary or is it sustainable, is that caused by the mix of the project or in future we are going to have a similar gross margin in the M&E segment? The third question is regarding the tax rate. Because in this quarter, the September quarter and last quarter, June quarter; we all take 25% in doing the tax calculation in a conservative way.

So when we got the High Tech company Enterprise certification and so how much value we are going to take back into this fiscal year and your expected timeline and also what is the effective tax rate for this fiscal year? And fourth question is regarding the new products. For the Company, Mr. Shao has mentioned PLC and the factory automation solution and also you have a subway signaling technology and in the rail, you have a track circuit, you have mentioned (inaudible). So when are you going to in fact see early contribution and a more significant contribution or which is the most meaningful for the Company from the new product segments?

(interpreted) For the second question, the gross margin of M&E. The M&E segment gross margin is between 15% to 20%. In the past two years, the gross margin was relatively low while in this past quarter because the progress has a higher gross margin during this quarter when it's put into the revenue so we also expect the higher gross margin, I mean [it's not] going to be sustainable in this full fiscal year. For the tax rate because we haven't got the High Tech Enterprise certification, we haven't finished the renewed progress for applying this certificate so we are currently using a 25% tax rate in the calculation.

But once we got the certificate, we will use 15% and definitely we will take the tax expense back into this fiscal year and the exact value is hard to give you. But for the time because we have finished the preparation of the recent work and have already entered into the later stage in getting the certificate so if everything goes well, we may get a certificate by the end of December 31 or at least we can get the certificate by March 31, 2015. For the effective tax rate usually it was between 15% to 17% while this year because of the influence of the certification issue, so we upgraded around lower than 15% effective tax rate in this fiscal year.

(interpreted) For the first question, it's (inaudible) bidding for the high-speed trains. Usually it will take three months later for us to sign the signaling contract so for the contract value and time, it's not appropriate to tell you now. For the new product development that is for the future sustainable growth of the whole Company and for example, we have very good growth throughout traditionally China medical industry, we have a lot of successful application track record. So, this industry is going to continue to get more revenue contribution and higher growth in the future. For the subway, we have finished development of the subway signaling system and we are also finishing the testing of our subway signaling system in Tongji University. In the future we are going to combine SCADA and subway signaling technology into one solution to enhance our industry competitiveness. Besides in both China and abroad, we will increase our sales effort to create more revenue contribution from this sector. For the track circuit in the rail segment, now we are finishing the process in getting the official permission progress by the Central Rail authorities. And in the next year in 2016, we are going to have the revenue from the track circuit.

Due to the time constraints, we will now take one last question from the queue. Thank you.

Baiding Rong, Credit Suisse.

(interpreted) Baiding Rong from Credit Suisse. The first question is regarding the new order and revenue performance in the IA segment during the past two months in October and November. And the second question, because the last quarter we had a little bit decrease in the IA revenue, but management still maintained full-year growth guidance around 10% in IA. So, that means that you're going to accelerate the IA growth or going to have accelerated growth from IA in the next few quarters? And also, you mentioned that you have a slower growth from the mechanical industry so where is the new growth from, which industry?

(interpreted) As I mentioned, we have solid growth from the thermal power, food and beverage, and medical industries. And I also imagine that in this fiscal year, we are still working hard to achieve the 8% to 15% growth in the IA segment.

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

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

Portions of this transcript that are marked (interpreted) were spoken by an interpreter present on the live call. The interpreter was provided by the Company sponsoring this Event.