Hollysys Automation Technologies Ltd (HOLI) 2015 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Hollysys Automation Technologies' Fiscal Year 2015 Third Quarter Ended on March 31st, 2015 Earnings Conference Call. (Operator Instructions) Please be advised that this conference is being recorded today, May 14, 2015.

I would now like to hand the conference over to Mr. Lily, the Investor Relations of Hollysys Automation Technologies. Thank you. Please go ahead, Mr. Lily.

Hello everyone and thank you for joining us. Today our speakers will be Mr. Baiqing Shao, CEO of Hollysys Automation Technologies; Ms. Herriet Qu, CFO of Hollysys; and Ms. Jennifer Zhang, 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 a financial perspective and financial outlook of 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 relating to expected growth for the 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 those set forth in the 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 transitions 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'd like to turn the call over to Mr. Baiqing Shao. Please go ahead, Mr. Shao.

Thank you, Lily and greetings to everyone.

In the third quarter, we achieved solid financial and operational result amid the weak general economic environment and made quite a few achievements and new contract wins, here I would like to discuss some key events during this quarter.

In industrial automation business, during this quarter, we continuously insisted in executing our strategies to penetrate the high-end industrial automation market and provide more complete solution. In March 2015, we signed a significant contract to provide our Distributed Control System to [2*1000] megawatt ultra-supercritical Thermal Power Generating Units in Datang Sanmenxia Power Plant in Henan Province; this is the fourth contract we signed in gigawatt level thermal power industry, which demonstrate our leading technology and firm our market position in the high-end thermal power market in China.

Besides high-end thermal power market penetration, Hollysys also focused on penetrating into other high-end industries such as chemical, medical, food and beverage and environmental protection related industries, and providing total solution such as software solution, safety protection and critical hardware solution. We were also focusing on building strong after-sale department and setting long-term goals on improving our after-sale services. Our total solution in reducing waste emission and environment protection proved successful. Even though in the short term we have pressure under the current weak external environment, but with our leading technology and proprietary customized solution, we have gradually recovered and performed better than the previous quarters.

Going forward, we will continue to expand our sales force and allocate more resources to high-growth industries, penetrate further into high-end market while increasing market share in the low to mid-end market, expand our products supply such as software and safety protection solution, increase our overall market share and grow the business in the industrial automation leveraging our advanced technologies, experienced professionals, profound industry expertise, customization and innovation capability.

In railway transportation, we signed an approximately $95 million ATP contract in January and it partially contributed to this quarter's strong rail revenue performance. We believe there are more contracts to be expected in the next few months. We are quite confident of the whole fiscal year's strong rail revenue performance. Besides, we also won two ground-based signaling contracts, which are for Jinhua-Wenzhou Line and Xi'an-Chengdu Line in the recent past few months, valued at approximately $20.1 million in total, which demonstrate our strong orders taking momentum in high-speed rail market.

We also worked to expand our rail products supply such as track circuit and interlocking system. We have finished one year testing of track circuit and the official admission progress and got the permit to enter track circuit market, which is a another sizable market. We are entering into this market and expecting to gain our first track circuit contract in calendar year 2015.

For subway business, we are following both domestic and overseas opportunities in both subway SCADA and subway signaling projects, we will continue to deliver quality works and work closely with subway authorities in the future to promote our SCADA system and future subway signaling technologies both in China and abroad.

With China's tremendous rail and subway construction nationwide as well as "one belt one road" policy, there is going to be an exciting prospect for Hollysys both domestically and abroad. As a well-recognized rail signaling system provider, we are confident that with our strong R&D capability, leading technologies, solid execution and reliable products, Hollysys will continue to penetrate into China and the world's vast rail and subway market and achieve significant results.

In the mechanical and electrical solution segment, it delivered solid growth during this quarter given solid local market position, abundant customer resources and strong execution in Southeast Asia and in the Middle East. For the overseas industrial automation and rail 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, we will continue to make exciting achievements in the international market in both industrial and rail transportation fields, and create value for our shareholders.

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

Thank you, Mr. Shao. I would like to share some highlights for the third quarter of fiscal year 2015 ended March 31st, 2015. In this quarter, total revenues were $118.2 million, representing an increase of 23.4% compared to the comparable prior-year period. Non-GAAP net income was $29.6 million, increased by 95.6% compared to the same period of last year. Non-GAAP gross margin was at 46%, compared to 36.2% from the comparable prior-year period. Non-GAAP diluted EPS were at $0.50, increased by 92.3% compared to the [third quarter] of last fiscal year.

Comparing to the third quarter of last year, the total revenues for this quarter increased from $95.8 million to $118.2 million, representing an increase of 23.4%. Broken down by the revenue types, integrated contracts revenue increased by 19.3% to $106.4 million, products sales revenue increased by 70.7% to $9.8 million, and services revenue increased by 111.8% to $2.1 million. The Company's total revenues are as follows. Industrial automation was $41.6 million. Rail transportation automation was $56.1 million. M&E solution was $16 million. Miscellaneous was $4.5 million. Total was $118.2 million.

Overall gross margin, excluding non-cash amortization of acquired intangibles was 46.0% for this quarter as compared to 36.2% for the same period last year. The non-GAAP gross margin for integrated contracts, product sales, and services rendered were 43.4%, 71.7% and 56.0% for this quarter as compared to 34.4%, 57.5%, and 73.7% for the same period last 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 45.5% for this quarter as compared to 35.2% for the same period of the prior year. The GAAP gross margin for integrated contracts, product sales, and service rendered were 42.8%, 71.7% and 56.0% for the third quarter as compared to 33.3%, 57.5%, and 73.7% for the same period last year respectively.

Selling expenses were $5.7 million for this quarter, representing a decrease of $0.3 million or 4.4% compared to $6.0 million for the same quarter last year. Presented as a percentage of total revenues, selling expenses were 4.8% and 6.2% for this quarter and 2014, respectively.

General and administrative expenses, excluding non-cash share-based compensation expenses were $9.0 million for the third quarter, representing an increase of $1.6 million, or 22.0%, as compared to $7.4 million for the same period of the prior year. The increase was mainly due to an increase of $0.7 million in employee compensation expenses, and $0.3 million in amortization and depreciation expenses. Presented as a percentage of total revenues, non-GAAP G&A expenses were 7.6% and 7.7% for quarters ended March 31, 2015 and 2014 respectively. The GAAP G&A expenses, which include the non-cash share-based compensation expenses were $9.7 million and $7.8 million for the three months ended March 31, 2015 and 2014, respectively.

Research and development expenses were $9.4 million for the third quarter, an increase of $1.5 million or 19.3% compared to $7.9 million for the same quarter of the prior year, mainly due to the increased R&D activities. Presented as a percentage of total revenues, R&D expenses were 7.9% and 8.2% for the quarter ended March 31, 2015 and 2014, respectively.

The VAT refunds and government subsidies were $6.6 million for the third quarter as compared to $5.2 million for the same period in the prior year, representing a $1.4 million or 27.9% increase, which mainly due to the increase of VAT refunds for $1.0 million.

The income tax expenses and the effective tax rate were $6.6 million and 16.9% for this quarter as compared to $2.9 million and 21.2% for comparable prior year period. When excluding the impact of non-GAAP adjustments on the income before income taxes, the effective tax rate would have been 17.8% for the current quarter and 15.4% for the comparable prior year period.

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 $29.6 million or $0.50 per diluted share based on 59.2 million shares outstanding for the three months ended March 31, 2015. This represents a 95.6% increase over $15.1 million or $0.26 per share based on 58.9 million shares outstanding reported in the comparable prior year period.

On a GAAP basis, net income attributable to Hollysys was $31.6 million or $0.53 per diluted share, representing an increase 216.1% over the $10.0 million or $0.17 per diluted share reported in the comparable prior year period.

Hollysys' backlog for integrated contracts as of March 31, 2015 was $498.7 million, representing an increase of 15.0% compared to $433.7 million as of December 31, 2014, and a decrease of 17.3% compared to $602.9 million as of March 31, 2014. The detailed breakdown of the backlog for integrated contracts by segments is as follows. Industrial automation was $145.3 million, rail transportation automation was $257.5 million, M&E solution was $95.9 million. Total was $498.7 million.

For this quarter, the total net cash outflow was $37.6 million. The net cash used in operating activities was $20.3 million, of which $16.5 million cash was pledged as restricted cash in a bank to secure a short-term loan. Excluding the impact of this transaction, the net cash used in operating activities would have been $3.8 million. The net cash used in investing activities was $3.2 million. The net cash used in financing activities was $11.8 million, which includes a dividend payout of $23.5 million, and repayment of long-term loan of $4.2 million, all of which was offset by the proceeds from short-term bank loans of $18.4 million.

The total amount of cash and cash equivalents and time deposits with original maturities over three months were $179.7 million, $215.8 million, and $150.5 million as of March 31, 2015, December 31 and March 31, 2014, respectively. As of March 31, 2015, the Company held $151.1 million in cash and cash equivalents and $28.6 million in time deposits with original maturities over three months.

For this quarter, days sales outstanding (DSO) was 228 days, as compared to 248 days from the comparable prior year period and 206 days from last quarter; and inventory turnover was 66 days, as compared to 45 days from the comparable prior year period and 52 days from last quarter.

Given our strong backlog currently on-hand, sales pipeline envisioned and operating margin expansion, we reiterate our fiscal year 2015 revenue guidance in the range of $565 million to $600 million, and revise up fiscal year 2015 non-GAAP net income guidance from $94 million to $98 million, to $100 million to $102 million.

At this time, we'd 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 a translation.

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

(spoken in Chinese).

Okay. Thank you, Baiding. [I'll translate the question]. The first question is about the high gross margin performance in the third quarter, and it is very high, and he wants to know the reason. Is it because of the ATP delivery in the third quarter or because of the IA gross margin improvement? And second question, he wants to ask about the operating cash flow performance. It seems that this quarter's performance is weak. So, could you please comment on the reason? And the third question is regarding the receivable performance. He asked the management to give some [ideas on] the accounts receivable condition. And the fourth question is regarding the sales expenses. It seems the sales expenses and the percentage has decreased compared with the previous quarters. He wants to know the reason. And also the fifth question is regard (inaudible) such as the JVs and other associates' performance, and please comment as well. Thanks.

(spoken in Chinese).

For the first question, regarding gross margins, you may have noticed that in the previous quarters, our gross margin has increased gradually and continuously. There are two reasons for the high gross margin performance in this quarter. Firstly, the whole Company's gross margin has already improved substantially. And the second reason is that the one-time factor. So, previously the IA takes about 40% to 50% of whole Company's revenue. Well, in this quarter, [our rail strengthening than IA, because the] rail's gross margin is higher than IA's gross margin, so the two factors combined together contributed to high gross margin performance.

(technical difficulty) the second reason (technical difficulty) but you have noticed that in (inaudible) gross margin for the whole Company had already increased. So I think the first factor will last in the next few quarters.

(spoken in Chinese).

Second question about the operating cash flow. It's not because of the weak performance of the cash flow in itself. Actually operation is very solid, very strong. The main reason is because of the dividend payment in the last quarter. In paying a dividend, we used a bank overseas, and so the cash in the Mainland, some portions [will be applied cash to] use as a restricted cash, so that it shows that there was operating cash outflow this quarter. So that is the real reason for the operating cash flow outflow.

(spoken in Chinese).

For the sales expenses, actually the absolute value has decreased but it seems the percentage increased compared with the same quarter last year. And in the sales expenses, a larger portion has come from industrial automation, while in this quarter, rail revenue takes a larger percentage. So that's because of structural reasons to cause the sales expenses is lower, and also the percentage is lower in this quarter.

(spoken in Chinese).

(spoken in Chinese).

Okay. (inaudible) the major factor because of the JV, and the JV is the CTEC, the joint venture with China Guangdong Group. Because we established joint venture to provide our nuclear control system, today's larger SOE, we provide the control system and they provide the safety control system. And they had already spent a lot of cost in the R&D of the safety related products. But the revenue and also the government subsidies already has not yet been fully booked into their reports in this quarter. So it shows that the joint venture's performance in this quarter is a little bit weak [if not worse]. But we are expecting going to the second half of this year and gradually -- their performance will be gradually recovered.

Nick Zheng, JPMorgan.

(spoken in Chinese).

Thank you, Nick. Nick has four questions. The first question is about the gross margin in this quarter, the same question as Baiding, the first question. Because in the previous quarters, we have been shrinking the low gross margin products in our total solution supply in IA. Is that the same situation and same strategy in this quarter that caused IA gross margins to [remain] high? And second question is we noticed that IA revenue growth rate has been positive since this quarter. So he wants to know the reason. Is that because of the, probably, of the industry, or it's because of the low base of the same quarter of last year? And third question regarding track circuit. It is a new product in the railway transportation. And he wants to know the expected market share in the next three to five years. Is the Company has a target for the market share? And fourth question is about the M&A. Is there any target in M&A and kind of activities in the sector? Thanks.

(spoken in Chinese).

Okay. We think the IA high gross margin will continue because our strategy has been established and had been (inaudible) quarters ago. We'll continue to shrink the low gross margin products and provide more high gross margin products in our total solution in IA. So we think the high gross margin of IA will continue going to next few quarters.

(spoken in Chinese).

So the growth of the IA has turned to be positive because of several reasons. One, firstly, we don't think the base for the IA in the [same quarter] of last year is low. I think we found several reasons, one is because of the gradual recovery of several sectors in the IA that we are [presenting] and the second reason is because of the internal effort we have made in improving the whole IA performance.

(spoken in Chinese).

One year ago, we have had the one-year testing for the track circuit. And at the end of last year, we got the official permission of this product. And we will work hard to achieve the same market share percentage as the other signaling products in the rail. But it may take a long time, quite a long time. Thanks.

(spoken in Chinese).

For M&A, we are continuously searching for M&A targets. Some two are quite serious. One is the technology -- similar technology and the second one is like the channels in overseas. So now we are conducting some communication and discussion with some potential targets. And finally I cannot tell you too much about the M&A. If we have any further progress, definitely we will let you know.

Frank Shi, Goldman Sachs.

(spoken in Chinese).

Frank has two questions. One is about the new products development. And second question, he wants to know the bidding activities in rail sector. Are there any projects we are participating in the bidding in contracts we are going to sign in the next few months? I want to know the new products in the secular automation, and ask the management to comment on this business. And fourthly, for the ATP product, because of the [CNR and CSR most ever] will there be any impact of our ATP supply in the future? Thanks.

(spoken in Chinese).

For the new products, firstly, the track circuit we are aiming to get also a contract by the end of this calendar year 2015. And secondly, for the ATO, stand for automatic train operation, we have already got our first contract in this technology. And we are expecting this product will contribute on revenue in the future in the segment.

And thirdly, for the secular automation, currently we are developing the packaging solution and the related products that we're expecting to get our first contract in this year as well.

(spoken in Chinese).

Okay. Because the China Rail Corporation is bidding for ATP products (inaudible) CNR and CSR. So currently we haven't seen any negative impact because of they are merging together, between CNR and CSR.

Alex Chang, Citibank.

(spoken in Chinese). I have three questions. The first one is about the bad debt provision. Because Holly reported around $5 million bad debt in the last quarter results, we haven't found any bad debt provision in this quarter. So I just wonder, is there any change on the [default rates], are there specific reasons? The second question is about M&E new contract. And we see there is still fluctuation on the new contract quarter-over-quarter. And I would like to have more details on any explanations on this. This is there because of the seasonality or any other reason? The third question is about IA expansion, the impact on the selling expense. Given the decline in trend of the selling expense and which shows only around 5% for FY14, if Holly have more revenue contribution from IA and maybe adopt a more aggressive strategy in the IA market, does that mean the selling expense ratio will increase seriously going forward? Thank you.

(spoken in Chinese).

Okay. M&E orders performance in this quarter, specifically weak new order taken in this quarter is temporary. And we are actually bidding for quite a few contracts in overseas. And it will be shown in the next few quarters. So I think it is temporary in this quarter.

(spoken in Chinese).

(spoken in Chinese).

(spoken in Chinese).

(spoken in Chinese).

(spoken in Chinese).

(spoken in Chinese).

In the last quarter, second quarter of this fiscal year, there was about a $5 million bad debt provision increase compared with same quarter of last year. For this quarter, actually there's no increase of the bad debt provision. That is mainly because of the risks of the bad debt has been decreasing, and we have been -- we haven't seen any more potential risks in doing the provision of the bad debt.

So overall speaking, the performance of the accounts receivable has been [gradually] increasing because the quality of the contracts increased.

(spoken in Chinese).

(spoken in Chinese).

(spoken in Chinese).

This question about the -- selling expenses decreased because we are focusing on the effective usage of the selling expenses and are improving the efficiency. So we think the percentage of IA will continue to be controllable and sustainable and in a reasonable level going to the future.

Kevin Luo, Morgan Stanley.

Hello, Kevin. Hi Kevin. Hello, Kevin, are you on the line? So, operator, please take the next question, please.

(Operator Instructions).

Hello.

(spoken in Chinese).

Okay Kevin, thanks for the questions. The first question is regarding the high gross margin this quarter. Because overseas segment [currently] takes more than 20% the whole company, and overseas our manufacturing gross margin is only around 20%. So, excluding the overseas portion, so that means that the domestic business gross margins should be higher than 50%. And also because the rail has the higher gross margin than IA, so he assumes that the rail's gross margin is higher than (inaudible) high gross margins IA and rail, is that special, is seasonal in this quarter, or it is sustainable going into the future? (inaudible) the signaling products we supply in the railway transportation. Also want to know, is there any potential (inaudible) requiring higher speed, and the frequency of -- beginning the train operation. So is there any possible and potential business opportunity and is there any potential and fixed timeline of such new orders? Thanks.

(spoken in Chinese).

[Each different quarters] gross margin will be caused by several factors. One is the structure of the business -- different business segments in this quarter and also the different performance in different contracts, and even the delivery and the booking revenue [off the pace in this quarter]. For the different gross margin, in the different sectors, has already substantially increased, will mean that each different (inaudible) gross margin performance, such as in IA and in the rail.

So this quarter may be special, we have very high gross margins, around 46%. We don't think the 46% will last in each quarter going forward. But we are confident that the entire gross margin in the IA and also in the rail has already substantially increased.

(spoken in Chinese).

(spoken in Chinese).

(spoken in Chinese).

Thank you, Kevin. Answering the signaling system (inaudible) high-speed trains. Also as we have communicated with the [markets] before, we're also planning some lower-speed train signaling system opportunities. And also the (inaudible) train signaling opportunities. For the expected timeline, (inaudible) but we will keep you posted. Thanks.

(spoken in Chinese).

(spoken in Chinese).

(inaudible) we look forward to speaking with you again in the near future. Thank you.

And this does conclude today's conference. Thank you all for your participation.