Hollysys Automation Technologies Ltd (HOLI) 2016 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Hollysys Automation Technologies fiscal year 2016 second quarter ended on December 31, 2015 earnings conference call. (Operator instructions). Please be advised that this conference is being recorded today, February 3, 2016. I would now like to hand the conference over to Mr Arden Xia, the investor relations of Hollysys Automation Technologies. Thank you. Please go ahead, Mr Xia.

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 myself, Arden Xia from investor relations 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 the second quarter of fiscal year 2016 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 the 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 those set forth in these statements -- business conditions in China and in Southeast Asia, continued compliance with government regulations, litigation or regulatory environments, requirements or changes adversely affecting the businesses in which Hollysys is engaged, succession or changes in government incentive programs, potential trade barriers affecting international expansion, fluctuation 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' filing with the Securities and Exchange Commission.

The information set forth here 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 US dollars unless otherwise noted. I'd now like to turn the call to Mr Baiqing Shao. Please go ahead, Mr Shao.

Thank you, Arden and -- thank you Arden and good evening to everyone. I would like to discuss some key events in this quarter. During this quarter, industrial automation business has been affected by a weak external environment, with particular impacts on the process control sector, that we have not seen the recovery signs from the market. However, despite all of the challenging conditions, our strategy of developing after sales and services is proving successful, which continuously take larger percentage of our revenue.

Besides, given the new construction projects in the near future would be lack of sustainable, we have already focused on the construction or upgrading opportunities as supplemented through sign maintenance and service contracts to lock potential customers, helping them to improve efficiency and saving the costs. Breaking down in the industries, power is maintaining stable. We have taken several numbers of high level generator units and signed large contracts such as Jiujiang Shenhua two gigawatt power units which was the highest level units in coal fire power industry.

While petrochemical is still weak, the same as metallurgy and building materials. Overall speaking, we have to say that external environment brings large impact to our industrial automation business, but we will adjust ourselves through better internal management and controls such as to insist keeping gross margin for long term health development within industrial automation to better cope with this situation and try our best to gradually recover the business.

In high speed railway, we signed a large contract to provide automation train protection equipment and system to China Railways Corporation. We are quite confident of the steady high speed rail revenue and backlog performance. As China is continuously investing a certain scale on supporting high speed railway sector for the next five years, we will see a benefit from the policy of the 13th Five-Year Plan. Furthermore, we are also working to expand our railway new products and technologies such as track circuits which would make potential revenue contribution in the near future.

For subway business, we have signed quite a few SCADA contracts in the recent quarters and are seeking opportunities to work with more local transportation bureaus. We will continue to deliver quality works and work closer with other subway authorities in the future to build up our SCADA and subway signaling businesses both in China and abroad.

In the mechanical and electrical solution segment, seasonal lumpiness affected the sector's performance in the short term. However, we are unshakeable to penetrate South Asia and the Middle East markets and make progress on delayed projects. We also actively communicated with local customers to discuss new project opportunities and even seek business partners for further cooperation.

At last, for extending international business, we have recruited local engineers to support our overseas team.

With our proprietary technology and products, industrial expertise and customer resources, we will continue to make exciting developments and achievements in both industrial and rail transportation fields and create value for our shareholders.

With that, I would like to turn the call over to Arden Xia, who will deliver the financial results analysis, on behalf of our CFO, Ms. Herriet Qu. Arden.

Thank you, Mr. Shao. I would like to share some highlights for the second quarter of fiscal year 2016 and December 31, 2015. Comparing to the second quarter of the prior fiscal year, the total revenues for the three months ended December 31, 2015 increased from $130.3 million to $152.8 million, representing an increase of 17.3%. Broken down by the revenue types, integrated contracts revenue increased by 12.7% to $134.2 million, products sales revenue increased by 49.4% to $15.4 million and services revenue increased by 229.3% to $3.2 million.

The Company's total revenues can also be presented in segments, as shown in the following chart. Industrial automation, $54.2 million. Railway transportation, $63.8 million. Mechanical and electrical solutions, $29.7 million. Miscellaneous, $4.9 million. Total, $152.7 million.

Overall gross margin excluding non-cash amortization of acquired intangibles was 39.8% for the three months ended December 31, 2015 as compared to 38.3% for the same period of the prior year. The non-GAAP gross margin for integrated contracts, product sales and services rendered were 37.2%, 57.4% and 65.2% for the three months ended December 31, 2015, as compared to 35.7%, 63.7% and 80.4% for the same period of 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 39.7% for the three months ended December 31, 2015, as compared to 37.1% for the same period of the prior year. The GAAP gross margin for integrated contracts, product sales and services rendered were 37%, 57.4% and 65.2% for the three months ended December 31, 2015, as compared to 34.4%, 63.7% and 80.5% for the same period of the prior year, respectively.

Selling expenses was $7.1 million for the second quarter, representing a decrease of $0.1 million, or 1.5% compared to $7.2 million for the same quarter of the prior year. Presented as a percentage of total revenues, selling expenses were 4.6% and 5.5% for the three months ended December 31, 2015 and 2014 respectively.

G&A expenses, excluding non-cash share-based compensation expenses, were $10.8 million for the quarter ended December 31, 2015, representing a decrease of $4.6 million or 29.9%, as compared to $15.5 million for the same period of prior year. The decrease was mainly due to the decrease of $2.1 million in bad debt expenses. Presented as a percentage of total revenues, non-GAAP G&A expenses were 7.1% and 11.9% for quarters ended December 31, 2015 and 2014 respectively. The GAAP G&A expenses, which include the non-cash share-based compensation expenses, were $12.1 million and $15.9 million for the three months ended December 31, 2014 and 2015, respectively.

Research and development expenses were $11.9 million for the three months ended December 31, 2015, an increase of $1.8 million, or 17.6%, compared to $10.1 million for the same quarter of the prior year. Presented as a percentage of total revenues, R&D expenses were 7.8% and 7.8% for the quarter ended December 31, 2015 and 2014 respectively. The VAT refunds and government subsidies were $10.7 million for the second quarter, as compared to $5 million for the same period in the prior year, representing a $5.7 million or 112.7% increase, which is primarily due to the increase of VAT refunds of $6.1 million.

The income tax expenses and the effective tax rate were $5.1 million and 13.2% for the second quarter, as compared to a net of $0.3 million and a net of 1.5% for the 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 12% for the current quarter and a net of 1.2% for the comparable prior year period.

During the second quarter ended December 31, 2014, Beijing Hollysys and Hangzhou Hollysys were certified as High and New tech companies, effective for three years, from January 1, 2014 to December 31, 2016 and applied to preferential income tax rate of 15% and Beijing Hollysys and Hangzhou Hollysys accordingly recalculated the tax expenses accrual for calendar year 2014, based on the newly applied income tax rate of 15% instead of 25%. Excluding the impact of the accrual adjustment, the effective tax rate for three months ending December 31, 2014 was 15.2%.

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 $36.8 million or $0.61 per diluted share based on 60.6 million shares outstanding for the three months ended December 31, 2015. This represents a 56% increase over the $23.6 million or $0.40 per share based on 59.2 million shares outstanding reported in the comparable prior year period. On a GAAP basis, net income attributable to Hollysys was $32.9 million or $0.55 per diluted share, representing an increase of 72.4% over the $19.1 million or $0.32 per diluted share reported in the comparable prior year period.

Integrated contracts backlog highlights. Hollysys' backlog for integrated contracts as of December 31, 2015 was $527 million, representing an increase of 7.5% compared to $490.4 million as of September 30, 2015 and an increase of 21.5% compared to $433.7 million as of December 31, 2014. The detailed breakdown of backlog for integrated contracts by segments is shown below. Industrial Automation, $105.8 million; Rail Transportation, $301.5 million; Mechanical and Electrical Solutions, $119.6 million, total $526.9 million.

Cash flow highlights. Cash flow for the three months ended December 31, 2015, the total net cash outflow was $1.8 million. The net cash provided by operating activities was $46.7 million. The net cash used in investing activities was $45.5 million, mainly consisting of $47.2 million placed as term deposits with original maturities over three months in banks. The net cash provided by financing activities was $0.4 million.

Balance sheet highlights. The total amount of cash and cash equivalents and term deposits with original maturities over three months were $275.6 million, $234.9 million and $215.8 million, as of December 31, September 30, 2015 and December 31, 2014, respectively. As of December 31, 2015, the Company held $188.7 million in cash and cash equivalents and $86.9 million in term deposits with original maturities over three months.

For the three months ended December 31, 2015, days sales outstanding was 138 days as compared to 206 days for the comparable prior year period and 179 days for the last quarter. Inventory turnover was 34 days, as compared to 52 days for the comparable prior year period and 42 days for the last quarter.

Outlook for fiscal year 2016. Given our strong backlog currently on-hand and sales pipeline envisioned so far, we reiterate our guidance for fiscal year 2016 with revenue in the range of $565 million to $600 million and non-GAAP net income in the range of $110 million to $120 million.

At this time, we would like to open up for the Q&A session. Please note that as Chinese speaking participants, we can do Q&A in Mandarin and we will provide translation. Operator, please. (Spoken in Mandarin).

We will now begin the question and answer session. (Operator instructions). Our first question today comes from Alex Chang from Citigroup. Please go ahead.

(Spoken in Mandarin).

Hello Alex.

(interpreted) The first two questions from Alex, first about the ATP orders lost time and we saw the price go down, what about this order to affect the gross margin and also, what about the future gross margin for the high-speed rail segment? The second question is about the G&A expenses and this quarter we found that 2.1 million reviews, compared with last year at the same quarter and what about in future, about G&A expenses in the rail segment and also the industrial segment, which part will affect and that the provision goes down?

(interpreted) About the first question, answer is the ATP last order, the price, it goes down but we also have very special procurement and the cost can show internally. So for the order itself, the gross margin is going down, but for a long term and the whole segment of high-speed rail, the gross margin we think will maintain between 40% to 50%. Also, inside of this percentage asset, it will go down a little bit, but still yield this level.

The second question answer is about the better provision we focused on come mainly from IA, Industrial Automation and this quarter goes down because several quarters before, our margin team internally can show the contract and also we revealed our customers' performance to show this part. That's why we have already taken up better provision and in future, it still goes down from our perspective.

(interpreted) Xie xie, Alex.

Our next question comes from Jacqueline Du from Goldman Sachs. Please go ahead.

(Spoken in Mandarin).

Hi Jacqueline, ni hao.

(interpreted) The first question is about the Industrial Automation backlog and the revenue and also new order goes down and what about the trend in future? Also please mention and talk about the contract size, even gross margin look at something in the project of Jiujiang Shenhua one gigawatt power station project. Second question is about Concord and Bond and M&E, mechanical electrical installation services, and their business, what about the cost structure, which part, spare parts for example or components, comes from abroad and which parts are produced by themselves.

(interpreted) About the Industrial Automation, the revenue backlog and also new orders are going down, but I want to mention in the backlog, this is just including the integrated contract, not already excluding the service rendered and the after-sale spare parts sale. So along with our after-sale, revenue goes up, like services rendered you could see and also spare parts is growing. So in future, we will try our best to increase our Industrial Automation business. Also, about the Jiujiang Shenhua project, its one gigawatt power station and the contract side, generally speaking we cannot disclose here, but just to let you know, within the Industrial Automation, most of our contracts are constructed by the small sites and we have a lot of number of projects.

(Spoken in Mandarin).

(interpreted) Actually Jacqueline is concerned about if the external rate will affect any part or even the whole business of Hollysys and therefore asked about external rate. It will affect very little in our business. Actually we have local accounts spend money -- I mean for the local settlement for the business and this does not affect our P&L, but because a lot of components or business will already divest in local areas and also we -- right now our business is based on a lot of localization providers, suppliers, but its rate will affect the translation. For example, we have a whole asset translation in the balance sheet, so this is what effect, but each company will meet the same situation.

(Spoken in Mandarin).

(interpreted) Xie xie, Jacqueline.

Our next question comes from Boyong Liu from JP Morgan. Please go ahead.

(interpreted) The first question is about Industrial Automation. The Industrial Automation gross margin is going down, so what about the future trend? Second question is about C3, 300 kilometers per hour ATP, the price that order is going down, so when is it going to reflect to the net income and why -- because this order book, the price is -- was goes down very large, so why you could also can show the high speed rail gross margin between 40% to 50%. The last question is down to the second quarter railway revenue, goes up very quickly. So which main reason, I mean which part of products are contributing to this sector?

(interpreted) For industrial automation, gross margin goes down, it has a lot of factors account for the changes. In future, it will continue to go down a little bit, but why compare this year and last year? Because last year the gross margin was very high because internally the nuclear power contract we have actually from CNNC that that project affected the overall gross margin for industrial automation, but we don't think in future we will continue to get the contract from that side. So generally speaking, it's really based on the project, the internal of the Industrial Automation structure, but as a trend, it will go down a little bit but still maintain 35% to 40% from we announced that first time.

About the reflection of that contract to the net income, it will be based on the percentage of completion of our project and along with it finish the project, we will continue to make the recommendation of the revenue and some part of it already enters to this quarter and some parts will go to the next fiscal year.

About the last question, I want to emphasize here that 40% to 50% is the overall high speed rail signaling part gross margin. If based on the single order of last time, the gross margin is lower than that, but from our structure of internal control of the cost and the procurement, we still have confidence to achieve 40% to 50% generally for the high speed rail whole segment.

(Spoken in Mandarin).

(Spoken in Mandarin).

(interpreted) About the question is the SCADA gross margin is very low compared to high speed rail. So what about the overall for railway transportation segment? The answer is about because the high speed rail revenue right now still takes a very large percentage of the whole rail transportation segment. So we still could control very well with the sector gross margin.

(Spoken in Mandarin).

Xie xie.

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

Thank you. Our final question today comes from Peter Halesworth from Heng Ren Investments. Please go ahead.

Thank you. This is for Mr. Shao. I want to address an important issue for Hollysys shareholders and that's the rising pile of cash on the balance sheet and ask for a regular dividend to be paid to shareholders.

Our analysis at Heng Ren, which we'll share with management and shareholders, shows Hollysys could easily pay shareholders a minimum $50 million annual dividend now and through fiscal year 2019 and Hollysys would comfortably be able to cover its CapEx and debt service as well. There's a $250 million net cash pile, doesn't really need to grow anymore. Hollysys' valuation needs to grow and we believe it's a great opportunity now to do just that.

If Hollysys made a commitment to a regular dividend, we believe it would win many more shareholders and a valuation premium, which we believe Hollysys deserves, and with Chinese stocks being so volatile, a predictable growing stream of income from Hollysys for shareholders would stand out and, we believe, be rewarded with a premium valuation instead of a stock trading in the single digits in terms of PE.

Also embarking on M&A with the cash at such a low valuation would be counterproductive. So my question for CEO Shao is would you pledge tonight to implement a regular dividend to increase greater value for all shareholders? I also would be curious to know what other shareholders think of this proposal, which we'll share shortly. Thank you.

Thank you Peter. (Spoken in Mandarin).

(interpreted) Thank you Peter for the question. Generally speaking, because the microeconomics are slowing down and a lot of uncertainty. So we still want to hold the cash relatively in a large base because in Chinese word, we have -- if winter comes, we need more clothes. So that's why we hold a lot of cash on hand and also we are a very small company, you know, in such an environment.

For the dividend, your suggestion, we will consider it very seriously. Actually, last fiscal year we already paid a dividend but that was just a one-time. In future, we are in the discussion right now for the management team and we will consider your suggestion very seriously. Thank you.

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

Thank you.

Xie xie. Thank you.

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