Hollysys Automation Technologies Ltd (HOLI) 2016 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Hollysys Automation Technologies fiscal year 2016 third-quarter ended on March 31, 2016 earnings conference call. (Operator Instructions). Please be advised that this conference is being recorded today, May 16, 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 from Investor Relations.

On today's call Mr. Shao will provide a general overview of our business, including some highlights for the quarter. And Ms. Qu will describe our performance from a financial perspective and financial outlook for the third quarter of fiscal year 2016. And the whole senior management will answer questions afterwards.

Before getting 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 and 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, 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' 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 in its 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 to Mr. Shao. Please go ahead, Mr. Shao.

Thank you, Arden, and good evening to everyone. I would like to discuss some key events during this quarter.

For industrial automation business, we have insisted in executing our strategy to review the potential needs of the market in upgrading and reforming projects to mitigate the revenue which is continuously declining from new constructions in current situation. Industries like petrochemical, metallurgy and building materials still perform weak.

However, as supplemental, power industry is maintaining stable. We have signed several new DCS contracts in coal fire power, especially in high levels, the supercritical coal fire generating units, such as Jiujiang Shenhua, two units of 1 gigawatt; Guohua Ningdong, two units of 60 -- 660 megawatt; and Xinjiang, two units of 660 megawatt power units.

Nuclear side, we are providing DCS for Hongyanhe unit 5 and unit 6.

In factory automation, we will continue to expand our salesforce and allocate more resources to this area and to make an effort to raise our uniquely customized turnkey solutions.

As mentioned above, even though industrial automation revenue is declining, we will always try our best to minimize the impact, including adjusting internally to better cope with external environment and to keep a sustainable long-term healthy development.

In high-speed railway, as China is continuously investing a certain scale on supporting high-speed railway sector for the next five years, we are still benefiting from the policy of 13th five-year plan. As new products and technologies contribute in the next, we have confidence that the high-speed railway's performance will be remain stable.

For subway business, we won the new biddings for Chengdu Line 10 and Wuhan Subway Line 8 SCADA contracts. Meanwhile, the SCADA for Beijing Subway Line 14 middle section and Beijing Changping Subway Phase II are both in operating stages.

We gained consistent favorable reputation by the customers. This is encouraging us for seeking opportunities to work with more local transportation bureaus from the first-tier cities down. We will continue to deliver quality works and work closely with subway authorities in the future to build up our SCADA and subway signaling businesses.

In the mechanical and electrical solution segment, Concord and Bond have mainly focused in further development of Southeast Asia and Middle East markets. Even they are face difficulties, such as worsening markets, competitive environment, the lack of the new-built projects and project delays, rising cost and seasonal lumpiness. They are persevering in hard working.

For this quarter, revenue and backlog are both increased compared to same quarter last year. For long term, we think the market still has much potential demand. And we will strengthen internal control and adjustment to keep M&E development in the future.

Lastly, for extending international business, we are in the process of setting up local service centers in abroad. In India, we won the bidding to provide DCS and SIS to Lanco Solar Power Polycrystalline Silicon Project. In Southeast Asia region, we won the bidding to provide DCS and DEH for Indonesia Qingshan two-unit 350-megawatt coal-fire power units.

Through accumulating track record in the targeting area, we are enhancing our brand name recognition overseas. With our proprietary technologies and products, with industry expertise and customization solutions, we will continue to create value for our shareholders.

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

Thank you, Mr. Shao. I would like to share some highlights for the third quarter of fiscal year 2016 ended on March 31.

Comparing to the third quarter of the prior fiscal year, the total revenues for the three months ended March 31, 2016, increased from $118.2m to $118.8m, representing an increase of 0.5%.

Broken down by the revenue types, integrated contracts revenue decreased by 6.2% to $99.8m, products sales revenue increased by 64.7% to $16.2m, and services revenue increased by 39.6% to $2.9m.

The Company's total revenues can also be presented in segments. Industrial automation, $38m; rail transportation, $56.2m; M&E, $17.1m; miscellaneous, $7.5m; total, $118.8m.

Overall gross margin, excluding non-cash amortization of acquired intangibles, was 31.7% for the third quarter 2016 as compared to 46% for the same period of prior year.

The non-GAAP gross margin for integrated contracts, product sales, and services rendered were 27.1%, 55.5% and 59.1% for the third quarter as compared to 43.4%, 71.7% and 56% 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 31.7% for the third quarter as compared to 46% for the same period of prior year.

The GAAP gross margin for integrated contracts, product sales, and service rendered were 26.9%, 55.5% and 59.1% for the third quarter as compared to 42.8%, 71.7% and 56% for the same period of prior year respectively.

Selling expenses were $5.2m for this quarter, representing a decrease of $0.5m or 8.8 -- 8.3% compared to $5.7m for the same quarter of the prior year. Presented as a percentage of total revenues, selling expenses were 4.4% and 4.8% for the three months ended March 31, 2016 and 2015 respectively.

G&A expenses, excluding non-cash share-based compensation expenses, were $8.7m for the third quarter, representing a decrease of $0.3m or 3.2% as compared to $9m for the same period of the prior year. Presented as percentage of total revenues, non-GAAP G&A expenses were 7.3% and 7.6% for the quarters ended March 31, 2016 and 2015 respectively. The GAAP G&A expenses, which include the non-cash share-based compensation expenses, were $9.8m and $9.7m for the three months ended March 31, 2016 and 2015 respectively.

R&D expenses were $8.4m for this quarter, a decrease of $1m or 10.7%, compared to $9.4m for the same quarter of the prior year. Presented as a percentage of total revenues, R&D expenses were 7% and 7.9% for the quarter ended March 31, 2016 and 2015 respectively.

The VAT refunds and government subsidies were $4.3m for the third quarter, as compared to $6.6m for the same period in prior year, representing a $2.3m or 35.1% decrease.

For the nine months ended March 31, 2016, the VAT refunds and government subsidies were $20.1m, an increase of $2.1m compared to $18m for the same period of prior year respectively.

The income tax expenses and the effective tax rate were $3.4m and 12.4% for the third quarter, as compared to a $6.6m and 16.9% 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 11.9% for the current quarter and 18.1% (sic - see Press Release "17.8%")for the comparable prior-year period. The effective tax rate fluctuation was mainly due to the different pre-tax income mix with different tax rates as the Company's subsidiaries apply to different tax rates.

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 $23.1m or $0.38 per diluted share based on 60.6m shares outstanding for the three months ended March 31, 2016. This represents a 20.2% (sic - see Press Release "21.7%") decrease over the $29m or $0.49 per share based on 59.2m shares outstanding reported in the comparable prior-year period.

On a GAAP basis, net income attributable to Hollysys was $21.9m or $0.36 per diluted share, representing a decrease of 31% over the $31.6m or $0.53 per diluted share reported in the comparable prior-year period.

Hollysys' backlog for integrated contracts as of March 31, 2016, was $498.5m, representing a decrease of 5.4% compared to $527m as of December 31, 2015, and almost equal to $498.7m as of March 31, 2015.

The detailed breakdown of the backlog for integrated contracts by segments is industrial automation, $107.8m; rail transportation, $259.8m; M&E, $103.9m; total, $498.5m.

For the three months ended March 31, 2016, the total net cash inflow was $10.8m. The net cash used in operating activities was $16.7m. The net cash provided by investing activities was $29.8m, mainly consisted of $52.2m as maturity of time deposits with original maturities over three months, which was partially offset by $20.4m in time deposits over three months placed with banks.

The net cash used in financing activities was $3.8m, mainly due to repayments of long-term bank loans of $5.4m, which was partially offset by proceeds from short-term bank loans and long-term bank loans of $1.2m.

The total amount of cash and cash equivalents and time deposits with original maturities over three months were $256.4m, $275.6m, and $179.7m as of March 31, 2016, December 31, 2015 and March 31, 2015, respectively.

As of March 31, 2016, the Company held $199.5m in cash and cash equivalents and $56.9m in time deposits with original maturity over three months.

For the three months ended March 31, 2016, DSO was 181 days, as compared to 228 days for the comparable prior-year period and 138 days for the last quarter. And inventory turnover was 40 days, as compared to 66 days for the comparable prior-year period and 34 days for the last quarter.

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 $565m and $600m, and non-GAAP net income in the range of $110m to $120m.

At this time, we would like to open up for Q&A session. Please note that for Chinese-speaking participants, we can also to the Q&A in Mandarin and we will provide a translation.

(Spoken in Chinese).

Operator, please.

(Operator Instructions). Baiding Rong, Credit Suisse.

(Interpreted). The first question is about the gross margin relatively declined. What about the reason? Is it caused by ATP? Last time the one-time ATP contract cut off the price. This is maybe the one of the reasons, but what about the others? And what about after this quarter, in the next the trend will affect the future.

The second question is about the coal fire. Right now we hear about some information that the Chinese government in some province stopped to pass the new projects in coal fire stations. What about the factor with Hollysys in the next fiscal year? And what about the net income?

So the third question is in the longer term are we able to maintain, say, 10% EPS growth in the future given that the process automation still has a lot of headwind going forward? Thank you.

Thank you.

(Interpreted). The gross margin decline for this quarter was mainly due to the different revenue mix with different margin. For example, in IA, the low-margin products take more percentage. In high-speed rail the one-time reduced price ATP contract -- besides that rail revenue is increasing -- take around 17 to 18 percentage of the total rail transportation revenues. So the gross margin relatively lower than the other business.

These factors account for the gross margin temporarily falling to around 31.7% for this quarter. However, at the whole fiscal year the gross margin will remain between 35% to 40%. And right now, for nine months the gross margin is 37.2%.

And also another question relates to the future trend about ATP contracts. Last time the reduced-price ATP contract, we already make a -- recognized revenue in this quarter, the [March] percentage than the others. So in the next quarters it will affect relatively small.

(Interpreted). Recently, the news related to the central government to continue to stop to sign the -- [tap] the new projects within the coal-fired power station. This is not affect our business in fiscal year 2017 too much because we already got a lot of projects and contracts within the coal-fired power station.

And for long term, this is not sustainable so we already change our strategy to focus on the upgrading, maintenance to review the customer projects. So we will continue to focus these areas, and also in the new energy, such as new energy, the other industries as supplement to support the whole IA revenue, relatively keep it steady in future.

For long term, we still have confidence to achieve the 10% growth of the net income in future. Besides we will focus on IA high-quality solutions and also inside the vertical, penetrate in the other industries. And also in the distributed control factory automation, we will continue to reallocate the resources into this area.

In addition, we're also seeking to do the expansion on international business, like we got the contract in India and Indonesia recently. We will continue to do that as supplement to support the whole Hollysys revenue and net income keep a steady growth.

(Interpreted). The question is about the projects in India and Indonesia. Is this the One Belt, One Road opportunities?

(Interpreted). And the answer is that in India the project we based on our direct sale. We set up a local center to cooperate with the customer and we get -- we got the contract.

For Indonesia, that contract is followed by the EPC project. Thank you.

Operator, next one.

Alex Chang, Citigroup.

(Interpreted). The first question is about the cash flow. Especially you could see equity investee increased $4.6m. What does it come from?

The second question is about the revenue structure. We could see product sale increased $16m. What this part represents?

(Interpreted). This part is come from the joint venture company with CGNPC and the equity investee around $4.6m. In the past years, this part is negative. However, from this year it turns to positive and the joint venture company gets -- already got the government subsidy. So that's why as the 40% of the joint venture company we got this money as [the same].

The product sale increase is really because all the sub -- all the business, product sale is increasing. For example, like IA is increasing and also railway transportation and also medical automation.

And Alex continue to ask about what about IA and rail inside the increase of the product sale. Is it a matter related to the lifecycle, we see the trend to start?

(Interpreted). The answer is it is not like that way. Actually from -- the product sale is one hand. On the other hand, we also increased from the spare parts of the projects. Thank you.

Operator, please, next one.

Jacqueline Du, Goldman Sachs.

(Interpreted). The question is about the -- what about the future new order in the railway transportation within the fiscal year 2017 and 2018? What about the rail transportation segment that will take the percentage of total revenue? And how about the SCADA and the new product like [track circuit] trend or contract size in future?

(Interpreted). Actually subway business, we already been for a long time and each year we will focus on to penetrate one or two new cities and we'll meet this target. So the subway revenue is increasing. Besides the track circuit, the new product that's already in the testing and we will finish around June, this fiscal year -- this calendar year. And after that we will got the new orders. And also the subway signaling, we will try our best to take one -- the first contract in future.

Related to the number in future of the whole railway transportation revenue, we will -- we have confidence to keep increasing. However, it's hard to give you the number, exact number right now. It's really based on the performance in future. Thank you.

At this -- due to the time constraint, we will now take one last question from the queue. Operator?

Boyong Liu, JPMorgan.

Hi, Boyong. Hello?

(Operator Instructions).

Hi, Boyong?

(Interpreted). The first question is about the joint venture company with CGNPC. What about the government subsidy? This is around RMB80m for the joint venture company. What about the future? Each year we'll get the same amount of money?

Second question about the gross margin. Besides the ATP contract, what about IA? It seems like IA gross margin is also going down. So what about the trend?

The third question is about ATP order. It seems not get too much for this quarter. So as the result, the subway revenue will take even more percentage than before. So what about the next quarters, the trend? Is it worse than before?

And the DCS, the last question is about the DCS inside. What about the distributed control factory automation progress right now? It seems like PLC market is still not good. So what about your view of this part?

(Interpreted). The first question is about the joint venture company with CGNPC. This is just a one-time government subsidy. It's not guaranteed in future.

For the IA gross margin, it's also declined. This is not for the business itself; it's just for timely -- one-time for this quarter relatively the low-margin projects take more percentage.

Because the quarterly lumpiness, this is really because of what we said before, inside of IA, the integrated contracts, the projects just are relatively 5% in the range of 35% to 40% gross margin. The other half will lower than the 35% and also the other half will higher than 40%. So this is really because the mix of the projects.

So for the long term the gross margin is still under control between 35% to 40% for the whole business. However, the lumpiness in quarterly, this will remain [in it].

So back to the subway, you said it will take much more percentage. We also will try our best to increase the gross margin inside the subway. And so basically to say for the whole business, we will continue to maintain 35% to 40%, this range of gross margin. Thank you.

(Interpreted). The IA business will continue to keep the DCS in the process control to accumulate track records, take more percentage, take more market share in future.

Back to the factory automation question, in the past years we just provide PLC as the single product sales. However, we right now want to do the turnkey solution. This will include our PLC products, and also with the other product, like motion controller and also the software. And by the industries we will get involved like the medical, pharmaceutical area.

So right now -- and also in the solution, we also provide SCADA, for example. SCADA refers to supervisory control and data acquisition. This platform can also implemented into the factory automation.

So in future we will continue to keep our best to keep -- to help the factory automation increase to contribute to the revenue of the IA. And we also will create a new company.

(Interpreted). And also Boyong ask us another question about how -- about the percentage right now for the factory automation [take] part of inside of IA.

(Interpreted). And the answer is right now the number is not very large. It's not very large, so still small. But we will continue to reallocate resources into this area and you could see the new order in recent quarters. 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 contact. We look forward to speaking with you again in the near future. Thank you.

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