Hollysys Automation Technologies Ltd (HOLI) 2016 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Hollysys Automation Technologies fiscal year 2016 fourth quarter and fiscal year ending on June 30, 2016 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, August 15, 2016 Beijing time. 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 the fiscal year, and Ms. Qu will discuss our performance from financial perspective and the financial outlook for fiscal year 2017, 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, the mix -- the statements are the statements that are not historical fact [yes], the mix of products in future periods and future operating results. Such forward-looking statements, based upon the current beliefs and the expectations of Hollysys' management, are subject to risks and uncertainties which could cause actual results to differ from 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; 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' 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 U.S. 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 greetings to everyone. I would like to discuss some key events during this year. In fiscal year 2016 we kept a steady revenue growth and outperformed the challenging earnings guidance we had announced previously, as well as cash flow, despite difficulty in macro economy. When we (inaudible) the achievements, we calmly evaluated the future opportunities and the challenges, and also carefully planned for the future growth.

Here we would like to discuss some achievements in the past fiscal year and strategies in future. In industrial automation, the soft performance was mainly because of the influence of general economic environment. During the past fiscal year, China continued adjusting its industry structure and reducing the capacity in some industries such as petrochemical, metallurgy and building materials.

However, Hollysys took several strategies to mitigate the impact of market headwinds. We gained more market share from rising industries to make up for the loss from decreasing industries. We were doing well in power and chemical, which took up the largest portion of our revenue in industrial automation.

We further penetrated into high-end market. For instance, we won several [bids] in providing DCS for supercritical coal fire generating units, such as Funeng Luoyuanwan, double gigawatt, Jiujiang Shenhua double gigawatt, Guohua Ningdong double 660 megawatts, and Xinjian TBEA double 660 megawatt power units.

In nuclear sector, we supplied DCS for Hongyanhe number 5 and number 6 units. In addition, after-sales revenue was still reinforced for fiscal year 2016. With our special team we kept reviewing existing customers, the demand of upgrade and maintenance continued growth.

Besides, the Company has actively expanded in abroad. We signed some contracts which delivered our own proprietary products in overseas markets. In India, for example, Lanco Solar Power Polycrystalline Silicon Project [where we] implemented our DCS (inaudible). In Indonesia, Qingshan double 350 megawatt coal fire power units will use our DCS and DEH. We will continue to win more customers and enlarge overseas business of scale to support long-term growth of IA.

In factory automation sector of IA, we are changing the strategies around providing single products, to providing customized turnkey solutions, like what we are doing in the process control to help the customers solve their problems and satisfy their needs. We expect this sector has a good performance in the near future.

The performance of railway transportation are prominent. In high-speed rail sector, we won some contracts to provide the train control center and other related ground-based products, such as Chongqing to Wanzhou line and Xi'an to Chengdu line. We also won several contracts in automatic train protection.

In the future, according to the new five-year plan and even longer, the investment scale of the central government in high speed rail will be still sizable. At the same time, track circuit has finished the second test in June 2016. This new product could make a revenue contribution in the upcoming years.

Another strong driver of railway transportation sector for this fiscal year was subway business. We signed the contracts to provide SCADA system for Qingdao line R3, Kunming line 3, Chengdu line 10, Lanzhou line 1, Wuhan line 8, et cetera. We will continue to work closer with local subway authorities, to expand our SCADA business for better marketing our subway signaling control system.

In the mechanical and electrical solutions segment, although Concord and Bond are facing some difficulties, like project delays and depreciation of local currency, they are still working hard to expand their business. Concord, for example, signed a very large contract to provide electrical installation service for Doha Metro Phase 1.

As one of the strategies to expanding the overseas market, we will ensure a healthy development of Concord and Bond, and take use of the advantage of these two companies, such as good customer relations and sales channels, to ink more international opportunities.

With that, I'd like to turn the call over to Arden Xia who will [revisit] the financial results analysis, on behalf of CFO Ms. Herriet Qu.

Thank you Mr. Shao. I would like to share some highlights for the fourth quarter of fiscal year 2016 and the fiscal year ending June 30, 2016.

Comparing to the prior fiscal year, the total revenues for fiscal year 2016 increased from $531.4 million to $544.3 million, representing an increase of 2.4%. Broken down by the revenue [tasks], integrated contracts revenue decreased by 0.7% to $477.8 million, product sales revenue increased by 37.2% to $54.5 million, and service revenue increased by 13% to $12 million. The revenues in categories, industrial automation $182.9 million, rail transportation $240.3 million, mechanical and electrical solutions $95.3 million, miscellaneous $25.8 million, total $544.3 million.

Overall gross margin, excluding non-cash amortization of acquired intangibles, was 37.9% for the fiscal year 2016, as compared to 41.2% for the prior year. The non-GAAP gross margin for integrated contracts, product sales and services rendered were 35.2%, 56% and 66.4% for fiscal year 2016, as compared to 38.5%, 68.4% and 61.4% for 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 37.8% for the fiscal year 2016, as compared to 40.3% for the prior year. The GAAP gross margin for integrated contracts, product sales and services rendered were 35%, 56% and 66.4% for the fiscal year 2016, as compared to 37.6%, 68.4% and 61.4% for the prior year respectively.

Selling expenses were $25.6 million for the fiscal year 2016, representing a decrease of $0.7 million, of 2.4%, compared to $26.3 million for the prior year. Presented as a percentage of total revenues, selling expenses were 4.7% and 4.9% for the fiscal year 2016 and 2015 respectively.

G&A expenses, excluding non-cash share-based compensation expenses, were $42 million for fiscal year 2016, representing a decrease of $6.3 million, or 13.1%, as compared to $48.3 million for the prior year. The decrease was mainly due to a decrease of $7.4 million in bad debt provision. Presented as a percentage of total revenues, non-GAAP G&A expenses were 7.7% and 9.1% for fiscal year 2016 and 2015 respectively. The GAAP G&A expenses, which include the non-cash share-based compensation expenses, were $45.8 million and $50.8 million for the fiscal year 2016 and 2015 respectively.

R&D expenses were $36.6 million for the fiscal year 2016, an increase of $0.8 million, or 2.2%, compared to $35.8 million for the prior year. Presented as a percentage of total revenues, R&D expenses were both 6.7% for fiscal year 2016 and 2015 respectively.

The VAT refunds and government subsidies were $22.9 million for the fiscal year 2016, as compared to $30.4 million for the prior year, representing a $7.5 million, or 24.7%, decrease which was primarily due to decrease of the VAT refunds of $5.5 million and the government subsidies for $2 million.

The income tax expenses and the effective tax rate were $14.2 million and 10.3% for fiscal year 2016, as compared to $26 million and 20.8% for the prior year. According to the Notification of Preferential Enterprises Income Tax of Software and Integrated Circuit Industry finance and tax policy in 2016, the 49th article which was issued in May 2016 by the China State Administration of Tax and the Ministry of Finance, Beijing Hollysys and Hangzhou Hollysys satisfied the definitions of Key Software Enterprises, and applied to a preferential tax rate of 10% effective for the year from January 1, 2015 to December 31, 2015, instead of the 15% used by the Company in calendar year 2015.

As a result, the Company recorded a tax benefit of $7 million during the fourth quarter of fiscal year 2016. In addition, during the fourth quarter of fiscal year 2016, $3.1 million withholding tax expenses were accrued for the potential profits distribution from PRC to overseas. Excluding the impact of the abovementioned tax benefit and withholding tax expenses, the effective tax rate for fiscal year of 2016 should be 13.2%.

The non-GAAP net income attributable to Hollysys, which excludes non-cash share-based compensation expenses, amortization of acquired intangibles, acquisition-related consideration fair value adjustments and convertible bond related fair value adjustments, was $121.5 million, or $2.02 per diluted share based on 60.6 million shares outstanding for fiscal year 2016.

This represents a 17.6% increase over the $103.3 million, or $1.72 per share based on 60.1 million shares outstanding, reported in the prior year. On a GAAP basis, net income attributable to Hollysys was $118.5 million, or $1.97 per diluted share, representing an increase of 22.7% over the $96.5 million, or $1.61 per diluted share, reported in prior year.

The quarter results ended June 30, 2016 as follows. Comparing to the fourth quarter of prior fiscal year, the total revenue for the three months ended June 30, 2016 increased about $142.2 million to $147.7 million, representing an increase of 3.9%. Broken down by the revenue types, integrated contracts revenue increased by 4.5% to $132.9 million, product sales revenue increased by 7.3% to $11.6 million, and services revenue decreased by 24% to $3.3 million.

The revenue in categories. Industrial automation $41.3 million [sic - see press release: $41.1 million], rail transportation $65.9 million, M&E $32.9 million, miscellaneous $7.7 million, total $147.7 million.

Overall gross margin, excluding non-cash amortization of acquired intangibles, was 39.9% for the fourth quarter, as compared to 41.4% for the same period of the prior year. The non-GAAP gross margin for integrated contracts, products sales and services rendered were 37.4%, 58% and 74.7% for the fourth quarter, as compared to 39.2%, 61.1% and 59.4% 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 39.8% for the fourth quarter, as compared to 41.2% for the same period of prior year. The GAAP gross margin for integrated contracts, product sales and services rendered were 37.3%, 58% and 74.7% for the fourth quarter, as compared with 38.9%, 61.1% and 59.4% for the same period of prior year respectively.

Selling expenses were $6.7 million for fourth quarter, representing an increase of $0.1 million, or 1.6%, compared to $6.6 million for the same quarter of the prior year. Presented as a percentage of total revenues, selling expenses were 4.5% and 4.6% for the three months ended June 30, 2016 and 2015 respectively.

G&A expenses, excluding non-cash share-based compensation expenses, were $13.5 million for the fourth quarter, representing a decrease of $1 million, or 6.9%, as compared to $14.5 million for the same period of prior year. Presented as a percentage of total revenues, non-GAAP G&A expenses were 9.2% and 10.2% for the quarters ended June 30, 2016 and 2015 respectively. The GAAP G&A expenses, which include the non-cash share-based compensation expenses, were $14.1 million and $15.4 million for the three months ended June 30, 2016 and 2015 respectively.

R&D expenses were $8.6 million for the fourth quarter, an increase of $1.1 million, or 14.3%, compared to $7.5 million for the same quarter of prior year. Presented as a percentage of total revenues, R&D expenses were 5.8% and 5.3% for the quarter ended June 30, 2016 and 2015 respectively.

The VAT refunds and government subsidies were $2.8 million for the fourth quarter, as compared to $12.4 million for the same period in prior year, representing a $9.6 million, or 77.2%, decrease primarily due to a decrease of VAT refunds of $7.1 million.

The income tax expenses and effective tax rate were $1.1 million and 3.1% for fourth quarter, as compared to a $12.3 million and 38.5% for the comparable prior year period. During the fourth quarter of fiscal year 2016, the Company recorded a tax benefit of $7 million according to the newly issued Notification Withholding Tax -- Notification on Preferential Enterprises income Tax of Software and Integrated Circuit Industry finance and tax policy in 2016, the 49th article, and withholding tax expenses of $3.1 million for the potential profits distribution from PRC to overseas. Excluding the abovementioned impact, the effective tax rate for the fourth quarter should be 14%.

Non-GAAP net income attributable to Hollysys, which excludes non-cash share-based compensation expenses, amortization of acquired intangible, acquisition-related consideration fair value adjustments and the convertible bond related fair value adjustments, was $34.3 million, or $0.57 per diluted share based on 60.7 million shares outstanding for the fourth quarter. This represents a 48.8% increase over the $23 million, or $0.38 per share based on 60.6 million shares outstanding, reported in comparable prior year period. On a GAAP basis, net income attributable to Hollysys was $33.4 million, or $0.55 per diluted share, representing an increase of 78.9% over the $18.7 million, or $0.31 per diluted share, reported in comparable prior year period.

Hollysys' backlog for integrated contract, as of June of 2016, was $527.2 million, representing an increase of 5.8% compared to $498.5 million as of March 31, 2016, and a decrease of 7.3% compared to $568.5 million as of June 30, 2015. The detailed breakdown of backlog for integrated contracts by segment is shown below. Industrial automation $112.1 million, rail transportation $216.5 million, M&E $198.6 million, total $527.2 million.

For the fourth quarter, the total net cash inflow was $21.3 million. The net cash provided by operating activities was $46.7 million. The net cash used in investing activities was $2.5 million, mainly consisting of $107.1 million term deposit with original maturities over three months placed with banks, and $7.9 million used for purchases of property, plant and equipment, which was partially offset by $112 million generated from mature term deposits with original maturity over three months.

The net cash used in financing activities was $6.8 million, mainly consisting of $17 million used for repayment of short-term loans, $9.7 million used for repayments of long-term loans, which was partially offset by $7.7 million proceeds from issuance of shares of a subsidiary, $5.4 million proceeds from exercise of options, and $4.1 million proceeds from short-term bank loans.

For the fourth quarter of 2016, the total net cash inflow was $29.6 million. The net cash provided by operating activities was $9.9 million. The net cash provided by investing activities was $11.6 million. The net cash provided by financing activities was $12.2 million, mainly consisting of $7.7 million proceeds from issuance of shares of a subsidiary, and [$5.1] proceeds from exercise of share options.

The total amount of cash and cash equivalents and time deposits with original maturities over three months were $271.5 million, $256.4 million and $257.5 million as of June 30, 2016; March 31, 2016; and June 30, 2015 respectively. As of June 30, 2016, the Company held $229.1 million in cash and cash equivalents and $42.4 million in time deposits with original maturities over three months.

For fiscal year ended June 30, 2016, DSO was 162 days as compared to 176 days from the prior year. The inventory turnover was 38 days as compared to 41 days from the prior year. For the fourth quarter, DSO was 147 days as compared to 176 days for the comparable prior year period and 181 days for the last quarter, and inventory turnover was 37 days as compared to 43 days for the comparable prior period and 40 days for the last quarter.

Outlook for fiscal year 2017. Given our strong backlog currently on hand and sales pipeline envisioned so far, we set our guidance for fiscal year 2017 with revenue in the range of $565 million to $600 million and non-GAAP net income in the range of $130 million to $140 million.

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

We will now begin the question-and-answer session. (Operator Instructions) Our first question comes from Patrick Xu from Nomura. Please go ahead, the line is open.

(interpreted) The first question is about the regular dividend for the 2016; is there any trend right now? And the second question is about the cash flow and we saw last year's [financial report] they have no cash flow related dividend.

And the third question is about the Southeast Asia performance is relatively good. What kind of project or what kind of business is there and what are the cash flow circumstances? Is there any AR, accounts receivable or account payable related [consideration]? And the fourth [caller] [sic] is about the translation adjustment.

(interpreted) The Company has no regular dividend policy in the past years, so that's why the last year cash flow financial report you couldn't see any about this. But this is for year 2016, it really depends on the final decision of meeting of Board of Directors' resolutions.

(Spoken in Mandarin).

(Inaudible) [should income statement] (inaudible) [should comprehensive income] (Spoken in Mandarin) [GAAP net profit] (spoken in Mandarin).

(Spoken in Mandarin).

(Spoken in Mandarin).

Balance sheet, equity.

Okay. (Interpreted) Okay. The third question is about the income in the P&L financial report that the translation adjustment [is related] convert from the balance sheet, not for the P&L. So it is not a factor at the aggregate.

(interpreted) In Southeast Asia, our business, including the M&E part and besides that we also provide our own products like rail and industrial automation.

(interpreted) And also, for example like the industrial automation we have two directions. One is EPC project like the Qingshan project about the coal-fired station in Indonesia and also like the second direction is the local sales. We already set up a local team to sell our products like the project in India, Lanco project.

(Spoken in Mandarin). And currently the cash flow is also very [healthy] and we have not any problem with this situation.

(Spoken in Mandarin).

(Spoken in Mandarin).

Thank you. Operator, next one please.

Your next question comes from Kevin Luo from Morgan Stanley. Please go ahead, the line is open.

(Spoken in Mandarin)

Hi, Kevin.

(Spoken in Mandarin). I have three questions. The first one is why did the VAT refunds and the government subsidies decrease by 25% in fiscal year 2016?

And my second question is why did -- we find that our earnings contribution from the equity investment turned around and contributed $8 million in fiscal year 2016. Can you explain why?

The third question is we find the Company's effective income tax rate dropped by only 10% in fiscal year 2016. Will this be sustainable in fiscal year 2017 and the future? Thank you.

(interpreted) The first question is about the VAT refund and subsidy decline and this fiscal year compared to last fiscal year it goes down and the first (inaudible) VAT. VAT goes down is because we have a onetime discount for the railway contract [in 300] this fiscal year.

So we pay less and we pay less tax, and then we get less result. That's the reason for the VAT, and the subsidy is also in the health range of up and down, so if (inaudible) cheaper in future.

(interpreted) And the government subsidy is really related to the final [close] of the project. This does not mean we get less subsidy, just this fiscal year we have less projects. We do have [incremental] projects that are not finished yet, so that's why not that subsidy.

(interpreted) The second question about the share of net income of equity investees, these parts represent the company of China Techenergy Corporation. And in effect, the first reason is [they gave us] a government subsidy around [RMB88 million] versus 40% of our shares; we get around [RMB30 million].

Besides, their performance turns to positive this fiscal year. You could see in the financial report and in past years they -- that part is loss but this fiscal year turns to gain. That's why represented this (inaudible) which would see [7.8 million] increase from this part.

(interpreted) The third question is about the tax. This fiscal year we get a certificate of Key Software Enterprise and that this is related to policy of finance and cash, with the number 49 articles of Tax of Software and Integrated Circuit Industry, actually that part we just pay 10% of the income tax versus 15% as before. And this part [renew] each year and we believe we could continue [to get] the [license].

(Spoken in Mandarin).

Operator, next one.

Your next question comes from Alex Chang from Citigroup. Please ask your question, the line is open.

(Spoken in Mandarin)

Hello, operator? Alex?

Sorry, pardon the interruption. The line has disconnected; the line of the participant. If you wish, I can take a --

Okay, no problem. We can wait for the reconnect and I'll translate the first question right now. The first question from Alex is about the please share the information about the gross margin in each category within IA, rail, M&E and also what the trend is in next fiscal year, 2017?

And maybe we could answer the first question right now. (Spoken in Mandarin).

(interpreted) Okay. About the gross margin, in last fiscal year the first quarter, as we already said, for the gross margin we have different mix of different products and also the structure, right now it's changing. That's why these two main factors account for different gross margin and also the [influence].

And so we believe the next fiscal year, just like this fiscal year, that the gross margin will depend on the different project mix and also different revenue structure. Currently the IA is still okay and the rail, M&E is still in the range of what we said. So we will keep the gross margin in the next fiscal year.

Hi, Alex.

(Spoken in Mandarin).

(Spoken in Mandarin).

(interpreted) The second question is about that we give some guidance for the next fiscal year is the same as before, but just like this fiscal year 2016 the net income is performing very good. So could you break down the number that which part contributed the net income? And also, in future the three segments, IA, rail and M&E, what about their performance or performance in future, and also what about the control of the expenditure in future?

(interpreted) With the breaking down in future, the IA will -- we are (inaudible) in the fiscal year 2017 will keep flat. This is because one is from the (inaudible) automation that we will focus on the intelligent turnkey solution, and also have the overseas revenue contribution will continue to expand overseas market.

And also in the [mass] area the market currently seems not to go down any more and from the [new owner's] side, this fiscal year turns to good, then that fiscal year. So for example, last fiscal year each quarter had more than 30% decline but this fiscal year it turns to flat. And besides, the revenue structure is changing -- [aftersales] is increasing so the IA our target is to keep flat for the next fiscal year.

And the [railway transportation] -- because the subway side we continue to expand the SCADA business and also we have potential chance to get [some signaling] in the new product, the CBTC and the high-speed rail (inaudible) that everything is ready and we will get the contract. So that's why for railway transportation generally speaking for the next fiscal year we will achieve at least 5% to 10% revenue growth.

The last one is M&E segment, because we've already got a very large contract, $[16] million, so that is to say even that fiscal year this part will keep a very good performance. So we will try our best to achieve growth if we can.

And from the gross margin side, because [aftersales] revenue for example is increasing, and also we control the expenditure, the expenditure of the marketing, sales, selling, everything, that part will keep the same as this fiscal year. And also the [R&D] expenditure we'll keep at the same. This will not affect any operating expenditure, and also we will control the (inaudible) and the effective tax rate will keep relatively lower and will continue to do that.

(Spoken in Mandarin).

(Spoken in Mandarin).

(interpreted) The question is about could you please tell us the size of the contract for the track circuit and the CBTC system or any planning for the fiscal year 2017? The answer is we have no -- we cannot disclose the timeline currently and maybe when we (inaudible) first contract we can better give you a better landscape about the [process] side in future.

With the time constraint the last question, please, operator. Hello, operator, please?

Your next question comes from Boyong Liu from JPMorgan. Please ask your question.

(Spoken in Mandarin)

(Spoken in Mandarin)

(Spoken in Mandarin)

Okay, okay. The first question is about the first quarter, the result from the high-speed rail, [seems to be] performing very strong but last calendar year we get the contract and it seems like it already (inaudible) in the last quarter. And also the gross margin is still very high, above 45% so could you explain where it's from.

And the second part is about the effective tax rate. Is it possible that we can [just populate] the effective tax rate at 10% in the next fiscal year?

(Spoken in Mandarin)

The real (inaudible) rail for this quarter is because we have implemented the -- we based it on percentage of completion. The ATP contract would be (inaudible) in nine to 12 months.

So actually, this quarter will still have the ATP contract. Besides, the gross margin is relatively high because we get the supplement of the ATP project. So not just this quarter; even that quarter we still have ATP on hand, so that's why either from the revenue and the gross margin, high-speed rail is still very strong.

And the second question about the effective tax rate?

(Spoken in Mandarin)

About the effective tax rate, it's better not to calculate it at 10% because 10% is just [implemented] within two companies in Beijing, and the other companies' subsidiaries in China still implemented, some of them are around 15% and some of them are still 25%.

And [abroad], the subsidiaries, they implemented effective tax rates of currently about 17%. So it is better to [populate at] the comprehensive and also that depends on the revenue structure. So we think it's again around 13% for effective tax rate, and also like the same for the next fiscal year.

(Spoken in Mandarin)

(Spoken in Mandarin) 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. (Spoken in Mandarin).

(Spoken in Mandarin)

(Spoken in Mandarin)