Hollysys Automation Technologies Ltd (HOLI) 2017 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Hollysys Automation Technologies' Fiscal Year 2017, First Quarter, Ended on September 30, 2016 Earnings Conference Call.

(Operator Instructions). Please be advised that this conference is being recorded today, November 15, 2016, Beijing Time.

I would now like to hand the conference over to Mr. Arden Xia, the Investor Relations Director 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, the IR Director of Hollysys.

On today's call Mr. Shao will provide a general overview of our business, including some highlights for the quarter. Ms. Qu will discuss our performance from a financial perspective, 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 Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that are not historical facts, including statements relating to the expected growth of Hollysys' future product introductions, the mix of products in future periods, and future operating results. Such forward-looking statements, based upon the current beliefs and expectations of Hollysys' management, are subject to risks and uncertainties which could cause actual results to differ from the forward-looking statements.

The following factors, among others, could cause actual results to differ from 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 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 US dollars unless otherwise noted.

And now I'd like to turn the call to Mr. Shao. Please go ahead, Mr. Shao.

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

Due to continued uncertainties of macroeconomic, the pace of industrial automation is still slow. However, we are actively taking actions to dampen the impact of challenging markets. The new contract turns to be positive. We got several significant contracts from the power and chemical sectors.

For example, in power, we signed the contract to provide products for Fujian Luoyuanwan two 1-gigawatt power units and Guohua Ningdong two 660-megawatt power units. In chemical, we will provide DCS and SIS for Xinjiang East Hope Company, as well as DCS and Batch for ASIA CUANON in its Waterborne Coatings Project. In after-sale, we signed some upgrading contracts for power units like Guohua Jinjie two 600-megawatt power units.

Additionally, we signed DCS contracts to #5 and #6 units of Tianwan Nuclear Station, as well as #3 and #4 units of Fangchenggang Nuclear Station. In abroad, we signed a contract with Indonesia Qingshan to provide products for their two 350-megawatt coal-fired power units. We also got a contract from Lanco to provide PLC to them in India.

For factory automation, we integrated [international] resources to do customized turnkey solutions. In this quarter, we signed a contract with Haier to help them improve the level of automation and intelligence of their Tianjin-based factory which focuses on washing machines. Our goal is to make each project into a demonstration project to create value for the customers.

In high-speed railway, as it is the first year for the thirteenth five-year plan, the infrastructure of the new planned railway just starts. In short term, there will be fluctuation both on order and revenue. However, for long run, we are confident that the high-speed railway's performance will be as good as before since China is continuously investing a certain scale on supporting high-speed railway sector for the next even ten years, plus the increasing in (inaudible) and the expanding of rail products such as track circuit. We believe to achieve the yearly target and maintain steady revenue contribution in railway. For subway business, we will continue to actively expand domestic market and looking for opportunities to keep steady growth.

In the mechanical and electronic installation services, although Concord and Bond are facing some difficulties because of the local political and economic uncertainties in South East Asia and Middle East area, they are still hard working to develop the businesses. As one of the strategies to expanding overseas market, we will ensure a healthy development of Concord and Bond and take use of their advantages such as good customer relations and sales channels to find more international opportunities.

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

Thank you, Mr. Shao. I would like to share some highlights for the first quarter of fiscal year 2017, ended on September 30, 2016.

Comparing to the first quarter of the prior fiscal year, the total revenues for the three months ended September 30, 2016 decreased from $125.1 million to $103.5 million, representing a decrease of 17.2%. Breaking down by the revenue types, integrated contracts revenue decreased by 16.2% to $93.1 million; products sales revenue decreased by 27.3% to $8.3 million; and services revenue decreased by 17.9% to $2.1 million.

In July 2016, the Company's interests in Hollycon were diluted from 51% to 30% and the Company lost the control of Hollycon. As a result, Hollycon's financials would not be included in the Company's consolidated financials from July 2016. If Hollycon's revenue was excluded from the comparable figure for the first quarter of the prior fiscal year, the products sales revenue for the three months, ended September 30, 2016 should be increased by 45.7%.

The Company's total revenues can also be presented in segments. Industrial automation $45 million, railway transportation $33 million, M&E Solutions $25.3 million; miscellaneous $0.1 million. Total $103.5 million.

Overall gross margin excluding non-cash amortization of acquired intangibles was 29.6% for the first quarter, as compared to 39.3% for the same period of prior year. The non-GAAP gross margin for integrated contracts, product sales, and services rendered were 25%, 70.5% and 69.7% for the first quarter, as compared to 37.3%, 52.6% and 65.5% 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 29.5% for the first quarter, as compared to 39.1% for the same period of prior year. The GAAP gross margin for integrated contracts, product sales, and service rendered were 24.9%, 70.5% and 69.7% for the first quarter, as compared to 37.1%, 52.6% and 65.5% for the same period of prior year, respectively.

Selling expenses were $5.6 million for the first quarter, representing a decrease of $1 million or 16.2% compared to $6.6 million for the same quarter of prior year. Presented as a percentage of total revenues, selling expenses were 5.4% and 5.3% for the three months ended September 30, 2016 and 2015, respectively.

G&A expenses, excluding non-cash share-based compensation expenses, were $9.7 million for the first quarter, representing an increase of $0.8 million or 9%, as compared to $8.9 million for the same period of prior year. Presented as a percentage of total revenues, non-GAAP G&A expenses were 9.3% and 7.1% for quarters ended September 30, 2016 and 2015, respectively. The GAAP G&A expenses, which included the non-cash share-based compensation expenses, were $10.6 million and $9.8 million for the three months ended September 30, 2016 and 2015, respectively.

R&D expenses were $7.7 million for the respective quarters ended September 30, 2016 and 2015. Presented as a percentage of total revenues, R&D expenses were 7.4% and 6.2% for the quarter ended September 30, 2016 and 2015, respectively.

The VAT refunds and government subsidies were $9.6 million for the first quarter, as compared to $5.1 million for the same period in prior year, representing a $4.5 million or 88.7% increase, which was primarily due to increase of VAT refunds of $2.2 million and the government subsidies of $2.3 million.

Gains on dilution and divestment of the Company's interests in Hollycon was $6.1 million for three months ended September 30, 2016. During the period from June to July 2016, Hollycon received cash injections of $30.9 million from two outside shareholders, and the Company decided not to make the additional cash investment proportionally. As a result, the Company interests in Hollycon were diluted from 51% to 30.6%. Then, the Company sold 0.6% interests of Hollycon to one of Hollycon's shareholders in a cash consideration of $464,000, and the Company interests in Hollycon were further decreased to 30%. The Company recorded a gain of $6.1 million for the series of the transactions. As the Company lost the control of Hollycon, Hollycon's financials would not be included in the Company's consolidated financials from July 2016 on.

The income tax expenses and the effective tax rate were $3 million and 12.2% for the first quarter, as compared to a $4.7 million and 12.9% for comparable prior-year period.

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 $22.7 million or $0.37 per diluted share based on 61.1 million shares outstanding for the first quarter. This represents a 16.7% decrease over the $27.3 million or $0.45 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 $21.7 million or $0.36 per diluted share, representing a decrease of 28.3% over the $30.3 million or $0.5 per diluted share reported in comparable prior-year period.

Contracts and backlog. Hollysys achieved $116.2 million (sic -- see press release '$99.2 million') new contracts for the first quarter. And the backlog as of September 30, 2016 was $525.2 million.

The detailed breakdown of the new contracts and backlog by segments. Industrial -- new contracts. Industrial automation, $61.5 million, railway transportation $31.5 million, M&E solutions $6.2 million. Total $99.2 million.

Backlog. Industrial automation $132 million, railway transportation $218.7 million, M&E $174.6 million. Total $525.2 million.

Cash flow. For the first quarter, the total net cash outflow was $16.8 million. The net cash provided by operating activities was $17.8 million. The net cash used in investing activities was $34 million, mainly consisted of $20.4 million time deposits placed with banks, and $16.7 million outflow as a result of that Hollycon would not be included in the consolidated financials from July 2016. The net cash provided by financing activities was $0.4 million.

The total amount of cash and cash equivalents and time deposits with original maturities over three months were $260.9 million, $271.5 million, and $234.9 million as of September 30, 2016, June 30, 2016 and September 30, 2015, respectively. As of September 30, 2016, the Company held $212.3 million in cash and cash equivalents and $48.6 million in time deposits with original maturities over three months.

For the first quarter, DSO was 207 days, as compared to 179 days for the comparable prior-year period and 147 days for the last quarter; and inventory turnover was 48 days, as compared to 42 days for the comparable prior year period and 37 days for the last quarter.

Outlook for fiscal year 2017. Given our strong backlog currently on hand and sales pipeline envisioned so far, we reiterate 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-speaking participants, we can also do the Q&A in Mandarin and we'll provide translation.

Operator, please.

We will now begin the question and answer session. (Operator Instructions).

Your first question comes from Alex Chang from Citigroup. Please ask your questions.

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The first question is about, first, the IA new order is increasing. Is there any -- please introduce by industries which areas we see the recovery and how much percentage.

The second question is about the railway. The revenue is declining, but the after-sale revenue is also decline. In my personal view, the installation base, and the after-sale revenue based on installation base -- the rail sector you have very good installation base. Why the after-sale revenue is still declining?

The third question is about Hollycon. The Hollycon business is what kind of specific business? And why management team considered not control for Hollycon?

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The first question answer is about the power industry, coal-fired, is still very strong, even there will regulations of limitations from the government, but this part still increased very good. We fund a lot of chances and opportunities to raise large capacity gigawatt -- large capacity projects. And also after-sale revenues increased within this part.

But, however, it is not a kind of recovery (technical difficulty) --

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(Spoken in Mandarin) -- (inaudible) because he lost connection.

Pardon the interruption ladies and gentleman, it appears the moderator's line has disconnected. Please stand by while we reconnect him.

Hi, [Jessica], this is Arden. Sorry, the line was off, and I will translate again.

And the first question, the answer is although, beyond -- the coal-fired industry is increasing and also after-sale revenue is increasing, but it is not that as they recover -- we think there are still a lot of uncertainties. So we have to see in the future.

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The second question tends to focus on not just the rail -- as the whole business, why the revenue and also after-sale revenue declined. The contract revenue has been affected a lot by the decline in rail transportation revenue. The product sale decrease was due to the Hollycon company's revenue being excluded. If eliminating these factors, the first quarter of product sales should be increased, even more than 45%.

And the services revenue decrease was because of the time difference on the forming of revenue. Some of our service contracts, for example, are based on complete contract method so there will be a (inaudible) by quarterly but no disruptive effect on a yearly basis.

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Hollycon's main revenue stream is come from TCM dispensing machines and the business is [too unitary]. For better developed market business, especially the ones close to the team or healthcare robot automation we choose to cooperate with new partners which are more professional in medicine for healthcare areas.

New business developed will also bring more risks or uncertainty. To balance the risks and incentives, partners -- we adjusted equity from 51% to 30%. The last one I want to emphasize, this does not mean we jeopardized the medical automation, but defined more clearly -- if the business feature is close to medicine or healthcare, we would do it like the Hollycon. If the business is focused on automation, we would like the relevant team to do that.

There are also examples that we currently do in factory automation like on Chinese medicine extraction with [Jing Yue Chuan] TCM pharmaceutical factory, we signed a contract provided automation side control products and solutions. Thank you.

Operator, next one?

Your next question, Kevin Luo from Morgan Stanley. Please go ahead, sir.

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The first question is about the revenue structure. Is it possible to divide by IA, rail and M&E separately to provide the proportion of the revenue and also compare prior year of the three -- increase or decline and how much?

The second question is on the gross margin. The gross margin adjusted down a lot and this is because of the last year, the one-time discount within the highspeed rail ATP contract, is that for this one? If yes, what about the effect in the next quarter?

And the third question is about the Hollycon. the TCM traditional dispensing machine, this machine currently is within the Hollycon, or within the Hollysys automation site?

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The first question, (inaudible) combined together to answer. This automation take -- this quarter, around the $45 million -- take around 43.5% of total revenue. Rail transportation, $33 million, take around the 31.9% of total revenue. M&E, $25.3 million, take around the 24.5% of total revenue. Compare to the same period of last year, and this automation take around 39.6% of total revenue, rail take around 43.4% of total revenue, and M&E taking 12.4% of total revenue.

So, answering the second question about the gross margin is not because the one-time ATP contract, the discount contract -- because that one already close to (inaudible). And actual -- the dropdown of gross margin recently is the mix results and you could see this quarter, the mixed results currently, rail has taken a large percentage of total revenue, but it contributed to the gross margin revenue higher than the others. And we recognize M&E and also the subway sector, the other thing would be taking more of (inaudible) -- the same period of prior years. So that is why the gross margin goes down to 30% and this is the mix.

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The second question that is -- let me -- the contribution of this quarter revenue is 40% from the subway and M&E sector, so this part of the gross margin is actually lower than the average.

But I want to emphasize for each segment, IA, rail or M&E, there is no change within the gross margin. But the whole gross margin for this quarter, down to 30% is really because of the mixed results as a large percentage of recognized revenue from the subway and M&E sector.

But this is just a (inaudible). For the yearly basis, we think it's going to -- what we announced between 35% to 40% for the total business of the gross margin.

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The last question, about the TCM, traditional dispensing machine, is to launch to joint venture not the Hollycon.

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The question is about the dispense machine, the gross margin is what kind of level? The answer is about close to the product sale -- more than average gross margin

Thank you, Kevin. Operator, the next one.

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

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The first question is about the 2017 fiscal year second quarter already past the half and so what about the first -- the landscape about right now, revenue. Can you introduce a little visibility about this part? And also, during the events today, it seems like the whole management have very good confidence with the Company and so what about the next revenue or the other performance?

And the second question is about the Hollycon. The other partners, and the background, it seems like not related to too close to the medicine area so how about to explain?

And the third one is about the coal-fired. Coal-fired, even you get a lot of new contracts and orders but the central government regulation still is very tough on this area. Do you see any difficulties or delays on the implementing projects?

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The CFO focused on the first and third questions. The revenue recognition, we follow by percentage of completion and so it is really hard if you are -- the reason on the current performance based on Q2 2017 fiscal year. But from the new order side, we think that this is a good sign, at least.

The third question about coal-fired, there will be delay or even extend the period of execution time, this has not just happened within the coal-fired. It also happened with the other industries like the petrochemical, metallurgy, those kinds of areas.

And so the analysts concerned about it, even new order is increasing but it is the period of time of execution of contract extends, that will affect the recognized revenue. And so this part, we said the large part of -- currently, the after-sale revenue is increasing and the new contract from after-sale, like product sale service vendor is increasing. The structure is changing and so that would be reasonable, we could think in the next 10 to 12 months -- the contract is still okay to secure the revenue contribution.

But also, there are a lot of uncertainties within IA but at least we put performance on better than the last of fiscal year of 2016.

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The second question, the partners background actually they have the experts inside that focus on the medicine area and also they have the resources to introduce to us, not just the (inaudible) background and also one of the partners can help us to extend our current product to abroad, they have very good resources abroad and so this is a good challenge for our product to be delivered to that area.

So that is why we cooperate with the new partners. Thank you, Boyong.

Thank you.

Due to the time constraint, the last question, operator, please?

Your last question comes from Patrick Xu from Nomura. Please ask your question.

Okay, good morning. My first question is regarding the Southeast Asia business and you mentioned that it has seen some difficulty but we are not really seeing a weakness in the numbers. It seems that the revenue in new contracts backlog all look fairly good and so why are you saying that Southeast Asia is seeing some difficulties. Could you just elaborate on that, please? That is the first question.

The second question is on Haier project. You mentioned that you are doing an automation project for Haier. Could you tell us the -- probably the revenue margin or the return of the project? Thank you.

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The first question about the M&E sector. Their business focus on Southeast Asia, Middle East, (inaudible) for example, Singapore, Malaysia, and recently, for example, Bond, their business in Malaysia, the Johor area -- their contract, new orders and also project execution looks relatively good.

And also Concord recently got their large contract of $60 million on Doha project so that is why the performance is currently within M&E, is good -- than before. However, the difficulties, for example, the Singapore economic slowing down very sharply. Right now, we meet the new order, everything delayed or even tough -- and the environment (inaudible) process, tough than before. So also the exchange rate, everything would affect our business.

So there will be a lot of uncertainty and potential risks for this area. And the second one about Haier, we provide -- we signed a contract with Haier to help them improve the level of automation intelligence of their production line and we want to -- they are use for exploring Hollysys' great digital and intellectual abilities and -- but the contract size is not very large. It's just several million CNY level.

So we want to -- this part will not be a very supportive contribution for the revenue but this part, we hope to make achievement to satisfy customer needs to continue to find more projects to do it into a demonstration project to get more contract or potential opportunities to cooperate with the customers.

Thank you.

Thank you.

Thank you, everyone, for joining us on the call today. If you haven't got a chance to raise your questions, we are pleased to answer them through follow-up contacts.

We look forward to speaking with you again in the near future. Thank you.

This concludes our conference today. Thank you for participating, you may now disconnect.