Hollysys Automation Technologies Ltd (HOLI) 2017 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the HollySys Automation Technologies Fiscal Year 2017, the Third Quarter Ended on March 31, 2017, Earnings Conference Call. (Operator Instructions) Please be advised that this conference is being recorded May 12, 2017, 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 business, including some highlights for the quarter; and 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 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 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 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 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.

And now, I'd 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 quarter.

With the market stabilization in [cast-out] process industries -- in parts of process of -- industries. The performance of Industrial Automation has been getting better, especially recent order trends reflecting a political [sic] [positive] momentum.

Through actively traced our customers' new demands under adjusting circumstance, we got several significant contracts. For example, in power, we signed a contract to provide products for Sichuan Jiangyou 2 1,000 megawatts power units, Shanxi Yangmei 2 660 megawatts power units. In chemical, we provided DCS and SIS products for producing polycarbonate of Luxi Chemical Company. In petrochemical, we won the contract to provide DCS to Shengli Oilfield Gudong production plant. In nuclear power, we are continually providing DCS for Hongyanhe #5 and #6 units and Tianwan units -- #5 unit and #6 unit.

For Factory Automation, after changing strategies for selling products to providing solutions to customers, we did have some progress such as Hair project to help the customer improve the level of automation and intelligence of their Tianjin-based factory, which focuses on washing machines; integrated internal resources to provide the production; and Hai Di Lao Hot Pot project to help the customer improve their efficiency of hot pot-based marketing in the restaurant. HollySys aims to make each project into a demonstration project to create the value to the customers and explore more opportunities in subindustries.

In high-speed railway, we won the 106 C2-ATPs and 10 C3-ATPs. But since the customer is changing their procurement timeline, it increases uncertainty and volatility of the performance of the high-speed railway. In addition, since it is the beginning of the 13th 5-year plan, the finished infrastructure of the new planned railway is limited. Therefore, in short time -- in short term, the performance of the high-speed railway segment was unfavorable. However, from long run, according to the mid- and the long-term plan of the high-speed railway and with the increasing of the aftersales and replacement as well as new products launch, we expect the sector will gradually recover in the future. For subway, we won the contract to provide power SCADA for Dalian intercity line from Jinzhou to Pulandianwan.

In the mechanical and electrical installation services, although Concord and Bond are facing some difficulties because of the local political and economic uncertainties in Southeast Asia and Middle East area, they are still working hard to develop businesses. As one of the strategies to expand the 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 read the financial results analysis on behalf of our CFO, Ms. Herriet Qu.

Thank you, Mr. Shao. I would like to share some highlights for the first 9 months and the third quarter of fiscal year 2017 ended March 31.

Compared to the third quarter of prior fiscal year, the total revenues for the third quarter decreased from $118.8 million to $91.3 million, representing a decrease of 23.1%. Broken down by the revenue types, service revenue increased by 17.7% to $3.4 million, integrated contracts revenue decreased by 21.6% to $78.2 million, and product sales revenue decreased by 39.7% to $9.7 million.

In July 2016, the company's interests in Hollycon were diluted from 51% to 30%, and the company lost control of Hollycon. As a result, Hollycon's financials will not be included in the company's consolidated financials from July 2016 on.

If Hollycon's revenue was excluded from the comparable figure for the third quarter of prior fiscal year, the product sales revenue for the third quarter should be increased by 17.8%.

The company's total revenues be -- presented in segments, three months ended March 31: Industrial Automation, $38.1 million; railway transportation, $34.8 million; M&E, $18.5 million; total, $91.3 million.

Nine months ended March 31: Industrial Automation, $128.9 million; railway transportation, $91.1 million; M&E, $74 million; total, $294 million.

Overall gross margin, excluding noncash amortization of acquired intangibles, was 30.7% for the quarter as compared to 31.7% for the same period of prior year. The non-GAAP gross margin for integrated contracts, product sales and service rendered were 24.4%, 65.2% and 78.8% for the third quarter as compared to 27.1%, 55.5% and 59.1% 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 noncash amortization of acquired intangibles, was 30.7% for the third quarter as compared to 31.6% for the same period of prior year.

The GAAP gross margin for integrated contracts, product sales and service rendered were 24.4%, 65.2% and 78.8% for the third quarter as compared to 26.9%, 55.5% and 59.1% for the same period of prior year, respectively.

Selling expenses were $6 million for the third quarter, representing an increase of $0.8 million or 13.8% compared to $5.2 million for the same quarter of prior year. Presented as a percentage of total revenues, selling expenses were 6.5% and 4.4% for 3 months ended March 31, 2017, and 2016, respectively.

G&A expenses, excluding noncash share-based compensation expenses, were $8.8 million and $8.7 million for the quarter ended March 31, 2017, and '16, respectively. Presented as a percentage of total revenues, non-GAAP G&A expenses were 9.6% and 7.3% for the quarters ended March 31, 2017, and '16, respectively.

The GAAP G&A expenses, which included the noncash share-based compensation expenses, were $6.8 million and $9.8 million for the 3 months ended March 31, 2017, and '16, respectively.

R&D expenses were $6.1 million for the third quarter, representing a decrease of $2.3 million or 27.2% compared to $8.4 million for the same quarter of prior year. Presented as a percentage of total revenues, R&D expenses were 6.7% and 7% for the quarter ended March 31, 2017, and '16, respectively.

The VAT refunds and government subsidies were $5.5 million for third quarter as compared to $4.3 million for the same quarter in prior year, representing a $1.2 million or 27.9% increase.

The income tax expenses and the effective tax rate were $4.4 million and 22.1% for the 3 months ended March 31, 2017, as compared to $3.4 million and 12.4% for comparable prior year period. The fluctuation of effective tax rate was mainly due to the different pretax income mix with different tax rates as the company subsidies apply to different tax rates.

For the 9 months ended March 31, 2017, the effective tax rate was 16%.

The non-GAAP net income attributable to Hollysys, which excludes noncash share-based compensation expenses, amortization of acquired intangibles, acquisition-related consideration fair value adjustments and the convertible bond-related fair value adjustments was $13.7 million or $0.22 per diluted share based on 61.2 million shares outstanding for the quarter. This represents a 40.7% decrease over the $23.1 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 were $15.6 million or $0.26 per diluted share, representing a decrease of 28.5% over the $21.9 million or $0.36 per diluted share reported in comparable prior year period.

Contracts and backlog. Hollysys achieved $108.4 million new contracts for the third quarter, and the backlog as of March 31, 2017, was $509.8 million.

The detailed breakdown by new contracts and backlog by segments: New contracts, Industrial Automation, $52.8 million; railway transportation, $50.3 million; M&E, $5.3 million; total, $108.4 million.

Backlog: Industrial Automation, 121 -- sorry, $127.6 million; railway transportation, $238.5 million; M&E, $143.7 million; total, $509.8 million.

Cash flow. For the 3 months ended March 31, 2017, the total net cash outflow was $27.6 million. The net cash used in operating activities was $12.5 million. The net cash used in investing activities was $10 million, mainly consisted of $22.8 million time deposits placed with banks, which was partially offset by $12.5 million maturity of the deposits.

The net cash used in financial activities was $3.5 million, mainly consisted of $4.9 million repayments of long-term bank loans, which was partially offset by $1.1 million for proceeds from short-term bank loans.

Balance sheet. The total amount of cash and cash equivalents and time deposits with original maturities over 3 months were $268.8 million, $285.4 million and $256.4 million as of March 31, 2017, December 31, 2016, and March 31, 2016, respectively.

As of March 31, 2017, the company held $182.5 million in cash and cash equivalents and $86.4 million in time deposits with original maturities over 3 months.

For the 3 months ended March 31, 2017, DSO was 20 -- 219 days as compared to 181 days for the comparable prior year period and 208 days for the last quarter. And the inventory turnover was 61 days as compared to 40 days for the comparable prior year period and 52 days for the last quarter.

Outlook for the fiscal year 2017. Consideration on the volatility of high-speed railway performance, we would like to keep the guidance even though we meet potential challenges, for fiscal year 2017, with revenue in the range of $480 million to $520 million and non-GAAP net income in the range of USD 90 million to USD 100 million.

At this time, we would like to open up for the Q&A session. Please note that for Chinese-speaking participants, we can also do Q&A in Mandarin, and we'll provide translation. (foreign language) Operator, please.

(Operator Instructions) Your first question comes from the line of Alex Chang.

(foreign language)

And the first question about the new orders. The third quarter, we found, it is recovered very good. So can you tell us about the structure of the new orders, especially the railway transportation. And we estimated 8 -- from the number of ATP's procurement, it should be USD 220 million, but it seems like USD 50 million right now, so what about distribution? And also, I want to ask the formal days from the official CRC procurement website, we could see the new order for C3, and there are 3 companies won the bidding. So how about Hollysys? How much Hollysys could get? The second question is about the share-based compensation. And this quarter, we saw this number is positive. Can you explain about it?

(foreign language)

Okay. The first question about the railway transportation structure, the distribution, you can see, if compare your prediction is larger. But actually, we just announced a significant contract. We gained a lot of supplement contract in this quarter. For example, like Hong Kong MTR project, because this project is delaying, so we get some payment from the customer. And also, the small TCC project and also including the other supplemented project for the former larger projects.

(foreign language)

The share-based compensation is based on the guidance. Last time, we -- the disclosure, based on this guidance, the management team cannot achieve the target, so they cannot get the options. The options based on the performance of the EPS, for example. So this quarter, the cost of amortization, we adjust -- we do adjustment, so we could see gain from the value. And next quarter, we have continued the same thing, booking into the financials, but the number will be smaller than this quarter. (foreign language)

(foreign language)

(foreign language)

(foreign language)

Let me translate the last one Mr. Shao said, because several days ago, the official website disclosed the bidding won for 3 companies, but the number -- we not signed the contract yet, so we cannot disclose that at this time. And back the last question of Alex, he asked about the ATP contract, currently, the ASP for the C2 and C3. Are there any changes? And the answer is just last fiscal year, the C3 segment had a onetime discount for the ASP within 300-kilometer for our segment, but right now, when we won the contract, our recover for the regular price. Thank you, Alex.

Your next question comes from the line of Jacqueline Du from Goldman Sachs.

(foreign language)

The question is about the guidance. Based on the first 9 months of the performance, we not changed the guidance. So does this means that fourth quarter, we have to achieve more than $200 million revenue to meet the guidance. So can you explain about the -- because this has not happened in the history, so can you explain more about this -- the guidance?

(foreign language)

In current situation, the guidance is really meet the challenge. And -- but this is not as you mentioned that it will bring the revenue treatment by the new businesses. We especially focused on the high-speed rail. And this part, the performance is uncertainty and it will affect the revenue and net income sharply. So that's why -- because currently, the CRC side, not very transparency, so it's hard for us to make the precise prediction for the guidance. That is to say the performance is really based on the high-speed rail performance at the end of this fiscal year.

(foreign language)

So for the Factory Automation, what about the progress and -- within the new businesses? And also, relate to the revenue contribution, how we could expect the timeline?

(foreign language)

For the new business or technology, looking at them [like the traction], okay, we will have the order. But the top line, hardly to give you right now. And for Factory Automation, from -- we changed the strategy from single-product sales to the total solutions provide. And we based on several subindustries to do appraised demonstration projects. Right now, everything is -- goes well, but from the contract or revenue to see, it cannot make even of the declining. I mean, it is not very -- too large contract size cannot support right now. For the long term, we have confidence to develop this area, keep a very high growth rate.

(foreign language)

(foreign language)

(foreign language)

(foreign language) The first question is about some risks control that -- from our side, we think that there are some risks, for example, like the ATP bidding procurement. We can see the C3 segment, the -- can we grow the size -- the company, can grow the size. It's the first time to join this area, so is this will affect the market share in the future? And the second question about the mechanical and electrical solutions services, there are some uncertainties. Can you explain more about these uncertainties?

(foreign language)

From the Hollysys high-speed rail revenue aspect as compared to 2016 and '17, the sharp decrease is a onetime problem, not structural. For the short term to see, it is hard to achieve the performance of fiscal year 2016 because the year based at the end of 12th 5-year plan and there was -- won a lot of ATPs. So from the market share aspect, this is a long-term issue. We cannot maintain 50% market share in 300-kilometer segment, but we will keep at least the 30% for both C2 and C3. And also, can we [resign] new player joining, we are disclosed to the institutional investors before. And meanwhile -- I mean -- at last, I want to measure some good areas from the mid- -- long term to see the high-speed railway after-sale revenue will keep steady growth. And also, new products, new technology, like the track circuit will join. And the very important thing is replacement cycle or treatment life cycle with 10 years now just to meet the cycle. So what we sold the ATP, we'll sell again. All of this will secure high-speed rail revenue, keep a steady performance in the future.

(foreign language)

The mechanical electric installation services segment, because this area focus -- the business focuses on Southeast Asia and those local economic not very good in recent years, so we meet a lot of competition and -- especially from the new orders to see -- still have challenge. But we are trying our best to do the business right now. You could see the M&E sector; the revenue growth came out is 10%. But no matter what, just add to the fact that the potential risk for those areas still exists, especially, we mentioned, the new orders side.

(Operator Instructions) Your next question comes from the line of Thomas Zhang from Morgan Stanley.

(foreign language)

The first question about the P&L, which we see the share net income after the investee. That item was inside, especially the Hollycon, how much performance by the Hollycon? And of course, last fiscal year, we could see our government subsidy from the nuclear power JV also included data within this item. So can you explain how much about the net subsidy? And the second question, about the Industrial Automation new order. Right now, we see the trend is very good and compare increase, but it's separated by the DCS demand. Which industry performance is better? And can you explain based on industries?

(foreign language)

The first question, about the net income equity investee. This part was based on equity matters. And inside, there has mainly 2 companies. One is Hollycon, and that company will hold around 30% shares; and the JV with CGNPC, that company hold around 40%. And this time, USD 2.4 million will receive $0.6 million from Hollycon. And also, you said right, last year, we have subsidy from the JV, CGNPC. That total number would be 3 -- CNY 13 million. If transferred to the U.S. dollar, it would be $6 million, around.

(foreign language)

(foreign language)

The question is about the -- so that is to say in the last 9 months’ performance of JV with CGNPC, that company is positive. The answer is yes.

(foreign language)

The Industry Automation side, too, are hardworking. From [mainland] to see right now the new contract compare increased a lot. And this is based on we received our existing projects and large customers to do the upgrading, those kind of things, and we found a lot of new opportunities. And from the whole industry to see, it is based on the large industries, what we gained before, like the thermal power, like the chemical, petrochemical. Those industries increasing, and also, new energy. And we do that -- but right now, the total environment is still hard to say, but we do it very cautious and optimistic. And next quarter, the -- to be frank, the revenue would be turn to positive compares. And we have confident to maintain and Industrial Automation gradually recover in the future. Because the timeline constraint, so the last question.

Your last question comes from the line of Patrick Xu from Nomura.

(foreign language)

The first question is about the order within the rail -- high-speed rail sector. From the backlog to see, it is compare not goes down very fast. So -- but the high-speed rail revenue is continue declining, so can you explain about this trend? I mean -- especially the backlog is going down, what's the reason behind? The second question about the working capital. We could see the DSO days and inventory days goes up. Can you explain about that? The third one is miscellaneous. It seems like compare last fiscal year, the miscellaneous items have not been right now. So is there anything changed behind or can you please explain about this item?

(foreign language)

The first question about the new order within the high-speed rail is to see the backlog structure. Actually, it contains less ATP than before. However, ATP contract, recognized revenue compared TCC is shorter. For example, normally, it would be 6 to 12 months, finished recognized revenue, but TCC will be 1 or 2 years. But right now, our -- because we -- the ATP contract is delaying, so we have last ATP contract within the backlog. But relatively, the high base belongs to after sale TCC, those contracts. But average, the recognized revenue period would be 1 or 2 years.

(foreign language)

The DSO days goes up, is not means the AR getting larger. Actually, you could see the absolutely -- value for the account receivable is still stable. And at this time, it's because the revenue goes down, so that's why DSO day goes up. And inventory, because we are right now preparing the goods for the potential contracts, so that's why the inventory goes -- is increasing.

(foreign language)

The miscellaneous, because last fiscal year, that one represented the large percentage of Hollycon. But Hollycon diluted from 51% to 30%. And right now, we lost control of Hollycon, so not consolidated with the financials. That's why, this time, the miscellaneous, you could see, have no things. And this part, right now, you could see from the P&L the equity investee area.

(foreign language)

(foreign language)

The question is about -- you said the inventory goes up, can you explain which part of the business prepare for the inventory? The answer is high-speed rail would be much -- the larger percentage than the others. Thank you, Patrick.

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

We're looking forward to speaking with you again in near future. Thank you. Thank you, operator.

This does conclude your conference. Thank you all for your participation.