Hollysys Automation Technologies Ltd (HOLI) 2018 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Hollysys Automation Technologies Earnings Conference Call for the Fiscal Year 2018 First Quarter Ended September 30, 2017. (Operator Instructions) Please be advised that this conference is being recorded today, November 14, 2017, Beijing Time.

I would now like to hand the conference over to Mr. Arden Xia, 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; 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 fiscal year 2018, and I will, on behalf of CFO, Ms. Qu, discuss our performance from a financial perspective. The Q&A session will be 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 that are not historical facts, including statements relating to the expected growth of Hollysys' future product introductions and 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 the 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 here should be read in 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.

I'd now like to turn the call to CEO, 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.

The momentum of our recovery in Industrial Automation continued in this quarter as we recorded 27.6% and 18.9% year-on-year growth in revenue and new contract, respectively, with revenue achieving year-on-year growth for 3 consecutive quarters. Our performance in power industry remained stable and dominant as we signed contracts on Datang Dongying 2 gigawatts power units and Guohua Yongzhou 2 gigawatts power units, et cetera. In chemical, we signed several major contracts, including a DCS contract with Inner Mongolia FuFeng Group on Biology ingredients workshop project and a contract with Zhonganlianhe Coal-chemical Company on 1.9 million (sic) [1.7 million] ton methyl alcohol and olefin conversion project. In food beverage area, we signed a contract with Xinjiang Kashi Aodu Sugar Industry on 20 million tons per year Beet Sugar DCS project. In nuclear, we continued to provide products for Tianwan #5 and #6 units.

In factory automation, we kept focusing on several key industries and [renowned] players, and our demonstration-for-further-application approach has been going smoothly. As we perform these projects, we improve our capability of providing turnkey solutions, accumulate track records and raise brand awareness. In white-goods area, our cooperation with Haier went further as we won new contracts on their Tianjin-based and Qingdao-based washing machine factories. Additionally, breakthrough was achieved in new energy area, as we won contracts from Do-Fluoride Chemicals Co., Ltd. to help improve the interconnection, data collection and management of production equipment in their lithium battery workshop. We believe that these projects will lead to more business opportunities from the current and an increasingly wider customer base.

In high-speed rail, we signed contract to provide TCC to Longchuan-Shanwei Railway. Our short-term performance can be affected by factors such as limited completion of newly planned railway infrastructure in the early years of the 13th 5-year plan and the change in customer procurement time line. However, we believe that outlook for rail business in the long run remains positive, given an explicit national plan, growing after-sale service demand and launching of our new products. For subway, we adhered to the expansion strategy to win new SCADA contracts in more cities and work closer with subway authorities to promote our SCADA system and subway signaling technologies in future.

In mechanical and electrical installation services, with macroeconomic and political circumstances in Southeast Asia and Middle East being closely followed, Concord and Bond remained active in exploration and kept executing projects covering various industries. Management and risk control have been -- have also been addressed to improve operation efficiency. The strategic value of Concord and Bond as customer resources and international sales channels remains significant, and we expect a moderate growth in the future.

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

Thank you, Mr. Shao. I want to share some highlights for the fiscal year 2018 first quarter ended September 30, 2017.

Comparing to the first quarter of prior fiscal year, the total revenues for the 3 months ended September 30, 2017, increased from $103.5 million to $115.5 million, representing an increase of 11.6%. Broken down by the revenue types, service revenue increased by 378.7% to $10.4 million, product sales revenue increased by 13.8% to $9.5 million and integrated contracts revenue increased by 2.8% to $95.6 million.

The company's total revenues by segment: Industrial Automation, $57.5 million; Railway Transportation Automation, $35.2 million; Mechanical and Electrical Solution, $22.8 million; total, $115.5 million.

Overall gross margin, excluding noncash amortization of acquired intangibles, was 36.6% for the first quarter as compared to 29.6% for the same period of prior year. The non-GAAP gross margin for integrated contracts, product sales and services rendered were 29.3%, 71.8% and 71.6% for the first quarter as compared to 25%, 60.5% and -- sorry, 70.5% and 69.7% 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 36.4% for the first quarter as compared to 29.5% for the same period of prior year. The GAAP gross margin for integrated contracts, product sales and service rendered were 29.1%, 71.8% and 71.6% for the first quarter as compared to 24.9%, 70.5% and 69.7% for the same period of prior year, respectively.

Selling expenses were $6.7 million for the first quarter, representing an increase of $1.1 million or 20.6% compared to $5.6 million for the same period of prior year, mainly due to increased sales activities. Presented as a percentage of total revenues, selling expenses were 5.8% and 5.4% for the 3 months ended September 30, 2017, and '16, respectively.

General and -- G&A expenses, excluding noncash share-based compensation expenses, were $11 million for the first quarter, representing an increase of $1.3 million or 13.3% as compared to $9.7 million for the same period of the prior year, mainly due to an increase of $2.1 million in allowance for doubtful accounts. Presented as a percentage of total revenues, non-GAAP G&A expenses were 9.5% and 9.3% for the quarters ended September 30, 2017, and '16, respectively. The GAAP G&A expenses, which include the noncash share-based compensation expenses, were $11.3 million and $10.6 million for the 3 months ended September 30, 2017, and '16, respectively.

R&D expenses were $8.6 million for the first quarter, an increase of $0.9 million or 11.7% compared to $7.7 million for the same period of prior year, mainly due to increased R&D activities. Presented as a percentage of total revenues, R&D expenses were 7.5% and 7.4% for the quarter ended September 30, 2017, and '16, respectively.

The VAT refunds and government subsidies were $7.1 million for the first quarter as compared to $9.6 million for the same period of prior year, representing a $2.5 million or 26% decrease, which was primarily due to decrease of government subsidies of $3 million.

The income tax expenses and the effective tax rate were $3.7 million and 14.9% for the first quarter as compared to $3 million and 12.2% for the same period of prior year.

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 $21.9 million or $0.36 per diluted share based on 61.3 million shares outstanding for the 3 months ended September 30, 2017. This represents a 3.6% decrease over the $22.7 million or $0.38 per diluted based on 61.1 million shares outstanding reported in the comparable prior year period.

On a GAAP basis, net income attributable to Hollysys was $21.4 million or $0.35 per diluted share representing a decrease of 1.5% over the $21.7 million or $0.36 per diluted share reported in the comparable prior year period.

In July 2016, the company's interests in HollyCon were diluted from 51% to 30%, the company recorded a gain on dilution and divestment of company's interests in HollyCon of $6.1 million during the first quarter of fiscal year 2017. Excluding the impact of above-mentioned for the same period of the prior year, the non-GAAP net income attributable to Hollysys for the first quarter should be increased by 31.7%, and GAAP net income to Hollysys should be increased by 37%.

Hollysys achieved $91.6 million new contracts for the first quarter. And the backlog as of September 30, 2017, was $498.3 million.

Breaking down by segments: Industrial Automation, $73.1 million; Railway Transportation, $7.4 million; M&E, $11.2 million; total, $91.6 million for the new contracts.

The backlog: Industrial Automation, $168.2 million; Railway Transportation, $210.9 million; M&E, $119.1 million; total, $498.3 million.

Cash flow. The 3 months ended September 30, 2017, the total net cash inflow was $47.2 million. The net cash provided by operating activities was $36.1 million. The net cash provided by investing activities was $6.6 million, mainly consisted of $38.4 million maturity of time deposits, which was partially offset by $27.1 million deposits placed with banks. The net cash provided by financing activities was $1 million.

Balance sheet. The total amount of cash and cash equivalents and time deposits with original maturities over 3 months were $331.5 million, $293.9 million and $260.8 million as of September 30, 2017, June 30, 2017, and September 30, 2016, respectively. As of September 30, 2017, the company held $244.8 million in cash and cash equivalents and $86.7 million in time deposits with original maturities over 3 months.

The first quarter DSO was 196 days as compared to 207 days for the comparable prior year period and 153 days for the last quarter. And inventory turnover was 61 days as compared to 48 days for the comparable prior year period and 51 days for the last quarter.

Based on our backlog currently on-hand and sales pipeline envisioned so far, we set our guidance for fiscal year 2018 with revenue in the range of $500 million to $530 million and non-GAAP net income in the range of $100 million to $110 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 Q&A in Mandarin, and we will provide a translation. Operator, please.

(Operator Instructions) We'll take our first question from Kevin Luo with Morgan Stanley.

(foreign language)

Okay. The first question about (inaudible). This quarter, the Industrial Automation compare increase, but from the revenue or (inaudible) from the new contracts, but the railway transportation compare not too much. So this quarter, the need from the railway transportation part, the new contracts following what kind of (inaudible). And also, we'll hear about 175 unused trains will be in the procurement for the 300. How about when we can find the contract? This is the first question. The second one is about the international business. What about the net income support for the whole group? And also about the -- for this fiscal year, the potential performance to increase what kind of percentage and also talk about the strategy for this area for the coming years.

(foreign language)

The railway transportation new contract for this quarter compare not too much, but it mainly come from the after-sale contract like the service. And you said about 175 trains for the procurement pipeline, and we will participate bidding. Actually, we won some part of the trains, but we have not finished the whole [signing] contract yet, so we cannot disclose the exact numbers. But we will -- we believe it will start finish bidding at the end of the calendar year, and we will disclose it later. And also the subway sector we also recently won some contracts, we will disclose later. The second question for the M&E sector international business, beyond the (inaudible) product sales, the M&E factories, especially Concord last fiscal year, we added some costs for some specific projects, so lead to the goodwill impairment. And also, the net income gross margin, [our] performance very good. And right now, we are focusing on this area to control improvement of the management feel and also the product. And because their projects around Southeast Asia and Middle East, so those areas, either economic or political sector, may have some potential challenges. So we are focusing on the control of the rate rather than to gain revenue and contract. So this is why the performance does not compare increase. But this part, we are striving to improve other [factor] of performance, and it feels under control. We think it will gradually keep positive in the future. Thank you.

(foreign language)

(foreign language)

And the question (inaudible)...

(foreign language)

(foreign language)

The question is about the future landscape about the 300-kilometer [for our] segment. And there are [3] players, how about the market share and also the price? Actually, about -- from the historical record, we could see Hollysys hold around 30% of the market shares, so business will continue, but not based on each contract. It's based on yearly total average trains procurement. And also, the price is very stable. We mean, the gross margin, the trains, the CRC (inaudible) pressure [to 3] of us right now. Thank you. (foreign language)

We'll go next to Gary Cheung with Haitong International.

(foreign language)

The question is about the gross margin. If we compare increase and improve a lot, so can we talk about the gross margin future trend?

(foreign language)

Okay. The gross margin 36% compare increase, so the specific background, I will let Mr. Arden Xia to introduce. And from this aspect, actually, the percentage of the structure are different than before. And right now, if you see the after-sale revenue, its compare increased a lot. This quarter, around 17% after-sale revenue, of total revenue from the after-sale. And this part of gross margin is higher than average. So that's why for this quarter, the gross margin is better than the last quarter and in the same period of last year. But right now, we want to emphasize that due to trend, it's a new challenge because right now, for example, the Industrial Automation gross margin is slowing down because we're strategically focusing on penetration with significant contract. So we will balance the gross margin, try our best, between the range of 35 to 40 as what we said before. Thank you.

(Operator Instructions)

Okay. Thank you, everyone. It seems like there's no further questions. I think this quarter performance, just like what we've said before, and for the coming quarters, we believe it will trend better. Okay, next one. Alex.

We'll go next to Alex Chang with Citigroup.

(foreign language)

Alex, (foreign language).

(foreign language)

The first question is about the exchange loss and also the cost in that piece. What about -- to better explain, what about the items? And the second question about the expenditure is increasing and the compare revenue a little bit higher ratio than the revenue increase. So what about the whole fiscal year expenditure trend? (foreign language) The first question about the exchange loss. And this part, not affected too much because it relates to the import and export of our [house] products. Right now, it takes a very small percentage. And from the whole transport -- the whole financial report translation, it always meet the acceleration. But right now, you talk about the exchange loss this quarter will -- not too much in future. And the second one about the cost investee. Actually, this is also compared, the equity investee. The equity investee and the cost investee are related, partially of holding of the company, less than 50%. If between 30% to 50%, it will be booked into the equity investee, and if between 20% to 30% of the shares, it will be booking into the cost investee. So this is the item differences. And the second question about the expenditure, it's growing. And right, the trend is growing right now because we create more SG&A like the tailwind activities, those kinds of things. But from absolute value to see in recent years, around USD 85 million you could see. And this year, from absolute value, it's just a little bit, maybe 10% increase around, but it feels not too much. Thank you. Okay. Thank you, everyone, for joining us on the call today. Oh we do have another one? Sorry.

We'll go next -- and we have no further questions in the queue.

Okay. Operator, we can -- okay. We can go to next one. The last one more question.

We'll go next to Peter Halesworth with Heng Ren.

Arden, a quick question to Mr. Shao. Could you please explain the CapEx budget for this new year? And also, I understand that there should have been a board vote regarding the dividend, the regular dividend. Could you inform us the result of that vote and also what the payout ratio is?

(foreign language)

(foreign language)

Okay. I do the translation. The CapEx each year, not too much. We are close to several companies. So you could see no more than USD 10 million each year. And second question about dividends. Dividends, we have a regular dividend policy. The payout ratio is 10%. And last year, we changed the policy to a regular dividend policy.

So just to follow up. The payout ratio is going to remain unchanged at 10% because that seems to be a very low payout ratio relative to the CapEx needs and also to the cash flow you're generating on an annual basis. So I'm just curious why we are keeping the payout ratio so low when the company is brimming with cash.

(foreign language)

(foreign language)

From the -- from recent years, because in China, it's changing their path for industry automation. So you can see our business focusing on the IA, especially Industrial Automation, and also international business expansion. And that's why we more like to put the resources into these areas to keep pace with the market in recent years. But from the long term, we definitely will consider to raise the payout ratio. Thank you, Peter.

And we'll go next to Kevin Luo with Morgan Stanley.

(foreign language)

(foreign language) The first question is about the track circuit new contract. And we heard that from the market that we [went our] regular speed contract. How about the contract? Can you give us a little bit more information? The second question is about the subway signaling control system. Because right now, the market, you could see it will lead -- it has been led by the local government and also some construction companies. So even to the PBT model, what about your method currently, maybe participate PBT or cooperate with the local government? That would be better to penetrate the signaling control system.

(foreign language)

Okay. The first question is about the track circuit. We separate by 2 parts. One is regular speed license, and second one is high-speed rail license, above 300. Right now, we just got the regular speed license. And we won a contract that's called (inaudible) line. But the contract size is not very sizable. It's just less than 10 [million] China [event] because, currently, the regular speed procurement compare high-speed rail procurement of the track circuit have just a field contract. And -- but the high-speed rail license, we already got the [tax] line and -- for running at least 1 year. So we will probably get the license in the fiscal year 2019 calendar year. And by the way, the (inaudible) line, when we win the contract, it will be finished -- the whole contract recognize revenue within this fiscal year. And the second question is about the PBT project and subway signaling. We are participating in the bidding. And hopefully, we can get the subway signaling within 1 year. And the PBT project, because we really need to do it very cautiously, it depends on the PBT model the project itself, because sometimes, it's not just limited with [capability]. It's limited with capability and also put a lot of money. We can just do what we can afford and it depends on the profit of the project and it also depends on the [risk] control. We not deny to do PBT project. We are also end of discussions with the local government right now. Thank you, Kevin.

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

Thank you.

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