Hollysys Automation Technologies Ltd (HOLI) 2018 Q2 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 second quarter ended December 31, 2017. (Operator Instructions) Please be advised that this conference is being recorded today, February 9, 2018, 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; 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 second quarter of fiscal year 2018, and I will, on behalf of the CFO, Ms. Harriet Qu, discuss our performance from a financial perspective. And then we will answer questions afterwards.

Before getting started, I would like to remind everyone that this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that are not historical facts, including statements relating to the expected growth of Hollysys' future product introductions and statements are not statements of historical facts, 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 (inaudible) 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 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.

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

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

Industrial automation remained on the track of recovery, with revenue recording at 25.9% year-on-year growth at $57.6 million. Management team has adhered to the low- to high-end market expansion strategy in industries such as chemical and petrochemical, et cetera, while building comprehensive service capacity to address the substantial aftersales potential from the entire customer base and seeking new opportunities from existing end-users.

On the chemical industry, we signed a contract with Jinan Taixing Fine Chemicals Company to provide the system for their polyphosphazene project, a contract with Jiangsu Jingshen Salt & Chemical Industry Corporation Ltd. to provide Manufacturing Execution System for information integration of their salt packaging and distribution center. On the petrochemical industry, we signed a contract with China Petroleum & Chemical Corporation to provide DCS and instruments for their liquid chemical wharf project. We entered into a strategic cooperation agreement with CEET, a wholly-owned subsidiary of China National Offshore Oil Corporation, to collectively push for the localization of core equipment on offshore oil platforms. In the new energy and food beverage area, we signed a contract to provide a system for Chia Tai Group's recycling of waste project and a contract with Lihua Starch Corporation Ltd. for a sorbitol project.

Our demonstration-for-further-application strategy in factory automation has brought us more market recognition. We earned a government-level recognition as we were listed as 1 of the 23 intelligent manufacturing system solution providers recommended by the Minister of Industry and Information Technology. We continued to focus on several key industries and cooperate with famous players. On white goods, our cooperation with Haier went further as we signed contracts on their Tianjin-based and Qingdao-based washing machine factories. On food beverage area, we are decided to provide innovative solution to address the safety and efficiency issues. Upon the successful delivery of the first project, our relationship with Hai Di Lao went deeper, with a regular communication mechanism set. We expect broader cooperation with them and more clients in the future.

The performance of the high-speed rail was prominent in this quarter, with revenue recording at 199.0% year-on-year growth at $69.6 million. One of the contributors is the significant increase in aftersales orders, including ATP maintenance and replacement contracts. Signing 80 sets of automatic train protection, ATP, to high-speed trains in 300 and 350 kilometers per hour also contributed greatly to the revenue because of the tightening delivery schedule to secure the Spring Festival travel.

Breakthrough has been made in our new product as we signed our first track circuit contractor for Chengdu-Ya'an regular speed railway line. In subway, we signed SCADA contract for Chengdu Subway Line 5. We will adhere to the expansion strategy to win SCADA contracts in more cities and work closer with the subway authorities to promote our SCADA system and subway signaling technology in future. Management teams will adhere to the diversity strategy to create revenue streams from more new products and services and to maintain a stable and healthy growth in the future.

In oversee business, we signed several EPC contracts with domestic companies, including a contract with Shandong Ludian Corporation Ltd. to provide DCS for 2 350-megawatt power station in Indonesia. Mechanical and electrical installation services recorded a 0.4% of revenue growth at $30.2 million. We continued to address the operation management and risk control issues to ensure the project can be delivered in good quality, while closely following economic and political circumstances in Southeast Asia and the Middle East. Concord and Bond remained active in seeking business opportunities, and we believe that their strategic value as a customer resource and international sales channels remains significant.

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

Thank you, Mr. Shao. I would like to share some highlights in this fiscal year 2018 the second quarter and December 31, 2017. Comparing the second quarter of the prior fiscal year, the revenue for the second quarter increased from $99.1 million to $157.4 million, representing an increase of 58.8%. Broken down by the revenue types, service revenue increased by 274.3% to $13.3 million; product sales revenue increased by 60.4% to $9.7 million; and integrated contracts revenue increased by 58% to $134.4 million.

The company's total revenue presented in segments by 3 (inaudible): industrial automation, USD 57.6 million; railway transportation, USD 69.6 million; M&E, USD 30.2 million; and the total, $157.4 million.

Overall gross margin, excluding noncash amortization of acquired intangibles, was 39.4% for the second quarter as compared to 28.7% for the same period of prior year. The non-GAAP gross margin for integrated contracts, product sales and service rendered were 34.5%, 67.4% and 68.6% for the second quarter as compared to 24.3%, 72.1% and 64.9% 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 39.3% for the second quarter as compared to 28.6% over the same period of the year. The GAAP gross margin for integrated contracts, product sales and service rendered were 34.4%, 67.4% and 68.6% for the second quarter as compared to 24.2%, 72.1% and 64.9% for the same period of prior year, respectively.

Selling expenses were $7.7 million for the second quarter, representing an increase of $1.4 million or 22.7% compared to $6.3 million for the same quarter of prior year. Presented as a percentage of total revenues, selling expenses were 4.9% and 6.4% for the 3 months ended December 31, 2017 and '16, respectively.

G&A expenses, excluding noncash share-based compensation expenses, were $12.2 million and $10.8 million for the second quarter and the same quarter with 2016, respectively. Presented as a percentage of total revenues, non-GAAP G&A expenses were 7.7% and 10.9% for the quarters ended December 31, 2017 and '16, respectively. The GAAP G&A expenses, which include the noncash share-based compensation expenses, were $12.1 million and $11.7 million for the 3 months ended December 31, 2017 and '16, respectively.

Research -- R&D expenses were $10.6 million for the second quarter, representing an increase of $2.3 million or 27.6% compared to $8.3 million for the same quarter of the prior year. Presented as a percentage of total revenues, R&D expenses were 6.7% and 8.4% for the quarter ended December 31, 2017, and '16, respectively.

The VAT refunds and government subsidies were $9.4 million for the second quarter as compared to $8.2 million for the same period in prior year, representing a $1.2 million or 15.2% increase.

The income tax expenses and the effective tax rate were $9.3 million and 20.4% for the second quarter as compared to $1.6 million and 13.5% for the comparable prior year period. The effective tax rate fluctuation was mainly due to the different pretax income mix with different tax rates as the company's subsidiaries is applied to different tax rates.

The non-GAAP net income attributable to Hollysys, which excludes the non-cash share-based compensation expenses, which is calculated based on the numbers of shares or options granted and the fair value as of the granted date, amortization of acquired intangible assets, fair value adjustments of acquired -- acquisition related considerations and the fair value adjustments of our derivative was $36.3 million, or $0.60 per diluted share based on 61.3 million shares outstanding for the second quarter. This represents a 229.4% increase over the $11 million, or $0.18 per share based on 60.9 million shares outstanding reported in the comparable prior year.

On a GAAP basis, net income attributable to Hollysys was $36.2 million, or $0.60 per diluted share, representing an increase of 263.4% over the $10 million, or $0.17 per diluted share reported in comparable prior year period.

Contracts and backlog highlights. Hollysys achieved $220 million in new contracts for the second quarter, and the backlog as of December 31, 2017, was $547.6 million. The detailed breakdown by the new contracts and backlog. For the new contracts, industrial automation, $45.8 million; railway transportation, $143.8 million; M&E, $30.4 million; total, $220 million.

Backlog as of December 31, 2017. Industrial automation, $152.6 million; railway transportation, $272.2 million; M&E, $122.8 million; total, $547.6 million.

The cash flow was $13.8 million for the second quarter -- the total net cash outflow for the second quarter was $13.8 million. The net cash provided by operating activities was $36.1 million. The net cash used in investing activities was $45.5 million, mainly consisted of $92.6 million time deposits placed with banks, which was partially offset by $47.8 million maturity of time deposits. The net cash used in financing activities was $7.2 million, mainly consisting of $7.2 million payment of dividends.

The total amount of cash and cash equivalents and time deposits with original maturities over 3 months were $365.4 million, $331.5 million and $285.4 million as of December 31, 2017, September 30, 2017, and December 31, 2016, respectively. As of December 31, 2017, the company held $231 million in cash and cash equivalents and $134.4 million in time deposits with original maturities over 3 months.

For the 3 months ended December 31, 2017, DSO was 147 days as compared to 208 days for the comparable prior year period and 196 days for the last quarter. And the inventory turnover was 48 days as compared to 52 days for the comparable prior year period and 61 days for the last quarter.

The management concluded that the guidance we will reiterate for fiscal year 2018 with revenue in a range of $500 million and -- to $530 million and non-GAAP net income in a range of $100 million to $110 million.

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

(Operator Instructions) We will go first to Sky Hong with Deutsche Bank.

(foreign language)

The first question is about the tax automation. Is there any progress within recent months for the factory automation because we also see from the government side we add the first right person within our standard -- to establish a new standard for the industry focused on the intelligence. (foreign language)

(foreign language)

Okay. We're focused on the 3 dimensions to do the best automation. The first, is focus on the -- cooperate with the large area or industry or cooperate with the companies like Haier or Hai Di Lao. We signed a contract to do the project and they're satisfied with the final results. So we signed the further -- the larger contract than before. And this is by the recognition of different subvertical and recognition by the potential customers. The second one is focused on the inter-intelligence area because we all need the same situation. The factory automation, the traditional industry wants to upgrade. So to focus on the digital and intelligence is the next step. And beyond the cooperate-with-the-customer focus on the product, we also have to raise our solution to focus on the whole area. And that's why we provide a white book. This is also including our own product, new product and new technology to support the potential end markets. And the third one is to enlarge our brand name within the whole industry, within China especially, to participate some activities especially like to raise the standard of the central government. We're in the government level recognition as one of the 23 intelligent manufacturing system solution providers recommended by the Ministry of Industry and Information Technology. And so these activities, what we are doing for the factory automation and we hope it will bring to you the new product and new technology in the coming months. Thank you.

And we'll go next to Alex Chang with Citi.

(foreign language)

Okay. The first question include managed sub-verticals. The first one is the -- can we provide the percentage for the high-speed rail and the subway, the proportion for this quarter? And the second vertical is for the aftersales revenue -- for the service contract that we could see our large increase. And this part with recognized revenue is booking into the after-sale or looking into the integrated revenue -- integrated contract revenue. And the third one is the proportion of the after-sale revenue for the high-speed rail right now. (foreign language)

(foreign language)

I'll translate. The first question is for the proportion of the high-speed rail and the subway revenue. The proportion will (inaudible) the end of this fiscal year. Currently we have no data on hand. But it's probably like more than 80% from the high-speed rail revenue at the end. And the second is about recognition of the service contract with high-speed rail, we will calculate into the after-sale revenue, not integrated contract revenue. And the third one, the after-sale proportion for the high-speed rail, we're not disclosing that number. We just provided the total after-sale revenue right now currently by total around more than 15%. But from another aspect, the after-sale revenue is increasing very fast from original single-digit of high-speed rail revenue to right now to 2 digits.

(foreign language)

(foreign language) The question is for the -- on the replacement is for what kind of level of the [repairment], 5 or what kind of a name?

And the answer is it's not very directly equal to the 5 level repairment . Actually right now, a lot of [repairments] from the level 4 and the replacement is not named at the level 5.

(foreign language)

The first question is the 80 MUs for the ATP contract, and how many are recognized by the end of December 31. And also the second question is about ASP trend for these contracts. And the third question is about the D2 area, 300, 350 kilometers per hour segment. What about the future trend for the procurement? (foreign language)

(foreign language)

I corrected the first question, it's not for the recognized how many trains. Actually the question is for the 80 sets or MUs contract is calculate or won by the first half year of 2017 or the second half year 2017. The answer is second half of 2017, especially within the second quarter of fiscal year 2018. The second question about ASP trend. The ASP, no change compared before because, in this area, we all provide the signal (inaudible) system so the CRC not give any 3 of us pressure within the price. And then the third one for the 250 kilometers trains procurement, it still have to wait from the information of CRC after Spring Festival. Currently, we can just know from the CRC like until 2020, there will be 900 trains in use for the 300. But 200 still, need to wait for the information. Thank you, Alex.

(foreign language)

(foreign language) The first question is about the trend. Because we can see the second quarter of the industrial automation new contract just flat. So what about the trend for the coming 2 -- next 2 quarters? And the second question is focused on the -- if not, can this call breaking down industry better revenue of IA, can you give us any sense of which special industry support or generated the revenue increase?

(foreign language)

We combined these 2 questions together to answer. The industrial automation revenue is made from the industry from power and chemical -- petrochemical and power, including the coal-fired, thermal and new energy, and this area is increasing. And the trend for the whole fiscal year, we will keep the compared increase. The second -- within the quarter maybe have to fluctuate but the whole trend is positive. And we believe at the end of the fiscal year, we still can keep more than 2-digits growth, either from the revenue and the new contracts. Thank you, Alex.

We'll go next to Jacqueline Du with Goldman Sachs.

(foreign language)

The question for the procurement we won, the 80 trains for the ATP, what about the delivery? It's all focused on the Spring Festival? (foreign language)

(foreign language)

(foreign language)

(foreign language)

Okay. The answer for the 80 trains of the procurement ATP we won. Partially, we deliver for the Spring Festival, not for all the Spring Festival needs. And also the supplement question for us about the new procurement time line for the -- for recent months, is it will within the third quarter or after March?

It's hard to say the deadline because it's all dominated by CRC, the only customer, so we really have to wait for their information. Thank you.

We'll go Patrick Xu with Nomura.

(foreign language)

The first question is about the high-speed rail sector recently have an accident for the train within the Qingdao line, and can you describes some information about this accident. And the second one is for -- we granted by the (inaudible) intellectual program of the central government. Is there any such theory or any award by -- from this grant?

(foreign language)

Okay. And first relates to the accident. Actually, it is just a single equipment problem. We think the train is not too much affected by the problem and time line. It's -- everything right now just goes smoothly. So it's not a very large -- lead to any bad results. It's just our equipment at fault. So -- but not to relate any signaling control products. The second is for the 23 intelligent manufacturing system solution provider recommended by the ministry of central government. We will benefit from many facts. For example, like we can carry on the large central government program and also we can -- we have similar recognition by the industry can easy to expansion or factory automation business.

Because of time restraints, so the one last question.

We'll take our last question from Thomas Zhang with Morgan Stanley.

(foreign language)

(foreign language) The first question is about -- here, I want to clarify 2 things. The 80 sets means the 80 sets of ATP is worth 40 trains, not 80 trains. The second one -- and back to the question, the first question is about the 80 sets of the ATP contract is all from the 300, so we will not see any 200 area procurement, and especially the replacement equipment. The -- if all comes from the 300, that means there has no replacement for the 200. (foreign language)

(foreign language)

And also the question is focused on the 80 sets ATP's all for the new generation of the 300. Are there any older ones?

The answer is yes, all comes from the new model of the 300, no old ones. And also the replacement we have but not within these 80 sets. Actually it's also booking into the upper sales revenue. Right now, not too much replacement. And maybe the cycle will start from several years later. The -- this is -- yes, this is the first question. Yes, and the second question is about the R&D distribution. Right now, we also focus on the factory automation development and also the high-speed rail we have a new product like the Track Circuit. So how you allocate the resource within the R&D and balance the expenditure? (foreign language)

(foreign language)

(foreign language)

(foreign language)

Actually, the R&D expenditure from the numbers to see, it will have a little bit increase but not too much. This is as before. I mean, 6% to 8% of total revenues. But we want to emphasize from the R&D itself, we focus on the overlapping part of the share -- share -- the platform like -- and also we emphasize the platform, not the single product. The platform is for the solutions. But when we do the R&D, the engineers have overlapping parts. For example, if electronic company wants to use part of the SCADA, it also can use the -- to share with the rail factor. And also IA can also do the SCADA. So they can share the SCADA by the rail and IA. So we emphasize the efficiency of the R&D to have the like the overlapping part that can reduce the R&D expenditure. And also we want to say -- I want to explain more about what we'll go do within the R&D right now. Beyond the rail factor, like the factory automation, we emphasize on 2 things: the first one, is mechanical ability. This is focused on like the machine product. Like, will it meet the project like Hai Di Lao? After the teaching side, they need us to provide a machine, replace the labor. So we have to raise the ability to provide the machine. This is to emphasize the mechanical ability. And also the (inaudible) from the Chinese (inaudible) area, they also focus on the machine mechanical ability raised. But the second path is for the subtle layer or the technology based on solution. This kind of solution is focused on the layer of data close to the equipment. For example, like the proximity computing or like the data analyzing or data storage of the cloud. Those kinds of things focused on the traditional industry upgrading, intelligence upgrading. So this area we have to provide a lot of new technology or new matter to combine with our existing products into a platform to assume that the solutions focus on different sub-verticals. So that's why the factory automation, we actually have a lot of things to do and we are working on it. (foreign language) Thanks, Thomas.

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

That does conclude our conference for today. Thank you for your participating, and you may now disconnect.

Bye-bye.