Hollysys Automation Technologies Ltd (HOLI) 2018 Q4 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 Fiscal Year 2018 and the Fourth Quarter Ended June 30, 2018. (Operator Instructions) Please be advised that this conference is being recorded today, August 15, 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. Thank you for joining us. Today, our speakers will be Mr. Baiqing Shao, CEO of Hollysys Automation Technologies; Mr. Steven Wang, CFO 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 and the quarter results. Mr. Steven Wang will discuss our performance from a financial perspective, and 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 expectation 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 the 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 such forward-looking 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 in U.S. dollars, unless otherwise noted. And now I would 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.

Industrial automation recorded a 46.2% year-to-year growth in quarterly revenue at $64.0 million. Annual revenue and new contract recorded a 30.2% and 16.0% year-to-year growth, respectively. Management continued to execute the low to high end market expansion strategy for process automation business. Contract growth in chemical and petrochemical remained healthy. Major contracts included a DCS, SIS, ITCC and AMS solution for Shandong Haiyou Chemical's 1 million tons delayed coking equipment project and a DCS solution for Suzhou Sinye Materials Technology Co., Ltd, covering its furan, cold-core and sulfonic curing agent project.

We signed several additional contracts in the quarter, the milestone Zhong'an United Coal Chemical Project, where we applied our comprehensive solution to many new equipment for the first time.

On power, despite the slowdown of the coal fire industry, growth in the thermal power and new energy remained healthy. We continued to maintain our market share in high-end coal fire market while actively expanding market for multiple product lines. Major contracts signed include a DCS solution for Shenhua Wucaiwan 2X660MW power station and a DEH solution for Datang Pingluo 2X660MW turbine unit. We continue to address service and upgrading demand from the entire customer base. Our databased, value-added solution, including energy saving, control optimization and information security, et cetera, have received growing acceptance from customers of several industries. With our widespread national service network, we are capable of communicating with and delivering to our customers from various industries regular and value-added customized services and products they need.

Rail business recorded a 37.6% year-to-year decline in quarterly revenue at $40.4 million, while quarterly new contract declined year-to-year by 16.8% at $58.1 million. Annually, new contracts increase year-to-year by 24.2%, while revenue increased year-to-year by 22.4%. Breakthrough was made as we signed a C2 track circuit contract for Guiyang Southwest line. New contracts were also signed on subway SCADA for Beijing Subway Line 17 and Line 19. And for ATP product line, CRC started the bidding of C3 ATP in early June, but the contract has not been signed yet. We continue to strengthen our marketing capacity through reviewing and updating strategic partnership and improving local service network coverage and signed several maintenance contracts, covering both on-board and on-ground equipment. Management team will adhere to the diversity strategy to creating revenue stream from more new products and services and to maintain a stable and healthy growth into the future.

In oversea business, we continue to seek opportunities in process automation business through EPC products -- projects and direct sales. Contracts were signed on DCS, DEH, BATCH, et cetera, solution with customers from India and Southeast Asia.

The M&E business, performed by Concord and Bond, recorded a 45.1% year-to-year growth in quarterly revenue, at $42.9 million, and a 150.9% quarterly new contract growth, at $40 million. Annual M&E revenue and new contracts recorded 21% and 134.5% year-on-year growth, respectively. Effort on improving management and risk control in this fiscal year has taken effect and the work is ongoing. The economic and political circumstances in Southeast Asia and Middle East Asia will continue to be closely followed.

With that, I'd like to turn the call over to Steven Wang, who will read the financial results analysis.

Thank you, Mr. Shao. I would like to share some highlights for the fiscal year and quarter ended June 30, 2018. Comparing to the prior fiscal year, the total revenue for the fiscal year 2018 increased from $431.9 million to $540.8 million, representing an increase of 25.2%. Integrated contracts revenue increased by 21% to $466.5 million. Product sales revenue increased by 23.2% to $40.2 million, and services revenue increased by 147.3% to $34.1 million.

The company's total revenue can also be presented in segments as follows: For fiscal year 2018, industrial automation, $224.8 million; rail transportation automation, $190.6 million; mechanical and electrical solution, $125.3 million; total revenue, $540.8 million.

Non-GAAP gross margin was 38.2% for the current fiscal year as compared to 32.7% for the prior year. The non-GAAP gross margin for integrated contracts, product sales and services were 32.8%, 73.2% and 71% for the current fiscal year as compared to 28.2%, 69.5% and 70.8% for the prior year, respectively. The gross margin fluctuation was mainly due to the different revenue mix with different margins.

Selling expenses were $27.2 million for the current fiscal year, representing an increase of $2.8 million or 11.2%, compared to $24.4 million for the prior year. Non-GAAP G&A expenses were $45.1 million for current fiscal year, representing an increase of $1.3 million or 2.9% compared to $43.8 million for the prior year.

R&D expenses were $36.6 million for the current fiscal year, representing an increase of $6.5 million or 21.6% compared to $30.1 million for the prior year, mainly due to the increased research and development activities.

The VAT refunds and government subsidies were $24.5 million for the current fiscal year as compared to $29.8 million for the prior year, representing a $5.3 million or 18% decrease, primarily due to decrease of government subsidies. Income tax expenses and effective tax rate were $22.2 million and 71.1% (sic) [17.1%] for the current fiscal year as compared to $14.4 million and 71.3% (sic) [17.3%] the prior-year period.

The non-GAAP net income attributable to Hollysys was $108.9 million or $1.78 per diluted share based on 61.2 million diluted shares outstanding for the current fiscal year. This represents a 55.4% increase over the $70.1 million or $1.16 per share based on 61 million diluted share outstanding in the prior year.

Operating results for the fourth quarter ended June 30, 2018 compared to the fourth quarter of the prior fiscal year, the total revenue for quarter ended June 30, 2018, increased from $138 million to $147.2 million, representing an increase of 6.7%. Integrated contract revenue increased by 5.5% to $131.6 million. Product sales revenue increased by 30.4% to $11.1 million, and services revenue decreased by 4.4% to $4.5 million.

The company's total revenue and the presenting segments are as follows. For the Q4 of 2018, industrial automation, $64 million; rail transportation automation, $40.4 million; mechanical and electrical solution, $42.9 million; total revenue is $147. 2 million.

Non-GAAP gross margin was 39.6% for the quarter as compared to 39.1% for the same period of prior year. The non-GAAP gross margin for integrated contracts, product sales and services were 35.7%, 72.4% and 73.2% for the quarter as compared to 35.7%, 71.5% and 69.9% for the same period of prior year, respectively. The gross margin fluctuation was mainly due to the different revenue mix with different margins.

Selling expenses were $6.5 million for the quarter, representing a decrease of $0.1 million or 1.2% compared to $6.6 million for the same period of prior year. Non-GAAP G&A expenses were $14.4 million for the quarter ended June 30, 2018, representing a decrease of $0.2 million dollars or 1.5% compared to $14.6 million for the same quarter of the prior year.

R&D expenses were $8.6 million for the quarter, representing an increase of $0.6 million or 7.5% compared to $8 million for the same quarter of the prior year.

The VAT refunds and the government subsidies were $4.1 million for the quarter as compared to $6.5 million for the same period in the prior year, representing a $2.4 million or 37.9% decrease, primarily due to the decrease of government subsidies.

The government income tax expenses and effective tax rate were $4.6 million and 14.2% for the quarter ended June 30, 2018, as compared to $5.4 million and 19.9% for the comparable prior year.

The non-GAAP net income attributable to Hollysys was $28.6 million or $0.46 per diluted share based on 61.3 million diluted share outstanding for the quarter ended June 30, 2018. This represents a 26.5% increase over the $22.6 million or $0.37 per share based on 61.3 million shares outstanding in the prior year.

Contracts and backlog highlights. Hollysys achieved $181.2 million new contracts for the quarter ended June 30, 2018. And the backlog as of June 30, 2018, was $569 million.

Cash flow highlights. For the fiscal year June 30, 2018, the total net cash inflow was $64.4 million. The net cash of operating activities was $122.2 million. The net cash of investing activities was $50.4 million. The net cash used in financing activities was $12.2 million.

For the quarter ended June 30, 2018, the total net cash inflow was $24.1 million. The net cash of operating activities was $45.1 million. The net cash of investing activities was $6.4 million. Net cash off of financing activities was $4.7 million.

Balance sheet highlights. The total amount of cash and cash equivalents were $262.1 million, $238 million, $197.6 million as of June 30, 2018, March 31, 2018, June 30, 2017, respectively.

For the fiscal year ended June 30, 2018, day sales outstanding was 174 days as compared to 201 days from the prior year, and inventory turnover was 58 days as compared to 51 days from the prior year. For the 3 months ended June 30, 2018, DSO was 166 days as compared to 153 days for the prior year period and 196 days for the last quarter.

The inventory turnover was 59 days as compared to 50 days for the prior-year period and 63 days for the last quarter.

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

(Operator Instructions) Your first question comes from the line of Lingxin Kong from CICC.

(foreign language)

(foreign language)

(foreign language)

The first question is focused on the gross margin for the fiscal year 2018, and we could see the integrated contracts gross margin from 28% raise to 33% and beyond the reasons that the mix of the different products was either an added reasons for this matter and also we could see the railway translation compare IA the gross margin is higher but that fiscal year, for example, the railway translation revenue goes down but still from that point now, we could see the IA compare increase a lot. But still can mix the gross margin maintain a high basement like this fiscal year, 38.2%, so just to give us a hint about the gross margin. The second one, question, is about the guidance. There is no guidance for the fiscal year 2019 and could give us a little bit more landscape of our future.

(foreign language)

The first question is about gross margin, and this fiscal year, still maintain a high basement beyond the mix reasons. We also have the other 2 reasons. The first one is railway transportation compare the percentage of total revenue contribution is too high and this part of the gross margin is higher than the other business. And also, this fiscal year the M&E business, also the gross margin, is improve -- makes a big improvement. So that's why the whole gross margin still maintain a good level.

And the second question about guidance, the first thing we can see there is technically to predict the 1 year a little bit hard for the current circumstances, for example, like the matter external environment, the policy, the other things. And the second one is internally element because our current management team is thinking about the long-term strategy and sometimes for achieve long term strategy or target, not to concentrate on the short-term of the numbers. So that's the reason. Thank you.

(foreign language)

(foreign language)

The question is about the high-speed rail revenue the percentage of this fiscal year compared last fiscal year is increasing, but we provided a data about that part. And the answer is currently not in our hands. But you can calculate by the financial results. Thank you.

Your next question comes from the line of Varun Ginodia from JPMorgan.

So my question is, we have recently seen CRC coming up with a blue sky plan. So I wanted to get a sense from you how -- what impact do you expect to see on Hollysys from that particular plan in terms of margin procurement going forward and how does that impact the new order contracts for your company?

And also, if you can -- if it's possible to provide some guidance on new orders in second half of this year, like second half calendar year '18. What is your thoughts on that? Can we see increased procurement coming in and that getting translated into higher growth in new orders?

Thank you. (foreign language)

(foreign language)

Right now the China Railway Corporation is under reform of the structure and also operating trends. And that's why the bidding process is being influenced by business act. And also, you could see that, the 2018 calendar year actual should be get the contract but a lot of bidding postponed to the second half of the calendar year. And that's why we think the second half year performance are better from the other -- than the first half. For example, like the [8B] contract, and we will sign a contract before September 30. And also, at end of the year, no matter from the 200 or 300, the 300 still have some orders and the 200 is under recent development of new models but end of this calendar year will be finished. But whether or not it's for open the bidding for end of this year or at the beginning of next calendar year, it's hard to make a prediction. So conclusion, I mean, it's hard to make a prediction of the bidding process, but we believe from the current information that the CRC want to enlarge the investment to CNY 800 billion for this calendar year. So that's why we are positive for the orders. But the time line would be fluctuate. Thank you.

Your next question comes from the line of Gary Cheung from Haitong Capital.

(foreign language)

The first question about the industrial automation. From last year to right now, the new contract is increasing very fast. So what about the future momentum? It can maintain this momentum? And the second question about the business treaty, the conflicts between United States and China, how long we go further, is there added influence from your customer side? Or how much it could be influenced and from which effects?

And then third question is about the gross margin. The [ESAT] And M&E sector have big fast improvement of our gross margin. Is this sustainable and why? Thank you.

(foreign language)

The first question is about the industrial automation. And this kind of increased because we internally strengthened our management skill and also we focus our target more about the high end of the market. And also, this is including the recent intellectual projects emphasized by central government as with our own enterprises. And through the improvement of management skill and capability, we believe we can maintain the momentum.

And the second question about the conflicts -- business conflicts between China and the United States. The influence really have and but more positive to us. For example like raised the tax -- the import tax of the DCS and PLC product from outside, and gives the momentum for us to penetrate the market. And also the central government to emphasize on the procurement, the local companies, domestic companies should emphasize on the house-made IP and proprietary technology, that's why no matter from the procurement they take different technology or products, we are all made by our house so this is also good for us.

The third question about Concord -- sorry, the third question about the gross margin for M&E. Last fiscal year, the Concord, some product at raised cost, so lead to the gross margin down and through our internal equipment and we strengthened the control about the product and this fiscal year, why the M&E recover to a normal, above 10% gross margin, and this is sustainable. Thank you.

(foreign language)

The first question is about the adding -- about the second -- the trading conflict. To raise the import tax is better for Hollysys. But from the customer side, do you see any slowing down because from customer side they are more cautiously to do like large production, like raise the sound at like all the time, so maybe shows the slowing down by customer.

And the second question is about the industrial automation, the fourth quarter gross margin.

(foreign language)

The first question about our customer side, we are doing the engineering project. Actually, these projects were plenty several years ago, and that's why, right now, costly influence not to transfer to fast right now. So we see -- we have to see the future reset maybe the second half of the calendar year or next calendar year, we can see the influence. This is kind of delay about the -- our business. And the second question ...

(foreign language)

The IA gross margin fourth quarter still maintain a good level, so no any sharply influence. Thank you.

Thank you, everyone, for joining us on the call today. If you haven't got the chance to raise questions, we will please answer them through follow-up contacts. We look forward to speaking with you again in the near future. Thank you. (foreign language)

(foreign language)

This concludes our conference today. Thank you for participating. You may all disconnect.