Hollysys Automation Technologies Ltd (HOLI) 2019 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 first quarter of fiscal year 2019 ended September 30, 2018. (Operator Instructions) Please be advised that this conference is being recorded today, November 14, 2018, Beijing time.

I'd 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.

Thank you. Hello, everyone, and thank you for joining us. Today, our speakers will be Mr. Baiqing Shao, CEO of Hollysys; and Mr. Steven Wang, CFO of Hollysys; and myself, the IR Director of Hollysys. On today's call, Mr. Shao will provide a general overview of our business, including some highlights for the first quarter of fiscal year 2019. 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 Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that are not historical facts, including statements relating to the expected growth of Hollysys' future product introductions, the mix of product 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 the market acceptance of new product introductions; general economic conditions, geopolitical events and regulatory changes; as well as other relevant risks detailed in the 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 the information discussed in this conference call or in its filings.

Please note that all amounts noted in this conference call will be 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 first quarter.

Industrial automation business recorded a 0.4% year-to-year growth in revenue at $57.7 million. New contract recorded a 9.9% year-to-year growth at $80.2 million. We continued to maintain our share in high-end power industries to execute the low- to high-end market expansion strategy in chemical and petrochemical industries and to build and maintain our leadership in other verticals.

In power, major contracts we signed include a DCS solution for Guohua Jinjie 2X660MW power and Shenhua Shengli 2X660MW power. Contracted growth in chemical and petrochemical remained healthy. Major contracts include additional SIS contracts for the milestone Zhong'an United Coal Chemical Project and additional DCS contract for SINOPEC's p-xylene project.

In addition to the efforts in gaining and maintaining market share in various industries, the company is paying adequate attention to the intelligence manufacturing based on sizable customers we have accumulated through decades, as it is a valuable asset for our long-term sustainable growth.

Leveraging our consistent emphasis on R&D, we continue to provide both regular and value-added services to our customers and to accompany them along the cause of the better productivity. Our widespread national service network enables us to stay closer to the customers to respond faster and to understand better.

Rail business recorded a 43.1% year-to-year growth in revenue at $50.4 million, while new contract increased sharply year-to-year at 866% at $71.5 million.

In high-speed railway business, new ATP contracts were signed this quarter, while CRC has published the bidding notice in mid-October for another 320 sets of ATP. Intake of heavy maintenance contracts are gradually seen as the ATPs are approaching their first 10 years' maintenance cycle.

In subway business, we signed SCADA contracts on Shenzhen subway line 2 and line 8. Going forward, we will continue to strengthen our marketing capability -- capacities through reviewing and updating strategic partnership and improving local service network coverage for both high-speed railway and subway business. Management team will adhere to the diversity strategy to create revenue stream from more new products and services and to maintain a stable and healthy growth into the future.

In oversea business, we continued to seek opportunities in industrial automation business through EPC projects and direct sales. Contracts were signed on DCS, DEH, BATCH, instrument integration, et cetera, solution with customers from India and Southeast Asia in coal fire, thermal power, chemical and construction material, et cetera.

M&E business, performed by Concord and Bond, recorded a 34.2% year-to-year growth in revenue at $30.6 million and a 32% year-to-year growth in new contract at $14.8 million. M&E will continue to act as a pioneer of internationalization for Hollysys, with growing coordination to be built in between M&E and domestic business. Meanwhile, the economic and political circumstances in Southeast Asia and Middle East will continue to be closely followed.

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

Thank you, Mr. Shao. I'd like to share some highlights for the first quarter of fiscal year 2019 ended September 30, 2018. Comparing to the first quarter of the prior fiscal year, the total revenues for the 3 months ended September 30, 2018, increased from $115.5 million to $138.7 million, representing a 20.1%. Integrated contract revenue increased by 21.9% to $116.7 million. Product sales revenue decreased by 15% to $8 million, and service revenue increased by 35.4% to $14 million.

The company total revenue presented by segments is as follows: for the first quarter of fiscal year 2019, industrial automation revenue, $57.7 million; rail transportation automation revenue, $50.4 million; mechanical and electrical solutions revenue, $30.6 million; total revenue, $138.7 million.

Overall non-GAAP gross margin was 37.2% for the 3 months ended September 30, 2018, as compared to 36.6% for the same period of the prior year. The non-GAAP gross margin for integrated contracts, product sales and services were 30.8%, 75% and 67.9% as compared to 29.3%, 71.8% and 71.6% for the same period of the prior year, respectively. The gross margin fluctuation was mainly due to the different revenue mix with different margins.

Selling expenses were $7.7 million for the first quarter, representing an increase of $1.0 million or 15.1% compared to $6.7 million for the same quarter of the prior year, mainly due to the increased sales activities. Selling expenses were 5.6% and 5.8% for the 3 months ended September 30, 2018, and 2017, respectively.

Non-GAAP G&A expenses were $8.6 million for the quarter ended September 30, 2018, representing a decrease of $2.4 million or 19.3% compared to $11 million for the same quarter of the prior year, mainly due to the decreased bad debt allowances. Non-GAAP G&A expenses were 6.2% and 9.5% for the quarters ended September 2018 and 2017, respectively.

R&D expenses were $8.8 million for the first quarter, representing an increase of $0.2 million or 1.6% compared to the $8.6 million for the same quarter of the prior year.

The VAT refunds and government subsidies were $3.5 million for the first quarter compared -- as compared to $7.1 million for the same period in the prior year, representing a $3.6 million or 49.9% decrease, which was primarily due to the decrease of the VAT refunds.

The income tax expenses and effective tax rate were $5.5 million and 16.3% for the first quarter as compared to $3.7 million and 14.9% for the comparable prior year period.

The non-GAAP net income attributable to Hollysys was $28.1 million or $0.46 per diluted share based on $61.3 million diluted shares outstanding for the 3 months ended September 30, 2018. This represents a 27.9% increase over the $21.9 million or $0.36 per share in the comparable prior year period.

Contracts and backlog highlights. Hollysys achieved $166.5 million new contracts for the 3 months ended September 30, 2018. And the backlog as of September 30, 2018, was $516.2 million. The detailed breakdown of new contracts and backlog by segments is as follows: for the first quarter, industrial automation new contracts, $80.2 million; rail transportation, $71.5 million; mechanical and electrical solutions, $14.7 million; total new contracts, $166.5 million.

Backlog industrial automation first quarter, $176.5 million; rail transportation backlog, $244.7 million; mechanical and electrical solutions, $95 million; total backlog, $516.2 million.

Cash flow highlights. For the first quarter, the total net cash inflow was $11.2 million. Operating cash flow was $36.6 million. Investing cash flow was $17 million. The net cash of financing activities was $0.1 million.

Balance sheet highlights. The total amount of cash and cash equivalents were $276.9 million, $265.7 million and $244.8 million as of September 30, 2018, June 30, 2018, and September 30, 2017, respectively.

For the 3 months ended September 30, 2018, DSO was 170 days as compared to 196 days for the comparable prior year period and 166 days for the last quarter. And inventory turnover was 51 days as compared to 61 days for the comparable prior year period and 59 days for the last quarter.

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

Operator, please.

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

(foreign language)

The first question is no matter year-to-year -- year-on-year compare for the first quarter or over to the -- over quarter to compare the industry automation and rail, new contracts actually have improved a lot. But why the backlog still compare a decrease, I mean, sharply. It seems like not the mix equal.

The second question, about the ATP question. The maintenance cycle for the 10 years -- at the 10 years is the CRC the only customers you have a real cooperation? Or do you have a contract presently or just a common standardized bidding? And also, what we do for the maintenance is our entire product change or the components or the other things change gradually?

The third question is about R&D expense. Actually, at the beginning of this year, you mentioned not this guidance. So I suppose that the expense is going to increase. But right now, the R&D as a percentage of total revenue decreased. So I want to ask about what about the coming 1 or 2 years' disproportion and also how you manage the R&D.

(foreign language)

(foreign language)

The first question about the backlog. Actually, backlog compare just increased 3% to 4%, but new contract compare increased a lot because according -- this fiscal year, according to the ASC 606, the new principal of the GAAP -- U.S. GAAP we adopt from July 1, parts of our service contract revenue recognition are changing from special performance matters into percentage of completion in light of several one-off effects on our financial results, including backlog. This partly influenced around CNY 240 million versus USD 35 million roughly. And this new standard is also influenced just the balance sheet of accounts. So this is why this part, you could see a little bit different between new contract increased rate -- growth rate and also the backlog.

(foreign language)

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(foreign language)

The question still refers to the backlog numbers. But actually, the answer is the main influence is just that $35 million, and it's just a time of point of recognition revenue that is different. But actually, the whole quarter recognized revenue just compare a little bit fast, but this is influenced by our end customer. We also followed by the percent of completion. So current base still in a healthy range. Thank you.

(foreign language)

Okay. The maintenance about the high-speed rail were a bit emphasized on the electronic components. And we discussed with the CRC, the only customer, we settled down -- all the providers settled down to the same thing. 7 to 10 years is our time for the maintenance and also replacement because we want to secure the reliability of the whole railway transportation operation. And the CRC and our providers together set up these rules that just between 7 to 10 years, changing the internal components gradually. So the large cabinet do not change, but the inside of each unit and our components, we gradually need to change.

(foreign language)

(foreign language)

The -- about the R&D expense, actually, before the yearly target, we give the range 6% to 8% of total revenues. This is still in the range. And from the actual value, you could see this color still with a good number. And also, we want to emphasize beyond R&D. Actually, we also finished the R&D activity by the other activities, for example, the investment or M&A potential to make the sufficient support for the R&D purposes. Thank you.

(foreign language)

(foreign language)

The last question, have you had any evaluate about -- in the past 10 years, if you start to do the maintenance or replacement, what about the price or the potential market value for those part?

(foreign language)

This part has no exactly in the data for your reference, but in the future, we're glad to share to you for better landscape. But generally speaking, for the gross margin, we have no change. And also, this kind of gradually exchange the components, we also have our own pricing strategy. Thank you.

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

(foreign language)

Okay. The first question is about the rail transportation. New order increased a lot, could you separate the ATP, TCC maintenance and also an increase the Track Circuit the contracts? And the second -- and also right now, we could see the trend for the open bidding or the competition of the construction for the rail is very -- it's just a start, and what about your vision for the whole 2019 cabinet year? And second question is about the IA. Industrial automation new contract is $80 million level, and this is still a good level. Could you explain a little bit about separated verticals trends? I mean, power, chemical, the other trends? And the last question is about the highly evolved cases. This is representative of the every industry, and what about the co-pay or with these solutions, a transit ability to the other areas of leverage?

(foreign language)

(foreign language)

(foreign language)

The first question, we actually would not disclose the separate down number for the ATP, TCC maintenance. And by the way, we included the Track Circuit contract this quarter, just the regular -- just the high-speed rail, it has aligned.

(foreign language)

(foreign language)

Okay. We also do not disclose the bridging number exactly, but I can tell you about the roughly range. No matter revenue or new contract within IA, the power around the 40% to 45%, and also the same with the chemical, petrochemical. And by the way, power including the coal fire, thermal power and new energy. And the 5% roughly around from the new nuclear power and 10% to 15% from others, like the metallurgy, building materials, those kind of industries. And the coal fire new, construction slowing down, but from the asset value, still okay because we have tremendous basement of track records. We can do the other maintenance, upgrading potential contracts. So this is the basic spread of the industries. (foreign language)

(foreign language)

The Hai Di Lao case, we helped them to finish the kitchen side automation work. This is including like the automatic preparing the soup area. It's like a different revenues to automatic -- integrated together. And also the wash -- included the wash function, washing function. And we want to achieve the purpose of the Hai Di Lao itself. They want to do the automation to do the standardized and also want to finish the increase of their satisfaction from the customer. And we already signed for the contract with the other franchise. They want to do this case to deliver to the other franchise.

(foreign language)

I want to make emphasis on the Hai Di Lao case. Actually, it's very significant because from the customer settle down the order from the iPad and transfer to the kitchen side, and the whole thing is the system execution and reflect the whole process is automatic. This is the -- also through the MES, the whole production manufacturing product. And also the control objectives, also including the solid material and the liquid material. So it's a kind of improve of our capability of the team to focus on the different situation of the working conditions due to manufacturing or intellectual manufacturing product. So this is a very good standpoint and also can reinforce our capability to provide more complex conditions automation work in future.

(foreign language)

And we very -- expect that the tech automation is part of future performance. And by the way, I'll return to our -- my question about the rail. ATP, for example, amounted 320 sets. How many do you deliver currently? And what about the price? And also, the last thing is, I also want to focus on the landscape or expectation for the whole 2019 calendar year performance. Can you explain a little bit more about this?

(foreign language)

The ATP contract for this calendar year, 2019, right now has 2 batches of the bidding. One is -- all for 300. One is in August around the -- totally around the 190 sets of ATP, and we won 52 sets. And the second batch in October 15, around 320 sets. But right now, we not sign contract yet, so we cannot disclose the number. We will see later and will do the press release for all our investors. And generally speaking, the high-speed rail, the total investment, no changing. And also, our market share is very stable. So we are very optimistic for the 2019 whole fiscal year. And later, we will still provide a lot of service contracts and also new product contracts as a supplement. Thank you.

(foreign language)

(foreign language)

I want to confirm the -- about the unit price, no changing, right?

The answer is yes. Thank you.

At this -- due to the time constraint, we will now take one last questions.

Your last question comes from the line of Gary Cheung from Haitong International.

(foreign language)

(foreign language)

(foreign language)

Okay. The first question is about the U.S. new principal for the GAAP principal this year to start reflecting from your financials. And could you give me a little bit about the data? Before, no change before about the backlog number. This is better for us to contrast the differences. And the second question is about the IA new contract. The revenue just compare increase flat, and the new contract compares increase. And what about your sales area expenditure? Is there any other significant growth? And also about the new order, I want to say -- or new contract, I want to ask about any cancel situation? The last question for -- you said the CNY 240 million backlog influenced by the service contract and -- but beyond this influence, we also could see the backlog a little bit going down. So is there any particular IA area industries not good right now?

(foreign language)

(foreign language)

(foreign language)

(foreign language)

(foreign language)

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(foreign language)

The question for the first one is, we will -- to answer the question about the comparison of the corporate result of the backlog. But actually, I want to emphasize the $35 million is still the main difference between the -- between including the service contract. And also, the second one for the new contract, we have -- and even the backlog, we have not any cancellation. Actually, this part is also stable. We have the latest cycle of the automation work, by the way. And for the long-term proceeds, the revenue and the backlog should be at the same trend, but probably, it will be -- have differences. But no reliable relationship between each other. I mean, actually, probably, it depends on the recognized revenue, actually, the percentage completion of our implementation work by the customers' side.

And then the last question also including the same as the first 2 questions, beyond the $35 million influence, maybe you have to have the currency exchange rate. If you're calculating these 2 things, the -- our backlog actually compares increase 12%. This is a little bit softer than the revenue. And also, you could use that as slowing down, but actually, this kind of fluctuation in the normal range, just like what I said, have no reliable relationship. It just depends on different -- but probably, it's just the difference depends on the percent of completion.

(foreign language)

(foreign language) The question is about the focus on the IA, industrial automation. And this part do have to see any verticals special decline, or from the contract size, needed a cancellation or the other things, just focus on the industrial automation. And actually, our IA, the customers side, more than 90% already investment to finish the infrastructure and also finish the equipment procurement. So the last part is the automation. So that's why we meet very few -- I mean, actually, not any cancellation of the contract situation. And also, the backlog -- also, the new contract, in the past 10 quarters, if you see the actual value, normally, in the range of USD 50 million to USD 60 million. But this quarter, still above USD 80 million, in the high ranges. So the momentum is still very good by our side. And the -- by verticals, it's just a methodology due to material, those industries still not good. But actually, the main generator from the power and the chemical -- petrochemical is still strong with our side. This is also including -- we increased above the average of the industry growth. It also depends on our internally strengthen our penetration for the market share. So these elements influence the total momentum of the new contract of IA.

(foreign language)

And I want to make supplement about the industrial automation entire environmental market circumstances. Actually, from our side, we not see any sharply declining of particular industry, so we still can maintain the momentum right now.

Thank you, Gary.

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.

That does conclude our conference for today. We thank you for your participation. You may all disconnect.