Hollysys Automation Technologies Ltd.
Q2 2017 Earnings Call Transcript

Published: 15 Aug 2017

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Hollysys Automation Technologies Earnings Conference Call for the Fiscal Year 2017 and the Fourth Quarter Ended on June 30, 2017. [Operator Instructions] Please be advised that this conference is being recorded today, August 15, 2017, Beijing time. I would now like to hand the conference over to Mr. Arden Xia, the Investor Relations Director of Hollysys Automation Technologies. Thank you. Please go ahead, Mr. Xia.

[Arden Xia:]

Hello, everyone, and thank you for joining us. Today, our speakers will be Mr. Baiqing Shao, CEO of Hollysys Automation Technologies; Ms. Harriet Qu, 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 fiscal year 2017; and Ms. Qu will discuss our performance from a financial perspective. And the whole senior management team 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 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

[Baiqing Shao:]

Thank you, Arden, and greetings to everyone. I would like to discuss some key events during this year. Industrial automation presented signal of the stabilization starting from the second half of the fiscal year. Our third quarter revenue achieved year-on-year growth for the first time in the last two years, recorded at 0.1%. The growth went further up to 6.5% in the fourth quarter, driving fiscal year revenue decline down to a single digit while new contracts was recovering. Performance in power remained prominent. We signed contracts to provide products for large power units, including Sichuan Jiangyou 2 gigawatt power units, Xinjiang East Hope 4 660 megawatts power units, Guohua Yongzhou 2 gigawatts power units and Datang Pingluo 2 660 megawatts power units. In chemical, several major contracts we signed include DCS and SIS contract for the polysilicon of Xinjiang East Hope Company, DCS and Batch contract for ASIA CUANON in its Waterborne Coatings Project and DCS, AMS and SIS contract for Bosheng Clean Energy Company. In nuclear, we continued to provide products for Tianwan, Fangchenggang and Hongyanhe Nuclear Stations. In Factory Automation, under the transition from an equipment provider to be a total solution provider, we are developing demonstration projects whose practice and model can be transferable for future application in related industries. We are currently running testing products -- projects for some renowned domestic enterprises, including an automation-and-intelligence boosting project for Haier's Tianjin-based and Qingdao-based wash machine factories, and another product -- project for Hai Di Lao, the famous hot pot chain, to improve efficiency in hot pot base material making. In high-speed railway, a flat fourth quarter performance was not enough to offset the 48% decline accumulated in the first 3 quarters. Weakness persisted throughout the year. Limited completion of the newly planned railway infrastructure in the early years of the 13th 5-year plan, coupled with change in customer procurement time line presented unfavorable short-term outlook and rendered uncertainties and volatilities in the performance of ATP contracts. For ground-based control, we signed contracts to provide TTC to Jinan-Qingdao Line, Haerbin-Jiamusi Line and Jiujingqu Line. For subway, we adhered to the expansion strategy, winning new SCADA contracts in more cities, such as Wuhan Line 21 and Dalian intercity line from Jinzhou to Pulandianwan. Even with the short-term uncertainty, however, outlook for our rail business in the long run remains positive. National mid- and long-term plan for the high-speed railway describes a sizable market, while we are paying adhered -- adequate attention to after sale and replacement demand and expanding our products range. In the mechanical and electrical installation services, although facing uncertain macroeconomic condition in Singapore and Southeast Asia and as well as the political tensions in Middle East, M&E recorded a high single-digit growth at 9%. Concord, for example, signed a contract to provide electrical installation services for Macau LRT Phase 1 project. Ongoing economic and political situation in these areas raised concern on performance and should be closely followed. Moreover, management and risk control can be addressed to improve operation efficiency as a counter measure. 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 discuss the financial results analysis on behalf of our CFO, Ms. Harriet Qu.

[Arden Xia:]

Thank you, Mr. Shao. I would like to share some highlights for this fiscal year 2017 and the fourth quarter ending on June 30 2017. Comparing the prior fiscal year, the total revenue for fiscal year 2017 decreased from $544.3 million to $431.9 million, representing a decrease of 20.6%. Broken down by the revenue types, service revenues increased by 14.9% to $13.8 million, integrated contracts revenue decreased by 19.3% to $385.5 million and product sales revenue decreased by 40.1% to $32.7 million. In July 2016, the company's interests in Hollycon were diluted from 51% to 30%, and the company lost the control of Hollycon. As a result, Hollycon's financials would not be included in the company's consolidated financials from July 2016 on. If Hollycon's revenue was excluded from the comparable figure for the prior fiscal year, the product sales revenue for the fiscal year 2017 should be increased by 13.8%, and the total revenues for the fiscal year 2017 should be decreased by 16.7%. The company's total revenue in segments

[Operator:]

[Operator Instructions] And our first question will come from Patrick Xu with Nomura.

[Patrick Xu:]

[Foreign Language]

[Arden Xia:]

Okay. The first question is about the railway transportation. The high-speed rail sector, the end customer, CRC, recently announced 104 trains for the new generation Fuxing Hao procurement and how much percentage we can get from this procurement. The second question is about the dividend. How much dividend for this fiscal year we will pay? The third one is for the guidance of 2018 because last fiscal year, on the beginning -- in the beginning of the year, we received roughly high expectation. But after that, we changed the guidance. What about this fiscal year? How much confidence we have for this fiscal year because right now, currently, we can see the backlog just comparing increase three points? So can you talk more about this?

[Baiqing Shao:]

[Foreign Language]

[Arden Xia:]

And the railway transportation high-speed rail, about the new generation Fuxing Hao, we all participated the R&D, the whole work, 3 of us, Hollysys and CRC and Academy of Railway Science. So we absolutely will get the shares from the new procurement. But right now, because we have no results, so we cannot disclose it here. But this is related to the 300 kilometers for our segment. Originally, we have one-third of the market share.

[Baiqing Shao:]

[Foreign Language]

[Arden Xia:]

About dividend, last year, we changed our dividend policy from, to a regular dividend policy. So the payout ratio is 10%, so we will intend to do that. But the final results will depend on the approval of the Board of Director meeting.

[Harriet Qu:]

[Foreign Language]

[Arden Xia:]

About the guidance. Last year, at the beginning, we changed our -- we give a rough -- high estimation. And later, we changed our guidance because we overestimated the business from high-speed rail and the industrial automation. And you could see in the whole year, the CRC side changed a lot, so the high-speed rail procurement lag. And what we see, frankly, the industrial automation also not recovered with very [indiscernible], so also achieved the final result. And the guidance beyond what I mentioned, also included one [phase], it's M&E, mechanical and electrical installation services. This part, the Concord adding some selling cost expenditure, so it leads to have a loss. And also, the goodwill impairment. So this part, it was the net income either. So that's why these factors account for the -- we didn't achieve the guidance. But for fiscal year 2018, we have confidence because from each segment, we could see the recover. Industrial automation, you could see the new contract is either recovering. And also the recent 2 quarters, last quarter, the first time flat from the revenue side, and this quarter compare increase more than 6%. And with the high-speed rail sector, we think the bottom has gone and -- sorry, the Industrial Automation, we expected that the fiscal year 2018, the growth rate revenue should be 15 to 25. And the rail sector, the bottom has gone, and we think this fiscal year 2018 should -- the revenue growth should be between 15 to 25. The subway factor, the existing backlog to see, we could achieve single-digit growth for the fiscal year 2018. And the mechanical and electric installation services, M&E sector, the 2017 fiscal year, it influenced the net income. So this fiscal year 2018, we are focusing on the recover -- focusing on the operating management for the business and also the projects. The current backlog is still okay, so we give the revenue growth should be between 10% to 20%. And also, we will focus on the net profit of M&E performance for this fiscal year, so that's why we gave this guidance.

[Operator:]

Our next question will come from Kevin Luo with Morgan Stanley.

[Kevin Luo:]

[Foreign Language]

[Arden Xia:]

The first question is from the guidance, the industrial automation, we did 15 to 25 revenue growth. But from the -- we can understand that the new contract is recovering. But this percentage is like more aggressive. I mean, it can hardly support the growth from the revenue side. Even the new contract is increasing. So, how you consider about this sector, industrial automation? It will -- the coming revenue is from the traditional business or the new business. The second question is about the subway. We did single-digit growth rate. But in China, currently, everything is very promising within the subway sector. So, why you give such a conservative number? Can you provide some detail?

[Arden Xia:]

[Foreign Language] Industrial automation revenue from two effects, the traditional related to DCS and the new business from the express factory automation. And currently, we can see the backlog with the DCS is relatively strong than before years. So the fiscal year 2018, it will mainly coming from the traditional DCS business. But the express right now have very good improvement. So compared the increased speed, we think the express growth rate would be higher than DCS growth rate. About the subway sector, yes, you said right. Currently, in China, everything in this area is very strong. But what we talk is about performance of 2018 fiscal year, we just focus on the current orders on hand, the backlog are all from SCADA. And relatively, the SCADA will be implemented within 1 or 2 years, [indiscernible] longer. So we recognize revenue, it will not bring very strong growth rate. So that's why we give such a conservative number. But to see the long term, subway will be a very good market in China right now. And Kevin also asking a question about the -- is the IA, traditional DCS, is increasing, for example, especially focus on integrated contracts, it will influence the gross margin of IA, right? And the CFO said, yes, it will influence the gross margin, but not too much, just 1 or 2 points for the industrial automation gross margin. Kevin?

[Kevin Luo:]

[Foreign Language]

[Baiqing Shao:]

[Foreign Language]

[Arden Xia:]

The question is a...

[Kevin Luo:]

[Foreign Language]

[Arden Xia:]

When it could find a signaling contract. And we are striving to penetrate this market, and we want to get the subway signaling contract, but it's hardly to guarantee here. We already have plans in the fiscal year 2018. Thank you, Kevin.

[Kevin Luo:]

[Foreign Language]

[Arden Xia:]

Because of time constraint, so we just have enough for 1 or 2 questions.

[Operator:]

And the question here from Alex Chang with Citi.

[Alex Chang:]

[Foreign Language]

[Arden Xia:]

The first question is about can you give us some broken down number for the IA, for example, the revenue by different areas, the power, the chemical, petrochemical, et cetera? And the second -- and also, the railway transportation. Please give us some broken down number for the high-speed rail and subway. And the second question is about the gross margin. What about the range for the fiscal year 2018? This question is about Hollycon. And what is this total gain? And I remember last year, you've already have this one, but why this quarter still have? And is there any new changes related to Hollycon share changes?

[Harriet Qu:]

[Foreign Language]

[Arden Xia:]

[Foreign Language] The first question, the industrial automation or rail, we do not have such or specific number or not -- we do not separate for such a specific detail of numbers, because what we can see right now within the financial report is just see the IA, rail and M&E, not like the -- from the production line side like [indiscernible], like the power, like chemical, petrochemical or within the rail, ATP, TCC. So we cannot provide you a number right now. Okay, just a second.

[Harriet Qu:]

[Foreign Language]

[Arden Xia:]

About the gross margin, I think [indiscernible] about within several segments. Industrial Automation, for this fiscal year 2017, we can achieve around 38% and the coming year 2018, we have, it will a little bit decrease because of the integrated contract and also some of the specific projects influence, we think it will reduce a little bit. For example, 1 or 2 points. And the railway transportation, if we separate it by the high-speed rail and the subway, sorry, the whole railway transportation for the fiscal year 2017, the gross margin should be around 44.7%. If we separated by the high-speed rail and subway, the high-speed rail is around 55% and subway around 15%. For the coming fiscal year 2018, we think the high-speed rail and subway should be maintained the same level. But the whole railway transportation for the 2018, it will depend on the mix of the final result. And the M&E sector, this fiscal year 2017 a little bit special because it has several projects adding expenditure cost. It will lead to this fiscal year 2017, the M&E sector gross margin just went down to 4.6 to 4.7 around. But the upcoming 2018, we should expect, we are focusing on changes, operating, improved the operating management. So we think it will recover to the normal, around 15.

[Harriet Qu:]

[Foreign Language]

[Arden Xia:]

About the Hollycon, we adopt the equity method. So it has some equity cost at the beginning. You said the last year is the fourth quarter of the fiscal year 2017. So at the end fiscal year, we had to recalculate the whole phase. And finally, from the share change expenditure or benefit to calculate from Hollycon, we have a gain finally. Thank you, Alex. Operator?

[Operator:]

Yes. sir. Okay, I'm sorry sir, you want to take one more question. Okay no problem that question will come from Jacqueline Du with Goldman Sachs.

[Jacqueline Du:]

[Foreign Language]

[Arden Xia:]

The question is about the goodwill impairment of Concord. We made acquisition in 2011. And this fiscal year, we could see about $11.1 million goodwill impairment. So can you explain more about the future business of Concord?

[Harriet Qu:]

[Foreign Language]

[Baiqing Shao:]

[Foreign Language]

[Arden Xia:]

From [indiscernible] you see this figure, we have around $11 million goodwill impairment. And also 2 years ago, you could see we also have $2 million from the Concord goodwill impairment. So [call it] total together, around $ 13 million. And the rest of the goodwill of Concord should also around $13 million. This time, we do the goodwill impairment more than [15] of the Concord. And from the business you see, because this was -- the Concord is focused on the mechanical and electrical utility services for the railway sector. And this year, because some of the projects, we did not control very well for the project execution, so it will lead to -- it added some cost. That's why this year, performance is not good. But from the backlog you see it's still large enough to support the Concord to have good performance in future. And the current management team already see the problem and we are changing the operating management, the whole phase within the Concord. So, we will strengthen the control, strengthen the project execution. We believe the coming year 2018 should have a positive number and it will recover to normal. Thank you, Jacqueline. Okay. Thank you, everyone, for joining us on today's call. If you haven't got a chance to raise your questions, we will be pleased to answer them through follow-up contacts. We look forward to speaking with you again in the near future. Thank you.

[Operator:]

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