Hollysys Automation Technologies Ltd.
Q1 2015 Earnings Call Transcript

Published: 15 Nov 2014

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Hollysys Automation Technologies Fiscal Year 2015 First Quarter ended on September 30, 2014 Earnings Conference Call. [Operator Instructions] Please be advised that this conference is being recorded today, November 14, 2014. I would now like to hand the conference over to Ms. Jennifer Zhang, the Investor Relations Director of Hollysys Automation Technologies. Thank you. Please go ahead, Ms. Zhang.

[Jennifer Zhang:]

Hello, everyone, and thank you for joining us. Today, our speakers will be Dr. Jianfeng He, Chairman of Hollysys Automation Technologies; Mr. Baiqing Shao, CEO of Hollysys; 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 quarter, and Ms. Qu will discuss our performance from financial perspective and a financial outlook for fiscal year 2015, and Hollysys' senior management will answer questions afterwards. Before we get 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, 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 set forth in the statements

[Baiqing Shao:]

Thank you, Jennifer, and greetings to everyone. Earlier this quarter, we continuously insisted in executing our strategies to vertically penetrate in the high-end industrial automation market. And we had won several high-end projects in chemical, thermal, food and beverages and the new energy industries. We were also focusing on building strong after-sale department and set long-term goals on improving after-sale services. Our solution in reducing waste emission and environment protection proved successful. In recent operation, we have won a significant bidding to provide our proprietary DCS 1 gigawatt Guangdong Yuedian Bohe thermal power plant. We also had a contract win of 2 800 megawatts thermal power plant DCS reconstruction project for Liaoning Suizhong power plant, which marks our footsteps on largest scales of power plant reconstruction area in China, provided our leading technology and a total solution has won the trust of our client to replace the foreign players' control technology and products. With China becoming an aging society and the labor shortage tends to be a bigger problem, China is putting more efforts in automation to replace labor and improve efficiency to reduce emission and protect environment. We believe, we will financially benefit more in the long run. Going forward, we will continue to expand our sales force and allocate more resources to high-growth industries, penetrate further into high-end market, increase market share in the low- to middle-end market, expand our products and supplies such as software and safety protection solutions, increase our overall market share and grow the business in the industrial automation, leveraging our advanced technologies, experienced professionals, profound industry expertise, and customization and innovation capability. In Rail Transportation, during this quarter, we feel excited of the significant subway supervisory control and data acquisition system, SCADA, bidding win in Tianjin Subway Line 5, which is scheduled to be in operation by the end of 2017, leveraging our previous successful subway SCADA experience in Beijing, Guangzhou, Shenzhen subway lines. We will continue to deliver quality works and work closely with subway authorities in the future to promote our SCADA and the future subway signaling technologies. Besides in the high-speed railway, we continuously make remarkable achievements and market share increase. Currently, we are tightly executing quite a few railway line including Qingdao-Rongcheng line, Guiyang-Guangzhou Line, Shenyang-Dandong Line and bidding for new projects. We also work to expand our rail products' supply, such as track circuit. We have finished the 1 year testing of this product on the line authorized by Beijing Railway Bureau, and soon we are going to finish this official admission process. With China's tremendously rail and subway construction nationwide, there's going to be an exciting prospect for Hollysys. As a well-recognized rail signaling system provider, we are confident that with our strong R&D capability, solid execution and reliable products, Hollysys will continue to penetrate China's vast rail and subway construction market and achieve significant results. In the mechanical and electrical solution segment, Bond and Concord delivered solid growth during this quarter, given their solid local market position, abundant customer resources and strong execution in Southeast Asia. For the overseas industrial automation and the rail transportation expansion, we are sending qualified and experienced engineers from China to overseas, and recruiting local engineers to expand our overseas team. With our proprietary technology and products, industry expertise and strong competitive advantages, together with our expanded local channels through Bond and Concord, we will continue to make exciting achievements in the international market in both industrial and rail transportation fields, and creating value for our shareholders. With that, I'd like to turn the call over to Jennifer Zhang, who will read the financial results, analyze on behalf of Mr. Harriet Qu. Jennifer, please.

[Jennifer Zhang:]

Thank you, Shao-la. In [indiscernible] of positive financial and operational results for fiscal year 2015 first quarter ended September 30, 2014, the company reported solid financial results. Comparing to the first quarter of the prior fiscal year, the total revenues for this quarter increased from $113.2 million to $140.7 million, representing an increase of 24.2%. Broken down by the revenue types, integrated contracts revenue increased by 21.8% to $128.5 million, product sales revenue increased by 27.8% to $8.9 million, and the services revenue increased by 332.6% to $3.3 million. The company's total revenue in segments are as following

[Operator:]

[Operator Instructions] Your first question comes from David Jin from Goldman Sachs.

[David Jin:]

So I have 3 questions here. The first question is regarding gross margin. And I saw a pretty strong gross margin this quarter. However, if you look at revenue breakdown, actually M&E contributed a higher portion compared to last year. So can you elaborate more on why margin came out so fast? And is it sustainable? That's my first question. And second question is on automation. It seems that new orders is relatively weak this quarter. And when do the management plan -- expect to see the pickup in new orders? And do you think your full year 8% to 15% revenue growth is achievable? That's my second question. And third question is on rail. It seems that rail was pretty strong. And considering the acceleration of high-speed rail buildouts and the amount for unit tendering, do you think your flattish railway revenue is too conservative at this moment?

[Jennifer Zhang:]

Thank you, David, for the questions. [Chinese]

[Xiaorong Qu:]

[Chinese]

[Jennifer Zhang:]

Okay. For the first question for the gross margin, even though M&E takes a larger percentage of our revenue, but the M&E segment also have higher gross margin. The gross margin of the M&E segment used to be 15% to 16%, but in this quarter, it reached to 20% in gross margin. Besides, the IA and rail also had very good gross margin performance, so our efforts in the better control, taking more contracts and better cost control in the implementation and the cost rather have a higher gross margin in IA. Besides in the rail, because rail is always a high-growth margin business, we also believe that all efforts in the next 1 to 2 years, rail also will have better gross margin.

[Baiqing Shao:]

[Chinese]

[Jennifer Zhang:]

Thank you, Shao-la. For the second question, yes, indeed we have the new orders decreasing IA during last -- past quarter. Well, actually that is within our expectation. The first reason is because of the external environment, which should cause a delay of the implementation here at the power projects.

[Baiqing Shao:]

[Chinese]

[Jennifer Zhang:]

Okay. Secondly, because of the industry restructure of the Hollysys strategy 2 years ago, we're also focusing and spending more assets in the new growth industries, such as the environment protection-related industry. And also we have very good growth from the medical industries as well. And certainly, because we also effectively [ph] providing the IA route to provide more higher gross margin businesses such as service, such as the software, such as the safety protection solution. And also, in the meantime, we control our low gross margin businesses, which also caused the new order decrease during last quarter. But it's actually beneficial for the long-term growth of the whole business.

[Baiqing Shao:]

[Chinese]

[Jennifer Zhang:]

Okay. We still maintain our whole full year guidance in fiscal year 2015 for the whole company. That is around 115% growth, in number that is USD 565 million to USD 600 million in revenue for fiscal year 2015. And for the IA, we are still working hard to achieve our original guidance for 8% to 15% growth in this fiscal year. Thanks.

[Baiqing Shao:]

[Chinese]

[Jennifer Zhang:]

I think we are, given the time to keep investing more in the rail construction and given the new orders pending in the multiple units and the Hollysys [ph] line construction, well, usually, after 2 to 3 months, we will sign the contract for the signaling system providing. So we expect that we are going to have good new orders taken in the near future. So overall speaking, we expect we will have the relatively like a flat revenue performance in the Rail Transportation in this fiscal year. Thanks.

[Operator:]

Your next question comes from Saiyi He from Macquarie Capital.

[Saiyi He:]

Jennifer, [Chinese]. The first question is about the VAT refund. If we exclude the overseas M&E business, the proportion of VAT refund in terms of our China-related business is significantly increased compared to previous years and on previous quarters. And I just want to check if in this quarter we have included some of the rebates for -- the delayed rebates from the previous quarters? And if in terms of China's VAT refund we're receiving this year, should we remain in line as previous year? So that's my first question. My second question is -- continue to be about our industrial automation segment. And Mr. Shao just now have given quite a detailed explanation. And on your confidence of maintaining the 8% to 15% original full year guidance, could you just share some light with us on where you get the confidence from? Are there some potential big contracts in the pipeline from some customers that we have tried to establish over the past couple of years? And also, can you give us some update on the company's commercial launch over the PLC business? And if we do expect some revenue contribution, albeit how small it is, towards end of this fiscal '15 year? And lastly, my question is about the company's SG&A cost, especially the selling expense this quarter is significantly low. I want to ask, is this going to be one-off for this quarter? Or we should actually forecast the SG&A positive in similar percentage of sales as the previous year? Or we do have a trend of gradually reducing those expenses?

[Xiaorong Qu:]

Thank you, Saiyi. [Chinese]

[Saiyi He:]

[Chinese]

[Xiaorong Qu:]

[Chinese]

[Saiyi He:]

[Chinese]

[Xiaorong Qu:]

[Chinese]

[Saiyi He:]

[Chinese]

[Xiaorong Qu:]

[Chinese]

[Jennifer Zhang:]

Okay. For the first and third questions, first question, you've got the VAT refund because it's a little bit difficult for us to project how much these refund we are going to take [indiscernible] year. We think it will be more than $20 million because yearly, we take -- when we look [ph] for cash, we recognize the VAT refund. So for the third question, the G&A expense percentage decreased in this fiscal year compared to last year. We think we are going to maintain the similar percentage in the full fiscal year. And also for the selling expenses, it takes about 5%, and the same situation is going to maintain that 5% in this fiscal year and going forward.

[Saiyi He:]

[Chinese] to do the $6.4 million, [Chinese] $20 million.

[Xiaorong Qu:]

[Chinese]

[Jennifer Zhang:]

Okay. Just to reconfirm that, we're going to have more than $20 million of VAT refund in the full fiscal year 2015, including 4 quarters.

[Baiqing Shao:]

[Chinese]

[Jennifer Zhang:]

Okay. And the chemical and the petrochemical takes the largest percentage of our revenue in the process automation within the whole IA. Well, 3 years ago, we started to invest more resources and grow our business in the industries such as medical industry, food beverage, new energies and waste and power, et cetera. So by our efforts, we have significant growth from these above-mentioned industries.

[Baiqing Shao:]

[Chinese]

[Jennifer Zhang:]

Okay. We'll continue to see our results after investment in the new growth industries and benefit on the trends on the long term. And also, the after-sale service is going to be another significant driver of our whole IA growth. However, it takes about 5% to 8% of our revenue for -- is going to be the increase in the future.

[Baiqing Shao:]

[Chinese]

[Jennifer Zhang:]

Okay. We not only increase our market share in the mid- to low-end market, but also recruits the -- in this effort to provide a total solution targeting to the high-end customers. The total solution will include the DCS, the one-stop rail solutions, Safety Instrumentation Systems and et cetera. And this will increase the single-contract value from the single customer and to increase our efficiency of the whole company.

[Baiqing Shao:]

[Chinese]

[Jennifer Zhang:]

Besides, since [indiscernible], our new generation DCS was launched in market. We have won the full recognition from our customers. This will also provide more products and solutions to customers, which are also going to benefit from -- for the revenue growth in the long term.

[Baiqing Shao:]

[Chinese]

[Jennifer Zhang:]

And for the CRC business, we have been spending more energy in doing the research and the development in the integral automation area. So in the future, we think the PLC or the SIS automation is going to take another percentage in the whole IA business.

[Baiqing Shao:]

[Chinese]

[Jennifer Zhang:]

In the next stage, we not only to provide the product in the segment of automation, but also to provide a total solution and a service to our customers in this industry to increase or enhance our supreme influence and the revenue growth.

[Baiqing Shao:]

[Chinese]

[Saiyi He:]

[Chinese]

[Jennifer Zhang:]

Thank you, Saiyi.

[Operator:]

Your next question comes from the line of Nick Zheng from JPMorgan.

[Nick Zheng:]

[Chinese]

[Jennifer Zhang:]

Okay. Thank you, Nick. The first question regarding our railway transportation. Recently, the CRC opened the bidding for the high-speed trains in the [indiscernible] and C3 segment. So we're -- Hollysys got the order for the signaling providing for this batch of high-speed trains. The second question is regarding the gross margin. And we have noticed that the M&E takes another percentage in the revenue this quarter. So for the gross margin increase in the M&E segment, is that temporary? Or is that sustainable? Is that helped by the mix of the project? Or in the future, are we going to have to have a similar gross margin in the M&E segment? The third question is regarding the tax rate. Because in this quarter, the September quarter and last quarter, June quarter, we all take 25% in doing the tax calculation here in a conservative way. So when we got the high tax company enterprise certification, so how much value, tax value, we are going to take back to this fiscal year and your expected timeline? And also, what is the effective tax rate for this fiscal year? And fourth question is regarding the new products. For the company, Mr. Shao have mentioned the PLC and the industrial automation solution and also you have the subway signaling technology, and in the rail, you have a track circuit you have mentioned in your press release. So when are you going to effect the earliest contribution and most significant contribution? Or which is the most meaningful for the company about the new product segment?

[Xiaorong Qu:]

[Chinese]

[Jennifer Zhang:]

For the second question, the gross margin of M&E. The M&E segment gross margin is between 15% to 20%. 2 years -- in the past 2 years, the gross margin was relatively low. Well, in this past quarter, because the projects had higher gross margin during this quarter when it's booked into the revenue, so we all expect the gross margin is -- higher gross margin in M&E is definitely sustainable in this full fiscal year.

[Xiaorong Qu:]

[Chinese]

[Jennifer Zhang:]

Okay. For the tax rate, it's probably -- because we haven't got the high tax enterprise certification, we haven't finished the renew process for applying the certificate. So we are currently using a 25% tax rate in the calculation. But once we got the certificate, we would use 15%. And definitely, we will -- to take the tax expense back into this fiscal year. But for the time and the exact value, it's hard to give you. But for the time, if -- because we have finished the preparation of original work and had already entered into the later stage in getting the certificate. So if everything goes well, we may get a certificate by the end of December 31, or at least we can get a certificate by March 31, 2015.

[Xiaorong Qu:]

[Chinese]

[Jennifer Zhang:]

For the effective tax rate, yearly, it's between 16% to 17%. While this year, because of the influence of the certification issue, so we expect to have around lower than 15% effective tax rate in this fiscal year.

[Baiqing Shao:]

[Chinese]

[Jennifer Zhang:]

For the first question, CRC has finished bidding for the high-speed trains. Our new leads [ph] will take 3 months later for us to sign the signaling contract. So for the contract value and time, sorry, it's not appropriate to tell you now.

[Baiqing Shao:]

[Chinese]

[Jennifer Zhang:]

Okay. For the new product development, that is for the future sustainable growth of the whole company. For example, we have medical growth from the traditional medicine industry. We have a lot of successful application track record. So this industry is -- can you look at more revenue contribution and even higher growth in the future.

[Baiqing Shao:]

[Chinese]

[Jennifer Zhang:]

For subway, we have finished the development of the subway signaling system. And we are also finishing the testing of our signaling -- subway signaling system in Shanghai [indiscernible]. In the future, we're going to combine SCADA and Subway Signaling has merged into one solution to enhance our industry competitiveness. Besides in both China and abroad, we will increase our sales efforts to create more revenue contribution from this sector.

[Baiqing Shao:]

[Chinese]

[Jennifer Zhang:]

For the track circuit in the rail segment, now we are finishing the process in getting the official permission progress by the central rail authorities. And in the next year, in 2015, we're going to have the revenue from the track circuit. [Chinese] Okay, that's -- okay. Due to the time constraints, we will now take one last question from the queue. Thanks.

[Operator:]

Your last question comes from Baiding Rong from Crédit Suisse.

[Baiding Rong:]

[Chinese]

[Jennifer Zhang:]

Okay. Thank you, Baiding. [Chinese]

[Baiding Rong:]

[Chinese]

[Jennifer Zhang:]

Okay. Baiding Rong from Crédit Suisse has 2 questions. The first question is regarding the new order and the revenue performance in the IA segment during the past 2 months in October and in November. And the second question, because the last quarter, we have a little bit of decrease in the IA revenue, but we still maintain -- but the management still maintain the guidance, full year gross guidance around 10% in IA, so that means that you're going to accelerate the IA growth. Are going to have the accelerated growth and the tax in the next few quarters? And also, you mentioned that you have a slower growth from the technical industry. So where's the new growth from, so which industries?

[Baiqing Shao:]

Okay. [Chinese]

[Jennifer Zhang:]

Okay. As I've mentioned, we have solid growth from the thermal power, food and beverage and medical industries. And I also mentioned that in this fiscal year, we will still be working hard to achieve the 8% to 15% growth in the IA segment.

[Baiqing Shao:]

[Chinese]

[Jennifer Zhang:]

Okay. Thank you, Baiding. And thank you, everyone, for joining us on the call today. If you haven't got a chance to raise your questions, we'll be pleased to answer them through follow-up contacts. We look forward to speaking with you again in the near future. Thank you. [Chinese]

[Operator:]

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