Hollysys Automation Technologies Ltd.
Q2 2015 Earnings Call Transcript

Published: 13 Feb 2015

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Hollysys Automation Technologies' Second Quarter and First Half of Fiscal Year 2015 Ended December 31st, 2014 Earnings Conference Call. [Operator Instructions] Please be advised that this conference is being recorded today, February 13, 2015. I would now like to hand the conference over to Ms. Jennifer Zhang, the Investor Relations Director of Hollysys Automation Technologies. Please go ahead, Ms. Zhang.

[Jennifer Zhang:]

Hello everyone and thank you for joining us. Today our speakers will be Mr. Baiqing Shao, CEO of Hollysys Automation Technologies; Ms. Herriet 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 a financial perspective and financial outlook for fiscal year 2014. And the whole 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. In the second quarter and last month, we achieved solid financial and operational result amid the weak general economic environment and made quite a few achievements and new contract wins. Here I would like to discuss some key events during this quarter

[Jennifer Zhang:]

Thank you, Mr. Shao. I would like to share some highlights for the second quarter and the first half of fiscal year 2015 ended December 31st, 2014. In the first half of fiscal year 2015, total revenues were $271 million, increase by 1.6% compared to the first half of last fiscal year. Non-GAAP net income was $50.7 million, increase by 9.6% compared to the same period last year. Non-GAAP gross margin was 39%, compared to 34.1% for the first half of 2014. Non-GAAP diluted EPS were $0.86, increase by 7.5% compared to the first half of last fiscal year. In the second quarter of this fiscal year 2015, total revenues were $130.3 million, representing a decrease of 15.1% year over year. Compared to the same quarter of last year, integrated contracts revenue decreased by 18.7% to $119 million. Product sales revenue increased by 76.2% to $10.3 million. And services revenue decreased by 15.7% to $1 million. The company's total revenue by segment were as follows. Industrial automation $56.8 million, railway transportation $33.6 million, mechanical and electrical solution $37 million, miscellaneous $2.9 million. Overall gross margin excluding non-cash amortization of acquired intangibles was 38.3% for the second quarter, as compared to 32.3% for the same period of last year. The non-GAAP gross margin for integrated contracts, product sales, and services rendered were 35.7%, 63.7% and 80.4% for the second quarter, as compared to 30.7%, [34.2%], and 19.6% for the same quarter of last year. The gross margin fluctuation was mainly due to the different revenue mix with different margin. The GAAP overall gross margin, which includes non-cash amortization of acquired intangibles, was 37.1% for this quarter, as compared to 31% for the same period of last year. The GAAP gross margin for integrated contracts, product sales, and service rendered were 34.4%, 63.7% and 80.4% for the second quarter, as compared to 29.3%, 74.2%, and 19.6% for the same period of last year, respectively. Selling expenses were $7.2 million for the second quarter, representing a decrease of $2.3 million or 23.8% compared to $9.5 million for the same quarter of last year, mainly due to the company's efforts in efficiency improvement. Presented as a percentage of total revenues, selling expenses were 5.5% and 6.2% for the three months ended December 31, 2014, and 2013, respectively. General and administrative expenses, excluding non-cash share-based compensation expenses were $15.5 million for the second quarter, representing an increase of $6.6 million or 73.6%, as compared to $8.9 million for the same period of last year. The increase was mainly due to an increase of $2.8 million in bad debt expenses, $2.4 million in employee compensation expenses, and $0.6 million in amortization and depreciation expenses. The increase in employee compensation expenses was mainly caused by the accrued bonus expenses. Presented as a percentage of total revenues, non-GAAP G&A expenses were 11.9% and 5.8% for the quarters ended December 31, 2014 and 2013, respectively. The GAAP G&A expenses, which include the non-cash share-based compensation expenses, were $15.9 million and $10.1 million for the three months ended December 31, 2014 and 2013, respectively. Research and development expenses were $10.1 million for the second quarter, a decrease of $2.1 million or 17.4% compared to $12.2 million for the same quarter of last year. Presented as a percentage of total revenues, R&D expenses were 7.8% and 8% for the quarter ended December 30, 2014 and 2013, respectively. The VAT refunds and government subsidies were $5 million for the second quarter, as compared to $10.4 million for the same period of last year, representing a $5.4 million or 51.8% decrease which primarily due to the decrease of the VAT refunds for $5.7 million. The income tax expenses and the effective tax rate were negative $0.3 million and negative 1.5% for the second quarter, as compared to $3.6 million and 16.3% for comparable prior year period. During the second quarter of fiscal year 2015, Beijing Hollysys and Hangzhou Hollysys were certified as HNTE, high-tech enterprise tax -- high-tech enterprise effective for three years from January 1, 2014 to December 31, 2014, and are applied to the preferential enterprise income tax of 15%. In the second quarter, Beijing Hollysys and Hangzhou Hollysys accordingly recalculated the tax expenses accrual for calendar year 2014 based on the newly applied enterprise income tax rate of 15% instead of 25%. Excluding the impact of the accrual adjustment for the prior fiscal year, the effective tax rate for the current period was 15.2%. The non-GAAP net income attributable to Hollysys, which excludes non-cash share-based compensation expenses, amortization of acquired intangibles and acquisition-related consideration fair value adjustments, was $23.6 million or $0.40 per diluted share based on 59.2 million shares outstanding for the second. This represents a 11.1% decrease over the $25.9 million or $0.45 per share based on 58.2 million shares outstanding reported in the comparable prior-year period. On a GAAP basis, net income attributable to Hollysys was $19.1 million or $0.32 per diluted share, representing an increase 4.3% over the $18.3 million or $0.31 per diluted share reported in the comparable prior-year period. Hollysys' backlog for the integrated contracts as of December 31, 2014 was $433.7 million, representing a decrease of 12.5% compared to $495.7 million as of September 30, 2014, and a decrease of 13.8% compared to $503.3 million as of December 31, 2013. The detailed breakdown of backlog for integrated contracts by segments is

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from David Jin from Goldman Sachs. Please go ahead, David.

[David Jin:]

[Chinese Language Spoken]

[Jennifer Zhang:]

Thank you, David. The first question is regarding the industrial automation. DCS performance was weak for the first quarter because of the weak external general environment. For the first half of this fiscal year, I would like to know the percentage of the process automation and discrete automation in the industrial automation segment. And the second question is regarding the rail, because in the -- in January Hollysys signed a big contract to provide ATP to CRC, so that means there will be a big increase in the revenue in the third and fourth quarter in the rail segment. So -- and also I would like to know the track circuit penetration pace in -- for -- because it is a new product. I would like to when the company can sign the first contract of the track circuit.

[Baiqing Shao:]

[Interpreted] For the first question, sorry, we did not disclose the percentage of the discrete average versus the process automation in the whole industrial automation segment, but the discrete takes a very small percentage in the whole IA. During the past few years we increased our efforts in growing the discrete automation business, so in the future we believe the percentage for the discrete will take a larger percentage, and which we'll achieve a balanced performance of the process and discrete in the whole IA sector. And for the second question, yes, we signed a big order in the rail in January, so we think we'll achieve solid revenue performance in the rail in the third and fourth quarter, and we think we can achieve our rail guidance in this fiscal year. For the third question, for the track circuit and also the subway signaling system, we are confident that we will make and achieve our first breakthrough project in the current year of 2015.

[Jennifer Zhang:]

Okay. Thank you, David.

[Operator:]

The next question comes from Baiding Rong. Please ask your question.

[Baiding Rong:]

[Chinese Language Spoken]

[Jennifer Zhang:]

Okay. Thank you, Baiding. The first question is regarding the track circuit. I'd like to know the amount for bidding each year and also the market size of the track circuit. And the second question, I had noticed that the company has signed a high-speed rail contract with the ATO type of technology, so I want to know what kind of -- how many potential and what potential projects, ATO projects, the company participate in the bidding right now? And third question is regarding the CBTC. Also I want to know the products the company is bidding for the CBTC.

[Baiqing Shao:]

[Interpreted] Okay. Firstly, for the track circuit, the track circuit is applied for both high-speed rail and lower-speed rail lines. The market size is, while it's similar, of the ATP and DPC, currently high-speed rail technology we are providing to the rail segment, so the market size is quite large for the track circuit. And because it's a new product and we believe, because of our technology, we are confident to sign our first contract with track circuit this year. And second, for the ATO, we are aggressively participating in the ATO bidding, but sorry, I cannot disclose the project name of the ATO we are participating. So maybe we can communicate later after this conference call. And thirdly, for the CBTC, we are bidding for the railway line both in China and overseas. And besides, we also recruit more experts joining Hollysys in helping us to bidding for the CBTC projects. And we believe that we can make some achievement in this year 2015.

[Baiding Rong:]

[Chinese Language Spoken]

[Jennifer Zhang:]

Xie-xie, Baiding. Next question please?

[Operator:]

The next question comes from Kevin Luo. Please go ahead, Kevin.

[Kevin Luo:]

Hey.

[Jennifer Zhang:]

Hey, hello.

[Kevin Luo:]

Hi, Jennifer. Ni hao. [Chinese Language Spoken]

[Baiqing Shao:]

[Chinese Language Spoken]

[Jennifer Zhang:]

Okay. Mr. Kevin Luo has two questions. First one, he noticed that in the second quarter the gross margin and operating margin increased. And also he noticed that the percentage of rail revenue is smaller in the whole company's revenue. So, is that because of the improvement of the gross margin from the M&E segment or there are some other reasons? And the second question is about the track circuit. Is that -- the track circuit will be used on the -- outside the railway lines every 2 kilometers? Is that used to receive and send signals? And then Mr. Shao answered the second question. He thinks the understanding from Mr. Luo is right. Yes, that is also a safety signaling system that is used to receive and send signals on the ground base. Okay. Ms. Qu will answer the first question.

[Herriet Qu:]

[Interpreted] Okay. The margin increase is mainly because the industrial automation, not because of the M&E segment, gross margin increased. Even though every quarter has a very good gross margin performance, but IA is especially better, that is because of the previous better improvement and the margin increasing of the single -- each single product we supply to the industrial automation. So that makes the whole IA sector gross margin is the higher compared to the past. So that makes the whole second quarter's gross margin is higher.

[Kevin Luo:]

[Chinese Language Spoken]

[Jennifer Zhang:]

Okay. The next question is about the pricing of the contract we signed in the January about the ATP product supply. Mr. Kevin noticed that the products supplied by the CNR [ph] and CSR [ph] was lower. Is Hollysys placed the same situation?

[Herriet Qu:]

[Interpreted] Okay. I didn't give a calculation of each single ATP price compared with past, but for your info, the gross margin in the rail segment is not lower compared with the past. So that means we still maintain a very good same gross margin of the rail compared with the past.

[Kevin Luo:]

Thank you very much.

[Operator:]

The next question comes from Nick Zheng. Please go ahead.

[Nick Zheng:]

[Chinese Language Spoken]

[Jennifer Zhang:]

[Chinese Language Spoken]

[Nick Zheng:]

[Chinese Language Spoken]

[Jennifer Zhang:]

Okay. Thank you, Nick. Okay, Nick has three questions. The first question is about the industrial automation. He want to know the -- each industry performance in the industrial automation. And the second question is that he want to know the guidance of each individual sector of the industrial automation and the rail and also the M&E segment. And the third question is about the dividend, because Hollysys has announced a dividend paying for the first half of this calendar year. And does the company have a policy to pay the dividend every year? Or -- and also, does that mean that the company does not have a short-term target for the M&A? Thank you.

[Baiqing Shao:]

[Interpreted] Okay. Firstly, we adjust our efforts allocating into different industry sectors. Firstly, we reduced our investment in the pollution related environment industries, and we are more focusing on the contract quality in those industries, such as cement, metallurgy and et cetera, and other industries. And also we increased our efforts in those industries such as environment protection and the medical and food beverage industries. And also certainly, in the aftersales service, the increase is good compared with the past because of our efforts in doing more aftersales service in the industrial automation. And also fourthly, we have very good growth from the discrete automation such as the medical solution, the growth was strong, in the [inaudible] a few quarters.

[Operator:]

The next question comes from Huimin Wu. Please go ahead.

[Jennifer Zhang:]

I'm sorry, operator?

[Operator:]

Yes.

[Jennifer Zhang:]

We haven't finished up.

[Operator:]

I do apologize. I'll bring them back.

[Jennifer Zhang:]

Thank you. [Chinese Language Spoken]

[Herriet Qu:]

[Chinese Language Spoken]

[Nick Zheng:]

[Chinese Language Spoken]

[Herriet Qu:]

[Chinese Language Spoken]

[Jennifer Zhang:]

Okay. The different segment guidance may be a little bit different compared with the previously guidance. Firstly, for the industry automation, previously we are -- we were guiding around 8% to 15% growth, but now we think that maybe a little bit overoptimistic. Now we are guiding slight growth of the industrial automation segment for the revenue, but because of the gross margin increase, so the net profit of the IA maybe still [inaudible] in the range of our previous guidance. For the rail, previously we are guiding the flat performance of the rail, now we still maintain the same guidance, because our strong order and strong backlog, and also we are expecting more subway contract wins in this year. But because it takes time for the contracts to turn to be the revenue, so the revenue contribution from the subway will be small. So we are still guiding a flat performance in the rail. For the M&E segment, because previously we are guiding 15% to 20%, now we are still reading [ph] our expectation in the similar performance. So, okay, that's the guidance of the different segment. Also for the --

[Herriet Qu:]

[Interpreted] Okay. So just question of the dividend. This dividend is the special cash dividend, but that does not mean we are not considering the long-term dividend payout policy. And also this does not mean that we will not spend just mainly on the M&A target, because now it only means that we have enough cash on hand, so we want to take some money and to reward the investors. And if we have any good M&A target, we are able to have the enough money to finish the M&A. Thank you.

[Nick Zheng:]

[Chinese Language Spoken]

[Herriet Qu:]

Xie-xie, Nick.

[Jennifer Zhang:]

Okay. Operator, next question please.

[Operator:]

The next question comes from Huimin Wu. Please go ahead.

[Huimin Wu:]

[Chinese Language Spoken]

[Jennifer Zhang:]

[Chinese Language Spoken]

[Huimin Wu:]

[Chinese Language Spoken]

[Jennifer Zhang:]

Okay. Thank you, Huimin. Huimin has two questions. Firstly, the Bombardier and NUG former joint venture in doing the signaling, so potentially there may be another provider of the signaling in the rail segment. So does that mean the company facing more competition in the rail? And then secondly, for the overseas market penetration, because a lot of big SLEs [ph] are doing more overseas projects and participate in a lot of biddings, so the company, I want to know the company's overseas play in the rail segment. Thank you.

[Baiqing Shao:]

[Interpreted] Firstly, because of the safety concern and the permission by the CRC, the strict control of the permission, so we don't think we will face competition in the near term and the competition landscape will not change in the near future. Secondly, we have won our [inaudible] in providing SCADA to the Singapore LTA, Land Transport Authority, and now we are increasing our cooperation and communication with the local large customer. Beside that, we are also talking with the big contractors and increasing our cooperation and discussion with the large SLEs [ph] and increasing our cooperation. So we will all do the overseas projects in the above three ways, including the local customer communication and the communication with big contractors, and also the cooperation with large SLE [ph] companies in doing the project in overseas [inaudible]. Thank you.

[Huimin Wu:]

[Chinese Language Spoken]

[Jennifer Zhang:]

Thank you, Huimin. Okay, next question please?

[Operator:]

The next question comes from Alex Chang. Please go ahead.

[Alex Chang:]

[Chinese Language Spoken]

[Jennifer Zhang:]

[Chinese Language Spoken]

[Alex Chang:]

[Chinese Language Spoken]

[Jennifer Zhang:]

Okay. Thank you, Alex. Firstly, I noticed that the accounts receivable and inventory absolute amount increased a lot. And there was one reason, because of revenue decrease in this quarter. And also I want to know which sector contributed the increase to accounts receivable most. And also in the bad debt allowance, there was $2.8 million bad debt allowance in this quarter. Is that enough? And also for the inventory, I also noticed the increase of the inventory. So what is the reason?

[Herriet Qu:]

[Chinese Language Spoken]

[Jennifer Zhang:]

Okay. Thank you, Qu-zong. The main reason is because of the internal policy change, because of the more strict control of the accounts receivables. You have noticed that the total amount of the accounts receivables viewed accounts receivables and [inaudible] receivables, the total amount actually decreased, because the company is now more actively chasing the accounts receivable and [inaudible] we're adopting more strict measures in define the accounts receivable so that it makes the account receivable seem to be larger, even though that makes in the short the DSO, days receivables increase. But in the long term it may benefit the company in better control the accounts receivable and eventually reduce the day sales outstanding.

[Herriet Qu:]

[Interpreted] Okay, for the bad debt allowance, actually the bad debt allowance increased by $2.8 million in this quarter. It's not only $2.8 million bad debt allowance incurred in this quarter, so. And currently we think the bad debt allowance is enough in the current situation. Okay. For the inventory, your understanding is right, because the -- especially because of the contract signing with rail, the CRC, because the contract is now signed. But actually before the contract is signed, we have already executed the contract in preparing and also delivering of the products. So that makes the inventory increase for this single contract reason, there was about $10 million in the inventory.

[Alex Chang:]

[Chinese Language Spoken]

[Jennifer Zhang:]

[Chinese Language Spoken] Okay. Because of time constraint, we'll take our last question. Operator, please.

[Operator:]

The next question comes from Patrick Xu. Please go ahead.

[Patrick Xu:]

[Chinese Language Spoken]

[Jennifer Zhang:]

Okay. Patrick has three questions. Firstly is about G&A expenses, the G&A expense and also the percentage increased in this quarter, so what is the reason, and especially for this one-time reason? And also for the second question, I noticed there's some investing loss with the related enterprise, so, what is the enterprise? And also for the nuclear power business, does the company expect any breakthrough or improvement in the nuclear power performance in the first half of this calendar year? Thank you.

[Herriet Qu:]

[Interpreted] Okay. There are two major reasons for the increase of G&A expense. Firstly is the bad debt allowance increase by $2.8 million. And the second reason is because of the bonus for the Bond, because Bond after -- Bond delivered very strong performance in the past two years, and now they finished their review period. So we have more expense for the bonus in the G&A. The investment loss is mainly because of the joint venture with CGNPC, the name is CTech [ph]. We're holding 40% holding of the CTech [ph]. Okay. For the nuclear, we are more optimistic. We think we will have better development of the nuclear power business in this year. Besides our cooperation and business with CGNPC, we are also starting cooperating with CNC, that is a good news for Hollysys and also for the investors.

[Patrick Xu:]

Xie-xie.

[Jennifer Zhang:]

Thank you, Patrick.

[Jennifer Zhang:]

Okay. 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. Xie-xie.

[Operator:]

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

[Jennifer Zhang:]

Thank you. Bye-bye.