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Harbin Electric Inc. (NASDAQ:HRBN)

Q3 2008 Earnings Call

November 10, 2008; 8:30 am ET

Executives

Yang Tianfu - Chairman and Chief Executive Officer

Xu Zedong - Chief Financial Officer

Christy Shue - Executive Vice President - Finance and Investor Relations

Analysts

Brian Drab - William Blair

Ping Luo - Global Hunter Securities

Hue Mei - Hua-Mei 21st Century

Jason Knapp - Dolphin James

Robert Susman - Bentley

Rachel Scott - Heller capital

Operator

Good morning. My name is Dennis and I will be your conference facilitator. At this time, I would like to welcome everyone to the Harbin Electric Inc. third quarter 2008 earnings results conference call. (Operator Instructions) This will be available for replay beginning at 9:30 am ET time today, through 11:59 pm ET time on November 17. The conference ID number for the replay is 71191627; again, the conference ID number for the replay is 71191627. The number to dial for the replay is 1-800-642-1687 or 706-645-9291.

I would now like to turn the conference over to Christy Shue, Executive Vice President of Finance and Investor Relations of Harbin Electric Inc. Thank you Miss Shue. You may begin your conference.

Christy Shue

Thank you, Dennis. Welcome to Harbin Electric’s third quarter 2008 earnings conference call. This is Christy Shue. Today I am joined by our Chairman and the Chief Executive Officer Mr. Yang and the Chief Financial Officer Mr. Xu on the call from Harbin China. We filed our third quarter 10-Q early this morning and also issued a press release to highlight our third quarter and year-to-date financial results and the business updates. You can download our SEC filings and the press release by going to our website www.harbineletric.com and click the Investor page.

During the call we will make forward-looking statements that are subject to the risks and uncertainties outlined in our quarterly reports and also listed at the end of our earnings release. Right now, let me turn the come over to Mr. Yang, Chief Executive Officer and Chairman of Harbin Electric.

Yang Tianfu - [Interpreted]

Welcome to our third quarter earnings conference call and thank you for your attention and your interest in our company. First of all, I’m very pleased that we have again achieved remarkable results for this quarter; particularly, when we are facing the economic crisis and the financial crisis recently and also many other international corporations companies reported not very good financial results, but we still maintained continues growth.

Again it demonstrates and reflects that our product, our technology and our cost has a competitive advantage and also demonstrates that we have successfully executed our strategic growth strategies, because our products are mostly specialized and customized and also our customers. We have developed in the past few years our products and are custom made specific for those customers. So our results have not been impacted by this recent economic crisis and we have maintained very good results.

Due to the limited time, I will not summarize all the results and the business updates in Chinese. I will let Christy Shue to give you summarizing the English directly, so that we save time for the translation.

Christy Shue

Okay, first of all I will give you a summary of our third quarter key financial results. For the third quarter our total revenues reached nearly $40 million, more than doubled the $18.5 million in 2007 third quarter. This remarkable year-over-year growth reflects about $15 million sales from our industrial rotary motor business we acquired in July this year.

Sales from automobile micro-motors business increased to 38% over the prior year. We also delivered 64 units of our high tech oil pump during that quarter, while in the third quarter of last year; the oil pump was still in a testing lab. The overall gross profit margin decline by about 14 percentage points primarily due to the addition of the lower margin rotary motor business. The gross margin of our linear motor business and the specialty micro-motor business remain solid up 54% and 41% respectively.

Operating income increase by about $3.5 million, reflecting a 49% growth year-over-year. Selling, general and administrative cost as a percentage of sales dropped to 7.9% this quarter compared to 9.2% the same quarter last year; primarily due to the addition of the industrial rotary motor business that has lower SG&A.

Our net income was about $3 million higher, 62% year-over-year growth, despite about $1.3 million provisions for income tax due to the expiration of the income tax exemptions status at our Harbin Tech subsidiary. Net earnings per diluted share grew to $0.34 from $0.26.

For the year-to-date financial results I would like to refer you to our quarterly report filed this morning and the press release issued today. For the business updates, although the recent economic and financial prices has brought new challenges to all the companies, we deal and we think we believe this is actually a historical opportunity for us.

First of all, it’s well known that several international automobile makers and automobile part suppliers have reported less than financial results and demand for Automobile has declined sharply, but for these companies to survive and sustain, they must make a choice and one of the choices is to partner with companies that can provide value added products and help them to increase their competitiveness and provide products that has lower cost, help them to reduce their cost and our company is this kind of company and then the products such as the automobile micro-motors that we designed can enhanced the functionality of the car and also increase the appealing for the investors, attract the consumers, attract the car shoppers.

So we expect that the opportunity coming from this economic crisis for our company is we expect to be an outsourcing of the automobile parts and moving outsourcing to China actually will be accelerated. Particularly the company like our company has the comparative strengthen in manufacturing and has the ability to develop the products and would provide high quality products, but at the lower cost, lower price than other international companies and we believe again, our product has a strong potential and we expect to gain market share during this time.

For example, we’d like to tell you, are our Shanghai facility that is dedicated to the automobile business has moved into full-scale equipment testing periods and we expect that we will be on time to start our trail production in December. Given this historic opportunity we remain very confident to achieve the targets of $4 million units in 2009 for Shanghai facility.

Another important information for you to know is the Chinese government has recently announced a serious of policies and the measures to drive up the domestic demands and the consumption in order to resist the inactive effect by the global economical crisis and also to maintaining a solid GDP growth in China.

By 2010 the Chinese governments expected or estimated that the government has above the full chain in R&D should drive up the domestic demand and consumption and the full sign in R&D is about US$508 million and also in the fourth quarter, the Chinese government is planning to invest about RMB 100 billion, approximately US$14.13 to drive up the demand, the support to the developments of the domestic of growth.

Our company’s business is just in the right industry that the government is supporting. For example our linear motor driving-system designed for mass transit systems as what the governments is supporting, our company has just been approved officially as the only domestic linear motor driving-system manufacturer for the mass transit systems.

Although, the production plan is still in the preliminary stage, but we estimate that in 2009 we are targeting to begin production of about 10 groups of trains to supply 10 sets of trains with the 80 sets of the linear motor driving system and we expected the production to begin during the second or third quarter.

Another importance area that the Chinese government is supporting and investing to speed up the growth is the rural areas and including the infrastructure development, including the railroads, energy, water irrigation system, etc.

The company that we acquired in July, Hengda Electric motor, some of the products invested in industrial rotary motors are used and applied in the agriculture developments machinery and tools and we believe our industrial automotive business will benefit from the Chinese governments support of the rural area development.

Another product that we believe we’re interested in is our tower-type oil pumps. The tower-type oil pump has been gaining acceptance in the market. Given that we only launched this product last year and this is only the beginning of the great products and showing the acceptance, showing the recognition by the consumers and by the customers.

This years sales and the market testing has actually laid a very good beginning with foundation for us to open up to further develop this product moving to working with other customer. Although our production plan for Daqing oil fields in 2009 and it is still in the final stage of finalizing we believe we have a possibility of doubling the production volume in 2009, compared to the 2008 production volume.

Finally, we believe that our company, facing the challenging environments, we are confident that we can transform the challenges into opportunities. Based on the current developments in our customer base and our projects in the pipeline, we remain very confident about the target we previously established for our company in 2010. Excluding that position, we targeted to reach US $350 million sales. Including in Weihai Hengda, the company we acquired, we target to reach more than US $400 million.

That is today’s business update and there are some details in the press release and some results analysis in the press release please refer to that.

Now, we are ready to answer your questions.

Question-and Answer-Session

Operator

(Operator Instructions). Your first question comes from Brian Drab - William Blair.

Brian Drab - William Blair

Just a couple of questions for you; first of all, could you talk a little bit more about how things are progressing at Weihai Hengda and specifically about the gross margin. Gross margin was 13% in the quarter and I think that’s a little bit below what you were expecting?

: [Interpreted]

Okay Brain. Thank you, I think you have a very good eye and you spotted the issue right way. The gross profit margin in Weihai Hengda is below what it was before, primarily driven by the raw material costs. During the second quarter and the third quarter, there was the time that raw material like copper, steel those material reached to their highest price level almost in the history and so that is the main reason that drove the costs up for the products.

However, we have seen obviously that raw material prices have declined, has been moderating recently. Actually, during this quarter right now we’re seeing the price level and the second quarter and third quarter price level, is almost double what we are seeing now. So, right now we are expecting that in the next quarter or so. Because of the raw material costs moderating, we don’t expect the gross profit margins going to be affected as much and so that is the main reason.

Brian Drab - William Blair

Okay, thank you and it sounded like you have a little bit more visibility to the railway opportunity then you do in the last call. You mentioned specifically 80 sets of linear motors should be your target for 2009. Do you have more visibility to that project now and how many dollars do you expect to generate in revenue from each set of linear motors for the train; so you said 80 sets, how many dollars per set?

: [Interpreted]

Brain, when you look at this one set. What he said in the beginning is that when the financial crisis has started, obviously the Chinese government will try and find ways to protect the economic growth in China. I mean, the recent measures that the Chinese government’s announced including like 10 of them and the second of them is to support and develop the infrastructure in China, fundamental infrastructure in China including the mass transit system. So, the mass transport system obviously has the very high priority on the Chinese government list.

Actually officially the subway line in Beijing at Dongzhimen officially ordered 10 group of trains from Chempton Vehicle Corporation and 10 groups of trains has 40 train cars and each train car needed two electrical motors and one controller and for that set the price is about 1.3; actually a very rough estimate is RMB 1.8 million. So, a total of all these units will give us approximately US $20 million. Yes, that is just at the very beginning of the projects.

Operator

Your next question comes from Ping Luo - Global Hunter Securities.

Ping Luo - Global Hunter Securities

My question is; I understand most of your linear products are exported and also basically, the global demands slowing down and I was concerning whether that part of business has been affected and secondly your automotive motors business as well, basically the automotive market slowdown whether that will slowdown your growth in that segment? Especially, you have just viewed a new facility; the mission you have dedicate to micro motor. I want to know in 2009 what kind of capacity you plan to use considering the current market conditions?

: [Interpreted]

Okay. First of all, regarding the linear motor, the one set that we need to correct is actually our linear motor products are sold domestically, not exported. Our export products according to our 10-Q report, the numbers we’ve reported there and you can refer to.

The exact number is about 15%, so a very small fraction of our sales are exported. So actually the global market demand that’s slowing down, first of all has not impacted our linear motor business and secondly, our linear motor is specifically designed to customize it, it’s designed for the customer and because this is an advanced technology and it is in the leading frontier of the technology, so it is not the products or the system that is growing out and it is a product that the company’s, our customers need to actually help them to stay competitive and help them to grow their business, so that’s the basic foundation of our linear motor business.

In regards to the automobile business, I think the key points is that, although you see the automobile industry and the demand in the car has sharply declined, but we believe and this is testing our believing and because of this global markets slowing down, we have said this and now we’re saying this again, that for us it’s an opportunity and it is a historical opportunity.

First of all, for the automobile makers to stay competitive and to continue sell their products, attract customers and then the only choice is they have to develop better car at a lower costs and currently the trends to develop the better car is we need to get alternative energy cars, not using the gas, instead of using electricity or high grades, so that’s one direction.

The other direction to improve the competitiveness for the automobile maker and to improve their attractiveness of their products is to mix the car appealing to customers; for example to have a car in the high-end equipments interior application usage. For example our micro motor is designed to enhance the functionality, to make the car function better at a high end. So it is actually a solution that the automobile makers are looking for to enhance their products.

Given that our products have top quality, and also compared to the other international companies and we have a lot faster development cycle, at also a relatively lower cost. So, we’re expecting that many of the automobile makers and part suppliers are moving their stores into China and after visit of what we’re seeing today and obviously our major North American partner into Magna.

Actually Magna from what we now is that they obviously want to increase their competitiveness. They actually increase the communication and interactions with us. Actually, today there is a team from Magna in Shanghai in discussion with us about any projects.

So, for that reason we believe this will be a really good opportunity for us. So we are not projecting any demand for our products are slowing down, we are actually expect more orders, more projects coming to us. So that this are the major point.

Ping Luo - Global Hunter Securities

Thank you, very much. My second question, at you Shanghai facility; when do we expect you to start production and the first shipment. I think you gave the number before; what kind of the capacity? Basically this is one has about 10 million capacity of automotive motor. So what kind of utilization rate do we expect to achieve in 2009 okay, that’s for automotive motor. Also in industrial motor business, I believe you’ll have a number about that 30% annual growth rate for that part of the system. When you turn that growth expectation; it’s basically like 20% or 30% growth in 2009, in that segment?

Christy Shue

Okay, let me just cut that question down. The first question Ping is asking is that when our Shanghai facility began production and when we can recognize the revenue? The answer is that, we still expected that in December we’ll start total production, but to recognize revenue, that is expected to be in the first quarter of next year, because we have a delay in recognizing the revenue.

The second question is for our Shanghai facility, does the target for our Shanghai facility for 2009 remain?

The answer is yes. Based on the trend that we’re seeing now and initiations that we’re experiencing now, we remain committed to the target that we set before for our Shanghai facility and our total capacity for Shanghai is 10 million units in 2009. Right now we’re just shooting for production of 4 million units.

Ping Luo - Global Hunter Securities

And you current market condition for the industrial motor business, are you still expecting 30% growth for next year?

: [Interpreted]

Okay. I guess qualitative we have not yet provided the number for the 2009 projection; however, what we also have said in the beginning of the conference call is note that the Chinese government has actually announced 10 important measures to drive up the domestic consumption and demand.

One of it; I think there was the third or second measure is to help support investing heavily in the rural area for the development of the agriculture and rural area. One area is the agricultural machines and tools and we expect, we believe our Hengda industrial rotary motor business has a lot of potential in benefiting from this part of the policy, because currently some of the orders that we see are largely from the agricultural machines and tools and we see that will be the trend for next year.

A lot of the increases is from the agricultural developments and the industrial automotives are very important electric equipments for those rural areas infrastructure developments such as, irrigation, energy, all those and different automatic agricultural machine and tools. So there is more quality to speak and we have not provided a number for the world for 2009 yet.

Operator

Your next question comes from Hue Mei - Hua-Mei 21st Century.

Hue Mei - Hua-Mei 21st Century

Thank you for taking my questions and all of my questions have been asked before by others, so I got the answers for what I need, so now I’ll hand it over to other questions. Thank you very much.

Operator

Your next question comes from [Jason Knapp with Dolphin James].

Jason Knapp - Dolphin James

I just have one question with regards to the trains. You said that each train car has two electric motors, correct and one control system, and you gave out a $20 million; that $20 million is for the total number for the set of 80 correct?

Christy Shue

Correct.

Operator

Your next question comes from Robert Sussman - Bentley.

Robert Sussman - Bentley

The downturn in the automotive market in China only really begun in August and has continue. How do you expect the fourth quarter to be versus the third quarter? Are we going to see more of the automotive in the economic downturn in China in the fourth quarter than we saw in the third, such that the fourth quarter could be well below the third quarter?

Christy Shue

Okay. Let me answer the first part of your questions. First of all, if you’re talking about how the global economic downturn affect the overall economy in China, that is one thing and if you’re talking about how the global downturn effect our automobile business, that’s another thing.

Keep in mind that we’re specialized in automobile micro-motors that are designed specifically enhancing the function of the car, improving the car appearance and I guess the maneuvering for the consumers, for the car shoppers. So, on this particular products we do not think that the automobile demand going to affect this part of the product greatly.

I think to start, It would be a lot of standardized car parts that goes to all kind of parts, like the difference in the bodies, the BOB, plastic type of parts, although it’s the low end, I mean standardize the parts and our micro-motors are not in that category and also I think another factor that Mr. Yang mention earlier is for the whole entire car, especially for car auto parts like Magna; our product is only a very small fraction of their overall grant scheme. So, like Magna’s reported third quarter weakness, we do not that is come from our product and our product actually probably help them.

So, overall in that door we do not see any active impact on our sales and on our sales and automobile segment in focusing on the micro-motors.

Robert Susman - Bentley

Well, what I was asking is that the first time new car sales in China, fell 6% in August and from what I’ve read, it continues to be weak. So I’m wondering if that will impact your fourth quarter results?

Christy Shue

Okay. We have said that we do not expect that to impact our fourth quarter result, on the automobile parts. You’re talking about automobiles?

Robert Susman - Bentley

Yes.

Christy Shue

Yes and also another fact that Mr. Yang had said in the beginning is, our products, our customer design is specifically on order and the supply agreement is pretty much set a year or two years ago, and we have never experienced that the customer withdraw or cancelled their orders so far and he said early that we do not expect anything to impact on our fourth quarter result.

Robert Susman - Bentley

So could the fourth quarter be comparable to the third quarter in that case?

Christy Shue

We usually do not provide a very number oriented guidance.

Robert Sussman - Bentley

Okay; aside from the automotive business; are there any pluses in the fourth quarter that we’re lagging in the third, in terms of non-automotive, either in terms of the oil pump business or any other new products?

: [Interpreted]

Our supply order is received for the fourth quarter and from what we have now we expect the comparable results for the fourth quarter as compared to the third quarter. As far as upside potential or any increase over the third quarter we are not sure at this time and we are watching how the scene’s evolving, but with the orders on hand we are still very solid.

Operator

Your next question comes from Rachel Scott - Heller capital.

Rachel Scott - Heller capital

With regards to Magna International and the trial production in December, can you provide any color on how long the trial production will run, and if it’s still possible to deliver the 1 million micro motors to magna by the end of the year?

Christy Shue

Okay. What we actually have also answered it and part of your question is that; we expected in December will start trial production; however, we do not expect that the revenue will be realized during the fourth quarter, and the revenue recognition is a little bit delayed compared to the production fed. So we expect that the first quarter of 2009 we’ll see the revenue contribution from Shanghai.

Rachel Scott - Heller capital

You don’t expect or anticipate any issues with Magna, I guess with the delivery being later than expected; can that be pushed, the dead line be pushed out for that?

Christy Shue

Okay, can you say that question again, like expected Magna going to delay their orders or --?

Rachel Scott - Heller capital

Yes, I understand that revenue recognition might be in the first quarter, but when the unit actually gets shipped, do they have a deadline where they need the units or if it’s shipped in the first quarter then that is fine for them?

Christy Shue

We actually have not received any information that they are going to delay the shipments and so we’re still expecting us to start production in December and start shipping products in generally in the first quarter, and as of right now actually every week we’ve got a team from Magna coming to our Shanghai facility working with us together to get that production trail run very smoothly. So we are really working very hard in Shanghai.

Rachel Scott - Heller capital

Great, and my last question is, can you provide any color on the price promoter or how we should think about grasping the size of this commitment from Magan for the 1 million micro motors?

: [Interpreted]

Currently I think we have four products that are for Magna and including the mechanical part servicing, one motor is roughly $20 dollars each slight with the low $20 dollars.

Rachel Scott - Heller capital

US dollars.

Christy Shue

US dollars.

Operator

(Operator Instructions). This call will be available for replay beginning at 9:30 am ET today, through 11:59 pm Eastern Time on November 17. The conference ID number for the replay 71191627; again the conference ID number for the replay is of 71191627.

At this time there are no further questions. I would now like to turn the conference back over to management for closing remarks.

: [Interpreted]

Obviously we know that our investors and share holders really care about our company and are interested in the future of our company. We are coming to the Ross conference to be held in Las Vegas next week and am really hoping to have more time there with the shareholders being able to come to the conference. The presentation and the conference will be webcast.

We hope to have more time to help our investors and shareholders and to further enhance our business and we have such a confidence for our future, our industry and our products and also the involvement of all is a favorable condition for us. Because of the limited time, we can’t help you to understand more, but they are also based on what we see now for the next quarter. We expect another solid quarter, but however the economic uncertain prices are still happening globally and are still evolving.

We are also monitoring and watching how this financial crises is going to evolve; obviously we need to watch it carefully. However I want to tell you that, our company and our employees and our board has confidence that we can face these challenges and adapt strategies to deal with these challenges and transform these challenges to opportunities that are favorable to us.

Thank you very much for coming to today’s conference call and if you have further question, you can give me a call at 6013 128 612. Thank you very much. Bye, bye.

Operator

This concludes today Harbin Electric Incorporated conference call. Thank you for your participation. You may now disconnect.

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