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Harbin Electric, Inc. (NASDAQ:HRBN)

Q4 2008 Earnings Call

March 13, 2009 8:30 am ET

Executives

Christy Shue - Executive Vice President, Finance and Investor Relations

Tianfu Yang - Chairman and Chief Executive Officer

Analysts

John Ma - Roth Capital Partners

Brain Drab - William Blair

Ping Luo - Global Hunter Securities

Chad Cooper – Roth Capital

Gu Wei – HuaMei

Jason Knapp – Dawson James

Operator

(Operator Instructions) Welcome everyone to the Harbin Electric, Inc. Fourth Quarter and Fiscal Year 2008 Earnings Results Conference Call. I would now like to turn the conference over to Christy Shue, Executive Vice President, Finance and Investor Relations of Harbin Electric, Inc.

Christy Shue

Welcome to Harbin Electric’s fourth quarter and the 2008 earnings conference call. I am joined by our Chairman and Chief Executive Officer Mr. Yang on the call. Our Chief Financial Officer Mr. Xu Zedong is ill today so he cannot be with us here.

We issued a press release this morning to highlight our fourth quarter and annual financial results. Our 10-K for 2008 will be filed shortly. During the call we will make forward looking statements that are subject to the risks and uncertainties outlined at the end of our press release. For today’s call I will give a brief summary of our fourth quarter and full year 2008 financial results. After that Mr. Yang and I will be ready to answer your questions.

For year 2008 we reported total revenues of $120.8 million up 85% from $65.4 million in 2007 with great contributions from the acquisition of our Hengda, industrial rotary motor business. Net income was a record $25.4 million up 50% from $16.9 million in 2007. Diluted earnings per share were $1.19 compared to $0.91 in 2007.

For the fourth quarter 2008 total revenues were $34.7 million up 80% from $19.3 million in the fourth quarter of 2007, but declined sequentially from $39.7 million in the third quarter. Reflecting the impact of the global economic downturn net income was $6 million up from $4.1 million in the fourth quarter of 2007 but down quarter over quarter from $7.8 million due to lower sales just mentioned. Diluted earnings per share were $0.27 up from $0.22 year over year, down from $0.34 quarter over quarter.

The company’s operating results for 2008 reflected two distinct economic periods. During the first three quarters business conditions were solid. We achieved the results that met or in some areas exceeded our expectations. Beginning with the fourth quarter global economic activity contracted significantly which negatively impacted our business beginning in November.

While we had significant demand growth from our major international customers in the fourth quarter this was more then offset by softer demand from our domestic customers, particularly in the rotary motor and automobile specialty micro motor businesses and the seasonality of oil pump sales. The combined net impact resulted in fourth quarter sales dropping below third quarter levels.

Also the startup of our Shanghai facility was delayed as our customers reacted with great caution to the global financial crisis. Despite this severe unstable business conditions we posted 85% sales increase and generated a record $25 million net income, $42 million cash from operations. Excluding the acquisition of Hengda the industrial rotary motor business we acquired in July last year, sales increased by 43% and net income was also a record $23.7 million.

Our strong results for 2008 testify to our strategic vision over the past year and reflect the resilience of our business model. As we begin 2009 we continue to experience soft demand in some areas but see some signs of demand improvements in other parts of our business. Overall for 2009 we expect some sales and earnings growth over 2008.

The major drivers for the growth are our linear motors for subway train cars which we expect central production to begin towards the end of the second quarter. The startup of the Shanghai facility in March and also volume growth in oil pumps which could double the volume of last year.

Additionally, we expect to benefit from the Chinese government stimulus package much of which have been and will be invested in China’s infrastructure build out and the development of agriculture and rural areas in which our business has built effort out. We expect that these positive factors will begin to impact our business mostly in the second half of the year. However, it is hard for us to judge the size of our business growth for 2009 at this point given the uncertainties associated with the current difficult economic environment and a possible further deterioration in global economic conditions.

Despite this unprecedented economic uncertainty and the many challenges we are facing we believe that we are well positioned to navigate this turbulent time and to achieve growth and build long term value for our shareholders.

We will use the remaining time to answer your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from John Ma - Roth Capital Partners

John Ma - Roth Capital Partners

Can you give us details on gross margin by your product line, how much gross margin you had in Q4 for linear motors and auto micro motors?

Christy Shue

By product line?

John Ma - Roth Capital Partners

Yes.

Christy Shue

Our gross profit margin for our linear motors held stable. For linear motors it remained around the 60%. I do not have exact number but it hasn’t changed much from previously. The gross profit margin for the automobile segment also stayed around 40%. Our rotary motor business gross profit margin is about 11% for the whole year that’s what I’m talking for the whole year 2008.

John Ma - Roth Capital Partners

Looking to 2009 how the gross margin will trend in each of your business sectors?

Christy Shue

We expect the gross margins for the linear motors and for automobile specialty micro motors will stay stable going forward. For industrial rotary motor business we expect some improvement because in the past, particularly in the third quarter and fourth quarter the gross margins were mainly impacted by the higher raw material costs. However, in the later half of the year the raw material price has been declining. However, for the quarter we’re pretty much running the inventory. In 2009 we expect after we finish the inventory and we expect the gross margin will have some improvements.

John Ma - Roth Capital Partners

A question on your oil pump, can you tell us a bit more of your new customer development, and did you develop any new customers?

Christy Shue

At this stage we are in the process of working with different customers. We still do not know when the commercial production for those customers will begin. One major reason this is a very new product and also because it’s specially developed and designed for specific customers. For example, if we work for a customer in Northwest China then you would have to design differently according to their geographic conditions so it takes some time for development.

Mainly while we are developing new customers we are focusing particularly on working with Daqing oil field because Daqing is one of the largest oil field in China and their demand is huge right now. We’re feeling a very small fraction of their demand in terms of oil pumps so we believe this is a huge demand and the customer will have a huge market potential for us so we’re focusing on working with them currently.

John Ma - Roth Capital Partners

I want to get more detail about your rotary motors and how the government stimulus plan help the farmers and what subsidies they will get in terms of their purchasing of your rotary motors.

Tianfu Yang

(Chinese Language Comment)

Christy Shue

Let me translate what Mr. Yang is saying. Mr. Yang has been in the Congress meeting for the last two weeks and so tomorrow he will be going to Weihai again. During the Congress he felt that the Chinese government has been and will actually strengthen the development of investments in the agricultural area and particularly the policy of encouraging agricultural and farmers to purchase electronic equipment and the electric farming equipment will continue.

One particular benefit for our business is when we acquired Hengda the rotary motor business there is a patent product, its called Single Phase Electric Motor, this Single Phase Electric Motor because it’s a particular international property and patent has some special features for example the heat resistance and also lower cost. This type rotary motor is particularly good for the farmer use in agricultural type of applications for example for the grinding, de-shelling machine and grinding machine, powdering machine for the farmers to processing their crops.

This type of equipment we see because of the government stimulus package encouraging farmers to purchase both farming equipment and gave them 30% of rebate right away if they purchase any electronic or electric equipment. We see immediate growth in the sales activity growing for this particular product.

Not only is to be useful for farmers also because the voltage particularly in the rural area they are 220 volts and traditionally the other type of rotary motors its called three phase has been using in this area but now more and more outdated. Now all of a sudden our products, the Single Phase Electric Motor is very popular with the farmer.

When we looked our March order we see roughly the order is already 30 million RMB for this type of industrial rotary motors and we are expecting the continued growth for this particular product and it could be a large part of our industrial rotary motor business for this year. The other competitors who are industrial motor business, not many of them make this type of industrial rotary motors. This is very good news make us very excited for this product.

Tianfu Yang

(Chinese Language Comment)

Christy Shue

Let me continue the translation. We shall continue talking about this particular Single Phase mode distribution type of rotary motor particularly good for the farmer use. He explained some technical terms why this particular product is good for them because of the special situation in China the rural area there some electricity shortage, sometimes you get shortage when you use 220 volts type of machine or equivalent so there is some type of protection system in the product that we make that help them to prevent those type of technical things happening.

He believes that the market for this particular product is great just for the Northeast three provinces he estimates that the market potential could reach 4 billion RMB for this particular type of Single Phase Electric Motor. The government’s policy to encourage farmer is to give 30% rebate of this 4 billion potential sales of this type of motors.

We see that we would benefit quite a lot from this government stimulus package investing in developing the rural area, encouraging farmers to purchase this type of electric equipment. We believe in our industrial rotary motor business for this year with the trend that’s going right now our sales could be slightly better then 2008 with this trend continue for the rest of the year.

The government is going to invest a lot more then what they have invested so we believe there’s going to be a lot coming from this just for this particular product.

John Ma - Roth Capital Partners

(Chinese Language Question)

Christy Shue

I apologize that our CFO, Mr. Xu is not here, he got sick so he is a few days resting at home so he could not be here.

Operator

Your next question comes from Brain Drab - William Blair

Brain Drab - William Blair

You talked about gross margin for the rotary motor business but I think if I heard correctly that you only gave gross margin for the full year. Could you tell me what gross margin was for rotary motors in the fourth quarter specifically?

Christy Shue

For the fourth quarter it slightly declined from the third quarter probably just about one percentage declining, roughly. We can get you the exact number later. It’s probably less then 1% as I remember.

Brain Drab - William Blair

Can you remind us what it was in the third quarter, I can’t remember off the top of my head?

Christy Shue

The gross profit is $24.6 million. For the whole year the gross profit for Hengda is $24.7 million.

Brain Drab - William Blair

Can you tell me what revenue was for Weihai Hengda in the fourth quarter?

Christy Shue

Hengda’s gross profit was $2.9 million out of the cost of sales is $24.7 million. That is 10.7% of gross margin for 2008. I will get back to you with the fourth quarter one later on.

Brain Drab - William Blair

Do you have fourth quarter revenue for Weihai?

Christy Shue

The fourth quarter revenue for Hengda is about $12.5 million.

Brain Drab - William Blair

Given your current projections that you have for revenue and earnings in 2009 do you expect that you’d be generating free cash flow in 2009 or do you think that you’re going to be a user of cash in the year?

Christy Shue

For 2008 we generated $40 to $43 million free cash flow from operations. For 2009 we expect that our capital spending running from $30 to $40 million depending obviously how fast and how soon that we can start our initiatives of new projects like the railway projects and how fast the Shanghai startup, all that.

It’s difficult to say, if we generate the same amount of cash for 2009 and our spending is $30, $40 million a rough estimate is, in that there it’s even but we have $6.4 million principal on our 2006 notes that we need to pay back. It could be slightly negative but we should still have a $48 million cash in balance sheet so pretty good for 2009. We feel pretty solid; have very good liquidity position in 2009.

Brain Drab - William Blair

Regarding the Shanghai plant you said that production is expected to begin at the end of March. What sort of impact do you think any unabsorbed overhead might have on margins in the first quarter of 2009?

Christy Shue

You’re talking about the depreciation?

Brain Drab - William Blair

Yes, given the depreciation or any other factors associated with that plant given that the volume isn’t going to be what you originally expected.

Christy Shue

Right now for the first quarter it seems that the production is going to start in March. We will start small scale production in March. We do not expect great contribution, meaningful contribution in the first quarter. We’ll start depreciating some of the plant and equipment once we start production. Right now we do not have a number on that yet. We have not looked at the dollar amount for depreciation so I cannot tell you that number.

Operator

Your next question comes from Ping Luo - Global Hunter Securities

Ping Luo - Global Hunter Securities

My question is regarding your linear motors business because most of your linear motor projects are customized orders. I would like to know how the economic slowdown impacts the linear motor business. I would like to know what customers you’re working with in the first quarter and what customers you expect to work with in 2009.

Tianfu Yang

(Chinese Language Comment)

Christy Shue

Let me translate the answer. The question is about the linear motors how we feel about the linear motors business for 2009. Basically what we feel our current existing customers for our legacy linear motors are very stable. It’s not like the first two years that it’s growing very fast. The good news is that it’s very stable. It hasn’t been felt a big impact from the economic downturn so that is the positive side.

Most of the customers using the linear motors they are very higher technology and so we sign orders when we develop the product so its same quantity of orders pretty stable. What our focus this year is we’re focused more on the large linear motors, our new product for example large tower type oil pump and the linear motor for the railway subway car. Those projects are supported by the government stimulus package so we want to fully take advantage benefiting from the government stimulus package.

For example, Beijing has a plan of eight linear motor subway lines to be after the government announcement to encourage the infrastructure and the mass transportation building. Our oil pump business although right now we still have not received a confirmation on order amounts because the Daqing oil company that we’re working with they are state on the company they are still working on their budgets for the year. They said some of their relatives on the government investments. We still expect this is a very good market to them, its going to continue to grow.

To give you an update on our linear motors for the railway project, on our side we have completed design and the simple prototype testing in our facility. Actually in the next week we’re having a final evaluation meeting at our Harbin facility with a few potential customers and the train maker to come in to our Harbin facility make a final evaluation. If everything goes fine we expect that in the second half of this year we could start some sales. The main point is for us this is a very good opportunity because it’s supported by the government and we believe we can benefit from that greatly.

Operator

Your next question comes from Chad Cooper – Roth Capital

Chad Cooper – Roth Capital

Can you talk about your visibility right now specifically for 2009 as well as Q1, we’ve got two weeks left until your first quarter is over?

Christy Shue

You mean visibility for the whole year 2009?

Chad Cooper – Roth Capital

Yes, 2009 and Q1.

Christy Shue

In the very beginning I actually had said that in the beginning of the year we still see some soft demand overall particularly for our automobile segment. For the year we expect the drivers such as what we just talked about the linear motor project, the oil pump project and the Shanghai startup are going to start impact more in the second half of the year. Overall we still expect some growth in 2009 over 2008.

In the first quarter, for the first two months we still see softness. It all depends on how well it goes in March and then we can know for sure whether it’s better or worse then the fourth quarter. Right now it is very difficult for us to give you a certainty as far as the size of the growth for this year.

Chad Cooper – Roth Capital

Is your cash on your balance sheet, is it all in RMB or do you have any in US dollars from the capital raise you did?

Christy Shue

The cash mainly in RMB on our balance sheet. The funds that we reached last year in July we used to pay for obviously we use RMB to acquire this company so we had to convert them all into RMB to pay for the acquisition.

Chad Cooper – Roth Capital

Has the Board had any discussions about using some of your capital to repurchase shares or anything like that?

Christy Shue

No, the Board has not discussed anything. The reason that we have this size of the cash on balance is we are obviously first of all we are a manufacture company and its capital intensive industry. Also, particularly we have several projects like we have talked about lined up in the pipeline and we have to be very well prepared to meet the demands there because the close working with our customers although we cannot tell you the exact schedule when we can start on these projects but we do need to be prepared once the orders start it could pick up pretty quickly.

That we need all the cash for building up working capital and the expanding capacity. For us our focus is more on growth, continue to grow our business given we have a few very good projects in the pipeline. We have not considered using the cash to do share repurchase or that we believe the best way to reward the investors is to grow our business continuously.

Operator

Your next question comes from Gu Wei – HuaMei

Gu Wei – HuaMei

I have two concerns, one is I know because of the financial crisis a global outsource market might be trouble and how we maintain our specialty micro motors given its growth in the year and do you think what if the growth rate for the sector is in 2009?

Tianfu Yang

(Chinese Language Comment)

Christy Shue

Let me translate. The question is asking about because of the financial crisis and also the auto industry in the US has been deteriorating and a lot of uncertainties with it how we are dealing with this situation in our automobile segment business. This is a very good question and actually we have talked about this question before, I think this is a very good venue I would like to basically emphasize several points again in dealing with this situation.

Basically if you look at all the data and sales data in the automobile industry the market has been declining and is not in very good shape. The overall car sales globally have declined including Toyota, all the prestigious companies. However, even though the car sales have declined the demands are still there, it hasn’t stopped.

Also, in terms of the OEM supplier to the automobile industry there are quite a lot of changes also. Some of the suppliers, he mentioned one name, Delphi; they have been changing a lot of the strategies. For example the outsourcing they stopped producing some of the products, the outsourcing the products to China to other parts of the world. Also, some of the suppliers they have their own problems so they go out of the business. Things happening in the supplier side of the business too.

Our company actually has seen this historical point where that we not only have the R&D capability and also we have a very good high quality manufacturing system and to be able to as the OEM supplier to the automobile, also products not only have quality but at a lower cost. This is actually a very good entry point for us a lot of times we are replacing some of the previous suppliers they stopped producing some of the products and now outsourced those products to China so we’re coming in to be that role, replace those big OEM suppliers now.

Another point I want to emphasize in the car there were two different types of parts, one parts is structural type of parts such as iron cast, the plastic chair frame, car seat frame, all that. The second type of the parts is called functional parts. For example, the engine, the motors, and our micro motors it falls into the functional parts. Actually to improve a cars function and our motors is very critical to a car. In that sense, the demand for this type of product actually has grown.

The car sales when the car market is good and automobile industry is growing you probably don’t need a lot of functional and features in a car you can easily sell the car but right now the automobile market is not good and then the automobile markers all need to come up with all different ideas to sell the car to make the car sell better. This functional part becomes more in demand to make the car sell better.

We believe that actually this is a good opportunity for us. That’s pretty much what he emphasized. We believe that for us we actually take all this advantage and continue to grow our automobile segment in this market.

Tianfu Yang

(Chinese Language Comment)

Christy Shue

The major point he emphasized is although we acknowledge the overall car automobile market is not good but however the market is still there remains and particularly for better car for the car with higher end features are still growing and also the construction has been changing. On the other hand we are still a small company; our capacity is still considered very small compared to a large company in the market. For us there’s still a lot of room to grow.

We believe long term for the next few years we expect it to continue to grow in this business even though right now people think the automobile market is not good, we still have confidence to grow in this market.

Operator

Your last question comes from Jason Knapp – Dawson James

Jason Knapp – Dawson James

I had one quick question with the oil pumps. I know that you guys beat by your expectations of 214 from 200. Are you still getting about $50,000 US for each one of those oil pumps?

Christy Shue

No, you mean average price for each oil pump?

Jason Knapp – Dawson James

Yes, for the oil pumps. I know at the beginning of this year they were about $50,000.

Christy Shue

No actually it has been running from $42,000 right now it’s around the $42,000. We haven’t changed the price from last year.

Tianfu Yang

(Chinese Language Comment)

Christy Shue

First of all I would like to thank all the investors coming to this conference call. Just a final few words, although this is a very difficult economic time but there’s also good news. For example, the Chinese government has invested quite a lot and we think that’s a very encouraging bright spot there. Even for the Made in China concept in China electronic equipment generally the industry the impact from the financial crisis is relatively small I believe.

For example, the big machines were made in the US in Western country but the parts actually all coming from countries like China so there are more assembly lines but we’re supplying their parts and so the sourcing the purchasing is to happen in China. Due to this economic crisis we actually see more and more those types of customers approaching us sourcing more parts from China.

For 2009 our focus is going to be priorities to maintain our current business strengthening our relationships with our current customers and clients. We still explore new growth opportunities.

Thank you everyone and see you next quarter.

Tianfu Yang

(Chinese Language Comment)

Christy Shue

Thank you again and we will continue to communicate with you our business anytime if you have any questions or follow up question please contact me. Right now I’m traveling in China so you can call my China cell phone if you any follow up questions. My China cell phone is 134-3952-7259. My US cell phone is 631-312-8621 you can still reach me by US cell phone.

Operator

This concludes today’s Harbin Electric, Inc. Conference Call. (Operator Instructions) Thank you for your participation you may now disconnect.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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