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Hollysys Automation Technologies, Ltd. (NASDAQ:HOLI)

F2Q2014 Earnings Conference Call

February 17, 2013 8:00 p.m. ET

Executives

Jennifer Zhang – IR Director

Baiqing Shao – CEO

Herriet Qu – CFO

Analysts

Chapman Deng – JPMorgan

Alex Chang – Citigroup

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Hollysys Automation Technologies' Fiscal Year 2014 Second Quarter Ended on December 31, 2013 Earnings Conference Call.

[Operator Instructions] Please be advised that this conference is being recorded today, February 17, 2014.

I would now like to hand the conference over to Ms. Jennifer Zhang, 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 Mr. Baiqing Shao, CEO of Hollysys Automation Technologies; Ms. Herriet Qu, CFO of Hollysys; and myself, the IR Director of Hollysys.

On today 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. Both Mr. Shao and Ms. Qu will answer questions after their remarks.

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: business conditions in China and in Southeast Asia; continued compliance with government regulations; legislation or regulatory environments, requirements or changes adversely affecting the businesses in which Hollysys is engaged; cessation or changes in government incentive programs; potential trade barriers affecting international expansion; fluctuations in customer demand; management of rapid growth and transitions to new markets; intensity of competition from or introduction of new and superior products by other providers of automation and control system technology; timing, approval and market acceptance of new product introductions; general economic conditions; geopolitical events and regulatory changes; as well as other relevant risks detailed in Hollysys' filings with the Securities and Exchange Commission.

The information set forth herein should be read in light of such risks. Hollysys does not assume any obligation to update the information discussed in this conference call or its filings.

Please note that all amounts noted in this conference call will be in U.S. dollars unless otherwise noted.

And now I'd like to turn the call over to Mr. Baiqing Shao. Please go ahead, Mr. Shao.

Baiqing Shao

Thank you, and good evening everyone. We are very excited to report our solid financial and operational results for the second quarter of this fiscal year. Here I would like to discuss some key events during the quarter.

During this quarter, we insisted in executing our strategies to vertically penetrate in the high-end industrial automation market and improve our market share in mid to low-end markets, and to horizontally explore the potentials of each customer to supply entire automation and control solutions and service leveraging our complete and mature products and platforms. Both new orders and revenue of industrial automation delivered strong growth. There were satisfied achievements in some particular industries, for instance, thermal power, chemical, petrol chemical, cement, metallurgy and et cetera.

Going forward, we believe that we will increase our overall market share in the industrial automation, nurture and quickly take commanding height in our new businesses leveraging our advanced technologies, experienced professionals, profound industry expertise, and customization and innovation capability.

In rail transportation, we have seen meaningful progress and consistent revenue contribution in high-speed rail signaling field. We are encouraged by the continuous contract wins to provide the Automatic Train Protection equipment and system for 200 to 250 km/h and 300 to 350 km/h high-speed trains recently.

Moreover, our proprietary ZPW-2000s Track Circuit was successfully applied in Beijing Xiaohongmen-Baiziwan trial railway line, and passed the trail operation examination by Beijing Railway Bureau. This will expand our products providing in the railway transportation market and will prove [ph] to be another revenue growth driver for Hollysys in the future. All in all, as a well-recognized rail signaling system provider, we are confident that with strong R&D capability, solid execution and reliable products, Hollysys will continue to penetrate China's vast railway construction market and explore international opportunities.

For the overseas industrial automation and 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, 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.

With this, I'd like to turn the call over to Jennifer Zhang who will read the financial results analysis on behalf of CFO Ms. Herriet Qu. Jennifer, please.

Jennifer Zhang

Thank you, Shao.

In a nutshell [ph], Hollysys financial and operational results for the fiscal year 2014 second quarter and December 31, 2013, the company reported solid financial results.

For this quarter total revenues increased by 75.9% to $153.4 million from $87.2 million for the same period in the prior year. Of the total revenues, revenue from integrated contracts increased by 81.8% to $147.6 million, as compared to $81.2 million for the same period of the prior year. Revenue from products sales decreased by 2.9% to $5.8 million, as compared to $6 million for the same period of the prior year.

The company's total revenue by segment was as follows. Industrial Automation, $55.3 million; Rail Transportation $35.2 million; Mechanical and Electrical solutions $26.8 million; Miscellaneous $6.1 million.

As a percentage of total revenues, overall gross margin excluding non-cash amortization of acquired intangibles was 32.3% for this quarter, as compared to 32.1% for the same quarter last year. The gross margin for integrated contracts and product sales excluding non-cash amortization of acquired intangibles were 30.6% and 74.2% for this quarter, as compared to 29.8% and 63.8% for the same quarter of last year. The gross margin fluctuation was mainly due to the different revenue mix with different margin.

Including non-cash amortization of acquired intangibles, recorded on a GAAP basis, overall gross margin was 31% for this quarter, as compared to 32.1% for the same quarter last year. The gross margin for integrated contracts and product sales including non-cash amortization of acquired intangibles were 29.2% and 74.2% for this quarter, as compared to 29.8% and 63.8% for the same quarter last year.

For this quarter, selling expenses were $9.5 million, as compared to $8.1 million for the same quarter last year, representing an increase of $1.4 million or 16.9% year over year. As a percentage of total revenues, selling expenses were 6.2% and 9.3% for the three months ended December 31, 2013, and 2012, respectively.

General and administrative expenses, excluding non-cash share-based compensation expense, were $8.9 million for this quarter, representing an increase of $4.8 million or 115% growth, as compared to $4.1 million for the same quarter last year. The increase was mainly consisted of an increase of $1.5 million from the newly acquired company Bond Corporation and its subsidiaries, and an increase of $1.9 million in bad debt allowance.

As a percentage of total revenues, general and administrative expenses were 5.8% and 4.8% for the three months ended December 31, 2013, and 2012, respectively. Including the non-cash share-based compensation expenses recorded on a GAAP basis, G&A expenses were $10.1 million and $4.7 million for the three months ended December 31, 2013, and 2012, respectively.

In this quarter, research and development expenses were $12.2 million for this quarter, as compared to $8.3 million for the same quarter last year, representing a year over year increase of $3.9 million or 46.9%. The increase was mainly due to an increase in certification fees. As a percentage of total revenues, R&D expenses were 8% and 9.6% for the quarter ended December 31, 2013, and 2012, respectively.

The VAT refunds and government subsidies amounted to $10.4 million for this quarter, as compared to $7.3 million for the same quarter last year. The income tax expenses and the effective tax rate were $3.6 million and 16.3% for this quarter, as compared to $2.6 million or 16.8% for the same quarter last year.

This quarter's non-GAAP net income attributable to Hollysys, excluding non-cash stock compensation expenses, amortization of acquired intangibles and acquisition-related consideration fair value adjustments, was $25.9 million or $0.45 per diluted share based on 58.2 million shares outstanding. This represents an increase of $12.3 million or 90.7% over the $13.6 million or $0.24 per share based on 56.1 million shares outstanding, reported in the prior-year period. On a GAAP basis, net income attributable to Hollysys was $18.3 million or $0.32 per diluted share, representing an increase of $5.2 million or 40.1% over the $13.1 million, or $0.23 per diluted share reported in the prior-year period.

Hollysys' backlog as of December 31, 2013 was $503.3 million, representing a decrease of 2.4% quarter over quarter and an increase of 40% year-over-year growth.

The detailed breakdown of the backlog by segment was as follows. Industrial Automation $149.4 million, Rail Transportation $223.3 million; M&E $106.5 million, Miscellaneous $24.1 million.

The net cash provided by operating activities was $24.4 million for this quarter. Including investing and financing activities, the total net cash inflows for this quarter was $22.4 million. Of the total net cash inflows, there was a net cash inflow of matured time deposits with original maturities over three months amounting to $2.4 million and proceeds from bank loan amounting to $3.8 million, a net cash outflow of repayment bank loans amounting to $4.3 million.

The total amount of cash and cash equivalents and time deposits with original maturities over three months were $150.1 million, $129.4 million and $133.5 million as of December 31, September 30, 2013, and December 31, 2012, respectively. Of the total $150.1 million as of December 31, 2013, cash and cash equivalents were $135.1 million, and time deposits with original maturities over three months were $15 million.

For this quarter, days sales outstanding was 156 days, as compared to 161 days year over year and 175 days quarter over quarter; and the inventory turnover days was 27 days, as compared to 42 days year over year and 44 days quarter over quarter.

In view of solid Industrial Automation growth, strong recovery of the high-speed rail signaling segment, and future exciting growth momentum envisioned, we are revising up our fiscal year 2014 revenue guidance from previous $460 million to $490 million, to $500 million and $530 million and non-GAAP net income guidance from previous $65 million to $69 million, to $84 million to $86 million.

Going into the future, Hollysys will continue to leverage on its core growth pillar foundations of its proprietary technology, profound industry expertise and solution capabilities to increase its market share in respective high-growth end-markets. Besides, Hollysys will continue to set up strategic alliance with industry leading organizations to penetrate into the new market and accelerate its growth pace to create long-term value for our shareholders.

At this time we'd like to open up for the Q&A session. Please note that for Chinese-speaking participants, we can also do the Q&A in Mandarin and we will provide translation.

[Chinese language spoken]

Operator please.

Question-and-Answer Session

Operator

[Operator Instructions]

Your first question comes from the line of Chapman Deng from JPMorgan. Please ask your question.

Chapman Deng – JPMorgan

Okay, thank you. Thank you, management. Congratulations on a set of very strong results. I've got three questions.

First, for the -- I noticed that you revised your FY14 revenue and net profit guidance. But can you actually walk us through the revenue growth guidance segment by segment in FY14? And at the same time, can you also provide your guidance for FY15 as well? That's the first question.

The second question is on the Industrial Automation segment. I noticed that the new order growth in the past quarter has been very, very strong. May I know the reason why? And can you tell us a little bit more about which sub-segmented drive the revenue growth? That's the second question.

And my last question is on the overseas operation. I also noticed that new order from overseas was very strong on Q-on-Q basis. May I know the reason why? Thank you.

Jennifer Zhang

[Chinese language spoken]

Baiqing Shao

[Chinese language spoken]

Chapman Deng – JPMorgan

[Chinese language spoken]

Baiqing Shao

[Chinese language spoken]

Chapman Deng – JPMorgan

Xie-xie, Shao.

Baiqing Shao

Xie-xie.

Jennifer Zhang

Okay, thank you. I will provide translation briefly regarding the revenue and net income guidance revise up. It's mainly from several aspects. The first one is because of the Bond acquisition from the overseas segment. And secondly, definitely the most important, is because of the high-speed rail revenue growth. It's more than our original expectations. And thirdly is because of the strong growth from Industrial Automation. So overall speaking, in the first half of 2014, it will continue to deliver very strong growth, so that's why we revised up our guidance.

As for the 2015 guidance, we think we will continue with the sustainable and strong growth. For the specific figures, we will talk and announce later.

And the second question about the Industrial Automation new order growth, the reason is -- the industries. Firstly, because of the thermal power as well as in the petrochemical industries. Last quarter the revenue achieved more than 20% growth. So briefly, in the thermal power industry we'll continue to improve our market share, and also there is very large existing reconstruction opportunities in the thermal power industry.

And second, in the petrochemical and chemical industries, our market share is still very low, so there is a lot of space to penetrate. And thirdly, it is because of the after-sales revenue, we will continue to enlarge our after-sales network and strengthen our work in this field. So as a percentage from the after-sales revenue will continue to improve.

And the last question about the overseas growth, it's mainly because of the Bond acquisition. So that is a strong growth driver to sustain our overseas growth.

Herriet Qu

[Chinese language spoken]

Chapman Deng – JPMorgan

[Chinese language spoken]

Jennifer Zhang

Okay. Ms. Qu added that the major reason for the guidance revise up is mainly because of the high-speed rail strong growth, because originally we were expecting about 30% of revenue growth from high-speed rail, but actually we may deliver over 70% growth.

As for the other reasons, from the IA and Bond, we have already considered in the original period when we are adjusting our guidance. So the major reason is mainly to talk about high-speed rail.

Thanks. Next question please.

Operator

[Operator Instructions]

Your next question comes from the line of Alex Chang from Citigroup. Please ask your question.

Alex Chang – Citigroup

[Chinese language spoken]

Baiqing Shao

[Chinese language spoken]

Alex Chang – Citigroup

[Chinese language spoken]

Baiqing Shao

[Chinese language spoken]

Herriet Qu

[Chinese language spoken]

Alex Chang – Citigroup

Xie-xie.

Jennifer Zhang

Okay. For the first question regarding the percent of increase of net income revise up is a little bit higher compared with the revenue growth revise up. The major reason is because of the high-speed rail ATP orders because this is a high gross margin business. So that's why the percentage of increase of the net income is higher for the whole year guidance.

For the second question regarding the new orders in the first half of this calendar year, I'm sorry we cannot give you a specific time, as well as the market share we believe that after the CRC [ph] established, which should create a better competition environment, so we can sustain our growth -- our market share.

For the third question regarding the overseas acquisition targets, we are evaluating and searching some targets, but there's no specific targets to be fixed and enough [ph]. So we will announce when it is settled.

Thanks.

Next question please.

Operator

Your next question comes from the line of Oscar Yang [ph] from Impex [ph]. Please ask your question.

Unidentified Participant

[Chinese language spoken]

Herriet Qu

[Chinese language spoken]

Unidentified Participant

[Chinese language spoken]

Herriet Qu

[Chinese language spoken]

Jennifer Zhang

Okay. The first question is about the Big Four was considered [ph] by the SEC. Briefly, our auditor is E&Y. We have made continuous communication with E&Y. Currently we are not affected by this affair. And we believe that it will take some time to take the effect of this suit [ph]. So we'll continue to focus on the progress and believe this affair will be solved in the future. So we have a very optimistic view for this issue.

And secondly, regarding about the Hong Kong listing, so the management will consider a proper time and chance for evaluating to be listed in Hong Kong. But it will be mainly depend on the market opportunities and our internal demand. Thanks.

Operator

[Operator Instructions]

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 our contacts.

We look forward to speaking with you again in the near future. Thank you. Have a nice day. Xie-xie.

Operator

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

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