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Hollysys Automation Technologies, Ltd. (NASDAQ:HOLI)

Q3 2014 Results Earnings Conference Call

May 14, 2014 9:00 p.m. ET

Executives

Jennifer Zhang - IR Director

Jianfeng He - Chairman

Baiqing Shao - Chief Executive Officer

Herriet Qu - Chief Financial Officer

Analysts

Saiyi He - Macquarie

Alex Chang - Citigroup

Baiding Rong - Credit Suisse

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Hollysys Automation Technologies' fiscal year 2014 third quarter ended on March 31, 2014 earnings conference call. (Operator Instructions) Please be advised that this conference is being recorded today, May 14, 2014.

I would now like to hand the conference over to Ms. Jennifer Zhang, 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 Dr. Jianfeng He, Chairman of Hollysys Automation Technologies, Mr. Baiqing Shao, CEO of Hollysys; Ms. Herriet Qu, CFO; 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: 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, Jennifer and good evening everyone. We are very pleased to report a solid financial and operational result for the third quarter of this fiscal year. Here I would like to discuss some key events during this quarter.

During this quarter, we continuously insisted on executing our strategies to vertically penetrate in the high-end industrial automation market while improving our market share in mid to low-end markets. We achieved several high-end projects wins in chemical, thermal and enlarged our market share in food beverage and new energy industries. We were also focusing on building strong after-sale department and set long-term goals on improving after-sale services. Our solution in reducing waste material emission and environment protection proved to be successful.

The past few months have been very exciting for Hollysys. A series of strict testing and on-site engineering application indicates that our new generation K-series DCS products meet the requirements for large and complicated projects including power and chemical, etc. Our products will significantly improve our market competitive advantages and effectiveness of project as well as improve our client recognition.

For the past few months, our HOLLiAS-N DCS product has been successfully operating in the Yangjiang Nuclear Power Plant, proving that our quality assurance system and products are completely qualified for the high standard of nuclear usage. When China accelerates its nuclear power plants construction in the future, we believe we will benefit more financially as well as in reputation in the long run. 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 railway transportation, during this quarter we feel excited about the significant high-speed rail ATP contract wins for high-speed trains in 200-250 km per hour and 300-350 km per hour, total valued at RMB687 million. Besides, our strong R&D capability, extraordinary project management and high-quality and reliable products had ensured our wins on a few recently operated high-speed rail lines, including Xiamen-Shenzhen line, Xi'an-Baoji line, Chongqing-Lichuan line and Wuhan-Xianning line.

Those high-speed rail lines are all equipped with our high-speed rail signaling system. We will continue to deliver quality works and work closely with railway authorities in the future. With China's increasing rail construction and equipment procurement budget for this year and exciting prospect envisioned, Hollysys, as a well-recognized rail signaling system provider with strong R&D capability, solid execution and reliable products, will continue to penetrate China's vast railway construction market and achieve significant results.

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 and products, industry expertise and strong competitive advantages, together with our expanded local channels through Bond and Concord, we will continue to make exciting achievements in the international market in both industrial and rail transportation fields and creating value for our shareholders.

With 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.

Jennifer Zhang

Thank you, Mr. Shao. In a nutshell, Hollysys' financial and operational results for the fiscal year 2014 third quarter ended March 31, 2014, the company reported solid financial results.

For this quarter total revenue increased by 58.8% to $95.8 million from $60.4 million compared to the same quarter last year. Of the total revenue, revenue from integrated contracts increased by 59.6% to $90.1 million, as compared to $56.4 million for the same quarter last year. Revenue from products sales increased by 47.1% to $5.7 million as compared to $3.9 million for the same quarter last year. The company's total revenue by segment was, Industrial Automation, $39.6 million; Rail Transportation $26 million; M&E solutions $23.7 million; Miscellaneous $6.5 million.

As a percentage of total revenues, overall gross margin excluding non-cash amortization of acquired intangibles was 36.2% for the this quarter, as compared to 43.8% for the same quarter last year. The gross margin for integrated contracts and product sales excluding non-cash amortization of acquired intangibles were 34.8% and 57.5% for the three-months ended March 31, 2014, as compared to 42.5% and 62.1% for the same quarter last year respectively.

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 35.2% for the three-months ended March 31, 2014, as compared to 43.8% for the same quarter last year. The gross margin for integrated contracts and product sales including non-cash amortization of acquired intangibles, were 33.8% and 57.5% for the three-months ended March 31, 2014 as compared to 42.6% and 62.1% for the same quarter last year respectively.

For this quarter, selling expenses were $6 million, as compared to $5.3 million for the same quarter last year, representing an increase of $0.7 million or 11.7% year-over-year. As a percentage of total revenues, selling expenses were 6.2% and 8.9% for the three-months ended March 31, 2014 and 2013, respectively.

General and administrative expenses excluding non-cash share-based compensation expense were $7.4 million for this quarter, representing an increase of $1 million or 15.6%, compared to $6.4 million for the same quarter last year. The increase was mainly due to an increase of $1.2 million contributed by the newly acquired company Bond. As a percentage of total revenues, G&A expenses were 7.7% and 10.5% for the quarter ended March 31, 2014 and 2013, respectively. Including the non-cash share-based compensation expense recorded on a GAAP basis, G&A expenses were $7.8 million and $6.9 million for the quarter ended March 31, 2014 and 2013, respectively.

Research and development expenses were $7.9 million for this quarter as compared to $7.4 million for the same quarter last year, representing a year-over-year increase of $0.5 million, or 6.7%. As a percentage of total revenues, R&D expenses were 8.2% and 12.2% for the quarter ended March 31, 2014 and 2013, respectively. The VAT refunds and government subsidies amounted to $5.2 million for the quarter ended March 31, 2014, as compared to $3.6 million for the same quarter last year.

The income tax expenses and effective tax rate was $2.9 million and 21.2% for the quarter ended March 31, 2014. Excluding the impact of non-GAAP adjustments on the income before income taxes, the effective tax rate was 15.4% for the current quarter. For the same quarter in the prior year, the income tax credit was $1.2 million due to the refund Beijing Hollysys received as a result of being certified as a key software enterprise for the calendar year 2011 & 2012.

For this quarter, the 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 $15.1 million or $0.26 per diluted share based on 58.9 million shares outstanding. This represents an increase of $3.4 million or 29.1% over the $11.7 million or $0.21 per share based on 56.5 million shares outstanding, reported in the prior year same period. On a GAAP basis, net income attributable to Hollysys was $10 million or $0.17 per diluted share representing a decrease of $1.2 million or 10.5% over the $11.2 million or $0.20 per diluted share reported in the prior year period.

Hollysys' backlog as of March 31, 2014 was $602.9 million, representing an increase of 19.8% compared to $505.3 million as of December 31, 2013, and an increase of 61.2% compared to $374 million as of March 31, 2013. The detailed breakdown was, Industrial Automation $172.1 million, Rail Transportation $278.3 million, M&E solution $152.4 million, Miscellaneous $0.1 million.

The net cash provided by operating activities was $3.1 million for the quarter ended March 31, 2014. Including investing and financing activities, the total net cash outflows for this quarter was $10.9 million. During this quarter, there was $2.6 million net cash inflow from the proceeds of short-term bank loans and $1.6 million net cash inflow from the proceeds of long-term bank loans. There was a net cash outflow of $12 million used in time deposits placed with bank and a net cash outflow of $2.7 million as a result of repayment of long-term bank loans.

The total amount of cash and cash equivalents and time deposits with original maturities over three months were $150.5 million, $150.1 million and $131.1 million as of March 31 2014, December 31, 2013 and June 30 2013, respectively. Of the total $150.5 million as of December 31, 2013, cash and cash equivalents were $124.2 million and time deposits with original maturities over three months were $26.3 million.

For this quarter days sales outstanding, DSO, was 248 days as compared to 250 days year-over-year, and 156 days quarter-over-quarter. Inventory turnover days of 45 days for the current quarter compared to 78 days year-over-year and 27 days quarter-over-quarter.

In view of our strong backlog and future exciting growth momentum envisioned, we are reiterating our fiscal year 2014 revenue guidance of $500 million to $530 million and non-GAAP net income guidance of $84 million to $86 million. Going into the future, Hollysys will continue to leverage on its core 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 alliances with industry leading organizations to penetrate into the new markets 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. Operator, please.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Saiyi He from Macquarie. Your line is open. Please go ahead.

Saiyi He - Macquarie

We have a question about the company's fourth quarter segment revenue guidance. Which segment you believe will become the major revenue and earnings contributor because we maintain our full guidance which means in the fourth quarter this financial year we will see a record level revenue and [outstanding] (ph) profits.

Herriet Qu

Hi, Saiyi. This growth mainly comes from the high-speed rail business.

Saiyi He - Macquarie

Okay. So in terms of the industrial automation, can you give us the guidance how -- what's the guidance for the fourth quarter and what about for FY '15, that we should have some visibility?

Herriet Qu

So we are expecting to achieve about 10% growth for fiscal year 2014 and for next fiscal year it will definitely increase from 10% to 15%.

Operator

Your next question comes from the line of Alex Chang from Citigroup. Your line is open, please go ahead.

Alex Chang - Citigroup

[Foreign Language]

Herriet Qu

[Foreign Language]

Operator

Your next question comes from the line of Baiding Rong from Credit Suisse. Your line is open, please go ahead.

Baiding Rong - Credit Suisse

[Foreign Language]

Baiqing Shao

[Foreign Language]

Operator

Your next question comes from the line of [David Jim] (ph) from Goldman Sachs. Your line is open. Please go ahead.

Unidentified Analyst

[Foreign Language]

Baiqing Shao

[Foreign Language]

Operator

Your next question comes from the line of [Lex Tong] (ph) from CICC. Your line is open. Please go ahead.

Unidentified Analyst

[Foreign Language]

Herriet Qu

[Foreign Language]

Operator

Your next question is a follow-up question from Alex Chang from Citigroup. Your line is open. Please go ahead.

Alex Chang - Citigroup

[Foreign Language]

Baiqing Shao

[Foreign Language]

Operator

Your next question comes from the line of [Chwang Fo] (ph) from [Hwan Hau Capital] (ph). Your line is open. Please go ahead.

Unidentified Analyst

[Foreign Language]

Herriet Qu

[Foreign Language]

Jennifer Zhang

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

Operator

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

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