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Harbin Electric, Inc. (HRBN)

Roth Capital Conference

February 20, 2007 1:30 pm ET

Executives

Barry Raeburn - EVP of Finance and Corporate Development

Presentation

Barry Raeburn

Thank you. Thanks for coming to the presentation today. I think this presentation is also being webcast. So, I would like to thank the members on the Internet that are watching us now or might watch us on the recorded version.

I want to introduce you today to Harbin Electric, but first, let me introduce myself. My name is Barry Raeburn. I work in the US office of Harbin Electric, that runs the day-to-day operations for the US presence that we have and we are building outside of Harbin, China, which is where we operate 100% of the limited company.

I am joined here at the conference today by two of our team members, who have come over from Harbin. They currently reside in Philadelphia. Mr. Chan Ching Chuen is here with us and [Ms. Shimen Kai] are here in the audience, spread around. They have come over on their visas to help us build out the operation. So, we do have a full force on the ground in the US. We aren't just an IR presence here, to smile and make funny faces at you.

We are a company who are building an internationally competitive leader in industrial motor marketplace. As Dan pointed out, we make linear motors, the base supply. Our current revenue right now is in our technological expertise of linear motors. We also sell special motors, and we'll get into that.

Consider yourself in the realm of the Safe Harbor.

Welcome to Harbin Electric. We are China's leading industrial motor technology company. I am not going to get into a lot of the basics of the industrial motor marketplace in China or in the world. It is suffice to say, motors are a massive market globally. There are a lot of applications in a lot of different industry sub-segments and we are going to address them one-by-one as our technical expertise allow us.

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China Direct (ticker: CHND.OB) is a diversified management and consulting company. Our mission is to create a platform to empower medium sized Chinese entities to effectively compete in the global economy. As your direct link to China, our organization serves as a vehicle to allow investors to participate directly in the rapid growth of the Chinese economy.

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Harbin, if you don't know, is in the northeastern China. It's a very large city, with 9.5 million person population or more. It is a Special Economic Zone where we do enjoy a tax holiday. The company utilizes leading edge proprietary technology to manufacture linear motors and do have patents for these linear motors. These are patents offered by the China Patent Office.

We are the only domestic company in China with patented manufacturing technology for linear motors. We'll get into some applications of linear motors and some of the benefits down the slides.

We've recently upgraded from the Bulletin Board to the NASDAQ, ticker symbol HRBN. Our market value is about $210 million, with trailing 12-month EPS of $0.83 through the third quarter. We have not yet reported our fiscal fourth quarter numbers.

Investment highlights for Harbin. We are a pure play on China's industrial growth. The majority of our sales are in China to Chinese end users. We have a high margin manufacturing model. Gross margin is in the north of 45%, and has been sustained there. Operating margin is north of 33% and that's been sustained there as well.

We enjoy the low-cost producer status by leveraging the supply chain in the low-cost labor and all of the other factors of manufacturing in China that you all know well.

The capabilities that the company has, addresses multi-billion dollar markets and we will be expanding capacity in different segments. We will look like a very different company at the end of this year than we are now. I am going to show you slide-by-slide of how exactly we plan to do that.

We will be expanding our capacity to support our future growth initiatives in these new segments. We're going to grow our export sales to Fortune 500 customers. The main recognition in our reportable customer base will satisfy some of the people in the room. We enjoy favorable Chinese Government policy. We have an experience, what I like to quantify in a qualitative sense, of a western-oriented senior management team from Harbin.

This is one of the reasons why I am here today with people from Harbin, China and with a footprint on the ground in the US. I think that is one illustration of their western orientation, and I can illustrate more of that as we go through the presentation today.

The company enjoys a multi-faceted growth strategy. The primary goal is to continue invest in our R&D for the linear motor technology but also invest in technology for other spatiality motor areas. We are developing and supplying linear motors to railway projects. We are addressing custom motors for interior automobile applications such as folding third row seats and sliding doors.

We are expanding our activity in the oil field services, pumps and land rig business. In fact, we've recently received two new patents in that field in China for a vertical pumping system, which is very different than [horizontal] pumping system that you used to see in current land pumps. We'll get into that a little later as well. There is a lot to talk about today.

We're expanding our capacity in the micro motor markets for automotive by building a factory in Shanghai. That factory should be completed and capacitized initially by the third quarter of this year.

We'll continue to expand our customer base and range of customized linear motor products and applications in China. I failed to point out to this point; all of our products are custom products. We don’t have a catalog of products, where a customer comes to us and says, we'll take three of those, four of these and two of those. We've customized this manufacturing to scale for the customer per application. That's how we are able to enjoy significantly higher gross margins, and have some visibility in the model.

You will see decretive acquisitions with the potential to broaden our customer base and product capabilities, and continue again to develop the strategic relationships with our Fortune 500 companies.

A lot of our growth initiatives can be read in some other detail in our recent $50 million fund raising, which was closed on 31st. There is an 8-K on file with the SEC that discloses a lot of these growth initiatives that are currently in place.

What are our competitive advantages? Low-cost manufacturing and proprietary technology for the motor market is where we have a significant advantage. I think everyone understands the tag 'made in China' for the low-cost labor expertise. But Harbin, China enjoys a labor pool of technical specialists that are trained in the industrial arena specific to electrical motors. That's an under-known fact that allows us to source highly qualified technical personnel as we continue to grow the company.

Our low R&D costs; we have the lowest cost supply chain for our motor inputs. It gives us about a 50% to 70% cost advantage on a custom product over the global competition, not the catalogs products.

I mentioned our three patents. The most easy to understand of the three patents is the one that goes into the plane goods transmission line, which is really a linear motor-driven conveyer.

Continuing the competitive advantages, our company has been able to build key relationships over the last five years with the Institute of Electrical Engineering at the Chinese Academy of Sciences. In fact, we are jointly developing R&D to build the first linear motor-driven train with linear motors produced in China and our partner is the IEECAS on that. And Zhejiang University as well as Sheffield University in UK and the University of Hong Kong are also all the areas of expertise that we look out for R&D.

The government is currently focused on fostering domestic industry, especially in the areas that are focused on higher levels of technology input. We are the only domestic manufacturer in China with our own patented linear motor technology. It's an advance motor that saves a lot of cost and a lot of energy. And as there are applications for energy efficiency savings put into place over the next five years, we believe this is a great opportunity for our company's technology.

We also enjoy a tax holiday and the government is likely to continue to approve linear motor projects in the future for a railway build-out.

We have some of the examples of our product applications. Right now, we are in Generator sets. We build a small motor that links the generator set, when you have a power outage, our motor is what turns it off to go into generation and turns it back on when the power comes on. That's with the Fortune 500 customer.

Postal Sorting Machine has been our biggest customer today. Our second biggest customer has been in the industrial machine for oil pumps. And as I mentioned, our new patented oil pump will be produced and sold throughout the remainder of this year and was tested at the Daqing Oilfield. That's currently one of our largest customers.

You see a few other smaller applications at the bottom for a conveyor and the Food Slicer application is an application close to the heart of our R&D team and CEO. It's something that was invented in Harbin, for those of you that follow the restaurant and food industry, has recently won awards for Product of the Year and Design of the Year. And we will see more about that product in the future.

Where are we moving to? Urban Transit Systems, as I mentioned, we are working with the IEECAS and capacitizing our factory to build-out Ford linear motor-driven trains. The specialty auto market is an area we will expand significantly in this year, and the micro motors and armatures as well. We will go in to that specialty motor market.

Just to go back a second, you can see that's a folding third row seat application right there. That's one of our primary initial opportunities outside of China.

Our current customers through the third quarter; GuiYang is the China postal sort integration company for the linear motors for the conveyor systems for the upgrade of the China postal systems sorting machines. And you can also see here, to the left in yellow, the Daqing Oilfield, a customer that we didn't have at the end of '05 that grew quiet quickly through '06.

So, where are the linear motors used? In fact, Design News reported that they are being used in a much wider array of sub-industries in the last few years. It used to be that their precision factors and their cost limited them to the semiconductor manufacturing industry and other specific applications. That's broadened out. Now the packaging industry and the machine tools industry are adopting these tools. It allows them to have a smaller form factor and lower maintenance characteristics.

Those are the advantages of the linear motor versus rotary motor which is the primary consumption of anything that's driven by a motor. A linear motor has fewer moving parts. It uses the principles of electromagnetism rather than chains and gears and linkages to turn rotating force into linear force. It can produce linear force against its secondary part of the motor without having those linkages.

The bottom line here is reduced contact between the moving surfaces, reduced wear and tear and maintenance is a big factor for any OEM designer of packaging material.

The company's quarterly sales growth trends; I would like to highlight here that they have been pretty consistent in their growth. They have a step functioning nature. Because we've been a custom manufacturer, the design cycle tends to be a little longer and when we bring on new customers, those customers tend to immediately contribute to the top line. We are closing a few long sales cycles in a few different segments at this time. We hope to enjoy the continued sales growth into the future.

I mentioned earlier, our gross margin trends are healthy and stable, above 46%.

We have a healthy balance sheet, largely because the company continues to generate cash, 33% operating margins and 48% gross margins. This allows us to continue to generate cash. We recently raised $50 million to help springboard our growth in the initiatives that we are talking about here today.

Long-term business model target here is to have the gross margin remain in the mid to high 40s, operating expenses at 12% and EBITDA margins in the low to mid 30s. Our tax holiday through 2007 will cap us zero tax for 2007. Our tax rate will cap at a maximum of 15, because of the Special Economic Zone characteristics. But because we are expanding into other areas like Shanghai, the blended tax rate is likely to be lower for a few years to come.

So, I have been mentioning all of the strategic growth initiatives that we are going to do to put it in place. The first one is capacity additions into new markets and new product areas, which basically stems from our focus on R&D. We will expand the capacity in to micro motor market for the automotive business. In the automotive business we will supply two things; we will supply seat adjusters, folding third-row seats, that is one thing and the other is, we have a patent on electronic power steering in China. That product is in prototyping and test phase right now. We hope to see that continue its prototyping throughout the year and continue to gain traction with that product.

These products will be produced in the Shanghai facility, which is currently under construction, and will be completed sometime in the third quarter of this year.

We're expanding capacity in railway motor and systems production, which is the traditional Linear Motor driven subway, beginning our R&D in the Maglev area. We'll expand our custom linear motor capabilities to continue to develop a product set for current base of customers. We will expand our activity in the oilfield Services, as I illustrated on the slide. And we'll enter the high efficiency rotary motor market in China, likely by acquisitions to expand our product base.

In specialty motor market for autos, I've already talked about most of this. The controllers for interior automotive applications, we think it's a huge market in China alone. We've also been able to win some mindshare outside of China, with some major OEMs that we're currently working with in the United States. We're currently going through tests and prototype phases with them.

We will be building our factory with high margin manufacturing for scale. We'll have over $30 million in initial revenue at this facility. We have brought in some technical experts that have run plants in Korea and Japan. They will take over this plant and design it and run it for us from the design phase through the initial production phases as we begin to win customers. As I mentioned a numerous times, the factory will be operational by early Q3 of this year.

Our joint development with the China Academy of Sciences; I do urge you folks who are interested in knowing more about this to read our 8-K filed in late August. It has a detailed table of the deliveries that I'm going to go through right here, of exactly what we're working on, how we're working on and when are we supposed to deliver on these different goals. But the main goal is to develop China's first homemade linear motor driven train with an industrial base of capacity to supply the subway build out in China. It's going to be a market; we are not going to be alone in this market.

We've already completed phase one of the three phased process with the IEECAS. Theoretical analysis and design work of the key input technologies has been completed and we have moved on to the next step. Over the next six months, what we currently have in Harbin are prototype motors. They are very big, they are probably the size of half of one of these tables, and they are probably twice as wide as these tables that we are sitting at.

Those prototype motors will be tested in our factory. Those prototype motors will be assembled into a car and that car will be put onto the track. That's the final phase; the system integration and test and appraisal of an actual car on an actual track.

Before I get to these two slides, I am going to jump ahead. This is the track that we are going to put on, the Beijing Airport line, from the Beijing Capital Airport to Dongzhimen, we'll have a car on that track some time at the end of this year or first quarter of next year. That will be our test to prove that this technology can be developed and produced by Chinese manufacturers.

It is a huge market. Some of you may have already studied this market. The long-term construction plan is a central government priority. The projecting investments are over $100 billion. That's going to be split between both freight and passenger. These subway lines that are planned for construction are in excess of 2000 kilometers and the focus is on cities of greater than 1 million in population, of which there are currently more than 40. That slide is a bit old, there is more than that.

We know it's the largest mass transport market in the world, and giving an illustration on this slide here, is the difference between the future needs and the existing supply of railcars for the passenger marketplace. We estimate that there is going to be a need for 5000 cars by the year 2020, which would translate to an addressable market size in excess of $5 billion.

Our strong management team; we have got this far in the presentation without mentioning our Founder, President and CEO. He spearheads all of the excitement in the business that both come out and what you see in the presentation and exhibits from myself hopefully today. He is our Founder and chief visionary. He has a technical degree from Zhejiang University, which is basically where we have been able to get a stronghold in our domestic investment in China.

Our CFO has 12 years of experience in the financial industry, and was formally a CFO of another electrical company in China. We have round-out the slide with our other management team members.

In summary here, we are a pure play on China's industrial growth. We are moving into three different segments with a high margin manufacturing model. We enjoy low cost producer status for a variety of reasons, while focusing on high quality R&D and custom products. Our capabilities address multibillion dollar markets.

We are expanding our capacity in different areas. We are growing our export sales to higher profile customers than the customer slide that we looked at earlier. We enjoy favorable government policy and our management team continues to deliver good results, and has a focused mission and has a plan to make sure this company continues to grow for the foreseeable future in a sustainable manner.

Thank you for your interest. The floor is open for questions.

Question-and-Answer Session

Unidentified Audience Member

[Question Inaudible].

Barry Raeburn

Well, Bud, we haven't given any guidance. The company's policy to this point has been to stay clear of giving guidance.

Unidentified Audience Member

[Question Inaudible].

Barry Raeburn

I appreciate the question, thank you, Bud. The company has followed, what I think is a sequence that other companies will adopt in the future of understanding what it takes to quietly deliver results. Build your company to the point where you have a sense of credibility in the marketplace, and we'll get to the point when we do give guidance in the future. But with all of these initiatives that we're currently putting in place in front of us, its very difficult to come to a true hard and fast decision on exactly when that's going to be.

Moderator

Okay. There are no questions. Thank you, Barry. Thank you everyone. We have a breakfast session right next door. Thank you.

TRANSCRIPT SPONSOR

China Direct Logo

China Direct (ticker: CHND.OB) is a diversified management and consulting company. Our mission is to create a platform to empower medium sized Chinese entities to effectively compete in the global economy. As your direct link to China, our organization serves as a vehicle to allow investors to participate directly in the rapid growth of the Chinese economy.

Read all investor conference presentation transcripts here.

To sponsor an investor conference presentation transcript please contact us.

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