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Harbin Electric Inc. (NASDAQ:HRBN)

Q2 2008 Earnings Call

August 11, 2008 8:30 am ET

Executive

Christy Y. Shue - Executive Vice President of Finance and Investor Relations

Yang Tianfu - Chairman and Chief Executive Officer

Xu Zedong - Chief Financial Officer

Analyst

Ping Luo - Global Hunter Securities

Robert Susman - Bentley

James Stone - PSK Advisors

Operator

Welcome to Harbin Electric second quarter 2008 earnings conference call. (Operator Instructions) 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

Today I am joined by our Chairman and Chief Executive Officer, Yang Tianfu and the Chief Financial Officer, Xu Zedong, from China. We filled our second quarter 10-Q last Friday. This morning we issued a press release to highlight our financial performance and the business updates for the quarter. 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 the uncertainties outlined in our quarterly report and also listed at the end of our earnings press release. For today’s call first of all I will give you a summary of our second quarter key financial results, after that Mr. Yang will give you a quick business updates. We will then leave the remaining time for Q&A session when Mr. Yang and the CFO Mr. Xu are also available to answer your questions.

For this quarter our total revenues increased by 71% year-over-year to nearly $24 million from only $14 million last year, largely attributable to the sales of new products including automotive specialty micro-motors and the tower-type, linear Motor given oil pumps. The micro-motors business contributed approximately $9 million for the quarter.

Gross profit margin declined by about four percentage points compared to the same quarter last year, mainly due to relatively lower gross margin in the automotive micro-motors business that we began in the second half of last year. For comparison, the gross margin for automotive micro-motors business is running at about 40%, while for the linear motor business it is at an average of 50% currently.

Operating income increased by nearly $2.7 million reflecting of 48% growth year-over-year. Operating margin declined by about six percentage points primarily driven by two factors. Firstly again due to change of product mix with the introduction of micro-motors business that has relatively lower gross margin. Another factor is that we generally have higher administrative expenses this year than last year due to higher level of sales and marketing activities, higher compensation and higher expenses related to the company’s listing on NASDAQ.

Additional labor was some one time expenses incurred this quarter related to the activities of our equity offering and acquisition of Weihai Hengda. Those were the percentage of total sales. The SG&A expenses was 2.5% higher and about 12.7% compared to only 10.8% last year. We expect that total SG&A expenses as a percentage of sales to be in the range of 10% to 12% on average going forward.

We grew net income by about $1.7 million, a 37% year-over-year growth despite nearly $1 million provision for income tax as the company began to pay income tax on January 1 this year. Our net profit margin is up 26% for the quarter. We believe it is considered the high net margin in the industrial growth sector. Net earnings per diluted share grew $0.31 from $0.24. For the financial results during the first six months periods I’d like to refer you to our quarterly report filed the last Friday and the press release issued today.

Now let me turn the call to Mr. Yang for our business updates.

Yang Tianfu [Interpreted]

First of all, let me welcome everyone to attend our second quarter earnings conference call and also I would like to thank everyone for your interest in the company. Right now, let me give you a brief update on several projects that investors are paying close attention to.

First of all at the end of the second quarter we have successfully completed the financing of nearly USD $49 million through our private placements. This enabled our company to be able to acquire Hengda, Weihai Electric Motor Company. The completion of this acquisition allowed our company to own right now three core product lines, which includes the Linear Motors and the integrated systems. The second one is the specialty micro-motors for automobile applications and a third one from Hengda is the industrial Rotary Motors.

After we closed the acquisition at the beginning of July, we have gone through nearly one-month integration. I believe after this one-month integration, the Hengda is being smoothly transitioned to our company. Currently our main focus Hengda is to insure Hengda smoothly completes the contracts for this year. The current contracts will allow company, to allow Hengda to grow revenues and the profits by 30% on the basis of 2007.

The next important step, the task before us at Hengda is to gradually upgrade the technology, optimize the product portfolio, upgrade the product grades and allow the company to have capabilities to be in the top of the international level with their product quality and their technology of the International Standards.

This plan is a more long-term plan to improve Hengda. We have already organized a team led by the Chief Technology Officer of the company Mr. Okawa to conduct a solid of the manufacturing processes and technology of Hengda, diagnose the opportunities and make your recommendations and established a plan to improve the manufacturing efficiency of Hengda. So for now, the most important task for us is to ensure Hengda has all the necessary resources and the support to complete the current contract on hand and ensure a new transition to our company.

Next let me give you a brief update on our Shanghai Tech, the construction of the new facility and the status. There is a good news that I would like to tell everyone; that is the main beauty, the main trends at Shanghai has been completed and has been handed to show us and also the core production equipment we ordered from Japan have already arrived at the facility.

As currently planned, the entire plan will be completed by October 15 and turned over to us. Therefore it was scheduled to move our people into this new facility on October 15; gradually everyone will be moving and all the departments will start to test the equipments and start the trial run.

Well, our plan is a bit delayed due to the continuous one month rain in Shanghai; because the one month continuous rain in Shanghai kind of delayed the construction of this plant; however all of our people at Shanghai are working very hard and to meet our commitments to our customer.

Our major North American customer Magna International required us to have the capability of at least 1 million units available ready by December of this Shanghai new facility where we’ll make every effort to pursue our commitments to the customer. As of now, we have successfully developed the three automobile micro-products for Magna and these products have already been passed and validated by our customer and according to the plan and our agreements with the customer all these products will be produced at the Shanghai plant and we are confident to that we’ll be able to fulfill our commitment to the customer.

When we worked on the project with Magna, we estimated based on the information provided by the customer and some marketing research. We estimated that the market potential for the next four years just for these three products we developed should reach a total of USD $500 million.

I’m very pleased to say that for our company the demand for products is so strong. Even before we completed the construction of the plants we have customers orders weighted in the pipeline for us to push out to finish the construction. This is rare in the industry that even before you have capabilities you have order already on hands. So, I’m very pleased to tell the investors that it’s very good news for the company.

For the project of the oil pump that we order for Daqing Oil Fields, we are on track. In the first quarter, we completed the 39 units and during the second quarter, we completed the 80 units. So for the first half of the year, we have already completed the 119 units. Based on this progress, we believe, we estimate that the 200 units we have for this year should be able fulfill very smoothly.

Now, let me give you a brief update on the linear motor driven subway train system that we have been working on. I believe that everybody already probably know that the subway line between Beijing airports and to the city Dongzhimen station has already started operation before the Beijing Olympics. Obviously, to ensure the security and everything’s going smoothly in Beijing Olympic, the government chooses to use the imported train.

Before the Olympic of the top officer in China, the Presidents HU Jintao, has already taken the subway line and actually have complemented that the new linear motor technology. I believe this is a clear indication and clear validation by the government for the linear motor technology and its application to the urban mass transportation system. I believe after Beijing Olympics, China’s own linear motor driven subway train will receive more attention and we expect we’ll have a new progress on this project.

On the other side that we have completed the parts of our work to develop the linear motor driven system we have sent our sample prototype and we have tested our prototype at our facility and we are also expecting and waiting for the new progress to continue. All the other business parts, our company have also been going smoothly of not being affected by the other factors.

We can start the Q-and-A session now.

Question-and-Answer session

Operator

(Operator Instructions) Your first question comes from Ping Luo - Global Hunter.

Ping Luo - Global Hunter Securities

The first question is regarding your automotive micro-motor business I understand that you sold $80 million in the first half and I want to know what’s the kind of break-down between your domestic sales and international sales? From what I saw to your in the 2Q 1filing, it looks like your domestic sale has a higher margin than the international sales, which is what’s [Inaudible], so I want to see the break down in terms and also, in 2008 what did that kind of break downs look like? Yes, I’m just wondering for the automotive micro-motors, what kind of break down and also going forward is it mainly for ex court or for domestic sales.

Yang Tianfu [Interpreted]

Currently our micro-motor business break down between the international and the domestic about half and half. I’m expecting next year the international part will go up, possibly two-thirds of the micro-motors business.

Ping Luo - Global Hunter Securities

Can we have approximately how many units you are going to sell for this automotive micro-motor in 2009?

Yang Tianfu [Interpreted]

First of all, let me answer part of this question and we have provided the guidance for 2009 but in 2009 we expect the capacity utilization at Shanghai would reached 40% and given that our total capacity of Shanghai is 10 million units so again at that speed that would be 4 million units at Shanghai and then our condor level at (inaudible) being and so that should that add up to, yeah to be that level.

Ping Luo - Global Hunter Securities

And it’s just a follow up question on that automotive micro-motor business. I understand and no matter from domestic market and from international markets and the OEM actually cutting price, I want to know whether that also is putting any pricing pressure on your automotive micro-motor product and then what’s the current unit price for that automotive micro-motor product?

Yang Tianfu [Interpreted]

The product that we have developed for our customers in the automobile micro motor business, they are all new products that have never been on the car yet. Although the automobile market has some ups ad downs, however all the automakers in an effort to improve the market to attract the customers and the thing that they are doing, the trend that is in the market is to improve the automation, improve the intelligent, the level of intelligent of the car so that we can offer more functions to our customers.

So that is the trend that is happening in the automobile industry, just to improve the intelligent automation of the car and this is the new trend so therefore our products happens to be the core hearts in this new trend, the new application, in the new industry. Therefore when we developed the products for the customers, worked together with the customer, we held the leverage on determining the price. We have insisting on that point. So far we have not experienced any issue over the price of our products.

Ping Luo - Global Hunter Securities

In terms of your senior notes, I know in the second quarter you paid down too many senior notes. I would like to know in the second half of the year and next year what’s your schedule in terms of paying down that debt.

Yang Tianfu [Interpreted]

In terms of the senior note we started to pay down for the one that matures 2010; some are annually and $2 million each six months. So, in the second quarter we paid the $2 million and in the September, does the second PA that will pay another $2 million ad for the future years I would ask you to refer to our 10-Q filing and all the schedules are acutely described. So I’m not going to spend much time going though all the details on the payment schedule.

Operator

Your next question comes from Robert Susman - Bentley.

Robert Susman - Bentley

My question is when you talk about a $400 million market for the micro motors for autos for four years, do you mean $100 million per year or $400 million per year beginning in tow or three or four years out.

Christy Shue

Let me clarify that part of the information. When we say the market potential we said $500 million over the four year. That means on average its $125 million per year on average; it does not necessarily happen evenly ever year, but in total that’s our estimate.

Robert Susman - Bentley

You provided no guidance; can you give us an idea how you see in general the second half of the year verses the first half of the year?

Christy Shue

It is our company policy that we do not provide guidance over the earnings for the future.

Operator

Your next question comes from James Stone - PSK Advisors

James Stone - PSK Advisors

I wonder if you could tell us a little bit more about what’s happening in the base business, the original linear motor business. If I look at the first half of ’08 versus the first half of ’09 and subtract out the oil pumps, it looks like that base business has been declining. Is my arithmetic correct and if so could you tell us what’s happening there.

Christy Shue

I think you are referring to the comparison of ’08 versus ’07 right, just want to clarify you said ’09.

James Stone - PSK Advisors

Correct I meant ’08 versus ’09.

Yang Tianfu [Interpreted]

First of all I would like to just clarify and emphases that all of our linear motor products are customized, designed specifically for a particularly application and one particular product, because it’s not a standardized commodity product, so you can’t use it universally. So, that’s the thing that we need to transition here.

Once we develop one product it has a market and the market is there but its not like a standard product that we can sell universally and expand unlimited, so there is a limitation on the market potential and in terms of our calling to customer, from looking at their orders for the overall year orders, they are not declining. The variation is spaced because month-to-month the spending order changes a little bit from month-to-month, but overall for the whole year we have not seen these declining from our existing old customers that we have already developed the products for; so I need to remind everyone the need to pay attention that the liner motor is a customized and not a standardized product.

For that reason, our company also needs to develop new products every year and to enter into new application, new markets and get new customer. For example this year we have developed another logistic system, supply chain system they used in supermarkets for the U.S, the customer mark and its still undergoing and we expect that the fastest progress will allow this product to enter into the market possibly next quarter.

So every year we have many products under development and we hope to develop a new product to get into a new application. That is the way to actually increase our existing linear mode of business market potential.

James Stone - PSK Advisors

But what I’m trying to understand is, is this a business that you’re basically leaving twisting in the wind or is it something you had obviously grew very fast in the early years of the company and its growth has definitely slowed. So, is this a business that you’re going to be aggressive in expanding or is it a business that is just going to sit there and twist.

Christy Shue

I think what you need to pay attention is of course the same product; for example, the logistic system; when we entered the market we had the Chinese post office as our major customer. For that particular product there is a certain market in China, however we pushed that product, also developing new products, a new application, although it’s in the same line of products, but then for specific application you need to do some new developments. So it’s the new developments. I’m not sure how you saying twist and we are outgrowing our linear motor business and by outgrowing new products, getting new customers, that is the way to expand in that part of the business.

Operator

You have a follow-up question from Robert Sussman - Bentley.

Robert Sussman - Bentley

One question on the oil field business; you indicated that you did a 119 units in the first half and are on track to do 200 for the year which remained fewer in the second half than the first half. Is there demand for more than just 81 in the second half so that you would do 81 versus 119 or could you do more than the 200 this year?

Yang Tianfu [Interpreted]

The 200 units is the supplier agreement that we have on hand. After these 200 units we believe that there could be potential for more and the issue is we have a capacity ton supply of 500 units, that’s not a problem. So, our issue right now is not our capacity, but we need to expand into new customers or have the existing customers buy more products.

Robert Sussman - Bentley

On the new automotive linear business Magna, should we expect that business to be a better 40% gross margin?

Yang Tianfu [Interpreted]

Because we have modular products for Magna and the gross profit margin are different for each different products; some of them are higher than 40, some of them maybe around 35% where hopefully when we get to the production we will give you a average; we can provide you information on the average profit margin on this particular business. Now we have by segment all the automobile micro motive put in together, our gross margin is on average at 40%.

Robert Sussman - Bentley

On the subway business, when could that be a meaningful contributor to the company’s revenues. Would it be 2009, 2010; how far out is that?

Yang Tianfu [Interpreted]

Our expectation based on what we know on this project, just to give you a brief summary is the [Chempton] motor Vehicle company is the one that produces the whole chain. Our company has already completed the linear motor service system and if you come to our plant facility you can see that every day we are running that prototype car on our track, on the track that we built in our facilities. So, we are doing, adjusting, modification and trying to improve it during all this process.

Based on what we know, the Chempton Motor Vehicles, their trend is putting everything together from the start, getting to production next year 2009, early next year, but obviously you have to make the body first so once they make the body, we supply the linear motor, part of the driven system in part. So, we expect that in the second half of the year, we could start supplying the linear motor driven part for the vehicle in putting all the trains together.

Operator

You have a follow up question from James Stone - PSK Advisors.

James Stone - PSK Advisors

Could you give us an update on what the status of the acquisition is of the Rotary Motor Company?

Christy Shue

We have completed the acquisition in early July; July 14 and Rotary Motor has already been transitioned into the company. Earlier at the conference call we updated that our focus right now, the company focus is to ensure that the company completes a supply agreement for this year that they already have which should help them to grow their revenues and earnings 30% over 2007. The next step is to improve the manufacturing efficiency by bringing new technologies and optimizing product portfolio and moving up with the product rates.

Operator

There are no further questions.

Yang Tianfu [Interpreted]

For the remaining six, two quarters of the year I am confident that all our employees at Harbin Electric will work very hard and we have many, many tasks that lie ahead of us and give us a very tight schedule for all the plans and strategies that we have laid out and to execute those plans. Now the good news is we have specific goals for every quarter and all our employees are very much motivated to reach the objectives that we have set. So I am confident that by next quarter the employees in the company will deliver another strong quarter.

Thank you very much for coming to our earnings conference call and if you have a follow up for the questions, please feel free to give me a call. My number in the US is 631-312-8612 and I’m available for today and Tuesday. Thank you very much.

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Source: Harbin Electric, Inc. Q2 2008 Earnings Call Transcript
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