Baiqing Shao - CEO Herriet Qu - CFO Jennifer Zhang - IR Director

Baiding Rong - Credit Suisse Nick Zheng - JPMorgan Frank Shi - Goldman Sachs Alex Chang - Citigroup Kevin Luo - Morgan Stanley

Ladies and gentlemen, thank you for standing by, and welcome to the HollySys Automation Technologies' Fiscal Year 2015 Third Quarter Ended March 31st, 2015 Earnings Conference Call. [Operator Instructions] Please be advised that this conference is being recorded today, May 14, 2015. I would now like to hand the conference over to Mr. Leo Li [ph], the Investor Relations of HollySys Automation Technologies. Thank you. Please go ahead, Mr. Li [ph].

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 Ms. Jennifer Zhang, 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 2015. 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 in its filings. Please note that all amounts noted in this conference call will be in U.S. dollars unless otherwise noted. I'd like to turn the call over to Mr. Baiqing Shao. Please go ahead, Mr. Shao.

Thank you, Leo Li [ph], and greetings to everyone. In the third quarter, we achieved solid financial and operational result amid the weak general economic environment and made quite a few achievements and new contract wins. Here I would like to discuss some key events during this quarter: In industrial automation business, during this quarter, we continuously insisted in executing our strategies to penetrate the high-end industrial automation market and provide more complete solution. In March 2015, we signed a significant contract to provide our Distributed Control System to 2*1000 MW ultra-supercritical thermal power generating units in Datang Sanmenxia Power Plant in Henan Province. This is the fourth contract we signed in the gigawatt level thermal power industry, which demonstrate our leading technology and affirm our market position in the high-end thermal power market in China. Besides high-end thermal power market penetration, HollySys also focused on penetrating into other high-end industries such as chemical, medical, food and beverage and environmental protection related industries, and providing total solution such as software solution, safety protection and critical hardware solution. We were also focusing on building strong after-sale department and setting long-term goals on improving our after-sale services. Our total solution in reducing waste emission and environment protection proved successful. Even though in the short term we have pressure under the current weak external environment, but with our leading technology and proprietary customized solution, we have gradually recovered and performed better than the previous quarters. Going forward, we will continue to expand our sales force and allocate more resources to high-growth industries, penetrate further into high-end market while increasing market share in the low to mid-end market, expand our products supply such as software and safety protection solution, increase our overall market share and grow the business in the industrial automation leveraging our advanced technologies, experienced professionals, profound industry expertise, customization and innovation capability. In railway transportation, we signed an approximately $95 million ATP contract in January and it partially contributed to this quarter's strong rail revenue performance. We believe there are more contracts to be expected in the next few months. We are quite confident of the whole fiscal year's strong rail revenue performance. Besides, we also won two ground-based signaling contracts which are for Jinhua-Wenzhou Line and Xi'an-Chengdu Line in the recent past few months, valued at approximately $20.1 million in total, which demonstrate our strong orders taking momentum in high-speed rail market. We also worked to expand our rail products supply such as track circuit and interlocking system. We have finished one year testing of track circuit and the official admission progress and got the permit to enter track circuit market which is another sizable market. We are entering into this market and expecting to gain our first track circuit contract in calendar year 2015. For subway business, we are following both domestic and overseas opportunities in both subway SCADA and subway signaling projects. We will continue to deliver quality works and work closely with subway authorities in the future to promote our SCADA system and future subway signaling technologies both in China and abroad. With China's tremendous railway and subway construction nationwide as well as "one belt one road" policy, there is going to be an exciting prospect for HollySys both domestically and abroad. As a well-recognized rail signaling system provider, we are confident that with our strong R&D capability, leading technologies, solid execution and reliable products, HollySys will continue to penetrate into China and the world's vast rail and subway market and achieve significant results. In the mechanical and electrical solution segment, it delivered solid growth during this quarter given solid local market position, abundant customer resources and strong execution in Southeast Asia and in the Middle East. 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, we will continue to make exciting achievements in the international market in both industrial and rail transportation fields, and create value for our shareholders. With that, I'd like to turn the call over to Leo Li [ph], who will read the financial results analysis on behalf of our CFO, Ms. Herriet Qu.

Thank you, Mr. Shao. I would like to share some highlights for the third quarter of fiscal year 2015 ended March 31st, 2015. In this quarter, total revenues were $118.2 million, representing an increase of 23.4% compared to the comparable prior-year period. Non-GAAP net income was $29.6 million, an increase by 95.6% compared to the same period of last year. Non-GAAP gross margin was at 46%, compared to 36.2% from the comparable period year -- prior-year period. Non-GAAP diluted EPS were at $0.50, increased by 92.3% compared to the third quarter of last fiscal year. Comparing to the third quarter of last year, the total revenues for this quarter increased from $95.8 million to $118.2 million, representing an increase of 23.4%. Broken down by the revenue types, integrated contracts revenue increased by 19.3% to $106.4 million, product sales revenue increased by 70.7% to $9.8 million, and services revenue increased by 111.8% to $2.1 million. The Company's total revenues are as follows. Industrial automation was $41.6 million. Rail transportation automation was $56.1 million. M&E solution was $16 million. Miscellaneous was $4.5 million. Total of $118.2 million. Overall gross margin excluding non-cash amortization of acquired intangibles was 46% for this quarter, as compared to 36.2% for the same period last year. The non-GAAP gross margin for integrated contracts, product sales, and services rendered were 43.4%, 71.7% and 56% for this quarter, as compared to 34.4%, 57.5%, and 73.7% for the same period last year, respectively. The gross margin fluctuation was mainly due to the different revenue mix with different margin. The GAAP overall gross margin, which includes non-cash amortization of acquired intangibles, was 45.5% for this quarter, as compared to 35.2% for the same period of the prior year. The GAAP gross margin for integrated contracts, product sales, and service rendered were 42.8%, 71.7% and 56% for the third quarter, as compared to 33.3%, 57.5%, and 73.7% for the same period last year, respectively. Selling expenses were $5.7 million for this quarter, representing a decrease of $0.3 million or 4.4% compared to $6.0 million for the same quarter of the prior year. Presented as a percentage of total revenues, selling expenses were 4.8% and 6.2% for this quarter, and 2014, respectively. General and administrative expenses, excluding non-cash share-based compensation expenses, were $9 million for the third quarter, representing an increase of $1.6 million or 22% as compared to $7.4 million for the same period of the prior year. The increase was mainly due to an increase of $0.7 million in employee compensation expenses and $0.3 million in amortization and depreciation expenses. Presented as a percentage of total revenues, non-GAAP G&A expenses were 7.6% and 7.7% for quarters ended March 31, 2015 and 2014, respectively. The GAAP G&A expenses, which include the non-cash share-based compensation expenses, were $9.7 million and $7.8 million for the three months ended March 31, 2015 and 2014, respectively. Research and development expenses were $9.4 million for the third quarter, an increase of $1.5 million or 19.3% compared to $7.9 million for the same quarter of the prior year, mainly due to the increased R&D activities. Presented as a percentage of total revenues, R&D expenses were 7.9% and 8.2% for the quarter ended March 31, 2015 and 2014, respectively. The VAT refunds and government subsidies were $6.6 million for the third quarter, as compared to $5.2 million for the same period in the prior year, representing a $1.4 million or 27.9% increase, which primarily due to the increase of the VAT refunds for $1 million. The income tax expenses and the effective tax rate were $6.6 million and 16.9% for this quarter, as compared to $2.9 million and 21.2% for comparable prior year period. When excluding the impact of non-GAAP adjustments on the income before income taxes, the effective tax rate would have been 17.8% for the current quarter and 15.4% for the comparable prior year period. The non-GAAP net income attributable to HollySys, which excludes non-cash share-based compensation expenses, amortization of acquired intangibles and acquisition-related consideration fair value adjustments was $29.6 million or $0.50 per diluted share based on 59.2 million shares outstanding for the three months ended March 31, 2015. This represents a 95.6% increase over $15.1 million or $0.26 per share based on 58.9 million shares outstanding reported in the comparable prior-year period. On a GAAP basis, net income attributable to HollSsys was $31.6 million or $0.53 per diluted share, representing an increase 216.1% over the $10 million or $0.17 per diluted share reported in the comparable prior-year period. Hollysys' backlog for integrated contracts as of March 31, 2015 was $498.7 million, representing an increase of 15% compared to $433.7 million as of December 31, 2014, and a decrease of 17.3% compared to $602.9 million as of March 31, 2014. The detailed breakdown of the backlog for integrated contracts by segments is as follows. Industrial automation was $145.3 million. Rail transportation automation was $257.5 million. M&E solution was $95.9 million. Total was $498.7 million For this quarter, the total net cash outflow was $37.6 million. The net cash used in operating activities was $20.3 million, of which $16.5 million cash was pledged as restricted cash in a bank to secure a short-term loan. Excluding the impact of this transaction, the net cash used in operating actives would have been $3.8 million. The net cash used in investing activities was $3.2 million. The net cash used in financing activities was $11.8 million, which includes a dividend payout of $23.5 million, and repayment of long-term loan of $4.2 million, all of which was offset by the proceeds from short-term bank loans of $18.4 million. The total amount of cash and cash equivalents and time deposits with original maturities over three months were $179.7 million, $215.8 million, and $150.5 million as of March 31, 2015, December 31 and March 31, 2014, respectively. As of March 31, 2015, the Company held $151.1 million in cash and cash equivalents and $28.6 million in time deposits with original maturities over three months. For this quarter, days sales outstanding, DSO, was 228 days, as compared to 248 days from the comparable prior-year period and 206 days from last quarter. and inventory turnover was 66 days, as compared to 45 days from the comparable prior year period and 52 days from last quarter. Given our strong backlog currently on-hand, sales pipeline envisioned and operating margin expansion, we reiterate our fiscal year 2015 revenue guidance in the range of $565 million to $600 million, and revise up fiscal year 2015 non-GAAP net income guidance from $94 million to $98 million, to $100 million to $102 million. 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.

We will now begin the question-and-answer session. [Operator Instructions] Your first question comes from the line of Baiding Rong of Credit Suisse. Your line is open, please go ahead. Baiding Rong - Credit Suisse: [Chinese language spoken]

Okay. Thank you, Baiding. I'll translate the question [ph]. The question is about the high gross margin performance in the third quarter, and it's very high, and he wants to know the reason. Is it because of the ATP deliver in the third quarter or because of the IA gross margin improvement? And second question, he wants to ask about the operating cash flow performance. It seems that this quarter's performance is weak. So, could you please comment on this? And the third question is regarding the receivable performance. He asked management to give some ideas on the accounts receivable condition. And the fourth question is regarding the sales expenses. It seems the sales expenses and the percentage has decreased compared with the previous quarters. He wants to know the reason. And also the fifth question is regard [inaudible] such as the JVs and other associates' performance, and please comment as well. Thanks.

[Interpreted] For the first question, regarding gross margin, you may have noticed that in the previous quarters our gross margin has increased gradually and continuously. There are two reasons for the high gross margin performance in this quarter. Firstly, the whole Company's gross margin has already improved substantially. And the second reason is that the one-time factor. So, previously the IA takes about 40% to 50% of whole Company's revenue. Well, in this quarter, our rail [inaudible] because rail's gross margin is higher than IA's gross margin, so the two factors combined together contributed high gross margin performance. [Inaudible] gross margin for whole Company [inaudible] the first factor will [inaudible] in the next few quarters. Second question about the operating cash flow. It's not because of the weak performance of the cash flow in itself. Actually operation is very solid, very strong. The main reason is because of the dividend payments in the last quarter. In payment dividend, we used a bank overseas, and so the cash in the mainland, some portions will be applied to use as restricted cash, so that it shows that there was operating cash outflow this quarter. So that is the real reason for the operating cash flow outflow. For the sales expenses, actually the absolute value decreased but it seems the percentage increased comparatively same quarter last year. And in the sales expenses, a larger portion is come from industrial automation, while in this quarter rail revenue took a larger percentage. So that's because of structural reasons to cause the sales expenses is lower, and also the percentage is lower in this quarter.

[Interpreted] Okay. For the [inaudible] so the major factor is because of the JV, and the JV is CTEC, the joint venture with China Guangdong Group. Because we established joint venture to provide our nuclear control system [inaudible] we provide the control system and they provided the safety control system. And we had already done a lot of cost in the R&D [inaudible]. But the revenue and also the [inaudible] has not yet been fully booked into their reports in this quarter. So in short, the joint venture's performance in this quarter is a little bit weak [inaudible]. But we are expecting going to the second half of this year [inaudible] the performance will be gradually recovered. Baiding Rong - Credit Suisse: Xie-xie- Qu-zong; xie-xie Shao-zong. Xie-xie, Jennifer.

Xie-xie.

Your next question comes from the line of Nick Zheng of JPMorgan. Your line is open, please go ahead. Nick Zheng - JPMorgan: [Chinese language spoken]

Thank you, Nick. Nick has four questions. The first question is about the gross margin in this quarter, the same question asked by Baiding, the first question. Because in the previous quarters we have been shrinking the low gross margin products, for the solution supply [ph] and IA. Is that the same situation and same strategy in this quarter [inaudible] gross margins [inaudible] high? And second question is we noticed that IA revenue growth rate has been positive since this quarter. So he wants to know the reason. That is because of the, probably, of the industry, or it's because of the low base of the same quarter last year? And third question, about the [inaudible] new product in the railway transportation. And he wants to know the expected market share in the next three to five years, if the Company has a target for the market share. And fourth question is about the M&A. Is there any target in M&A and kind of activities in the sector? Thanks.

[Interpreted] Okay. We think the IA high gross margin will continue because our strategy has been established and had been [inaudible] two quarters ago. We'll continue to [inaudible] the low gross margin products and provide more high gross margin products in our total solution in IA. So we think the high gross margin of the IA will continue going into the next few quarters. So the growth of the IA has turned to the positive because of several reasons. One, frankly, we don't think the base for the IA in the same quarter of last year is low. I think [inaudible] one is because of the gradual recovery of several factors in the IA as we are [inaudible] and the second reason is because of internal effort we have made in improving the whole IA performance.

[Interpreted] So one year ago we have had the one-year testing for the track circuit. And at the end of last year we had official commission [ph] of this product. And we will work hard to achieve the same market share percentage as the other signaling products in the rail. But it may take a long time, quite a long time. Thanks. For M&A, we are continuously searching for M&A targets. Two are quite serious. One is a technology -- similar technology and the second one is like the channel in overseas. So now we are conducting some communication and discussion with some potential targets. Sorry, I cannot tell you too much about the M&A. If we have any further progress, definitely we will announce and let you know. Nick Zheng - JPMorgan: Xie-xie, Qu-zong, Shao-zong, xie-xie, Jennifer. Xie-xie.

Your next question comes from the line of Frank Shi of Goldman Sachs. Your line is open, please go ahead. Frank Shi - Goldman Sachs: [Chinese language spoken]

Thank you, Frank. Frank has two questions. One is about the new product development. And second question, he wants to know the bidding activities [inaudible] is there any projects we are participating in the bidding and contracts that are going to sign in the next few months? He wants to know the new products in the [inaudible] automation, and asks the management to comment on this business. And fourthly, for the ATP product, because the [inaudible] will there -- any impact of our ATP supply in the future? Thanks.

[Interpreted] For the new products, firstly, the track circuit we are aiming to get a contract by the end of this calendar year 2015. And secondly, for the ATO, that is for automatic train operation, we have already got our first contract in this technology. And we are expecting this product will contribute on revenue in the future in the segment. And thirdly, for [inaudible] automation, currently we are developing the packaging solution and the related products that we're expecting to get our first contract this year. Okay. Of course, the China Rail Corporation is bidding for ATP products [inaudible]. So currently we haven't seen any negative impact because of their merging together, between CNR and CSR. FS: [Chinese language spoken]

Thank you.

Xie-xie.

Your next question comes from the line of Alex Chang of Citibank. Your line is open, please go ahead. Alex Chang - Citigroup: [Chinese language spoken] So my -- I have three questions. The first one is about the bad debt provision. Because Holly reported around $5 million bad debt in the last quarter results, we haven't found any bad debt provision in this quarter. So I just wonder, is there any change on the [inaudible] or other specific reasons? The second question is about the M&E new contract. And we see there is still fluctuation on the new contract quarterly -- quarter over quarter. And I would like to have more details on any explanations on this. Is there because of the seasonality or any other reason? The third question is about IA expansion, the impact on the selling expense. Given the decline in trend of the selling expense and which is only around 5% for FY14. If Holly have more revenue contribution from IA and maybe adopt a more aggressive strategy in IA market, does that mean the selling expense ratio will increase seriously going forward? Thank you.

Xie-xie-, Alex. [Interpreted] Okay. For the M&E orders performance in this quarter. Specifically weak order taken in this quarter is temporary. And we are actually bidding for quite a few contracts in overseas. And it will be shown in the next few quarters. So I think it is temporary in this quarter.

[Chinese language spoken] Alex Chang - Citigroup: [Chinese language spoken]

[Chinese language spoken] Alex Chang - Citigroup: [Chinese language spoken]

[Chinese language spoken] Alex Chang - Citigroup: [Chinese language spoken]

In the last quarter, second quarter this fiscal year, there was about a $5 million bad debt provision increase [inaudible] same quarter of last year. Well, for this quarter, actually there's no increase of the bad debt provision. That is mainly because of the [inaudible] of the bad debt has been decreasing, and we have been -- we haven't seen any more potential risk in -- during the provision of the bad debt. So [inaudible] speaking, the performance of the account receivable has been gradually increasing because of the quality of the contracts increased.

[Chinese language spoken] Alex Chang - Citigroup: [Chinese language spoken]

This question about the selling expenses decreased because we are focusing on the effective use of the selling expenses and improving the efficiency. So we think the percentage of IA will continue to be controllable and sustainable and in a reasonable level going into the future. Alex Chang - Citigroup: Xie-xie.

Xie-xie.

Your next question comes from the line of Kevin Luo of Morgan Stanley. Your line is open, please go ahead.

Hello, Kevin. Hey, Kevin. Next question. Hello, Kevin, are you on the line? So, operator, please take the next question please.

[Operator Instructions]

Hello? Kevin Luo - Morgan Stanley: [Chinese language spoken]

Kevin, thanks for the question. The first question is regarding the high gross margin this quarter. Because overseas segment takes more than 20% of the Company, and overseas [inaudible] gross margin is only around 20%. So, excluding overseas portion, so that means that the domestic business gross margins should be higher than 50%. And also because the rail has the higher gross margin than IA, so we assume that the rail gross margin is higher than 50% [inaudible] IA and rail, is that special, it's seasonal in this quarter, or is it sustainable in the future? Thank you. And the second question is [inaudible] the signaling products we supply in the railway transportation. Also want to know, is there any potential [adaptation] of rail signaling [inaudible] requiring higher speed, and the frequency of -- beginning the train operation. So is there any possible and potential business opportunity [inaudible] is there any potential and fixed timeline of such new orders? Thanks.

[Interpreted] Each different quarter's gross margin will be caused by several factors. One is the structure of the business -- different business sectors in this quarter and also the different performance in different contracts, and even delivery and booking revenue are [inaudible]. For the different gross margin, in the different sectors, has already substantially increased, will mean that each different [inaudible] gross margin performance, such as in the IA and in the rail. So this quarter may be special, we have very high gross margin, around 46%. We don't think the 46% will last in each quarter going forward. But we are confident that the entire [ph] gross margin in the IA and also in the rail has already substantially increased.

[Chinese language spoken] Kevin Luo - Morgan Stanley: Xie-xie, Shao-zong. Xie-xie, Qu-zong.

[Chinese language spoken]

Thank you, Kevin. Answering the signaling system [inaudible] high-speed trains. Also as we have communicated with the markets [ph] before, we're also planning some low-speed train signaling system opportunities. So, and also the [inaudible] speed train signaling opportunities. For expected timeline, I think [inaudible] investors, but we will keep you posted. Thanks.

Thank you everyone [inaudible] --

[Chinese language spoken]

[Inaudible] we look forward to speaking with you again in the near future. Thank you.

And this does conclude today's conference. Thank you all for your participation.