Jennifer Zhang - IR Director Changli Wang - Chairman and Chief Executive Officer

Chapman Deng - JP Morgan Chase & Co, Research Division

Ladies and gentlemen, thank you for standing by, and welcome to the HollySys Automation Technologies Fiscal Year 2013 Fourth Quarter and Fiscal Year Ended June 30, 2013 Earnings Conference Call. [Operator Instructions] Please be advised that this conference is being recorded today, August 14, 2013. I would now like to hand the conference over to Ms. Jennifer Zhang, the Investor Relations Director of HollySys Automation Technologies. Thank you. Please go ahead, Ms. Zhang.

Hello, everyone, and thank you for joining us. Today, our speakers will be Dr. Changli Wang, CEO and Chairman of HollySys Automation Technologies; Ms. Herriet Qu, CFO of HollySys; and myself, the IR Director of HollySys. On today's call, Changli will provide a general overview of our business, including some highlights for the quarter, and Herriet will discuss our performance from financial perspective and a financial outlook for fiscal year 2014. Both Changli and Herriet 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 the future operating results. Such forward-looking statements, based upon the kind of 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; decisions or changes in government incentive programs; potential trade barriers affecting international expansion; fluctuations in customer demand; management of the revenue growth and transition 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. I'd now like to turn the call over to Dr. Changli Wang. Please go ahead, Dr. Wang.

Thank you, Jennifer, and greetings to everyone. Looking back to the past fiscal year of 2013, we were making strides under the circumstances of the slowdown of economic growth and economic restructure adjustments, which hampered our progress. In the early part of this fiscal year, industrial automation growth rate declined sharply, which knocked us that the situation was worse than we expected and could last for a relatively long period. Even though we outperformed the whole industry and other automation providers, we were not satisfied and we didn't complain. We analyzed the business environment calmly and adjusted our strategy in the time. At that time, our small and medium enterprises got affected by the weak economy most. We set the strategies to capture growth and we try to enhance our position in the high-end industrial automation market and spared no efforts to increase our market share in the mid-to-low end markets. And horizontally, they would explore all the potentials of each customer to supply entire automation and control solutions and service leveraging our complete and mature products and platforms. Meanwhile, we organized industry professional teams and appointed some new sales managers and conducted some personnel change, cut some management members' bonus and salaries, including myself to boost our will to fight. In the past fiscal year, even though difficult, we overcome the hardships and the obstacles and until this quarter, we recovered growth rates of industrial automation. And then going into the next fiscal year, we believe that the recovery of the economy and rail rate -- rail orders inflow, we would deliver much better results. Here, I would like to share some of achievements and the breakthroughs and our future development thoughts in the specific areas. Last calendar year, we released the new generation of the DCS to the market, and it stood proved to be a very competitive product in terms of comprehensive capability. Until now, it has built up successful application track records, and we won several significant projects in the high-end markets in the thermal power and chemical industries. One significant project is to provide the ProfiBus DCS for the 2 1-gigawatt ultra-supercritical thermal power generating units in Fujian Hongshan Thermal Power Plant. The DCS is designed to control more than 13,000 points, and the ProfiBus will control over 3,600 distributed devices, which is currently the largest of ProfiBus DCS project in the thermal power industry in China. Another significant contract win is in chemistry industry, which is to provide the complete suite of automation and control systems, both within Fujian Tianchen Yaolong New Material Co. Ltd. for the 2 -- for 20-ton a year caprolactam projects with more than 16,000 points, which is also the largest one in this industry in terms of the scale and complexity. We are proud of our achievements in DCS, what's more, our proprietary Safety Instrumented System named HiaGuard SIS used for the emergency shutdown and the safety protection in that industrial plants, which was released to the market at end of last year and also accumulated successful application cases, and we will accelerate the marketing process in the near future. Our HiaGuard SIS was certified according to the international standards and currently is the only domestic proprietary technology in China. We believe it will contribute more for the revenue growth by complementing our total solution providing. Since the Chinese government has issued more stringent revelations and incentive policies for every -- for energy conservation and emission reduction, one of our software systems, the Energy Management Systems, EMS, achieved exciting growth compared with last year. The related software package includes process optimization systems, Real-Time Management Information Systems, Asset Management Systems, operator training systems and et cetera, which will play a more important role in our future revenue contribution. Despite of all the exciting achievements, we have to admit that because of the slowdown of the economy, we have some businesses affected seriously. Our new developed Large Scale Comprehensive Control and Safety Surveillance System in the coal mining industry, which was successfully applied in Datong Mining Group, because the external conditions some bidding and big contracts signing were postponed. But we are confident this business will be recovered and then booming in the near future. Even though the market recovery may last for another period, we feel fortunate that we take the leading position in the thriving industrial automation industry, and because of the China's demographic change and environmental protection, there will be more and more automation and cost control application opportunities, and the China's industrial automation market potential is large enough for us to expand. Going forward, we will further penetrate and expand our business in the high-end markets to grow more share and dig deep potential and enlarge our service scope for the existing old customers. In the high-speed rail sector, it's another booming[ph] year for fiscal year 2013. The reorganization of Ministry of Rails and the personnel change took much longer time that we expected, and some rail orders was repeatedly postponed. The domestic market has plummeted more than expected. However, we still worked out our way to make sure all the contracts are signed for those we should take. Since June, we have signed 2 significant high-speed rail signaling system contract. One is the Datong-Xi'an high-speed rail line Yuanping-Xi'an section. The other is the Mudanjiang-Suifenhe high-speed rail line, with the costs valued at $14.72 million and $5.47 million, respectively. The accelerated order signing process restored public confidence. We will tightly follow and grasp the opportunity of the intercity high-speed rail line construction and take market share as much as we can. We believe our -- with our key position in China's high speed rail signaling system providing superior products performance and a well-reputed track record, we are well prepared to take our fair share in the high-speed rail signaling market in the future. In the subway sector, the development of a subway signaling system CBTC is finished and we are currently preparing to test our system with several subway construction customers. And we believe that our proprietary subway signaling system will be in a good position to be applied on the subway lines in both China and abroad. Nuclear automation and control business continues its delivering process. This quarter, our proprietary HoLLiAS-N DCS was successfully applied to Unit 1 of Ningde Nuclear Power Plant and Unit 1 of our Hongyanhe Nuclear Power Plant. Currently, China's nuclear power usage level is much lower than the world average and this China's economic demand for electricity and the pursuit of new -- of clean energy and the environment's protection, we believe, with our leading position in the industry, we will contribute -- continue to benefit from China's nuclear developments. Overseas, we're excited on the Bond Group's solid financial and operational performance and a strong order backlog, while some large contracts of Concord delayed. In the next phase, we will accelerate the overseas business expansion, ensure the healthy development of Bond and Concord's original businesses and the increase of our proprietary products and the systems providing based on their marketing resources and improve our overseas business gross margin. Our target is to have more than 1/3 of our group's revenue from overseas in the next 5 years. In addition, analysts and the investors are invited to attend our Annual Investor Day in the middle of October at our Beijing premises, which will be filled with showcasing of our whole executive team, insightful presentations from various corporate executives and a facility tour to further enhance our transparency, corporate investor relations and communication. Our shareholders who would like to participate in this annual event should contact our brokerage firms or contact with us directly to arrange a reservation. We are looking forward to meet with you in October at our premises. With that, I would like to turn the call over to Jennifer Zhang, who will read the financial results analyst -- analysis on behalf of CFO, Ms. Herriet Qu.

Thank you, Dr. Wang. [indiscernible] of HollySys Financial and Operational results for the fiscal year 2013 ended June 30, 2013, the company reported solid financial results. For the fiscal year 2013, total revenues increased by 8.5% to $349.1 million from $321.7 million of the prior year. Of the total revenues, revenue from integrated contracts increased by 7.7% to $328.6 million, as compared to $305 million of the prior year. Revenue from product sales increased by 22.5% to $20.5 million, as compared to $16.7 million for the prior year -- for the prior fiscal year. The company's total revenue by segment was as followings: industrial automation, $211.7 million; Rail Transportation, $82.3 million; mechanical and electrical solutions, $36.2 million; miscellaneous, $18.9 million. As a percentage of total revenues, overall gross margin excluding noncash amortization of acquired intangibles was 36.2% for the fiscal year 2013, as compared to 39.3% for the prior year. The gross margin for integrated contracts and the product sales, excluding noncash amortization of acquired intangibles, were 34.3% and 66.8% for the fiscal year 2013, as compared to 38% and 62.9% for the prior year, respectively. The gross margin fluctuation was mainly due to the different revenue mix with different margin. Including noncash amortization of acquired intangibles recorded on a GAAP basis, overall gross margin was 35.4% for the fiscal year 2013 as compared with 39.3% for the prior year. The gross margin for the integrated contracts and product sales including noncash amortization of acquired intangibles were 33.5% and 56.8% for the year ended June 30, 2013, as compared to 38.8% and 62.9% for the prior year respectively. For this fiscal year 2013, selling expenses were $26.8 million, representing a slightly decrease of $0.8 million, or 3.1% as compared to $27.6 million year-over-year. As a percentage of total revenue, selling expenses were 7.7% and 8.6% for fiscal year 2013 and 2012, respectively. General and administrative expenses, excluding noncash share-based compensation expense, were $28 million for the fiscal year 2013, representing an increase of $3.2 million, or 12.7%, as compared to $24.9 million year-over-year. The increase was mainly due to newly acquired company, Bond Corporation Limited and its subsidiaries. As a percentage of total revenue, G&A expenses were 8% and 7.7% for the fiscal year 2013 and 2012, respectively, including noncash share-based compensation expense recorded on a GAAP basis. G&A expenses were $29.6 million and $26 million for the fiscal year 2013 and 2012, respectively. Research and development expenses were $32.5 million for the fiscal year 2013, as compared to $25.6 million of the prior year, representing an increase of $6.9 million or 27%. The increase was mainly due to the certification cost of the safety systems. As a percentage of total revenues, R&D expenses were 9.3% and 7.9% for the year ended June 30, 2013, and 2012 respectively. The VAT refund and government subsidies amounted to $23 million for the year ended June 30, 2013, as compared to $18.3 million for the prior year, representing an increase of $4.7 million. The increase was consistent of an increase of $3.1 million in VAT refund an increase of $1.6 million in government subsidies. The income tax expenses and the effective tax rate were $8.1 million and 13.4% for the fiscal year 2013, as compared to $10.4 million and 15.5% of the prior year. During this year, Beijing HollySys,one of our subsidiaries, was certified as a Key Software Enterprise for calendar year 2011 and 2012, and applied to a preferential income tax rate of 10% retroactively from January 2011 to December 2012. The company thus recognized an income tax credit of $2.7 million during quarter -- during this year. Excluding this impact, the income tax expense and the effective tax rate were $10.8 million and 17.8% for the fiscal year 2013. For the fiscal year 2013, the non-GAAP net income attributable to HollySys, excluding noncash stock compensation expenses, amortization of acquired intangibles and acquisition-related contingent consideration fair value adjustments was $57.6 million or $1.02 per diluted share based on 56.4 million shares outstanding. This represents an increase of $0.2 million, or 0.4% over the $57.4 million, or $1.03 per-share based on 55.8 million shares outstanding, reported in the prior year period. On a GAAP basis, net income attributable to HollySys was $52 million, or $0.92 per diluted share, representing a decrease of $4.2 million or 7.5% over the $56.2 million or $1.01 per diluted share reported in the prior year period. HollySys' backlog as of June 30, 2013, was $488.7 million, representing an increase of 30.7% compared to $374 million, as of March 31, 2013, and an increase of 25.4% compared to $389.8 million as of June 30, 2012. The detailed breakdown of the backlog by segment was as followings: industrial automation, $155.5 million, rail transportation, $210 million; M&E, $94.5 million; miscellaneous, $28.7 million. The net cash used by operating activities was $9.1 million for the 3 months ended June 30, 2013, including investing and financing activities. The total net cash inflow for the quarter was $1.9 million. Of the total net cash inflows, there was cash inflow of a mature time deposit with original maturities over 3 months amounting to $7.6 million and a $4.5 million provided by Bond Group after acquisition included in the investing activities during this quarter. For fiscal year 2013, the total net cash inflow was $15.9 million, mainly consisted of $30.7 million provided by operating activities; $7.5 million proceeds from short-term loan; and $28.1 million for matured time deposits with original maturities over 3 months, offset by $19.6 million deposited in banks from current accounts to time deposits with maturities between 6 months and 1 year; $4.6 million used for repayment of short-term loans; $9.1 million used for purchase of property, plant and equipment; $12 million is for Bond acquisition; and $8.2 million used for repayment of long-term loans. The total amount of cash and cash equivalents and time deposits with original maturities over 3 months were $133.1 million, $128.9 million, and $117.9 million as of June 30, March 31, 2013 and June 30, 2012, respectively. Of the total $133.1 million as of June 30, 2013, cash and cash equivalents were $112.2 million, and time deposits with original maturities over 3 months were $20.9 million. For the 3 months ended June 30, 2013, days sales outstanding was 153 days as compared to 139 days year-over-year and 250 days quarter-over-quarter, and inventory turnover was 40 days as compared to 53 days year-over-year and 78 days quarter-over-quarter. For the year ended June 30, 2013, DSO is 180 days as compared to 145 days for the prior year. And inventory turnover is 52 days as compared to 54 days for the prior year. Given our strong backlog currently on-hand and sales pipeline envisioned so far, we set our guidance for fiscal year 2014 with revenue in the range of $460 million to $490 million, and non-GAAP net income in the range of $65 million to $69 million. Thank you. At this time, we'd like to open up for the Q&A session. [indiscernible] for Chinese, speak in [indiscernible], we can also do the Q&A in Mandarin, and we will provide a translation. [Chinese] Operator, please?

[Operator Instructions] Your first question comes from the line of Chapman Deng from JPMorgan Chapman Deng - JP Morgan Chase & Co, Research Division: This is Chapman from JPMorgan. I have 3 questions here. The first one is actually regarding your FY '14 guidance. You expected over 30% revenue growth. May I know your revenue growth outlook by segment, including IA, rail and overseas revenue? And then in Q4, I noticed that your new order for industrial automation actually recovered quite strongly. May I know which segment, I mean, which downstream segment drove the new order recovery in Q4 last year? This is the first question. The second question is regarding your cash flow. I noticed that cash flow in Q4 was actually negative. May I know what's the reason behind? And also, if I look at full year cash flow, although the operating cash flow was positive, but it's actually weaker than the same period last year. So is it because of the tight quantity in China? And how do you see the balance between qualitative risk versus revenue growth going forward? This is the second question. And lastly, may I know the revenue contribution from Bond in the last quarter as well as the net profit contribution? And may I know your guidance in FY '14 for Bond?

Okay, Chapman. For the 2014 guidance, we actually -- we analyzed their shares, as we discussed with [indiscernible] several times. And we make up this cadence based on several assumptions. First of all, we have a very strong backlog so far. And if according to our historical track records. Based on this backlog, we can generate quite a positive revenue for the year 2014. And secondly, we assume that our industrial automation market will remain, not grow faster, but we will work hard to gain market share more. So we make this guidance for IA parts not based on the growth of the market, but based on our work, our growth market share. And if the markets become -- recovers much faster than we expected, then we may do better in the future. And also, for the rail business parts, we assume the system motor and certain part of our business. But according to our understanding, the worst time of the railway business has passed. Because if you consider our history in the past several years, the railway business, high-speed rail business has been decline year-after-year. And this year, we think it has reached the bottom. And for the year 2014, it will be better than, not worse than the year 2013, and hopefully do better. And if the recovery of the construction of the high-speed rail becomes faster and then we can get much more orders, and in this case, this part of the business can do better than we expected. And for the overseas part, the -- also we can see that the worst time has passed because several big projects for Concord has been delayed and delayed. But now we have worked our new strategy to grow, no matter -- whether the -- I mean, the big projects recover or not, we will gain more opportunities. We have been studying the market very carefully and worked very hard. And also, for Bond, Bond is very healthy. It's not only has a good market, but also have a very solid backlog. So we can guarantee that part of the business. And also, we make up this new strategy to explore the overseas market. So we are going to sell more DCS, which I'm going to tell later, if anyone is interested in the international markets. So for this part, the 2014 guidance, we think, is quite reasonable. And if the Chinese economy is just -- remain slightly, a little bit better than this, we can do better, okay? And for the cash flow, for the fourth quarter is negative. In HollySys, the margin and the cash flow purely update -- emulate, I mean, sometimes up, sometimes down because of the business structure. And also, for the cash flow, it's the same. Some -- if the -- some of the projects, I mean, does turn to revenue and also some good customers pay on time, then our cash flow is good. But this year, not only this quarter, the whole year -- however, everyone knows in China, the financial market is very hard. And also, our -- the banks hold very tight on money lendering. So the customers, they are very -- also keeps very tight to pay. So this year and this 2013, has been very hard for us. Not only for us, I think for every industry and every business. So we have been trying to get a positive cash flow, but unfortunately, I mean, this quarter is really hard. But we have also made a lot of procedures and also some policies to collect our money. So in the future, we will try to improve the cash flow. And we are confident about that. And about your third question, how much Bond will contribute to our business, we have -- when we signed the acquisition contract with Bond, we have our incentive target, which was announced before. So far, we just-- based on that target to make their forecasting. Okay, Chapman?

[Operator Instructions]

Thank you, everyone, for joining us on the call today. If you have not got the chance to raise your questions, we'll be pleased to answer them to follow up contact. We look forward to speaking with you again in the near future. Thank you. [Chinese]

Thank you.

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