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Hollysys Automation Technologies Ltd (NASDAQ:HOLI)
Q2 2020 Earnings Call
Feb 20, 2020, 8:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Hollysys Automation Technologies' Earnings Conference Call for the Second Quarter and the First Half of Fiscal Year 2020 ended December 31, 2019. [Operator Instructions] Please be advised that this conference is being recorded today, February 20, 2020, Beijing Time.

I would now like to hand the conference over to Mr. Arden Xia, the Investor Relations Director of Hollysys Automation Technologies. Thank you. Please go ahead, Mr. Xia.

Arden Xia -- Investor Relations Director

Hello, everyone, and thank you for joining us. Today, our speakers will be Mr. Baiqing Shao, CEO of Hollysys Automation Technologies; Mr. Steven Wang, CFO of Hollysys; and myself, the IR Director of Hollysys. On today's call, Mr. Shao will provide a general overview of our business, including some highlights for the second quarter of fiscal year 2020. Mr. Steven Wang will discuss our performance from a financial perspective, and we will answer questions afterwards.

Before getting started, I would like to remind everyone that this conference call may contain forward-looking statements within the meaning of 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 these statements: business conditions in China and in Southeast Asia; continued compliance with government regulations; legislation or regulatory environments; requirements or changes adversely affecting the business 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 systems 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 information discussed in this conference call or in its filings. Please note that all amounts noted in this conference call will be in US dollars, unless otherwise noted.

And now, I would like to turn the call to Mr. Baiqing Shao. Please go ahead, Mr. Shao.

Baiqing Shao -- Chairman and Chief Executive Officer

Thank you, Arden, and greetings to everyone. I would like to discuss some key events during this quarter. Industrial Automation business finished the second quarter with revenue and contract at $69.3 million and $69.5 million, achieved 40.1% and 58.2% year-to-year growth, respectively. For the first half of the fiscal year, IA revenue and contract achieved 25% and 23.6% year-to-year growth, respectively.

In coal fire sector, despite slowdown in new construction market, performance in aftersales remained healthy as we kept responding to various demands from our existing customers in face of the replacement cycle. We offered system upgrade and modification, security product and regular maintenance, etc., that addressed the currently installed solutions in part or in whole.

Our chemical and petrochemical sector continued to see healthy growth, thanks to our efforts in organization optimization, talent recruitment, marketing and relationship maintenance, etc. With our quality in the previous milestone project being recognized by the clients, we moved on to prepare for project quality assessment seminar to seek wider recognition in the industry.

To better showcase our capability, we have also constructed a demo center for high-end ethylene project. Meanwhile, we kept improving our solution for the industry through internal R&D and cooperation with external parties. In the oil and gas vertical, we won a new bidding this quarter in providing control solution to the Central Equipment Platform of the oil field for CNOOC. It was also the first time that the client has adopted domestic control solution on such production site. Going forward, with successful projects as track record and with solid technology and quality engineering as the gene of the Company, we will maintain close interaction with the client base to gradually spread the concept that Hollysys is a qualified provider for the chemical and petrochemical industry.

In smart factory sector, our boiler combustion optimization solution, a solution within our industrial software matrix tailored developed for power generating-related business, has gained wider acceptance. The solution was widely welcomed by our customers, as we have received numerous feedbacks from customers acknowledging the value of our solution in cutting production cost and improving production stability. We are continuing our internal R&D effort while also actively collaborating with external parties along the value chain to expand and improve the solution within our industrial software matrix.

Under the 3+1+N strategy, we continued the effort to integrate internal sales platform for better cross-selling. We expect such effort will put us in a better position to utilize the specialties of each member company for the offering of total solution of the Company. Meanwhile, we signed an EPC contract in December for a chemical project, in which we assumed the role as the general contractor. Such contract marked a step further toward our vision of offering comprehensive solution covering project full life cycle.

[Technical Issues] finished the second quarter with revenue and contract at 75 -- $78.8 million and $104.2 million, recorded 24.1% year growth and 39.8% year decrease, respectively. For the first half of the fiscal year, revenue and contract recorded 8.4% year-to-year growth and 48.8% year-to-year decrease, respectively.

In high-speed rail sector, we signed contracts of 40 sets of [Technical Issues] quarter. Meanwhile, we kept responding to the replacement demand of our customers. In project delivery, several new lines commenced operation this quarter, including Wuhan-Shiyan line, Zhengzhou-Xiangyang section of the Zhengzhou-Wanzhou line, Zhengzhou-Fuyang line, Qianjiang-Zhangjiajie-Changde line, Beijing-[Technical Issues] and Zhangjiakou [Technical Issues]. Solutions that we have provided to these lines include TCC, RBC, TSRS and LEU, etc.

In subway sector, we signed an SCADA contract for Kunming Subway line 5. In project delivery, we completed the Chengdu subway line 5 SCADA project and were honored with the title outstanding equipment provider. We have also fully delivered Phase 1 of Hohhot subway line 1 cloud-based SCADA project. In this project, though given limited execution time, we have showcased our consistency in quality engineering. Through optimizing system deployment and promoting better standardization in early stage, we have improved efficiency in design and product delivery, while paving the way of the earlier easier maintenance afterwards.

In subway signaling sector, we signed a contract in October to provide CBTC to a three kilometer long tramcar transportation within Kunming Changshui Airport. With a value of around RMB25 million. This is a milestone contract in which the total function of our CBTC [Technical Issues].

Going forward, our rail business will continue to adhere to the diversity strategy for stable and healthy growth and to improve our local service network for more value-adding and differentiated services. With urbanization and an ongoing process, we will keep leveraging our strong R&D capacity and prepare for the application of various types of railway transportation systems in the future.

M&E business finished the quarter with revenue and contract at $22 million and $12 million, recorded 39.7% and 67.2% year-to-year decrease, respectively. For the first half of the fiscal year, revenue and contract recorded 46.4% and 11% year-to-year decrease, respectively. Given the macro economy in Southeast Asia and the Middle East, risk control remains to be the key focus of our M&E business.

In our direct sales and overseas EPC project, progress is constantly made in terms of establishment of new cooperation with new key EPC players, as well as ongoing cooperation with existing partners. To prepare our overseas business for the new era of development, further actions were taken following the upgrade of our Singapore overseas headquarter in mid-2019. We have recently undertaken organization adjustment and appointed a new head to lead the Singapore headquarter. With those actions taken as a beginning, we expect to upgrade our overseas business with improved management, marketing, R&D capability and deeper localization, and to create better synergy between all overseas businesses.

In response to the outbreak of the novel coronavirus, the Company has taken necessary actions to minimize the risk of spread of disease and adverse effects on the Company's business operation. Since late January, we have been monitoring the health condition of our employees through ongoing online survey. Starting from early February, we have been implementing a two week long work from home scheme. Meanwhile, we have set forth general rules of action for operation in each of our bases for precautionary purpose. For particular urgent projects covering R&D, production and engineering, staff has been requested for on-site work in accordance with the rules of action.

Going further, we are planning to gradually resume on-site work with the staff density in our bases being prudently controlled. However, the potential downturn brought by and the duration of the coronavirus is difficult to assess or predict where actual effects will depend on many factors beyond our control. We are closely monitoring its impact on us. Our business, results of operations, financial conditions and prospects could be adversely affected directly, as well as to the extent that the coronavirus harms the Chinese economy in general.

With that, I'd like to turn the call to -- over to Steven Wang, who will read the financial results analysis.

Steven Wang -- Chief Financial Officer

Thank you, Mr. Shao. I'd like to share some highlights for the first half, second quarter ended September [Phonetic] 31, 2019. Comparing to the second quarter of the prior fiscal year, the total revenues for the second quarter of 2020 increased from $149.5 million to $170.1 million, representing an increase of 13.8%. Broken down by the revenue types, integrated contract revenue increased by 11.1% to $129.7 million, products sales revenue increased by 10.5% to $6.5 million, and services revenue increased by 26.2% to $33.9 million.

The Company's total revenues can be presented in segments as follows: for the three months ended December 31, 2019, Industrial Automation revenue achieved $69.3 million; Rail Transportation Automation revenue $78.8 million; Mechanical and Electrical Solution revenue $22 million.

For the six months ended December 31, 2019, Industrial Automation revenue achieved $133.9 million; Rail Transportation Automation revenue $123.4 million; Mechanical and Electrical Solution revenue $36 million.

Overall, non-GAAP gross margin was 36.3% for the second quarter as compared to 38.2% for the same period of the prior year and non-GAAP gross margin for integrated contracts, product sales and services rendered were 28%, 66.4% and 62.6% for the second quarter as compared to 30.8%, 72% and 62.9% for the same period of the prior year, respectively. The gross margin fluctuation was mainly due to the different revenue mix with different margins.

Selling expenses were $10.6 [Phonetic] million for the three months ended December 31, 2019, representing an increase of $2.5 million, or 32.2%, compared to $7.9 million for the same quarter of the [Technical Issues] mainly due to the increased sales activities. Presented as a percentage of total revenues, selling expenses were 6.1% and 5.3% for the three months ended December 31, 2019 and 2018, respectively.

Non-GAAP G&A expenses were $10.6 million for the quarter ended December 31, 2019, representing a decrease of $1 million, or 8.9%, compared to $11.6 million for the same quarter of the prior year. Non-GAAP G&A expenses were 6.2% and 7.8% for quarters ended December 31, 2019 and 2018, respectively.

R&D expenses were $13.8 million for the three months ended December 31, 2019, representing an increase of $3.4 million, or 32.7%, compared to $10.4 million for the same quarter of the prior year, mainly due to the increased research and development activities. Presented as a percentage of total revenues, R&D expenses were 8.1% and 7% for the quarter ended December 31, 2019 and 2018, respectively.

The VAT refunds and government subsidies were $6.3 million for the second quarter, as compared to $14.8 million for the same period in the prior year, representing a $8.5 million or 57.6% decrease, which was primarily due to decrease of the VAT refunds.

The income tax expenses and the effective tax rate were $6.8 million and 16.7% for the three months ended December 31, 2019, as compared to $6.3 million and 12.5% for the comparable prior year period. The effective tax rate fluctuation was mainly due to the different pre-tax income mix with different tax rates, as the Company's subsidiaries are subject to different tax rates in various jurisdictions.

The non-GAAP net income attributable to Hollysys was $34.2 million or $0.56 per diluted share for the three months ended December 31, 2019. This represents a 22.9% decrease from $44.3 million or $0.73 per share reported in the comparable prior year period.

Contracts and backlog highlights. Hollysys achieved $185.7 million of new contracts for the second quarter. The backlog as of December 31, 2019 was $587.0 million. The detailed breakdown of new contracts and backlog by segments are as follows: new contracts, Industrial Automation achieved $69.5 million; Rail Transportation $104.2 million; Mechanical and Electrical Solutions $12 million. Backlog as of December 31, 2019, Industrial Automation $192.4 million; Rail Transportation $307.3 million; Mechanical and Electrical Solutions $87.3 million.

Cash flow highlights. For the three months ended December 31, 2019, the total net cash inflow was $52.8 million. The operating cash flow was $70.5 million. The investing cash flow was $10.1 million and mainly consisted of $2.4 million purchase of property, plant and equipment and $27.2 million of time deposits placed with banks, which were partially offset by $19.4 million of matured time deposits. The net cash used in financing activities was $13.7 million and mainly consisted of $12.7 million payment of dividends.

Balance sheet highlights. The total amount of cash and cash equivalents were $403.9 million, $340 million, and $270.8 million as of December 31, 2019, September 30, 2019 and December 30, 2018, respectively.

For the second quarter of fiscal year 2020, DSO was 137 days, as compared to 157 days for the comparable prior year period and 204 days for the last quarter. Inventory turnover was 39 days, as compared to 39 days for the comparable prior year period and 56 days for the last quarter.

Arden Xia -- Investor Relations Director

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'll provide the translation. [Foreign Speech]

Operator, please.

Questions and Answers:

Operator

We will now begin the question-and-answer session. [Operator Instructions] Your first question comes from the line of Kevin Luo from Morgan Stanley. Please ask your question.

Kevin Luo -- Morgan Stanley -- Analyst

[Foreign Speech]

Arden Xia -- Investor Relations Director

[Foreign Speech]

Kevin Luo -- Morgan Stanley -- Analyst

[Foreign Speech] Okay. The first question is about the virus epidemic situation. Could you give us some hint about the second half, especially the Q3 of fiscal year 2020 performance and the guidance for the whole fiscal year affected by the virus situation? And what plan for alleviate the effects by the virus epidemic situation?

The second question is about this quarter, the second quarter, we could see the revenue compare increase, it is a very good, but -- and also the structure of the revenue is changing the high gross margin that take larger percentage like the M&E sector compare decreased. So, it should be the net income increase and also the gross margin and net margin should increase. But why it's lower -- the net income increase is lower than the revenue increase? Could you give us the trend for the coming second half of fiscal year about the margin [Technical Issues] performance?

The third question about the Industrial Automation right now [Technical Issues] market share is at an increase and what about compared last year [Technical Issues] about the market share?

The fourth question is [Technical Issues] also emphasize on the whole fiscal year trend and prediction about the revenue and net income guidance?

Baiqing Shao -- Chairman and Chief Executive Officer

[Foreign Speech] The virus epidemic situation actually impacted the business of our Company and also the whole China economy. And as what I mentioned at the first time, we -- the first time and the Company have taken necessary action to minimize the risk of spread of disease and a diverse effect on Company business operation. And also, right now, our employees have no any infection. It's just part of the employee because transfer from the outside of Beijing, so right now, under the isolator for 14 days period. And right now, our employees going to work on-site more than 40% and the next week, it's going to increase more.

And we get admission by the government in each site like Shiyan, Zhengzhou and also the other sites spread across the country, excluding Hubei, Wuhan. And also, we're doing the home work condition and to do the meetings and to do the plan for focus on the special production or a special project support. And this is on the -- like the R&D and production engineering staff has been requested for [Technical Issues] work in accordance with the rules of action. And the virus epidemic situation will depend on manufacturers beyond our control, and we are closely monitoring its impact and trying to minimize the impact.

[Foreign Speech] And the third question about the market share for the domestic DCS and before our market share between 10% to 12% but right now it is increasing. There is no statistical bureau [Phonetic] for the numbers, but we believe going to above 13% to 15%. And right now, we are still trying to increase the market share.

Steven Wang -- Chief Financial Officer

[Foreign Speech] The question is about the revenue structure is changing better but why the net income still compare a decrease? The answer is about first, the net income this quarter have two influences: one is VAT refund. This quarter just $6 million and compare to last fiscal year $14.8 million. This is just one-time not because decrease, it's because the postponed -- delayed that the money not arrived to account yet, but for the fiscal year to compare, it's going to stable like the same.

And the other -- and second element influence is the other income. Last fiscal year, we have $4.7 million in other income for the dealing with the controlled stock company. And this quarter, we have no such other income. So, if excluding these two was actually the net income should compare increase 10%. This is like the trend with the revenue increase.

And about the gross margin, also have some fluctuation, but it is still under the range of our expectation. We could see the new contract that we signed, the gross margin is still very stable and also because the competition with IA, like the market share, like the chemical, petrochemical, so we are proactively to do the gross margin competition. But still like what I said, under the control range.

And about the net margin, because expenses is growing like the sales and -- sales, marketing and also R&D, the expense is growing. The sales growing one element is at the end of the calendar year, we have one-time expense and most important is, like what I said, we are landscape for the competition about IA market share. So, what we are investment or expense, right now not reflected to the revenue yet. In future, this kind of influence is going to enlarge to support the revenue and market share. So that is to say that sales and marketing is growing. It's also under the control and also good as a percentage of the revenue growth.

And R&D expense is growing, definitely, this is our strategy because we are providing a lot of smart manufacturing products technology. So this part is growing, but still in a healthy range. So, for the future, the gross margin going to be stable as what we said that range before, but the net margin, because of the expense, a little bit growth. So it's going to be influenced. However, we want to emphasize everything right now, we are top line for the support will reflect for the future.

And the virus epidemic situation, before the virus epidemic situation, we planned the fiscal year 2020 should compare increase, both revenue and net income. However, right now because of the virus unpredictable, so it a really influenced the performance for the coming second half of fiscal year. Right now, it's hard to say, about -- how much about the revenue and net income, but we will try our best to alleviate to minimize the effects.

Arden Xia -- Investor Relations Director

Operator, next one, please.

Operator

Your next question comes from the line of Steph Yan from J.P. Morgan. Please ask your question.

Stephanie Yan -- J.P. Morgan -- Analyst

[Foreign Speech] The first question, could you breaking down the after-sale revenue percentage about the IA and Rail, respectively?

And the second question about the Rail sector, the CRC procurement. Do you have any information about the procurement top line? And also, we heard about before at the end of 2019 is going to start bidding for the 2020, but what about the right now situation?

Arden Xia -- Investor Relations Director

[Foreign Speech] The first question about the after-sale revenue breaking down for the Rail and IA, the answer is right now, we'll not provide the breaking down number for the IA and Rail. But we can tell you about the whole after-sale revenue percentage of total revenue right now is about 23%. And actual IA and Rail are above this percent, respectively. And especially the Rail right now, the momentum is the after-sale is increasing, so this percent is growing.

The second question.

Baiqing Shao -- Chairman and Chief Executive Officer

[Foreign Speech] About the procurement for CRC, and actually the last year 2019 at the end of the year, we got a CRC for bidding about 126 sets of ATP, for example, we got 40 sets like a 30% of total. And also, it should have the C2 ATP procurement. But right now because of the virus epidemic situation, it's going to postpone to the second half of the year. And also, the 2020 is the last year of 13 [Phonetic] five-year plan, it should concentrate for bidding a lot of contracts. But right now because the virus, so it's going to postpone -- most probably it is going to postpone to the second half of the calendar year.

Arden Xia -- Investor Relations Director

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

Baiqing Shao -- Chairman and Chief Executive Officer

[Foreign Speech]

Arden Xia -- Investor Relations Director

Okay. Thank you.

Baiqing Shao -- Chairman and Chief Executive Officer

[Foreign Speech]

Operator

[Operator Closing Remarks]

Duration: 48 minutes

Call participants:

Arden Xia -- Investor Relations Director

Baiqing Shao -- Chairman and Chief Executive Officer

Steven Wang -- Chief Financial Officer

Kevin Luo -- Morgan Stanley -- Analyst

Stephanie Yan -- J.P. Morgan -- Analyst

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