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Hollysys Automation Technologies Ltd (NASDAQ:HOLI)
Q2 2021 Earnings Call
Mar 5, 2021, 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 Fiscal Year 2021 Second Quarter ended December 31, 2020. [Operator Instructions] And I would 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 & Corporate Communications

Hello, everyone, and thank you for joining us. Today's attendees are CEO, Mr. Colin Sung; CFO, Mr. Steven Wang; CSO, Mr. Yi Ma; COO, Mr. Yue Xu; and Mr. Lei Fang, who are in charge of IA and Rail business, respectively; and myself, IR Director of Hollysys.

On today's call, Mr. Sung will provide a general overview of our business, including some highlights for the second quarter and the first [Phonetic] half of fiscal year 2021. Mr. Steven Wang will discuss our performance from a financial perspective. And all management team 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 that are not historical facts, including statements relating to the expected rollouts of Hollysys' future product introductions, the mix of products in future periods and future operating results. Such forward-looking statements based upon its 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 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 business in which Hollysys is engaged; cessation or changes in government incentive programs; potential trade barriers affecting international expansion; fluctuation 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 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.

And now, I would like to turn the call to CEO, Mr. Colin Sung. Please go ahead, Mr. Sung.

Chit Nim (Colin) Sung -- Chief Executive Officer and Director

Thank you, Arden, and greeting to everyone. Our Industrial Automation, IA, business finished the second quarter with the revenue and new contracts at $92.9 million and $71.4 million, achieving 34.1% and 2.7% year-on-year growth. For the first half of the fiscal year, IA revenue and contract grew 30.5% and 16.8% [Phonetic] year-on-year, respectively.

In power sector, we maintained our market position. Highlights of the quarter include, won a bid for one 600-megawatt power unit DCS replacement project and the bid for two 600-megawatt power units DCS replacement project for the two high-profile clients. Both clients are switching from an overseas solution to a domestic solution for these two projects, and we expect these recent wins to be indications of further cooperation of this kind in the future. In chemical and the petrochemical sector, we continued penetrating into different verticals by winning key projects and solid execution.

In addition, we are building our extensive capacity through our R&D efforts and collaboration with external parties along the value chain. With our consistent high-quality project delivery, we are recognized as a market leader by our clients and continued to enhance our reputation within the industry. Sector highlights of the past quarter include launching our new versatile I/O solutions, specifically designed for clients in the chemical and petrochemical sector with sizable production sites.

Our solution aims to optimize the signal transmission section of the entire control solution in the field, and that will lead to increased transmission reliability as well as substantial reduction in cable consumption and the space required for equipment cabinet layout. Petrochemical clients will gain increased delivery efficiency and benefit from reduced project costs. We expect our solution to be drive -- to drive further penetration in the sector.

Won the bid for DCS and ESD, emergency shutdown devices, solution for a gas field platform project, the largest platform project for the Company to date in terms of contract value and SIS control points, demonstrating meaningful progress for Hollysys in these verticals. Signed a comprehensive control solution contract with a client on its phenolic resin project. The contract covers both basic and advanced control solution and the first time the Company has applied its solution to this specific chemical process, marking another breakthrough for the Company in these fine chemical verticals.

Successfully delivered our DCS, GDS and SIS solution for a client on its oil refining capacity expansion project. The client's production capacity is expected to increase to 10 million tons per year level, and it is the first time the client has adopted a domestic control solution for an oil refining project with this level of production capacity.

Successfully delivered an APC solution for a client on its organosilicone project. The value provided by our solution was greatly appreciated by the client. Our client has seen distinct improvement in terms of increase in equipment self-control level, decrease in input consumption both steam and electricity, and an increase in production capacity, creating a substantial economic benefit.

In aftersales services, we continued to leverage on our national service network to capture market opportunities for our existing client bases, responding to various services and replacement demands in order to safeguard their productions. Our consistent high-quality delivery continues to be well regarded. We successfully completed a DCS replacement and upgrade project for an existing client for its 5 million tons per year oil refining capacity. The project encompassed software and hardware upgrades, information security deployment, delivering improved system performance and reliability.

In the smart factory business, we continue to actively engage potential clients through our various marketing events, gaining an in-depth understanding of market demand. Hollysys continues to develop and improve its value-creating solutions, driving economic benefits and improved operational safety. Highlights of the past quarter include established a cooperative relationship with a client from chemical sector which the Company and the client aim to collaboratively promote future smart factory upgrades for other clients in the region.

Won a smart factory contract for a client from the chemical sector for its organosilicone project. The project covers a comprehensive DCS, SIS, GDS, AMS, ODS control solution as well as the construction of an integrated data platform as the foundation for further digital upgrade initiatives. Won a smart factory contract for an existing client from the power sector on its two 1,000-megawatt power units. The project will cover control-level solution such as smart control, equipment diagnostic, smart alarm and the production management level solutions.

Rail business finished the quarter with revenue and contract at $81.3 million and $99.9 million, recording 3.1% year-on-year growth and 4.2% year-on-year decrease. For the first half of the fiscal year, rail revenue and contract achieved 10.9% and 0.9% [Phonetic] year-on-year decrease, respectively. In the high-speed rail, HSR, sector, with the railroad construction progress, we continued to sign new contracts, deliver on existing projects, maintaining our position in existing product lines and exploring opportunities in the new market lines.

We have also been devoting consistent R&D resources to key technologies with the intention of expanding our solution capabilities and to drive our future performance. Highlights of the quarter include, won the bid for 50 sets out of the total package of 166 sets of ATP for C3 350-kilometer China standard high-speed train during the quarter. Completed the delivery of several projects where the Company provided on-ground solutions, such as train control center, TCC; radio block center, RBC; temporary speed restriction, TSRS; and our high-quality engineering continued to be recognized by our clients.

Some of the completed projects include Weifang-laixi high-speed rail, Taiyuan-Jiaozuo session of Zhengzhou-Taiyuan high-speed rail and Shaanxi session of the Xi'an-Yinchuan high-speed rail. Signed a regular-speed track circuit contract for the Xingguo to Quanzhou rail, Ninghua-Quanzhou session. The rail connects Jiangxi and the Fujian provinces. The contract marks another step forward for the Company in the regular-speed track circuit market.

In subway sector, the Company provided several lines to which SCADA solution was put into operation in the quarter, including Phase 3 of Shenzhen Subway line 2, Phase 1 of Shenzhen Subway line 8 and the line 2 of Hohhot Subway. Our role in those projects covered product provision, system integration, debugging and our delivery quality continued to be trusted by our clients.

In aftersales business, we continued to strengthen our local service network to expand service solution and to develop a technology and service centered services for better differentiation. In HSR sector, we continued to respond to demand, including advanced maintenance, system and software upgrade, part component sales as well as total replacement. Our service capability continued to be highly recognized by our clients.

Following the breakthrough contract of smart highway solution in the previous quarter, we continued to get actively involved in marketing events for further market opportunities. Meanwhile, as an experienced and responsible player in the railway industry, we took part in the national initiatives on industry-education integration, and we jointly established Hollysys Institution of Railway Industry with a local vocational technical institute from Nanjing City this quarter. We expect to join hands with more railway transit schools in the future. And leveraging on our market experience, we hope to continue more to the talent raising of the industry as well as deeper industry-education collaboration.

Mechanical and Electrical Solutions, M&E, business finished the quarter with the revenue and contract at $21.2 million and $22.3 million, recording 3.8% year-on-year decrease and 86.7% year-on-year increase, respectively. For the first half of the fiscal year, M&E revenue and contract achieved 11.1% year-on-year growth and a 24% year-on-year decrease. COVID-19 remain a challenge to M&E and overseas business. We will keep monitoring the impact on this sector and the risk control remain to be the key focus.

With that, I would like to turn the call to Steven Wang, our CFO, who will provide a financial result analysis. Steven?

Steven Wang -- Chief Financial Officer

Thank you. Thank you, Mr. Sung. I would like to share some financial highlights for the quarter ended December 31, 2020. Comparing to the second quarter of the prior fiscal year, the total revenues for second quarter ended December 31, 2020 increased from $170.1 million to $195.3 million, an increase of 14.8%. Integrated contract revenue increased by 9.9% to $142.5 million. Product sales revenue increased by 29.3% to $8.5 million. And service revenue increased by 31% to $44.4 million. The Company's total revenue by segment are as follows. For Q2 of fiscal year 2021, Industrial Automation revenue, $92.9 million; Rail Transportation Automation revenue, $81.3 million; Mechanical and Electrical Solution revenue, $21.2 million. Total revenue, $195.3 million.

Overall non-GAAP gross margin was 37.7% for the Q2 of fiscal year 2021 as compared to 36.3% for the same period of last year. The non-GAAP gross margin for integrated contracts, product sales and services rendered were 28%, 85.6% and 59.8% for the second quarter as compared to 28%, 66.4% and 62.6% 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 $10.3 million for the second quarter, a decrease of $0.1 million, or 1.3%, compared to $10.4 million for the second quarter of last year. Presented as a percentage of total revenues, selling expenses were 5.3% and 6.1% for the three months ended December 31, 2020, and 2019, respectively. Non-GAAP G&A expenses were $13.6 million for the second quarter, represented an increase of $3.1 million, or 28.8%, compared to $10.6 million for the same quarter of the last year. Presented as a percentage of total revenues, the non-GAAP G&A expenses were 7% and 6.2% for the quarters ended December 31, 2020, and 2019, respectively.

R&D expenses were $18.6 million for the second quarter, an increase of $4.8 million, or 34.9%, compared to $13.8 million for the same quarter of prior year. R&D expenses were 9.5% and 8.1% for the quarter ended December 31, 2020, and 2019, respectively. The VAT refunds and government subsidiaries -- subsidies, excuse me, were $3.1 million for the second quarter as compared to $6.3 million for the same period in the last year, represented a $3.2 million, or 50.4% decrease, which is primarily due to the decrease and delay of VAT refunds.

The income tax expenses and effective tax rate were $5.9 million and 15.9% for the second quarter as compared to $6.8 million and 16.7% 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 $32.2 million, or $0.53 per share based on the 60.9 million diluted share outstanding for the second quarter of 2021. This represents a 5.7% decrease over $34.2 million or $0.56 per share in the second quarter of last year. On a GAAP basis, net income attributable to Hollysys was $31.4 million, or $0.51 per share, a decrease of 7.9% over $34.1 million, or $0.56 per diluted share, in the comparable prior year period.

Contract and backlog highlights. The backlog as of December 31, 2020, was $601.3 million. The detailed breakdown of new contract and backlog as is follows. New contracts for Q2 of 2021: Industrial Automation, $71.4 million; Rail Transportation, $99.9 million; Mechanical and Electrical Solutions, $22.3 million. Backlog at December 31, 2020: Industrial Automation backlog, $234.2 million; Rail Transportation, $273.3 million; Mechanical and Electrical Solutions backlog at the end of the last quarter was [Phonetic] $93.7 million.

Cash flow highlights. For the second quarter of fiscal year 2021, total net cash inflows was $33.6 million. The net cash provided by operating activities was $33.4 million. The investing cash flow was $0.4 million and mainly consisted of 2.8 million purchase of property, plant and equipment and $35.9 million of purchase of short-term investments, which was partially offset by $39.1 million of matured short-term investments. The financing cash flow was $12.1 million and mainly consisted of $12.1 million payment of dividends.

Balance sheet highlights. The total amount of cash and cash equivalents is $356.9 million, $321.6 million and $403.9 million at December 31, 2020, September 30, 2020, and December 31, 2019, respectively. For the second quarter of fiscal year 2021, DSO was 142 days as compared to 137 days for the comparable year period and 185 days for the last quarter. The inventory turnover was 40 days as compared to 39 days for the second quarter of last year and 58 days for the last quarter.

Arden, please go ahead.

Arden Xia -- Investor Relations & Corporate Communications

At this time, we would like to open up for the QA session. Please note that for Chinese-speaking participants, we can also do the QA in Mandarin, and we'll provide translation. [Foreign Speech] Operator, please?

Questions and Answers:

Operator

Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] And your first question comes from Kevin Luo. Your line is now open. Please ask your question.

Arden Xia -- Investor Relations & Corporate Communications

Hi, Kevin.

Kevin Luo -- Morgan Stanley -- Analyst

[Foreign Speech]

Arden Xia -- Investor Relations & Corporate Communications

Okay. Thank you. The first question comes from Kevin, Morgan Stanley. And three questions. One is for the privatization and also offers. We always -- the Company always would be focused by the other group for the offer, and what about the Company's attitude and what the Company expect to see in this kind of offer.

The second one is about the revenue and gross margin. Currently, the quarter and half year, still OK, and -- but the operating expenses is growing relatively fast, especially the R&D expenses. What is the key behind, for example, like the employee number is growing? Or are there other reasons? And what about the trend for the operating expense in the next moments?

And the third question for the industrial automation sector. The revenue is growing relatively faster. But the new order, we could see a little bit slower than the revenue. And what about the trend for the new contract in the coming moment?

Chit Nim (Colin) Sung -- Chief Executive Officer and Director

Hi, Kevin. This is Colin here. So I will respond to your first question and our CFO will respond to the second question. And then the last question, I will leave to our COO to respond. So for the first question regarding this privatization offer, first of all, we only received two unsolicited offers from the same party. So we did not receive numerous offers. That's the first statement I want to make correction. And then regarding the first offer, the Board had a discussion and reviewed it.

And on the second one, basically, our Board of Directors issued a press release stating that the Board is consistent with its operational [Phonetic] duty and its consultation with our independent financial and legal advisor. [Indecipherable] is being carefully reviewed and they value the revised proposal we received. I mean, that review process still is ongoing, and we will provide more update when a determination has been made. At this current -- at this point, we have no further update nor any announcement related to this offer.

Okay. I think the second question, Steven, you may answer regarding our expenses related to R&D increase. I think Kevin also asked the question is there any additional substantial people, head count, increase related to those R&D. So go ahead, Steven.

Steven Wang -- Chief Financial Officer

Right. Okay. Look, at a quarterly basis, for the second quarter, our R&D expenses increased 35%. On first half year, we increased about 25.7%. So you can see quite an amount of increase for R&D expenses. And there are various reasons. We see the numbers of people increase. We also see the labor cost rising.

For the detailed investment of different sectors, I will leave that to Mr. Fang and Mr. Xu to give more details and color on the IA and rail industry.

Arden Xia -- Investor Relations & Corporate Communications

Sorry, by the way -- this is Arden. I also want to add some colors about the R&D aspect. And actually, we are focused on developing a lot of new technology and products currently. For the IA, for example, like the smart factory solution, new DCS platform and also new DCS base on domestic supply chain. And also in the rail sector, like the infrastructure platform for the rail smart products and also C4 signaling system, those stuff like that. So this is also the other reasons for the rising R&D expenses.

Okay, go ahead, Mr. Fang.

Lei Fang -- Co-Chief Operating Officer

[Foreign Speech]

Arden Xia -- Investor Relations & Corporate Communications

And Mr. Fang also emphasized two things within R&D. One is the next-generation DCS product and also focus on the intelligence smart manufacturing plant. And also, second one is focused on -- because domestic customers also focus on the localization of supply chain, so that's why we also develop our product based on the supply chain changing.

Yue Xu -- Co-Chief Operating Officer

[Foreign Speech]

Arden Xia -- Investor Relations & Corporate Communications

Okay. For the Rail Transportation, Mr. Xu Yue has also mentioned about, in the rail sector, we focus on several things. One is the intelligence business platform, for example, such as the product like the engine controller. And this kind of new product also launching within the city line and national line. And right now, we are [Indecipherable] more into these new products and technology.

And the other side, the focus on the high-speed rail signaling. This is the kind of combination, interlocking system combined with train control signal in the other technology together, and also develop the C4 technology. And this year, we are doing the experimental design and also the trial within the project. This is a kind of centralized investment. At this stage, we keep the pace with the China Rail Corporation. I mean our client's speed.

And the R&D expense is not like this term and will continue where we keep high investment from the rail -- high-speed rail sector because right now, it's the beginning. So we centralized to invest [Indecipherable] more. This also depends on the China Railway Corporation and customers' demand.

Yeah, the last question for the IA [Foreign Speech]

Yue Xu -- Co-Chief Operating Officer

[Foreign Speech]

Arden Xia -- Investor Relations & Corporate Communications

Okay. The Industrial Automation, the revenue compare increase, and this is normal. If we talk about the contract, right now, you could see it relatively slower. But it's because of the COVID-19 influence. Because of COVID-19, the contract process is sometimes -- the reason is this changing by -- distributed by different process. So right now, it's just -- the process is normal, but final signed contract may delay a little bit. So from the distribution to, say, the trend for the new contract is still very steady, and we could see the steady contribution in the coming moment.

Thank you, Kevin.

Kevin Luo -- Morgan Stanley -- Analyst

Thank you very much.

Operator

Thank you. [Operator Instructions] The next question is from the line of Lingxin Kong from CICC. Please ask your question.

Lingxin Kong -- CICC -- Analyst

[Foreign Speech]

Arden Xia -- Investor Relations & Corporate Communications

Okay. The question from CICC, Mr. Kong Lingxin. Three questions. One is for the business outlook. And what about the outlook for the second half fiscal year performance, especially IA and Rail? And IA, is it possible to keep the momentum, like the revenue growth, at this point? And also, the second question is in January, we had a press release about the share buyback by the management team. What's the proceed right now -- the procedure, if you could update to us. The third question is about the factory automation. In this part, Colin, CEO, said we won the orders and made progress. Can you talk a little bit more about the discrete control affected automation progress? And what kind of project and also new -- is there any new customers? Thank you.

Steven Wang -- Chief Financial Officer

[Foreign Speech] Yeah. I'll take the first question. Yeah, well, I think we're going to see healthy steady growth trend for Industrial Automation business for the coming two quarters. In other words, for the second half of fiscal year 2021, we're going to see still the same trend for our railway business -- Rail business because the longer term -- we have a longer-term cycle for the contract to be realized to be revenue. So we're going to see a slower growth for railway business. The similar trend and pattern we saw in the first half of the fiscal year.

Chit Nim (Colin) Sung -- Chief Executive Officer and Director

Yeah. On the second question regarding the management share buyback. Company implemented a corporate governance review in late last year and continuing the first -- sorry, late 2019 and continued in the first half 2020. And then one of those policy implemented is regarding the Company insider trading policy. Obviously, the announcement -- announced for the management the share buyback up to the $50 million over a six-month period. Given the close window at the time that we made the announcement, and then they were not able to purchase on the open market for the period time until today. So once the window is open in the next 24 hours, and management team will be making a purchase, which will be additional six months from the day of opening. And then if there is any progress or any update, we will -- Company will update the shareholder as well as the Street. So at the current stage, the purchase program [Indecipherable], but not any share is being purchased from the open market yet.

Lei Fang -- Co-Chief Operating Officer

[Foreign Speech]

Arden Xia -- Investor Relations & Corporate Communications

For the Industrial Automation, right now, the main contract is still coming from the existing customer based on the process control area because this part currently have very good demand. And we have a lot of customer base based on the process control. And also, I want to emphasize this kind of customer are very good customers, no matter from the margin by Hollysys or the technology maturity to say it's much easier and reasonable to launching the factory discrete control system than the single factory automation customers. So that's why right now, our focus is to tackle the factory automation combination of PA and -- process control and factory automation together and also help them to optimize the management-related demand.

Lingxin Kong -- CICC -- Analyst

Okay. Thank you. [Foreign Speech]

Arden Xia -- Investor Relations & Corporate Communications

Okay. Thank you. 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 looking forward to speaking with you again in near future. Thank you.

Steven Wang -- Chief Financial Officer

Thank you.

Chit Nim (Colin) Sung -- Chief Executive Officer and Director

Bye, bye.

Operator

[Operator Closing Remarks]

Duration: 44 minutes

Call participants:

Arden Xia -- Investor Relations & Corporate Communications

Chit Nim (Colin) Sung -- Chief Executive Officer and Director

Steven Wang -- Chief Financial Officer

Lei Fang -- Co-Chief Operating Officer

Yue Xu -- Co-Chief Operating Officer

Kevin Luo -- Morgan Stanley -- Analyst

Lingxin Kong -- CICC -- Analyst

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