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Edited Transcript of HOLI earnings conference call or presentation 14-May-19 1:00am GMT

Q3 2019 Hollysys Automation Technologies Ltd Earnings Call

Beijing May 28, 2019 (Thomson StreetEvents) -- Edited Transcript of Hollysys Automation Technologies Ltd earnings conference call or presentation Tuesday, May 14, 2019 at 1:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Arden Xia

Hollysys Automation Technologies Ltd. - IR Director

* Baiqing Shao

Hollysys Automation Technologies Ltd. - Co-Founder, Chairman & CEO

* Steven Wang

Hollysys Automation Technologies Ltd. - CFO

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Conference Call Participants

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* Jacqueline Du

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Kevin Luo

Morgan Stanley, Research Division - Head of China Capital Goods & Construction Research Team and Executive Director

* Xiaoshi Zhang

Morgan Stanley, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by. And welcome to the Hollysys Automation Technologies Earnings Conference Call for Fiscal Year 2019, the Third Quarter Ended March 31, 2019. (Operator Instructions) Please be advised that this conference is being recorded today, May 14, 2019, 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.

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Arden Xia, Hollysys Automation Technologies Ltd. - IR Director [2]

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Okay. Ladies and gentlemen, welcome to conference call of Hollysys Automation Technologies. Today, our speakers will be Mr. Baiqing Shao, CEO of Hollysys Automation Technologies; Mr. Steven Wang, CFO of Hollysys Automation Technologies; 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 third quarter of fiscal year 2019. Mr. Steven Wang will discuss our performance from 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 the 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, that 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 transition 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 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 US dollars, unless otherwise noted.

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

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Baiqing Shao, Hollysys Automation Technologies Ltd. - Co-Founder, Chairman & CEO [3]

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Thank you, Arden, and greetings to everyone. I would like to discuss some key events during this quarter.

Revenue and new contract for our IA business for the quarter were $60.1 million and $84.0 million, representing a 31.6% and 2.2% year-to-year increase, respectively. For the first 9 months of the fiscal year, revenue and contract presented a 4.0% and 3.5% year-to-year increase, respectively.

Our effort in market penetration and addressing the current customers' base for the maintenance and upgrade opportunities continued.

Within high-end coal fire market, our solid performance in the past have earned our reputation. We signed a breakthrough contract to provide DCS+ DEH solution to the 660-megawatt power units of the China Huaneng Group, which is the first time that Huaneng has accepted Hollysys' control solution for its 660-megawatt power units.

We continued to address other subverticals of power including garbage power, biomass and solar thermal power. In solar thermal power, we entered into a strategic relationship with Zhongnan Engineering Corporation Limited on jointly developing the control solution for the world's first molten salt linear [Fresnel] solar thermal power station in Gansu, China.

In chemical and petrochemical, our effort in penetrating the market continued, and with the execution of our previous breakthrough project as a reference, we continued to actively promote ourselves.

We signed a contract to provide control solution to coal-to-clean industrial gas project in Jiangxi with a design capacity of 13 billion normal cubic meter per year, which is to be the world's largest project of such kind once completed. We kept addressing our valuable customer base and the momentum of aftersales service continued.

In addition to regular maintenance, our value-added industrial software that covers advanced process control, industrial information security, et cetera, are being accepted by more of our customers. Following the breakthrough in our first intelligent plant solution in the last quarter, we maintained close communication with the potential customers. Meanwhile, our intelligence-oriented solutions are earning its reputation. In February, Hollysys was named by Ministry of Industry and Information Technology of the People's Republic of China, outstanding data collection and edge computing technology provider, outstanding PaaS technology provider and outstanding SaaS technology provider.

Our HolliMachine Smart Equipment Cloud Industrial Internet APP also listed in the Outstanding Industrial Internet APP Solution published by MIIT. Furthermore, we have recently formed a strategic partnership with Arup, one of the largest global engineering consulting firms, to develop and implement world-leading intelligent solutions and expand into overseas markets together.

Quarterly revenue and new contract for our railway business were $46.8 million and $35.5 million, representing an 2.7% year (sic) [year-to-year] increasing and 6.3% year-to-year decreasing, respectively. For the first 9 months of the fiscal year, revenue and new contract recorded an 6.9% and 48.1% year-to-year increasing, respectively. With 13th Five Year Plan period entering its final 2 years and the amount of the contract signed previously, we have been busy delivering. Going forward into the future and given a visible long-term railway construction plan, we will continue to adhere to the diversity strategy for the stable and healthy growth and to improve our local service network for more value-adding and differentiated solutions -- services.

With urbanization as an ongoing process, we will keep leveraging our strong R&D capacity and prepare for the application of various types of railway transportation system in the future.

In the overseas business, M&E recorded a quarterly revenue and new contract of $18.4 million and $16.8 million, representing a 37.7% and 20.8% year-to-year decrease, respectively. For the first 9 months of the fiscal year, revenue and new contract recorded a 3.6% and 8.4% year-to-year increase, 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 IA overseas business, we continued our effort in developing partnership with the key EPC players and to create opportunity to join EPC project in its early project cycle by cooperating with the design institution. We have achieved our first cooperation with Shanghai Electric overseas as we signed a contract on a 2x300-megawatt power unit optimization project in Malaysia. Going forward, we will take gradual steps to improve the marketing and service capability of our overseas business for greater localization.

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

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Steven Wang, Hollysys Automation Technologies Ltd. - CFO [4]

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Thank you, Mr. Shao. I'd like to share some financial highlights for the third quarter ended March 31, 2019. Comparing to the third quarter of the prior fiscal year, the total revenues for the 3 months ended March 31, 2019, increased from $120.6 million to $125.2 million, representing an increase of 3.8%. Broken down by the revenue types: integrated contracts revenue decreased by 3.3% to $101.3 million, product sales revenue increased by 33.1% to $13.2 million and services revenue increased by 79.1% to $10.7 million.

The company's total revenues can also be presented in segments as follows: for the third quarter of fiscal year of 2019, industrial automation revenue achieved $60.1 million; rail transportation automation revenue, $46.8 million; mechanical and electrical solution revenue, $18.3 million; total revenue, $125.2 million.

Overall non-GAAP gross margin was 39.6% for the third quarter of 2019 as compared to 36.5% for the same period of the prior year. The non-GAAP gross margin for integrated contracts, product sales and services rendered were 30.2%, 85.6% and 71.9% for the third quarter of 2019 as compared to 30.1%, 81.2% and 73.6% for the same period of prior year, respectively. The gross margin fluctuation was mainly due to the different revenue mix with different margins.

Selling expenses were $6.5 million for the third quarter of 2019, representing an increase of $0.3 million or 4.3% compared to $6.2 million for the same quarter of the prior year. Selling expenses were 5.2% and 5.1% for the 3 months ended March 31, 2019 and 2018, respectively.

Non-GAAP G&A expenses, excluding noncash share-based compensation expenses, were $8.7 million for the third quarter of 2019, representing an increase of $1 million or 12.9% compared to $7.7 million for the same quarter of the prior year. Non-GAAP G&A expenses were 7% and 6.4% for the quarters ended at March 31, 2019 and 2018, respectively.

R&D expenses were $8.7 million for the third quarter of 2019, representing a decrease of $0.1 million or 1.2% compared to $8.8 million for the same quarter of the prior year. R&D expenses were 6.9% and 7.3% for the quarter ended March 31, 2019 and 2018, respectively.

The VAT refunds and government subsidies were $4.6 million for the third quarter of 2019 as compared to $3.9 million for the same period in the prior year, representing a $0.7 million or 17.1% increase, which was primarily due to the increase of the VAT refunds.

The income tax expenses and the effective tax rate were $4.9 million and 15% for the third quarter of 2019 as compared to $4.6 million and 17.2% for the comparable prior year period. The effective tax rate fluctuation was mainly due to the different pretax income mix with different tax rates as company's subsidiaries are subject to different tax rates in various jurisdictions.

The non-GAAP net income attributable to Hollysys was $28.1 million or $0.46 per diluted share based on 61.3 million outstanding diluted shares for the 3 months ended March 31, 2019. This represents a 27.1% increase over $22.1 million or $0.36 per share in a comparable prior year period. On a GAAP basis, net income attributable to Hollysys was $28 million or $0.46 per diluted share representing an increase of 28% over $21.8 million or $0.36 per diluted share reported in the comparable prior year period.

Contracts and backlog highlights. Hollysys achieved $136.2 million of new contracts for the third quarter of 2019. The backlog as of March 31, 2019 was $599.2 million. The detailed breakdown of the new contracts and backlog by segments are as follows: new contracts for the third quarter of 2019, industrial automation, $84 million; rail transportation, $35.5 million, mechanical and electrical solutions, $16.8 million. Backlog of 31st -- March 31, 2019, industrial automation backlog, $182.6 million; rail transportation, $322.1 million; mechanical and electrical solutions, $94.5 million.

Cash flow highlights. For the third quarter of 2019, the total net cash outflow was $15.3 million. The net operating cash flow was $25.2 million. The net investing cash flow was $45.3 million, mainly consisted of $93.8 million time deposits placed with banks and $4.2 million purchases of property, plant and equipment, which was partially offset by $52.7 million maturity of time deposits. The net financing cash flow was $0.2 million, mainly consisted of $1.9 million repayments of short-term bank loans, which were partially offset by $1.7 million proceeds from short-term bank loans.

Balance sheet highlights. The total amount of cash and cash equivalents were $253.4 million, $270.8 million and $238 million as of March 31, 2019, December 31, 2018 and March 31, 2018, respectively. For the third quarter of 2019, DSO was 193 days as compared to 196 days for the comparable prior year period and 157 days for the last quarter. And inventory turnover was 50 days as compared to 63 days for the comparable prior year period and 30 days for the last quarter -- excuse me, 39 days for the last quarter.

Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions)

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Xiaoshi Zhang, Morgan Stanley, Research Division - Equity Analyst [2]

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(foreign language)

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Operator [3]

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There are no questions at this time. Please continue speakers. Wait, yes, we've got questions, just came in. And our first question comes from the line of Thomas Zhang from Morgan Stanley.

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Xiaoshi Zhang, Morgan Stanley, Research Division - Equity Analyst [4]

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(foreign language)

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Arden Xia, Hollysys Automation Technologies Ltd. - IR Director [5]

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[Interpreted] Okay. The first question is related to the industrial automation, and we got a common factor from the bottom and state-owned enterprises and about this 660 megawatts power station. What about the discount factor, total amount of the bidding? And second, also about their execution time period or recognized revenue period of this contract?

The second question for the industrial automation. Right now, we could see the backlog is increasing and also we could see the good news from the Ministry of Industry and Information Technology of central government granting you several awards and qualifications. And this is a combination of a large industrial automation. So could you talk a little bit about the factory automation area compared with the whole IA, what are new contracts or the backlog, those kind of information?

The third one, question about VAT refund and government subsidy. Could you help us to separate about the VAT refund and government subsidy? And what about -- government subsidy is focused on the research and development area and also what kind of direction for the R&D activity?

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Baiqing Shao, Hollysys Automation Technologies Ltd. - Co-Founder, Chairman & CEO [6]

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(foreign language)

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Arden Xia, Hollysys Automation Technologies Ltd. - IR Director [7]

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[Interpreted] And the first question is related to the Huaneng contract. This is our first time to sign contract that is related to the 660 megawatts power station with Huaneng, a state-owned enterprise. And also the contract size issued at around RMB 10 million and recognized revenue followed by percent of the completion normally have a different period like the down prepayment and the delivery and finish the whole project and warrant. So generally speaking, the recognized revenue will be in 1 -- 12 to 18 months.

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Baiqing Shao, Hollysys Automation Technologies Ltd. - Co-Founder, Chairman & CEO [8]

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(foreign language)

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Arden Xia, Hollysys Automation Technologies Ltd. - IR Director [9]

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[Interpreted] Okay. The second question about the industrial automation. And right now, the Hollysys group have more than 40 service centers and spread across the whole country. And each center also takes over the ability to provide the comprehensive solution, including the process control and Factory automation products technology. And right now, this strategy also brings the good result. The revenue is -- keeps increasing. And through our working, we also satisfied by the central government of MIIT, and we got reward from the SaaS, the PaaS. And this also can demonstrate that Hollysys can provide very comprehensive solutions based on the process control and digital control. And we also will provide more solutions to the state-owned enterprises that's currently emphasized on proprietary technology, the house-owned IP and also information security-related business. So we have confidence to continue to keep this part making progress.

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Xiaoshi Zhang, Morgan Stanley, Research Division - Equity Analyst [10]

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(foreign language)

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Baiqing Shao, Hollysys Automation Technologies Ltd. - Co-Founder, Chairman & CEO [11]

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(foreign language)

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Xiaoshi Zhang, Morgan Stanley, Research Division - Equity Analyst [12]

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(foreign language)

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Baiqing Shao, Hollysys Automation Technologies Ltd. - Co-Founder, Chairman & CEO [13]

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(foreign language)

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Arden Xia, Hollysys Automation Technologies Ltd. - IR Director [14]

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[Interpreted] Okay. Let me translate. And right now, we -- the question is about, have you ever communicated with any state-owned enterprises currently based on -- because you recently got award from the MIIT like the PaaS, the SaaS. So have you ever already communicated (inaudible) or agreement or make some deal with state-owned enterprises that they admit to use your products or technology? The answer is about, right now, we really negotiated with several tens of the state-owned enterprises and based on the industrial Internet. And they want to do the upgrading from automation to the digitalization. And also, we provided comprehensive intellectual solutions to help them to achieve their goals. And we want to emphasize, Hollysys will play a better role from the application aspect, it help them to make the progress due to upgrading. And for the question about the industrial -- the technology is based on -- or solutions based on the subverticals or a specific area, actually, our -- the answer is, actually, our technology and platform and comprehensive solutions is emphasized on general purposes. And it can manage to solve the problem about those companies, enterprises, the common problems. So the state-owned enterprises, right now, the up-level want to do the upgrading, but also reading the specific area, we can downsize to focus on our workshop or a specific area of process to help them to do the digitalization, the intellectual manufacturing, those kind of stuff.

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Baiqing Shao, Hollysys Automation Technologies Ltd. - Co-Founder, Chairman & CEO [15]

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(foreign language)

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Steven Wang, Hollysys Automation Technologies Ltd. - CFO [16]

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(foreign language)

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Arden Xia, Hollysys Automation Technologies Ltd. - IR Director [17]

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Okay. About the third question...

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Xiaoshi Zhang, Morgan Stanley, Research Division - Equity Analyst [18]

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(foreign language)

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Baiqing Shao, Hollysys Automation Technologies Ltd. - Co-Founder, Chairman & CEO [19]

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(foreign language)

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Arden Xia, Hollysys Automation Technologies Ltd. - IR Director [20]

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[Interpreted] The question is about the VAT refund and government subsidy increase. And actually, this quarter compared increase USD 0.67 million and the first 9 months increase about $2.5 million, may come from the VAT refund. This is a onetime issue because recently the value-adding tax rate policy is changing. So we got a lot of receipt and the invoice, the billing for invoice, so to bring the onetime increase for the VAT refund.

But for the whole fiscal year, if you see, it's still very steady about the total amount. And also the first question is, also, want to confirm about the onetime. And yes, this is a onetime that come from the policy change.

Okay. Operator, next one, please.

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Operator [21]

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And our next question comes from the line of Kevin Luo from Morgan Stanley.

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Kevin Luo, Morgan Stanley, Research Division - Head of China Capital Goods & Construction Research Team and Executive Director [22]

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(foreign language)

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Arden Xia, Hollysys Automation Technologies Ltd. - IR Director [23]

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[Interpreted] the question documents about the railway transportation segment. The ATP -- what is, about now, the ATP market share? And also could you help us to later predict about 2019? We know about that you have ATP contract on hand within the backlog, but what about the recent quarters about the delivery of the ATP? What about the ATP delivered numbers?

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Steven Wang, Hollysys Automation Technologies Ltd. - CFO [24]

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(foreign language)

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Kevin Luo, Morgan Stanley, Research Division - Head of China Capital Goods & Construction Research Team and Executive Director [25]

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(foreign language)

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Steven Wang, Hollysys Automation Technologies Ltd. - CFO [26]

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(foreign language)

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Baiqing Shao, Hollysys Automation Technologies Ltd. - Co-Founder, Chairman & CEO [27]

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(foreign language)

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Arden Xia, Hollysys Automation Technologies Ltd. - IR Director [28]

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[Interpreted] About the market share, based on yearly, we could achieve 1/3 of the market share. And the second related to the delivery, and actually, Mr. Shao also introduced the bidding for normally and the CRC, the (inaudible) started centralized bidding in the second half of the calendar year. That is to say our fiscal year, first half year, you could see the strong bidding new contracts, but from the ATP -- may come from the ATP. But the second half of fiscal year, right now, we -- the bidding may focus from the TCC. And right now, it's hard to say about when will start with new ATP bidding, but normally should in the second half of this calendar year. And about delivery, it also depends on the CRC's procedure. And we won a lot in the first half at the end of December of last fiscal -- of last calendar year, but we will deliver within 1 year. So it's hard to give you a number about each month. It really depends on the CRC side requirements. Thank you.

Operator, next one.

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Operator [29]

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And our next question comes from the line of Jacqueline Du from Goldman Sachs.

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Jacqueline Du, Goldman Sachs Group Inc., Research Division - Equity Analyst [30]

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(foreign language)

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Arden Xia, Hollysys Automation Technologies Ltd. - IR Director [31]

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[Interpreted] Okay. And the first question about IA orders. Could you help us to -- we know about -- you have not provided sub breaking down for the IA for this industry. But could you give us landscape about the coal fires, chemical, petrochemical, metallurgy, building materials, those kind of trends or the perspective about the coming days?

And the second question about IA rail, the maintenance, upgrading potential order, the proportion, and also, the rail sector beyond the ATP, TCC, what about the other product of technology providing a new contract, like the track circuit? The third one about -- we know about you just did a 200 million public offering to issue the new shares, and right now, we saw. However, I want to ask about do you have any update for the new investment directions or potential M&A targets to tap more about this information?

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Baiqing Shao, Hollysys Automation Technologies Ltd. - Co-Founder, Chairman & CEO [32]

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(foreign language)

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Arden Xia, Hollysys Automation Technologies Ltd. - IR Director [33]

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[Interpreted] the first question about the IA. We'll not keep breaking down specific number, but roughly around 40% of the IA come from the power and 40% IA come from chemical and petrochemical and the rest of 20% belongs to others. And this is also including the single-digit nuclear area and this part of the gross margin are high by the way. And therefore, the coming trend, it is still the same roughly at this proportion. And the second about the maintenance, upgrading and I want to emphasize the after-sale revenue is increasing, you could calculate from that. And because we provide safety-level control system, so the -- originally customer would glad to use the original provider. So this is especially, the example, like the rail, the high-level repairment or the replacement, they will find the original provider. So this part is increasing and at a sustainable recurrent revenue for the long term.

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Baiqing Shao, Hollysys Automation Technologies Ltd. - Co-Founder, Chairman & CEO [34]

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(foreign language)

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Arden Xia, Hollysys Automation Technologies Ltd. - IR Director [35]

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[Interpreted] Related to the M&A and our procurance is: first, technology; second, the sales channel; the third one, the business synergy. And right now, we are still under discussions, so we will update the information if we have progress.

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Jacqueline Du, Goldman Sachs Group Inc., Research Division - Equity Analyst [36]

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(foreign language)

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Baiqing Shao, Hollysys Automation Technologies Ltd. - Co-Founder, Chairman & CEO [37]

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(foreign language)

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Steven Wang, Hollysys Automation Technologies Ltd. - CFO [38]

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(foreign language)

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Baiqing Shao, Hollysys Automation Technologies Ltd. - Co-Founder, Chairman & CEO [39]

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(foreign language)

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Arden Xia, Hollysys Automation Technologies Ltd. - IR Director [40]

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[Interpreted] And Jacqueline clarifying her questions about the first one. I want to emphasize on the trend, which subvertical is increasing very fast? And actually, from our side, the coming years should be -- come from the chemical, petrochemical. And the second is -- clarifying question is about the after-sale revenue proportion. Could you give us the separate number about IA rail? And the answer is, right now, we'll not give -- disclose separate number, but I can tell you the whole after-sale portion of whole revenue, right now, achieved roughly around 19%. And this is compared to last fiscal year 2018 to 13.7%.

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Jacqueline Du, Goldman Sachs Group Inc., Research Division - Equity Analyst [41]

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(foreign language)

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Baiqing Shao, Hollysys Automation Technologies Ltd. - Co-Founder, Chairman & CEO [42]

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(foreign language)

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Arden Xia, Hollysys Automation Technologies Ltd. - IR Director [43]

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[Interpreted] the question is related to, beyond the TCC ATP, what about the others, like the track circuit. Right now, the track circuit is still under the rail testing line, and it will be finished at the end of this year, and we can start bidding from the next year. So that will come from the revenue contribution.

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

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Baiqing Shao, Hollysys Automation Technologies Ltd. - Co-Founder, Chairman & CEO [44]

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Thanks, everyone.

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Steven Wang, Hollysys Automation Technologies Ltd. - CFO [45]

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Thank you.

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Operator [46]

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And that does conclude the conference for today. Thank you for participating. You may all disconnect.