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Buyer Consortium Comments on Recent Financial and Operational Information Released by Hollysys Automation Technologies

On May 13, 2021, Hollysys Automation Technologies Ltd. (NASDAQ: HOLI) (the “Company”) disclosed financial condition and results of operations for the quarter and the nine-month period ended March 31, 2021, together with its review and analysis of the comparable periods for fiscal year 2020. The Company intended to “highlight” selected financial metrics by making comparisons to the low base numbers for the first three months of 2020, when the Company’s performance was severely and negatively affected by COVID-19, and sought to convince the public that the Company is on the right track under the current management. But a close look at these data, in particular by comparing them to 2019 pre-pandemic results, reveals significantly deteriorating financial and operational conditions of the Company since the sudden removal of previous management in July 2020.

Negative Net Operating Cash Flow Highlights Financial Struggle of Core Business Activities

Net operating cash flow for the quarter ended March 31, 2021 was negative $6.4 million, the first negative quarterly operating cash flow in the last 16 consecutive quarters. The result is particularly troubling given that the Company was able to produce a positive net operating cash flow of $8 million for the same period in 2020, even when the effect of COVID-19 pandemic was most severe and abrupt. The downward trend in operating cash flow is stark, decreasing from a positive $33.4 million from the previous quarter ended December 31, 2020 to a negative $6.4 million for the current quarter, and decreasing from $117.5 million for the first three quarters of fiscal year 2020 to $48.6 million (almost 60% decline) for the same period ended March 31, 2021.

This rapid and substantial deterioration in net operating cash flow reflects the Company’s poor contract quality and fulfillment capabilities, and its ineffective management of accounts receivable and payable. The Company’s fast declining cash-generating abilities in the past three quarters, while the overall China economy has been emerging from the COVID-19 pandemic with strong growth, suggests that the Company is facing fundamental issues in its operations and will likely encounter long-term struggle with its core business activities.

Decline in Revenue and Profitability Compared to Pre-Pandemic Level Suggests that the Company Is Losing Its Edge in High-Margin Segment

Revenue for the quarter ended March 31, 2021 was $109.9 million, representing a 12% decrease from $125.2 million for the comparable pre-pandemic period in 2019. Gross margins for the quarter and nine-month period ended March 31, 2021 were 37.5% and 36.4% respectively, representing a decrease from 39.6% and 38.3% for the same periods in 2019. The decline in revenue and profitability was primarily attributable to Company’s inability to grow its Rail Transportation business, a key high-margin segment that had traditionally given the Company a competitive edge over its competitors.

Poor Cost Control Results in Significantly Reduced Net Income from Pre-Pandemic Levels

Selling, G&A and R&D expenses for the nine-month period ended March 31, 2021 all increased significantly compared to the same period in 2019, and as a result, total operating expenses increased by $27.05 million (approximately 48% increase) compared to 2019. Total operating expenses for the quarter ended March 31, 2021 increased by 8.6% while revenue for that quarter decreased by 12%, in each case compared to the same period in 2019.

The disproportionate increase in expenses manifests the Company’s inability to control costs, which is vital to the Company’s success. As a result of the Company’s poor cost control, among other factors, its net income in the quarter and the nine-month period ended March 31, 2021 dropped significantly by 44% and 33%, respectively, compared to the same periods in 2019.

Significant Decline in High Margin Business Segment Foreshadows Lower Overall Profitability and Tougher Competition

Although total new contracts signed in the third quarter of fiscal year 2021 totaled $142 million, representing a slight increase of $5.75 million, or 4.2%, over the same period in 2019, primarily due to increases in the Industrial Automation segment, new contracts in the Rail Transportation segment totaled only $15.7 million, representing a 56% decline from $35.47 million in the same period in 2019.

As noted above, Rail Transportation is a more profitable segment. According to S&P Capital IQ, the gross margin for Rail Transportation for the fiscal year 2020 was 47%, compared to 36% for Industrial Automation. Consequently, even if top line growth in Industrial Automation may partially offset a deteriorating Rail Transportation performance, the declining Rail Transportation business has resulted in, and will continue to result in, a lower overall profit margin for the Company. In addition, it is unclear whether the current growth in Industrial Automation is sustainable because the electric power industry, a key contributor to the Company’s Industrial Automation business, is experiencing a downturn and facing limited growth prospects as China rolls out its carbon neutral policies, so it remains to be seen whether the Industrial Automation segment can bring in sustainable and robust sales, profits and cash flow. At the same time, the Company’s Rail Transportation segment is shrinking significantly, accounting for only 27.9% of the Company’s total revenue in the third quarter of fiscal year 2021, a decrease of 9.5% from 37.4% for the same period in 2019. Due to the nature of the Rail Transportation business, it will be very difficult for the Company to reclaim lost ground in market share unless the Company adjusts its operation priorities and devotes significant resources to revamp its Rail Transportation segment.

J.P. Morgan Analysts’ Report Maintains Business Forecast and Price Target of $15 Per Share

On May 14, 2021, J.P. Morgan released its analysts’ report and maintained its forecast of the Company’s stock price of $15 per share, despite certain short-term financial metrics the Company attempted to “highlight”.

Statement of the Consortium

The Company’s closing price on May 25, 2021 was $13.38, significantly lower than the $17.10 offer price provided in the proposal (the “Proposal”) by the buyer consortium consisting of Mr. Shao Baiqing, Ace Lead Profits Limited and CPE Funds Management Limited (the “Consortium”). The Consortium believes that the Company’s operations and financial conditions will further weaken because existing management and the board of directors do not know how to run the Company successfully.

The Company’s struggling operations, the general negative sentiment towards U.S.-listed Chinese companies and the associated risk of forced delisting, the very low trading volume of the Company shares, and the highly attractive offer price are some of the many compelling reasons why the board should immediately engage with the Consortium and convene a shareholder meeting for the shareholders to consider and vote on the Proposal. The board should also take all necessary corporate action to render the shareholder rights plan inapplicable to the Proposal as the Proposal offers all shareholders, other than the Consortium, with a compelling premium in a fair and equal manner and is not the type of takeover that the rights plan intends to prevent. Short of those actions, the board would find themselves at great risk of further violating their fiduciary duties to the shareholders. With the Company’s condition worsening quarter by quarter, the board is presented with ever increasing urgency to act on the Proposal immediately.


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