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Executives

Kevin Theiss

Weng Ming Hoh - President and Director

Kok Ho Leong - Chief Financial Officer

Lai Tak Chuen

Analysts

Alexander E. Potter - Piper Jaffray Companies, Research Division

China Yuchai International Limited (CYD) Q3 2013 Earnings Call November 11, 2013 8:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the China Yuchai International Limited Third Quarter 2013 Earnings Conference Call. [Operator Instructions] I would now like to hand the conference over to Mr. Kevin Theiss. Thank you, sir. Please go ahead.

Kevin Theiss

Thank you for joining us today and welcome to China Yuchai International Limited's Third Quarter and 9 Months Ended September 30, 2013 Conference Call and Webcast. My name is Kevin Theiss, and I'm with Grayling, China Yuchai's U.S. Investor Relations adviser. Joining us today are Mr. Weng Ming Hoh and Mr. Kok Ho Leong, President and Chief Financial Officer of CYI, respectively. In addition, Mr. Kelvin Lai, VP of Operations of CYI is also joining us today.

Before we begin, I will remind all listeners that throughout this call we may make statements that may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words believe, expect, anticipate, project, targets, optimistic, intend, aim, will or similar expressions are intended to identify forward-looking statements. All statements other than statements of historical fact are statements that may be deemed forward-looking statements. These forward-looking statements are based on current expectations or beliefs, including, but not limited to, statements concerning the company's operations, financial performance and condition. The company cautions that these statements by their nature involve risks and uncertainties and actual results may differ materially depending on a variety of important factors, including those discussed in the company's reports filed with the Securities and Exchange Commission from time to time. The company specifically disclaims any obligation to maintain or update the forward-looking information whether of the nature contained in this release or otherwise in the future.

Mr. Hoh will provide a brief overview and summary, and then Mr. Leong will review the financial results for the third quarter and first 9 months ended September 30, 2013. Thereafter, we will conduct a question-and-answer session.

For the purposes of today's call, the financial results are unaudited and they will be presented in RMB and U.S. dollars. All the financial information presented is reported using International Financial Reporting Standards as issued by the International Accounting Standards Board.

Mr. Hoh, please start your presentation.

Weng Ming Hoh

Thank you, Kevin. We are excited to report that we achieved the highest revenue in any third quarter in the company's history. Net revenue for the third quarter 2013 increased 21.6% to RMB 3.7 billion or USD 608.7 million from RMB 3.1 billion in the third quarter of 2012. Our gross margin was maintained at 20.9% for the third quarter, which was a result of higher sales volume.

According to data from the China Association of Automobile Manufacturers, overall commercial vehicle sales in the third quarter of 2013 rose by 9.3% and were led by 13.2% increase in heavy-duty truck sales. Truck sales benefited primarily from the continued prebuying of trucks in the third quarter of 2013 and inventory restocking to meet future demands. We continue to increase our leading market position as our diesel unit sales rose by 21.5% year-on-year, exceeding industry growth.

We are optimistic over the long-term growth prospects in the heavy-duty truck segment, and we believe that our strategy to expand our production capacity and develop new engines to improve our market position in the heavy-duty truck market provides us with a growth opportunity for the future.

While the National IV emissions standard were implemented nationwide on July 1, 2013, we have been producing engine compliant with National IV and V emissions standards much earlier. By selling advanced engines meeting the new, more stringent emission standards before our competitors, we are able to capture market share with our first-to-market strategy and raise technology bar compared with our smaller rivals. Our robust research and development program is designed to make us an innovative leader in China to accommodate the changing technology growth requirements of our customers. Innovation is critical to position the company for future growth and market leadership.

We are developing new higher horsepower engines for power generation, marine, mining and other industrial applications in order to reach new customer and further capture market share in these markets. One of our focus is on the marine market due to growing demand for recreational boats and leisure craft. We have been successful in penetrating this market with our line of low-speed, medium-speed and high-speed marine engines. In the third quarter of 2013, we announced the release of our latest high-speed engine model, YC4S, YC4G, YC6A, YC5L (sic) [YC6L], YC6MK, YC6MJ and YC6D for both steering, [indiscernible] and light. To complement our traditional diesel engine portfolio, a complete line of natural gas engines have been introduced as it provides economical and environmental advantages to our customers.

In the first 9 months of 2013, sales of our natural gas engines continued to grow and approximately 21,000 natural gas engines have been sold, representing a substantial increase compared with the same period last year when approximately 13,000 engines were sold. Our natural gas engines, which are compliant with National IV emissions standard, is a key factor for our dominant position in China's spot market.

Our new efficient development specifically located in within the High Tech Development Zone of Nanning, the capital of Guangxi province, and which commenced operation this October 2013 [indiscernible] will be a new catalyst for further innovation. Additionally, our joint venture with key partners add to our technology base through new engine design and advanced industrial knowledge. For example, our joint ventures of advanced YC6K 6 cylinder 12 liter series of engines recently received the European Union's E-Mark Certification due to the new technology in this design. As our technology base grows, so does our ability to quickly anticipate change and design engine for the future

Let me now touch upon the recent developments that occurred in the third quarter. We remain committed to becoming one of China's leading heavy-duty engine manufacturers. The market for heavy-duty engines have accelerated over the past 2 quarters, which provides us with a number of long-term opportunities. Our YC6K engine is the basis of a number of new diesel and natural gas engines we offer with strong performance, low emissions and improved fuel efficiency.

The YC6K design engines are part of our family of heavy-duty engines, including the 6L, 6M, 6J and our enhanced 6MK heavy-duty engine. During the third quarter of 2013, Dalian Public Transport Group Tourism Branch used our engines in 80% of its fleet of approximately 80 buses. The YC6M and YC6MK engines are now preferred engines for use due to their superior power and fuel efficiency.

Our main operating subsidiary, GYMCL and GYMCL's joint venture entity, Y&C Engine Co., Ltd., entered into a full-way joint venture with Baotou Beifang Chuangye Co., a company listed on the Shanghai Stock Exchange, and Baotou Bei Ben Heavy Duty Truck Co. The new joint venture will produce advanced diesel and gas engines to meet the need for powerful [ph] vehicles heavy-duty and medium duty truck and buses. GYMCL and Y&C Power will hold, together hold, 50% of the joint venture. We are excited over the prospect of this new venture as it allows us another avenue to extend our heavy-duty engines' capability and increase market share in this lucrative segment.

In the first 9 months of 2013 ended 30th September, we maintained our market leadership as we sold 390,000 engines, a 15.3% increase over the same period in 2012. With a more diverse range of advanced engines and new production capacity being added, we are targeting to capture additional market share in the on-road and off-road market in China. I'm pleased to update that we sold 41,000 engines in the month of October this year.

In the first 9 months of 2013, we generated positive cash flows from operating activities and we continue to invest in property, plant and equipment such as adding capacity for natural gas and high horsepower engines, as well as upgrading our foundry capabilities. By investing in building high-quality advanced products, we can improve our market position, thus creating long-term value for our shareholders.

To share our success with our shareholders, we paid an interim $0.10 cash dividend per ordinary shares to shareholders on August 26, 2013. We believe that the payment of dividend is a best way to reward our shareholders.

We continue to expand our market share in the third quarter of 2013 and maintain a leading position in the world's largest commercial vehicle engine market. Entering into the fourth quarter of 2013, we remain cautiously optimistic as while demand for commercial vehicle has improved, uncertainty remains over the Chinese economy. However, I believe that we are well positioned to take on the challenges ahead with our strong OEM relationship, the largest service network in China, the diverse and growing platform of advanced diesel and natural gas engines to address multiple engine markets and sound financial strength.

With that, let me now turn the call over to Kok Ho Leong, our CFO, to provide more details on the financial results.

Kok Ho Leong

Thank you, Weng Ming. Let me first walk you through our unaudited third quarter and first 9 months ended September 30, 2013 financial results. And then, we can begin the Q&A session.

Net revenue for the third quarter of 2013 was RMB 3.7 billion, USD 608.7 million, which is the highest revenue achieved in any third quarter in the company's history, compared with RMB 3.1 billion in the third quarter of 2012. The increase in net sales was RMB 665.5 million or 31.6% as compared with the same period in 2012.

The total number of diesel engines sold during the third quarter of 2013 was 118,282 units compared with 97,328 units in the same quarter a year ago, representing an increase of 20,954 units or 21.5%. This was mainly attributable to an increase in the sales of engine to the truck market and for agriculture applications.

Truck sales benefited primarily from the continued pre-buying of trucks in the third quarter of 2013 and inventory restocking to meet future demand. Sales of diesel-powered commercial vehicles grew by 5.2% year-over-year in the third quarter of 2013 led by 12.8% growth in the heavy-duty trucks compared to the same period in 2012.

Gross profit increased 25.7% to RMB 781.5 million, USD 127.1 million, compared with RMB 621.5 million in the same quarter of 2012. Gross margin was 20.9% in the third quarter of 2013 compared with 20.2% in the same quarter last year. The higher sales volume in the third quarter of 2013 compared with the same period a year ago resulted from better economies of scale, which contributed to the higher gross margin.

Other operating income was RMB 28.9 million, USD 4.7 million, a decrease of RMB 11.8 million from RMB 40.7 million in the same quarter last year. The decrease was mainly due to foreign exchange revaluation losses as compared to a gain in foreign exchange revaluation in the same quarter in 2012.

Research and development, R&D, expenses were RMB 111.6 million, USD 18.2 million, compared with RMB 93.9 million in the same quarter of 2012, an increase of 18.9%. As a percentage of net revenue, R&D spending was 3.0% compared with 3.1% in the same quarter of 2012.

Selling, general and administrative, SG&A, expenses were RMB 446.0 million, USD 72.5 million, up from RMB 353.1 million in the third quarter last year, an increase of RMB 92.9 million or 26.3%. SG&A expenses represented 11.9% of the net revenue compared with 11.5% in the third quarter of 2012. The increase in the SG&A percentage was mainly due to higher warranty charges and provision for doubtful debts associated with increased sales in the third quarter. The lower provision for doubtful debt in the third quarter last year was attributed to a reversal of the provision upon successful collection.

Operating profit increased by 17.4% to RMB 252.8 million, USD 41.1 million, from RMB 215.2 million in the third quarter of 2012, mainly due to higher gross profit partially offset by higher SG&A and R&D expenses. The operating margin was 6.8% compared with 7.0% in the third quarter of 2012.

Finance costs increased to RMB 61.6 million, USD 10.0 million, from RMB 28.7 million in the same quarter last year, an increase of RMB 32.9 million. Higher finance costs mainly resulted from increased bills discounting at higher interest rates compared with the same period in 2012.

The share of joint ventures was a loss of RMB 7.2 million, USD 1.2 million, compared with a loss of RMB 8.3 million in the same quarter last year.

In the third quarter of 2013, total net profit attributable to China Yuchai's shareholders was RMB 106.5 million, USD 17.3 million, or earnings per share of RMB 2.86, USD 0.46, compared with RMB 111.1 million or earnings per share of RMB 2.98 in the same quarter in 2012.

I will now move on to the financial results for the 9 months ended September 30, 2013.

Net revenue was RMB 11.8 billion, USD 1.9 billion, compared with RMB 10.2 billion in the same period last year. The increase in the net sales was RMB 1.7 billion or 16.2% as compared with the same period in 2012.

The total number of diesel engines sold by GYMCL during the first 9 months of 2013 was 390,173 units compared with 338,354 units in the same period last year, representing an increase of 51,819 units or 15.3%. This increase was mainly attributable to an increase in the sales of engines to the truck market and for agriculture applications.

Gross profit was RMB 2.4 billion, USD 392.6 million, compared with RMB 2.1 billion in the same period last year, reflecting a 16.3% increase. Gross profit margin remained at 20.4% for the first 9 months of 2013 and 2012.

Other operating income was RMB 86.4 million, USD 14.1 million, an increase of RMB 8.0 million from RMB 78.4 million in the same period last year.

Research and development, R&D, expenses were RMB 322.3 million, USD 52.4 million, compared with RMB 271.0 million in the same period in 2012, an increase of 18.9%. As a percentage of net revenue, R&D spending was 2.7%, which was the same compared to the first 9 months of 2012. The R&D expenses related mainly to the ongoing research and development of new and existing engine products as well as continued initiatives to improve engine quality.

Selling, general and administrative, SG&A, expenses were RMB 1.3 billion, USD 203.7 million, up from RMB 1.1 billion in the same period last year, an increase of RMB 0.2 billion or 12.9%. SG&A expenses represented 10.6% of net revenue for the first 9 months of 2013 compared with 10.9% in the same period last year. The decrease was mainly due to higher sales in the first 9 months of 2013 as compared with the same period in 2012.

Operating profit increased 19.8% to RMB 925.4 million, USD 150.5 million, from RMB 772.5 million in the same period last year, mainly due to an increase in gross profit and other income, partially offset by higher R&D and SG&A expenses. The operating margin was 7.8% compared with 7.6% in the same period last year.

Finance costs declined RMB 135.4 million, USD 22.0 million, from RMB 166.2 million in the same period last year, a decrease of RMB 30.8 million or 18.5%. The decline in finance cost was mainly due to lower interest costs from the outstanding short-term and medium-term notes and less bills discounting in the first half of 2013 as compared with the same period in 2012. This saving was partially offset by higher finance costs in the third quarter of 2013.

The share of joint ventures was a loss of RMB 32.9 million, USD 5.4 million, compared with a loss of RMB 31.2 million in the same period in 2012.

For the 9 months ended September 30, 2013, total net profit attributable to China Yuchai's shareholders increased 28.9% to RMB 446.3 million, USD 72.6 million, or earnings per share of RMB 11.98, USD 1.95, compared with RMB 346.1 million or earnings per share of RMB 9.29 in the same period last year.

I shall highlight a few key items in the balance sheet. As of September 30, 2013, cash and bank balances were maintained at RMB 3.2 billion, USD 527.7 million, which was the same as December 31, 2012. Short-term and long-term borrowings were RMB 2.6 billion, USD 416.2 million, compared with RMB 2.5 billion at the end of 2012.

Net inventory was to RMB 2.2 billion, USD 361.4 million, compared with RMB 2.0 billion at the end of 2012.

With that, operator, we are ready to begin the Q&A session. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Alex Potter from Piper Jaffray.

Alexander E. Potter - Piper Jaffray Companies, Research Division

I was wondering if you could talk a little bit about the percentage of your production right now that is compliant with NS IV?

Weng Ming Hoh

Alex, this is Weng Ming here. Okay. Now as you know, the -- this covers the last conference call, so the -- whilst the National IV compliant engines has already been implemented the regulation, but the enforcement has not been strictly exercised or enforced across the board. So other than those major cities where the enforcement is strictly enforced, a large part of the country is still not truly enforcing in a strict manner. So the proportion of National IV engines that we're producing right now, although increasing, but it's still not very big. The portion -- proportion of our National IV engines produced for the bus market is increasing, it's much larger than the truck market. Does that answer your question?

Alexander E. Potter - Piper Jaffray Companies, Research Division

Okay. So approximately how high do you think it is in the truck market? When you say it's not very big, does that mean it's 5% or 10% or more than that?

Weng Ming Hoh

Yes, it will be less than that. It will be less than that.

Alexander E. Potter - Piper Jaffray Companies, Research Division

Less than 5%?

Weng Ming Hoh

Less than 10% definitely.

Alexander E. Potter - Piper Jaffray Companies, Research Division

Okay. Less than 10%, okay. And then -- so if that's production as it stands right now, where do you think that will go? If you look at your orders right now into November, December, in the first part of next year, do you see that proportion of NS IV increasing in your actual orders or is it still staying around 5%?

Weng Ming Hoh

So we are seeing an increase in the bus market because the city is requiring, I call, better, environmental-friendly engine vehicles. But in the truck market, we are not seeing it growing in a big way yet, all right? So there are still quite a fair bit of prebuy in anticipation of the strict enforcement of National IV, but we don't really know when they will come.

Alexander E. Potter - Piper Jaffray Companies, Research Division

Okay. So then this relates to my next question. If production and orders are not yet increasing for NS IV and the prebuy is continuing, could it be still several quarters where we get prebuy continuing like this, driving big growth in truck and engine orders? And presumably, people wouldn't prebuy unless they thought there was strict NS IV enforcement coming. But as strict NS IV enforcement doesn't come, does that mean that we -- this prebuy could just continue indefinitely?

Weng Ming Hoh

Well, if it doesn't come at all then it stays the way it is. So I mean, they will come, we are -- I'm sure, the government really wants to control the environment in the country. But how soon and how fast they're going to do it, honestly, Alex, we don't have an idea right now. And I would hesitate to guess right now.

Alexander E. Potter - Piper Jaffray Companies, Research Division

Okay. So does it make you at all uneasy when you see these big growth numbers and, presumably, a big pickup in inventory of NS III trucks when there's no real strict deadline for NS IV? Because, by definition, when somebody is prebuying a truck, they're buying a truck that they don't really need now, they're buying a truck that they anticipate they will need over the next couple of quarters. So if everybody keeps pulling forward this demand month after month after month, that seems like eventually we're going to hit a wall and volume is going to fall pretty substantially?

Weng Ming Hoh

Yes. It'd be difficult to forecast that totally. I think that we are very confident and we believe that the government will come in and strictly enforce it. But when, honestly, it's difficult to tell. So yes, the way we look at things, so a function of [indiscernible] is, yes, it will come.

Alexander E. Potter - Piper Jaffray Companies, Research Division

Right. Okay. And then I was wondering if you could comment a bit on R&D. Over the last couple of years, I'd say that the R&D percentage as a percentage of sales has increased a bit. I'm just wondering if you think that's a trend that will continue going forward? Do you have targets for R&D as a percentage of sales? So that's question number one. And then question number 2, is what are you spending the R&D dollars on mostly? Is it mostly the high horsepower stuff?

Weng Ming Hoh

Yes. Well, to answer question 1, yes. We will not continuously increase for ever. It will creep up certainly the cost of labor in China is kind of a lot, it's going up in the double-digits. And also, we have now built a new R&D center in Nanning. We also could see some additional costs there. Yet we need that center to attract talents to come through and join us. Now the R&D spending profile is on getting us -- our engines [indiscernible] helping us for a while back now to comply with National IV emissions, and V engines. Now we are working on, of course, the next National VI engines as well. So -- and initially, I think that we are [indiscernible] focused on the gas engine. So we are working on that and also working on ways to reduce our cost structure as well, so our cost reduction. So that requires a fair bit of research and development, okay? And we have testing materials, new way of doing things and how we can improve the cost structure or cost base of these engines.

Alexander E. Potter - Piper Jaffray Companies, Research Division

Okay. Okay. Very good. And then the last question I had was related to natural gas again. There have been some recent, I guess, concerns about gas availability and gas allocation, potentially allocating more gas -- so the government potentially allocating more gas toward residential, power generation and heating as opposed to industrial and transportation markets. Have you seen that trend? And has that impacted sentiment or order volume for natural gas engines?

Weng Ming Hoh

Well, the sentiment from -- and natural gas engine is still very buoyant. In fact, we're seeing this year a massive increase compared with previous year. The industry as a whole grew, it's selling a lot more natural gas engines in both trucks and buses, I must say. So we think that going into next year, this trend will continue, but whether or not this will continue in the same magnitude is questionable. But we believe that it's going to grow quite significantly next year.

Operator

[Operator Instructions]

Kok Ho Leong

Okay. If there's no question, I'd like to answer a question by Mr. Ti Chen [ph] on the cash flow status, okay? You like me to repeat on the cash flow status? I just want to assure that for the 9 months year-to-date, we are generating positive cash flow. We have positive -- generating healthy EBITDA to cover our CapEx. Our estimated CapEx for the first 9 months is close to 350 million, on track with our CapEx initiative that we are doing at the moment.

Weng Ming Hoh

All right. There's a question here about the 3Q sales on both natural gas engines, marine engines and heavy-duty engines. As I mentioned earlier, for the natural gas engines, we sold quite a number of them. In fact, we've had very good sales. In fact, all of them, we sold about nearly 8,000 natural gas engines in the third quarter, whereas in the case of marine engine, it's still quite small. We're going to look at this in a more focused manner going forward. But the heavy-duty engine sales has improved as well compared to the previous year. We had a quite good growth in the heavy-duty engines.

Now there's another question here asking when can visitors, investors visit or see our R&D facility. We are looking to that. Hopefully, we can organize something in the not-too-near future, not just to visit our R&D facility, but also perhaps to visit our new [indiscernible] plant as well. We do conduct some analyst visit from time to time, yes.

There's a question here on -- to ask about the JV status for Caterpillar and CIMC and the growth prospects in this joint venture. Now I'll let Kelvin answer this question. Thank you.

Lai Tak Chuen

Regarding on the status of the joint venture, and then -- it's also still regarding on the JV. And then the said JV, on that we are still in the development stage, of course. And then we -- the prototype engine of which is still under developing and we are targeting on that to be complete by the first half of 2014. So -- but following that, and then the -- we will be -- still [indiscernible] the ongoing development. Regarding on the CIMC-Chery, we have the production of this year and last year are pretty good, and then multiple of last year. And then we will expect -- and then the production will be -- and now -- and that is going up and then on the 2014 as well. On the -- remaining on the Caterpillar JV, remaining with manufacturing, we announced the new business strategy regarding on the remaining [indiscernible], and then -- but we are now focusing on the remaining engines, but the whole business is still another perhaps preliminary stage and then we expect -- and then it will be growing the remaining engine production by 2014 as well.

Operator

Thank you. We have now reached the end of the Q&A session, and I will turn the call back over to Mr. Hoh. Thank you, Mr. Hoh.

Weng Ming Hoh

Thank you, all, for participating in our conference call for third quarter and 9 months ended 30th September. We look forward to speaking with you again. Goodbye.

Operator

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.

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