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China Automotive Systems, Inc. (NASDAQ:CAAS)

Q1 2014 Earnings Conference Call

May 14, 2014 8:00 AM ET

Executives

Kevin Theiss – IR

Analysts

Bill Gregozeski – Greenridge Global

Unidentified Company Representative

Operator

Greetings and welcome to the China Automotive First Quarter 2014 Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to Mr. Kevin Theiss with Grayling Global. Thank you, Mr. Theiss. You may begin.

Kevin Theiss

Thank you for joining us today and welcome to China Automotive Systems 2014 first quarter conference call. My name is Kevin Theiss, and I am with Grayling, China Automotive’s U.S. Investor Relations Advisor.

Joining us today are Mr. Hanlin Chen, Chairman; Mr. Qizhou Wu, Chief Executive Officer; Mr. Jie Li, Chief Financial Officer; and Mr. Daming Hu, Chief Accounting Officer of China Automotive Systems. They will be available to answer questions later in the conference call. And we will help with translation.

Before I begin, I’d remind all listeners that throughout this call, we may make statements that may contain forward-looking statements. Forward-looking statements represent our estimate and assumptions only as of the date of this call. As a result, the Company’s actual results could differ materially from those contained in these forward-looking statements due to a number of factors including those described under the heading Risk Factors in the Company’s Form 10-K Annual Report for the year-ended December 31, 2013 filed with the Securities and Exchange Commission on March 31, 2014, respectively; and then documents filed by the Company from time-to-time with the Securities and Exchange Commission. The Company expressly disclaims any duty to provide updates to any forward-looking statements made in this call whether as a result of new information, future events or otherwise.

I will provide a brief overview and summary of the 2014 first quarter financial results. And then I will turn to management to conduct the question-and-answer session. The 2014 first quarter results are unaudited numbers, and they are reported under U.S. GAAP. For today’s call, I will review the financial results in U.S. dollars.

In the first quarter of 2014, our net sales topped to $100 million level for the first time in any first quarter in our history. And we grew by 17.6% beyond last year’s record first quarter in net sales. Our domestic passenger and commercial products and exports generated net sales of $100.3 million in the first quarter of 2014.

We benefited from a 30.7% increase in the sales to North America, as Chrysler reported its 48th consecutive month of sales increases on a year-over-year basis in March, and Jeep also reported that March was its best sales month with an increase of 47% above last year’s same month.

Van pickup truck sales also increased 26% in March compared with March of 2013. We continue to strengthen our relationship with Chrysler even as we are drawing attention from other global vehicle OEMs as they begin to recognize our technology and the value we can contribute to their success.

Domestically, we continue to supply over 60 OEMs including the leading and most demanding vehicle manufacturers in China. We captured market share in both the commercial market and passenger vehicle market in the first quarter of 2014.

New national four emission standards have been going into effect to reduce vehicle pollution emissions in the commercial vehicle segment, beginning in mid 2013 with enforcement expanding in 2014. The pre-buy of national three compliant vehicles provides momentum for higher commercial vehicle sales, especially for heavy-duty trucks.

Total commercial vehicle sales increased by 5.1% in the first quarter of 2014, as trucks grew by 4.4% and bus sales rose by 10.5%, according to statistics from the China Association of Automobile Manufacturers.

With our 13.7% increase in sales to the commercial vehicle market, we captured additional market share in the first quarter of 2014. The final date for nationwide enforcement of the new emission standard is January 1, 2015 and we anticipate the pre-buy will continue to generate higher commercial vehicle sales and we will expand our market position further.

A rise in infrastructure spending for railway, highway and public housing projects will help building commercial vehicle sales in 2014 as we’ll begin of a new five year vehicle replacement cycle to replace older vehicles.

We also continue to capture market share in the passenger vehicle market as of 18.6% increase in sales to pay us the 10.1% increase in total passenger vehicle sales year-over-year. In centers to purchase low emission cars and fuel efficient cars continue to stimulate passenger vehicle sales in the first quarter of 2014 and the Chinese economy continue to grow.

In addition to our broad line of steering products for the passenger vehicle market, our electric power steering products are experiencing strong growth due to their contribution to reducing engine emissions and increasing fuel efficiency.

Operating income increased $9.8 million from $9.3 million as our stringent cost controls resulted in a 9.6% reduction in selling and general administrative expenses even as we increased our investment and research and development by 73.2% year-over-year.

Our enhanced research and development programs, our updating legacy products with more advanced technology provides better solutions and greater product differentiation to maintain our strong customer relationships as a preferred vendor.

Selective new products are specifically designed to meet global standards as we plan to use that we want to make in-roads in the global markets, especially in the North and South American markets.

We also increased our investment and research and development to accelerate the development of our proprietary electric power steering systems. We are developing and expanding our EPS product offerings to meet the needs of our growing customer base that managing our EPS systems.

As we offer a greater variety of products, we expect to meet the needs of current customers and attract new ones. In the Chinese EPS market, we believe our EPS products are highly competitive and we’ll replace imported systems. By growth in both the Chinese and foreign vehicle markets is largely due to our effective research and development investments, which is attracting the leading companies in the industry, such as Chrysler, GM’s joint venture in China SAIC, Volkswagen joint venture with FAW in China, Peugot growing joint venture with Dongfeng and domestic leaders such as Geely, Great Wall, Chery Auto and others.

At March 31, 2014 our cash and equivalents in short-term investments are a very solid $78.9 million, despite spending a $3.5 million in capital expenditures in the quarter. An increase of $1.8 million, increase in operating expenses due to higher investment in research and development and a $4.5 million investment in higher inventories as we begin a seasonal period of higher sales. We continue to maintain zero long-term debt.

We will use these resources to further grow our market position in China with more advanced products and efficient manufacturing to strengthen our customer relationships and capture market share. The price, performance and quality of our steering products are also becoming more recognized internationally, as we increase our presence towards achieving our goal of becoming a leading providing of steering products worldwide.

Now let me walk you through the 2014 first quarter financial results. In the first quarter of 2014, net sales increased by 17.6% to a first quarter record of $114.3 million compared to $97.2 million in the same quarter of 2013. The net sales increase is mainly due to higher market share in the Chinese passenger and commercial vehicle markets as well as higher sales to the North American market.

Gross profit increased by 10.2% to $21.3 million in the first quarter of 2014, compared to $19.4 million in the first quarter of 2013. The gross margin was 18.7% in the first quarter of 2014 versus 19.9% in the first quarter of 2013, and compared to 17.3% in the fourth quarter of 2013.

Selling expenses decreased by 3.9% to $3 million in the first quarter of 2014 compared to the $3.2 million in the first quarter of 2013. Selling expenses represented 2.7% of net sales in the first quarter of 2014 compared to 3.3% in the first quarter of 2013. The decrease is mainly due to lower personnel compensation.

General and administrative expenses decreased by 14.1% to $3.5 million in the first quarter of 2014 compared to $4.1 million in the same quarter of 2013. The decrease was mainly due to lower legal expenses. G&A expenses represent a 3.1% of net sales in the first quarter of 2014 and 4.2% in the first quarter of 2013.

Research and development expenses increased by 73.2% to $5.9 million in the first quarter of 2014 compared to $3.4 million in the first quarter of 2013. The increase in R&D expenses was mainly due to higher expenditures for the development of our electric power steering products and includes a higher personnel related expenses and mould improvement expenses. R&D expenses represent 5.2% of the net sales in the first quarter of 2014, which was an increase from 3.5% in the first quarter of 2013.

Income from operations increased by 4.5% to $9.8 million in the first quarter of 2014, compared to $9.3 million in the same quarter of 2013. As a percentage of net sales, the operating margin was 8.5% in the first quarter of 2014 compared to 9.6% in the first quarter of 2013 and compared to 6% in the fourth quarter of 2013.

Net financial expenses changed by $0.4 million in the first quarter of 2014, as higher time deposits generated $0.2 million in higher interest income and financial expenses declined by $0.2 million due to lower interest expenses as bank debt decline compared with the first quarter of 2013.

Income before income tax expenses and equity in earnings of affiliated companies was $10.2 million in the first quarter of 2014, compared to $9.2 million in the first quarter of 2013. The increase in income before income tax expense and equity in earnings of affiliated companies of$1million in the first quarter of 2014 was mainly due to an increase in operating income of $0.4 million, a decrease in financial expenses of $0.4 million, and an increase in other income of $0.2 million.

Net income attributable to parent company’s common shareholders was $6.8 million in the first quarter of 2014 compared to net income attributable to parent company shareholders of $5.9 million in the corresponding quarter of 2013. Diluted earnings per share was $0.24 in the first quarter of 2014 compared to $0.21 in the first quarter of 2013.

The weighted average number of diluted common shares outstanding was $28, 063,501 in the first quarter of 2014 compared to $28,050,937 in the first quarter of 2013. As of March 31, 2014 total cash and cash equivalents and short-term investments were $78.9 million compared to $89.5 million as of December 31, 2013.

Working capital was $186.3 million as of March 31, 2014 compared to $179.3 million as of December 31, 2013. Management reiterates its revenue guidance of 15% year-over-year growth for the full year 2014. This target is based on company’s current view with the operating and market conditions which are subject to change.

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

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question is from Bill Gregozeski of Greenridge Global. Please go ahead.

Bill Gregozeski – Greenridge Global

Hi, great quarter. I’m curious as to what you guys see in the domestic brand market, seems like most of the companies are reporting lower sales such area is down quite a bit again this year and you guys actually reported flat sales, if I missed here, so I’m curious if you can talk a little bit about, what you see in the domestic brand market and how you are gaining sales, you’re staying flat in those markets?

[Foreign Language]

Unidentified Company Representative

Okay. So to answer your question, yes overall domestic brand showed some weakness starting from last year, still over to the first quarter of 2014. Let’s look at it a little detail, if you look into the different brands in the first quarter and in some parts of the last year, Chery Auto has – has been weaker than the other peers. Geely, BYD has done, they have their graph they’ve done okay. But Great Wall has made lot of progress towards market share and grows too. So, but there are other brands we should look at it, they are also domestic brands such as Shanghai Auto and all you know in the past as mostly Shanghai Auto into Volkswagen and General Motors. But Shanghai Auto has their own brand too, that area they want to grow it, we are here to support them.

Beijing Auto, we have a joint venture with them, Beijing Auto they are introducing some of the soft vehicles like Soft 94, Soft 90, Soft 96 models. And they are definitely some efforts on their part trying to penetrate into the domestic brand market. Then you have Brilliance Auto, through their JV with BMW and they have improved a lot technology front. So now they are also looking to rely more aggressively on own brands. They own their products. And so that’s some area we’re also working with them.

And then Shanghai first auto SAW and they have their own [indiscernible] models has done well, reasonably well. So we’re working on that, trying to get into. So overall we see there are brands are traditionally strong in the marketplace, they are relatively losing ground to others brands. But we are more diversified, we are working with just about everybody that help us to continue to grow even with some of the customers, larger customers in the historical large customers has experienced some weakness in the recent year or quarter. That’s how we continue to offset the weakness.

Bill Gregozeski – Greenridge Global

Okay, all right. Are you doing more with some of the JVs, you mentioned the launching their own brands for some of these companies that had the partners, are you selling into any of those JVs, I know that was something you talked about previously?

[Foreign Language]

Unidentified Company Representative

In general that we’re still – we’re working with those big – bigger OEMs, we just closed in the past with GM-Wuling and Peugot Citroen have a joint venture with Dongfeng, the VW Volkswagen they have joint venture with FAW we are supplying to them. And then internationally we are shipping to Chrysler North America, we are working with another global name outside of China; we’ll make announcements when it’s ready.

And also the other thing, Mr. Wu mentioned earlier, even the ones that Chery and Geely know well, they are working hard to upgrade their product line, for instance Chery is traditionally making economy vehicles. Now they are introducing a high-end model too. So we are working with them, supplying to their model. And Geely grew their relationship is wonderful and they have done a lot of technological upgrade. And so we are working with them trying to click into their some of their high-end vehicles, be for instance we’re supplying to them.

Bill Gregozeski – Greenridge Global

Okay. And can you provide what the EPS sales were in this year versus the year ago period?

[Foreign Language]

Unidentified Company Representative

Yes. We had almost doubled our sales and that’s the year where you should get about 400,000 units and this quarter we had about 100,000 units shipment here.

Unidentified Company Representative

So, last year its 400,000, this quarter alone we shipped 100,000 units in the first quarter. And as you know first quarter it’s traditionally seasonal, low season, weak quarter.

Unidentified Company Representative

Last year’s first quarter was 40,000 units, not 400,000, 40,000 units.

Unidentified Company Representative

I’m sorry 40,000.

Bill Gregozeski – Greenridge Global

Okay. All right that’s all I have, thank you.

Thank you.

Operator

Thank you. The next question is from [indiscernible] of Wall Street Wonders. Please go ahead.

Unidentified Analyst

Hey good morning, thank you for a good presentation. My query is what foreign markets do you think for the best opportunity for exports in the coming year?

[Foreign Language]

Unidentified Company Representative

Okay mainly still the prospects it’s in North America. We’re working very closely with Chrysler now, we are working; we are developing relationship with other OEMs in North America. And in addition to that we believe South America present one of the transforming opportunity for us. So, Brazil in particular it’s interesting for us as well Argentina.

And in Asia other than China we see India an adequate, potential market. And in Europe, we’ve been talking to some of the OEM there in Russia; it’s been couple of years. So we definitely want to break into that market.

Unidentified Analyst

Okay, thank you.

Unidentified Company Representative

Thank you.

Operator

Thank you. The next question is from Michael Coble [phonetic] with Independent Research. Please go ahead.

Unidentified Analyst

Hi, thank you. Couple of my questions have been answered. In late 2002 the company bought back quite a few shares and currently the stock price is falling, a bit below book value, I was wondering the company could say something about where they stand with regard to buying back shares?

[Foreign Language]

Unidentified Company Representative

We – our Board still had to make a decision on those share buyback, well you know once we reach a decision. On the other hand we are working on some other options to, other ways to our shareholders. So we are working on proposal line out. So we hope we can make announcements soon.

Operator

Thank you. [Operator Instructions] And the next question is from Peter [indiscernible]. Please go ahead.

Unidentified Analyst

Hi, thank you for taking my questions. A quick question about the weakening UN or Renminbi, could you talk a little bit about how that impacted the first quarter reward and what the outlook is from your perspective and particularly on pricing/

[Foreign Language]

Unidentified Company Representative

Regarding your question on the weakening RMB, as you know up to now 85% of our revenue is generated in domestic China market. So the currency fluctuation, has – not much negative impact to our business in China. If you look at our export weakening RMB is actually helping us with export business. In terms of pricing, we haven’t made much changes on the pricing strategy; we are going to just stay in the current pricing.

Unidentified Analyst

Okay. Thank you. And if I may, a quick follow-up on the electronic power steering production. I understand, it looks like you’re on track for the production target of about 420,000 units for this year, if we can have that reason from and then also what is the target, three year out is it still one million units for production capacity?

[Foreign Language]

Unidentified Company Representative

We are making steady progress, as we mentioned earlier. The annual target for 420,000 units EPS electric power steering product well on track that target has not changed. In terms of three year target for 1 million units EPS product that’s we’re still on track. And just to recap the first quarter of 2014 we shipped 400,000 units that’s up from 40,000 units in first quarter 2013.

Unidentified Analyst

Okay thanks. And my last question is just on Brazil, any updates on developments there in terms of that enterprise? Thank you.

[Foreign Language]

Unidentified Company Representative

Okay. We as we announced in the past, we had a LOI in place with the local player. We’re still working on that progressing. We look forward to make a further announcement when we get there. In terms of one of our long-term partner in China customer, OEM customer and partner in China Chery Auto their factory in Brazil is going to have a grand opening in July. We think, when their production starts in July we are going to try to work on that – that business and grow with them, as we have a such relationship with Chery starting many years ago in China.

Unidentified Analyst

Great, thank you very much for the updates and congratulations on a solid 1Q.

Unidentified Company Representative

Thank you.

Operator

Thank you. [Operator Instructions] And it appears we have no further questions at this time. I would like to turn the floor back over to management for any additional remarks.

Kevin Theiss

Thank you for attending China Automotive Systems 2014 first quarter earnings conference call. We look forward to speaking with you.

Operator

Thank you. Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. And thank you for your participation.

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