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China Automotive Systems, Inc. (NASDAQ:CAAS)

Q2 2014 Results Earnings Conference Call

August 13, 2014 08:00 AM ET

Executives

Kevin Theiss - Grayling Global

Analysts

Bill Gregozeski - Greenridge Global

Operator

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

It is now my pleasure to introduce your host, Kevin Theiss with Grayling Global. Thank you, sir. You may begin.

Kevin Theiss

Thank you for joining us today and welcome to China Automotive Systems 2014 second quarter and six month 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 we 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 estimates 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 second quarter and six months financial results. And then I will turn to management to conduct the question-and-answer session. In 2014 second quarter and six months results are unaudited numbers or the fiscal year numbers are audited, both periods’ results are reported under U.S. GAAP. For our call today, I will review the financial results in U.S. dollars.

In the second quarter of 2014, our overall sales increased by 18% to a second quarter record of $115.5 million, compared to $97.9 million in the same quarter of 2013. This was the first time our net sales exceeded the $100 million level in any second quarter in our history. We continue to capture market share as our domestic sales growth of 19.1% exceeded the 12.2% growth of passenger vehicles in China in second quarter of 2014, according to statistics from the China Association of Automobile Manufacturers. Passenger vehicle sales expanded to incentives to purchase low emission cars and fuel efficient cars in the second quarter of 2014.

In addition, the Chinese economy continues to grow as GDP increased at 7.5% rate in the 2014 second quarter. We further penetrated the passenger vehicle market in China especially with our foreign joint venture brand customers SAIC, GM, Wuling, FAW, Volkswagen and Peugeot Citroen. Our higher sales of the Chinese passenger vehicle market in the second quarter of 2014 were due to increased volume and higher sales contribution of our higher priced mid-level electric power steering units. Electric power steering units are achieving strong growth as our ability to lower engine emissions and increased fuel efficiency is increasingly being recognized. Sales also continued to grow in the North American market as well.

Our 2014 second quarter sales to North America grew by 10.2% compared to the same quarter last year. Our key customer Chrysler reported its 51st consecutive month of year-over-year sales gains in June 2014. The Jeep brand reported that June 2014 sales were the highest June sales in its history and Jeep’s 28% sales increase in June was the highest growth rate among all Chrysler’s segments in that month.

RAM pickup trucks, sales increased by 12% in June besides June sales in the last 10 years. Our relationship with Chrysler has never been stronger than it is today. We continue to attract interest of other global vehicle OEMs to achieve our goal of becoming a leading supplier of steering products worldwide.

The sale of new products and upgraded products contributed to our sales growth in China during the second quarter of 2014. Research and development expenses, R&D increased by 12.2% to $5.2 million in the second quarter of 2014. Higher R&D expenses were mainly due to the accelerated development of our EPS products. Our new products and upgraded legacy steering units have been designed to meet the evolving needs of our customers to attract new customers and to position us further to penetrate foreign markets.

Our new products’ advanced features have generated significant sales over the past several years. And as a result, our customer relationships have improved. We maintained our gross margin at 18.7% despite product enhancement cost and more higher cost products sold in the 2014 second quarter.

Income from operations increased by 111.5% to $16.5 million in the second quarter of 2014 compared to $7.8 million in the same quarter of 2013. This increase is primarily due to higher gross profit and a $7.5 million gain on other sales, mainly from the sales of idle land use rights. With the latest transactions, our idle land use rights at this location are exhausted.

We have also invested an additional $1.7 million in our operations by expanding our selling, general and administrative, and research and development areas in the second quarter of 2014.

As of June 30, 2014, total cash and cash equivalents and short-term investments were $94.2 million. For the six months ended June 30, we generated cash from operations of $7.7 million, but we achieved this financial strength despite spending $1.4 million of net capital expenditures, $11.9 million in higher inventories and $3 million for the company's first acquisition for a 51% equity control position in Fujian Qiaolong Special Purpose Vehicle Company. This new subsidiary produces special emergency vehicles and represents a unique opportunity in the automotive industry in China.

Subsequent that second quarter, was our fully consolidating the remaining 20% minority interest in Jingzhou Henglong and remaining 19% minority interest in Shashi Jiulong. The purchase price is 4,078,000 shares of CAAS stock. Both subsidiaries will be 100% owned, these are two of our largest contributor to sales and we will consolidate higher profits.

Additionally given our growth, profitability and cash flow generation, the Board of Directors declared the first cash dividend in the company's history, a special cash dividend of $0.18 per common share representing total for investor shareholders of approximately $5 million was paid in late July. We believe shareholders to share in our success in the cash dividend will provide an immediate return. Our investment in Fujian Qiaolong represented a target of opportunity in an area with substantial growth potential, enumerative competition in the Chinese Automotive Industry. With Jingzhou Henglong and Shashi Jiulong 100% subsidiaries, these actions were taken to enhance shareholder value.

Additionally, we may use our substantial financial resources to make further opportunistic investments or make strategic acquisitions with the automotive related industries. Each transaction will be focused on earning a superior return to enhance valuation overtime.

Let me now walk you through our 2014 second quarter financial results. In the second quarter 2014, net sales increased by 18% to a second quarter record of $115.5 million, compared to $97.9 million in the same quarter of 2013. The net sales increase is mainly due to higher sales of passenger vehicles in China and North America, sales of certain new products such as mid-level electric power steering units and upgraded legacy products expanded the company's market care in China.

Gross profit increased by 17.4% to $21.6 million in the second quarter of 2014, compared to $18.4 million in the second quarter of 2013. The gross margin was 18.7% in the second quarter of 2014 versus 18.8% in the second quarter of 2013 and also 18.7% in the first quarter of 2014. The gross profit mainly increased due to the greater volume of units sold.

Selling expenses increased by 13.9% to $4.3 million in the second quarter of 2014, compared to $3.8 million in the second quarter of 2013. Selling expenses represented $3.7 million of net sales in the second quarter of 2014, compared to 3.9% in the second quarter of 2013. The increase was mainly due to higher warehousing, transporting and travel expenses related to the higher volumes sold.

General and administrative expenses, G&A, increased by 17.4% to $3.8 million in the second quarter of 2014, compared to $3.2 million in the same quarter of 2013. The increase was mainly due to higher personnel costs. G&A expenses represented 3.3% of net sales in both the second quarter of 2014 and the second quarter of 2013.

Research and development expenses, R&D, increased by 12.2% to $5.2 million in the second quarter of 2014, compared to $4.6 million in the second quarter of 2013. The increase in R&D expenses was mainly due to higher expenditures for the development of our EPS products, and included higher personnel-related expenses and mold improvement expenses. R&D expenses represented 4.5% of net sales in the second quarter of 2014, which was a decrease from 4.7% in the second quarter of 2013.

Income from operations increased by 111.5% to $16.5 million in the second quarter of 2014, compared to $7.8 million in the same quarter of 2013. The increase in income from operations was primarily due to higher gross profit, and a $7.5 million gain on other sales mainly from the sales of idle land use rights. As a percentage of net sales, the operating margin was 14.3% in the second quarter of 2014, compared to 8% in the second quarter of 2013.

Net financial expenses in the second quarter of 2014 were nil compared with expense of $0.1 million in the second quarter of 2013. The decrease was mainly due to lower interest income from a decline in time deposits, and an increase in gain on the foreign currency exchange.

Income before income tax expenses and equity in earnings of affiliated companies was $16.6 million in the second quarter of 2014, compared to $7.7 million in the second quarter of 2013. The increase of $8.9 million in the second quarter of 2014 was mainly due to an increase in operating income of $8.7 million. Net income attributable to parent company's common shareholders was $11 million in the second quarter of 2014 compared to net income attributable to parent company’s common shareholders of $5 million in the corresponding quarter of 2013. Diluted earnings per share were $0.39 in the second quarter of 2014, compared to diluted earnings per share of $0.18 in the second quarter of 2013. The weighted average number of diluted common shares outstanding was 28,064,376 in the second quarter of 2014 compared to 28,048,789 in the second quarter of 2013.

Let me now summarize results for the first six months of 2014. Net sales increased by 17.8% to a six-month record high of $229.8 million, compared to $195.1 million in the first six months of 2013. Six months gross profit was $42.9 million, compared to $37.8 million in the corresponding period last year. Six months gross margin was 18.7%, compared to 19.4% for the corresponding period in 2013. The gain on other sales of $9.1 million in the first six months of 2014 consisted of income on the sale of idle land insurance which represented a pre-tax gain of $7.5 million calculated as a difference between the selling price and net book value of related land use rights.

Income from operations was $26.3 million, compared to $17.2 million in the first six months of 2013. Operating margin was 11.4%, compared to 8.8% for the same period of 2013. Net income attributable to parent company’s shareholders was $17.8 million in the first six months of 2014 compared to $10.9 million in the corresponding period in 2013. Diluted earnings per share were $0.63 in the first six months of 2014 compared to diluted earnings per share of $0.39 for the corresponding period of 2013.

As of June 30, 2014 total cash, cash equivalents and short-term investments were $94.2 million compared to $89.5 million as of December 31, 2013, working capital was $181.9 million compared to $179.3 million at December 31, 2013.

Cash flow from operations was $7.7 million for the six months ended June 30, 2014. Total parent company stockholders equity was $237.4 million as of June 30, 2014 compared to $226.7 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 the company’s current views of operating and market conditions which are subject to change.

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

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). Thank you. Our first question comes from the line of Bill Gregozeski with Greenridge Global. Please proceed with your question.

Bill Gregozeski - Greenridge Global

Hi guys. I guess my first question is in regards to the domestic branded business in China. Just curious to get an outlook from management on what they see, I guess the potential for those brands since they just keep losing market share to the foreign brands?

Unidentified Company Representative

[Foreign Language].

So, Thank you for your question. Regarding your question on the domestic print, during the second quarter, we did see a noticeable decline for the Chinese domestic brands. They posted a 20% year-over-year decrease in terms of volume sales that including Chery Auto, Geely, BYD. However, we did -- what we did with those two OEMs, we actually increased our market share within supply contract with those players.

So, for example, we used to supply 50% to 60% from BYD’s steering systems and now we increased to 80%. So, that being said, their sales decline affected us a little bit to but not a lot, because we have increased our market share with those OEMs.

And also, we want to bring to your attention, there are 20 different Chinese domestic brands, not everyone are loading at such a fast pace in terms of market share. And some of the players actually are gaining some market share. These are joint venture partners of the multinationals FAW, Dongfeng, Shanghai Auto. They all have joint venture with multinationals where they develop their knowledge in how to produce a high quality vehicle.

So, these are the players we are working with as well. So, all-in-all, we recognized, has been couple of difficult years for the Chinese brands in China, domestic brands in China. But we strongly believe, this trend is not going to continue. We do not believe Chinese domestic brands will continue to lose market share. With their technology continue to mature and the production quality is moving up and we believe and they will stage a comeback at some point

Bill Gregozeski - Greenridge Global

Okay. All right. Could I get your update on the international activities of the company and in particular in Brazil?

Unidentified Company Representative

[Foreign Language]

As you know we have a plan, a grand plan for Brazil. We do have a general assembly facility is under construction in Brazil. We believe it will be -- the construction will be completed by the end of 2014 and we believe 2015 and ‘16 will have some shipment coming out of that facility.

Bill Gregozeski - Greenridge Global

Okay. And so I think the company is unable to win customers or is this just for a period there?

Unidentified Company Representative

[Foreign Language]

Okay. So we do have prospects and actually we do have customers in Brazil that’s why we went there set up our shop and we do have quite detailed order indication. And so when everything is ready, we will make a public announcement.

Bill Gregozeski - Greenridge Global

Okay. My last question is on the R&D, that’s increased quite a bit over the last few years and it seems like the EPS as always mentioned as the reason why, at what point will that spending of EPS slow down a bit or stabilize?

Unidentified Company Representative

[Foreign Language]

Okay. Yes. The R&D expenditure I think increasing. Once the money went to the testing software as well as the recruitment for the R&D engineers, at some point this hardware and software investment is going to plateau. And I don't believe it may still take couple of years, we're making some push to increase our EPS product shipment.

The engineering part of that, we have lot of staff on the R&D team. That part is going to stay, so to answer your question the R&D expense will continue to increase as we grow our business.

Bill Gregozeski - Greenridge Global

Is it mostly a lot of the spending for the EPS or are there other activities being done?

Unidentified Company Representative

[Foreign Language]

Okay. So, the answer to your question it is not all R&D bunch goes to EPS and there are a good portion of that actually will continue to flow into hydraulic and mechanic fueling systems. As you know, the lion share of business is still the right term the traditional steering systems. And on the CV, commercial vehicle market, we don't see any time soon it will be any product replacing the hydraulic power gen systems. With that being said, I will continue to invest in R&D in those areas for the traditional line of product.

Bill Gregozeski - Greenridge Global

Okay, alright. Thank you.

Unidentified Company Representative

Thank you.

Operator

Our next question comes from the line of Gary Nash with (inaudible) Capital. Please proceed with your question.

Unidentified Analyst

Yes, good morning everyone. What will your capital expenditures be and to expand which products?

Unidentified Company Representative

[Foreign Language]

Okay. So, the CapEx for 2014 is between $20 million to $25 million. There are three areas that we’re going to put our CapEx, first as our CEO just mentioned electric power steering EPS product line were not only increasing the testing equipment also at the software we’re also ramping up our production capacity. So, the EPS area is definitely taking some of the CapEx. And secondly, our export business that line has been growing steadily in the last couple of years mainly the shipment to North America. We are now at very high utilization rate of our capacity and we definitely increase our capacity, so we’re increasing -- putting more money for the production in that area. And lastly is the regular maintenance CapEx for our existing facility. So, that being said all together it is $20 million to $25 million in 2014.

Unidentified Analyst

Thank you.

Unidentified Company Representative

Thank you.

Operator

Our next question comes from the line of [Peter Ellsworth with Hanbank]. Please proceed with your question.

Unidentified Analyst

Hi, good evening gentlemen. Quick question just on the outlook for EPS, what is the target production for this year and then also in three years time? And then I also have a follow-up.

Unidentified Company Representative

Okay. Thank you peter.

[Foreign Language].

Okay. Our target production for 2014 in terms of EPS is 400,000 units. We expect to increase to 1.5 million to 2 million units by 2017.

Unidentified Analyst

Okay. And just is that all domestically produced or is that overseas as well, could you elaborate on that considering that you’re already at a high utilization rate. I am just wondering how that production capacity will be created.

Unidentified Company Representative

[Foreign Language].

Okay. Peter, for your question, it’s going to have international shipment for the EPS product as well going forward.

Unidentified Analyst

Okay. And then a follow-up question on the -- I know the North American exports are solid and you have a good relationship with Chrysler. Are there any other OEMs in North America, where you’re making relationships? I remember, I recall that Ford was a target; has that developed in any way?

Unidentified Company Representative

[Foreign Language].

Okay. We have already begun to look forward in one other model and we’re also preparing and expanding production line for Ford on few other models. So that business is going, ongoing.

It’s very different from shipping to I mean it's very different supplying to domestic Chinese OEMs, both international companies. And for example, also Chrysler or Ford, they require their specific production facility just dedicated for their product. And so, we already have a facility for Chrysler. We are finishing up, ramping up the second facility which is for Ford and so that's ongoing.

Unidentified Analyst

Great, thank you. And just on the land sale, could you elaborate a bit more on why it was done now? What the amounts of the proceeds were and what the uses of the proceeds will be and perhaps could we, shareholders expect another dividend?

Unidentified Company Representative

[Foreign Language].

Okay. Last year for this piece of land, last year we received RMB 28 million for the sale. And this year, the second part, tranche of payment came in at around RMB 31 million. We believe there is another RMB 10 million coming later. So, all these together, and if we subtract the acquiring cost for the land, the minority interest and related taxes with the net about $5 million that’s going to flow into working capital. And regarding the question on the dividend, we have recently announced the dividend. We have not have any plan for further dividend yet, but we’ll discuss internally then make announcement.

Unidentified Analyst

Okay. Thank you. Congratulations on a record first half and look forward to sharing your success. Thank you.

Unidentified Company Representative

Thank you.

Operator

Our next question comes from the line of [Greg Samuels] with Samuels Capital Management. Please proceed with your question.

Unidentified Analyst

Hello. Can you just further elaborate on production capacity in the Brazil facility please?

Unidentified Company Representative

[Foreign Language].

In terms of production capacity, we have about 5 million units annual production capacity. We’re running at 95% utilization rate at the moment. Brazil, we have -- we are in the cautiously constructing a general assembly facility in Brazil. We expect to complete the construction by the end of 2014.

Unidentified Analyst

Right. I heard that in the earlier remarks to a prior question as far as capacity is how much volume or total revenue might that facility yield?

Unidentified Company Representative

You mean at Brazil?

Unidentified Analyst

Yes.

Unidentified Company Representative

[Foreign Language]

So the phase one in Brazil is 350,000 units the design capacity and we are targeting to sell at US$200 per unit.

[Foreign Language].

And as you expect the utilization will have to go through a period to ramp up.

Unidentified Analyst

Right, okay. As far as Ford goes, have you guys announced which models your products are going into?

Unidentified Company Representative

[Foreign Language]

Okay, it's one of the pick-up trucks, but we are not at, have the liberty to disclose the name of the model yet.

[Foreign Language]

Yes, they typically send us facts and in specific product model for the steering system and we will produce that based on their requirement. They don't specifically discuss with us what the exact car model it will go in there.

Unidentified Analyst

Okay, good. Thank you very much.

Unidentified Company Representative

Thank you.

Operator

Our next question comes from the line of [Nin Ju] with UBS. Please proceed with your question.

Unidentified Analyst

[Foreign Language]

Unidentified Company Representative

Okay, this question, let me summarize, this comes from through the (inaudible) the UBS auto analyst. His question is regarding the ongoing, the current anti-monopoly investigation by Chinese government multinational auto maker and auto part component suppliers. One of the specific area he asked is the investigation of 10 or 12 Japanese auto part suppliers involved in some of the alleged price manipulation. And so he wants to know whether that has any impact to CAAS business or a benefit as well.

So, the answer is most of the investigation is targeting at the components and mostly in the aftermarket space. However, it may have any impact if there is any impacted OEM sector and will not be translated to any benefit to us, reason being the Japanese are very close circuit for their suppliers, the OEM buys parts mostly from their Japanese suppliers.

We have dealt with -- compete with some Japanese power steering power house JTEKT formally Koyo. We believe it’s for the same quality of product; we are very competitive, it’s not because of their close circuit Japanese supplier, [culture] we would have run the business long time ago.

That being said, we don’t anticipate any -- we have not seen any benefit to us yet.

Operator

We have no further questions at this time. I would now like to turn the floor back to management for closing comments.

Kevin Theiss

Thank you all for participating in the second quarter 2014 earnings conference call. We looking forward to speaking with you again and we wish you a good day.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. We thank you for your participation and have a wonderful day.

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