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Wonder Auto Technology Inc. (OTCPK:WATG)

Q1 2007 Earnings Call

May 10, 2007 10:00 am ET

Executives

Leslie Richardson - IR, CCG Elite

Mark Collinson - Partner of CCG Elite

Mabel Zhang - CCG Elite

Qingjie Zhao - Chairman and CEO

Ryan Yuan - CFO

Analysts

John May - Roth Capital Partners

Alex Harbin - Wonder Auto

Anita Tumala - Sterne, Agee

Presentation

Operator

Good day, ladies and gentlemen. Welcome to the Wonder Auto First Quarter Earnings Call. Mabel, Leslie and I will be your coordinators for today. At this time, all participants are in a listen-only mode. We will be conducting a question-and-answer session towards the end of this conference. (Operator Instructions)

I would now like to turn the call over to Ms. Leslie Richardson from CCG Elite. Please proceed ma'am.

Leslie Richardson

Good morning, ladies and gentlemen. Good evening to those of you joining us from China. I'm Leslie Richardson from CCG Elite, the company's investor relations firm. Welcome to Wonder Auto Technology's first quarter 2007 earnings call.

With us today are Wonder Auto's Chairman, Mr. Qingjie Zhao, and CFO, Mr. Ryan Yuan, both join us from China and Mark Collinson, a Partner of CCG Elite. Also joining us is Mabel Zhang from CCG Elite who will provide translations for the Q&A section.

I would like to remind our listeners that in this call management's prepared remarks contain forward-looking statements such as forecast of future revenue and earnings, expected activities and other financial and business results. These statements are based on current expectations, but are subject to the risks and uncertainties. Actual results may differ materially from those contained in forward-looking statements. Management may make additional forward-looking statements in response to your questions and we can make no assurance that anticipated events or actual results will comport the forward-looking statements made on this call.

Therefore, the Company claims the protection of Safe Harbor for forward-looking statements that are contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ from those discussed today due to risks such as but not limited to fluctuation in customer demand, management of rapid growth, intensive competition from other providers of auto components, timing of approval or market acceptance of new product introductions, general economic conditions, geopolitical events, regulatory changes, and other factors detailed from time to time in the company's filing and future filings with the United States Securities Exchange Commission.

Accordingly, although the company believes the expectations reflected in such forward-looking statements are reasonable, there can be no assurance that such expectations will prove to be correct. In addition, any projections as to the company's future performance represents management's estimates as of today, May 10, 2007. Wonder assumes no obligation to update these projections in the future as market conditions change.

For those of you unable to listen to the entire call at this time, a recording will be available via webcast for 90 days. The web link is available in the press release that we issued earlier today. And now, I will turn the call over to Mark Collinson, who will provide further management discussions section on behalf of Wonder Auto's Chairman and CEO, Mr. Qingjie Zhao.

TRANSCRIPT SPONSOR

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China Direct (ticker: CHND.OB) is a diversified management and consulting company. Our mission is to create a platform to empower medium sized Chinese entities to effectively compete in the global economy. As your direct link to China, our organization serves as a vehicle to allow investors to participate directly in the rapid growth of the Chinese economy.

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Mark Collinson

Thanks, Leslie. Good morning, everyone. We believe our business model of high-quality backed by leading technology, flexible delivery and competitive pricing is serving us well in 2007. Our revenue for the first quarter at $21.6 million illustrates a very strong demand for our products, stronger than we had expected, in fact, for a quarter in which there is a major Chinese holiday. According to the China Association of Automobile Manufacturers, sales of Chinese made vehicles rose more than 22% in the quarter compared to the same quarter of 2006.

Typically, the demand for automotive components increases more than the demand for vehicles themselves, and this proved to be true in Q1. Revenues from both our alternators and starters were up strongly, driven almost entirely by increasing volume.

Our existing customers were the main source of revenue growth in this quarter, with the contribution to revenue from our three largest customers, Beijing Hyundai, Harbin Dong'an, and Shenyang Aerospace Mitsubishi increasing 49%, 21%, and 188% respectively compared to the same quarter last year.

While our relationships with our current customers remained strong, our sales to new clients also increased during the quarter. As Wonder Auto's brand Halla continues to gain market recognition for high-quality, competitively priced components.

We expect to experience continued growth from both current customers and new customers as the domestic environment for small and mid-sized automobiles remains very favorable, driven by a combination of high affordability for first-time buyers and the Chinese government's support for more energy efficient vehicles.

As we've mentioned before, starting in April of last year, the government implemented a consumption tax of up to 20% on cars with engines of four liters or more, while decreasing the consumption tax on cars with 1 to 1.5 liters to 3%. It's also pleasing to report that we continue to make headway in penetrating the export market.

Our export sales were approximately $900,000 greater for the quarter than in the same quarter last year, increasing from 1% of revenue to almost 5%. This represents encouraging progress towards our goal of generating 30% of our revenue from overseas markets within the next three to five years.

Profitability in the business remains strong, with our gross profit increasing 78.5%, $5.3 million in the first quarter of 2007 from the same quarter last year. Our gross margin for the quarter was 24.6% compared to a gross margin in the same period a year ago of 20.1%. I'll go into more details about this in the financial section. However, I will say that our increase in the margin is attributable to our commitment to being selective in the business that we take on, and the consolidation of the Jinzhou DongWoo for the full quarter.

Jinzhou DongWoo is proving to be a profitable acquisition. Its own gross margins are about 50% and the consolidation of this business for a full quarter has improved our gross margins by approximately 450 basis points. Dong Woo currently supplies exclusively within Wonder and not to outside parties. During the quarter, Jinzhou DongWoo has also had some success in reducing its own cost of goods sold, improving gross margin still further.

As to our operations, we remain on target for our new planned starter line of 520,000 units, our upgrade to a second starter line that will increase the capacity by 80,000 units, and our 600,000 unit alternator line, all to begin production in July. The additional starter and alternator capacity will not only increase our output, but enable us to produce more efficiently without running suboptimal shift patterns.

Overall, then, we had a very good quarter, in which we performed financially above the run rate which we'd been expecting, proving that the value of our quality, our technology and our manufacturing practices are being recognized in the market, and that we can take advantage of this stronger demand for our products while still maintaining gross margins and moderate levels of operating expenses.

Let me turn now to the financial results in more detail. Our revenue for the quarter, as I said, increased to a record $21.6 million, up 45.8% from revenue in the first quarter of 2006 of $14.8 million. Our revenue is also up 13% sequentially over the fourth quarter, whose revenue was $19 million, which was also a much larger increase than we had budgeted. We're happy to state that our increased revenue was primarily a result of increasing demand from existing customers for alternators and starters, which we feel demonstrates the strong customer relationships we've established.

Our gross profit for Q1 was $5.3 million for a year-over-year increase of 78.5% from $3 million in the first quarter of 2006. Gross margin was 24.6% for the quarter compared to 20.1% for the same quarter last year. And as I'd mentioned earlier, the gross margin was favorably impacted by the consolidation of our acquired interest in the business of Jinzhou DongWoo Precision Company.

The gross margin also benefited from the combined effects of business with more favorable margins and some innovative design initiatives that reduce the use of copper in our components. However, we would say that we believe that margin levels are likely to be slightly lower during the remainder of the year due to continuing commodity and customer pricing pressures.

Our administrative expenses for the quarter were $0.7 million or 3.1% of revenue, compared to $0.3 million or 2.1% of revenue for the same quarter a year ago. The increase of administrative expenses is due to expenditures for improvement of the company's internal control systems to ensure compliance with SOX 404, the inclusion of Jinzhou DongWoo, and increases in other costs of being a publicly traded company in the US.

Research and development expenditure for the first quarter was $0.3 million or 1.2% of revenue, compared to $0.1 million or 0.7% of revenue in the same quarter last year. The increased research and development expense is attributable to continued efforts to maintain our technological competitiveness.

Our selling expenses for Q1 were $0.7 million or 3% of revenue compared to $0.7 million or 4.7% of revenue in the comparable quarter a year earlier. The lower selling expense as a percent of revenue is due to our ability to improve the quality of our products, which reduced our costs of after-sales service. In addition, the increased sales volume allowed us to benefit from economies of scale, which reduced our per unit selling expenses.

Income from operations increased to $3.7 million for the first quarter of 2007, up 99.3% from $1.9 million in the first quarter of 2006. Our operating margin was 17.3% compared to 12.7% in the same period a year ago. The increase in operating margin is mainly attributable to the improved gross margins from the Jinzhou DongWoo acquisition and to operating efficiencies.

Net income for Q1 increased to $2.7 million, up 92.5% for the first quarter of 2006 of $1.4 million. And our fully diluted earnings per share for the quarter were $0.11.

Looking at our balance sheet, we had $10 million in cash and cash equivalents, working capital of $30.4 million and $10.9 million in long-term debt as of March 31, 2007. Our day sales outstanding declined to 106 from 122 in the fourth quarter of 2006, the decline being the result of our improved collection efforts. Our shareholders' equity stood at $41.3 million, up from $38.2 million on December 31, 2006.

Touching on our business outlook, as we look forward to the rest of the year, we're comfortable that the three aspects of our growth strategy are on track. Our sales to existing customers are growing strongly with the market. Having seen government statistics recently, we have a higher level of confidence that our market share in China is about 15% and we remain in the strong number two position.

We expect sales of new products to existing customers and export sales to be boosted following the closure of our acquisition of the remaining 80% of Jinzhou Wanyou Mechanical Parts that we did not own for a total cost of $16.4 million. That company, Wanyou, makes piston rods, vibration dampers and shock absorber rods for motor vehicles. And we believe that this will be an accretive acquisition, and it will broaden our product lines, customer base, and our geographic reach.

The terms of the acquisition also have minimum net income targets for the 12 month periods ending April 1st of approximately $2.99 million for 2008 and $3.87 million for 2009. We will finance the acquisition from drawings under existing credit lines. The $16.42 million acquisition price is payable over two years, contingent on results.

So, as a result of strong markets, a solid competitive position, and our recent acquisitions, we are reaffirming our belief that for the full year of 2007, our revenue should be approximately $100 million and our net income should be approximately $13.5 million.

With that, I'll conclude management's prepared remarks. Thanks very much for your interest in Wonder Auto Technology.

As we go to questions, a reminder that Mabel Zhang from CCG Elite will provide translations for those of you who wish to ask your questions in English. She will also provide English translations of management's answers. For those of you who wish to ask your questions in Chinese, please do so. Please also ask the question in English as well, or bear with us while Mabel translates both your question and management's response.

Thank you again, and with that, management is ready for your questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from John May from Roth Capital Partners. Please Proceed.

John May - Roth Capital Partners

[Translated] Good morning gentlemen. Congratulations on the first quarter, very strong number. I have a couple of questions to the management team. Number one is about the export business. You mentioned that your export proportion had grown from 1% to 5%. And my question is how does your acquisition help you expand the market?

And my second question relates -- if the management team can provide us more picture of the OEM new contract wins. I will translate for myself.

Qingjie Zhao

[Translated] So to answer your first question, actually in the Q1 the contribution from Wanyou in the export business was not up. Actually, we just owned 20% of its shares in the first quarter. Right now we just finished our acquisition a few weeks ago. So, actually in the Q1, that export business could be largely contributed to the [Hongdou San], which is why we export significant products to them.

And I also want to say that we have been working on an exporting business plan and executing it very well. So, we expect that this type of growth will be continued and steady in the rest of the year.

We are right now in negotiation phase with our new customers. And in the Q1, we didn't [size] of any new important customers and we will definitely share this news with you once the new contract is formed.

John May - Roth Capital Partners

[Translated] I just want to get be more specific on the product exports. I happen to have met with the Wanyou Company at an Auto Shanghai Show and they produce these pistons and rods. So my question is, will you use the Wanyou's international market to export your starter and alternator or will you focus more on just exporting your own products?

Qingjie Zhao

[Translated] We are right now starting this possibility and believe it could be possible for both parts. As you know, Wanyou is majorly exporting their shafts, their rods products to OEM and after-markets in United States. So, that could be a promising distribution channel for us to distribute our Wonder Auto products.

John May - Roth Capital Partners

Thanks.

Mabel Zhang

Operator?

Operator

(Operator Instructions). Our next question comes from Alex Harbin from Wonder Auto. Please proceed.

Alex Harbin - Wonder Auto

[Translated] Hi, congratulations on the great quarter, guys. Just wondering if you've heard back anything from the NASDAQ or if they've given you any feedback on your application to the GM there?

Qingjie Zhao

[Translated] No.

Ryan Yuan

[Translated] As you know, we have submitted an application and we also recently received the first round of the feedbacks from NASDAQ. We have made our answers to them, so we're still waiting to see if we can get second round of feedback or any updates.

Alex Harbin - Wonder Auto

Okay. Great, thanks.

Operator

(Operator Instructions). Our next question comes from Michael Coleman from Sterne, Agee. Please proceed.

Anita Tumala - Sterne, Agee

This is actually [Anita Tumala]. Michael regrets that he can't be on the call this morning. Congratulations on the excellent results this quarter. My question is in regard to Beijing Hyundai. They represented 20% of your sales last year. Did the shift in customer mix this quarter positively affect first quarter results?

Mabel Zhang

I'm sorry? Could you repeat your question?

Anita Tumala - Sterne, Agee

[Translated] Yeah. Did the shift in your customer mix this quarter, how did it positively affect results?

Qingjie Zhao

[Translated] To answer your question, Mr. Zhao said actually the customer mix is still quite the same as last year. But, Beijing Hyundai is doing some strategic adjustment of their marketing or production in China, so there will be some further expansion. But, in terms of the customer mix with Beijing Hyundai and other customers, this quarter still remains the same situation.

Anita Tumala - Sterne, Agee

[Translated] Okay. What would you say Beijing Hyundai represented as a percentage of your total sales for this quarter?

Qingjie Zhao

[Translated] The company didn't release this number, but Beijing Hyundai is still one of the major customers.

Anita Tumala - Sterne, Agee

[Translated] I see. One last question. Going forward, do you view their percentage as a total to remain stable or do you see it decreasing?

Qingjie Zhao

[Translated] We foresee this percentage will remain the same, unless the company is shifted to the smaller size of engines. But, at this point we didn't foresee any change.

Anita Tumala - Sterne, Agee

[Translated] All right. Great. Thank you so much and congratulations again on the great quarter.

Mark Collinson

Mabel, this is Mark Collinson. Can I just say that based on the numbers we released in our 1Q, investors can calculate the percentage of sales from Beijing Hyundai. We calculated it to be about 19%.

Anita Tumala - Sterne, Agee

All right. Thank you so much.

Operator

(Operator Instructions). I would now like to turn the call over to Mark Collinson for closing remarks.

Mark Collinson

[Translated] Well, thank you everyone for your interest in Wonder Auto Technology. We're very pleased to have provided you with excellent results for the first quarter, and we look forward to reporting our progress to you through the remainder of the year. Thank you again.

Qingjie Zhao

[Translated] Bye, bye.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.

TRANSCRIPT SPONSOR

China Direct Logo

China Direct (ticker: CHND.OB) is a diversified management and consulting company. Our mission is to create a platform to empower medium sized Chinese entities to effectively compete in the global economy. As your direct link to China, our organization serves as a vehicle to allow investors to participate directly in the rapid growth of the Chinese economy.

To sponsor a Seeking Alpha transcript click here.

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