China Zenix Auto International's (ZX) CEO Junqiu Gao on Q1 2016 Results - Earnings Call Transcript

| About: China Zenix (ZX)

China Zenix Auto International Ltd (NYSE:ZX)

Q1 2016 Results Earnings Conference Call

May 19, 2016, 8:00 am ET

Executives

Dixon Chen - Investor Relations, Managing Director and Co-Founder at Grayling

Martin Cheung - Chief Financial Officer

Junqiu Gao - Deputy Chief Executive Officer, Chief Sales and Marketing Officer, Director

Analysts

John Sheehy - Private Investor

Michael Rosenthal - QVT Financial

Operator

Greetings and welcome to the China Zenix Auto International first quarter 2016 earnings 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.

It is now my pleasure to turn the conference over to your host, Mr. Dixon Chen. Please go ahead, sir.

Dixon Chen

Thank you. Thank you for joining us today. And welcome to Zenix Auto's 2016 first quarter earnings conference call. Joining us today are Deputy CEO, Mr. Junqiu Gao and Mr. Martin Cheung, our CFO.

This conference call script contains forward-looking statements. These statements are made under Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements can be identified by terminology such as aim, anticipate, believe, continue, estimate, expect, going forward, intend, ought to, plan, potential, project, seek, may, might, can, could, will, would, shall, should, is likely to and the negative form of these words or other expressions.

Among other things, the quotations from management in this conference call announcement as well as Zenix Auto's strategic and operational plan contain forward-looking statements. Zenix may also make written or oral forward-looking statements in its periodic reports to the SEC and its annual report to shareholders, in press releases and other written materials and in oral statements made by its officers, directors and employees.

Statements that are not historical facts, including statements about Zenix's beliefs and expectations are forward-looking statements. Forward-looking statements involve inherent risks and uncertainties. A number of factors could cause actual results to differ materially from those contained in any forward-looking statements, including but not limited to the following.

Our growth strategies and our future business development, including our ability to successfully develop new tubeless steel wheels and the introduction of aluminum wheels, our ability to expand our distribution network, overall growth in the aftermarket and OEM markets in China and elsewhere, which depend upon a number of factors beyond our control, including economic growth rates and vehicle sales and changes in our revenues and certain costs or expense items as a percentage of our revenues.

In particular, readers should consider the risks outlined under the heading Risk Factors in our most recent annual report on Form 20-F and in our recent reports filed from time to time with SEC on Form 6-K.

Zenix Auto does not undertake any obligation to update any forward-looking statements except as required under applicable law or information provided in this press release, script and any attachment are as of this date and Zenix Auto undertakes no obligation to update those information except as required under applicable law.

Mr. Cheung will provide a brief overview and then he will review the 2016 first quarter. Thereafter, we will conduct a question-and-answer session. For the purposes of today's call, all financial results are unaudited and they will be presented in RMB and U.S. dollars. Zenix Auto prepares its financial statements in accordance with International Financial Reporting Standards, IFRS, as issued by the International Accounting Standards Board.

Mr. Cheung, please start your prepared remarks.

Martin Cheung

Thank you Dixon. So let me start with a brief discussion on the performance of 2016 first quarter. Our 2016 first quarter sales continue to reflect slower economic growth as China's GDP growth was 6.7% lower than the 6.9% in the 2015 year and the slowest growth since 2009 according to China's National Bureau of Statistics.

Slower economic growth restricted the sales of automobiles in China to 6.2% in the first quarter, according to the China Association of Automobile Manufacturers, CAAM. Passenger vehicle sales grew by 7.3% and commercial vehicle sales were positive, the first time in many quarters, but only grew by 1.2%. Truck sales was up 1.1% in the first quarter of 2016. Heavy-duty truck sales have continued to demonstrate positive sales growth in the first quarter of 2016 compared with a year ago. And while heavy-duty truck sales increased by 7% in the first quarter of 2016, bus sales were more inconsistent with only medium duty buses reporting positive growth, according to CAAM.

Turning into our performance in the first quarter. Our revenue for the first quarter ended March 31, 2016 with RMB525.4 million or $81.5 million, dropped from RMB722.3 million for the first quarter of 2015. The decline in revenue on a year-over-year basis was mainly due to weak performance at our key customers and a downward price adjustments due to lower raw material costs in our cost truck business model. Despite slower economic growth in China, a difficult commercial vehicle market and lower company sales, we still are able to improve our gross margin in 2016 first quarter to 19.1% from 14.4% in the same quarter a year ago and generated $12.2 million in cash flow from operations. This increase resulted from lower raw materials, compared with the same period a year ago. At March 31, 2016, we had cash and bank balances and fixed bank deposits with a maturity period over three months of approximately $176.9 million and also we have reduced our inventories to $27.8 million and manage our accounts receivable to $96.34 million. Total equity attributable to owners of company was $397.1 million.

We continue to introduce new models of both steel and aluminum wheels to reflect market conditions. We are encouraged by the acceptance of our new aluminum wheel models, especially in the bus market and the growth opportunities in both the OEM and aftermarket in China. We also adjusted our prices to preserve our leadership position as the largest supplier of wheels to the Chinese commercial vehicle market. With focus on the highest aluminum product quality, innovative designs and strict cost controls to meet the needs of our many OEM and aftermarket customers, our production of our high margin aluminum wheel continues to ramp up to meet the expected future demand. As always, our operations are focused on cash flow generation and building a strong financial position to provide the flexibility and resources to achieve our long-term goals.

Now before going to details of our first quarter results, let me comment on the overall macroeconomic environment and its impact to our end market. Government policies have a major effect on economic growth and commercial vehicle sales. The central government may provide a further incentive to stimulate commercial vehicle sales similar with the tax benefits in place for the current passenger vehicle program. Increased government investments in public housing and building China's infrastructure would increase demand for wheels of truck use accelerates. The government's yellow label program to remove most older, more pollution inefficient vehicles will add to demand for new OEM vehicles in the future. Further, the Chinese government has relaxed its monetary policies with a reduced reserve ratio and lower interest rates to stimulate economic growth.

Now, let me go over the first quarter results for 2016. Revenue for the first quarter ended March 31, 2016 was RMB525.4 million or $81.5 million, dropped from RMB722.3 million for the first quarter of 2015. The decline year-on-year basis was mainly due to weak performance of our major OEM customers and weak aftermarket segment and international markets. Such weakness was due to sluggish domestic and emerging market economies. The decline of total revenue was also attributable to downward price adjustments in response to the lower raw material costs.

Aftermarket sales in China decreased by 28% year-over-year to RMB357 million or $39.9 million in the first quarter of 2016 from RMB357.2 million in the first quarter of 2015. Total unit sales in the aftermarket decreased by 19.4% year-over-year as a result of weak commercial vehicle transportation market. Sales to the Chinese OEM market decreased by 23.3% year-over-year to RMB173.9 million or $27 million in the first quarter of 2016 compared to RMB226.5 million in the same quarter of 2015. Total unit sales in the OEM market decreased by 9.7% year-over-year during the first quarter of 2016. Our key OEM customers in the heavy-duty segment have recorded lower units of truck sales despite of an overall increase in unit sales in heavy duty truck market in the first quarter.

International sales decreased by 31.8% year-over-year to RMB94.5 million or $14.7 million in the first quarter of 2016 compared to sales of RMB138.6 million in the first quarter of 2015. Total unit sales in the international sales decreased by 24.3% year-over-year in the first quarter of 2016. It was mainly due to sluggish economies of Southeastern Asian countries including Thailand, Indonesia and Myanmar which have weakened the demand from those markets. In the first quarter of 2016, domestic aftermarket sales, domestic OEM sales and international sales contributed 48.9%, 33.1% and 18% of revenue, respectively.

Sales of tubed steel wheels comprised 54.8% of 2016 first quarter revenue compared to 57.2% in the same quarter of 2015. Tubeless steel wheel sales represented 38.2% of first quarter revenue compared to 38% in the same quarter of 2015. Tubed and tubeless steel wheel sales remain the main sources of revenue for the company. However, sales of aluminum wheels increased and accounted for 2.9% first quarter revenue as compared to zero in the same quarter a year ago.

First quarter gross profit increased by 1.4% to RMB100.6 million or $15.6 million compared to RMB99.2 million in the same quarter in 2015. Gross margin was 19.1% compared with 13.7% in the first quarter of 2015. The increase in gross margin on a year-over-year basis was mainly due to the decline of raw material costs.

Selling and distribution expenses decreased by 25.6% to RMB43.4 million, S$6.7 million from RMB58.3 million in the first quarter of 2015. The decrease in selling and distribution costs was primarily due to the lower number of units shipped in the first quarter of 2016 compared with the same quarter last year. As a percentage of revenue, selling and distribution costs were 8.3% in the first quarter of 2016, compared to 8.1% in the same quarter a year ago.

Research and development, R&D, expenses increased by 107.9% to RMB20.3 million or $3.2 million, which compares to RMB9.8 million in the first quarter of 2015. R&D as a percentage of revenue was 3.9% in the first quarter of 2016, compared to 1.4% in the same quarter a year ago.

Administrative expenses decreased slightly by 1% to RMB34.6 million or $5.4 million from RMB34.9 million in the first quarter of 2015. As a percentage of revenue, admin expenses were 6.6%, compared to 4.8% of revenue in the first quarter of 2015.

Net loss and total comprehensive loss for the first quarter of 2016 were RMB2.9 million or $0.5 million, compared to net income and total comprehensive income of RMB0.8 million in the same quarter of 2015. Basic and diluted loss per ADS in the first quarter of 2016 were RMB0.06 or $0.01 compared to basic and diluted income per ADS of RMB0.01 in the same quarter of 2015.

In the first quarter of 2016, the company recorded positive cash flows from operating activities of RMB78.6 million or $12.2 million. Capital expenditures for the purchase of property, plant and equipment in the first quarter were RMB5.2 million or $0.8 million. Deposits paid for acquisition of property, plant and equipment in the first quarter were RMB2.5 million or $0.4 million. During the first quarter of 2016 and 2015, the weighted average number of ordinary shares was 206.5 million and the weighted average number of ADS was 51.6 million.

Now let's go over our financial position. As of March 31, 2016, we had bank balances and cash of RMB880.5 million or $136.6 million and fixed bank deposits with a maturity period over three months of RMB260 million or $40.3 million. Total bank borrowings were RMB558 million or $86.5 million. Total equity attributable to owners of the company was RMB2,560.6 million or $397.1 million.

Now that wraps up my presentation on the results. Dixon?

Dixon Chen

Operator, question please?

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question today is coming from John Sheehy, a private investor. Please proceed with your question.

John Sheehy

Hello everybody. Thank you for taking my call. First I would like to ask, are you affected by the very high volatility in steel prices this year?

Unidentified Company Representative

[FOREIGN LANGUAGE]

Okay. And in the last couple of months, even the few quarters, the price of steel has been coming down a lot but again then in this month the price is also recovering. So it's going up a little bit. But for us, steel price volatility is not having too much impact to us as we use cost based pricing. So our cost fluctuates.

John Sheehy

Okay. Thank you. And can you comment on the increase in R&D expense in the quarter? And do you expect this level to continue for the rest of year?

Unidentified Company Representative

[FOREIGN LANGUAGE]

What happened was, for R&D expenses, before the aluminum wheel being put in place for commercial production, some of the aluminum wheel sales has been accounted for the R&D expenses. So in aggregate, while the plus and minus effect come together, combined that mix R&S expenses a little bit historic relatively. So I would say, for 3% to 4% of the normalized R&D expenses, going forward.

John Sheehy

Okay. Thank you. And can you explain in a bit more detail about the relative weakness of your sales to the truck OEMs compared to the new truck sales, which were a little bit up in the first quarter?

Unidentified Company Representative

[FOREIGN LANGUAGE]

Okay. Yes. In the first quarter, we do see overall truck market experienced a year-over-year increase, although it's only a smart slight increase. However, our numbered didn't reflect that. We actually had a down quarter year-over-year. The reason being, two reasons. One is, we still seeing the channel is working on cleaning up those inventories. So the sales is really picking up but production hasn't really increased on OEM side. So we are not benefiting from it yet for the first quarter.

And the second reason is, the overall truck market, the mix in the truck market is also changing. The trailer business, the sale of mainly trailer has increased quite a bit during the first quarter and their proportion increased from 30% of overall truck market to 50% of truck market, which this trend benefited a few major players in that space. For instance, FAW, they posted a very strong growth on a year-over-year basis in the first quarter and we are supplying to FAW in different kind of vehicles.

So we are not getting that increase reflecting in our sales. And the other companies are growing a lot is Shaanxi in the first quarter. And unfortunately, they are not our main customer. So that didn't help us either. So that's the main reason we generally -- some customers, main customers of us actually suffered a decline on a year-over-year basis. So that's the reason you see overall market actually slide up, trending up, but we were still down on a year-over-year basis.

[FOREIGN LANGUAGE]

Okay. So let me give you some more clarity of some of our customers, large customers of ours. For instance, Sinotruck in the first quarter their production was down 30% year-over-year. Their sales was down 15.7% year-over-year. Then the other customer of us, a large customer, is Huali. Their sales and production is down in the 20s on a year-over-year basis. And these two are major truck makers for the construction markets. So that was the reason because the product mix changes during this quarter and affected a supplier like us. And so some of our main customers actually didn't get any gross.

[FOREIGN LANGUAGE]

Like we mentioned earlier, this quarter, the growth of the sector are primarily coming from the semitrailer area and that's why during this trend there are some smaller players, producers of semitrailers, they are also out there ramping up production. Because these are really small factories and their financial condition is not strong, so we are very cautious and selective in signing those supply contract with those players. That's why we didn't really benefit from the increase of semitrailer sales.

John Sheehy

Okay. Thanks for that great detail. That's very helpful. And my last question is, if you have customer who are comparing your aluminum wheels with international competitors, what do tell them are the advantages of buying the Zenix wheels?

Unidentified Company Representative

[FOREIGN LANGUAGE]

[AUDIO GAP]

Operator

One moment please while I reconnect the speaker line. Please hold. Now rejoining the speaker.

Unidentified Company Representative

[FOREIGN LANGUAGE]

Okay. So in that situation, we tell them first our quality is, we have a very high quality product. These are all certified by the international standard. We are very proud. Our service network is the largest in our sector. So everyone in the truck business and users know about Zenix wheel in China and so they can come to our station to get service anywhere. And in third thing is the pricing. We correlate prices slightly lower than our US competitor. And last one is the different models. We have a number of models. We understand the truck market very well. We know how many different models are out there. So our product line is actually in terms of aluminum product are quite complete. So we believe with all these benefits, I think, a potential customer will come to us.

John Sheehy

That was great. Thank you very much. Thank you for all of the detailed explanations.

Unidentified Company Representative

Thank you.

Operator

[Operator Instructions]. Our next question today is coming from Michael Rosenthal from QVT Financial. Please proceed with your question.

Michael Rosenthal

Hi. Thank you. Good evening. And thanks to John for asking most of my questions. A question on the aftermarket. Can you give us an update on what trends you are seeing there? And if we should start to see that business stabilize along with the new truck sales?

Unidentified Company Representative

[FOREIGN LANGUAGE]

Okay. So in terms of aftermarket, we are seeing the market has changed in the recent quarter. As we mentioned earlier, the trucks for the construction market, that market has declined and the market also overall has shrank. The main reason is the slowdown on the infrastructure construction and the slowdown of the real estate market is affecting the truck sales, predominantly construction use trucks and cargo.

Operator

One moment please while I reconnect the speaker line. Please hold. Rejoining the speaker.

Unidentified Company Representative

[FOREIGN LANGUAGE]

Okay. So the semitrailer business mostly used in the logistic market has registered very robust strong growth and so for that reason we are adjusting our strategy to adapt to the market. For instance, we are introducing new products, fuel efficiency products, light weight wheel to fit into those logistic use trucks and they are extremely sensitive. They are very sensitive with the weight these shipping companies or the logistic companies. So they not only want the high quality high endurance wheels, but also they are more sensitive in the wheel's weight itself so they can carry more goods and to generate more business. So we introduced a new product in the aftermarket. That has been very well received.

Unidentified Company Representative

[FOREIGN LANGUAGE]

And the other encouraging sign for us is our aluminum product in the aftermarket. With our increased campaign and our production is ramping up as well and so now we are seeing a growth in the aftermarket for the aluminum products. And of aluminum product is a lot lighter, equally strong and so it has received a good feedback from our customers.

Michael Rosenthal

That's helpful. Just one other follow up on the aluminum wheel actually and one for Martin. Martin, can you just clarify that comment on R&D? Were you suggesting that when you were still in the test phase that the aluminum revenue was netted against the gross R&D expense which reduced the R&D expense?

Martin Cheung

Yes. Correct. So that's what we have been doing for the quarters in the past.

Michael Rosenthal

Okay. Adjusting up that netting impact year-over-year, have we seen a big increase in the aluminum sales?

Martin Cheung

Well, for the past quarters, the aluminum wheel has been steadily increased but not to a level that we can commit our commercial production since the third quarter and fourth quarter last year, we believe that we can kick start our commercial production. So that's why we take the aluminum wheel sales out of the R&D. So you can see that there would be a significant or pretty significant increase in the R&D last quarter and this quarter. And going forward, I believe if normalized, that could be 3% to 4%, in that sort of range.

Michael Rosenthal

Okay. Understood. And then just lastly on aluminum, I guess we understand that there is an investigation in the first quarter and continuing related to some activity in new energy buses, may be cheating or something like that, that maybe has slowed down the sales of new energy buses in the first quarter? Has that had any impact on sales? And could that have any impact on the growth of that business until new policy is reported?

Unidentified Company Representative

[FOREIGN LANGUAGE]

As you mentioned, there is an investigation going on in the EV OEM sector, especially the bus market. And with this supply to the bus market and lot of our aluminum product does go to the EV. However, we think these developments new regulations is going to help shape the industry and to be more professional to forbid some of the irregular, illegal practice. I think in the long run, we are going to benefit from that trend.

[FOREIGN LANGUAGE]

So as you know, the Chinese government has implemented a very strong program to subsidize the new energy vehicle sales and a portion of that went to the electric powered bus market and in the recent months, those OEM, there are some smaller OEM using some cheating method to get those subsidy. I think those ongoing investigation is overall a good thing because as well as their being stopped at this early stage and the government can regulate the market, we will see this sector will continue to experience healthy growth and the government subsidy will continue to come into the sector to support the growth of new energy vehicles. Otherwise if there is an old regulation, it should start to grow to a point, government may have to stop the subsidy. So we actually, I am very pleased to see government came in so early to crack down those cheatings for the subsidy. And so the subsidy can go to the right company and it will benefit because we supply to these large players, legitimate electric vehicle players.

Dixon Chen

Any further questions, Mr. Rosenthal?

Michael Rosenthal

No, sir. Thank you very much.

Operator

[Operator Instructions]. We have reached the end of our question-and-answer session. I would like to turn the floor back over to management for any further or closing comments.

Junqiu Gao

Thank you for attending Zenix Auto's first quarter 2016 earnings conference call. We look forward to speaking with you. Thank you for your support.

Operator

Thank you. It does conclude today's teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.

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