Kevin Theiss – IR
Qizhou Wu – CEO
Alain Lillie [ph] – Maxim Group
China Automotive Systems, Inc. (CAAS) Q2 2012 Earnings Call August 9, 2012 9:00 AM ET
Greetings and welcome to the China Automotive Systems’ second quarter 2012 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, Mr. Kevin Theiss. Thank you. You may begin.
Thank you for joining us today and welcome to China Automotive Systems 2012 second quarter conference call. My name is Kevin Theiss and I am with Grayling, China Automotives’ 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 will 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 and actual results may differ materially from the results described in or anticipated by our forward-looking statements due to certain risks and uncertainties, including those described under the heading "Risk Factors" in the Company’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 9, 2012, and in documents subsequently filed by the Company from time to time.
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 2012 second quarter results and then I will turn the call over to management to conduct the question-and-answer session.
The 2012 second quarter results are un-audited numbers under U.S. GAAP. In our call today, I will review the financial results in U.S. dollars. Second quarter unit sales in 2012 continue to be sluggish as total vehicle sales increased by 10.1% to 4.8 million units. However the growth was uneven, as unit sales of passenger vehicles increased 16.6% to 3.8 million units and commercial vehicle sales of 996,973 units were 10.2% lower compared with the same quarter of 2011.
Chinese commercial truck sales continued to decline by 33.6% in the 2012 second quarter due to fewer infrastructure projects, continuing slow real estate market and relatively low utilization of truck fleets compared with a few years ago. These results reflect a slow GDP growth of 7.6% in the second quarter of 2012, the first [ph] quarterly GDP growth in the past three years.
Some of our motor sectors showed growth as sales of passenger vehicles rose 2.5% and light duty and light buses [ph] all posted higher sales in the second quarter of 2012 versus the same quarter of 2011. China’s vehicle export sales grew 28% to approximately 488,000 vehicles during the first six months of 2012 compared with the same period last year.
As Chinese exports increased in our customers established foreign operations, we will have growth opportunities in both the after-market and OEM markets with these vehicles. To fine tune the economy as inflation is no longer a threat, a less disputative monetary policy has been instituted.
Interest rates have been cut twice since early in June 2012 and banks’ reserve requirements had been lower three times since November 2011 to stimulate loan and investment growth. Also railway construction spending has been accelerated and other investment projects are expected to be approved by the Chinese government to help the economy grow. We have dramatically increased our R&D to approximately 5% of net sales in the 2012 second quarter.
As we continue to invest in new advanced products to meet our customer evolving requirements for new technologies and new performance. We also look to innovate new cost efficient production techniques to reduce costs. Our R&D provides a competitive edge to further build our brand equity by supplying new products with global quality and performance that offer added value to our domestic customers and to capture additional contracts to the large international OEMs as well.
New products offer us a chance to enhance our leadership position as we get closer to our current customers, attract new OEM and vehicle models and replaced imported steering units now being used in different vehicles that we had supplied before. We are particularly focused on advancing our electric power steering technology and production capacities to capture additional market share.
We made two various strategic moves during the second quarter of 2012. First, on May 25, 2012, we redeemed all of our outstanding senior convertible notes before their maturity dates. The total principal amount at May 25 was $23.6 million and negotiated total redemption price was $32.4 million including all principal accrued and unpaid interest and the make-whole amounts as of the date of redemption.
The five-year senior convertible notes were part of the $35 million transaction in February 2008 with a schedule maturity date of February 15, 2013. As a result of the redemption of the senior convertible notes, the total share count on a fully diluted basis will be reduced by approximately 3.3 million shares. The senior convertible notes issued by the company included terms that restricted the actions we could take to defend our shareholder value. With the redemption of the senior convertible notes, CAAS has more financial flexibility to fund future operations as this enhances our ability to defend our shareholder value.
Secondly on May 23, we announced our wholly owned subsidiary, Great Genesis Holdings Limited entered into a definitive agreement to sell its 51% equity interest in Zhejiang Henglong & Vie Pump Company, to the Zhejiang Vie Group which was Great Genesis joint-venture partner in this pump operation. Zhejiang designs, manufactures and markets power steering pumps. The RMB52 million transaction price represents a 53% premium as compared with the May 20, 2012 estimated net book value of approximately RMB34 million.
According to un-audited accounting information, Zhejiang’s net sales for the first quarter of 2012 declined by approximately 25% as compared with the same fiscal quarter of 2011, mainly due to lower sales volume. These strategic moves have provided more financial flexibility to the Company and made us more focused as the sole top business is tied to the older hydraulic steering systems and is declining in sales and we are building Olympic power steering capabilities and other advanced products for the future.
We also want to welcome Mr. Arthur Wong who was appointed to the Board of Directors of the Company on May 15, 2012, where he also served as chairman of the audit committee and as a member of the nominating and compensation committees of the Board.
For the second quarter of 2012, our net sales increased 2.8% to $80.4 million. The increase was primarily related to higher volumes including export sales to customers in North America, as we exported our steering products to the Jeep Wrangler model and beginning in 2012 to supply the Dodge and RAM truck models 2500/3500. We realized a higher gross margin of 19.4% in the second quarter of 2012 compared with 17.7% in the year ago quarter and compared with 19% in the first quarter of 2012.
We believe our gross margin will be stable over the next several quarters to continuing our strict cost controls and add new, more profitable products generated greater percentage of sales. Net income attributable to the parent company’s common shareholders was $12.2 million in the second quarter of 2012 compared with $3.9 million a year ago. Diluted earnings per share were $0.29 in the second quarter of 2012 compared with $0.14 in last year’s same period.
The outlook for the rest of 2012 remains uncertain as market conditions are indicating, we may be near a bottom in the passenger vehicle market but the overall commercial market continues sluggish. The Chinese government has implemented a new subsidy in May 2012 to encourage the purchase of low emission, fuel efficient vehicle as well as lowering the price the oil to encourage new vehicle purchases. While we are focused on steering products, entering and capturing market share in a number of automotive market segments remains the guiding principal of our growth strategy.
We remain the overall largest power steering manufacturer in the Chinese domestic market. We are expanding through new safety-related steering products, as we sell these in more traditional hydraulic steering components to a large number of Chinese passenger and commercial OEMs. The large Chinese after-market is another focus as our Sino-joint ventures building vehicles in China and opportunities in the growing number of foreign markets. Our chief focus is to continue to generate free cash flow and build long-term shareholder value.
Now let me walk you through the second quarter financial results in more detail. For the second quarter of 2012, net sales increased 2.8% to $80.4 million, compared with $78.2 million in the same quarter of 2011. The increase was primarily due to higher sales volume including export sales to customers in North America, as well as the effect of the Chinese government lowering oil prices and implementing subsidies in the May 2012, towards the purchase of low emission cars and fuel efficient domestic cars as well as the appreciation of the Chinese RMB currency versus the U.S. dollar.
Gross profit was $15.6 million in the second quarter of 2012, compared with $13.8 million in the second quarter of last year. Gross margin improved to 19.4% in the second quarter of 2012, compared with 17.7% in the same quarter of 2011, primarily due to lower raw materials prices, lean production management and rigorous cost control measures.
Selling expenses decreased 14% to $2.1 million from $2.4 million in the second quarter of 2011, which were mainly due to tightened cost controls compared with the same quarter of last year. As a percentage of net sales, selling expenses were 2.6% in the second quarter of 2012, compared with 3.1% in the same quarter of 2011.
General and administrative expenses decreased 7.1% to $3.1 million in the second quarter of 2012, from $3.4 million in the same quarter of 2011. The decrease in G&A expenses was primarily due to lower wage and salary expenses, and lower performance bonuses. As a percentage of net sales, G&A expenses decreased to 3.9% in the second quarter of 2012 from 4.3% in the same quarter last year.
Research and development expenses increased 168.4% in the second quarter of 2012, to $3.7 million from $1.4 million in the same quarter of 2011, mainly due to the continued development of the Company’s electric power steering systems. Higher expenses were incurred for additional R&D staff, improvement of production molds and external technical support in the second quarter of 2012, compared with the same quarter last year. As a percentage of net sales, R&D expense rose to 4.5% from 1.7% in the second quarter of 2011.
Income from operations was $8.6 million in the second quarter of 2012, compared with $7.2 million in the same quarter of 2011. The increase was primarily due to increased gains on other sales and higher gross profit combined with lower G&A and selling expenses in the second quarter of 2012 as compared with the same quarter in 2011. As a percentage of net sales, income from operations was 10.7%, compared with 9.2% in the second quarter of 2011.
Net financial expenses were lower at $500,000, compared with $560,000 in the second quarter of 2011, mainly due to the Company’s redemption of the convertible notes before their maturity dates, thereby reducing the Company’s interest expenses.
The gain on the change of fair value of derivatives in the second quarter of 2012 was $3.4 million compared with a loss of $147,000 in the same quarter last year as the Company’s stock price declined during the second quarter of 2012. The gain on the change of fair value of derivatives was related to the convertible notes and was non-cash in nature.
On May 24, 2012, the Company and the holder of the convertible notes reached a settlement agreement whereby China Automotive Systems made an early redemption of all the convertible notes on May 25, 2012. A gain of $1.4 million was recorded in the second quarter of 2012 for the early redemption of the convertible notes. No convertible notes were redeemed during the second quarter of 2011.
Income before income taxes and equity in earnings of affiliated companies was $12.9 million in the second quarter of 2012, compared with $6.5 million in the same quarter of 2011. The increase in income before income taxes and equity in earnings of affiliated companies was primarily due to higher income from operations of $1.4 million, an increase in the gain on the changes in fair value of derivatives of $3.6 million, and a gain of $1.4 million on redemption of the convertible notes in the second quarter of 2012, as compared with the same quarter in 2011.
Income tax expense was $1.3 million for the quarter ended June 30, 2012, compared with $1.2 million for the second quarter of 2011. The effective tax rate decreased to 10.2% for the second quarter of 2012, from 17.7% for the same quarter in 2011, primarily due to the permanent difference for the change in the fair value of the derivatives and the gain on the redemption of the convertible notes.
Income from continuing operations was $11.6 million for the second quarter of 2012, compared with $5.4 million for the same quarter last year. The increase was mainly due to higher income before income tax expense and equity in earnings of affiliated companies and the decrease in income tax expenses.
In May of 2012, CAAS discontinued its operations at Zhejiang and sold its 51% equity interest in Zhejiang. Accordingly, the Zhejiang business is now recorded as a discontinued operation. Net income from the discontinued operations was $2.6 million for the second quarter of 2012, which included the transaction income recorded in connection with the sale of Zhejiang of $2.5 million after-tax. Net operational results of the Zhejiang business for the second quarter of 2012, was an after-tax income of $125,000, and $332,000 for the same period last year.
Net income attributable to parent company’s common shareholders, including net income from discontinued operations, was $12.2 million in the second quarter of 2012, compared with $3.9 million in the same quarter in 2011. Diluted earnings per share were $0.29 in the second quarter of 2012, compared with $0.14 in the corresponding period of 2011.
The weighted average number of our basic common shares outstanding was 28,260,302 in the second quarter of 2012, compared with 28,083,534 in the same quarter of 2011. The weighted average number of diluted common shares outstanding was 30,257,347 in the second quarter compared with 28,202,989 in the same quarter of 2011. Diluted earnings per share from continuing operations were $0.21 in the second quarter of 2012, compared with diluted earnings per share from continuing operations of $0.13 in the second quarter of 2011.
The six months results. Net sales for the first six months of 2012 decreased 2% to $161.3 million, compared with $164.6 million in the first six months of last year. Six month gross profit was $31 million, compared with $32.5 million in the same period a year ago. Six month gross margin was 19.2%, compared with 19.7% for the same six month period in 2011.
Income from operations was $14.9 million, compared with $18.1 million in the first six months of 2011. Operating margin was 9.2%, compared with 11% for the same period of 2011. Income from continuing operations was 11.9% in the first six months of 2012, compared with $26.7 million in the same period last year. Net income attributable to the parent company’s common shareholders, including net income from discontinued operations, decreased to $11.2 million from $21.2 million in the first six months of 2011. Diluted earnings per share were $0.40 for both the 2012 and the 2011 first six months periods.
As of June 30, 2012, total cash and equivalents were $77.7 million, compared with $73 million at December 31, 2011. Working capital was $123.9 million as of June 30, 2012. Net cash flows from operating activities in the first six months were $6.9 million, after the payment of $8.8 million for the interest expenses for the redemption of the convertible notes.
Business outlook. Due to the significant slacking of demand for automotive vehicles in the People’s Republic of China, management has lowered its guidance and now expects annual revenues to be even with that of the year 2011. This target is based on the Company’s current views on operating and market conditions, which are subject to change.
With that operator, we are ready to begin to Q&A session.
We’ll now be conducting a question-and-answer session. (Operator Instructions) One moment while we poll for questions. The first question comes from the line of Echo He with Maxim Group. Please proceed with your question.
Alain Lillie [ph] – Maxim Group
Hello. Hi, this is Alain Lillie on behalf of Echo. I’ve got two questions. Yes, two questions. Can you talk about the ASP in 2Q and how is that compared to last quarter and what do you expect in the coming quarters? And the second question is that given that actually your gross margin, operating margins improved in this quarter sequentially and year-by-year and also given that the inflation is not a threat anymore in the coming – in the rest of the year. Where do you expect gross margins going forward? Do you expect to remain at the current level or do you think you have room to improve? Thank you so much.
Unidentified Company Representative
[Interpreted]. In terms of ASP, if we look at the year-over-year comparison, actually it’s slightly down about 3%. We think that 3% if move on a breakdown a portion of that which is about 2% basically are price cuts. And the other 1% is our product mix as we increase from the lower price mechanics in steering products.
Unidentified Company Representative
[Interpreted]. Okay. In terms of ASP change in the coming quarters, we think the price has pretty much spent alike. There is not so much room for price reduction. So we believe we can control within 1% that maximum reduction on our price for the second half of the year in terms of year-over-year comparison.
Unidentified Company Representative
[Interpreted]. Okay. To your second question, first part of the gross margin. We saw a recovery of a gross margin mainly due to our cost control measures. We have seen a lot of things has been reduced in the common cost side. First is the raw material, the raw steel and price had gone down. On the labor side, it’s been a number of years since China has increased a quite a bit on the labor cost. Now we’re reaching equilibrium so we think the labor hike is pretty much flattened.
And lastly the procurement. We have done a number of – we’ve made number of efforts to improve our portfolio program and reduce relevant costs. So as a result of that, our gross margin has been improved. And looking into the second half of the year, we think that at least we believe that gross margin will maintain 19.4% 19.5%. If we’re looking to 2013, we think the gross margin could be better and mainly due to more increased sales to international markets and also the EPS metric power steering products sales are still been moderate in 2012. So we expect some kind of ramp up in 2013.
Unidentified Company Representative
[Interpreted]. Okay. So yes, and the selling and G&A expense also reduced during the quarter and we actually increased quite a lot on the R&D side. We’re focused around a number of initiatives. One is OEM relationship development. We’ve been using our R&D programs, building more models with our customers. Also we’ll be increasing our R&D effort on the EPS in (inaudible) building products and lastly is our joint venture – and lastly is this, our target market, new target market with both joint venture – Sino-foreign joint venture OEMs.
So going forward we’re going to leverage our strong R&D capability and keen to penetrate the market.
(Operator Instructions) There are no questions at this time. I’d like to hand the floor back over to management for closing comments.
Thank you for attending second quarter earnings conference call. We look forward to speaking with you in the coming quarter. Thank you. Bye.
Ladies and gentlemen, this concludes teleconference. You may disconnect your lines at this time. And thank you for your participation.
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