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China Automotive Systems, Inc. (NASDAQ:CAAS)

Q3 2012 Earnings Call

November 8, 2012, 8:00 a.m. ET

Executives

Kevin Theiss – IR

Qizhou Wu – CEO

Hanlin Chen – Chairman

Jie Li – CFO

Daming Hu - CAO

Analysts

(Liang Su) – King Capital

Operator

Greetings, and welcome to the China Automotive Systems, Incorporated third quarter 2012 conference call. (Operator Instructions)

It is now my pleasure to introduce your host, Mr. Kevin Theiss. Thank you Sir, you may begin.

Kevin Theiss

Thank you for joining us today and welcome to China Automotive Systems 2012 third 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. 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 10-K annual report for the year ended December 31, 2011. And under the heading risk factors in the company's form 10-Q for the nine months ended September 30, 2012 filed with the Securities and Exchange Commission on March 9th, 2012 and November 8th, 2012 respectively. And in documents subsequently 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 as a result of new information, future events, or otherwise.

I will provide a brief overview and summary of the 2012 third quarter results. And then I will turn to management to conduct the question and answer session.

The 2012 third quarter results are unaudited numbers under U.S. GAAP. For our call today, I will review the financial results in U.S. dollars.

Interesting comment, the third quarter unit sales in 2012 continued to be sluggish as total vehicle sales increased by 4.4% to 4.5 million units. The third quarter is seasonally a slower sales target due to summer shutdowns and vacations. The recent growth trend continued as unit sales of passenger vehicles increased to 6.7% to 3.7 million units. And commercial vehicle sales of 837,289 units declined by 4.4% compared to the same quarter of 2011.

Chinese commercial truck sales continued to do fine at 7.9% in the 2012 third quarter due to fewer infrastructure projects, and continually slow real estate market, and a relatively low utilization of truck fleets compared to a few years ago.

GDP growth declined to 7.4% in the third quarter of 2012 following 7.6% GDP growth in the second quarter of 2012. These rates are the slowest quarter of GDP rates over the past three years.

Some automotive sectors showed growth as sales of passenger buses rose 8%. And large and light buses continued to extreme higher sales in the third quarter of 2012 versus the same quarter of 2011.

China vehicle export sales grew 31.2% to 487,900 vehicles during the third quarter of 2012 compared to the same quarter last year.

As our Chinese customers continued to establish foreign passenger and commercial vehicle operations, we will have opportunities in both the after-market and OEM markets with these Chinese vehicles produced in local markets plus the vehicles exported from China as well.

Our investment in research and development increased by 12% compared to the third quarter last year as we continue to benefit from new and higher quality products. New advanced products who anticipate customer's needs, and then meet or exceed their expectations is one of our core foundations for growth. R&D is also used to develop new and more productive manufacturing methods and new higher performance materials to enhance the competitiveness of our products.

Both domestic and global OEM's are requiring products that have value. The automotive parts industry is highly competitive. And to the ability to rapidly produce innovative products on a cost competitive basis is becoming even more important to maintain or capture market share in the new OEM customers.

In addition to introducing new cost effective production techniques, to reduce costs, we are particularly focused on advancing our electric powered steering technology and building products of high quality and performance that increase our brand recognition globally. We are developing new products for our domestic customers to increase our leadership in the local markets as well as new products for overseas markets as part of our plan to become a tier one supplier on a global basis.

Our redemption of all outstanding senior convertible notes before the maturity date earlier this year provides us with greater financial resources and flexibility to defend our shareholder value and pursue our growth initiatives.

Additionally, our agreement to sell our 51% equity interest in Zhejiang Henglong & Vie Pump Manufacturing Company to Zhejiang Vie Group, which was joint venture partner in this pump operation rids us of a slow selling low profitability product line and provides greater focus going forward.

For the third quarter of 2012, net sales increased by 2.3% to $73.2 million compared to $70.9 million in the third quarter of 2011. The increase in net sales was mainly due to higher exports of new products into the North American market especially to Chrysler North America.

Income from operations was $5.5 million in the third quarter of 2012, consistent to the $5.5 million in the third quarter of 2011. Net income attributable to the parent company's common shareholders was $3.4 million in the third quarter of 2012 compared to $9 million a year ago. As a result, earnings per share were $0.12 in the third quarter of 2012 compared to $0.10 in last year's same period.

The Chinese government introduced a new subsidy in May, 2012 to encourage the purchase of low emission and fuel efficient vehicles. Oil prices have been reduced. And interest rates declined to encourage new vehicle purchases. This central government's policies have become more growth oriented with a less restrictive monetary policy. With new central government leadership about to assume authority, we look forward to new government proposals. We remain focused on developing state of the art streaming products to capture more customers and enter new markets as our principle growth strategy.

We remain the overall largest power steering manufacturer in China. We continue to sell passenger vehicles and commercial vehicle OEM's as we are expanding our safety related steering product line. It remains a large Chinese after-market. And sign of joint ventures are another target within China.

Most importantly, with our global quality and cost competitiveness, opportunities in a growing number of fine markets are within our reach. We will always be focused in generating free cash flow and building the long-term shareholder value.

On August 28th, 2012, we announced a share buyback program. And during the third quarter, our company purchased over 200,000 shares of common stock in open market transactions.

Now let me walk you through our third quarter financial results. For the third quarter of 2012, net sales increased by 3.2% to $73.2 million compared to $70.9 million in the corresponding quarter of 2011. The net sales increase is mainly due to higher exports of new products into the North American market especially to Chrysler North America and the growing domestic passenger vehicle market.

A new incentive policy launched by the Chinese government in 2012 aided purchases of low emission cars and fuel efficient cars. Greater unit sales and the appreciation of the Chinese RMD versus the U.S. dollar offset lower average unit prices during the third quarter of 2012.

Gross profit was $12.5 million in the third quarter of 2012 compared to $12.6 million in the third quarter last year. The gross margin was 17.1% compared to 17.8% in the same quarter in 2011 mainly due to an increase in sales volumes of lower gross margin products.

Selling expenses increased by 20% to $2.4 million and $2 million in the third quarter of 2011, which was mainly due to a greater number of sales personnel employees. As a percentage of net sales, selling expenses were 3.3% in third quarter of 2012 compared to 2.8% in the third quarter of 2011.

Generated administrative expenses declined by 20.5% to $2.5 million in the third quarter of 2012 from $3.1 million in the corresponding 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 3.4% in the third quarter of 2012 from 4.4% in the corresponding quarter of 2011.

Research and development expenses rose by approximately 12% in the third quarter of 2012 to $2.8 million from $2.5 million in the same quarter of 2011 mainly due to the continued development of the company's electric power steering systems. Expenses rose for additional R&D staff, improvement of production molds, and external technical support during the third quarter of 2012 compared to the same quarter of last year. As a percentage of net sales, R&D expenses rose to 3.8% from 3.5% in the third quarter of 2011.

Income from operations was $5.5 million in the third quarter of 2012 consistent to the $5.5 million in the third quarter last year. As a percentage of net sales, income from operations was 7.5% in the third quarter of 2012 compared to 7.7% in the corresponding period last year.

Net financial expenses declined by 69.2% to $0.4 million compared to $1.3 million for the third quarter of 2011 mainly due to lower interest expense resulting from the company's early redemption of its convertible notes. The company redeemed all outstanding convertible notes in 2012. Therefore, there was no gain or loss or change of par value derivatives associated with convertible notes for the three months ending September 30th, 2012. The gain on a change in par value derivatives was $7.8 million in the third quarter of 2011 primarily due to the company's stock price movement during the third quarter of 2011. And it was non-cash in nature.

Income before income tax expenses and equity earnings of affiliated companies was $5.3 million in the third quarter of 2012 compared to $12 million in the corresponding period last year. The decrease in income before income tax expense and equity in the earnings of affiliated companies was mainly due to a decrease in the change in fair value of derivatives as compared to the third quarter of 2011.

Income tax expense was $0.9 million for the third quarter of 2012 compared to $1 million for the corresponding quarter last year. The decrease of $0.1 million was mainly due to a decrease in income before income tax. The effective tax rate increased to 16.9% for the third quarter of 2012 from 8.3% for the corresponding period in 2011, which is primarily due to the permanent difference for the gain on change and the par value of derivatives recorded in the third quarter of 2011. Since the derivative was settled in the second quarter of 2012, we've seen a redemption of all convertible notes. There is no similar difference in the third quarter of 2012.

Net income from continuing operations was $4.4 million for the third quarter of 2012 compared to $11.1 million for the corresponding quarter of 2011. The decrease is mainly due to a decline in income before income taxes expense, and equity in earnings of affiliated companies, and lower income tax expenses of $0.1 million.

In May, 2012, CAS discontinued its operations in Zhejiang Henglong & Vie Pump Manufacturing Company. And sold its 51% equity interest in Zhejiang. Accordingly, the business of Zhejiang is recorded as a discontinuing operation. There were no net operational results from that business for the third quarter of 2012 compared to after-tax income of $0.4 million for the third quarter last year.

Net income attributable to parent company shareholders was $3.4 million in the third quarter of 2012 compared to $9 million including a $0.4 million from discontinued operations in the corresponding quarter of 2011.

Diluted earnings per share was $0.12 in the third quarter of 2012 compared to diluted earnings per share of $0.10 including diluted earnings per share of $0.01 from discontinued operations in the same quarter of 2011. The weighted average number of diluted common shares outstanding was 28 million, 268,880 in the third quarter of 2012 compared to 31 million, 503,995 in the corresponding quarter of 2011.

Nine months results, net sales for the first nine months of 2012 decreased by 0.4% to $234.5 million compared to $235.5 million in the first nine months of last year.

Nine month gross profit was $43.5 million compared to $45.1 million in the corresponding period of a year ago. Nine month gross margin was 18.6% compared to 19.2% for the corresponding nine month period in 2011.

Income from operations was $20.4 million compared to $23.5 million in the first nine months of 2011.

Operating margin was 8.7% compared to 10% for the corresponding period of 2011.

Income from continuing operations was 16.3% in the first nine months of 2012 compared to $37.8 million in the corresponding period in 2011.

Diluted earnings per share for continuing operations were $0.44 for the first nine months of 2012 compared to diluted earnings per share for continuing operations of $0.48 in the first nine months of 2011.

Net income attributable to the parent company's common shareholders including net income from discontinued operations decreased to $14.7 million or $30.3 million in the first nine months of 2011.

Diluted earnings per share was $0.52 in the first nine months of 2012 compared to diluted earnings per share of $0.50 for the corresponding period in 2011.

As of September 30th, 2012, total cash and cash in business was $72.5 million compared to $73 million as of December 31, 211.

Working capital is $123.9 million as of September 30th, 2012. Net cash provided by operations in the first nine months of 2012 was $11.4 million.

Business outlook, due to the continuing sluggish demands for automotive vehicles in the People's Republic of China, management reiterates that expectations that annual revenues will be even with that of the year 2011. This target is based on the company's current views on operating and marketing conditions

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

Question-and-Answer Session

Operator

(Operator instructions). It appears we have no questions at this time. Our first question comes from (Liang Su) of King Capital. Caller, please proceed with your question. (Liang Su), your line is live. If you’re using a speakerphone…

(Liang Su) – King Capital

Hello?

Operator

Hi.

(Liang Su) – King Capital

Hi. Hi, sorry about that. Yeah, just – at the very beginning of the presentation, you mentioned about total vehicle sales and I sort of missed that. So is that China also or is this regarding just [inaudible]? Hello?

Kevin Theiss – IR

That was a – that was an industry number that was provide.

(Liang Su) – King Capital

So those are industry numbers. Could you repeat that? Is the total vehicle sales 4% and passenger vehicles 6%, and commercial is down 9%, is that correct?

Kevin Theiss – IR

It was – I think we said 4.4% for total vehicle to 4.5 million units.

(Liang Su) – King Capital

Okay.

Kevin Theiss – IR

And then U.S. sales of passenger vehicles increased 6.7% to 3.7 million units, commercial vehicle sales were 0.8 million units, but that was down 4.4% compared to the same quarter in 2011.

(Liang Su) – King Capital

I see, I see.

Kevin Theiss – IR

One more, our Chinese commercial truck sales declined by 7.9% in the third quarter.

(Liang Su) – King Capital

Okay. In terms of the company specific, you don’t have that kind of breakdown numbers, right?

Kevin Theiss – IR

Jie?

Jie Li – CFO

Hello? Yeah, these numbers [inaudible] through China or the industry website. There is an official website called the CAAM, China Automobile Manufacturer [Inaudible] and there we are members there. So we have big numbers here. If you want to find some breakdown, I can also email you.

(Liang Su) – King Capital

Sure, sure. And you say you have seen the [inaudible] of recovery on the passenger vehicle, you know, in a quarter or…

Jie Li – CFO

Mm-hmm.

(Liang Su) – King Capital

Okay. But I’m just saying, do you have your company specific breakdown, you know, passenger versus commercial vehicles? I mean, the numbers you just provided, that’s the industry, right? But do you have them for your company specific?

Jie Li – CFO

Hold on. [Foreign conversation].

Kevin Theiss – IR

Okay, so to summarize, as you know, up to know, the Chinese commercial vehicles have experienced a severe decline in 2012. Most of those decreases is in the heavy-duty sector as well as construction-related equipment. Where we see some of the moderator growth is in passenger vehicles and that being said, it’s also in our number, our [inaudible] business are down with the industry. Our passenger vehicle business increased a bit and also because our export business has been growing very strongly.

In general, our volume in terms of [inaudible] remained the same year over year because of the economy has changed from the heavy-duty to more – towards more passenger vehicle. And so that affected our revenue.

(Liang Su) – King Capital

Okay. Hello?

Kevin Theiss – IR

Yes, any more questions?

(Liang Su) – King Capital

Yes, just in terms of geographic extension, I know you’re doing well in the North America and also trying to extending to the Latin America. Has this started yet?

[Foreign conversation].

Kevin Theiss – IR

Okay, so as you [inaudible] details of our growth in North America, which has been quite strong, let’s talk about Latin American market. Mainly it’s in Brazil. We have already started our aftermarket business over there. The volume is low at the moment, but we expect some growth there. We also actually spend more effort to develop OEM business. We have been in talk with a number of large OEMs in Brazilian markets and we pay each other visits and they have begun their due diligence and we have not got into a supply contract yet but again, as you know, OEM, it takes time to develop. But once we get into that stage, we should expect [inaudible] from those contracts.

To switch gears and talk about other emerging markets, Russia, we have been talking to some OEM there and is in the testing stage. We have some small trial orders, so you know, we look forward to develop that important market.

For India, we have some business over there and when we sign a major contract, we’ll make announcements.

(Liang Su) – King Capital

Okay, great. Thank you so much for taking my call.

Kevin Theiss – IR

Thank you.

Operator

(Operator Instructions). It appears we have no questions at this time. I would now like to turn the floor back to management for closing comments.

Kevin Theiss – IR

Our third quarter is seasonally low for the auto industry. First quarter is seasonally high in terms of revenue. So we’ll make our best effort to [inaudible], so we look forward to speaking with you when we report the fourth quarter. Thanks for joining us.

Operator

Thank you. This concludes today’s conference. Thank you for your participation.

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