SORL Auto Parts (SORL) Management on Q1 2016 Results - Earnings Call Transcript

| About: SORL Auto (SORL)
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SORL Auto Parts, Inc. (NASDAQ:SORL) Q1 2016 Results Earnings Conference Call May 16, 2016 8:00 AM ET

Executives

Dixon Chen - Grayling

Jinrui Yu - Chief Operating Officer

Min Kan Lin - Accounting Manager

Raymond Lin - Investor Relations

Phyllis Huang - Investor Relations

Analysts

William Gregozeski - Greenridge Global

Peter Siris - Private Investor

Operator

Greetings, and welcome to the SORL Auto Parts 2016 First Quarter 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.

I'd now like to turn the conference over to Dixon Chen. Thank you. Dixon, you may now begin.

Dixon Chen

Thank you. And thank you for joining us today, and welcome to SORL Auto Parts’ 2016 first quarter earnings conference call. Joining us today are Ms. Jinrui Yu, SORL’s Chief Operating Officer; Mr. Min Kan Lin, Accounting Manager; Mr. Raymond Lin, Investor Relations and Ms. Phyllis Huang, Investor Relations.

Before we begin, I would like to just remind all listeners that throughout this call, we may make statements that may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words believe, expect, anticipate, project, target, optimistic, intend, aim, will, or similar expressions are intended to identify forward-looking statements. All statements other than statements of historical fact are statements may be deemed forward-looking statements. These forward-looking statements are based on current expectations or beliefs, including but not limited to, statements concerning SORL Auto Parts’ operations and its financial performance and conditions.

SORL Auto Parts cautions that these statements, by their nature involve risks and uncertainties, and actual results may differ materially depending on a variety of important factors, including those discussed in SORL Auto Parts’ reports with the Securities and Exchange Commission from time to time. SORL Auto Parts specifically disclaims any obligation to update the forward-looking information in the future.

In 2016 first quarter results discussed on today’s call are unaudited numbers. All numbers are presented in U.S. dollars under the U.S. GAAP. Ms. Jinrui Yu, SORL's Chief Operating Officer, will give an overview of the operations for the first quarter of 2016 then I'll return to give the financial results. Thereafter, there will be a question-and-answer session conducted.

Ms. Yu, please begin your prepared remarks.

Jinrui Yu

Thank you, everyone. Thank you for joining us today. The first quarter of 2016 continues to affect slower economic growth according to National Bureau of Statistics. China GDP growth leads for 6.7% which is lower growth since 2009. The lower rate compares with 6.8% in the 2015 fourth quarter and the 6.9% for the 2015 year.

Slower economic growth caused the sales of automobiles in China to grow at 6.2% rate in the first quarter according to the China Association of Automobile Manufacturers.

Passenger vehicle sales grew by 7.6% and the truck sales grew by only 1.12% with a decline in production in the first quarter of 2015. The heavy-duty trucks sales increased by 10% in the first quarter with a 12.2% decline in the fourth quarter of 2015. In this environment our net sales for the first quarter of 2016 increased by 3.1% year-over-year to US$53.8 million.

Domestic OEM revenues increased year-over-year by 8.9% to US$28.2 million, mainly due to higher truck sales in the first quarter of 2015. Aftermarket sales in China increased to 6.5% year-over-year to US$13.2 million.

Revenues from international markets decreased to 10.1% year-over-year to US$12.5 million. Currently devaluation of RMB also lowered sales, as a large majority of our total sales are in RMB, but we report financial results in US dollars.

In the first quarter of 2016 our gross profit increased by 5.2% from US$13.7 million and our gross margin increased to 26.8% from 26.3% compared to the three months ending March 31, 2015. This increase results from the vehicles [ph] sales of our higher margin products in the first fiscal quarter of 2016. This remains amongst the highest gross margin in the industry.

In the monetary side, the People's Bank of China has lowered interest rates, fixed cost beginning in November 2014 and reduced the reserve requirement ratio for banks. Perpetually as a result of prior government exchange segments of China's economic private encouragement in the first quarter of 2016, the first quarter fixed asset investment to grow by 10.7% year-over-year.

In March 2016, industrial output increased 6.8% year-over-year. Also in March the official manufacturing Purchasing Managers Index depends to the growth for the first time since July 2015.

Here our latest growth and our confidence in our long-term growth potential, we entered into the purchase agreement with Ruili Group Company Limited, as a related party under common control with so to expand our production capacity and the capability with the agreement we are basically working our current plan use right and the facilities for a larger location on to buy the Ruili Group, as the total floor area we will be expanded from 58,714 square meters at the current location to 157,619 square meters in the future location to provide more manufacturing and service capacity.

The special allowance evaluation of the property value by the leading international financial company, there is price difference of RMB US$501 million between the two properties. We are also currently leasing 89,229 square meters from the Ruili Group which will be terminated upon the completion of the purchase.

Now, let me turn the call to Dixon. Thank you.

Dixon Chen

Thank you, Ms. Yu. Now I will briefly review the results for the first quarter. For the first quarter of 2016, net sales increased by 3.1% to $53.8 million from $52.2 million in the 2015 first quarter.

Revenues from the company's domestic OEM customers were $28.1 million, an increase of 8.9% from $25.9 million in the first quarter of 2015. The higher OEM sales were mainly due to higher truck sales in the first quarter of 2016.

Total truck sales were up by 1.1% led by a sales increase of 6% in the heavy-duty segment. Aftermarket sales in China grew by 6.5% to $13.2 million for the first quarter of 2016, compared with $12.4 million for the same period 2015.

New vehicle sales in China and the expiration of their OEM warranties assisted our aftermarket business growth. New product sales increased in the 2016 first quarter due to the sales in both Chinese OEM market and Chinese aftermarket.

Revenues from international markets decreased by 10.1% to $12.5 million, compared with $13.9 million in the first quarter of 2015 due to lower truck production and currency depreciation in several overseas markets.

The gross profit for the first quarter of 2016 increased by 5.2% to $14.4 million from $13.7 million a year ago. Gross margin was 26.8% compared with 26.3% in the first quarter of 2015.

In the first quarter of 2016, operating expenses increased 45.5% to $14.2 million from $9.8 million in the first quarter of 2015. The increase reflected higher selling and distribution, and G&A and research and development expenses. As a percentage of revenue, operating expenses were 36.4% in the first quarter of 2016, compared with 18.7% in the first quarter of 2015.

Selling and distribution expenses were $5.6 million, or 10.3% of quarterly revenues, compared with $5.4 million, or 10.3% a year ago. The higher selling and distribution expenses were mainly due to increased freight expense and packaging expenses.

General and administrative, G&A expenses in the first quarter of 2016 were $6.9 million, or 12.9% of quarterly revenues compared with $2.7 million, or 5.2% of total revenues in the first quarter of 2015.

The increase in G&A expenses was mainly due to the increase in allowance for doubtful accounts during this quarter. As the majority of customers are large State-Owned Enterprises, SOEs with a long standing history with SORL.

The company is not only confident on the full collection of these outstanding receivables, but also has demonstrated proven track records in collecting aged receivables.

Research and development, R&D expenses were $1.7 million in the first quarter of 2016 compared with $1.7 million in the first quarter of 2015. As a percentage of revenue, R&D expenses were 3.2% in the first quarter of 2016 compared with 3.3% of revenue in the first quarter of 2015. Financial expenses were $0.2 million in both the first quarter of 2016 and 2015.

Income before income taxes was $0.4 million for the first quarter of 2016, compared with $4.2 million in the same quarter of 2015. The decrease in income before income taxes reflected higher operating expenses during the first quarter of 2016 compared with the first quarter of 2015. The pretax income margin was 0.8% in the first quarter of 2016, compared with 8% in the first quarter of 2015.

The provision for income taxes was a positive gain of $0.03 million in the first quarter of 2016, compared with an expense of $1 million in the first quarter of 2015. The gain in the first quarter of 2016 was mainly due to subsidies from local government and companies ongoing R&D programs.

Net income attributable to stockholders in the first quarter of 2016 was $0.4 million, or $0.02 per basic and diluted shares, compared with $3.1 million, or $0.16 per basic and diluted share a year ago.

Now, let me walk you through our balance sheet highlights. As of March 31, 2016, the company had cash and cash equivalent and short term investments of $64.6 million compared to $91.2 million on December 31, 2015.

Inventory was $68.2 million compared with $73.7 million on December 31, 2015. Short-term bank loans were $17.4 million compared to $23.4 million on December 31, 2015. Total equity increased to $224 million at March 31, 2016 compared with $222.4 million at December 31, 2015. On March 31, 2016, working capital was $172 million with a total current ratio of 2.8 to 1.

Before we go into the discussion of the outlook of the remaining of the year, we will like to review some key recent events. On May 5, 2016 we grew our principal operating subsidiary, Ruili Group Ruian Auto Parts Company Limited, entered into a purchase agreement with Ruili Group Company Limited, a related party under common control with us pursuant to which we agreed to purchase a land use right and factory facilities located in the Ruian Development Zone.

In exchange for the Development Zone facility, we will transfer to the Ruili Group land use right of Dongshan factory facility that we currently own, plus RMB501 million in cash. The cash consideration in the amount of RMB481 million will be paid to the Ruili Group before June 30, 2016, and the remaining RMB20 million will be paid within 10 days of completion of the required procedures in the purchase agreement.

The market valuations of the Dongshan Facility and the Development Zone Facility have been recently assessed by the leading independent appraiser company, DTZ/Cushman & Wakefield respectively.

The total floor area of the Dongshan Facility was 58,714 square meters compared with the total floor area of the Development Zone Facility of 157,619 square meters, which will provide more manufacturing and service capacity to support to our future growth.

Now let me review our business outlook. For the fiscal year 2016, management reiterates that it expects net sales to be approximately $200 million and net income to be approximately $11.5 million. These targets are based on the company's current views on the operating and market conditions, which are subject to change.

The recent growth in the overall commercial vehicle business, as well as truck business and especially the important heavy-duty truck segment, provides optimism for the future. We are adding more advanced braking products to provide more solutions to fulfill our customer’s needs and attract new customers. With our new facility, we are adding capacity and ability to better control our costs,

With that, we'll now open the floor for questions. Operator?

Question-and-Answer Session

Operator

Thank you. We’ll now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question is coming from the line of William Gregozeski with Greenridge Global. Please go ahead with your question.

William Gregozeski

Hi, guys. Can you talk about why the sales guidance was cut $20 million for the year, I mean, over 10% for the rest of the year for the last three quarters that is cut. And then why the net income guidance was less from the previous guidance?

Dixon Chen

[Foreign Language]

Jinrui Yu

[Foreign Language]

Dixon Chen

We don’t believe we have changed our guidance, but we'll double check and we'll come back to you on that. And that’s a claim to managements review.

William Gregozeski

Okay. It should – they will be about 220 from last time?

Jinrui Yu

Yes, 220.

William Gregozeski

Okay. And then the net income results have been pretty volatile recently just because of the allowance for doubtful accounts. You know you noted that you are confident you'll get repaid on that and I know in the past you've talked about you wanted to be conservative with the accounting to provide for the allowance.

But as, I mean, how do you value or judge when to make that allowance, if you are confident they will be recovered just because of the big swings you have in that – result in net income?

Dixon Chen

Okay. [Foreign Language]

Jinrui Yu

[Foreign Language]

Dixon Chen

Yes. So the truck business, the supply incident on our truck OEM business is very cynical. And if you look it on the full year basis, the first cycle we mean the high seasons is actually first quarter and plus April. So January through April we're very busy taking orders from OEM, plus their payments have been commenced until September.

So that’s why in the first quarter we have to take them all under bad debt provision, when – because our sales which is also booking off results in new orders, and a lot of collection will happen in month of September then of course at the end of the year you will see the G&A expenses start come down and even having a reverse, a major reverse fourth quarter.

William Gregozeski

Okay. I mean, if that’s kind of how they do it, and you know, that’s kind of how its done in the past, why even make that allowance for doubtful and make the first quarter look so bad on the surface?

Dixon Chen

Yes. [Foreign Language] So we basically strictly follow the accounting rule, the US GAAP and it goes by, the receivable is aged over 180 days and then we have to go through bad debt provision. So we understand that situation very well, but not something we can change it. So we just follow the same rule there.

William Gregozeski

Okay. All right. There was $18.7 million advance through a related parties, is that tied to the real estate deal or what was that cohort?

Dixon Chen

[Foreign Language] Yes, it’s related – it was arranged as a down payment for that transaction.

William Gregozeski

Okay. And then can you just talk a little bit more why SORL was doing that real estate deal, you know, how just you can use up all the company's cash, so I am just curious what the incentive for the company and shareholders it is for using it for that transaction versus something like a dividend or a buyback?

Dixon Chen

[Foreign Language]

Jinrui Yu

[Foreign Language]

Dixon Chen

In the last number of years we have experienced very strong growth. We expanded our facility also, in ways it will suffer of a shipment to the customer. And our current facilities we were still in the process of receiving the land title from the local government, although we have legally – we are the legal owner of that property.

And however, and with the growth of the operation, we are – we have already exceeded the capacity of that facility. We are reaching out to our related party Ruili Group to rent out their – rent some of their facility.

And so – and with their help and we are expanding money on rental and so we figured if we need that space we should start seriously considering and acquiring that bigger space to move everything together. And that was the main reason.

William Gregozeski

Okay. All right. Thank you.

Operator

Thank you. And there are no additional questions at this time. I'd like to turn the floor management for further remarks.

Dixon Chen

Okay. Thank you for attending SORL's first quarter 2016 earnings conference call. And today's call is relatively short. If you have any questions, feel free to reach out to us and we will look forward to speak with you. And for one more time I will ask operator to poll the question once again and if there is no further questions then we'll conclude today's call. So Bob, can you just poll the question one more time to see anybody else…

Operator

Yes. [Operator Instructions] Dixon, we have a question coming from the line of Peter Siris, a Private Investor. Peter, ask your question.

Peter Siris

Thank you. I have a couple questions, but first I'd like to follow up on the last question about the real estate. So this means that you are going to have – am I correct in assuming that you will then have much larger facilities than you currently have, is that correct?

Jinrui Yu

Yes.

Dixon Chen

Yes.

Peter Siris

And you will purchase no – you are betraying cash, how will you will be financing this purchase, cash, debt, so this will - how do you finance it?

Dixon Chen

[Foreign Language]

Jinrui Yu

[Foreign Language]

Dixon Chen

Okay. Majority will be a cash payment with a little bank loan.

Peter Siris

Okay. So in the short term this will be negative to your earnings, obviously because you are paying cash towards - and that’s incorporating the value, so is that correct?

Dixon Chen

[Foreign Language]

Jinrui Yu

[Foreign Language]

Dixon Chen

[Foreign Language] Yes, Peter, to answer your question, this transaction should not affect and any impact to the P&L, what we also…

Peter Siris

Well, hold on, expect that if you have less cash you get less interest, I mean, the finance - so just on the financing cost, there is got to be some impact on financing cost?

Dixon Chen

Okay. [Foreign Language]

Jinrui Yu

[Foreign Language]

Dixon Chen

So, yes, because of the changes in the cash balance and yes because of the changes in the bank facility we'll have some impact. However, we are also renting facilities from Ruili Group, Affiliate Company, a related company and we are currently renting - leasing 89,000 square meter space from Ruili Group already because we have a shortage of space for all operations.

And with this purchase and add properties transfer we were going to terminate that lease which will save us a leas income - the lease expense, and the lease itself because of regulation and everything, local government has some minimal lease price. So it’s a cost, we have done our math, so we think that lease is lot more expensive and the interest impact of financial income.

Peter Siris

Okay. Link by. Now what I want to understand is, after this how much will increased production space will you have compared to what you have now?

Dixon Chen

[Foreign Language]

Jinrui Yu

[Foreign Language]

Dixon Chen

Yes, with this purchase and the incremental change with the Kaisa [ph] facility, we feel it’s about – the rough math is about 30%, 40% increase for the capacity.

Peter Siris

Okay. So now the question I wanted to ask, which is that, I know I am asking lot of questions to get here, a 40% increase says that you think you can grow your business substantially, we've come off couple of flattish years, can you tell us why, you know, in what areas you think you can grow and why this is a good time to think about significantly expanding your business?

Dixon Chen

[Foreign Language]

Jinrui Yu

[Foreign Language]

Dixon Chen

The growth area, we see that definitely the growth area is a new energy or we call it an EV…

Peter Siris

Right.

Dixon Chen

Electric vehicles. We are already growing rapidly in the bus, electric bus area. The next step we want to march into the passenger vehicle sector and now the passenger vehicles business, electric passenger vehicles sector and you know those are much a bigger market in terms of size and then in commercial vehicle.

And the OEM, this EV - passenger vehicle EV OEMs they have – always has a very high standard in the facility and for their suppliers. So we are definitely ramping up that facility to meet their requirements to start booking orders.

Jinrui Yu

[Foreign Language]

Dixon Chen

In addition to that, we are currently outsource some of the components and the production, and now however with this new capacity and new space we are planning to bring these productions of those components in the packing house and that will help us to further improve our margins and increase synergy between the full production line.

Peter Siris

Great. Its safe and I am really glad I asked these questions. Now I understand the whole thing with the buildings. Thank you very much.

Jinrui Yu

Okay. Thank you, Peter.

Dixon Chen

Thank you.

Operator

Thank you. There are no additional questions at this time.

Dixon Chen

Thank you.

Jinrui Yu

Thank you.

Dixon Chen

Thank you for attending 2016 first quarter SORL earning conference call. We look forward to speaking with you. Thank you.

Jinrui Yu

Thank you. Bye.

Operator

Thank you.

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