China Automotive Systems, Inc. (CAAS) Q1 2016 Earnings Report, Transcript and Summary

Greetings. And welcome to the China Automotive Systems First Quarter 2016 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 introduce your host Dixon Chen. Please go ahead sir.

Thank you. Thank you everyone for joining us today. Welcome to China Automotive Systems first quarter 2016 earnings conference call. Joining us today are Mr. Hanlin Chen, Chairman, Mr. Qizhou Wu, Chief Executive Officer; Mr. Jie Li, Chief Financial Officer; and Miss. Rachel Levine, Finance Manager for China Automotive Systems. They will be available to answer questions later in the conference call with the assistance of translation. Before we begin, I’d like to remind all listeners that throughout this call, we may make statements that may contain forward-looking statements. Forward-looking statements represent the Company’s 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 Form 10-K Annual Report for the year ended December 31, 2015 as filed with the Securities and Exchange Commission on March 30, 2016, and in other documents 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 whether as a result of new information, future events or otherwise. On this call, I’d provide a brief overview and a summary of financial results for the first quarter 2016. And then I’ll turn the call over to management to conduct a question-and-answer session. The following 2016 first quarter results are unaudited; and these results are reported under the U.S. GAAP. For the purposes of our call today, I’ll review the financial results in U.S. dollars. We will begin with a review of the recent dynamics of the automotive industry in China and Chinese Automotive’s market position. According to China’s National Bureau of Statistics, China’s our 2016 first quarter sales continue to reflect lower economic growth as China’s GDP growth rate was 6.7% lower than 6.9% in 2015 and the slowest growth ever since 2009. Slower economic growth, restrained the sales of automotive deals in China to 6.2% growth in the first quarter according to China Association of Automotive manufacturers CAAM. Passenger vehicle sales grew 7.3%, but there was a significant variation in different segment basic passenger cars and cross over passenger car sales declined while sales of SUVs and MPVs sales continued to increase in the first quarter of 2016. Commercial vehicle sales grew by only 1.2% and production declined in the first quarter of 2016. The depreciation of Chinese currency RMB against the U.S. dollars in the first quarter of 2016 also caused significantly lower reported net sales as more than 80% of our business is shipped [ph] in China. Technological change also affected our sales mix in the first quarter of 2016. OEM growing adoption of electric power steering EPS impacted our sales. Our growing EPS sales comprised 27.5% of total sales in the first quarter of 2016 but this growth could not offset the reduced sales of our traditional hydraulic steering sales. International markets remained a growth area for China all the more resistance as we continue to supply Fiat, Chrysler in North America in the first quarter of 2016 with Ford in North America also using our product. Our assembly plant in Brazil is renting up its operations to supply Chinese OEMs operating in South America and penetrating the local market as well. In early October 2015, Chinese government announced a 50% reduction in sales tax to stimulate sales of few efficient passenger vehicles by encouraging the sales of vehicle with small engine displacement, energy saving and emission reduction have been -- are being realized. As the primary steering supplier to smaller cars in China, we are well positioned to benefit from this policy. We also recently announced that our main subsidiary Hubei Henglong, won the Central Government China quality nomination award. This is the government’s highest award for product quality and we won the award based on our successful management model for securing customer services and excellent product quality. After reviewing thousands of nominations CAS was one of the only five winners from auto and auto components manufacturing sector. The China quality award which takes place once in every two years is organized by the State Council and National Bureau of Quality Inspection. Additionally, Hubei Henglong sold its 51% equity control position in Fujian Qiaolong Special Purpose Vehicle Company Limited to Longyan Huanyu Emergency Equipment Technology Company Limited. We will receive a cash payment of RMB20 million and the repayment of RMB34 million loan by Fujian Qiaolong to CAAS. Longyan Huanyu has pledged its 51% equity interest in Fujian Qiaolong as security for the repayment of the loan obligation. We believe we can better use these resources to strengthen our core steering operations. Now, let me go through our financial results for the first quarter 2016. In the first quarter of 2016, net sales were $116.9 million compared to $123.4 million in the first quarter of 2015, reflecting a 5.3% year-over-year decline. This year-over-year net sales decline was mainly due to the stronger dollar against Chinese currency as we report our financial results in U.S. dollars. Gross profit was $21 million in the first quarter of 2016, compared with $21.7 million in the first quarter of 2015. The gross margin was 18% in the first quarter of 2016 versus 17.6% in the first quarter of 2015. The increase in gross margin was mainly due to a change in product mix towards higher margin at those products. Gain on other sales was $0.8 million, compared with $1.7 million in the first quarter of 2015. Selling expenses were $4.3 million in the first quarter of 2016 compared to $3.6 million in the first quarter of 2015. Selling expenses represented 3.7% of net sales in the first quarter of 2016, compared to 2.9% in the first quarter of 2015. General and administrative expenses, G&A expenses were $4.3 million in the first quarter of 2016 compared to $4.4 million in the same quarter of 2015. G&A expenses represented $3.7 million of net sales in the first quarter of 2016 and 3.6% in the first quarter of 2015. R&D expenses were $6.1 million in the first quarter of 2016, up from $5.9 million in the first quarter of 2015. R&D expenses represented 5.3% of net sales in the first quarter of 2016 compared with 4.8% in the first quarter of 2015. Net financial income was $0.3 million in the first quarter of 2016 compared with net financial income of $0.8 million in the first quarter of 2015. Income from operations was $7.1 million in the first quarter of 2016, compared with $9.4 million in the first quarter of 2015. The decrease was mainly due to the reduced revenue, lower gain on other sales and higher operating expenses in the first quarter of 2016 compared with the same quarter in 2015. Income before income tax expenses and equity in earnings of affiliated companies was $6.5 million in the first quarter of 2016, compared to $9.7 million in the first quarter of 2015. The decrease in income before income tax expenses and equity in earnings of affiliated company was mainly due to lower operating income in the first quarter of 2016 compared with the same quarter in 2015. Net income attributable to the parent company’s common shareholders was $5.7 million in the first quarter of 2016, compared to net income attributable to parent company common shareholder of $8.5 million in the first quarter of 2015. Diluted earnings per share were $0.18 in the first quarter of 2016, compared to diluted earnings per share of $0.26 in the first quarter of 2015. The weighted average number of diluted common shares outstanding was 32,131,588 shares in the first quarter of 2016, compared with 32,134,732 in the first quarter of 2015. Now let me walk you through our balance sheet highlights. As of March 31, 2016 total cash and cash equivalent, pledged cash and short-term investments were $107.4 million, total accounts receivable including notes receivable were $301.1 million, accounts payable were $216.8 million and bank and government loans were $45.4 million. Total parent company stockholders' equity was $306.3 million as of March 31, 2016, compared to $299 million as of December 31, 2015. Now let me briefly comment our business outlook, management reiterated our projected revenue for fiscal year 2016 to be $450 million. This guidance is based on company’s current view of operating a market conditions which are subject to change. With that, operator, we’re ready to begin the Q&A session.

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question today is coming from [Indiscernible]. Please proceed with your question.

Hi, I just have two questions. My first one being you’ve announced a $5 million share buyback, would you consider buying more than just the 5 million back issuers stock continues to fall below $4 or also consider management buyback? [Foreign language]

Okay, since as you know we announced the buyback plan earlier in this year and the window just opened since we just reported our first quarter results. So we are looking forward to buying back shares in the coming days and weeks. And once we -- depleted [ph] that quarter then when they are looking into and also we have to discuss [Indiscernible] whether we want to increase to continue to buy more. And in terms of management buyback yes we have been and talking currently as well to buy some share back personally.

Okay. Great thank you for that. And then my second question is clearly there is a large trend moving away from hydraulic and towards electric power steering systems, I just want to know how capable are you of converting your existing production capacity from HPS to EPS and could you give us some outlook in terms of what your future product mix looks like in terms of when you will be more fully producing EPS? [Foreign language]

So clearly EPS is the trend and that your power steering is the trend. We are -- we have been impacted heavily into that area. We are moving in tandem with the market trend as well. Now, in terms of the product itself, it is actually is -- there’s quite a bit similarity in the EPS and in the mechanic part of HPS. But you know then with EPS there's still some differences in terms of product structures. There are differences, a clear difference between the high end, the median end and low end product. But we are adjusting our production procedure according to international customers request and these all can be fulfilled. We don't think it’s issue in terms of converting the HPS production to the EPS. [Foreign Language]

So to add it to what Chairman just commented, that's CFO. To add to your first question in more quantitatively, you commented about 90% of our production line for this HPS product can be converted for the EPS production. And so, it’s a very smooth transaction. Then in terms of product mix trend and right now our EPS business accounts for 27.5% for total sales. And our goal is to reach 50% and I think -- eventually work it to 50%.

Okay. That's great. Thank you for answering those questions.

Thank you.

Thank you. [Operator Instructions] If there are no further questions at this time, I'd like to turn the floor – I'm sorry. [Operator Instructions]. Our next question today is coming from Robert Polivich of Private Investor. Please proceed with your question.

Good morning. This is Robert Polivich. How is everybody today?

Good. Thank you.

I have a couple of quick questions. I see that selling expenses for the quarter went from $3.6 million to $4.3 million and I was just wondering is that kind of a one-time events or do you see a higher selling expenses going forward. And I have some other questions, but you know if you could answer this one first? [Foreign Language]

Okay. So the increase of selling expense is mainly due to the commission that we pay for international market expansion. As you know, we expanding to this international market, we're developing relationship locally, and in those relationships through the introduction can benefit us in many years and will turn into multiyear contract. And so, we are seeing these opportunity, so we sign a one-time deal pay a lump-sum to buy off the introduction function. And then ongoing year we'll no longer need to pay the commission. And so, that amount we will in taking this year 2016 is going to be amortize as spread out between quarters, so the following two-quarter that we have a bit of these coming into our selling expenses. But however it's going to benefit also in the longer run, because our sales is going to come in from a long term contracts.

Okay. My next question has to do with -- I know you're projecting $450 million for sales for 2016. I know it's looking out in to the future, but do you feel that number will hold as we go into 2017 and what's the likelihood we will return back to a level of growth in the forecast for 2017? [Foreign Language]

Yes. It will be a noticeable improvement, increase in 2017 mainly due to few large contract is going to materialize in the fourth quarter 2016. That's our contract for Ford and Fiat and we expect 2016 fourth quarter and these contracts will go into production and that will significant change the business. And as these are especially for our relatively new business relationship and order as well.

That sounds good. I have one other question, actually probably -- its probably two. When you – we're seeing automotive, automated steering systems and I'm just wondering how does that affect you as steering systems become automated? Is that something that you will be a part of? Does it – would it help your business and what can you say about that? Well, we'll go with that question first. [Foreign Language]

To answer your question, I think your question is regarding the driverless vehicle, and Chairman, Chen answer is driverless is important direction. We are clearly identified this. We have a role to play in that area as an important steering system supplier. And so we have ramped up our R&D in that area. We're also working – we have been working with the OEMs in that area as well for the driverless technology. And overall, we think this driverless still it's in – its infancy. The future is going to be bright. However, we think its still will take some time. Legislation needs a change and we get to a point at the vehicle and the technology is ready and they want to go on highways for [Indiscernible] it becomes an issue. So, for that reason we think it's still going to take some time. However, our R&D effort and collaboration with OEM has being ongoing, so we believe that we are well-positioned when the market matures and ready.

Okay. One last question, I'll let everybody go. The existing accounts or customers that have hydraulic steering systems converting over the EPS, does China Automotive generally hold to these customers when they transition over? Are you in a good position to make sure that you don't lose any of that business? Or how has it been going? Have you lost business, because you want in a good position to supply EPS? Or you're just doing good with it? [Foreign Language]

Chairman Chen, let me just give you conclusion. So he said, there are some and some business went to competitor. However, due to our branding and quality standard as well as R&D capability track record most of our existing customers are staying with us and moving, transitioning to EPS and so that has been ongoing. And the reason being is, actually there are -- because this EPS is clearly – it’s a mature technology now and all OEM when they launching a new model they are placing the EPS into their vehicle. So, now every new model including some old models upgrade is going through that transition just in our hand give you example we have over 40 to 50 different project ongoing, the whole certification, testing inspection processes are long as you know for automotive industry and for OEM procedures, different OEMs. So, we're working with ongoing with 40, 50 different project ongoing. We may lose one or two high-end product to a competitor, but also we will gain a few from other competitors. So all-in-all we think we're in decent position.

Okay. Thank you very much for answering my questions.

Thank you. [Operator Instructions] Our next question today is coming from Jason Cooper from Stuyvesant Capital. Please proceed with your question.

Hi. Thank you for taking my questions. Firstly, could you give us a little bit more guidance into the CapEx schedule for 2016 and 2017 pertaining to the facility for Ford/Fiat as well as the facility in Brazil and anything that might occur with the transition from hydraulic power steering to electronic power steering? [Foreign Language]

Okay. So, in terms of CapEx overall this year is going to big, about $35 million in 2016, and including $10 million going to the EPS. Next we still working on the budget, it will come down, but if you want to me to give rough estimate would be $20 million, 2017.

Okay. Thank you. And I appreciate the fact that you guys are trying to reward the shareholders via to buyback program, but the official limit is low and any additional buybacks might further hurt the liquidity of the company. After I guess your CapEx ramp up what are your thoughts on the dividend? [Foreign Language]

Okay. So, the board still researching what will be the best way to reward shareholders whether its buyback or dividend. We don't have a definitive answer yet, but we are working on it and trying to see what's the best benefit for shareholders. So, once we reach a conclusion we'll make an announcement.

Great. Thank you. I'll look forward to that. That's it from me. Thank.

Thank you.

Thank you. [Operator Instructions] Ladies and gentlemen, we reached at the end of our question and answer session. I would like to turn the floor back over to management for any further closing comment.

Thank you for attending China Automotive Systems fiscal year 2016 first quarter earnings conference call. We look forward to speaking with you.

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