China Automotive Systems, Inc. (CAAS) Q2 2019 Earnings Report, Transcript and Summary

Greetings, welcome to China Automotive Systems Second Quarter 2019 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] I will now turn the conference over to your host Kevin Theiss. Thank you, you may begin.

Thank you, everyone for joining us today. Welcome to China Automotive Systems 2019 second quarter conference call. Joining us today are Mr. Qizhou Wu, Chief Executive Officer and Mr. Jie Li, Chief Financial Officer from China Automotive Systems. They will be available to answer questions later on the conference call with the assistance of translation. Before we begin, I remind all listeners that throughout this call, we will 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, 2018, as filed with the Securities and Exchange Commission on March 28, 2019, 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 or whether as a result of new information, future events or otherwise. On this call, I will provide a brief overview and summary of financial results for the 2019 second quarter. Management will then conduct a question-and-answer session. The following 2019 second quarter financial results are unaudited and are reported in US GAAP. For the purposes of our call today, I'll review the financial results in US dollars. We'll begin with review of recent dynamics of the automobile industry in China Automotive's market position. China's GDP growth in the second quarter of 2019 grew 6.2%, down from 6.4% in the first quarter of 2019 and lower than 6.7% in the second quarter of 2018. Railroads represented the slowest growth in the last 27 years. China experienced a sharp decline in exports to the United States of 8.1% for the first six months of 2019. The Chinese economy is becoming more dependent on domestic consumption. But consumers are nervous and less willing to make major purchases and the government is campaigning against pollution. New automotive emission standards, the National VI were implemented on July 1 in some provinces and Tier 1 cities to improve air quality and this resulted in restricted vehicle sales. This implementation in these areas is actually ahead of the scheduled national implementation of the new emission standards. Unit sales of passenger cars and commercial vehicles declined by 9.6% in June and 12.4% in the first six months of 2019. The Purchasing Managers Index, PMI guide the Chinese factory conditions came in at 49.4 for June below the 50 level, indicating economic growth is not reached an expansion stage according to the National Bureau of Statistics. For the month of June, Chinese factory output growth slowed again to 51.3 from 51.7 in May, while total new orders declined 49.6 from 49.8. Export orders continues to decline following the 46.3 from May's 46.5. Manufacturers continue to cut jobs in June, with the employment declining to 46.9 compared with 47 in May. According to data reported by the China Association of Automotive Manufacturers, CAAM, overall vehicle production and June reflected a 17.3% year-over-year decline, with sales down 9.6% year-over-year. For the first six months of 2019, production decline 13.7% year-over-year, compared to the same period in 2018 and sales declined by 12.4% year-over-year. In June 2019, passenger car production declined 17.2% and sales was 7.8% down compared to June of 2018. Commercial Vehicle production in June was down 17.5% and sales was down 17.8% year-over-year. In the commercial vehicles segment, the traditional internal combustion bus market continues to experience a significant year-over-year decrease in unit sales in the second quarter of 2019. Overall truck sales were down 14.1% and total commercial vehicle sales declined by 13.9%. In response to this environment the net sales of our traditional hydraulic steering products declined by 15.9% year-over-year to $83.1 million in the second quarter of 2019. This reduction reflects lower vehicle sales and market conditions in the second quarter of 2019, as well as the transfer of our EPS business with the Henglong KYB joint venture. Our electric power steering product sales in the second quarter of 2019 was $202.6 million, a 16.3% decline compared with the 2018 second quarter. As a percentage of net revenues EPS sales accounted for 21.4% in the second quarter of 2019, which was consistent with the same quarter in 2018. We believe our Henglong KYB joint venture with Japan KYB Company Limited has the potential for stronger growth among Chinese and Japanese brand new vehicles in the future. Our combined operations will increase our market position in the Chinese market for EPS products, as well as create products to enhance exports in the future. We remain optimistic for the success of our exclusive contract with Great Wall Motor Company for our EPS systems to steer us new all electric small vehicle model ORA R150. Approximately 100,000 units are expected to be shipped in 2019 under this contract. We are also optimistic about the future of our joint venture with Hyoseong Electric Company to produce small electric motors for use in EPS systems. By producing these electric motors ourselves, we have better control over the quality, production and cost of these products for our own EPS systems. Recognize our growing steering technology one of our tier one customers North America selected us to develop a new recirculating-ball steering system the i-RCB program for their autonomous vehicle project. Commercial production is expected in October 2019 with initial annual sales approximating 45,000 units. Our export sales in North America of our hydraulic steering products decreased by 3.9% year-over-year in the second quarter of 2019. We are making progress on the i-RCB program through the new recirculating-ball steering systems for that company's autonomous vehicle, so now developed 45 will be used in other products in the future. Second quarter 2019 gross margin increased to 14.4% from 13.5% in the second quarter of 2018, mainly due to changes in the product mix. We reduced our operating expenses by 14.2% in the second quarter of 2019. And income from operations in the second quarter of 2019 increased 369.2% to $2.7 million in the second quarter of 2019, compared with point $0.6 million in the second quarter of 2018. Net income attributable to parent company's common shareholders increase to $2.5 million or diluted earnings per share of $0.08, compared to net income attributable to parent company's common shareholders of $0.8 million or diluted earnings per share of $0.30 in the second quarter of 2018. As of June 30, 2019 cash and equivalents and pledged cash were $89.1 million. At the annual general meeting on July 18, 2019, Dr. Henry Lu and Dr. Tong Kooi Teo were elected as new independent members of the board of directors. They replace Mr. Arthur Wong and Mr. Robert Tung, who did not stand for re-election. For 2019 and beyond the central government has initiated a fiscal stimulus plan, including about RMB 2 trillion or $291 billion of tax cuts which is slowly affecting the economy. Other recent government actions include using the regulations for using government debt in some infrastructure projects to help boost the economy. China's National Development and Reform Commission has announced new monetary incentives to promote growth in the automobile sector for rural area consumers complying vehicles with older emissions standards to purchase more efficient, compact vehicles. The plan will subsidize replacing the cars complying with the 2017 emission standards and cars with engines of 1.6 meters or smaller in rural areas. And some state owned companies are also adding incentives to encourage the purchase of automobiles to stimulate new car purchases, including significant discounts to sell new vehicles that do not meet the new emission standards. Vehicle sales under these programs may affect future sales later in 2019. As one of the largest suppliers of high quality steering products in China, we are well positioned to benefit from new growth opportunities even as we continue to supply a number of Tier 1 vehicle manufacturers in North and South America. We ventured into joint ventures to establish better mark position in the EPS market, create a foothold and autonomous steering and gain knowledge in other emergent steering technology. We continue to be financially strong and maintain the resources to accomplish our strategic goals. Now, let me review the financial results for the second quarter of 2019. Our net sales decreased 15.9% to $105.7 million, compared to $125.8 million in the same quarter of 2018. Net sales of traditional steering products declined by 15.9% as demand weakened in the Chinese domestic brand automobile market. Additionally, the company's sales to its North American customers declined by $1.1 million. Sales of electric power steering represented 21.4% of total net sales. Gross profit decreased to $15.2 million in the second quarter of 2019, compared to $17 million in the second quarter of 2018. The gross margin was 14.4% in the second quarter of 2019, versus 13.5% in the second quarter of 2018. The gross profit decrease was mainly due to lower sales, higher unit cost and a change in product mix. Gain on other sales was $2.5 million in the second quarter of 2019, compared to $1 million in the second quarter of 2018. Selling expenses were $3.9 million in the second quarter of 2019, compared to $4.9 million in the second quarter of 2018. The decrease was mainly due to lower logistics expenses related to decreased sales during the quarter. Selling expenses represented 3.7% of net sales in the second quarter of 2019 compared with 3.9% in the second quarter of 2018. General and administrative expenses, G&A expenses were $4.4 million in the second quarter of each of 2019 and 2018. G&A expenses represented 4.2% of net sales in the second quarter of 2019 compared to 3.5% in the second quarter of 2018. The percentage increase was mainly due to reduced sales in the second quarter of 2019. Research and development expenses, R&D expenses decreased 18.5% to $6.6 million in the second quarter of 2019, compared to $8.1 million in the second quarter of 2018. R&D expenses continue to focus on the development of the company's EPS and other new products. R&D expenses represented 6.2% of sales in the second quarter of 2019, compared with 6.4% in the second quarter of 2018. Income from operations was $2.7 million in the second quarter of 2019, compared to $0.6 million in the same quarter of 2018. The increase was primarily due to a higher gain on other sales and lower operating costs. As a percentage of net sales, the operating margin was 2.6% in the second quarter of 2019, compared to 0.5% in the second quarter of 2018. Net Financial income in the second quarter of 2019 was $1.6 million, compared with $0.9 million in the second quarter of 2018. Income before income tax expenses and equity in earnings of affiliated companies increased 143.5% to $3.1 million in the second quarter of 2019, compared to $1.3 million in the second quarter of 2018. Net income attributable to parent company's common shareholders increased 196.3% to $2.5 million in the second quarter of 2019, compared to net income attributable to parent company's common shareholders of $0.8 million in the corresponding quarter of 2018. Diluted earnings per share were $0.08 in the second quarter of 2019, compared to diluted earnings per share of $0.03 in the second quarter of 2018. The weighted average number of diluted common shares outstanding was 31,499,577 in the second quarter of 2019, compared to 31,647,305 in the second quarter of 2018. Now we'll go over six months financial highlights. Net sales decreased 17.3% to $214.9 million in the first six months of 2019, compared to $259.8 million in the first six months of 2018. Six month gross profit was $29.2 million, compared to $38.7 million in the corresponding period last year. Six month gross margin was 13.6% in the first six months of 2019 compared to 14.9% in the corresponding period in 2018. The gain on other sales was $3.8 million in the first six months of 2019 compared with $2.5 million in the corresponding period last year. Income from operations was $3.8 million in the first six months of 2019, compared to $5.2 million in the first six months of 2018. Operating margin was 1.8% in the first six months of 2019, compared to 2.0% in the corresponding period of 2018. Net income attributable to parent company's common shareholders was $4 million in the first six months of 2019, compared to $5.2 million in the corresponding period in 2018. Diluted earnings per share were $0.13 in the first six months of 2019, compared to diluted earnings per share of $0.16 in the corresponding period of 2018. We will now go over some balance sheet and cash flow items. As of June 30, 2019, cash and equivalents and pledged cash were $89.1 million. Total accounts receivable including notes receivable were $255.1 million. Accounts payable were $184.1 million and short-term loans were $71.0 million. Total parent company stockholders' equity was $308.5 million as of June 30, 2019, compared to $304.8 million as of December 31, 2018. Net cash used in operating activities was $25.7 million in the first six months of '19, compared with net cash used in operating activities of $5.4 million in the first six months of 2018. Payments to acquire property, plant and equipment were $10.3 million compared with $17.3 million in the first six months of 2018. The business outlook, management has revised its revenue guidance for the full year 2019 to $430 million from $510 million. 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 now ready to begin the Q&A session.

Thank you. [Operator Instructions] Our first question is from William Gregozeski with Greenridge Global. Please proceed.

Hi guys. Sales to the North American customers fell in the quarter. What are you expecting for the remainder of 2019 and into 2020 from these customers?

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[Interpreted] Okay, the first – in the first half of 2019 our export to North America was around $55 million and we anticipate the second half sales to the North America customer will have a slight increase due to a new model of product coming out, i-RCB product that's coming out for the second half of 2019. So that will increase total sales in the second half. 2020, we see total sales in North America will be equivalent to 2019, so it's going to be similar or flat.

Okay. So we should not expect really any growth going forward on this market?

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[Interpreted] Okay. Yes. The short answer is yes, in terms of North America sales in 2020, but we would not expect increase. It will be flat compared to 2019. When you see – in terms of international sales we see the growth will be coming from other markets such as South America. We have a contract with Chrysler, sorry, with Fiat. That's a 300,000 unit shipment for 2020. Also we have a – also with the Fiat in Europe, that's another 125,000 in 2020. So these are the growth area we see internationally. Domestically in China, we see our joint venture with KYB will boost our sales. That joint venture would take off in a significant way. So we have a number of product upgrade. And so we think the EPS product in 2020 is going to be much stronger in terms of growth.

Okay, can you talk a little more about the KYB? How is the customer reaction bent to that and when will we see that business turn profitable?

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[Interpreted] Okay, so in terms of customer feedback after six – more than six months of fine tuning in our KYB joint venture, our quality – product quality has increased significantly. To give you some examples, we use some of the higher grade materials, we also did some fine tuning on the engineering and so now, in terms of quality, we have reached Japanese standard the same level of product quality standard KYB is selling in Japanese market. So with that we already received overwhelming positive feedback from our domestic Chinese customers. On the cost side also we make measures right during this period. We have made some of the cost reductions on the production side, fine-tuned to production procedures. Now, our gross margin increased from previous 13%, but we are producing to now 18%. So that's a significant improvement in terms of cost structure because of volume right now in 2019 still hasn't reached the level we invested and so we are seeing 2019 KYB joint venture is going to be a slight loss. However, we expect that will turn around to 2020 to turn profit. So that will be a boost in 2020s business.

Okay, alright. And last question is, with the overall sales falling, why are we still seeing the inventory increase?

Say the quick question again?

The sales are falling and obviously the guidance is for lower sales in the near future, but the inventory is still increasing from previous levels. Why is that?

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[Interpreted] Okay to answer your question, it's mainly due to – the inventory increase is mainly due to the product mix, shift and product – our sales structure or our product mix has changed during the quarter. However, we don't see this inventory increase as significant. We increased from 88 million at end of the year to 90 million now in terms of inventory. These are mainly shifting from some of the components we used to use for hydraulic products and now we're moving to other kinds of products. And we believe this is a natural change because we are – in response to the market, we are shifting our sales mix to adapt to the market trend. So I will not worry about the inventory at the moment.

Okay, well, with the lower guidance, I mean, is there any risk then that some of the products you might have on hand, you might need to do like a larger write off later this year?

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[Interpreted] Okay. We do have appraisal evaluation on inventory every quarter and whatever we need to do to make the provision, it's already been done and there's no more provision is needed in terms of inventory at this moment. So to answer your question, we don't see any further write down coming.

Okay. Thanks.

Thank you.

Thank you.

Our next question is from Robert Povich [ph], private investor. Please proceed.

Yes. Good morning. I have a couple of questions. The first is the Hyoseong joint venture for the electric motors. I was wondering where you are in regards to production? I know they were building a plant I think for this product. I guess what stage are we in with that and will these motors ultimately be sold to, I guess, other companies making electric power steering systems? It's just a thought, but I'm thinking that that might be the case.

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[Interpreted] Okay. So the Hyoseong joint venture in terms of status right now, the workshop, it has been completed and construction of the workshop or the production factory has been completed. Now we're doing the interiors at this moment. We believe it will be done by the end of October. At the meantime, the equipment we ordered will be coming in from Korea during that time. And we will start trail production probably at the end of October. And we'll have prototype coming out during that time as well in the fourth quarter and our plan is to launch mass production in March 2020. So that's the general plan in terms of Hyoseong joint venture.

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[Interpreted] To your question on future sales of electric motor from this joint venture to other companies EPS producers. Yeah, the short answer is yes. Our design capacity for the joint venture is 3 million units’ annual production. With the Phase 1, we're aiming at 1 million units. In Phase 1 that 1 million units will be mainly used internally for CAAS EPS product. The remaining of the additional 2 million coming online, we'll decide and a big portion of that will be used for sales to other EPS producers.

Okay, I appreciate those answers. My next question is regarding, I guess the US market, North America and Brazil. I know Brazil you have some operations. You're assembling, I don't know what the extent is products at that location. In light of everything going on with the US and trade issues what would a good strategy be at this point to make sure that you continue to develop and grow in the North American market?

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[Interpreted] Okay. So we – yes, in terms of trade issues, ongoing trade issues, we have extended conversation with our customers in North America in terms of specifically on how we going to tackle the incremental part of it. So we have made some positive progress in terms of our negotiations – our discussion of our customers on how we going to share the increase of tariff. We remain optimistic. We'll have some resolution coming. And in terms of your comment on South America, in particular Brazil market, we have increased our capacity in Brazil. As we mentioned earlier, in 2020, we have already on an order book from Fiat, South America, 300,000 units. That's for 2020. And so we are increasing South America, in particular, Brazil facilities production. And we're hoping that will also help us to become another route to the US market, as most of the product will be produced locally in Brazil. In terms of other locations, we're looking at Canada and possibly Malaysia as well. These countries are not in a crosshair of the trade district. So we are working on some of the markets to develop another solution. So that being said, we think we'll – we are making progress, we are making strategic planning to diversify as well as to maintain our growth prospects in North America and other international markets.

Okay, thank you. And I had another question and it has to do with – back in the fall, I guess there was a go private proposal and that was told for China Automotive to become a privately owned company. Just wondering where are we or where is China Automotive at this point in their position? Are they committed to remaining a public company at this point? And if so, the company did have a share buyback in effect. Is that something that will still be ongoing? And those are my final questions. Thank you.

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[Interpreted] There's no further plan or intention to go private as far as we heard from large shareholders. And we are committed to be a US listed Chinese – a US listed company. In terms of the share buyback, as you may have heard in the past quarters and even a year also, Chinese government has implemented very strong capital control restrictions for capital to leave China. The whole processes become longer in terms of application, but we have – coming to a point, we believe our process of application for capital to come out to do share buyback has reached a point and we should see that our fund will get approved in the near future. And so with that, we will resume our share buyback as we announced in the past. Yeah, so that's part of the plan.

Okay, thank you for answering those questions. I appreciate it.

Thank you

[Operator Instructions] That concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.

Thanks for participating in today's conference call. We look forward to speaking with you again.