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Edited Transcript of CAAS earnings conference call or presentation 9-Nov-18 1:00pm GMT

Q3 2018 China Automotive Systems Inc Earnings Call

Jingzhou Dec 5, 2018 (Thomson StreetEvents) -- Edited Transcript of China Automotive Systems Inc earnings conference call or presentation Friday, November 9, 2018 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jie Li

China Automotive Systems, Inc. - Chief Financial Officer

* Kevin Theiss

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Conference Call Participants

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* Peter Halesworth

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Presentation

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Operator [1]

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Greetings, and welcome to the China Automotive Systems' Third Quarter 2018 Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Kevin Theiss, Investor Relations. Thank you, Mr. Theiss. You may begin.

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Kevin Theiss, [2]

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Thank you, everyone, for joining us today. Welcome to China Automotive System's 2018 Third Quarter Conference Call. Joining us today are Mr. Jie Li, Chief Financial Officer of China Automotive Systems. He will be available to answer questions later in the conference call with the assistance of translation.

Before we begin, I would 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, 2017, as filed with the Securities and Exchange Commission 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 will provide a brief overview and summary of financial results for the 2018 third quarter and 9-month periods. Management will then conduct a question-and-answer session. The following 2018 third quarter financial results are unaudited and the fiscal year results are audited. These results are reported under U.S. GAAP. And for the purposes of our call today, I'll review the financial results in US dollars. We will begin with a review of the recent dynamics of the automotive industry and China Automotive's market position.

For the third quarter 2018, China's GDP growth slowed to 6.5% from 6.7% in the second quarter and 6.8% in the first quarter of 2018. This number represents the weakest growth since the first quarter of 2009. Industrial production in the month of September grew by 5.8%, but was below Reuters' expectation of 6%.

According to the China Association of Automobile Manufacturers, China's vehicle sales fell 11.6% year-over-year in September 2018, the steepest decline in nearly 7 years. That drop followed a year-over-year sales decline of 3.8% in August and a drop of 4% in July. Passenger car sales fell 12% year-over-year to $2.1 million in September, resulting in a third quarter sales decline of 7.6% year-over-year. Commercial vehicles declined approximately 2.2% year-over-year with both bus and truck sales down in the third quarter of 2018.

For the 9-month period ended September 30, 2018, vehicle sales in China rose 1.5%. Passenger vehicle sales totaled $17.6 million for a 0.6% year-over-year gain. Commercial vehicle sales were $3.2 million, up 6.3% year-over-year. In the first 9 months of 2018, sedan sales were up 1.29% year-over-year, SUV sales were up 3.9% year-over-year and MPV sales were down 13.16% year-over-year.

Credit curves have made car loans more difficult and the falling stock prices on Chinese exchanges have impacted consumer confidence. In addition, in 2018, the vehicle tax levy was raised from 7.5% to its former standard of 10%. Slower economic growth combined with these specific actions affected passenger vehicle sales in the third quarter and 9 months of 2018.

Net sales of our traditional hydraulic steering products continue to anchor our sales in the third quarter of 2018. Hydraulic steering products sales declined by 1.7% due primarily to softness in the domestic branded passenger vehicle market. Net sales of our electric power steering products for the third quarter of 2018 declined to $21 million from $25.7 million in the same period last year and accounted for 18.7% of total sales revenue. We will quickly penetrate the domestic Chinese and export markets for electric power steering systems. We established a new joint venture, Hubei Henglong KYB Automobile Electric Steering System Company Limited, or known as Hubei KYB, with a subsidiary of Japan KYB Company Limited for the development and production of EPS systems.

Specific product categories include column type electric power steering systems, gear type electric power steering system and rack type electric power steering systems and other automotive EPS products. CAS and Japan KYB are transferring all their current Chinese EPS business, including KYB Japanese customers in China, to Hubei KYB. Japan KYB has been engaged in the development and manufacturing of EPS systems for 30 years. The rights to the EPS technologies of both parties are being transferred to the new joint venture with full technical support. We've already conducted a ground-breaking ceremony for the new facility at our production headquarters in Jingzhou city. We are highly optimistic that our new joint venture will quickly develop the market EPS products to enhance our markets share in China and build stronger export sales and become a larger supplier to the world's automotive market.

Our net export product sales to North America rose by 22.2% to $30.3 million and sales to both Fiat Chrysler North America and Ford remained robust in the third quarter of 2018. The products sold to our North American customers are advanced hydraulic steering. We believe we may be able to introduce new products using more advanced hydraulic features or products based on other technologies as well.

In addition, we continue to believe that our Brazilian assembly operation, which serves our global Tier 1 customer in Brazil and Chinese OEM operating in the region, has a bright future.

Our gross margin was 13.7% compared with 19% in the same quarter of 2017. This decline was mainly due to higher raw material cost and a change in the product mix. As part of our drive to control costs and improve efficiency, we lowered our selling, general and administrative and R&D expenses by 22.6%.

Our income from operations was $1.8 million in the third quarter of 2018 compared to $4.9 million in the same quarter of 2017. The decrease was mainly due to lower gross profit. Our diluted net income attributable to the parent company's common shareholders per share was $0.01 from $0.16 in the third quarter of 2017. We continue to invest in research and development with almost $7 million invested in the third quarter of 2018 compared to $9.2 million in third quarter of 2017. The lower R&D expenses were mainly related to more strict cost controls and transfer of our electronic power steering research projects to our new joint venture for electronic power steering. In addition to our EPS technology, our R&D is also developing other new products, such as our advanced driver assistance systems, ADAS, for the future.

At September 30, 2018, we had cash, cash equivalents, pledged cash and short-term investments of $144.1 million. During the third quarter, cash flow from operations was $9 million with capital expenditures of $24.3 million mainly to enhance our EPS production capabilities.

To provide an incentive to buy new vehicles, China's top economic planning body has proposed cutting the tax levied on car purchases by half to 5% with the vehicles that have engines no bigger than 1.6 liters. No decision has been made on the proposal or implementation, but the automotive industry is one of the most important in China, employing many people. The Chinese government has cut the tax in the past and successfully spurred the purchase of new vehicles.

We announced that the special committee of the board of directors received a letter dated August 16, 2018, from the buyer withdrawing its non-binding going private proposal. In the withdrawal letter, the buyer stated that considering the recent market conditions, they had decided to withdraw the proposal and immediately terminated any further discussions with the company regarding going private. As such, China Automotive Systems will remain a public company going forward. We are well positioned with our broad product portfolio of hydraulic steering products as we supply to more than 60 customers. Our prestigious customer list is clear evidence of the high-quality performance and reliability of our steering products. International operations in North and South America are growing. We believe our new EPS joint venture will bear significant returns and increase our market share in China as well as open new doors internationally in the future.

Let me review the financial results for the third quarter of 2018. Our net sales were $112.1 million compared to $118.4 million in the same quarter of 2017. The decrease in net product sales was mainly due to a change in the product mix and lower domestic sales volume due to softer demand in the Chinese domestic brand automobile market.

Net product sales to North America grew 22.2% to $30.3 million compared to $24.8 million for the same quarter in 2017. The increase in export sales to North America was mainly due to higher sales of the company's more advanced products. Gross profit was $15.4 million in the third quarter of 2018 compared to $22.5 million in the third quarter of 2017. The gross margin was 13.7% compared to 19% for the same period of 2017 mainly due to an increase in the cost of raw materials and the changes in product mix.

Selling expenses were $3.4 million in the third quarter of 2018 compared to $4.5 million in the third quarter of 2017. Lower selling expenses were mainly due to lower unit sales as well as utilizing lower cost shippers. Selling expenses represented 3% of net sales in the third quarter of 2018 compared to 3.8% in the third quarter of 2017.

General and administrative expenses were $3.7 million in the third quarter of 2018 compared to $4.4 million in the same quarter of 2017. The decline was primarily due to lower personnel expenses. G&A expenses represented 3.3% of net sales in the third quarter of 2018 compared with 3.7% in the third quarter of 2017.

Research and development expenses were $7 million in the third quarter of 2018 compared to $9.2 million in the third quarter of 2017. R&D expenses represented 6.2% of net sales in the third quarter of 2018 compared with 7.8% in the third quarter last year. The lower R&D expenses were mainly due to greater cost controls over R&D expenditures and the transfer of some research projects to our new joint venture, Hubei KYB, for electronic power steering.

Net financial income was $0.8 million in the third quarter of 2018 compared to net financial income of $1 million in the third quarter of 2017. Income from operations was $1.8 million in the third quarter of 2018 compared to $4.9 million in the same quarter of 2017. The decrease was mainly due to lower gross profit and lower gross margin.

Income before income taxes and equity in earnings of affiliated companies was $1.8 million in the third quarter of 2018 compared to $5.7 million in the third quarter of 2017. The decrease in income before income tax expenses and equity in earnings of affiliated companies was mainly due to lower operating income in the third quarter of 2018 compared with the third quarter of 2017. Net income attributable to parent company's common shareholders was $0.4 million in the third quarter of 2018 compared to net income attributable to parent company's common shareholders of $5.1 million in the third quarter last year.

Diluted earnings per share were $0.01 in the third quarter of 2018 compared to diluted earnings per share of $0.16 in the third quarter of 2017. Weighted average number of diluted common shares outstanding was 31,645,556 in the third quarter of 2018 compared to 31,644,271 in the third quarter of 2017.

Let me go over the results for the first 9 months of 2018. Our net sales in the first 9 months of 2018 were $371.9 million compared to $355.3 million in the first 9 months of 2017. 9-month gross profit was $54 million compared to $68.2 million in the corresponding period last year. 9-month gross margin was 14.5% compared to 19.2% for the corresponding period of 2017. For the 9 months ended September 30, 2018, gain on other sales amounted to $3 million compared to $5.9 million for the corresponding period in 2017. Income from operations was $7 million compared to $23.2 million in the first 9 months of 2017. The operating margin was 1.9% compared to 6.5% for the corresponding period of 2017. Net income attributable to parent company's common shareholders was $5.5 million compared with $19.7 million in the corresponding period last year. Diluted earnings per share were $0.17 in the first nine months of 2018 compared to diluted earnings per share of $0.62 for the corresponding period in 2017.

Our balance sheet highlights. As of September 30, 2018, total cash, cash equivalents, pledged cash deposits and short-term investments are $144.1 million. Total accounts receivable, including notes receivable, were $249.6 million. Accounts payable, including notes payable, were $196.6 million and short-term loans were $70.9 million. Total parent company's stockholders' equity was $309.5 million as of September 30 compared to $306.1 million as of December 31, 2017. Net cash flow from operating activities was $9 million in the first 9 months of 2018.

Management -- the business outlook. Management has reduced its revenue guidance for the full year 2018 to $510 million from $520 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're ready to begin the Q&A session. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of [Robert Paulovic], a private investor.

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Unidentified Analyst, [2]

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I had a couple of questions here. And of course, we feared the gross margins really have come down, and I guess that's as you indicated, the higher cost of raw materials. I'm just wondering, what's the time frame for getting price increases on new contracts to cover the cost of raw materials. Do you think that's something that can be passed on without too much difficulty? And will that be the plan as we move into 2019?

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Unidentified Company Representative, [3]

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Okay, thank you. (foreign language)

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Jie Li, China Automotive Systems, Inc. - Chief Financial Officer [4]

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(foreign language)

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Unidentified Company Representative, [5]

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Okay. Basically, raw material cost increase is only one of the factors affecting the gross margin depreciation -- gross margin decline. The other 2 factors are basically the product mix. During the third quarter 2018, we're increasing the sales of lower-margin mechanic steering products. So due to the increase of those products are affecting our blended gross margin. And also the last factor is the increase of warranty expenses. And so combining raw material and product mix and warranty expenses, those 3 factors are -- will see a pressure of the gross margin. In the past, we were able -- for instance, the gross margin -- the gross -- the raw material challenges increase is not the first time. In the past, we were able to pass some of the pressure to our suppliers, some of the raw material suppliers, were able to negotiate with it. But this year, because they are going through some challenges as well, so we're not able to do it during this quarter. But in the longer run, we believe we're able to renegotiate with them -- the raw material procurement costs as we are a large-volume buyer.

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Jie Li, China Automotive Systems, Inc. - Chief Financial Officer [6]

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(foreign language)

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Unidentified Company Representative, [7]

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Okay. Go ahead.

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Unidentified Analyst, [8]

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Okay, thanks. Let's see, I see that the joint venture, I guess, the signing of the start-up was in September. And I was looking at KYB's reports and it looks like the startup volume is about USD 175 million combined and as we move into 2020, the projection is for about USD 307 million from the combined joint venture, which is an increase of about USD 130 million. I'm assuming that the ramp-up of this new business will -- is happening now. And what can you say about the projections for growth over the next year to 2 years?

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Unidentified Company Representative, [9]

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(foreign language)

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Jie Li, China Automotive Systems, Inc. - Chief Financial Officer [10]

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(foreign language)

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Unidentified Company Representative, [11]

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Okay. Assuming the EPS is the (foreign language).

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Jie Li, China Automotive Systems, Inc. - Chief Financial Officer [12]

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(foreign language)

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Unidentified Company Representative, [13]

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So Robert, the projection you mentioned for joint venture is the -- after the discussion on both sides we've come to those numbers. We think it's achievable, given the size of Chinese market. And also, as you can tell, the EPS products are really catching up in China market. However, at the moment our EPS products -- our market share for EPS product in China is still relatively modest. We believe with the partnership with KYB, we're able to build out a major force and we can expand from there. So from that point on, we can grow 10% to 15% a year, that increase our market share.

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Unidentified Analyst, [14]

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Okay. I also see now too that -- it looks like Brazil is picking up, they had their vehicle sales, I think, were up 25% last month. Do you think that will help the situation with what China Automotive is doing in Brazil?

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Unidentified Company Representative, [15]

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(foreign language)

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Jie Li, China Automotive Systems, Inc. - Chief Financial Officer [16]

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(foreign language)

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Unidentified Company Representative, [17]

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Yes, you're right, Robert. In the first 9 months of 2018, our sales in Brazil also experienced a very strong growth. On a year-over-year basis, we grew 30% in Brazil.

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Unidentified Analyst, [18]

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Okay. I guess I have, like I say, a last quick question or 2. As minority shareholders regarding the status of China Automotive, we know that for about 1.5 year almost we were dealing with the potential for a buyout from Chairman Chen, and I know that that's been canceled. Are we now at a point where we can feel confident that China Automotive will remain a public company, traded, I guess, in U.S. markets? And in light of everything that's transpired, is there any possibility that we could see even some level of a share buyback in light of the share price now being as low as it is, as a vote of confidence for existing shareholders as well as potential new shareholders? I mean personally, I've owned China Automotive stock for a long time, and we've held it in good faith, but it sure would be nice to see some vote of confidence that we could feel comfortable continuing to hold the shares.

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Unidentified Company Representative, [19]

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(foreign language)

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Jie Li, China Automotive Systems, Inc. - Chief Financial Officer [20]

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(foreign language)

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Unidentified Company Representative, [21]

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Okay. So back to your comment, first comment, in terms of the Chairman's and his party's withdrawing the go-private proposal, that decision is final. And CAS will remain a U.S.-listed or NASDAQ-listed public company in the long run. And so we want you to know, CAS are very committed to maintain a U.S. listing status. In terms of a buyback and your points are well taken. The challenge right now is the Chinese government implemented very strict and stringent capital control policies. As you know, the U.S. China situation at the moment. And so the capital transfer from China to outside of China has been difficult in getting through the Chinese government's approval. However, we are working out some solutions and trying to be able to achieve that goal. In terms of a buyback, personally the CFO, Jie Li, he thinks it's something worth looking at it. And he's in -- he agrees with you that the company is undervalued.

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Unidentified Analyst, [22]

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Okay. I just wanted to say that I know the joint venture with KYB that is a significant development and I'm familiar with that company. They're over 100 years old. And you will have a great success with this joint venture, I have no doubt.

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Operator [23]

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Our next question comes from the line of John Sheehy with -- a private investor.

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Unidentified Analyst, [24]

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Can you share some expectations about how much capital expenditure will be required for the KYB joint venture over the next year?

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Unidentified Company Representative, [25]

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(foreign language)

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Jie Li, China Automotive Systems, Inc. - Chief Financial Officer [26]

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(foreign language)

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Unidentified Company Representative, [27]

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So the formation of the joint venture is based upon the contribution from CAS side and we'll have -- we'll contribute the equipment and the production line, because we have the existing production line equipment and KYB will contribute the cash to the joint venture. So they will probably put in about $10 million, with our equipment, we're able to increase the production for EPS product -- increase the production capacity for EPS product.

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Unidentified Analyst, [28]

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So from the China Automotive Systems' side, you will not make a large capital expenditure over the next year for the joint venture, is that correct?

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Unidentified Company Representative, [29]

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Correct.

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Unidentified Analyst, [30]

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Okay, that's great. And can you comment on the impact of U.S. tariffs on export sales to North America?

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Unidentified Company Representative, [31]

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(foreign language)

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Jie Li, China Automotive Systems, Inc. - Chief Financial Officer [32]

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(foreign language)

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Unidentified Company Representative, [33]

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So since the announcement, the State Department's announcement on the increase of the tariff imports, we have gone through a series of evaluations, the potential impact to our business in North America, and the short answer is it's controllable, it's manageable. So yes.

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Unidentified Company Representative, [34]

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(foreign language)

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Jie Li, China Automotive Systems, Inc. - Chief Financial Officer [35]

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(foreign language)

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Unidentified Company Representative, [36]

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And our projected sales to the North America is about $120 million. 1/3 of that is currently facing about 10% tariff. And with the potential -- we've still not announced and finalized but it's -- the U.S. government yet -- with the potential to increase to 25% at the end of the year.

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Jie Li, China Automotive Systems, Inc. - Chief Financial Officer [37]

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(foreign language)

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Unidentified Company Representative, [38]

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So after discussion -- after our discussion with our customers in North America, we come to a mutual agreement to share some of the impact on both side. And also combining -- or also will receive some of government subsidy and along with the appreciation of the U.S. dollars, which is in favor to us. And so these 3 things together, we believe, will help with mitigate the impact of increase of tariff. And so we believe the potential negative impact to our North America business will be manageable and minimal.

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Operator [39]

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Our next question comes from the line of Peter Halesworth with Heng Ren.

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Peter Halesworth, [40]

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Yes, so my first question is, was there any sense if there was a acceleration of orders, some pull through in this quarter in order to avert or mitigate tariffs on the part of U.S. customers? That's my first question.

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Unidentified Company Representative, [41]

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Peter, can you repeat your question, your voice is low? A bit low.

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Peter Halesworth, [42]

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Yes, is there any evidence that there was an acceleration of orders from U.S. customers to beat the tariffs? Is there any evidence of that? That's my first question.

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Unidentified Company Representative, [43]

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(foreign language)

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Jie Li, China Automotive Systems, Inc. - Chief Financial Officer [44]

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(foreign language)

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Unidentified Company Representative, [45]

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Our order book from the U.S. customer has been stable -- relatively stable. So there's no accelerating growth for that chapter -- area.

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Peter Halesworth, [46]

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Okay. And then my second question is, what was the valuation of the company provided by Houlihan Lokey, which was adviser to the special committee that was representing shareholders during the sale buyout by the Chairman? What was the value of the company that Houlihan Lokey arrived at?

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Unidentified Company Representative, [47]

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(foreign language)

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Jie Li, China Automotive Systems, Inc. - Chief Financial Officer [48]

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(foreign language)

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Unidentified Company Representative, [49]

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To answer your question, Houlihan Lokey was retained by special committee, which is formed by some of the board members. So the senior management has never -- has no access to that report. So the whole evaluation was done by the special committee.

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Peter Halesworth, [50]

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Okay. And just my last question. It relates to what Mr. [Paulovic] mentioned before, this loss of confidence on behalf of shareholders. It's very concerning to not see the Chairman on this call, who we haven't heard from directly for over 15 months. Also the CEO is not on the call. Shareholders want positive change in corporate governance and IR, and the $2 stock price is a heavy penalty that we're suffering because of this poor corporate governance and IR. And in fact, shareholders have given ideas about how China Automotive can improve their corporate governance and IR and it's been ignored. And it's a matter of fact that China Automotive is an American corporation in Delaware, listed on NASDAQ and it needs to start to act like it. You need to meet investors. You need to communicate directly and regularly. You have to have a board that's qualified and represents.

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Unidentified Company Representative, [51]

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(foreign language)

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Jie Li, China Automotive Systems, Inc. - Chief Financial Officer [52]

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(foreign language)

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Unidentified Company Representative, [53]

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So before the company's conference call, the Chairman actually called the CFO, his flight was delayed. So at the time of the conference call, he was -- he is actually up in the air. So he's -- he had planned to attend the call. So that -- but he is on his way to meet one of the largest customer of CAS, discussing a 2019 order. I think a lot of the shareholders of CAS will appreciate those efforts, especially in a year there has been some difficulties.

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Operator [54]

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There are no further questions at this time. I'd like to turn the floor back over to management for closing comments.

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Kevin Theiss, [55]

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Well, we thank everyone for joining us today. And we look forward to speaking with you in the future.

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Operator [56]

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This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.