CHINA AUTOMOTIVE SYSTEMS INC - Quarter Report: 2019 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark one)

For the quarterly period ended March 31, 2019

Or

For the transition period from ________ to _________

Commission file number: 000-33123

China Automotive Systems, Inc.

(Exact name of registrant as specified in its charter)

No. 1 Henglong Road, Yu Qiao Development Zone, Shashi District

Jing Zhou City, Hubei Province, the People’s Republic of China

(Address of principal executive offices)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes           x           No           ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes           x           No           ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes           ¨           No           x

Securities registered pursuant to Section 12(b) of the Act:

As of May 9, 2019, the Company had 31,497,723 shares of common stock issued and outstanding.

CHINA AUTOMOTIVE SYSTEMS, INC.

INDEX

Cautionary Statement

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. These statements relate to future events or the Company’s future financial performance. The Company has attempted to identify forward-looking statements by terminology including “anticipates,” “believes,” “expects,” “can,” “continues,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “should” or “will” or the negative of these terms or other comparable terminology. Such statements are subject to certain risks and uncertainties, including the matters set forth in this Quarterly Report or other reports or documents the Company files with the Securities and Exchange Commission from time to time, which could cause actual results or outcomes to differ materially from those projected. Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, levels of activity, performance or achievements. Undue reliance should not be placed on these forward-looking statements, which speak only as of the date hereof. The Company’s expectations are as of the date this Form 10-Q is filed, and the Company does not intend to update any of the forward-looking statements after the date this Quarterly Report on Form 10-Q is filed to conform these statements to actual results, unless required by law. All of the forward-looking statements are qualified in their entirety by reference to the factors discussed under Item 1A. “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018, as filed with the Securities and Exchange Commission.

PART I — FINANCIAL INFORMATION

China Automotive Systems, Inc. and Subsidiaries

Condensed Unaudited Consolidated Statements of Operations and Comprehensive Income

(In thousands of USD, except share and per share amounts)

The accompanying notes are an integral part of these condensed unaudited consolidated financial statements.

China Automotive Systems, Inc. and Subsidiaries

Condensed Unaudited Consolidated Balance Sheets

(In thousands of USD unless otherwise indicated)

The accompanying notes are an integral part of these condensed unaudited consolidated financial statements.

China Automotive Systems, Inc. and Subsidiaries

Condensed Unaudited Consolidated Statements of Cash Flows

(In thousands of USD unless otherwise indicated)

The accompanying notes are an integral part of these condensed unaudited consolidated financial statements.

China Automotive Systems, Inc. and Subsidiaries

Notes to Condensed Unaudited Consolidated Financial Statements

Three Months Ended March 31, 2019 and 2018

China Automotive Systems, Inc., “China Automotive,” was incorporated in the State of Delaware on June 29, 1999 under the name Visions-In-Glass, Inc. China Automotive, including, when the context so requires, its subsidiaries and the joint ventures described below, is referred to herein as the “Company.” The Company is primarily engaged in the manufacture and sale of automotive systems and components, as described below.

Great Genesis Holdings Limited, a company incorporated in Hong Kong on January 3, 2003 under the Companies Ordinance in Hong Kong as a limited liability company, “Genesis,” is a wholly-owned subsidiary of the Company.

Henglong USA Corporation, “HLUSA,” incorporated on January 8, 2007 in Troy, Michigan, is a wholly-owned subsidiary of the Company, and mainly engages in marketing of automotive parts in North America, and provides after-sales service and research and development support accordingly.

The Company owns the following aggregate net interests in the following Sino-foreign joint ventures, wholly-owned subsidiaries and joint ventures organized in the People's Republic of China, the “PRC,” and Brazil as of March 31, 2019 and December 31, 2018.

Basis of Presentation – The accompanying condensed unaudited consolidated financial statements include the accounts of the Company and its subsidiaries. The details of subsidiaries are disclosed in Note 1. Significant inter-company balances and transactions have been eliminated upon consolidation. The condensed unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions in Regulation S-X. Accordingly they do not include all of the information and footnotes required by such accounting principles for complete financial statements. These financial statements should be read in conjunction with the consolidated financial statements and related footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.

The accompanying interim condensed consolidated financial statements are unaudited, but in the opinion of the Company’s management, contain all necessary adjustments, which include normal recurring adjustments, for a fair statement of the results of operations, financial position and cash flows for the interim periods presented.

The condensed consolidated balance sheet as of December 31, 2018 is derived from the Company’s audited financial statements at that date but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements. 

The results of operations for the three months ended March 31, 2019 are not necessarily indicative of the results of operations to be expected for the full fiscal year ending December 31, 2019.

Estimation - The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

Foreign Currencies - China Automotive, the parent company, and HLUSA maintain their books and records in United States Dollars, “USD,” their functional currency. The Company’s subsidiaries based in the PRC and Genesis maintain their books and records in Renminbi, “RMB,” their functional currency. The Company’s subsidiary based in Brazil maintains its books and records in Brazilian reais, “BRL,” its functional currency. In accordance with ASC Topic 830, “FASB Accounting Standards Codification”, foreign currency transactions denominated in currencies other than the functional currency are remeasured into the functional currency at the rate of exchange prevailing at the balance sheet date for monetary items. Nonmonetary items are remeasured at historical rates. Income and expenses are remeasured at the rate in effect on the transaction dates. Transaction gains and losses, if any, are included in the determination of net income for the period. 

On January 1, 2019, the Company adopted ASU 2016-02, Leases (as amended by ASU Nos. 2018-10, 2018-11, 2018-20, and 2019-01), using the modified retrospective method. The impact of the adoption of the new standard on the consolidated financial statements is discussed in “Significant Accounting Policies” below.

The following significant accounting policies have been added or changed since the date of the Company’s 2018 Annual Report on Form 10-K.

Leases - As described in the “Recent Accounting Pronouncements” section, the Company adopted ASU 2016-02, Leases, and other related ASUs (collectively, ASC 842) on January 1, 2019, using the modified retrospective method of adoption.

The Company elected the transition method which allows entities to initially apply the requirements by recognizing a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. As a result of electing this transition method, prior periods have not been restated. There is no material impact on the balance of retained earnings, right of use assets or associated lease liabilities as of January 1, 2019 due to the adoption of ASC 842. The Company elected the package of practical expedients permitted under the transition guidance within ASC 842, which includes not reassessing lease classification of existing leases. The Company did not elect the hindsight practical expedient.

The Company determines if an arrangement is a lease upon inception. A contract is or contains a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration. The right to control the use of an asset includes the right to obtain substantially all of the economic benefits of the underlying asset and the right to direct how and for what purpose the asset is used. The Company’s major plants and buildings are self-owned and limited temporary small offices were rented.

For leases with a term of 12 months or less, the Company makes an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. The Company recognizes lease expenses for such leases on a straight-line basis over the lease term.

Operating lease assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. The discount rate used to calculate present value is the Company’s incremental borrowing rate or, if available, the rate implicit in the lease. The Company determines the incremental borrowing rate for each lease based primarily on the lease term and the economic environment of the applicable country or region. The discount rate used by the Company for its operating lease was 4.49%.

The operating lease right of use assets was included in other current assets and current portion of operating lease liabilities was included in other current liabilities and the non-current portion was included in other non-current liabilities. The weighted average remaining lease term was 4 years. The Company does not have finance lease arrangements as of March 31, 2019.

The Company’s accounts and notes receivable, net as of March 31, 2019 and December 31, 2018 are summarized as follows (figures are in thousands of USD):

The Company’s inventories as of March 31, 2019 and December 31, 2018 consisted of the following (figures are in thousands of USD):

The write down of inventories amounted to $1.1 million and $1.5 million for the three months ended March 31, 2019 and 2018, respectively.

In January 2010, the Company invested $3.1 million to establish a joint venture company, Beijing Henglong, with Hainachuan. The Company owns 50% of the equity in Beijing Henglong and can exercise significant influence over Beijing Henglong’s operating and financial policies. The Company accounted for Beijing Henglong’s operational results using the equity method. As of March 31, 2019 and December 31, 2018, the Company had $4.3 million and $4.2 million, respectively, of net equity in Beijing Henglong.  

In September 2014, Hubei Henglong entered into an agreement with other parties to establish a venture capital fund, the “Suzhou Venture Fund”, which mainly focuses on investments in emerging automobiles and parts industries. Hubei Henglong has committed to make investments of RMB 50.0 million, equivalent to approximately $7.4 million, in the Suzhou Venture Fund in three installments. As of March 31, 2019, Hubei Henglong has completed a capital contribution of RMB 50.0 million, equivalent to approximately $7.4 million, representing 12.5% of the Suzhou Venture Fund’s shares. As a limited partner, Hubei Henglong has more than virtually no influence over the Suzhou Venture Fund’s operating and financial policies. The investment is accounted for using the equity method. As of March 31, 2019 and December 31, 2018, the Company had $10.0 million and $9.7 million, respectively, of net equity in the Suzhou Venture Fund.

In May 2016, Hubei Henglong entered into an agreement with other parties to establish a venture capital fund, the “Chongqing Venture Fund”. Hubei Henglong has committed to make investments of RMB 120.0 million, equivalent to approximately $18.0 million, in three installments, representing 23.5% of the Chongqing Venture Fund’s shares. As of March 31, 2019, Hubei Henglong has completed a capital contribution of RMB 84.0 million, equivalent to approximately $12.5 million. As a limited partner, Hubei Henglong has more than virtually no influence over the Chongqing Venture Fund’s operating and financial policies. The investment is accounted for using the equity method. As of March 31, 2019 and December 31, 2018, the Company had $13.3 million and $13.1 million, respectively, of net equity in the Chongqing Venture Fund.

In October 2016, Hubei Henglong invested RMB 3.0 million, equivalent to approximately $0.4 million, to establish a joint venture company, Chongqing Jinghua Automotive Intelligent Manufacturing Technology Research Co., Ltd., “Chongqing Jinghua”, with five other parties. The Company owns 30% of the equity in Chongqing Jinghua, and can exercise significant influence over Chongqing Jinghua’s operating and financial policies. The Company accounts for Chongqing Jinghua’s operational results using the equity method. As of March 31, 2019 and December 31, 2018, the Company had $0.2 million and $0.2 million, respectively, of net equity in Chongqing Jinghua.

In March 2018, Hubei Henglong entered into an agreement with other parties to establish a venture capital fund, the “Hubei Venture Fund”. Hubei Henglong has committed to make investments of RMB 76.0 million, equivalent to approximately $11.5 million, in three installments, representing 27.1% of the Hubei Venture Fund’s shares. As of March 31, 2019, Hubei Henglong has completed a capital contribution of RMB 38.0 million, equivalent to approximately $5.6 million. As a limited partner, Hubei Henglong has more than virtually no influence over the Hubei Venture Fund’s operating and financial policies. The investment is accounted for using the equity method. As of March 31, 2019 and December 31, 2018, the Company had $5.6 million and $5.5 million, respectively, of net equity in the Hubei Venture Fund.

The Company’s consolidated financial statements reflect the net income of non-consolidated affiliates of $0.2 million and $0.6 million for the three months ended March 31, 2019 and 2018, respectively.

The Company’s property, plant and equipment, net as of March 31, 2019 and December 31, 2018 are summarized as follows (figures are in thousands of USD):

Loans consist of the following as of March 31, 2019 and December 31, 2018 (figures are in thousands of USD):

The Company must use the loans for the purpose as prescribed in the loan contracts. If the Company fails to do so, it will be charged penalty interest or trigger early repayment. The Company complied with such financial covenants as of March 31, 2019, and believes it will continue to comply with them.

The Company’s accounts and notes payable as of March 31, 2019 and December 31, 2018 are summarized as follows (figures are in thousands of USD):

The Company’s accrued expenses and other payables as of March 31, 2019 and December 31, 2018 are summarized as follows (figures are in thousands of USD):

For the three months ended March 31, 2019 and 2018, and for the year ended December 31, 2018, the warranties activities were as follows (figures are in thousands of USD): 

On January 31, 2018, the Company entered into an equipment sales agreement with a third party (the “buyer-lessor”) and simultaneously entered into a four-year contract to lease back the equipment from the buyer-lessor. The carrying value of the equipment was $13.6 million and the sales price was $14.9 million. Pursuant to the terms of the contract, the Company is required to pay to the buyer-lessor lease payments over 4 years with a quarterly lease payment of $1.1 million and is entitled to obtain the ownership of this equipment at a nominal price upon the expiration of the lease. The Company is of the view that the transaction does not qualify as a sale. Therefore, the transaction is accounted for as a financing transaction by the Company. As of March 31, 2019, $3.5 million is recognized as other payable (See Note 9) and $8.0 million is recognized as other long-term payable to the buyer-lessor according to the contract term.

The Company’s positions in respect of the amounts of additional paid-in capital for the three months ended March 31, 2019 and 2018, are summarized as follows (figures are in thousands of USD):

Assumptions used to estimate the fair value of the stock options on the grant date are as follows:

The stock options granted during 2018 were exercisable immediately. Their aggregate fair value on the grant date using the Black-Scholes option pricing model was $0.02 million. For the year ended December 31, 2018, the Company recognized stock-based compensation expenses of $0.02 million.

Appropriated

Pursuant to the relevant PRC laws, the profits distribution of the Company’s Sino-foreign subsidiaries, which are based on their PRC statutory financial statements, other than the financial statement that was prepared in accordance with generally accepted accounting principles in the United States of America, are available for distribution in the form of cash dividends after these subsidiaries have paid all relevant PRC tax liabilities, provided for losses in previous years, and made appropriations to statutory surplus at 10%.

When the statutory surplus reserve reaches 50% of the registered capital of a company, additional reserve is no longer required. However, the reserve cannot be distributed to shareholders. Based on the business licenses of the PRC subsidiaries, the registered capital of Henglong, Jiulong, Shenyang, USAI, Jielong, Wuhu, Hubei Henglong, Henglong KYB and Chongqing are $10.0 million, $4.2 million (equivalent to RMB 35.0 million), $8.1 million (equivalent to RMB 67.5 million), $2.6 million, $6.0 million, $3.8 million (equivalent to RMB 30.0 million), $39.0 million, $41.7 million (equivalent to RMB 320.0 million) and $9.5 million (equivalent to RMB 60.0 million), respectively.

The Company’s activities in respect of the amounts of appropriated retained earnings for the three months ended March 31, 2019 and 2018, are summarized as follows (figures are in thousands of USD):

Unappropriated

The Company’s activities in respect of the amounts of the unappropriated retained earnings for the three months ended March 31, 2019 and 2018, are summarized as follows (figures are in thousands of USD):

The Company’s activities in respect of the amounts of accumulated other comprehensive income for the three months ended March 31, 2019 and 2018, are summarized as follows (figures are in thousands of USD): 

The Company’s activities in respect of the amounts of the non-controlling interests’ equity for the three months ended March 31, 2019 and 2018, are summarized as follows (figures are in thousands of USD):  

Revenue Disaggregation

Management has concluded that the disaggregation level is the same under both the revenue standard and the segment reporting standard. Please refer to Note 24.

Contract Assets and Liabilities

Contract assets, such as costs to obtain or fulfill contracts, are an insignificant component of the Company’s revenue recognition process. The majority of the Company’s cost of fulfillment as a manufacturer of products is classified as inventory, fixed assets and intangible assets, which are accounted for under the respective guidance for those asset types. Other costs of contract fulfillment are immaterial due to the nature of the Company’s products and their respective manufacturing processes.

Contract liabilities are mainly customer deposits.

Customer Deposits

As of March 31, 2019 and December 31, 2018, the Company has customer deposits of $0.7 million and $0.8 million, respectively. During the three months ended March 31, 2019, $3.2 million was received and $3.2 million (including $0.8 million from the beginning balance of customer deposits) was recognized as net product sales revenue. Customer deposits represent non-refundable cash deposits for customers to secure rights to an amount of products produced by the Company under supply agreements. When the products are shipped to customers, the Company will recognize revenue and bill the customers to reduce the amount of the customer deposit liability.

During the three months ended March 31, 2019 and 2018, the Company recorded financial expense, net which is summarized as follows (figures are in thousands of USD):

The Company’s effective tax rates were 16.4% and 14.7% in the three months ended March 31, 2019 and 2018, respectively. The increase in effective tax rate was primarily due to the increase in the valuation allowance provided for loss-making entities.

Basic income per share is computed using the weighted average number of ordinary shares outstanding during the period. Diluted income per share is computed using the weighted average number of ordinary shares and dilutive ordinary share equivalents outstanding during the period. The dilutive effect of outstanding stock options is determined based on the treasury stock method.

The calculations of basic and diluted income per share attributable to the parent company for the three months ended March 31, 2019 and 2018, were as follows (figures are in thousands of USD, except share and per share amounts):

As of March 31, 2019 and 2018, the exercise prices for 112,500 shares and 112,500 shares, respectively, of outstanding stock options were above the weighted average market price of the Company’s common stock during the three months ended March 31, 2019 and 2018, respectively, and these stock options were excluded from the calculation of the diluted income per share for the corresponding periods presented.

A significant portion of the Company’s business is conducted in China where the currency is the RMB. Regulations in China permit foreign owned entities to freely convert the RMB into foreign currency for transactions that fall under the "current account", which includes trade related receipts and payments, interest and dividends. Accordingly, the Company’s Chinese subsidiaries may use RMB to purchase foreign exchange for settlement of such "current account" transactions without pre-approval. Regulations in the PRC currently permit payment of dividends of a PRC company only out of accumulated profits as determined in accordance with accounting standards and regulations in China. Under PRC law, China-based subsidiaries are required to set aside at least 10% of their after-tax profit based on PRC accounting standards each year to their general reserves until the cumulative amount reaches 50% of their paid-in capital. These reserves are not distributable as cash dividends or as loans or advances. These foreign-invested enterprises may also allocate a portion of their after-tax profits, at the discretion of their boards of directors, to their staff welfare and bonus funds. Any amounts so allocated may not be distributed and, accordingly, would not be available for distribution to Genesis and HLUSA.

Transactions other than those that fall under the "current account" and that involve conversion of RMB into foreign currency are classified as "capital account" transactions; examples of "capital account" transactions include repatriations of investment by or loans to foreign owners, or direct equity investments in a foreign entity by a China domiciled entity. "Capital account" transactions require prior approval from China's State Administration of Foreign Exchange, or SAFE, or its provincial branch to convert a remittance into a foreign currency, such as USD, and transmit the foreign currency outside of China.

This system could be changed at any time and any such change may affect the ability of the Company or its subsidiaries in China to repatriate capital or profits, if any, outside China. Furthermore, SAFE has a significant degree of administrative discretion in implementing the laws and has used this discretion to limit convertibility of current account payments out of China. Whether as a result of a deterioration in the Chinese balance of payments, a shift in the Chinese macroeconomic prospects or any number of other reasons, China could impose additional restrictions on capital remittances abroad. As a result of these and other restrictions under the laws and regulations of the PRC, the Company’s PRC subsidiaries are restricted in their ability to transfer a portion of their net assets to the parent. The Company has no assurance that the relevant Chinese governmental authorities in the future will not limit further or eliminate the ability of the Company’s PRC subsidiaries to purchase foreign currencies and transfer such funds to the Company to meet its liquidity or other business needs. Any inability to access funds in China, if and when needed for use by the Company outside of China, could have a material and adverse effect on the Company’s liquidity and its business.

The Company grants credit to its customers in the ordinary course of its business, including Xiamen Joylon, Xiamen Automotive Parts, Shanghai Jinjie and Jingzhou Yude, which are related parties of the Company. The Company’s customers are mostly located in the PRC.

During the three months ended March 31, 2019, the Company’s five largest customers accounted for 44.0% of its consolidated net product sales, with one customer individually accounting for more than 10% of consolidated net sales i.e., 18.1%. As of March 31, 2019, approximately 6.2% of accounts receivable were from trade transactions with the aforementioned customer and there was no individual customer with a receivables balance of more than 10% of total accounts receivable.

During the three months ended March 31, 2018, the Company’s five largest customers accounted for 41.9% of its consolidated net product sales, with one customer individually accounting for more than 10% of consolidated net sales i.e., 18.9%. As of March 31, 2018, approximately 4.8% of accounts receivable were from trade transactions with the aforementioned customer and there was no individual customer with a receivables balance of more than 10% of total accounts receivable. 

Related party transactions are as follows (figures are in thousands of USD):

Related sales

Related purchases

Related receivables

Related advances and loan balance

Related payables

These transactions were consummated under similar terms as those with the Company's third party customers and suppliers.

As of May 9, 2019, Hanlin Chen, Chairman, owns 56.4% of the common stock of the Company and has the effective power to control the vote on substantially all significant matters without the approval of other stockholders.

Legal proceedings

On January 7, 2019, three purported stockholders of the Company filed a stockholder derivative complaint on behalf of the Company against the Company’s directors Hanlin Chen, Qizhou Wu, Arthur Wong, Guangxun Xu and Robert Tung in the Delaware Court of Chancery, alleging that they had (a) breached their fiduciary duties by approving and paying excessive compensation to the non-employee directors of the Company, Arthur Wong, Guangxun Xu and Robert Tung, and (b) failed to make full and accurate disclosure of all material information with respect to director qualification and director compensation paid in 2017 in the Company’s annual proxy statement on Schedule 14A filed on October 10, 2018. The directors have engaged their own counsel to answer this complaint. On April 9, 2019, the Company moved to dismiss the complaint. Management expects the impact of the suit on the Company’s consolidated financial statements to be immaterial.

Other than as described above, (a) the Company is not a party to any pending or, to the best of the Company’s knowledge, any threatened legal proceedings and (b) no director, officer or affiliate of the Company, or owner of record of more than five percent of the securities of the Company, or any associate of any such director, officer or security holder is a party adverse to the Company or has a material interest adverse to the Company in reference to pending litigation.

Other commitments and contingencies

In addition to the bank loans, notes payables and the related interest, the following table summarizes the Company’s major commitments and contingencies as of March 31, 2019 (figures are in thousands of USD):

As of March 31, 2019 and December 31, 2018, the Company did not have any significant transactions, obligations or relationships that could be considered off-balance sheet arrangements.

The accounting policies of the product sectors (each entity manufactures and sells different products and represents a different product sector) are the same as those described in the summary of significant accounting policies disclosed in the Company’s 2018 Annual Report on Form 10-K except that the disaggregated financial results for the product sectors have been prepared using a management approach, which is consistent with the basis and manner in which management internally disaggregates financial information for the purposes of assisting them in making internal operating decisions. Generally, the Company evaluates performance based on stand-alone product sector operating income and accounts for inter- segment sales and transfers as if the sales or transfers were to third parties, at current market prices. Each product sector is considered a reporting segment.

As of March 31, 2019, the Company had 13 product sectors, six of which were principal profit makers and were reported as separate sectors and engaged in the production and sales of power steering (Henglong, Jiulong, Shenyang, Wuhu, Henglong KYB and Hubei Henglong), and one holding company (Genesis). The other seven sectors were engaged in the production and sale of sensor modular (USAI), automobile steering columns (Jielong), provision of after-sales and R&D services (HLUSA), production and sale of power steering (Chongqing Henglong), trade (Brazil Henglong), manufacture and sales of automobile electronic systems and parts (Wuhan Chuguanjie) and research and development of intelligent automotive technology (Jingzhou Qingyan).

As of March 31, 2018, the Company had 12 product sectors, five of which were principal profit makers and were reported as separate sectors and engaged in the production and sales of power steering (Henglong, Jiulong, Shenyang, Wuhu and Hubei Henglong), and one holding company (Genesis). The other seven sectors were engaged in the production and sale of sensor modular (USAI), automobile steering columns (Jielong), provision of after-sales and R&D services (HLUSA), production and sale of power steering (Chongqing Henglong), trade (Brazil Henglong), manufacture and sales of automobile electronic systems and parts (Wuhan Chuguanjie) and research and development of intelligent automotive technology (Jingzhou Qingyan).

 The Company’s product sector information for the three months ended March 31, 2019 and 2018, is as follows (figures are in thousands of USD):

The following discussion and analysis should be read in conjunction with the Company’s condensed unaudited consolidated financial statements and the related notes thereto and the other financial information contained elsewhere in this Report.

General Overview

China Automotive Systems, Inc. is a leading power steering systems supplier for the China automobile industry. The Company has business relations with more than sixty vehicle manufacturers, including JAC Motors, Changan Automobile Group, BAIC Group, SAIC Group and Dongfeng Auto Group, the five largest automobile manufacturers in China; Shenyang Brilliance Jinbei Co., Ltd., the largest light vehicle manufacturer in China; Chery Automobile Co., Ltd., the largest state owned car manufacturer in China; BYD Auto Co., Ltd. and Zhejiang Geely Automobile Co., Ltd., the largest privately owned car manufacturers in China. The PRC-based joint ventures of General Motors (GM), Volkswagen, Citroen and Chrysler North America are all key customers. Starting in 2008, the Company has supplied power steering pumps and power steering gear to the Sino-foreign joint ventures established by GM, Citroen and Volkswagen in China. The Company has supplied power steering gears to Chrysler North America since 2009.

Most of the Company’s production and research and development institutes are located in China. The Company has approximately 3,000 employees dedicated to design, development, manufacture and sales of its products. By leveraging its extensive experience, innovative technology and geographic strengths, the Company aims to grow leading positions in automotive power steering systems and to further improve overall margins, long-term operating profitability and cash flows. To achieve these goals and to respond to industry factors and trends, the Company is continuing work to improve its operations and business structure and achieve profitable growth.

Corporate Structure

The Company, through its subsidiaries, engages in the manufacture and sales of automotive systems and components. Great Genesis Holdings Limited, a company incorporated in Hong Kong on January 3, 2003 under the Companies Ordinance of Hong Kong as a limited liability company, “Genesis,” is a wholly-owned subsidiary of the Company and the holding company of the Company’s joint ventures in the PRC. Henglong USA Corporation, “HLUSA,” incorporated on January 8, 2007 in Troy, Michigan, is a wholly-owned subsidiary of the Company, and mainly engages in marketing of automotive parts in North America, and provides after-sales service and research and development support. CAAS Brazil’s Imports And Trade In Automotive Parts Ltd., “Brazil Henglong,” was established by Hubei Henglong Automotive System Group Co., Ltd., formerly known as Jingzhou Hengsheng Automotive System Co., Ltd., “Hubei Henglong,” as a Sino-foreign joint venture company with two Brazilian citizens in Brazil in August 2012. In May 2017, the Company obtained an additional 15.84% equity interest in Brazil Henglong for nil consideration. The Company retained its controlling interest in Brazil Henglong and the acquisition of the non-controlling interest was accounted for as an equity transaction. Fujian Qiaolong was acquired by the Company in the second quarter of 2014, as a joint venture company that mainly manufactures and distributes drainage and rescue vehicles with mass flow, drainage vehicles with vertical downhole operation, crawler-type mobile pump stations, high-altitude water supply and discharge drainage vehicles, long-range control crawler-type mobile pump stations and other vehicles, which was disposed of by the Company in the second quarter of 2016.

Critical Accounting Estimates

The Company prepares its condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amount of revenues and expenses during the reporting periods. Management periodically evaluates the estimates and judgments made. Management bases its estimates and judgments on historical experience and on various factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates as a result of different assumptions or conditions. The following critical accounting policies affect the more significant judgments and estimates used in the preparation of the Company’s condensed consolidated financial statements.

The Company considers an accounting estimate to be critical if:

The table below presents information about the nature and rationale for the Company’s critical accounting estimates:

Recent Accounting Pronouncements

Please see Note 2 to the consolidated financial statements under Item 1 of Part I of this report.

Results of Operations - Three Months Ended March 31, 2019 and 2018

Selected highlights from our results of operations are as follows (in thousands of U.S. dollars):

Net Product Sales and Cost of Products Sold

Net Product Sales

Net product sales were $109.2 million for the three months ended March 31, 2019, compared to $134.0 million for the same period in 2018, representing a decrease of $24.8 million, or 18.5%.

Net sales of traditional steering products and parts were $87.0 million for the three months ended March 31, 2019, compared to $109.0 million for the same period in 2018, representing a decrease of $22.0 million, or 20.2%. Net sales of electric power steering (“EPS”) were $22.2 million for the three months ended March 31, 2019 and $25.0 million for the same period in 2018, representing a decrease of $2.8 million, or 11.2%. As a percentage of net sales, sales of EPS were 20.3% for the three months ended March 31, 2019, compared to 18.7% for the same period in 2018.

The decrease in net product sales was due to the effects of three major factors: i) the decrease in sales volume led to a sales decrease of $8.6 million due to the soft demand in the China domestic brand automobile market; ii) the decrease in average selling price of steering gears led to a sales decrease of $7.5 million; and iii) the depreciation of the RMB against the U.S. dollar in this quarter compared to the same quarter last year, resulting in a sales decrease of $8.7 million.

Further analysis by segment (before elimination) is as follows:

Cost of Products Sold

For the three months ended March 31, 2019, the cost of products sold was $95.1 million, compared to $112.4 million for the same period of 2018, representing a decrease of $17.3 million, or 15.4%. The decrease in cost of sales was mainly due to the effect of the following major factors: i) the decrease in sales volumes with a cost of sales decrease of $5.3 million; ii) the decrease in unit cost with a cost of sales decrease of $4.4 million; and iii) the depreciation of the RMB against the U.S. dollar with a cost of sales decrease of $7.6 million. Further analysis is as follows:

Gross margin was 12.9% for the three months ended March 31, 2019, compared to 16.1% for the same period of 2018, representing a decrease of 3.2%, mainly due to the decrease in selling price and the changes in the product mix for the three months ended March 31, 2019.

Selling Expenses

Selling expenses were $3.1 million for the three months ended March 31, 2019, as compared to $5.8 million for the same period of 2018, representing a decrease of $2.7 million, or 46.6%, which was mainly due to decreased logistics fees as a result of decreased sales transactions and lower priced logistics suppliers.

General and Administrative Expenses

General and administrative expenses were $4.6 million for the three months ended March 31, 2019, as compared to $4.4 million for the same period of 2018, representing an increase of $0.2 million, or 4.5%, which was mainly due to the increased payroll expenses.

Research and Development Expenses

Research and development expenses were $6.6 million for the three months ended March 31, 2019, as compared to $8.3 million for the three months ended March 31, 2018, representing a decrease of $1.7 million, or 20.5%, which was mainly due to cost control on research and development expenditures.

Other Income, Net

Other income, net was $1.4 million for the three months ended March 31, 2019, compared to other income, net of $0.6 million for the three months ended March 31, 2018, representing an increase of $0.8 million, primarily due to an increase in the unspecific purpose subsidies being recognized in the first quarter of 2019.

Interest Expense

Interest expense was $0.6 million for the three months ended March 31, 2019, compared to interest expense of $0.4 million for the three months ended March 31, 2018, representing an increase of $0.2 million, primarily due to the new bank loans borrowed in 2019 and higher interest rates.

Income Taxes

Income tax expense was $0.2 million for the three months ended March 31, 2019, consistent with $0.6 million of income tax expense for the three months ended March 31, 2018. The income before income tax decreased to $1.2 million for the three months ended March 31, 2019 from $4.0 million for the same period in 2018 and the effective tax rate increased to 16.4% from 14.6% for the same period in 2018.

Net Loss Attributable to Non-controlling Interests

Net loss attributable to non-controlling interests amounted to $0.2 million for the three months ended March 31, 2019, compared to $0.3 million for the three months ended March 31, 2018.

Net Income Attributable to Parent Company’s Common Shareholders

Net income attributable to parent company’s common shareholders was $1.5 million for the three months ended March 31, 2019, compared to $4.3 million for the three months ended March 31, 2018, representing a decrease of $2.8 million, which was mainly due to a decrease in net income of $2.8 million.

Liquidity and Capital Resources

Capital Resources and Use of Cash

The Company has historically financed its liquidity requirements from a variety of sources, including short-term borrowings under bank credit agreements, bankers’ acceptances, issuances of capital stock and notes and internally generated cash. As of March 31, 2019, the Company had cash and cash equivalents and short-term investments of $84.1 million, compared to $103.9 million as of December 31, 2018, representing a decrease of $19.8 million, or 19.1%.

The Company had working capital (total current assets less total current liabilities) of $151.0 million as of March 31, 2019, compared to $154.1 million as of December 31, 2018, representing a decrease of $3.1 million, or 2.0%.

Except for the expected distribution of dividends from the Company’s PRC subsidiaries to the Company in order to fund the payment of the one-time transition tax due to the U.S. Tax Reform, the Company intends to indefinitely reinvest the funds in subsidiaries established in the PRC.

The Company believes that, in view of its current cash position, the cash expected to be generated from the operations and funds available from bank borrowings as detailed in subsequent paragraphs will be sufficient to meet its working capital and capital expenditure requirements, including the repayment of bank loans, for at least twelve months commencing from the date of this report. 

Capital Source

The Company’s capital source is multifaceted, such as bank loans and banker’s acceptance facilities. In financing activities and operating activities, the Company’s banks require the Company to sign line of credit agreements and repay all existing borrowings under such facilities within one year. On the condition that the Company can provide adequate mortgage security and has not violated the terms of the line of credit agreement, such one year facilities can be extended for another year.

The Company had short-term loans of $65.9 million (See Note 7) and bankers’ acceptances of $72.3 million (See Note 8) as of March 31, 2019.

The Company currently expects to be able to obtain similar bank loans, i.e., RMB loans, and bankers’ acceptance facilities in the future if it can provide adequate mortgage security following the termination of the above-mentioned agreements, see the table under “Bank Arrangements” below for more information. If the Company is not able to do so, it will have to refinance such debt as it becomes due or repay that debt to the extent it has cash available from operations or from the proceeds of additional issuances of capital stock. Owing to depreciation, the value of the mortgages securing the above-mentioned bank loans and banker's acceptances will be reduced by approximately $12.0 million over the next 12 months. If the Company wishes to obtain the same amount of bank loans and banker's acceptances, it will have to provide additional mortgages of $12.0 million as of the maturity date of such line of credit agreements, see the table under “Bank Arrangements” below for more information. The Company can still obtain a reduced line of credit with a reduction of $8.4 million, which is 70.0%, the mortgage rate, of $12.0 million, if it cannot provide additional mortgages. The Company expects that the reduction in bank loans will not have a material adverse effect on its liquidity.

Bank Arrangements

As of March 31, 2019, the principal outstanding under the Company’s credit facilities and lines of credit was as follows (figures are in thousands of USD):  

The Company may request the banks to issue notes payable or bank loans within its credit line using a 365-day revolving line.

The Company’s loan terms range from 7 months to 36 months. Pursuant to the comprehensive credit line arrangement, the Company pledged and guaranteed:

1. Equipment with an assessed value of approximately $56.0 million as security for its revolving comprehensive credit facility with Hubei Bank.

2. Land use rights and buildings with an assessed value of approximately $17.4 million as security for its revolving comprehensive credit facility with Shanghai Pudong Development Bank.

3. Land use rights and buildings with an assessed value of approximately $14.8 million as security for its comprehensive credit facility with China CITIC Bank Wuhan branch.

4. Land use rights and buildings with an assessed value of approximately $5.5 million as security for its comprehensive credit facility with China CITIC Bank Shenyang branch.

5. Land use rights and buildings with an assessed value of approximately $7.6 million as security for its comprehensive credit facility with China Everbright Bank.

6. Land use rights and buildings with an assessed value of approximately $2.3 million as security for its comprehensive credit facility with Bank of Chongqing.

7. Land use rights and buildings with an assessed value of approximately $4.1 million as security for its comprehensive credit facility with Agricultural Bank of China.

Short-term and Long-term Loans

The following table summarizes the contract information of short-term and long-term borrowings between the banks, government and the Company as of March 31, 2019 (figures are in thousands of USD). 

The Company must use the loans for the purpose described in the table. For the bank loans of $4.5 million and $1.9 million, respectively, with Shanghai Pudong Development Bank, the bank loan of $6.8 million with China Merchants Bank, the bank loan of $0.1 million with Agriculture Bank of China, the bank loan of $3.0 million with Hubei Bank, the bank loan of $2.2 million with China CITIC Bank, and the government loan of $0.3 million with Wuhu Municipal Science and Technology Bureau, if the Company fails to do so, it will be charged a penalty interest at 100% of the specified loan rate listed in the table above or early repayment will be triggered. The Company has to pay interest at the interest rate described in the table on the 20th of each month or quarter, as applicable. If the Company fails to do so, it will be charged compound interest at the specified rate in the above table. The Company has to repay the principal outstanding on the specified date in the table. If it fails to do so, it will be charged a penalty interest at 30% of the specified loan rate for bank loans with Bank of China, and penalty interest at 50% of the specified loan rate for bank loans with other banks.

The Company complied with such financial covenants as of March 31, 2019, and believes it will continue to comply with them.

Notes Payable

The following table summarizes the contract information of issuing notes payable between the banks and the Company as of March 31, 2019 (figures are in thousands of USD):

 The Company must use notes payable for the purpose described in the table. If it fails to do so, the banks will no longer issue the notes payable, and it may have an adverse effect on the Company’s liquidity and capital resources. The Company has to deposit sufficient cash in the designated account of the bank on the due date of notes payable for payment to the suppliers. If the bank has advanced payment for the Company, it will be charged a penalty interest at 50% of the loan rate that is published by the People’s Bank of China for the same period. The Company complied with such financial covenants as of March 31, 2019, and believes it will continue to comply with them.

Cash Flows

Net cash used in operating activities for the three months ended March 31, 2019 was $18.2 million, compared with net cash used in operating activities of $7.5 million for the same period of 2018, representing an increase in net cash outflow of $10.7 million, which was mainly due to the net effect of (1) the decrease in net income excluding non-cash items by $4.0 million and (2) the increase in cash outflows from movements of operating assets and liabilities by $6.7 million.

Net cash used in investing activities during the three months ended March 31, 2019 was $10.0 million, as compared to net cash provided by investing activities of $30.6 million for the same period of 2018, representing an increase of cash outflows by $40.7 million, which was mainly due to (1) a decrease in cash inflows due to the repayment of the loan to a related party by $20.4 million and (2) an increase in cash payment to purchase short-term investments by $14.1 million.

Net cash provided by financing activities for the three months ended March 31, 2019 was $2.0 million, compared to net cash used of $11.4 million for the same period of 2018, representing an increase in cash inflows by $13.4 million, which was mainly due to the effect of decreased proceeds from bank loans by $4.4 million, an increase in repayment of the borrowing for sale and leaseback by $1.1 million and the decrease in repayments of bank loan by $19.2 million.

Off-Balance Sheet Arrangements

As of March 31, 2019 and December 31, 2018, the Company did not have any significant transactions, obligations or relationships that could be considered off-balance sheet arrangements.

There were no material changes to the disclosure made in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 regarding this matter.

The Company’s management, under the supervision and with the participation of its chief executive officer and chief financial officer, Messrs. Wu Qizhou and Li Jie, respectively, evaluated the effectiveness of the Company’s disclosure controls and procedures as of March 31, 2019, the end of the period covered by this Report. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports, such as this Form 10-Q, that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Based on that evaluation, Messrs. Wu and Li concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2019.

The Company’s disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of its disclosure control system are met. Because of inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected.

There have been no changes in the Company’s internal control over financial reporting during the three months ended March 31, 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. — OTHER INFORMATION

On January 7, 2019, three purported stockholders of the Company filed a stockholder derivative complaint on behalf of the Company against the Company’s directors Hanlin Chen, Qizhou Wu, Arthur Wong, Guangxun Xu and Robert Tung in the Delaware Court of Chancery, alleging that they had (a) breached their fiduciary duties by approving and paying excessive compensation to the non-employee directors of the Company, Arthur Wong, Guangxun Xu and Robert Tung, and (b) failed to make full and accurate disclosure of all material information with respect to director qualification and director compensation paid in 2017 in the Company’s annual proxy statement on Schedule 14A filed on October 10, 2018. The directors have engaged their own counsel to answer this complaint. On April 9, 2019, the Company moved to dismiss the complaint.

Other than as described above, (a) the Company is not a party to any pending or, to the best of the Company’s knowledge, any threatened legal proceedings and (b) no director, officer or affiliate of the Company, or owner of record of more than five percent of the securities of the Company, or any associate of any such director, officer or security holder is a party adverse to the Company or has a material interest adverse to the Company in reference to pending litigation.

There have been no material changes from the risk factors previously disclosed in Item 1A of the Company’s 2018 Annual Report on Form 10-K.

None.

None.

Not applicable.

None.

INDEX TO EXHIBITS

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.