China Yuchai International Ltd (CYD) 2012 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. And welcome to the China Yuchai International Ltd, second-quarter 2012 earnings webcast. At this time, all participants are in a listen-only mode. There will be a presentation, followed by a question and answer session. (Operator Instructions).

I must advise you that this conference is being recorded today August 10, 2012. I would now like to turn the call over to your first speaker for today, Mr. Kevin Theiss. Please go ahead, sir.

Thank you for joining us today and welcome to China Yuchai International Ltd's second quarter 2012 conference call and webcast.  My name is Kevin Theiss and I am with Grayling, China Yuchai's US investor relations advisor.  Joining us today are Mr. Benny H. Goh, President and Mr. Kok Ho Leong Chief Financial Officer.

Before we begin, I will remind all listeners that throughout this call, we may make statements that may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words believe, expect, anticipate, project, targets, optimistic, intend, aim, will, or similar expressions are intended to identify forward-looking statements. All statements other than statements of historical fact are statements that may be deemed forward-looking statements. These forward-looking statements are based on current expectations or beliefs, including, but not limited to, statements concerning the Company's operations, financial performance and condition. The Company cautions that these statements by their nature involves risk and uncertainties, and actual results may differ materially depending on a variety of important factors, including those discussed in the Company's reports filed with the Securities and Exchange Commission from time to time.

The Company specifically disclaims any obligation to maintain or update the forward-looking information, whether of the nature contained in this conference call or otherwise, in the future.

Mr. Goh will provide a brief overview and summary, then Mr. Leong will review the financial results for the second quarter and half year ended June 30, 2012. Thereafter, we will conduct a question and answer session.

For the purposes of today's call, the financial results are unaudited and they will be presented in CNY and US dollars.  Mr. Goh, please start your presentation.

Thank you, Kevin. Good evening, everyone. According to the China Association of Automotive Manufacturers, CAAM, overall diesel-powered commercial vehicle sales were 15.3% lower and the unit sales of heavy-duty, diesel-powered truck and trailers declined by 33.6% in the second quarter of 2012 as compared with the same quarter last year. For unit sales unit in the first half of the year 2012, diesel-powered commercial vehicles declined by 13.7% and diesel-powered truck and trailers decline by 31.7% as compared with the same period last year.

Even in such a weak commercial vehicle market environment, there were areas of growth as unit sales of completed passenger buses rose 3.2% with large, medium and light buses recording higher sales in the second quarter of 2012 versus the same quarter of 2011. For unit sales in the first half of 2012, completed buses rose by 6.1% as compared with the same period last year.

As a leading player in the medium to large bus sector in China, we continue to benefit from higher bus sales. Our diversified product mix, especially with our natural gas engine products penetrating each engine class, enable us to defend our gross margin and maintain a competitive edge despite the overall weak commercial vehicle market. We continued to increase sales in the natural gas engine sector, and maintain our leadership in the on-road diesel engine market through our ongoing introduction of new products and closer collaboration with our OEM customers.

In recent years, the policies of the Chinese government have encouraged energy conservation and emissions reduction. Chinese 12 -- China's 12th Five Year Plan targets a 16% and 17% reduction in energy use and carbon dioxide emissions respectively per unit of economic output by 2015. Out of seven strategic investment areas identified under the 12th Five Year Plan, three related to energy, namely clean energy, energy conservation and clean energy vehicles. Under the 12th Five Year Plan, natural gas is to comprise 8.3% of the primary energy mix by 2015, which represents approximately 9.2 trillion cubic feet of gas, or more than three times the consumption in 2008.

Two natural gas pipelines are operating between Western and Eastern China with a third under construction to provide approximately 72b cubic meters of natural gas into the more heavily populated parts of China. Major Chinese oil companies are actively building pipelines, and currently operate five gas product facilities with more plants under construction. There are over 100 liquefied natural gas LNG filling stations in the gas rich areas of China, with plans to expand to 380 stations by the end of 2012. The intended distribution areas for the new gas engines will be the Eastern coast region of China where natural gas is abundant and actively promoted. Last year we sold approximately 13,000 natural gas engines, making us one of the industry leaders and we are off to a good start in 2012 with increased sales in the first half of the year as compared with the same period a year ago. We anticipate natural gas engines be a growth driver for us as we construct a new facility at our main manufacturing plant in Yulin City, Guangxi Province, to develop and produce a full portfolio of natural gas-powered engines to complement our existing suite of diesel engines.

Our new natural gas engines will fortify our position as the leading engine supplier to the bus market as these engines are well suited for this. The continuing expansion of the highway system and continued urbanization create demand for new buses. Furthermore, new bus regulations from China's Central Government to improve the quality standard of school buses have also increased bus sales.

Recently, we announced that 80 buses running on our YC6G260N-40 natural gas engines had completed a journey at high altitudes meeting the requirements for operating in a high altitude environment. The YC6G engine is a 6-cylinder engine, compliant up to National IV emissions standard with torque of 980 neutron meters at 1,400 rpm, which can use either compressed natural gas, CNG or liquid natural gas, LNG to power it.

During the second quarter of 2012, our overall engine sales declined by 21.5% compared with the second quarter of 2011 as sales of commercial vehicles decreased in China.

Net revenue for the second quarter of 2012 was CNY3.43b, $541.7m, compared with CNY4.02b in the second quarter of 2011. Gross margin increased to 19.7% in the second quarter of 2012 as compared with 19.2% a year ago.

Our cost controls continue to yield positive results. In addition to our lower cost of goods sold, SG&A expenses declined 9.5% in 2012 second quarter to CNY380.4m, $60.1m, from the second quarter in 2011.

Our investment in research & development, R&D rose 16.2% to CNY95.3m, $15.1m, compared with CNY82m in the second quarter of 2011. As a percentage of net revenue, R&D spending rose to 2.8% compared with 2% in the second quarter of 2011.

In conjunction with our reputation as engine technology leaders in China, we continue to invest in R&D. We look forward to the completion of our new Nanning Research and Development Institute, which is expected later this year and which will focus on the development new engine technology and components to meet more stringent emissions standards, provide products for new markets such as our natural gas engines for the bus markets and high horse power engines for our marine and other off-road applications. Engines with improved performance for our current applications and new products design to penetrate new markets are key to capturing market share.

For the six months ended June 30, 2012, based on our unit sales, we remain the market leader in diesel engine industry in China, the largest commercial vehicle market in the world. We offer the broadest range of diesel engines and we have introduced more models of natural gas and off-road engines in recent months.

According to the National Bureau of Statistics, gross domestic product of China in the second quarter of 2012 was 7.6%, the lowest in three years. As a result, we see the Chinese Government tweaking its economic policies to promote growth, such as the cutting of interest rates twice since early June of 2012 and lowering the reserve requirement ratios of banks three times since November 2011. Infrastructure projects are expected to be approved by the central government and railway construction spending has already been increased.

We are pleased with our mid-year balance sheet in the midst of an uncertain market. We are able to generate positive cash flow from operations and also free cash flow, due to our continual management of our inventory and accounts receivables, combined with prudent capital expenditures.

On July 9, 2012 we rewarded our shareholders with a dividend payment of $0.90 per share. As we move into the second half of 2012, we endeavor to continue to deliver value to our shareholders.

I will now provide a brief update of our joint ventures. Our joint venture with Caterpillar inaugurated its new permanent remanufacturing facility at Suzhou Industrial Park recently, and the installation and testing of the equipment is progress. Phase one of the permanent plant has approximately 14,000 square meters of space, and is expected to reach full operational capacity in 2014 with approximately 400 employees.

Through the remanufacturing process, we are again diversifying the cost-effective solutions we offer to customers, as matured parts and components are revitalized into like new products in terms of reliability, durability and performance. By remanufacturing parts, we will reduce raw material usage and waste, which is consistent with our green environmental agenda.

In relation to the joint venture between GYMCL and Geely, we decided to exit from one of the joint venture companies, namely Zhejiang Yuchai Sanli Engine Company Limited, and increased our shareholding in Jining Yuchai Engine Company Limited through a share swap arrangement. As a result, we will now concentrate on continuing the development and production of the 4D20 diesel engine for passenger cars, which is central to this joint venture, and the Zhejiang Yuchai will now continue to manufacture only crankshafts.

The second and third generation prototype 4D20 diesel engines are currently undergoing development tests, which are scheduled to be completed by the end of this year.

We are progressing with our joint venture with CIMC-Chery with 8,500 YC6-K heavy-duty engines scheduled for production in 2012. We have also developed a natural gas YC6-K engine for the heavy-duty truck market. It features 450 to 500 horsepower, which represents the highest power in its class in China. We remain committed to capturing market share in the heavy-duty vehicle market in China with a goal of being one of China's four largest heavy-duty engine providers by 2015. With the large Chinese population gaining wealth, more goods are being demanded, creating the need for heavier loads being shipped over an expanding highway system to supply the large urban centers throughout China. In addition, the expanding manufacturing base and construction industries require a growing number of materials to be shipped.

While we are maintaining our dominance in bus markets in China, we are accelerating our engine and market diversification plans as other areas become important growth drivers. Our compressed natural gas and liquid natural gas engine models are being introduced to provide customers a full suite of engines to complement our existing range of diesel engines. Our new natural gas engines have immediate application in the truck and bus markets, and our high horse power engines will soon be available to the marine and power generation markets. We believe this product diversification strategy, combined with our 2,800 service stations across China, will make China Yuchai a more formidable leader in the Chinese engine markets.

With that, let me now turn over the call to Mr. Kok Ho Leong, our Chief Financial Officer, to provide more details on our financial results.

Thank you, Benny. Let me first walk you through our second-quarter 2012 financial results. Net revenue for the second quarter of 2012 was CNY3.43b, $541.7m, compared with CNY4.02b in the second quarter of 2011.

The total number of diesel engines sold by GYMCL during the second quarter of 2012 was 109,329 units compared with 139,236 units in the second quarter of 2011, a decrease of 29,907 units or 21.5%. This was mainly due to weaker demand in the commercial vehicle market, especially in the truck segment. However, a greater number of natural gas engines were sold this quarter compared with the second quarter of 2011 as we executed our engine diversification strategy and maintained our dominance in the bus market.

The decline in net sales was CNY590.9m, or 14.7% as compared to the same period in 2011. Thanks to our increased sales of engines meeting higher emissions standard and natural gas engines across the light, medium and heavy-duty markets, our average selling price increased both sequentially and versus the same quarter a year ago.

Gross profit was CNY674.1m, $106.6m, compared with CNY771.1m in the second quarter of 2011. Gross margin increased to 19.7% in the second quarter of 2012 as compared with 19.2% a year ago. The higher gross margin was attributable to lower cost of raw materials. This gross margin increase was partially offset by the higher direct labor and factory overhead cost per unit, as the sales volume decreased in the second quarter of 2012.

Other income was CNY11.6m, $1.8m, a decrease of CNY9.7m from CNY21.4m in the second quarter of 2011. This decrease was mainly due to unrealized foreign exchange revaluation losses.

Research and development R&D expenses were CNY95.3m, $15.1m, compared with CNY82.0m in the second quarter of 2011, an increase of 16.2%. As a percentage of net revenue, R&D spending rose to 2.8% compared with 2.0% in the second quarter of 2011. The increase in R&D expenses was due to increased R&D staff costs and quality improvement initiatives.

Selling, general and administrative, SG&A expenses, were CNY380.4m, $60.1m, down from CNY420.2m in the second quarter of 2011, a decrease of 9.5%. SG&A expenses represented 11.1% of second quarter 2012 net revenue compared with 10.5% in the same quarter a year ago. The lower SG&A expenses in 2011, as a percentage of net revenue on a year over year basis was mainly due to write-back of doubtful debts provision in the second quarter of 2011.

Operating profit declined to CNY210.1m, $33.2m, from CNY290.2m in the second quarter of 2011, mainly due to lower gross profit. The operating margin was 6.1% as compared with 7.2% in the second quarter of 2011.

Finance costs rose to CNY62.2m, $9.8m, from CNY28m in the second quarter of 2011. The increase in finance costs was due to increased borrowings and at higher cost.

GYMCL issued short-term financing bonds or STFBs totaling CNY2.39b in 2011, over three tranches in March, July, November. The recent easing of interest rate in China only occurred at the end of the second quarter of 2012.

The share of joint ventures was a loss of CNY6.2m, $1.0m, compared with a loss of CNY9.3m in the second quarter of 2011. In the second quarter of 2012, total net profit attributable to China Yuchai's shareholders was CNY67.1m, $10.6m, or earnings per share of CNY1.80, $0.28, compared with CNY155.1m, or earnings per share of CNY4.16 in the same quarter in 2011.

Now I will move to six months financials. For the six months ended June 30 of 2012, net revenue was CNY7.11b, $1.12b, compared with CNY8.25b in the same period last year.

The total number of diesel engines sold by GYMCL during the first six months of 2012 was 241,026 units compared with 300,067 units in the same period last year, a decrease of 59,041 units or 19.7%. This was mainly due to weaker demand in the commercial vehicle market, especially in the truck segment. The decline in net sales was CNY1.14b, or 13.8%, as compared to the same period in 2011.

Gross profit was CNY1.45b, $229.8m, compared with CNY1.72b in the same period last year. Gross margin decreased to 20.4% in the first six months of 2012 as compared with 20.8% a year ago. In the first six months of 2012 the lower gross margin was attributable to a further shift to sales mix to more light duty engines offset by lower raw material costs.

Other income was CNY37.7m, $6.0m, a decrease of CNY3.1m from CNY40.7m a year ago. The decrease was mainly due to unrealized foreign exchange revaluation losses.

Research and development, R&D expenses were CNY177.2m, $28.0m, compared with CNY160.0m in the same period last year, an increase of 10.7%. As a percentage of net revenue, R&D spending rose to 2.5% compared with 1.9% in the same period last year. The increase in R&D expenses were a result of increased R&D staff cost and quality improvement initiatives.

Selling, general and administrative, SG&A expenses were CNY756.7m, $119.6m, down from CNY877.3m in the same period last year, a decrease of 13.7%. The decrease in SG&A expenses corresponds to the reduction in sales. SG&A expenses remained at 10.6% of net revenue for the first six months of 2012, which was the same level for the corresponding period last year.

Operating profit declined to CNY557.3m, $88.1m, from CNY718.7m in the same period last year. This was mainly due to lower gross profit offset by lower SG&A expenses. The operating margin was 7.8% compared with 8.7% in the same period last year.

Finance costs rose to CNY137.5m, $21.7m, from CNY75.3m in the same period last year. The increase in finance cost was due to increased borrowings and at higher cost.

The share of joint ventures was a loss of CNY22.9m, $3.6m, compared with a loss of CNY27.0m in the same period last year.

For the six months ended June 30, 2012, total net profit attributable to China Yuchai's shareholders was CNY235.0m, $37.2m, or earnings per share of CNY6.31, $1, compared with CNY385.6m, or earnings per share of CNY10.35 in the same period in 2011.

I shall move onto balance sheet highlights now. As at June 30, 2012, cash and cash equivalents were CNY5.90b, $932.3m, compared with CNY4.12b at December 31, 2011. Trade and bills receivable were CNY4.85b, $767.5m, compared with CNY6.69b at the end of 2011.

Net inventory was CNY1.97b, $311.6m, from CNY2.42b at the end of 2011. The inventory that the company built up in the first quarter of 2012 was gradually utilized for production in the second quarter of the year.

Short and long term borrowings were CNY2.97b, $469.9m, from CNY3.70b at the end of December 2011. On March 9, 2012, upon the maturity of the first tranche of STFBs amounting to CNY1b, and bearing a fixed annual interest rate of 4.59%, GYMCL repaid the full amount due.

With that, operator, we are ready to begin the Q&A session.

Certainly, sir. We will now begin the question and answer session. (Operator Instructions). Your first question comes from the line of Mr. Alex Potter of Piper Jaffray. Please ask your question, sir.

Yes, hi, guys. Thanks for taking the call. So, I guess first of all just on from a broad market standpoint, obviously truck market in China is still pretty weak. Are you guys seeing any sort of incremental pickup in demand on a year-over-year or sequential basis? And if not, when do you think that will start to materialize?

Hi Alex. Right, I think the market is still very bleak. In fact, we are seeing this quarter actually a much lower demand in the truck market than Q1. So, this is not a good sign. At first we anticipated this picking up towards the second half of the year. What we are now looking at is probably it will take a while, towards the end of the year if not early next year before the truck market recovers.

That is actually more or less in synch with the fact that with the change of government will also capitalize the incentive that we are all looking forward to. Right now there are virtually no incentives that are concrete enough for the market to be set up.

Okay, very good. And I had another questions here, just kind of a housekeeping issue, on a percent of sales basis, taxes were obviously somewhat big in the quarter, bigger than what I had expected. Can you give any forward-looking guidance on what sort of tax rate we should be modeling on an effective tax rate basis for the next couple of quarters?

Yes. Leong here, if you look at our effective tax rate we are always around 15% or slightly above that. You can do your mathematics. The underlying driver is our main operating subsidiary which is the Guangxi plant. It is operating from the Western province. We have been enjoying the preferential tax treatment of 15%, 15%. From the year 2011 onwards for another three years they are now under this high technology incentives scheme, whereby they also enjoy 15% of preferential tax.

And thereafter, well, our main operating subsidiary GYMCL can still continue to apply either under the Western development incentives or the high technology incentive. So we have succeeded and applied under both schemes. So we will see how it goes when the -- when we reach the point to apply for the tax incentive again. So barring unforeseen circumstances you can't see we will continue to operate in this level of tax rate of slightly above 15%. Thank you.

Thank you, sir. Your next question comes from the line of Mr. David Russell from ISI Group. Please ask your question, sir.

Thank you for the opportunity. Two questions, one about gross margin and one about the off highway demand. First, obviously the gross margins were impressive given the volumes were down. You obviously mentioned raw material costs are down. You also mentioned pricing was up year over year and sequentially. Just so I'm clear is that incorporating mix or is it apples to apples? You mention the mix was more light engines, so it seemed like a lot of mix issues working against you, volume working against you.

So I am trying to figure out how you were able to keep your gross margins up. So maybe more color on the raw materials. I am just trying to understand how to think about your margins the next couple of quarters, say even if volumes get worse. And then, of course, on the upside if volumes get better what that could mean. Just it was impressive gross margins were up with that type of volume decline.

Yes. David this is Leong here. Maybe I would want to answer both in the quarter as well as year to date. If you look at both the -- these two periods whether it's a quarter of a period to year to date that we have similar gross profit trend, we defended it well.

On the raw material side you can see that even in international scene the metal prices are coming down. And also in China domestic purchases we have witnessed a similar trend that the purchasing cost is lower. Actually our overseas purchase part has dropped even more, but it has not formed a significant part of our raw material cost. So overall these are the contributing factors for the raw material cost decline.

As for the sales mix there is a couple of -- a few factors. On the one hand, we have some pleasure because we are selling more to the light-duty engines. But on the other hand, we are starting increase our range of products to sell those higher emission standard engines. And this effectively I think increased our original sales price.

So as a result of all these factors you can see we are able to defend our gross profit in spite of the fact that we are moving more to the light-duty engines. Thank you.

And I am sorry on the pricing, so pricing on an apples-to-apples basis you are getting a higher price for your engines today than this time last year despite volumes down?

The answer is twofold, if we are selling the same model we are facing price pressure, and that is a fact. And it is not only affecting us as well as other competitors in the same business.

And on the other hand, there are certain customers that used to buy in the larger volume they used to buy in the larger volume. But at the reduced volume they are not able to enjoy the previously favorable sales price. So that has another dimension that helps us to increase our sales price in that stance. So it would -- it cuts both ways when the sales volume comes down.

And my last question and then I'll get off the line. Off-highway equipment, typically production improves the last few months of the year as manufacturers get ready for Chinese New Year. Have you had any conversations with your off-highway customers that suggest that we will or won't see that seasonal pickup, and if we will maybe put it in perspective versus last year.

David, off highway there are three classifications, we have (inaudible) parts, some of the construction you are talking about a bit of the marine, and also the power gen.

Let's look at it one after another, in terms of the construction it's still a bit hazy right now, we do not see a lot of [FEI] in our discussions about leisure customers. It's still a bit hesitant. They are not going to stock up at this moment. They are still looking for some clarity in where the incentives of the government and also the development is going to take place after the changeover of the leadership.

In terms of the marine off highway, yes, we see some traction in that, in fact we are looking at a lot of growth even in the first half of the year. And so we are fairly optimistic in terms of the marine side.

Power gen is relatively flat, and we believe this may pickup towards the last quarter of the year as the economy starts to improve. However, we are still pretty much cautious about this area as well.

Thank you very much.

Thank you.

Thanks, David.

Thank you sir. (Operator Instructions). Your next question comes from the line of Mr. Jerry Revich from Goldman Sachs. Please ask your question.

Hi, this is [Robbie Gillon] for Jerry. I guess one question on the natural gas market, can you say more about the natural gas engine opportunity? What's the size of the potential market? And which regions of China do you see that developing?

Okay, right now we see that the natural gas market as far as biggest opportunity, obviously it's in the buses. And that is because the busses are very much a municipal vehicle. So within the city themselves the infrastructure is very much in place. And so we have seen the traction and we see that as a growing market. As a matter of fact, we are anticipating probably about 8% of our sales will be in natural gas engine in about 2015.

For the truck market right now we are bullish about it, but we still need to have a few factors to be in place for this really to take off, and that is really for the refueling stations between cities. Having said that, our process technology of LPG with the tanks will allow us to have longer range of operation for the trucks, and that will also help in this growth as well.

Okay, and then can you talk more about maybe the current economics for the truck owners. What are the incremental costs to owning a nat gas engine versus a diesel? And what kind of pay back are they seeing on their investment?

Right, right now we are looking at the price difference of about 20% to 25% for a natural gas engine versus a typical diesel engine. That is of course you have initial high investment that you see in terms of price difference. But the operating impact is that they should see a payback towards -- within a year, year and half, so the cost savings are pretty substantial from that angle.

What we have actually kind of guessed is that for the price per kilometer for diesel is about maybe 45 to 50, whereas a gas engine is about 35 per kilometer so that's about 20% cost savings in operations. So that's a fairly attractive means of really switching into a new form of cleaner engine as well.

Okay, thanks. And just one final question what's the timing of the National 4 Engine Standard and how much do you expect that to increase engine prices?

We used to be very bullish about that having a huge impact on driving the demand. But now if you look at it it's time for the July 2013. But having said that if you look at it, we are looking at the fact that because of the poor economy we suspect maybe the authorities may not enforce it very closely.

So in other words there will still be National 3 engines in the market, whereas National 4 will be in place. So what we are seeing is there is going to be some kind of a takeoff, but not going to be as dramatic as we originally envisaged. Only the price difference, because of the emissions capability of the Euro 4 engines, you are looking about 20% kind of a price difference.

Okay, thanks for taking my question.

Thank you.

Thank you very much. Your next question comes from the line of Mr. Sandy Mehta from Value Investment. Please ask your question.

Yes, thanks for taking my question. It looks like you guys did a great job in cash generation. So it seems like your net cash balance, which is cash minus all debt, has increased by $175m. So you have $463m of cash which is now 90% of your market cap. But if I look at your receivables balance it still seems about $300m above the normal level that you've had the past few years.

So my question is this, that you still expect your receivable balance to come down a little bit over the next few quarters, and that could potentially release another $300m in cash that could be on the balance sheet as net cash? Thank you.

Okay, this is Leong here. When you look at the receivables, that line item that we disclose is the combination of trade receivables as well as billed receivables. So there are two components. At the moment a large part of this balance, a significant portion of this balance is actually from billed receivables which are bank-backed instruments, okay.

So when we are holding this instrument we can discount it for cash. So this is the combination of the dynamics between whether it is cheaper to hold this bill discounting or is it cheaper to have under funding instruments.

So my short answer to you is, well, it depends on the money market situation. So it is -- the only assurance I can give to you is a significant part of this balance comes from bank-backed instruments. Because we are dealing with the major OEMs in China, they have the ability to issue such instruments as a form of payment to us.

There's also another question that's come out from the sending in by text. I will answer it at the same time because it's relating to funding. Somebody has asked that have we issued any interest-bearing securities in 2012. Okay. We have not announced anything but as usual as a company of our size we are dealing with a large volume we have to explore all different options of funding, whether it's a straight bank loan or factoring of our accounts receivable or discount our billed receivables or even entering into financing bonds as we have done in 2011. These are all options on the table we will consider depending on the market dynamics, especially the money market dynamics.

So is it fair to assume that if money market rates or your factoring rates come down then some of these trade bills that you have, you might factor them and it again then releases cash?

The answer is yes. The answer is yes.

And if I may ask another question. A few quarters ago there was a lot of excess inventory of engines and trucks in the channels. Has that been worked down quite a bit now that the inventory in the channel is a lot less now or more at normal levels? Thank you so much.

Sandy, we have spoken to some customers recently and we are looking at inventories coming down somewhat but still relatively high. But I think it is good news that it's slowly being eaten down. So now they are saying they have reached about three months of inventory which is acceptable in this kind of situation.

Thank you.

Thank you very much. Your next question comes from the line of Mr. Jonathan Brodsky. Please ask your question, sir.

Yes, gentlemen, thank you very much for speaking with us today. As it relates to the balance sheet, given the considerable cash level it was a bit surprising to see short-term and long-term interest-bearing loans go up during the period although we saw receivables go down as well as cash and cash equivalents go up. Why would you take out relatively high interest-bearing notes at around 4.5% given the extremely high levels of cash that you're carrying and the opportunity to factor some of your receivables?

Yes, just to refresh a little bit of what we have done. In 2011 we actually have issued a total of CNY2.39b of short-term financing bonds over three tranches. The first one is in March followed by July and followed by November. So the number that you are seeing at the end of June 30 carries the second and third tranches -- second and third tranches. The second tranche is CNY700m, the third tranche is CNY690m. So this was something we have carried out in 2011.

But the big question behind this question would be what is our funding strategy because given such a size company like Yuchai we have to continue to explore various funding options. For example, if you don't start with the short-term notes you never have a chance to move to medium-term notes whether we want to move into the future or not but as a company as we mature we have to explore various options.

So my quick answer to you, what we are holding now as at June 30 is as a result of what we have issued in the year 2011.

But I guess just coming back to that the financing costs continue to escalate and yet your cash levels continue to go up. So I just ask you to perhaps help us understand, other than preparing for the future and making sure you have financing in place it seems like it's -- it seems to me to be getting to the point of excess. And perhaps you can explain why cash is held at such a high level but if you take the receivables, as you mention the majority of them are bills receivable and you can factor them at 80% and then you have your cash and your cash equivalents. You're looking at a Company with certainly more than $1b of excess cash and you're continuing to borrow. So can you just -- other than preparing for the future can you explain to us why you would do that?

Yes, okay. One of the reasons of continuing to do such arrangements with the bank is also it is part of our process of continuing to engage with the banks to build up the relationship so that the bank would expect a big company like us to have a variety of instruments with them because we do help them in a sense to meet their (inaudible) volume in various types of financing instruments.

That is good for us because that helps us to lead into other funding options and also to be able to continue to access. As you know in China, if you read the news and you can hear from other competitors, there are a lot of players that can't even get loans even though the interest rate is coming down. So as a big company like us we have to continue to engage the banks, we have to (multiple speakers).

But we are mindful of the question because having a large cash balance is a good thing and it's also a cautious thing. We value these comments, yes.

So -- I'll stop after this but let me just follow up on that. Does a traditional line of credit not exist where you're paying a fee but you're not actually holding the debt on your balance sheet? Does a concept like that exist, number one? But number two, the cash and the cash equivalents, is it earmarked for something or is it -- is this money that's just genuinely sitting on your balance sheet for defensive purposes or for projects that you want to use in the future?

Yes, okay. Also there is some further color for you because this balance is in the month of July and -- the month of June, this bank balance. In the month of July we have a tranche of CNY700m of bond that is due to be repaid and also in November we have another CNY690m. So you can see in our funding need we have to consider what other obligations are falling due.

Further than that it's also that we have been operating a lot of CapEx, a lot of operating and R&D on our own internal funds. And some of them as you can see in our recent announcement that we are going to building up our high cost (inaudible) facilities and new foundries, you can see our announcement. These are all these activities that we have to build up our cash to fund these because basically we are funding all this through our internal funds without going to the market to raise any (multiple speakers).

Great, okay. Okay, what about the concept of just traditional line of credit where you could have a commitment to a bank but not actually have to take the loans on your balance sheet?

Okay, this is not the case in China. Like you say in some international banks they give you a line of credit, they have a certain commitment fee, if you're not drawing the line they will still charge you. This is not a concept in China. So I hope I make it clear for as (multiple speakers).

No, that's very helpful. So just to replay what you said, going into the next quarter you have approximately CNY1.3b of loans that need to be repaid so we should in theory see debt coming down again in the next quarter and cash going down correspondingly?

That's correct.

Great. Thank you, gentlemen, very much, it's been very helpful. Thank you.

Thank you, Jonathan.

Your next question comes from the line of Ben Wong from Bank of America. Please ask your question.

Hi, thank you for having my question. I have basically two things. Number one from the margin outlook, you mentioned you would do another CNG engine, so what's the margin level for the CNG engine compared to existing diesel engine? That's the first margin question.

And secondly in July 2013 we will have emission upgrade. It's also mentioned that [FT] will increase by about 20%. What's the margin of the (inaudible) price increase? I know we have some components to increase the costs. So what's the margin compared with existing China 3 emission standard?

Okay, can you repeat your first question.

My first question is on the CNG engines margin compared to the diesel engine margin. And last one's on the CNG proportion for the long term. What are your expectations about the CNG truck (inaudible) market share of overall total truck? You just mentioned it would be about 8% of your product so for the long term what the number will be? Thank you.

Okay, the natural gas engine the margins are obviously much higher than the contemporary engines. We're looking at in the region of over [20%] which is something that is a very nice margin to have. As to what the ultimate size is, right now it's still much of a guess but my calculation is that at least on the natural gas side by 2015 it could possibly be a couple of hundred thousand engines at the rate it's going which is still not much compared to -- even heavy-duty trucks you're talking about 800,000 engines already. So this is a very conservative number at this point in time. But we'll have more clarity next year when the infrastructure is being rolled out and you can see the government putting more emphasis in this area.

Thank you. And about my second question on the China 4 emission standard engines margin compared to China 3 emission standard? Which kind are your thoughts?

The margins of Emissions 4 versus Emissions 3, that is your question.

Yes.

Again we're talking about the difference of approximately between a 10% kind of margin.

Higher? Higher (multiple speakers)?

Of course it's higher, that's right.

Thank you.

Thank you very much sir. Your next question comes from the line of Mr. Gerwin Ho from Cit. Please ask your question sir.

Hi, good morning gentlemen, thank you for your time. Just two questions. First of all Benny was commenting that third quarter situation is actually pretty tough and I just want to make sure I understood correctly. You said the third quarter run rate is actually similar to the first quarter? Is that correct?

No, actually we see third quarter probably very similar to our second quarter.

So sequentially the demand is roughly the same as second quarter?

This is what we are anticipating, that's right.

Okay, understood. And then in terms of the timing of the recovery now, we think it could be at the earliest end of this year or even going into early '13?

I would guess that probably '13 will be a more realistic kind of target. End of this year we should see actions being taken in place that will lay the groundwork for Q1 next year's recovery.

So in terms of for August I think the heavy-duty truck market is still negative growth year over year. So it seems like if the recovery is pushed into '13 that means we may not even get a positive year-over-year month even by fourth quarter this year? Is that a logical thing to think?

I think that's a logical conclusion, that's right, Gerwin.

Wow, okay. So it's quite tough. And secondly, have we been gaining market share in the heavy-duty truck engine market?

And lastly, in terms of pricing, given how soft the demand is are we seeing pricing pressure or because we are doing relatively well in terms of market share actually the pricing is stable?

In the heavy-duty truck market I would say that share is really a challenging. In fact everybody is going through the same sort of difficulties. So I think we are probably in the same category as well. Margin pressures continue to be the same as we have answered the first question with Alex and David at the time. We see for the same category engine we are actually going through a lot of pressures but what we want to do is really to prevent price erosion by giving better incentives for example, improved warranties or increased service levels.

Okay, so pricing -- just looking at pricing in isolation it's actually been relatively stable because we're giving some non-pricing type of incentives?

That's right. So, in fact, we want to up-sell if possible and that's where we are looking at trying to up-sell to some of our better and higher grade engines. So that's one way to go about [fighting] on price.

And in terms of market share it's -- because I remember in the last call we said we were gaining market share. So -- but you just said basically it's now harder to gain market share or market share is roughly year to date same year over year. Is that correct?

For the heavy-duty segment, yes, I think it's roughly about the same. Earlier on in my script I was talking about having the largest market share because actually in terms of both light duty and heavy duty combined we have sold approximately probably the largest number of engines so far.

Understood. I guess one more question is on the off-road side, on the construction machinery side are things better or worse than the heavy duty truck market do you think?

Actually construction is pretty dim right now actually, that's on the construction side. But we see a lot of upside on the marine engines so that's the bright spot that we're seeing so far.

And also the bus market obviously?

Absolutely.

Understood. Thank you so much for your insight and candid feedback. Thank you.

Thanks, Gerwin.

Thank you, sir. Your next question comes from the line of Mr. Himanshu Shah from Shah Capital. Please ask your question.

Good evening, gentlemen. Benny, can you talk about the positive contribution from joint ventures, especially in 2013, as we have been losing a lot of money on all those joint ventures? And then I have a follow-up question.

Okay Himanshu. For us we look at our joint ventures, the CIMC-Chery, we got a YC6-K engine and that's really one of our top engines that we have today. And to me I'm very optimistic about this joint venture because when the heavy-duty truck market takes off this will be our prize JV because we will be able to capture a sizeable segment because of the good engine that we have.

Obviously currently it's still in the -- very much on the pickup capability, right now we have a 15,000 engine unit capability but we are not selling to that number right now, as you know because the heavy-duty market is very much in a slump.

Okay. What about the passenger vehicle diesel engine joint venture? Are you -- I think you have about 70% ownership?

Yes, we have 70% in Jining. As I said just now we did a share swap so we're now very much focused on passenger cars. We have some traction. We are building the 4D passenger cars and we've got several orders. So next year we are optimistic that there will be more orders coming in and one of the thinking that we have right now is that not only in the China market but once you get a correct certification we could possibly the 4D passenger cars overseas as well.

The Company have a lot of cash and you wonder as the market leader it's trading at the lowest valuation in the industry. So I'm just curious why the Board of CYI are not contemplating a stock buyback, especially at discount prices?

Well, certainly, this is a Board direction, we are the management, our company -- we would not want to second guess what the Board wants to do. But having said that I think you are right, we have a lot of cash and I think the cash is really for strategic purposes because we are in a tough time today, we want to make sure that we have the cash for the right investment opportunities going forward.

I think the last point I want to make is that really a strong balance sheet is really a key for our business. We want to make sure that we continue to do well in our cash position so that we are poised for future growth.

But most of the machinery companies which are not even taking market share unlike Yuchai are trading at substantially higher valuation than where CYI trades. So why the Board is not taking -- using that, being opportunistic over here?

Himanshu, I'm sorry, I can't speak for the Board. I'm management. So we are doing our best in running the business, we've got to let the Board speak on their behalf at the next AGM.

Thank you.

Thank you very much, sir. Ladies and gentlemen, we have now reached the end of our Q&A session and I will turn the call back over to Mr. Goh.

Okay, thank you, everyone. Thank you for participating in our second-quarter 2012 earnings call. We look forward to speaking with you again. Goodbye.