China Automotive Systems, Inc.

Greetings, and welcome to China Automotive Systems' third quarter 2020 conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Kevin Thies, Investor Relations.

Thank you, everyone, for joining us today. Welcome to China Automotive Systems 2020 Third Quarter Conference Call. Joining us today are Mr. Quizu Wu, Chief Executive Officer, and Mr. Jay Lee, Chief Financial Officer of China Automotive Systems. They will be available to answer questions later in the conference call with the assistance of translation. Before we begin, I will remind all listeners that throughout this call, we may make statements that may contain forward-looking statements. forward-looking statements represent the company's estimates and assumptions only as of the date of this call. As a result, the company's actual results could differ materially from those contained in these forward-looking statements due to a number of factors, including those described under the heading risk factors in the company's form 10-K annual report for the year ended December 31, 2019, as filed with Securities and Exchange Commission on May 14th 2020 and in other documents filed by the company from time to time with the Securities and Exchange Commission. If the outbreak of COVID-19 is not effectively and timely controlled, our business operations and financial conditions may be materially and adversely affected as a result of the deteriorating market outlook for automobile sales to slow down our regional and national economic growth, weaken liquidity and financial condition of our customers, or other factors that we cannot foresee. Any of these factors and other factors beyond our control could have an adverse effect on the overall business environment, cause uncertainties in certain regions where we conduct business, cause our business to suffer in ways that we cannot predict, and materially and adversely impact our business, financial condition, and results of operations. A prolonged disruption or other further of unforeseen delay in our operations of the manufacturing, delivery, and assembly process with any of our production facilities could continue to result in delays in the shipment of products to our customers, increased costs, and reduced revenue. The company expressly disclaims any duty to provide updates to any forward-looking statements made in this call, whether as a result of new information, future events, or otherwise. On this call, I will provide a brief overview and summary of the financial results for the third quarter and first nine months of 2020. Management will conduct a question and answer session. The following 2020 third quarter and first nine months financial results are unaudited and are reported under U.S. GAAP. For the purposes of today, I will review the financial results in U.S. dollars. We will begin with a review of the recent dynamics of the Chinese economy, the automobile industry, and China automotive market position. In the third quarter of 2020, China's economy rebounded as GDP growth was 4.9%, a significant increase over the 3.2% in the second quarter of 2020, but much lower than the 6% growth in the third quarter of 2019. 0.7% compared with the same periods a year ago. The Chinese economy has continued to recover from the severe disruptions caused by the impact of the COVID-19 pandemic. After widespread business closures and travel bans in the first quarter of 2020, China was among the first countries to ease the transportation lockdown and travel restrictions, and the Chinese economy began to reopen in the second quarter of 2020. excuse me, government incentives to promote continued economic growth included higher physical spending, more approved infrastructure projects, and lower lending rates to help stimulate renewed economic activities. However, data from the National Bureau of Statistics show that the total retail sales in China grew by a paltry 0.9% in the third quarter of 2020 and declined by 7.2% for the first nine months of the year. compared with the same periods in 2020. I'm sorry, in 2019. Industrial production was up 6.9% in the month of September, but increased only 1.2% for the nine-month period. Six asset investments increased by 0.8% in the first nine months of 2020 as well. For the third quarter end of September 30, 2020, the sale, retail, passenger cars in China grew by 7.9% year over year, according to the China Passenger Car Association. A more detailed breakout by the China Association of Automobile Manufacturers, CAAM, showed that passenger car sales in the month of July 2020 rose by 8.5% year over year, with sedan sales up by 4.6%. The sale of MPVs was reduced by 0.7%, SUV sales rose by 14%, and crossover vehicle sales increased 8.5% in July 2020. Export sales of passenger cars declined by 25.9% in the month of July year over year. In August of 2020, CAM reported a 6% year over year increase in passenger car sales, with passenger car sedan sales up 5.8% year over year. MPV sales were 1.1% higher. SUV sales rose by 6.5%, and sales into the smaller market for crossover vehicles increased by 17.2%. Export sales of passenger cars decreased by 18.7% in August year over year. For the month of September 2020, passenger car sales increased by 8% year over year, with passenger car sedan sales up 3%. MPV sales decreased by 12.3%, SUV sales rose by 16% and crossover vehicle sales improved by 25.5% year-over-year. Export sales of passenger cars increased by 14.7% in September on a year-over-year basis. For the first nine months of 2020, CAM reports that passenger car sales declined by 12.4% year-over-year, with passenger car sedan sales 16% lower than the same period last year. SUV sales were down 5.5%. MPV sales were reduced by 32.7%, and crossover vehicles decreased by 7.9%. Export sales of passenger cars for the first nine months of 2020 declined by 11.1% compared with the first nine months of 2019. Given this industry background, in the third quarter of 2020, our net sales increased by 13.5%. to 114.1 million compared to 100.5 million in the third quarter of 2019. Higher sales of our advanced hydraulic steering products in China combined with increased export revenues from North America offset lower domestic sales of our electric power steering products, EPS. Net EPS sales were $14.3 million compared with $16 million in the third quarter last year. Our sales volume declined in some markets in the third quarter of 2020, and our average selling price in North America decreased, which combined with lower sales of our EPS products generated lower gross profit. However, we generated $19.8 million in positive operating cash flow in the third quarter of 2020 and $51.2 million in the first nine months of 2020. Our total cash and cash equivalents in pledged cash deposits were $113.5 million as of September 30, 2020, and we repurchased approximately 322,000 shares of common stock in the third quarter of 2020. We continue to prioritize on maintaining our strong balance sheet. Total parent company stockholders' equity was $289.6 million as of September 30, 2020. We have confidence that business conditions will continue to increase in China as the domestic government further stimulates the economy and consumers become more confident in its growth sustainability. The domestic demand and pricing environment should improve in 2021 compared with 2020. We look forward to foreign economies stabilizing and improving even as the COVID-19 pandemic continues. Let me review the results for the third quarter of 2020. In the third quarter of 2020, net sales were at 13.8% to $114.4 million, compared to $100.5 million in the same quarter of 2019. The increase in net product sales was mainly due to a change in the product mix and higher domestic sales volume of the company's hydraulic products, combined with increased sales to North American customers. Net product sales to North America grew by 9.8% to $37 million, compared to $33.8 million in the same quarter of 2019. Net product sales for the company's electric power steering, EPS, products worth $16.7 million or 14.6% of net sales. Gross profit was $13.6 million in the third quarter of 2020 compared to $17.3 million in the third quarter of 2019. Gross margin was 11.9% compared to 17.2% for the same period of 2019, mainly due to higher unit costs for EPS and export products compared to the third quarter last year. Selling expenses were $3.8 million in the third quarter of 2020, compared to $3.6 million in the third quarter of 2019. Selling expenses represented 3.3% of net sales in the third quarter of 2020, compared to 3.6% in the third quarter of 2019. General administrative expenses, G&A, were $5.1 million in the third quarter of 2020, compared to $4.4 million in the same quarter of 2019. The increase was primarily due to higher office expenses. G&A expenses represented 4.5% of net sales in both the third quarter of 2020 and the third quarter of 2019. Research and development expenses, R&D, were $6.1 million in the third quarter of 2020 compared to $6 million in the third quarter of 2019. R&D expenses represent 5.3% of net sales in the third quarter of 2020 compared with 6% in the third quarter last year. The lower R&D percentage was mainly due to more strict cost controls over R&D expenditures. Net financial expense was $2.3 million in the third quarter of 2020, compared to net financial income of $1.6 million in the third quarter of 2019, which was mainly due to foreign exchange losses compared with foreign exchange gains in the last year's third quarter. Income from operation was $0.1 million in the third quarter of 2020 compared to income from operations of $4.4 million in the same quarter of 2019. The lower income from operations was mainly due to reduced gross profit and lower gross margin in the third quarter of 2020. Loss before income taxes, expenses, and equity in earnings of affiliated companies was $2.3 million in the third quarter of 2020. compared to income before income tax expenses and equity in earnings of affiliated companies of $5.3 million in the third quarter of 2019. The loss before income tax expense and equity in earnings of affiliated companies was mainly due to lower gross profit and lower income from operations in the third quarter of 2020 compared with the third quarter of 2019. Net income attributable to parent companies common shareholders was $2.4 million in the third quarter of 2020 compared to net income attributable to parent companies, common shareholders of $4.3 million in the third quarter of 2019. Diluted earnings per share were 8 cents in the third quarter of 2020 compared to diluted earnings per share of 14 cents in the third quarter of 2019. Weighted average number of diluted common shares outstanding was 31,113,374. in the third quarter of 2020 compared to 31,492,035 shares in the third quarter of 2019. I'll provide a brief summary of the nine-month results. Net sales for the first nine months of 2020 were 271.2 million compared to 315.5 million in the first nine months of 2019, reflecting the impact of the COVID-19 pandemic in the automobile industry in China and globally. Nine-month gross profit was $32.6 million compared to $46.6 million in the corresponding period last year. Nine-month gross margin was 12% compared to 14.8% for the corresponding period in 2019. For the nine months into September 30, 2020, gain on other sales amounted to $2.9 million compared to $4.9 million for the corresponding period in 2019. Loss from operations was $4.1 million, compared to income from operations of $8.1 million in the first nine months of 2019. Net loss attributed to parent companies' common shareholders was $1.8 million, compared with net income attributable to parent companies' common shareholders, $8.2 million in the corresponding period last year. The alluded loss per share was $0.06 in the first nine months of 2020, compared to the alluded earnings per share of $0.26 for the corresponding period in 2019. Net cash provided by operating activities was 52.7 million in the first nine months of 2020 compared with net cash provided by operating activities of $4.1 million in the first nine months of 2019. Payments to acquire property, plant, and equipment were $8.9 million compared with $23.6 million in the first nine months of 2019. Approximately 322,000 shares of common stock were repurchased during the third quarter of 2020. And the company expects to repurchase more shares in the future, depending upon market conditions. Now, a few highlights of the balance sheet. As of September 30, 2020, total cash and cash equivalents in pledged cash deposits were $113.5 million. Total accounts receivable and notes receivable were $209 million. Accounts payable including notes payable were $201.4 million. And short-term loans were $44.6 million. Total parent company stockholders' equity was $293 million as of September 30, 2020, compared to $289.3 as of December 31, 2019. Business outlook. Management has increased its revenue guidance from $360 million to $390 million for the full year 2020. This target is based on the company's current views when operating the marketing conditions, which are subject to change. Operator, with that, we are ready for the Q&A.

Thank you, sir. At this time, we'll be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.

One moment, please, while we pull for questions. Once again, if you have a question, please press star 1 on your telephone keypad.

Once again, if you have a question, please press star 1 on your telephone keypad. Our first question today comes from Robert Polovich of A Private Investor.

Please proceed with your question. Thank you. Good morning. How is everybody today? You know, I was just wondering as we move into 2021, well, I guess Looking at 2020, we know that the margins are lower than they were a year ago. The outlook for 2021 as far as profit margins, do we see that at some point returning to more normalized levels?

Thank you for the question. Li Jie, his first question is about the interest rate. Our 2020 interest rate seems to be worse than before. He wants to know how the situation is in 2021. When will it be able to recover to a more normal interest rate level? Okay.

The impact of this interest rate is in several ways. The first is that there is an epidemic in the upper half of the country. The second one is the third stage. The performance of this EPS is much worse than expected. The third one is the impact of export products' tariffs. In terms of the impact, we believe that the epidemic will not have such a big impact. So this one can be improved. The second one is the EPS. The sales of CPS fell by about 10% this year compared to last year. There are some problems with the market opening. In addition, the cost control is not ideal. We are not satisfied with the quality of our high-end products. So, we have made a change in its total energy recently. In the fourth quarter and the first half of this year, there will be a major change. Okay.

Um, there are three contributing factors, uh, to a, uh, relatively soft, um, gross margin in, uh, in this year. Uh, first is the obvious for obvious reason is the COVID-19 pandemic, um, affected, uh, uh, every, manufacturers in the world, including China. Secondly, the electric power steering EPS product sales has been weak. We saw in the first nine months, we saw a 10% year-over-year decline, so that's the second factor. And the third one is we're facing a higher tariff for our international business. So combining these two, our gross margin was affected. In terms of 2021, first, COVID has been well under control in China. Life has come back to normal as our customers and suppliers and our own production as well. So that's a non-factor already, and we already... give you some data on the pretty strong rebound of the sales in the auto market. Secondly, on the EPS, we have some issues during the year, partly due to the cost control Recently, we made a management change. As a result of that, we believe in the coming quarter, in the fourth quarter, we'll see some very significant improvement, and we'll continue to see growth in 2021. And that's our plan. And so we believe next year will be a lot better. And with all these, we think gross margin next year will be improved.

Okay. I have another question. As it relates to EPS, how do we see the growth in that in that category moving into 2021, and also the chance for better profitability from EPS. I know that you have that joint venture with Heising Motors, and you have production, I guess, is underway at this point. Will that contribute to better profitability as we move into 2021? 他的第二个问题是他想知道2021年我们的EPS这块会是怎么样子的增长? 然后另外一块就是他想知道EPS的毛利是不是可以提高? 因为他看到我们以前宣布过我们

and Hyacinth, a Korean company, to build this motor. He wants to know if this can help us to increase our profits.

Next year, we expect that the real official plan will be released in December. But now there is a preliminary impression that there should be a growth of more than 20% in this year. So it's on the volume. And then the cost control part, in addition to the increase in the level of design control and the purchase part, the more important part is the internalization of the electric machine. Because this year's electric machine is also in the semi-transmission stage, so the entire energy climb is still in progress. We're still working on our 2021 projection.

We will have better clarity in December. However, the preliminary plan for next year is we will grow, we plan to grow our EPS business by 20%. We will continue to implement better cost control measures. That will help with margin. The electric motor side, as you just mentioned, our JV is still in trial production in 2022, I mean 2020. But next year, we will start full-scale commercial production. And that will... help significantly improve our insourcing capability of electric motor. We plan to have our JV to supply between 50 to 60% of our internal production for EPS. And so that will help with the gross margin in 2021.

Okay, I guess my last question really has to do with contract awards. We know that the automotive industry has been doing better than a lot of us anticipated six months ago, but with contract renewals, we would expect with a better outlook and better production numbers in automotive that The contract should renew at improving margins. How do you feel about this?

The last question is about the contract renewal. Because this year's car sales, as you can see in the data, are very active. In 2021, it is likely to continue. He wants to know, in such an environment, are we talking to the customer about the price in the contract to help us improve our profit margin?

As I mentioned earlier, first of all, The end-of-the-year planning is usually done in December. At that time, I started talking to customers about the sales and price of new products. At present, we are still in the phase of contact. But I can tell you a piece of news. Just now, the meeting of the Transformation Industry Association was held in Wuhan. Because CS is the chairman of the chairman of the chairman of the chairman of the chairman of the chairman of the chairman of the chairman of the chairman of the chairman of the chairman As we mentioned earlier, our 2021 planning will be completed sometime in December. However, we are in the preliminary

discussion with our OEM customers on volumes, on pricing for next year. As you just mentioned, 2020 has been a pretty remarkable turnaround for auto industry in China. And we also remain optimistic for 2021. continued growth for the sector we recently had a the auto the power steering industry recently had a conference in Wuhan we are the hosting company for such a large event consists of all pretty much all major steering producers in China. During the conference, we had a consensus in such an environment where the competition in the past many years has been quite intense. It's not really helping with the players like us, none of the players, because of the very intense price competition. So the consensus is going forward, we're going to come together a more rational pricing strategy among all players. That being said, we are optimistic for 2021 in terms of bargaining power with the OEM customers. As the demand for vehicles continue to rise, it will put pressure on the supplier side. In order to maintain top-notch quality and all-time delivery and safe production, we will need to have better margin. That being said, having such an industry leader consensus for the power steering industry. It's laying a great foundation for 2021. So we are very excited about next year. We think in many ways it will be a better year for us.

Okay, thank you. I appreciate that information.

Thank you. Thank you very much. Okay.

Once again, if you would like to ask a question, please press star 1 on your telephone keypad. Once again, if you would like to ask a question, please press star 1 on your telephone keypad.

We have a follow-up question from Robert Polovich, a private investor.

Please proceed with your question.

Oh, thank you. I'm back. You know, I had one more question as it relates to the tariffs, you know, imports into the U.S. and so forth. You think we have a little more optimism now that we're going to have a transition of power in Washington and maybe some of those import tariffs will come down? What are your thoughts on that situation?

Hmm.

He said, uh, uh, uh, uh, uh, uh, uh, uh, uh, uh,

We are hopeful the new president will be more open-minded

in terms of a global trade. It's a win-win for both customers and suppliers to ensure that the end product is top quality and price competitive. So we have proven we are a such a supplier to U.S. industries. And we'd like to see the leadership in Washington to realize there are many things U.S.-China can do together. So in a nutshell, we look forward to improved relationship and tariff can be one of these things will come to a more reasonable level.

Okay. You know, I had another question while we're doing questions here. I know you have some operation in Brazil. But what about the potential for maybe some assembly operation in Mexico? You see anything like that as a, as a potential. Development that you might consider.

Uh, uh, uh, uh,

Mexico is under consideration. And partly is our long-term global planning. The other part is

Actually, we're getting some suggestions and requests from our customers in North America. So we are doing some research on the possibility of setting up something in Mexico, although it's still a preliminary. Our long term, it doesn't change our long term planning. We want to be a global supplier. which means we have to have presence in all the key markets.

Yeah, that sounds good. Again, I appreciate your answers. Thanks for taking my call.

Thank you.

There are no additional questions at this time. I would like to turn the call back to Kevin Thies for closing remarks.

I want to thank everyone for participating in today's conference call. Please be safe and we look forward to speaking with you again in the future.

Have a good day.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.