China Automotive Systems, Inc.

Good morning, ladies and gentlemen, and welcome to China Automotive System first quarter 2022 conference call. At this time, all participants have been placed on a listen-only mode, and the floor will be open for questions and comments after the presentation. It is now my pleasure to turn the floor over to your host, Kevin Cease. Kevin, over to you.

Thank you, everyone, for joining us today. Welcome to China Automotive Systems 2022 first quarter conference call. Joining us today are Mr. Jay Lee, Chief Financial Officer of China Automotive Systems. He will be available to answer questions later in the conference call with the assistance of translation. Before we begin, I 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, 2021, as filed with the Securities and Exchange Commission, and in other documents filed by the company from time to time with the Securities and Exchange Commission. If the outbreak of COVID-19 is not effectively and timely controlled, our business operations and financial condition may be materially adversely affected as a result of the deteriorating market outlook for automobile sales. The slowdown of regional and national economic growth, weakened 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 uncertainty in the regions where we conduct business, caused our business to suffer in ways that we cannot predict and materially adversely impact our business financial condition and results of operations. A prolonged disruption or any further unforeseen delay in our operations of the manufacturing, delivery, and assembly process within any of our production facilities could continue to result in delays in the shipment of products to our customers, increase costs, and reduce revenue. The company expressly disclaims any duties 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 first quarter results for the period ended March 31, 2022. Management will then conduct a question and answer session. The 2022 first quarter financial results are unaudited, and all results are reported using U.S. GAAP accounting. For the purposes of our call today, I'll review the financial results in U.S. dollars. We'll begin with a review of the recent dynamics of the Chinese economy, the automobile industry, and China Automotive's market position. China's GDP growth was 4.8% in the first quarter of 2022, historically low but above expectations and higher than the 4% in the fourth quarter of 2021. The COVID-19 outbreak worsened during the first quarter with lockdowns in several cities across China. Supply chain interruptions increased, retail spending was weak, and unemployment rose to 5.8% in March. Computer chip shortages also continued to affect automobile production. In this environment, Chinese automobile sales increased by only 0.2% year-over-year in the first quarter of 2022, with sales declining by 11.7% in the month of March as the lockdowns and supply chain issues took stronger effect. Passenger vehicle sales rose 9% year-over-year and commercial vehicle sales declined by 31.7% in the first quarter of 2022. Truck sales were down by 32.8% and bus sales decreased by 18.7% on a year-over-year basis in the first quarter of 2022. Reflecting the auto industry conditions, our net sales in the first quarter of 2022 increased by 4.7% yearly year to $136.4 million, and we're consistent with the $138.8 million in the fourth quarter of 2021. Net sales of traditional steering products and parts decreased by 9.7% to $95.4 million for the first quarter of 2022, compared to $105.6 million for the same period in 2021. Sales of our electric power steering EPS products rose by 66% in the first quarter of 2022. Export sales primarily to our North American customers and South American operations increased by 7.7%. Our gross margin declined to 10.8% from 15.1% in the first quarter last year. Higher material costs and much higher international freight charges were affected by supply chain disruptions and lockdowns related to COVID-19 infections spreading in China and abroad. Additionally, our product sales mix compared with a year ago also affected our gross margin. Research and development expenses, R&D, increased 20.9% year-over-year to $8.1 million, mainly due to the higher investment in our EPS product line. We are enhancing the performance of our current EPS products as well as developing new EPS products to expand our market penetration. In 2021, we introduced a proprietary new EPS product, which for the first time was entirely developed in-house in China. This product communicates with the vehicle's main data to create lane-keeping assist, automatic parking assist, lane centering, and traffic jam assist functions as part of the company's Advanced Driver Assistance System, ADAS. Great Wall, Cherry Auto, Beijing Auto, and JAC Motors all began using our EPS products in 2021. To expand our advanced technology into the commercial vehicle space, in January 2022, we agreed with Scantia AB to develop an eRCB steering system for Scantia's trucks and buses. This eRCB steering system is a fully electric intelligent steering system for light and medium-duty trucks and heavy-duty commercial vehicles. Combining our proprietary technology with our advanced driver assist systems L4 platform named APO4, this driver assist system enables vehicles to execute level four autonomous driving. This ERCB steering system is expected to become the world's first mass-produced fully electric intelligent power steering system for commercial vehicles. Our access to the technology of Sweden's Sentient AB will further improve our NED steering products, especially for vehicle motion control for the fast-growing autonomous driving market in both passenger and commercial vehicle markets. As of March 31, 2022, we had cash equivalents and pledged cash of $109.4 million with working capital of $145.6 million. We have initiated a share repurchase program beginning in April 2022 of up to $5 million of the outstanding common shares over the next 12 months. Repurchases will be made in open market transactions at prevailing market prices up to $4 per share through March 30th, 2023. We have maintained our market share in the Chinese and North American steering markets. Our Brazilian operation continues to grow, and we are building a larger footprint in Europe. Our NEV technology are expanding, and our EPS product lines are growing in capabilities, performance, and in sales, as more customers have been added compared with a year ago. We look forward to adding more EPS products and using sentient AB technology to further enhance our steering products in the global market. Now let me review the financial results for the first quarter of 2022. Net sales increased by 4.7% to $136.4 million in the first quarter of 2022, compared to $130.3 million in the first quarter of 2021. The net sales increase was mainly due to the recovery of the Chinese economy post-COVID-19 and higher demand for passenger vehicles in the first quarter of 2022. Net sales of traditional steering products and parts decreased by 9.7% to $95.4 million for the first quarter of 2022 compared to $105.6 million for the same period in 2021. Net sales of electric power steering products, EPS, rose 66% to $41 million from $24.7 million for the same period in 2021. EPS product sales were 30.1% of total net sales for the first quarter of 2022 compared with 19% for the same period in 2021. Export net sales rose 7.7% to $43.4 million in the first quarter of 2022 compared with $40.3 million in the first quarter of 2021. Gross profit declined to $14.7 million compared to $19.7 million in the first quarter of 2021. Gross margin in the first quarter of 2022 was 10.8% compared with 15.1% in the first quarter of 2021. The main causes in the decline in gross profit and margin decline are increased raw material and international transportation expenses and the change in product mix. Gain on other sales was $0.9 million compared to $1.3 million in the first quarter of 2021. Selling expenses were $4.3 million compared to $5.6 million in the first quarter of 2021. This decline in selling expenses is primarily due to lower transportation expenses. Selling expenses represented 3.2% of net sales in the first quarter of 2022 compared to 4.3% in the first quarter of 2021. General administrative expenses, G&A, were $4.8 million compared to $4.6 million in the first quarter of 2021. G&A expenses represented 3.5% of net sales in the first quarter of 2022 and then the first quarter of 2021 also. Research and development expenses, R&D, increased 20.9% to $8.1 million compared to $6.7 million in the first quarter of 2021. R&D expenses represented 5.9% of net sales in the first quarter of 2022 compared to 5.1% in the first quarter of 2021. Net other income was $3.5 million for the first quarter of 2022 compared to $1.7 million for the three months ended March 31, 2021. The increase of $1.8 million was mainly due to increased government subsidies which totaled $3 million received in the first three months of 2022. Loss from operations was $1.5 million in the first quarter of 2022, compared to income from operations of $4.2 million in the first quarter of 2021. The 2022 first quarter loss was primarily due to lower gross profits and higher operating expenses in 2022, compared with the same quarter last year. Interest expense was $0.4 million in the first quarter of 2022, compared to $0.3 million in the first quarter of 2021. Net financial income was $2 million in the first quarter of 2022, compared with the net financial loss of $0.2 million in the first quarter of 2021. The net financial income in the first quarter of 2022 was due to foreign exchange gains. Income for income tax expense and equity and earnings of affiliated companies was $3.6 million in the first quarter of 2022 compared to $5.3 million in the first quarter of 2021. The reduction in income before income tax expenses and equity and earnings of affiliated companies in the first quarter of 2022 was mainly due to a loss from operations offset by higher other income, net, and financial income. Equity and loss of affiliated companies was $2.5 million in the first quarter of 2022 compared with equity and loss of affiliated companies of $1.4 million in the first quarter of 2021. Net loss attributable to parent companies' common shareholders was $0.06 million in the first quarter of 2022 compared to net income attributable to parent companies' common shareholders of $3.2 million in the first quarter of 2021. Diluted loss per share was nil in the first quarter of 2022 compared to net income per share 10 cents in the first quarter of 2021. The weighted average number of diluted common shares outstanding was 30,851,776 in the first quarter of 2022 compared to 30,857,736 in the first quarter of 2021. Next, we'll review a few balance sheet items. As of March 31, 2022, total cash and cash equivalents and pledged cash were $109.4 million. Total cash receivable, including notes receivable, were $222.4 million. Cash payable, including notes payable, were $227.7 million. And short-term bank loans were $48.2 million. Excuse me. Total parent company stockholders' equity was $322.3 million as of March 31, 2022, compared to $321 million as of March 31, 2021. Net cash used in operating activities was $4.3 million in the first quarter of 2022. The company purchased $44.7 million of short-term investments in the first quarter of 2022. The business outlook, management has reduced revenue guidance for the whole year 2022 to $490 million from $510 million due to the economic impact of COVID-19 and foreign exchange volatility. This target is based on the company's current view on operating and market conditions, which are subject to change. With that operator, we're ready to begin the Q&A.

Ladies and gentlemen, the floor is now open for questions. If you have any questions or comments, please press star one on your phone at this time. We ask that while posing your question, you please pick up your handset if listening on a speakerphone to provide optimum sound quality. Please hold while we poll for questions.

Thank you.

Your first question is coming from William Gregorzewski, Greenridge Global. William, please ask your question.

Hi, a couple of questions. First, with regards to the lockdowns in China, how much of an impact is that having? You know, you saw some of that in the first quarter. How much is that having right now, you know, in the current quarter?

This is our researcher William Bell's question. His question is about the current situation in China, the epidemic prevention and control situation. including some areas that have been closed down. Now, how much does it affect us in the first quarter? How much does it affect us in the first quarter due to the pandemic? The impact of the pandemic actually started in late March.

So the whole epidemic has not had a big impact on us in the first quarter. The real impact started in April. So from the data disclosed in April, the entire gas industry fell by nearly 40% in the same month. So I guess the impact of this epidemic is now a little better, but it is also slowly recovering. so um the pandemic um kobe related lockdown um release

the impact to our business is really in the second half of March so it it doesn't fully reflect it in our you know it doesn't have much significant impact to our first quarter number the the lockdown impact it did come in in a month of April in a very significant way. If you look at the entire auto industry in China, the sales of passenger vehicle in the month of April was down 40% compared to April last year. So for that reason, we have adjusted downward our annual guidance just to reflect the impact from the COVID lockdown, particularly in the month of April.

Okay, great. With regards to the gross margins, it looks like the international sales all had gross margins under 10% Is that all shipping related, or what's the reason for that, and how do you guys get that back up to more normal levels?

Uh, the whole company's one-year-old interest rate, uh, was affected by two factors. The first one is that the domestic commercial vehicle, then, uh, the sales have dropped a lot Uh, commercial vehicles, you know, with that real estate, it's a bit more of a concept, so the whole real estate, uh, this year's one-year-old performance is not good, then it also affects the performance of the entire commercial vehicle As for our commercial vehicles, the most important factor is the weight of the card. As a result, the turnover of commercial vehicles has decreased. As a result, the profit margin of commercial vehicles has also dropped significantly. Speaking of international business, what he said is more correct. There is an increase in shipping costs. The increase in costs also leads to a decrease in the amount of shipping, even some ports or containers are more difficult to get. Another reason is the impact of the exchange rate. The exchange rate is higher than last year's first quarter.

So the gross margin overall was impacted. In the first quarter, our overall gross margin, that's including domestic and international business, was affected by three factors. The first is our business in the domestic commercial vehicle sector. We are one of the major players in the commercial vehicle stealing market. The overall weak property market or real estate market does have an impact to the truck sales, in particular the heavy duty trucks. We do sell a lot of products to the heavy duty. Truck producers and weaker sales affected our overall margin for the commercial vehicle side of business. On the passenger vehicle business, just as you mentioned, the international business accounts for a sizable of our overall revenue. the higher shipping costs and due to the Inflated oil price does affected our cost and in last factor or the Forex foreign exchange in the first quarter RMB actually against US dollars as being a stronger which affected our Because we're reporting on U.S. dollars, so that's affecting our margin.

Yeah, as you also noticed, the RMB has been since then has depreciated against US dollars. So especially the month of April and May. So we are hopeful.

um the next few quarters our margin will improve especially with the help of you know stronger dollar and weaker r b okay all right um can you talk about what the r d spending is going towards now and how much you expect to spend on that in 2022 and 2023 okay What is the budget for research? How much will it cost in 2023? The entire R&D for the first quarter of this year is 8.1 million US dollars. The whole year's budget is about 30 million US dollars.

The main purpose is to increase the development of EPS. including R-EPS, DP-EPS, IRCB, ERCB, and higher-level aerosols. The goal is to aim for the future of intelligent transformation and unmanned driving. In 2023, the budget has not yet come out, but it is expected to grow. Okay.

So in terms of R&D, Q1 we booked about 8.1 million U.S. dollars. We expect about $30 million in R&D for fiscal year 2020. And most of the R&D expenses are going to the development of electric power steering, what we call EPS product. We now have a slew of EPS or the other intelligent steering systems, including REPS, GPEPS, IRCB, ERCB, and some of the level three functions we embed into our software and systems. as well as the steering systems are really featured the functions for autonomous driving and for the future of the artificial intelligence for the vehicles. So these are the area we will continue to invest. And that being said, we expect the R&D expenses will be slightly higher from 2022 next year. So we're going above, go higher, a little bit higher than this year's R&D spending.

Okay, great. And the last question is, when do you guys expect to do any share repurchases?

Okay. He said the last question is about our repurchase. When are we going to repurchase?

Yeah, so as we just finished reporting then we will be qualified to do the purchase so we have to

Line up with our brokers. It would take probably 10 days to get ready. Then we'll start buying.

Okay, great. Thank you, guys.

Thank you. Thank you.

Okay, ladies and gentlemen, as a reminder, if you wish to place any questions or comments, please press star 1 on your phone at this time.

Okay, there appears to be no more questions in the queue. I'm going to hand back over to Kevin. Kevin? Kevin, are you there?

Yes. We thank you for your participation in today's conference call. We wish you to be safe, and we look forward to speaking with you again. Thank you.

Thank you, ladies and gentlemen. This does conclude today's conference call. You may now disconnect your phone lines and have a wonderful day. Thank you for your participation.