China Automotive Systems, Inc.

Good morning, ladies and gentlemen, and welcome to the China Automotive Systems third 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, Mr. Kevin Cease, Investor Relations. Kevin, the floor is yours.

Thank you, everyone, for joining us today. Welcome to China Automotive Systems' 2022 third 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 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 conditions may be materially and adversely affected as a result of a deteriorating market outlook for automobile sales, the slowdown in regional and national economic growth, weakened liquidity in the 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 region where we conduct business, cause our business to suffer in ways that we cannot predict, and materially and adversely impact our business, financial conditions, and results of operations. 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 revenues. 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 third quarter and first nine months results for the period ended September 30, 2022. Management will then conduct a Q&A session. The 2022 third quarter and first nine months financial results are unaudited, and all results are reported using U.S. GAAP accounting. For the purposes of our today's call, I'll 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's market position. China's GDP growth of 3.9% year-over-year in the third quarter of 2022 was higher than a revised consensus projection of 3.4% growth and much higher than the 0.4% increase in the second quarter of 2022. Chinese industrial production trended upward at a 6.3% rate in September 2022, following a 4.3% rate in August and a 3.8% rate in July 2022. However, the Chinese real estate market remains in turmoil and the outlook for export is uncertain given the foreign exchange volatility and the economic outlook for key trading partners. Total vehicle sales in the third quarter 2022 increased by 24.9% year-over-year, with passenger vehicles up 36.6% year-over-year and commercial vehicles down 10.6% year-over-year, according to data from the Chinese Association of Automobile Manufacturers, CAAM. Truck sales continue to be weak, with a 10.8% year-over-year decline. These results were achieved despite Chinese supply chains continuing to be affected by COVID-19 lockdowns and travel restrictions affecting almost all provinces to some degree. Delays in raw material shipments and finished good deliveries, including for automobile microchips and other components, are still concerns for the automobile industry. For the first nine months into September 30, 2022, CAAM reported automobile sales increased by 4.4% year over year. Passenger vehicle sales rose by 14.2% year-over-year, with sedans 16.7% year-over-year higher, and SUVs 15% higher year-over-year. However, on a year-over-year basis, MPV sales declined by 7.8%, and cross vehicles were down by 14.6%, respectively. For commercial vehicle sales, CAAM, Data showed that an overall sales decline of 34.2% year-over-year for the first nine months of 2022. The truck market declined by 35.3% year-over-year, and bus sales were down by 23.9% year-over-year. Despite the mixed results in the Chinese auto vehicle markets in 2022 third quarter, our net sales grew by 26.8% year-over-year. Sales of our traditional hydraulic products remained strong. Our woohoo subsidiary sales, primarily the Cherry Auto, were up 50.2% year-over-year, and net sales into Brazil increased by 51.9% year-over-year. Additionally, sale of electric power steering, EPS, by our Henlong KYB operation rose by 93.7% year-over-year. However, our sales to our Tier 1 customers in North America were down slightly, and our commercial vehicle steering sales were flat, actually a solid result given the decline in the commercial vehicle sales in the third quarter. Most of our business segments achieved sales growth. Our commercial vehicle product division reported lower sales, which reflected the weak overall sales in the commercial vehicle sector. Our gross profit grew by 24.4% year over year, but the gross margin declined slightly to 15.2% from 15.5% in the third quarter of 2021, mainly due to changes in the product mix. Research and development expenses, R&D, increased by 66.7% year-over-year to $9.5 million in the 2022 third quarter as we grew our investments in new product development and to further build our technology base. Higher gross profit, stricter cost controls, and higher other income helped generate income from operations of $4.9 million in the third quarter of 2022 compared to $0.6 million in the third quarter of 2021. Our 2022 third quarter income per share was 24 cents versus the loss per share of one cent in the third quarter last year. For the nine-month period, our income per share was 55 cents compared with a 20-cent a year ago. Net cash provided by operating activities was $31.7 million in the first nine months of 2022, compared with net cash used in operating activities of $5.9 million in the first nine months of 2021. We continue to develop our ERCB systems with our Advanced Driver Assistance Systems L4 platform, known as the AP04, to execute level 4 autonomous driving systems. ERCB is a fully electric intelligent steering system for light and medium duty trucks and heavy duty commercial vehicles. We will add the technologies of our subsidiary in Sweden, Sentient AB, to improve our energy steering technology for autonomous driving products targeting passenger and commercial vehicles. As of September 30, 2022, we had cash and cash equivalents and pledged cash of $131.7 million and working capital of $153.4 million. For the third quarter of 2022, we repurchased 382,418 common shares under our repurchase buyback program at an average cost of $3.59. Our share repurchase program can use up to $5 million to buy outstanding common shares through March 30, 2023, at a price not to exceed $4 per share. Free cash flow increased to $19.8 million, compared with negative $11.7 million in the first nine months of 2021. We are particularly encouraged by the September sales of vehicles in China. All categories of passenger and commercial vehicles, as well as new vehicles tracked by CAAM, experienced a month-over-month increase in unit sales in September. These sales increases result from an improved supply chain, favorable government policies, including a 50% reduction in national purchase tax for some vehicles. Some of the favorable government programs may end at the end of 2022, so the remainder of 2022 may exhibit continued growth along the bill units as purchasers take advantage of these incentives. Now, let me review the financial results in the third quarter of 2022. Net sales increased by 26.8% to $137.2 million compared to $108.2 million in the same quarter of 2021. The increase in net product sales was due to a 17.3% gain in the company's sales of hydraulic products and an increase of 52.4% in EPS net product sales. EPS net sales were $44.8 million, or 32.7% of net sales, compared with $29.4 million, or 27.2% of net sales in the third quarter of 2021. Net product sales to North America decreased by 4.8% to $29.5 million, due primarily to changes in the product mix, compared with $31 million for the same quarter in 2021. Net product sales in Brazil rose by 51.9% to $11.5 million due to higher demand. Gross profit was $20.9 million in the third quarter of 2022 compared to $16.8 million in the third quarter of 2021. Gross margin was 15.2% compared to 15.5% for the same period in 2021, mainly due to the change in product mix. Selling expenses were $4 million in the third quarter of 2022 compared to $4.8 million in the third quarter of 2021. The lower selling expenses were mainly due to a decrease in transportation expenses. Selling expenses represented 2.9% of net sales in the third quarter of 2022 compared to 4.4% in the third quarter of 2021. General and administrative expenses were $4.9 million in the third quarter of 2022, compared to $6.2 million in the same quarter of 2021. The decrease was primarily due to a decline in the provision for credit losses provided for accounts receivable. G&A expenses represented 3.6% of net sales in the third quarter of 2022, compared with 5.7% of net sales in the third quarter of 2021. Research and Development, R&D, increased by 66.7% to $9.5 million in the third quarter of 2022, compared to $5.7 million in the third quarter of 2021. R&D expenses represented 6.9% of net sales in the third quarter of 2022, compared with 5.3% of net sales in the third quarter of 2021. Higher R&D expenses were primarily due to increased investment for new projects. Income from operations was $4.9 million in the third quarter of 2022 compared to income from operations of $0.6 million in the same quarter of 2021. Higher income from operations was mainly due to increased gross profit, a higher gain on other sales, and greater cost controls in the third quarter of 2022. Other income was $0.7 million in the third quarter of 2022 compared with $2.4 million in the third quarter of 2021, primarily due to lower government subsidies received in the third quarter of 2022. Net financial income was $4.8 million, compared with net financial expense of $0.8 million in the third quarter of 2021, mainly due to the foreign exchange volatility of the U.S. dollar against the RMB and the Brazilian real. Income before income tax expenses and equity in earnings of affiliated companies was $10 million in the third quarter of 2022 compared to income before income tax expenses and equity in earnings of affiliated companies of $1.9 million in the third quarter of 2021. The higher income before income tax expenses and equity in earnings of affiliated companies was mainly due to increased income from operations compared with the third quarter of 2021. Income tax expense was $0.9 million in the third quarter of 2022, compared to an income tax expense of $2.4 million for the third quarter of 2021, which was mainly due to the valuation allowance recognized in the third quarter of 2021. Net income attributable to parent companies' common shareholders was $7.5 million in the third quarter of 2022, compared to a net loss attributable to parent companies' common shareholders of $0.3 million in the third quarter of 2021. Diluted income per share was 24 cents in the third quarter of 2022, compared with the diluted loss of one cent in the third quarter of 2021. The weighted average number of diluted common shares outstanding was 30,640,260 in the third quarter of 2022, compared to 30,851,776 in the third quarter of 2021. Now we'll briefly go over the nine months financial highlights. Net sales for the first nine months of 2022 increased by 11.6% to $400.8 million, compared with $359.2 million in the first nine months of 2021. Gross profit for the first nine months of 2022 increased by 11.4% to $58.4 million, compared to $52.4 million in the corresponding period last year. Gross margin for the first nine months of 2022 is 14.6%, also compared to 14.6% for the corresponding period in 2021. So the nine months ended September 30, 2022, gain on other sales amounted to $5.3 million, compared to $2.5 million for the corresponding period in 2021. Income from operations was $10.5 million, compared to net income, I'm sorry, compared to income from operations of $4.9 million in the first nine months of 2021. Net income attributable to parent companies' common shareholders was $16.8 million compared with net income attributable to parent companies' common shareholders of $6.1 million in the corresponding period last year. Diluted income per share was 55 cents in the first nine months of 22 compared to diluted income per share of 20 cents for the corresponding period in 2021. Now we'll review a few balance sheet items. As of September 30, 2022, total cash and cash equivalents and pledged cash deposits were $131.7 million. Total accounts receivable including notes receivable were $208.6 million. Accounts payable including notes payable were $210.2 million. Total parent stockholders' equity was $302.2 million. as of September 30, 2022, compared to $321 million as of December 31, 2021. Net cash provided by operating activities was $31.7 million in the first nine months of 2022, compared with net cash used in operating activities of $5.9 million in the first nine months of 2021. Payments to acquire property, plant, and equipment were $11.8 million compared with $5.3 million in the first nine months of 2021. For the business outlook, management has increased its revenue guidance for the full year 2022 to $540 million. This target is based on the company's current views on operating and market conditions, which are subject to change. With that operator, we're ready to begin the Q&A.

Thank you very much, Kevin. Ladies and gentlemen, the floor is now open for questions. If you have any questions or comments, please press star one on your phone handset. We ask that while posing your question, you please pick up your handset if you're listening on a speakerphone to provide optimum sound quality. Please hold whilst we poll for questions. Thank you. Your first question is coming from William Gregorzewski from Greenridge Global. William, your line is live.

Hi, guys. Great, great quarter. I have a couple of questions. Sales to the U.S. were the lowest in about two years. Is there any reason for that? And are we going to see that reverse coming up here?

Okay. This is our analyst's first question. This is our American sales. This quarter has been the lowest quarter for many years. Do you have any special reasons? What is the situation? The main reason is the change in product resolution.

Our product with a higher price is a little less in quantity. The product with a lower price is a little more. Okay. To change this quarter, the change of sales to the North American market is primarily due to the product mix change. As we sell

a wide range of, you know, steering products based on functions and different pricing, too. So in this particular quarter, we happen to sell more lower-priced products, and we believe this can change as well going forward. Now, the other thing that's also been developing is we have been working on a few other new opportunities. So we're developing new customers in North America as well. So we'll give you a report when we have a major breakthrough.

Okay, great.

And then on the EPS side, obviously huge growth in the quarter. What are you looking at from that in the fourth quarter and in 23.

He said that the sales of EPS is very strong, and the growth is very good. What will happen in the fourth quarter of 2020? EPS has developed very quickly in the past two years.

This year, our total income in the past nine months has reached $1.2 billion. OK. This is OK. 62.7 this year, nine months.

So, our EPS sales has experienced pretty healthy and strong growth in the last two years. If you look at the first nine months of 2022, we already booked 120 million US dollars in sales. from the EPS electric power steering products. And that representing 62.8% year-over-year growth. And we believe we're going to continue to grow throughout the fourth quarter with a similar pace. Looking into 2023, we believe we can... achieve another around 50 percent growth from on a year-over-year basis.

You said five-zero percent? Five-zero.

Okay, wow. Okay, great. And then are we going to see the margins expand as well? Because, you know, it really didn't in the third quarter. Are we going to see that get up into that upper teens next year?

His third question is, seeing the growth of our EPS here, it's a very good thing. He wants to know about the hair power, including EPS and Hydraulic, if all of them are added up, will the hair power be like this next year? Will there be some improvement? Because the volume has increased.

Short answer is yes. 因为整个量增加之后,特别是EPS的毛利率就会越来越好,那么的话带着我们整体的毛利率上升。 今年的三季度的毛利率跟去年三季度比略有下降一点,主要是我们一些比较 Okay, so it's the, as we grow,

As we continue to experience significant growth for our EPS electric powering steering product volume, as the volume continues to pick up, we will see the growth margin will start to go up as well. As you know, we will continue to achieve better economy of scale. And when the EPS growth margin goes up, it's also going to benefit our blended growth margins. overall gross margin. So we were pretty optimistic for next year in terms of gross margin. Now, this particular quarter, third quarter, our gross margin is slightly soft. It's mainly due to the product mix because we're selling a little higher proportion of low gross margin product. But looking forward, we believe with the continued growth of EPS product volume and the ongoing recovery of the commercial vehicle market, we believe the margin will recover next year.

Okay, great. And then last question is, can you guys provide an update on how things are going with Sentient and your investment there?

Okay.

Then the whole product may start to be mass produced by the end of next year. By the end of the year, it can be fully produced. This is the part of product development. Then the part of technology development is also working with us to jointly develop BYD customers. Okay.

So sent in overall, we're very pleased with their progression. First, they signed a very sizable contract with Volvo recently, and we're very proud of them. And we are looking into in the mid 2023, we'll start mass production. And then it gradually ramp up to full production, reaching the full production capacity somewhere in 2024. And we also working together to provide a solution, a product to BYD, as you know, the largest electric vehicle producer in China is probably in a world right now. The volume Our technical solution in both hardware and software solution is going to be very meaningful. It's going to bring very meaningful revenue to us. We're looking at about 200,000 units a year coming from this new business opportunity. So it's pretty exciting for us.

Oh, great. Is that BYD? Is that a signed contract or just something you're working on and that's the potential volume?

BYD is not signed yet, right?

Now it's a development contract.

Okay.

We're in the development contract stage. Yeah, after that, then we'll start to go into the full commercial contract.

Okay, great. Thank you.

Thank you very much. Once again, ladies and gentlemen, if there are any remaining questions or comments, please press star 1 on your phone handset now. Okay, we don't appear to have any further questions in the queue. I'm now going to hand back over to Kevin for any closing remarks.

We thank you.

for your participation in today's conference call please be safe and we look forward to speaking with you in the future thank you ladies and gentlemen this does conclude today's conference call you may disconnect your phone lines at this time and have a wonderful day thank you for your participation