China Automotive Systems (NASDAQ:CAAS) Q2 2020 Earnings Call

0:00 Greetings. Welcome to China Automotive Systems' second quarter 2020 conference call. At this time, all participants are in a listen-only mode. A brief 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. Please note this conference is being recorded. At this time, I'll turn the conference over to Kevin Theiss. Kevin, you may begin.

0:26 Thank you, everyone. For joining us today, welcome to China Automotive Systems 2020 Second Quarter Conference Call. Joining us today are Mr. Qizhou Wu, Chief Executive Officer, and Mr. Jie Li, 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. and many more. 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. With the year ended December 31, 2019, S-Files Securities and Exchange Commission on May 14, 2020, and in other documents filed by the company from time to time with the Securities and Exchange Commission.

1:35 If the outbreak of COVID-19 is not effectively and timely controlled, our business operations and financial condition may be materially and adversely affected as a result of the deteriorating market outlook for automobile sales, the slowdown in regional and national economic growth, weakened liquidity, and financial condition of our customers, and 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 the 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.

2:20 A prolonged disruption or any further 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 shipments of products to our customers, increased costs, and reduced revenue. The company expressly disdains any duty to provide updates to any forward-looking statements 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 financial results for the second quarter and first six months of 2020. Management will then conduct a question and answer session. The following 2020 second quarter and first six months financial results are unaudited and are reported under U.S. GAAP. For the purposes of our call today, I'll review the financial results in U.S. dollars.

3:16 We'll begin with a review of the recent dynamics of the Chinese economy, the automobile industry, and China Automotive's market position. In the second quarter of 2020, the Chinese economy rebounded as GDP growth was 3.2%, compared with the 6.8% economic traction of the first quarter of 2020, which was tragically impacted by the COVID-19 pandemic. From the Chinese New Year in late January to mid-March, our operations were severely disrupted due to government actions to restrict the impact of the COVID-19 infections. As the first quarter of 2020 ended, closed factories began to slowly reopen, interrupted supply networks began to rebuild as materials became available and transportation was more accessible, and other disrupted daily activities began to rebound from the unprecedented effects of the COVID-19 pandemic in China.

4:13 However, sales to customers continued to be limited in the early stage of the economic recovery. In the second quarter of 2020, China was among the first countries to ease the transportation lockdown and travel restrictions. As the Chinese economy began to reopen, the government enacted incentives to promote continued economic growth, including higher physical spending, more approved infrastructure projects, and lending rates and bank reserve requirements were reduced. However, lingering fears of a second COVID-19 wave, continuing tensions between the U.S. and China, and slower economic growth and impacts continued to limit total retail sales, which declined by 11.4% in the first half of 2020, according to the National Bureau of Statistics.

5:01 Per capita consumer spending fell 5.9% in the same period. According to the China Association of Automobile Manufacturers, CAAM, automobile sales in April 2020 rose by 4.4% year over year. However, passenger car sedan sales declined by 6.2%. The sale of MPVs was reduced by 36%, and crossover vehicle sales were also down 11.5% in April. New energy vehicle sales also declined 22.1% in the month of April. In May of 2020, CAAF reported a 14.5% year-over-year increase in automobile sales, but with passenger car sedan sales Down by 0.9%.

5:50 And MTV sales were lower by 24.6%. End sale of new energy vehicles declined by 25.8%. For the month of June, automobile sales were up 11.6% year over year, with passenger car sales down, sedan sales, down 4.9%. And MTV sales decreased by 11.8%, with new energy vehicle sales down 33.1%. For the six months of 2020, CAAM reports that automobile sales declined by 16.9% with passenger cars today and sales 26% lower than the same period last year. SUV sales were down 14.9%. MPV sales were reduced by 45.7%.

6:38 And crossover vehicle sales declined by 19.8%. New energy vehicle sales were down 37.5%. Our production centers were back to full capabilities in mid-March after the COVID-19 lockdown restrictions, and we reopened our Wuhan headquarters. Given this industry background, our net sales in the second quarter of 2020 were $83.2 million, compared with $105.7 million in the second quarter of 2019, and compared with $73.6 million in the first quarter of 2020. We experienced reduced sales volume in some markets, and our selling prices declined due to competition.

7:23 Net sales of traditional steering products and parts decreased $14.5 million or by 18.5% year-over-year. Net sales of electric power steering, EPS, decreased by $7.1 million or 31.4% year-over-year. Sales to the companies with American customers, Fiat, Chrysler and Ford declined by $18.2 million as production was suspended for much of the second quarter of 2020 due to COVID-19. Our reduced operations still continues to generate positive cash flow of $31.4 million. We remain focused on maintaining a strong balance sheet with the resources to achieve our strategic goals over time. As of June 30, 2020, total cash and cash equivalents and pledged cash were $105.9 million.

8:15 Total parent company stockholders' equity was $280 million as of June 30, 2020. Economic conditions are slowly improving in China, but globally there is still great uncertainty, so our outlook remains clouded. However, we expect progress over the remainder of the 2020 year as domestic government incentives begin to stimulate the Chinese economy and the global economy stabilize. In addition, we anticipate greater revenue contributions from our newer ventures. High Sun Motion Mechanics Systems, Small Power Pack, Bresas Motors, new steering for the daily van for Iveco in Europe, a new recirculating steering system, the IRCV program, to be used in a Global One customer's future autonomous vehicles in North America, as well as supplying the new steering product for SCA's Jeep model starting in the late third quarter of 2020, also in North America.

9:16 We have maintained our leading market positions in our key domestic markets while preserving our excellent relationships with our three Tier 1 OEMs. Now, let me review the second quarter of 2020. In the second quarter of 2020, net sales decreased by 21.3% to $83.2 million, compared to $105.7 million in the same quarter of 2019. Net sales of traditional steering products declined by 18.5% as demand weakened in the Chinese domestic brand automobile market related to the effects of COVID-19 pandemic on the Chinese economy and passenger vehicle sales. Additionally, sales to the company's North American customers declined by $18.2 million due to the impact of the COVID-19 pandemic as production was suspended for much of the second quarter of 2020 as well as COVID-19 19 impact on the economies in North America and the resulting decline in new automobile vehicle sales.

10:20 Still, the electric power steering, EPS, represented 18.6% of total net sales. Gross profit increased to $7.8 million in the second quarter of 2020 compared to $15.2 million in the second quarter of 2019. The gross margin was 9.4% in the second quarter of 2021. versus 14.4% in the second quarter of 2019. The gross profit decrease was mainly due to lower sales and changes in the product mix. Gain on other sales was $0.8 million in the second quarter of 2020 compared to $2.5 million in the second quarter of 2019. Salary expenses were $3 million in the second quarter of 2020 compared to $3.9 million in the second quarter of 2019.

11:11 The decrease was mainly due to the lower freight expenses resulting from the suspension of Hubei Headlong's operations for most of the quarter due to the COVID-19 pandemic impact in North America. Selling expenses represented 3.6% of net sales in the second quarter of 2020 compared to 3.7% in the second quarter of 2019. General administrative expenses, G&A, were $4.8 million in the second quarter of 2020, compared with $4.4 million for the second quarter of 2019. The increase in expenses was mainly due to higher office and maintenance expenses. G&A expenses represented 5.7% of net sales in the second quarter of 2012, compared to 4.2% in the second quarter of 2019. Research and development expenses, R&D, decreased to 6%.

12:06 and many more. R&D expenses continued to focus on the development of the company's EPS and other new products. R&D expenses represented 7.4% of sales in the second quarter of 2020 compared with 6.4% in the second quarter of 2019. Loss from operations was $5.2 million in the second quarter of 2020 compared to income from operations of $2.6 million in the same quarter of 2019. The decrease was primarily due to much lower sales and gross profit related to the impact of the COVID-19 pandemic. Net financial expense in the second quarter of 2020 was .06 million compared to net financial income of $1.6 million in the second quarter of 2019.

13:02 lost before income tax expenses and equity and earnings loss of affiliated companies was $4.4 million in the second quarter of 2020 compared to income before income tax expenses and equity and earnings loss of affiliated companies of $3 million in the second quarter of 2019. Net loss attributable to the parent company's common shareholders was $4.1 million in the second quarter of 2020 compared to net income attributable to parent-companied common shareholders of $2.5 million in the corresponding quarter of 2019. Diluted loss per share was 13 cents in the second quarter of 2020 compared to diluted earnings per share of 8 cents in the second quarter of 2019.

13:52 The weighted average number of diluted common shares outstanding was 31,174,045 shares in the second quarter of 2020 compared to $31,499,577 in the second quarter of 2019. I will go over six-month financial highlights. Net sales decreased 27.1% to $156.7 million in the first six months of 2020 compared to $214.9 million in the first six months of 2019. Six months gross profit was $19 million compared to $29.2 million in the corresponding period last year. Six-month gross margin was 12.1% in the first six months of 2020, compared to 13.6% in the corresponding period in 2019. The gain on other sales was $1.4 million in the first six months of 2020, compared to $3.8 million in the corresponding period in 2019. Ballstrom operations was $4.2 million in the first six months of 2020, and Haimian Cai.

15:06 Net loss attributable to parent company's common shareholders was $4.1 million in the first six months of 2020 compared to net income attributable to parent company's common shareholders of $3.9 million the corresponding period in 2019. Diluted loss per share was 13 cents in the first six months of 2020 compared to diluted earnings per share of 12 cents in the corresponding period of 2019. We'll now go over some balance sheet and some cash flow items. As of June 30, 2020, cash and equivalents and pledged cash were $105.9 million. Total accounts receivable, including notes receivable, were $188.4 million.

15:51 Accounts and notes payable were $172 million. And short-term loans were $55.2 million. Total parent-company stockholder equity was $280 million as of June 30, compared to $289.3 million as of December 31, 2019. Net cash provided by operating activities was $31.4 million in the first six months of 2020, compared with net cash used in operating activities of $25.7 million in the first six months of 2019. Payments to acquire property, plant, and equipment were $4.5 million, compared with $10.3 million in the first six months of 2019. The business outlook. In April, the company regained its full operating capacity after lockdown restrictions were removed and reopened its headquarters after a temporary relocation to Jingzhou City in March. However, due to the lingering effects of COVID-19, it has taken substantial time to create economic growth, The COVID-19 pandemic continues to afflict our North and South American markets.

17:06 Management reiterates its revenue guidance for the full year of $360 million. This target is based on the company's current view of operating the market conditions, which are subject to change, especially in the light of the COVID-19's impact on the economies of China and the U.S. With that operator, we're back in the Q&A. Thank you. We'll now begin the question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad and 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 poll for questions.

17:55 Thank you. Our first question is coming from the line of William Greczewski with Green Ridge Global. Please proceed with your question.

18:07 Hi, guys. Can you talk a little bit more about how sales are looking for the second half of the year to the U.S. and also how the gross margins are looking? It seems like that was quite a bit lower than I was looking for even with the product mix you guys had in the second quarter.

18:28 In the second half, you mean, right?

18:34 Yeah, how sales are looking for international in the second half, and then also, you know, the gross margin was down pretty substantially in the second quarter, instead of from product mix. Can you just talk a little bit more about that, since it seemed, you know, more than just the mix was the reason for the decline?

18:56 Okay. Li Jie, his question is about the second question. The first question is that he wants you to talk about the sales of North America in the second half of 2020. The second question is about the second quarter. We just talked about the profit in the second quarter. He thinks that the profit, even with the change in sales, seems to be a lot lower than before.

19:33 Can you explain it? OK. Our business in North America has fully recovered now. The volume is slightly higher than last year. So if you look at it from the bottom, the export to North America should basically be fully restored, and this should be restored to normal. Speaking of this part of the second quarter, the main impact is that the export to North America has been greatly affected by the business. The entire second quarter, our export to North America, there is only one Yiu Wong Tse, Yiu Wong Tse, Yiu Wong In terms of average, the fixed cost of the company has increased significantly, resulting in a decline in profit and profit. For the entire North American business, the profit rate is less than that of the second quarter last year, which is about $7 million. So this part directly decreases the profit rate, resulting in a negative profit rate for the second quarter of the North American business unit.

21:03 For your first question, second half, we are anticipating that everything will go back to normal. So we see with the North America's customers,

21:33 will return to production, and our international export business will return to normalcy. And also, we are seeing, as a matter of fact, we believe second half of our sales is going to be higher than last year, same period. On the second question, the gross margin in the second quarter, Our gross margin during the second quarter was heavily affected by the North America business also. To give you some color, our revenue in the same period last year was $27 million, but this quarter it's only $11 million.

22:32 That was a significant loss of revenue because our North America customers, their factory were closed one and a half months, almost two months. As you know, we have a fixed cost and our facility supplied to the North America customers are heavily affected and negatively affected. Our most profit low for the North America and many other companies in the world. So, in the second quarter, our domestic China business was down, was a loss of, I mean, was down seven million US. That triggered a negative gross margin for the second quarter, our international business.

23:30 Our gross margin actually are equivalent to same period last year. So with the return of the North America business, and we think second half of the year, we should stage a comeback.

23:51 Okay, so you're expecting... Li Jie, go ahead. I would like to add that the second stage has also been affected by the impact of temporary tariffs. Because the price we give to North America is DDP, which means Delivery Duty Paid, which means that the price is included in the tariffs. But the one behind it, the one on the seashore, we think it should be extra tax. Also, in the second quarter, there was a one-time event related to the custom charge. Also, that's related to DOS America. Typically, our

24:54 I mean, I'll quote to the North America customer, use the DDP, deliver duty paid. There are some calculation changes during the second quarter, adjustment during the second quarter, which cost us a charge of $2 million. That's also affected our gross margin in the second quarter.

25:21 Okay, and that'll be just a one-time event then? or is that something that's going to impact the guys going forward?

25:33 This is the one-time event. It will not happen again.

25:40 Okay. Okay. And then just to clarify, you said second-half sales will be higher than last year. Is that just for North America or is that for the whole business?

25:49 Li Jie, he said... In the second half of this year, North American sales will be higher than those in North America last year, right? The domestic sales are still not as good as they used to be,

26:03 right? Yes, yes, mainly in North America. Because there are some urgent orders in the first half of the year that need to be released. Yes.

26:13 The answer is yes, the second quarter, second half of the year, what we're referring is the North America part of business is going to be higher this year than same period last year. Because we have a pretty, we have some business we want for the some models, new models, and it hasn't been put into Production. Yeah.

26:43 So it's going to be second half of the year. All I book is hiring in the same period last year from the North America customers. Okay. Okay. All right. Great. Thank you.

27:12 Thank you. As a reminder, you may press star 1 to ask a question. Thank you. Our next question is from the line of Robert Polovich, a private investor. Please receive your question.

27:33 Good morning. I had a question on Hyacinth Specialist Motors, the joint venture. I know, I believe that's up and running at this point. And I'm just wondering what the status is as far as... I would say it's more of a cost savings by making the motors in the joint venture versus acquiring them on the outside. What kind of volume are you doing there? And what kind of growth prospects? And what kind of cost savings might we see from this as we move into the second half and as we move into 2021?

28:28 Thank you. Okay. No problem.

28:31 This is a question from one of our shareholders, Robert. He said that it's faster to use a brushless machine. He wants you to talk about the current situation. The purpose of establishing Wusha Electronics is from the perspective of saving costs. This is a form of insourcing. Otherwise, it will ask other manufacturers to purchase. In this case, we need to know two questions. The first one is, How much did you save compared to your own production? Second, what is your volume? He wants to know the situation in the second half of the year. What do you expect from the wireless machine?

29:24 The wireless machine has already started production in June.

29:39 The next half-year plan is to produce 30,000 units. The next year's plan is to produce nearly 200,000 units. The current products are C-EPS motors, P-EPS, R-EPS motors, and five-speed motors. The first goal of the company is to reduce costs. Qizhou Wu, Kevin Theiss, Richard Gills, Haimian Cai, Henry Chen, Hanlin Chen Okay.

30:49 The brushless motor production is in, it started the batch production in the mass production in the month of June. We anticipate the second half of 2020 will produce around 30,000 units. Going into 2021, we expect the production will continue to ramp up to 200,000 units. We will start with CEPS product and then we'll increase the product often to P-EPS and R-EPS.

31:40 And the total, speaking of cost savings, our calculation is by doing insourcing, we will save between 12 to 15% on the cost. and most important thing by doing this, producing a design, producing brushless motor internally is to secure supply chain. As you know, this product has higher technology content and we are seeing a domestic shortage of such product.

32:26 So there are, there have been a, A lot of those companies or our peers have to either deal with the domestic shortage or they have to import from another country. And that being said, our goal is to to make sure we can have enough capacity to meet our internal demand for all lines of UPS product. And when we get to that stage, whatever we have in addition, we can supply and sell to the open market to other customers.

33:28 Okay, that's good to know. Another question, I was wondering, within five years, what kind of percentage are we looking at as far as EPS versus traditional power steering systems? How do you see the mix changing? and I know the other question I had was during the call I did hear something about competitive pressures from your competition. How are you dealing with that and what's your view over the next year or two?

34:13 Do we see that kind of abating or is that going to be something that is going to make things difficult for China Automotive as we move over the next several years.

34:27 他下面又有两个问题,第一个问题是从五年的规划来看,五年以后你估计这个EPS和传统的这个hydraulic的产品的next就是大概是多少的比例,我们的这个销售上面。 The second question is about the competitive environment. As we mentioned before, competition is more intense in China's domestic market. Of course, in the next one to two years, competition will continue. What kind of competition will we see? How are we going to deal with it? From the perspective of competitors, will we gradually control it or continue to put a lot of pressure on us? Speaking of EPS, from the future, it should occupy the leading position in the industry.

35:36 After five years, the occupancy rate of domestic car manufacturers must be more than 60%. And then the commercial cars, basically, are still in the leading position. But it will also combine the iRCP and eRCP that we developed. and so on. To your first question, five-year time, we see the EPS product will account for 60% of the market share in the passenger vehicle sector.

36:52 and as you know, the passenger vehicle market in China is very large and that's the trend heading. On the commercial vehicle, the hydraulic will continue to play a major role. However, when I say hydraulic power steering, However, with our new product we introduced, such as IRCB and ERCB product, we are actively adding electric control components and units, and that will help with the performance and also increase our technology competitiveness in the market. So that being said, we say in five-year time, combining passenger and commercial vehicle, we see the overall electric power steering, the sales will exceeding 50%, at least 50% in China.

38:16 Speaking of the market structure, the EPS competition in the Chinese market is indeed fierce. These international brands, including JETEC, BOSCH, and MaxDeal, have started EPS Deals in China. Our current market is mainly focused on the private brand. Because of the EPS model installed in the technical brand, the sales situation often fluctuates. So our performance is not very stable. Next, we may expand to the joint business. Because we have already successfully developed the R-EPS and P-EPS. In terms of volume, we have HPE in Japan. We have HPE in Japan.

39:15 We have HPE in Japan. We have HPE in Japan. We have HPE in Japan. We have HPE in Japan. We have HPE in Japan. We have HPE in Japan.

39:40 On a competitive landscape, at the current stage, there are some competition is intense in China. And as you mentioned in the past, the international brand on the EPS side are pretty aggressive coming to China. They were led by JPEG, Bosch, and next year those are Japanese, German, and American, respectively. And that being said is our main business is mostly in the domestic brand. You know, we're talking about the BYDs and GEs, Green Wall. Those are household names.

40:41 However, their sales has been, their sales growth or their sales expansion has been fluctuating quite a lot in the last few quarters due to the economic change, the environment, and also the pandemic impact. But our goal is on one side to continue to and maintain our strong tie relationship and sales with the domestic brand. On the other side, I want to expand into the international brand, those joint ventures in China, global names.

41:27 With our technology resource now, we're able to produce very high quality PEPS product and ARP EPS product and also our joint venture with our Japanese partner. We think our product will be very competitive in terms of cost, quality and also pricing. So that will be our goal to continue to strengthen our domestic brand presence and also extended to international brands, joint ventures.

42:15 Okay. One last question. As it relates to KYB, do you see a lot of growth potential? I mean, KYB has ties with all the Japanese automakers. Outside of Japan, potentially in the U.S., are those areas where you can do more business with the relationship with KYB, having been supplying, I guess, the Japanese brands for a long time?

42:50 他的最后一问题是, 刚才是说他讲到日本我们的合作伙伴JYB, 他想知道一下JYB, Is there a chance for us to enter some developed markets? For example, Japan. They have been supplying many brands in Japan for many years. And then there is the North American market. Is there a chance for us to enter these markets? This is the first one. It should be the first one in Japan.

43:30 Our main goal at the time of forming the environmentalist KYB is continue to strengthen our technological competitiveness for the domestic China market.

44:00 That's number one priority is we want to be able to not only continue to compete and maintain and strengthen our presence in domestic brands, but also expanding to the Japanese joint ventures in China. So that will be a huge lift in terms of market opportunities because the Japanese joint ventures in China are very well established in terms of both branding and the volume. And the secondary goal is to look beyond China. There are many markets internationally where we can potentially get into it. However, due to the joint venture arrangement, At the time of signing, we were not able to go into Japan because that's the KYB's main market.

45:10 So outside of Japan, it's still a very large market. The world is a large place, so we see a great potential there. But step one is we want to be able to... to connect through our both product and KYB relationship to connect with the Japanese joint ventures in China.

45:40 It's an interesting situation. You know, the KYB, I assume at some point your relationship with KYB may be renegotiated for some additional potential. and that would be a good thing. But, okay, that's all I have and I appreciate your responses.

46:09 He added that he thinks it is possible that your future KME agreement or cooperation may have some new changes. Because the changes in the future market, including your relationship, may also be a better opportunity. And then he thanked you for your answer. Is there anything else? Yes, sure. Great. Thank you, Robert.

46:43 Thank you. As a reminder, you can press star 1 if you'd like to ask a question. Thank you. At this time, we've reached the end of our In addition, time for question and answers, and I would like to turn the floor back to Benjamin for any final closing remarks.

47:13 Well, we thank you for your participation in today's conference call. We wish you to be safe and well and look forward to speaking with you again. Thank you. Thank you. Thank you, everyone. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.