China Automotive Systems Inc (CAAS) 2020 Q3 法說會逐字稿

Greetings, and welcome to China Automotive Systems Third Quarter 2020 Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Kevin Theiss, Investor Relations.

Thank you, everyone, for joining us today. Welcome to China Automotive Systems 2020 Third 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. 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 the 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.

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, slowdown in 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 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 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 cost 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 9 months of 2020. Management will conduct a question-and-answer session. The following 2020 third quarter and first 9 months financial results are unaudited and are reported under U.S. GAAP. For the purposes of today, 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 market position. In the third quarter of 2020, Chinese 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. For the first 9 months, Chinese GDP growth was 0.7% compared with the same periods a year ago.

The Chinese economy is continuing 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.

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 9 months of the year compared with the same period 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 9-month period. Fixed asset investments increased by 0.8% in the first 9 months of 2020 as well.

For the third quarter ended September 30, 2020, the sale of 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 the 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% from July 2020. Export sales of passenger cars declined by 25.9% in the month of July year-over-year.

In August of 2020, CAAM 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 9 months of 2020, CAAM 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 9 months of 2020 declined by 11.1% compared with the first 9 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 9 months of 2020. Our total cash and cash equivalents and 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 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 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 for the same quarter in 2019. Net product sales for the company's electric power steering, EPS, products were $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 and administrative expenses, G&A, were $5.1 million in third quarter 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 third quarter 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 third -- in 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 company's common shareholders was $2.4 million in the third quarter of 2020 compared to net income attributable to parent company's common shareholders of $4.3 million in the third quarter of 2019. Diluted earnings per share were $0.08 in the third quarter of 2020 compared to diluted earnings per share of $0.14 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.

Now I'll provide a brief summary of the 9 months results. Net sales for the first 9 months of 2020 were $271.2 million compared to $315.5 million in the first 9 months of 2019, reflecting the impact of the COVID-19 pandemic on the automobile industry in China and globally.

9-month gross profit was $32.6 million compared to $46.6 million in the corresponding period last year. 9-month gross margin was 12% compared to 14.8% for the corresponding period in 2019. For the 9 months ended 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 9 months of 2019. Net loss attributable to parent company's common shareholders was $1.8 million compared with net income attributable to parent company's common shareholders of $8.2 million in the corresponding period last year. Diluted loss per share was $0.06 in the first 9 months of 2020 compared to diluted 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 9 months of 2020 compared with net cash provided by operating activities of $4.1 million in the first 9 months of 2019. Payments to acquire property, plant and equipment were $8.9 million compared with $23.6 million in the first 9 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 and pledged cash deposits were $113.5 million. Total accounts receivable including 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 million as of September -- 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 on operating and market conditions, which are subject to change.

Operator, with that, we are ready for the Q&A.

(Operator Instructions) Our first question today comes from [Robert Polovich], a private investor.

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 your question. Li Jie, (foreign language)

Okay. (foreign language)

[Interpreted] There are 3 contributing factors to a relatively soft gross margin in this year. First is the obvious -- for obvious reason is the COVID-19 pandemic affected every manufacturers in the world, including China. Secondly, the electric power steering, EPS, product sales has been weak. We are -- we saw in 10% -- first 9 months, we saw a 10% year-over-year decline. So that's the second factor. And the third one is the -- we're facing a higher tariff for our international business. So combining these 2, our gross margin was affected.

In terms of 2021 -- and first, COVID has been under -- well under control in China. Life has came -- life has come back to normal and so as our customers and suppliers and our own production as well. So that's nonfactor 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. We made -- 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 category moving into 2021? And also, the chance for better profitability from EPS. I know that you have the joint venture with Hyoseong Motors, and you have production, I guess, is underway at this point. Will that contribute to better profitability as we move into 2021?

(foreign language)

(foreign language)

[Interpreted] Okay. We are still working on our 2021 projection. The -- 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 -- that will 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.

Oh, 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 6 months ago. But with contract renewals, we would expect, with a better outlook and better production numbers in automotive, that the contracts should renew at improving margins. How do you feel about this?

(foreign language)

(foreign language)

[Interpreted] 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 for a continued growth for the sector.

We recently had 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 -- and the competition in the past many years have been quite intense. It's not really helping with the players like us and 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 bargain 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 on-time delivery, safe production, we will need to have better margin. That being said, having such a industry leader consensus for the power steering industry is 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.

(Operator Instructions) We have a follow-up question from [Robert Polovich], a private investor.

I'm back. I have one more question as it relates to the tariffs, 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?

(foreign language)

(foreign language)

[Interpreted] We are hopeful the new President will be more open-minded in terms of the global trade. It's a win-win for both customers and suppliers and to ensure the product -- end product is top-quality and price competitive. So we have proven we are 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.

And so in a nutshell, we are -- we look forward to improve the relationship, and tariff can be one of these things, will come to a more reasonable level.

Okay. 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? Do you see anything like that as a potential development that you might consider?

(foreign language)

(foreign language)

[Interpreted] Mexico is under consideration and partly is our long-term global planning. And 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 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.

There are no additional questions at this time. I would like to turn the call back to Kevin Theiss 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.

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]