China Automotive Systems Inc (CAAS) 2020 Q2 法說會逐字稿

Greetings. Welcome to China Automotive Systems' Second Quarter 2020 Conference Call. (Operator Instructions) Please note this conference is being recorded. At this time, I'll turn the conference over to Kevin Theiss. Kevin, you may begin.

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. 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 condition may be materially 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 as well as 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.

The 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, increase cost and reduce revenue. The company expressly disclaims 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 6 months of 2020. Management will then conduct a question-and-answer session. The following 2020 second quarter and first 6 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.

We 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, China's economy rebounded as GDP growth was 3.2% compared with the 6.8% economic contraction 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. 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 fiscal 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 than in the past continued to limit total retail sales, which declined by 11.4% in the first half of 2020 according to the National Bureau of Statistics. 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, CAAM reported a 14.5% year-over-year increase in automobile sales, but with passenger car sedan sales down by 0.9% and MPV sales were lower by 24.6% and 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 MPV sales decreased by 11.8% with new energy vehicle sales down 33.1%.

For the 6 months of 2020, CAAM reports that automobile sales declined by 16.9%, with passenger cars sedan sales 26% lower than the same period last year. SUV sales were down 14.9%. MPV sales were reduced by 45.7% and crossover vehicles 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 or 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 average selling prices declined due to competition.

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 company's North 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. 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: Hyoseong Motion Mechatronics System, small powerpack brushless motors, new steering for the Daily van for IVECO in Europe, a new recirculating steering system, the i-RCB program to be used in a global 1 customers' future autonomous vehicles in North America as well as supplying the new steering product for FCA's Jeep model starting in late third quarter of 2020, also in North America. We've maintained our leading market positions in our key domestic markets, while preserving our excellent relationships with our 3 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. In addition, 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's impact on the economies in North America and the resulting decline in new automobile vehicle sales. Sales of electric power steering, EPS, represented 18.6% of total net sales.

Gross profit decreased 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 2020 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.

Selling expenses were $3 million in the second quarter of 2020 compared to $3.9 million in the second quarter of 2019. The decrease was mainly due to the lower freight expenses resulting from the suspension of Hubei's Henglong'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 and 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 2020 compared to 4.2% in the second quarter of 2019.

Research and development expenses, R&D, decreased to $6.1 million in the second quarter of 2020 compared to $6.8 million in the second quarter of 2019. R&D expenses continue 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 $0.06 million compared to net financial income of $1.6 million in the second quarter of 2019.

Loss before income taxes and -- income tax expenses and equity in earnings/loss of affiliated companies was $4.4 million in the second quarter of 2020 compared to income before income tax expenses and equity in 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 company's common shareholders of $2.5 million in the corresponding quarter of 2019. Diluted loss per share was $0.13 in the second quarter of 2020 compared to diluted earnings per share of $0.08 in the second quarter of 2019.

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.

Now we'll go over 6 months financial highlights. Net sales decreased 27.1% to $156.7 million in the first 6 months of 2020 compared to $214.9 million in the first 6 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 6 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 6 months of 2020 compared to $3.8 million in the corresponding period in 2019. Loss from operations was $4.2 million in the first 6 months of 2020 compared to income from operations of $3.7 million in the first 6 months of 2019.

Net loss attributable to parent company's common shareholders was $4.1 million in the first 6 months of 2020 compared to net income attributable to parent company's common shareholders of $3.9 million in the corresponding period in 2019. Diluted loss per share was $0.13 in the first 6 months of 2020 compared to diluted earnings per share of $0.12 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 was $105.9 million. Total accounts receivable, including notes receivable, were $188.4 million. Accounts and notes payable were $172 million, and short-term loans were $55.2 million. Total parent company stockholders' 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 6 months of 2020 compared with net cash used in operating activities of $25.7 million in the first 6 months of 2019. Payments to acquire property, plant and equipment were $4.5 million compared with $10.3 million in the first 6 months of 2019.

The business outlook. In April, the company regained its full operating capacity after lockdown restrictions were removed and reopened its Wuhan 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, restore consumer confidence and bring supply chains into full capacity in China. The COVID-19 pandemic continues to affect our North and South American markets.

Management reiterates its revenue guidance for the full year of $360 million. This target is based on the company's current view on operating and 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 ready to begin the Q&A.

(Operator Instructions) Our first question is coming from the line of William Gregozeski with Greenridge Global.

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?

In the second half you mean, right?

Yes. How sales are looking for international in the second half? And then also, the gross margin was down pretty substantially in the second quarter. Is that from product mix? Can you just talk a little bit more about that since it seemed more than just the mix was the reason for the decline?

Okay. (foreign language)

(foreign language)

[Interpreted] So for your first question, second half, we are anticipating that everything will -- going back to normal. So we see the -- with the North America, our customers returned to production. And our business export -- international business will return to normalcy. And also, we are seeing -- as a matter of fact, we believe second half 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 North America business also. To give you some color, our revenue last -- same period last year was $27 million. But this quarter, it's only $11 million. So that was a significant loss of revenue because our North America customers, their factory were closed 1.5 months, almost 2 months. As you know, we have a fixed cost, and our facility supplied to the North America customers are heavily affected -- negatively affected.

Our gross profit alone for the North America business was a loss of -- I mean was down USD 7 million. That triggered a negative gross margin for the second quarter, our international business. Now if you look at the domestic China business, our gross margin actually are equivalent to the same period last year. So with the return of the North America business, we think second half of the year we should stage a comeback.

(foreign language)

[Interpreted] Okay. Also, in the second quarter, there was a onetime event related to the custom charge. Our -- also that's related to North America. Typically, our -- I mean, our quote to the North America customer use a DDP, deliver duty paid. There are some calculation changes during the second quarter -- adjustment during the second quarter, which cause us a charge of USD 2 million, and that's also affected our gross margin in the second quarter.

Okay. And that will be just a onetime event then? Or is that something that's going to impact you guys going forward?

(foreign language)

(foreign language)

[Interpreted] This is the onetime event. It will not happen again.

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?

(foreign language)

(foreign language)

[Interpreted] Okay. Yes. 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 pre -- we have some business that we won for the -- some models, new models and hasn't been put into production. Now...

(foreign language)

[Interpreted] Yes. So it's going to be second half of the year, the order book is higher than the same period last year from the North America customers.

(Operator Instructions) Our next question is from the line of [Robert Polvich], a private investor.

I had a question on Hyoseong brushless motors, the joint venture. 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?

Okay. No problem. (foreign language)

Okay. (foreign language)

[Interpreted] Okay. The brushless motor production is in -- it started, the batch production in -- or mass production in the month of June. We anticipate the second half of 2020 we will produce around 30,000 units. Going into 2021, we expect to -- the production will continue to ramp up to 200,000 units. The -- we will start with CEPS product and then move to -- increase the product offering to PEPS and REPS. And the total -- speaking of cost savings, we had -- our calculation is by doing in-sourcing, we will save between 12% to 15% on the cost.

And most important thing by doing this -- producing a design or producing brushless motor internally is to secure supply chain. As you know, these products are -- has higher technology content, and we are seeing a domestic shortage of such product. And so there are -- there have been a bottleneck on the supply of brushless motor. And a lot of those companies -- or our peers have to either deal with the domestic shortage or they have to import from another country.

That being said, our goal is to first to make sure our -- we can have enough capacity to meet our internal demand for our -- all lines of EPS 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.

Okay. That's good to know. Another question. I was wondering, within 5 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 2? 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?

(foreign language)

Okay. (foreign language)

[Interpreted] Okay. The first -- to your first question, 5-year time, we see the EPS product will account for 60% the market share in the passenger vehicle sector. And as you know, the passenger vehicle market in China is very large, and the -- that's the trend heading. And on the commercial vehicle, the hydraulic will continue to play a major role. And however, I would -- when I say hydraulic, hydraulic power steering. And however, with our new product we introduced such as i-RCB 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, as we say in 5-year time, combining passenger and commercial vehicle, we see the overall electric power steering, the sales will exceeding 50% -- at least 50% in China.

(foreign language)

[Interpreted] On the competitive landscape, at the current stage, there are some -- the competition is intense in China. And as we mentioned in the past, the international brand on the EPS side are pretty aggressive in -- coming into China. They are led by JPAC, Bosch, and next year, those are Japanese, German, American, respectively. And that being said is our main business is mostly in the domestic bet. We're talking about BYDs and Geelys, Great Wall, those are household names. However, their sales has been -- their sales expansion has been fluctuating quite a lot in the last few quarters due to the economic change environment and also the pandemic impact. But our goal is on one side to continue to maintain our strong ties and relationship and sales with the domestic brand. On the other side, we want to expand into the international brand, those joint ventures in China, global names.

With our technology resource now, we are able to produce very high-quality PEPS product and REPS product. And also our joint venture with our Japanese partner, we think our product will be very competitive in terms of cost and quality and also pricing. So with -- that will be our goal to continue to strengthen our domestic brands presence and also expand it to international brands joint ventures.

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. And 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?

(foreign language)

(foreign language)

[Interpreted] Okay. Our main goal at the time of forming the joint venture with KYB is continue to strengthen our technology competitive -- technological competitiveness for the domestic China market. And so that's #1 priority is we want to be able to not only continue to compete and maintain and strengthen our presence in domestic brand, but also expanding to the Japanese joint ventures in China. So that will be a huge lift in terms of market and opportunities because the Japanese joint venture 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. However, due to the joint venture arrangement at the time of signing, we're not able to go into Japan because that's the KYB's main market.

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

It's an interesting situation. 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.

(foreign language)

(foreign language)

[Interpreted] Great. Thank you, Robert.

(Operator Instructions) At this time, we've reached the end of our additional time for question and answers. And I would like to turn the floor back to management for any final and closing remarks.

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.