China Automotive Systems, Inc. (NASDAQ:CAAS) Q4 2022 Earnings Call Transcript

China Automotive Systems, Inc. (NASDAQ:CAAS) Q4 2022 Earnings Call Transcript March 30, 2023

Kevin Theiss – Investor Relations: Jie Li – Chief Financial Officer

Operator: Good morning everyone and welcome to the China Automotive Systems’ Fourth Quarter and Fiscal Year 2022 Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note this conference is being recorded. I will now turn the conference over to your host, Mr. Kevin Theiss, of Investor Relations. Kevin, you may begin.

Kevin Theiss: Thank you everyone for joining us today. Welcome to China Automotive Systems’ 2022 fourth quarter and year conference call. Joining us today are, Mr. Jie Li, 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’ll 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, 2022, 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, 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 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 impact our business, financial conditions and results of operations. A prolonged disruption or any further unforeseen delay in our operations or 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 fourth quarter and fiscal year results for the period ended December 31, 2022. Management will then conduct a Q&A session. The 2022 fourth quarter unaudited and the fiscal year financial results are audited and all results are reported using U.S. GAAP accounting. For the purposes of our call today, I’ll review the financial results in U.S. dollars. We’ll begin with a review of the recent dynamics of the Chinese economy, the automobile industry and our market position. China’s GDP growth was 4.8% in the first quarter of 2022, marking a historical soft period which declined further to 0.4% growth in the second quarter of 2022 before rebounding a 3.9% in the third quarter.

However, GDP growth then slowed to 2.9% in the fourth quarter of 2022. Quarter-over-quarter economic growth during the third and fourth quarters from 2022 was essentially flat. For fiscal year 2022 Chinese economic growth was a low 3% down sharply from the 8.4% growth experienced in 2021. Total retail sales in china declined by 0.2% partially due to the effects of COVID-19 lockdowns and investment in real estate development declined by 10% in fiscal 2022. The COVID-19 outbreak worsened in 2022 first quarter resulting in lockdowns in several cities across China. The impact of COVID-19 affected the economy throughout the 2022 year, but lessened in the second half with the economy’s better growth. Supply chain interruptions increased in early 2022 which hindered production especially with critical computer chip shortages affecting automobile production.

Foreign exchange volatility and the economic outlook for key trading partners were concerns throughout 2022. Turning to the data from the Chinese Association of Automobile Manufacturers, CAAM, automobile sales increased by only 0.2% year-over-year in the first quarter of 2022, decreased by 13.3% year-over-year in the second quarter of 2022 increased by 29.4% year-over-year in the third quarter and then declined by 3.3% year-over-year in the fourth quarter of 2022. In 2022 total automobile sales grew by only 3.4% year-over-year. Passenger vehicle sales rose by 11.2% year-over-year with sedans up 12.5%, MTVs down 11.3%, SUVs up 13.5%, and cross passenger vehicles 20.3% lower. In 2022 commercial vehicle sales fell 31.9% and bus sales were 19.9% lower and the much larger market for truck sales declined by 33.4%.

Sales of New Energy Vehicles increased by 93.4% and new energy passenger vehicle sales rose by 94.3% and the much smaller new energy commercial vehicle sales were 78.9% higher. We introduced a proprietary EPS product in 2021 to further develop our own Advanced Driver Assistance Systems, ADAS. This EPS product communicates with the vehicle’s main data to create lane keeping assist, automatic parking assist, lane centering, and traffic jam assist functions. A number of auto manufacturers have already adopted our proprietary EPS primarily for their passenger vehicles.

Scania AB: The technology is from our subsidiary in Sweden, Sentient AB promise to further enhance our EPS steering technology especially for vehicle motion control for autonomous driving products targeting both passenger and commercial vehicles. Sentient has already won the installation contracts with global truck OEMs with their technologies. We have produced, shipped, and installed more than 3 million power steering sets, including EPS units to BYD Auto over a 20 year partnership. In late 2022 we expanded our strategic partnership with BYD the largest Chinese EV producer for future autonomous driving products. We won design contracts from BYD for C-EPS, DP-EPS and R-EPS from BYD for all its series of products. We have introduced a new series of EPS products for BYD.

Together with BYD engineers CAAS’s R&D engineers use computer aided design and artificial intelligence to shorten the design cycle to five months for our DP-EPS products. We completed the DP-EPS integration into the chassis general assembly for by BYD’s Model Tang in late 2022. Now, we develop new products and grow global market share we are maintaining our financial strength as our free cash flow increased to $27.7 million compared with $19 million in 2021. For 2022, we repurchased 666,074 common shares under our repurchase buyback program. As the Chinese automobile market is recovering, our North American and Brazilian operations continue to expand. Our EPS products are gaining greater market acceptance and our NEV technologies are acquiring more capabilities.

Our changing sales product mix is improving our margins. New COVID-19 policies have had a dramatic and positive impact on the Chinese economy, revitalizing social and business activities and restoring supply chains. We expect recovery of the economy who will strengthen overtime leading to greater automobile sales. Now, let me review the financial results in the fourth quarter of 2022. Net sales decreased by 7.2% to $128.8 million compared to $138.8 million in the same quarter of 2021. The net sales decrease was mainly due to a change in the product mix and lower demand for passenger automobiles and commercial vehicles in the fourth quarter of 2022 compared to the fourth quarter of 2021. Gross profit increased by 26.9% to $25 million in the fourth quarter of 2022 compared to $19.7 million in the fourth quarter of 2021.

Gross margin in the fourth quarter of 2022 was 19.4% compared to 14.2% in the fourth quarter of 2021, primarily due to a change in product mix. Selling expenses were $4.6 million in the fourth quarter of 2022 compared to $3.4 million in the fourth quarter of 2021. Selling expenses represented 3.6% of net sales in the fourth quarter of 2022 compared to 2.4% in the fourth quarter of 2021. General and administrative expenses were $10.8 million in the fourth quarter of 2022 compared to $7.6 million in the same period in 2021. G&A expenses represented 8.4% of net sales in the fourth quarter 2022 compared to 5.5% of net sales in the fourth quarter of 2021, which was mainly due to the increase in provision of allowance for doubtful accounts. Research and development expenses or R&D were $10.6 million in the fourth quarter of 2022 compared to $9.9 million in the fourth quarter of 2021.

R&D expenses represented 8.2% of net sales in the fourth quarter of 2022 compared to 7.1% in the fourth quarter of 2021, mainly due to an increase in salaries and wages as a result of the increased R&D activity for new projects. Loss from operations was $2.6 million in the fourth quarter of 2022 compared to income from operations of $0.6 million in the fourth quarter of 2021. Interest expense was $0.3 million in the fourth quarter of 2022 compared to $0.5 million in the fourth quarter of 2021. Financial income was $1.4 million in the fourth quarter of 2022 due to exchange fluctuations of the U.S. dollar to the Chinese RMB and the Brazilian real compared to financial expense of $1.5 million in the fourth quarter of 2021. Cost before income taxes and equity in the earnings of affiliated companies was $2.7 million in the fourth quarter of 2022, compared to a loss of $0.4 million in the fourth quarter of 2021.

Income tax benefit was $1.9 million in the fourth quarter of 2022 compared to an income tax expense of $0.7 million in the fourth quarter of 2021, mainly due to the loss before income tax expenses and equity and earnings of affiliated companies in the fourth quarter of 2022. Net income attributable to parent company’s common shareholders was $4.3 million in the fourth quarter of 2022 compared to net income attributed to the parent company’s common shareholders of $5 million in the fourth quarter of 2021. Diluted income per share was $0.14 in the fourth quarter of 2022 compared to diluted income per share of $0.16 in the fourth quarter of 2021. The weighted average number of diluted common shares outstanding was 30,229,987 in the fourth quarter of 2022 compared to 30,853,822 in the fourth quarter of 2021.

Now we’ll review the full year 2022 highlights. Net sales increase by 6.3% year-over-year to $529.6 million in 2022 compared to $498 million in 2021. This increase was mainly due to higher sales of passenger vehicles in China with sales to Chery Automobile up 54.5% year-over-year. In total sales of electric power steering EPS systems increased by 35.6% year-over-year. EPS sales represented 29.5% of total revenue in 2022 compared to 23.2% in 2021. Net sales of vehicle steering system to the company’s North American customers was approximately the same in 2022, but Brazil Henglong’s net sales grew by 54.1% year-over-year to $39.3 million. Gross profit in 2022 increased by 15.7% year-over-year to $83.4 million compared to $72.1 million in 2021.

The gross margin increased to 15.7% from 14.5% in 2021, mainly due to changes in the product mix. Gain on other sales in 2022, decrease to $3.7 million compared to $4.4 million in 2021. Selling expenses declined by 7.7% year-over-year to $16.9 million in 2022 compared to $18.3 million in 2021 mainly due to lower transportation expenses. Selling expenses represented 3.2% of net sales in 2022 compared to 3.7% in 2021. G&A expenses increased by 7% year-over-year to $26.1 million in 2022 compared to $24.4 million in 2021. G&A expenses represented 4.9% of net sales in 2022 compared to 4.9% of net sales in 2021. R&D expenses were $36.1 million in 2022 compared to $28.2 million in 2021. The increase was primarily due to higher investment in EPS products and other new products.

R&D expenses were 6.8% of net sales in 2022 compared to 5.7% of net sales in 2021. Operating income increased by 45.5% year-over-year to $8 million in 2022 compared to $5.5 million in 2021. The increase in operating income was mainly due to higher gross profit. Interest expense was $1.5 million in 2022 consistent with the $1.4 million in 2021. Net financial income was $10.8 million in 2022 compared to net financial expense of $2.4 million in 2021, primarily due to an increase in foreign exchange gains as U.S. dollar fluctuated against the Chinese RMB and Brazilian real. Income before income tax expenses and equity earnings of affiliated companies was $23 million compared to $8.4 million in fiscal year 2021. Excuse me. The change is primarily due to higher operating income and net financial income in 2022.

Income tax expense was $3.1 million in 2022 compared to $4 million in 2021. Net income attributable to parent company’s common shareholders was $21.2 million in 2022 compared to net income attributable to parent company’s common shareholders of $11.1 million in 2021. Diluted net income per share increased by 91.7% year-over-year to $0.69 in 2022 compared to $0.36 in 2021. The weighted average number of diluted common shares outstanding was 30,641,274 in 2022 compared to 30,855,431 common shares in 2021. Next, we’ll go over a few balance sheet items. As of December 31, 2022, total cash and equivalents, pledged cash in short-term investments were $171.8 million. Total accounts receivable, including notes receivable were $224.3 million. Accounts payable, including notes payable were $235.1 million and short-term bank loans were $45.7 million.

Total parent company stockholders equity was $311.7 million as of December 31, 2022 compared to $321 million as of December 31, 2021. Cash flow from operating activities was $48 million in 2022 compared to $28.3 million in 2021. Cash paid to acquire property, plant and equipment and land use rights was $20.3 million in 2022 compared to $9.3 million in 2021. The business outlook. Management has provided revenue guidance for the year 2023 to $560 million. This target is based on the company’s current use of operating and marketing conditions. This is subject to change. With that operator, we are now ready to begin the Q&A session.

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Q&A Session

Operator: Thank you, Kevin. Your first question is coming from Phil Gregozeski of Greenridge Global. Phil, your line is live.

William Gregozeski: Hi, thank you. I have four questions for you today. First off gross margins in the fourth quarter were much higher than expected. This is sustainable long-term margin figure based on the higher EPS contribution?

Jie Li: Oh, so EPS okay. So fully year 2022 gross margin is 16%. But our fourth quarter, as you saw, our fourth quarter gross margin is 19%. It is mainly it attributable to the electric power steering volume increase. And we also foresee 2023 our EPS, Electric Power Steering product volume will continue to increase. And that said, that will further propel the gross margin expansion. As you know, the EPS product in the past, the gross margin was somewhat in the 15% range and now we’re, with the higher volume, we believe the better economy scale will give us a better margin for EPS going forward. As a result, the planned gross margin will also continue to climb in 2023.

William Gregozeski: Okay. Thank you. And then what are your expectations for hydraulic and EPS builds for 2023 and 2024?

Jie Li: Expectation for volume?

William Gregozeski: Yes.

Jie Li: Okay 2024. Okay let’s look at 2023 first. We anticipate EPS sales volume will continue to climb another 30% increase in 2023. As a result, EPS sales will account for about 36% of total sales in 2023. Okay. So in 2024, we see our EPS sales volume will reach or surpass 40% of total volume.

William Gregozeski: Okay, awesome. But then R&D expense has increased $8 million in 2022 compared to 2021. How much R&D spending will there be in 2023, and what is going to be the focus of that spending?