ECARX Holdings Inc. Q2 FY2023 Earnings Call

Good morning, and welcome to our second quarter 2023 earnings conference call. With me today are ECARX Chairman, Chief Executive Officer and Co-Founder, Ziyu Shen; Chief Operating Officer, Peter Cirino; and our recently appointed Chief Financial Officer, Phil Zhou. This call is being recorded. Before we begin the prepared remarks, which will be followed by Q&A, today's presentation will refer to both GAAP and non-GAAP measures and also contains forward-looking statements which are based on the environment as we currently see it, and as such, include risks and uncertainties. Please refer to our filings with the SEC for more information on the specific risk factors that could cause actual results to differ materially. With that, I'd like to hand the call over to Ziyu.

Thank you, Adam. Hello, everyone, and welcome. Thank you for joining our second quarter earnings call. Our momentum built in the second quarter with strong revenue and quarter-on-quarter gross margin growth, demonstrating the growing interest in our products as the demand from consumers for a safe and more enjoyable in-car experience. There are now 5.2 million vehicles on the road that incorporate our technology across 21 brands offered by our clients, automotive OEM customers. Vehicles on the road equipped with our products increased 6% from last quarter and 30% from the same period last year. Our dedicated team of around 2,000 people, including over 1,500 engineers, has firmly established ECARX as the leading tech provider in China, and we are gaining increasing attention from important automotive OEMs outside of China as well. We operate in a rapidly growing and evolving marketplace. The rollout of digital cockpit also increased our content per vehicle and average selling prices. The appeal of a company like ECARX is that we are working in the sweet spot of automotive technology. Our marketplace is currently being reinvented and we are the experts with the know-how of the Chinese market, with some of the most demanding customers in the world playing a vital role. With more than 30 vehicles in our launch pipeline over the next 18 months, we expect those cars combined to add an additional million vehicles on the road with ECARX technology. In quarter three alone, we expect to see production of a new joint venture model using the Antora 1000 system-on-a-chip as well as the Lynk & Co 08, which showcases our technology with the Antora 1000 Pro cockpit Flyme Auto operating system and our automated driving control units, ADCU, with Level 2+ ADAS from JICA. Peter Cirino, our COO, will now discuss these important milestones and some of our operating accomplishments in quarter two. Peter?

Thank you, Ziyu, and good day, everyone. Ziyu detailed our strategy and customer successes. So I'll cover what we did operationally in Q2. Our focus is twofold: investing in R&D, which translates into better, more innovative products; and expanding our network of partners. Our company now operates in 14 locations across 3 continents, with recent facilities opened in the U.S. and Germany. The consolidation of JICA brought a further 300 engineers into our company, based mainly in Suzhou and Hangzhou, China. Our new R&D engineering center in San Diego complements our software development center in Sweden and will be led by ECARX CTO, Yong Shi Yen. The team there will focus on advanced automotive IP development, and we plan to scale up the facility over the next 12 to 36 months. Similarly, our engineering and sales facility in Stuttgart, Germany was announced this quarter. It aims to support European OEMs with a focus on customers in Sweden, Germany, France, and the U.K. These teams complement our core China-based engineering R&D team. And all in all, we have more than 1,500 engineers supporting our global R&D efforts. This commitment to R&D enables us to lead the sector in new product introductions that push the boundaries of the in-car experience. At our Tech Day on March 24 in Wuhan and at our Investor Day on May 9 in New York, we announced several new products that support our growth now and in the quarters ahead. These new hardware and software solutions include the Antora series, which provides a high-end automotive-grade intelligent cockpit experience with competitive cost performance. ECARX's well-integrated Antora SoC solution also helps customers reduce their engineering costs and speed up their time to market. Very soon, we will be seeing more and more cars on the road with this technology. Makalu is one of the most powerful intelligent cockpit products available today, and it offers a new in-vehicle experience with amazing 3D graphics, combining both security features as well as entertainment elements powered by an AMD SoC and Unreal Engine graphics solutions. Cloudpeak, recently debuted in the Volvo EX30, serves as a cross-domain infotainment system software. It is also worth noting that we continue to successfully sell our existing products, announcing in May that together with Neusoft Corporation, we will customize the mass production of an intelligent cockpit product for the Changan Mazda CX-50 model. These are based on our E02 SoC core module, which has already been deployed across almost 1 million vehicles across 26 separate models of a variety of automotive OEMs. This product offers many useful and sophisticated functions for the modern driver. As you know, ECARX is at the center of a unique differentiated partnership ecosystem designed to create disruptive innovation and technology for growth for the automotive sector. We were again active in the second quarter in expanding these partnerships, which enable us to more quickly add product features, enter new functional domains and attract new customers. We have established a close partnership with Xingji Meizu, a leading Chinese smartphone manufacturer. And most recently, we announced Flyme Auto, an exclusive new operating system that seamlessly integrates Meizu's smartphones in the vehicles. During the second quarter, we also signed an important agreement with Epic Games, a pioneer in 3D immersive tools. We will deploy their 3D graphics capabilities for our Makalu digital cockpit and collaborate on next-generation digital cockpit and infotainment applications. Finally, at the end of June, we increased our investment in our long-term partner JICA Intelligent Robotics to 70%, consolidating JICA's results into ECARX. JICA is already focused on autonomous solutions for the Geely Group and will continue to do so while ECARX will integrate JICA's systems into our products, helping us build an ADAS solution and a customer base outside of the Geely Group, both in China and globally. JICA further increases the breadth of ECARX's technology stack, bringing ADAS capability into our core product line. This combination increases the future content per vehicle we can provide to tech-minded vehicle OEMs. I'd like to spend a few minutes discussing the Lynk & Co 08, which will be on the road later this year. This vehicle contains our entire full product stack as we bring the software-defined vehicle to the road. The digital cockpit is powered by the Antora 1000 Pro platform, deeply integrated with Cloudpeak software and with Flyme Auto for connectivity and cloud services. It is ECARX's first launch with a Level 2+ ADAS solution from JICA, a technology that we've now brought in-house given our recent investment. The total solution offers the consumer a unique customizable desktop experience with powerful, intuitive easy-to-use functions that seamlessly connect the car to make travel more comfortable, more secure, and more supportive. And of course, with full intelligent-based learning and voice control, this is a fantastic vehicle. I would advise a test drive when you can. Finally, I want to introduce our recently appointed CFO, Phil Zhou, who has been with ECARX since early 2021 and was the CFO of China and Head of our China operations. His predecessor, Ramesh Narasimhan, will now go on to support Zhou as an advisor on key financial matters. I'll now turn the presentation over to Phil to review the financial results.

Thank you, Peter, and good morning, everyone. As you all have already seen this morning, ECARX enjoyed a very strong second quarter with revenue of RMB 952 million, up 45% compared to the prior year period, driven by sales of goods revenue at 87% and high-margin software licensing revenue at 212%. Service revenue was up 144% from the first quarter, but was down 36% year-on-year, offsetting some of the growth in goods and software. This was mostly as a result of timing differences in nonrecurring engineering revenue, which is expected to be booked in the second half of the year. Gross margin increased to 31.3% with increases in all major products and solutions. Between Q1 and Q2, the gross margin rate on computing platform products and hardware solutions improved from 20.7% to 21.1%; on the software and licenses front, it rose from 70.5% to 93.8%; and on the services front, it went from 21.6% to 29.7%. All this was realized through three main factors: a dedicated focus on product and solutions portfolio selling; persistent cost optimization; and new product development and launch at higher average selling prices. We also drove effective operating expense control with operating expenses decreasing by 26% year-on-year. The optimization was primarily driven by ECARX's autonomous driving inception development and high definition mapping in 2023, and by optimizing our China headcount. At the same time, we redeployed the savings and invested in global expansion into the U.K., Sweden, the U.S. and Germany, to ensure that we have a good footprint in international markets to work with top global OEMs. As Peter already emphasized, we continue to invest in R&D, up 2% quarter-on-quarter, but remaining lower than the same period last year as we lapped the cessation of our ADAS perception software development last year. Following our acquisition of an additional stake in JICA, some of that investment will now come back. Adjusted EBITDA was negative RMB 158 million, up RMB 30 million from the same period of last year as a result of a significant improvement in net loss due to a much higher level of share-based compensation expense last year. Turning to the balance sheet. At the end of the second quarter, the cash and cash equivalent balance was RMB 925 million, an improvement of RMB 24 million against the end of 2022, reflecting our good execution on profit improvement and controlling expenses. However, it is a RMB 90 million outflow versus the end of the first quarter. We are growing very rapidly and will need capital to drive that growth while we are on the right path to narrow our losses. Focusing on operational excellence in supply chain inventory and collection and payment management, as well as raising new funds, we aim to further improve the cash status. I'd like to remind you of the historical seasonality of the business, which mirrors the common pattern in the industry. We anticipate 2023 will keep a similar pattern through the end of the year given the pipeline of planned launches scheduled for the third and fourth quarter.

As we grow, it is important to remember why we are here and what our purpose is. The rise of the software-defined vehicle is critical for ECARX. As vehicles evolve into sophisticated digital devices with greater vehicle autonomy and as drivers' expectations of their in-car experience are starting to increase, the demand for high-powered seamlessly connected automotive-focused computer platforms expands significantly. ECARX is a global mobility tech provider, working with automotive OEMs to create new vehicle platforms from the ground up. We are well positioned to capture share in a large and rapidly evolving market, supported by our differentiated full technology that will simplify and expedite automotive OEM partners' developmental timelines. Our strong results this quarter demonstrate the strength of our competitive position and the attractiveness of the market we are pursuing. Operator, could we please start the question-and-answer session now? Thank you.

We are now taking the first question. The first question is from Jupi Jiang from CIC.

Congratulations on the results for the second quarter. I have four questions for the management team. The first two questions are about SiEngine development strategy. So the first question is regarding the collaboration with SiEngine. Can you provide a brief update on how the collaboration is progressing regarding the development of the next-generation SoC? I will ask questions one by one.

SiEngine produced their SoC and took out their most recent SoC at the end of last year, and we've been working closely with them to bring that product to launch in our Antora 1000 and Antora 1000 digital cockpit platforms. Both of those platforms will be launching on vehicles as we go through mid-2023 and in the fourth quarter. As I mentioned in my presentation about the Lynk & Co 08, this platform has our Antora 1000 Pro system on it, which includes the SiEngine SC1000 SoC. We're quite excited about the digital cockpit that we're able to launch on that vehicle, which features the full breadth of our technology stack.

Right. So for my second question, it concerns intelligent driving. We have seen from the presentation that ECARX is gaining a controlling stake in JICA. Could you provide more insights into how ECARX is going to lay out the roadmap for intelligent driving products?

Sure. We invested in JICA some years ago in close cooperation with Geely to launch the autonomous driving control unit. As mentioned, that will come out on the Lynk & Co 08. We're quite excited about the Level 2 capabilities that will bring to the market, including navigation on autopilot solutions that will eventually be brought to that vehicle. I expect we will be announcing further steps in the future to build out our ADAS solution set. We're continuing to make investments in both the Level 2 system that I mentioned as well as further advanced technologies in that space.

Right. Just a quick follow-up. We can see a lot of transformation, like the perception technology in the market. Is there any plan for JICA to follow that path with the perception technology?

Yes, there's no question we'll continue to advance our technology in the autonomous space. We're pretty excited about the Level 2 capabilities—the Level 2+ capabilities that get launched with this vehicle. There are additional vehicles that the system will be launched on. ECARX is also aggressively pursuing additional programs in the market. So I expect that we'll continue to make announcements in the future. I also expect that we'll continue to build out our technology stack in the ADAS space as we go forward.

For the next two questions regarding the performance of ECARX in the second quarter. We have seen a relatively large increase in revenue for the second quarter. Could you help us with a more detailed breakdown of what projects contributed to this increase in revenue?

Yes, this is Phil. I'm happy to take your question. First of all, we achieved the Q2 revenue with strong year-over-year growth of 45%, driven by our strong growth in our core computing platform and software products. Regarding the computing platform products and hardware solutions, we achieved a revenue of CNY 670 million, an 87 percent year-over-year growth. The majority of that achievement was attributed to our further penetration into Geely Auto and the Geely ecosystem brands this year, such as smart electric vehicles. We also focused on our product and solution offering in the new EV market segment and captured part of the market growth. If you look at the general market growth, the new EV sales in China actually saw a 44% growth year-over-year in the first half of 2023. In this quarter, we also drove the software and license revenue, achieving a record high of CNY 130 million, a 212% growth. The growth was primarily driven by IP license sales. At the same time, we also drove effective cost reduction on third-party software sales. So in short, we optimized the portfolio of the product and the solution sales, increased the average selling price or total revenue per unit, and persisted in cost optimization. Those are the three major reasons or engines for profitable growth.

The last question is regarding the projects. We have just heard that there are going to be 30 models in the next 1.5 years, right? Could you clarify this?

Yes, certainly. We've got a very robust pipeline within our business. As we mentioned, we have an engineering team of close to 1,500 engineers that are all working on various sets of programs. These products span numerous OEMs. We mentioned Changan Mazda, and we've recently announced FAW as well as the Lynk & Co product we mentioned today—all are in our pipeline. In addition to that, we've got international launches across brands like Smart, Lotus, Volvo, and Polestar. We're quite excited about the breadth of products that are in our launch pipeline, continuing to work with additional OEMs beyond that set to broaden the customers that we work with.

I wanted to start with gross margin. Gross margins have been on the rise. I'm curious if you can maintain gross margins above 30% or at these levels? And then, Phil, can you talk about how you're approaching the pricing of the hardware and software? Is there a target gross margin that you're hoping to achieve? How should we be modeling gross margin going forward?

Yes, of course, I'm happy to take your question. ECARX delivered a diversified product and a solution offering, and we intentionally shifted our focus on high value-added products and solutions for our customers. What happened recently as we focused on transforming our software and license selling? We want to shift our business model into a license or royalty by unit business model, which can significantly improve our profitability. At the same time, as Peter just mentioned, we're going to launch more than 30 vehicle programs in the market, which means we have enough pipeline to continue driving our R&D service growth in the longer term. We also aim to focus on our cloud computing product selling. We launched new products and are evolving our hardware solution offerings to improve the content per vehicle. With that, we are able to drive consistency in pricing as well as profit growth. These are the measures the company is taking.

That's helpful. I also wanted to touch on that strong pipeline just as my follow-up question. I'm curious what the revenue mix is between electric vehicles and combustion engine vehicles today. You guys mentioned around 30 vehicles or so in the pipeline plan for launch. How many of those are for combustion engine vehicles? Do you expect substantial growth in that market as well beyond electric vehicles? Or maybe that's not the focus?

We certainly have both types of vehicles within our portfolio. However, the area where we're quite excited about the technology and our investments is in the electric vehicle space. I think most of the vehicles in our pipeline are EVs, providing a great opportunity for us to introduce this always connected, always on, always updated software-defined vehicle life.

This is Shelley from Morgan Stanley. I have two questions here. First is about the revenue mix. If we look at the current revenue breakdown, the sales of digital cockpits still account for the majority of our revenue and profit. Do we have any target or priority for the future revenue mix? Do we want to do more hardware or software in the future?

Thank you, Shelley. This is Phil. This is a very good question. In the second quarter, we achieved significant growth in the software and license portion. Yes, you're right, the 70% of our revenue still came from the hardware and cloud computing platform. We're optimizing our revenue mix to have high value-added solution selling to our customers. With that, we are able to keep our pricing and margin stable, and potentially improve our profitability step by step. Ideally, going forward, we will aim for at least 60% to 70% of our revenue to come from our cloud computing platform, which is our fundamental solution. At the same time, we will drive software and service business to represent 30% to 40%.

Just to add to that, we mentioned the latest Lynk & Co 08 launch of an autonomous system. We have additional launches on that same ECU system in our pipeline. I think we'll continue to diversify our product set beyond the digital cockpit into more solutions like ECU that require fantastic software and solid computing platforms, which is at the core of our business. We're definitely excited about that launch and its abilities to increase content per vehicle going forward. Yes, certainly. I'll take that. The AI applications in the digital cockpit and various vehicle applications are quite exciting for ECARX. We've been collaborating with Baidu for some time and are thrilled to announce it. The customization and capabilities that we believe it can bring to the user experience inside the car are quite extensive. Certainly, there are clear applications like improving voice control inside the car. I think we will continue to evaluate and expand how we can customize the digital cockpit with these kinds of AI applications within them.

I have two questions as well. The first one is about the increasing application of large language models to vehicles. We're seeing higher requirements on the computing power of SoCs. I'm wondering how we cope with this new trend in our next-generation products.

Yes, certainly. That's a trend that I think ECARX has been participating in for some time. If you look across our SoC roadmap, we continue to launch more capable computing solutions into the vehicle at a regular cadence. We will continue this. The Antora series that we launched recently can provide solutions both in Antora 1000 and Antora 1000 Pro, which includes two SoCs. It's a scalable solution that is also cost-effective for OEMs to implement. Both of those systems will be in vehicles this year. Early next year, we will launch our Makalu system, known for being powerful. We are excited about what these capabilities will bring to the car, especially in AI applications.

My next question is about the service revenue. We noticed that service revenue was down 36% year-over-year. Any guidance for the second half?

Yes. Service revenue in the second quarter showed a net decrease of 36% year-over-year, but we also grew by 45% quarter-to-quarter. The decline in service revenue is primarily due to timing differences. In the second half of the year, we are on track to book those nonrecurring engineering or R&D service deals, which will allow us to restore our service revenue growth.

I apologize if it's redundant, but can you discuss gross margins? Gross margin percentage was just a little over 31%. What is the outlook for the second half of the year and then looking into 2024 from that standpoint? Has your pathway to positive adjusted EBITDA changed, and are you expecting positive EBITDA in 2024? Will the first half have negative EBITDA margins and the second half be positive? Can you provide an idea on that?

This is a good question. The team is fully committed to driving profitable growth. We've diversified our product and solution offering in the market. At the same time, we're continuing to evolve our offerings. We integrate industrial value for our customers, which explains our strong momentum on profitable growth in Q1 and Q2. We believe this momentum will continue. We have confidence in delivering profit growth as we mentioned earlier. Regarding the EBITDA outlook, the team is diligently working on our operational controls. As you can see, we've optimized operating expenses year-over-year by 26%. This allows us to invest savings into strategic areas such as expansion and advanced technology development. We will continue to do that, and our profitability target will be met.

Great question. We operate in a very competitive landscape, and we've navigated it successfully for years. The automotive and digital cockpit industries in China are indeed quite competitive, but we're optimistic that as we launch new products, whether it's the Antora 1000 Pro or Makalu, we have opportunities to increase our content per vehicle. We believe as these solutions continue to add capabilities to our vehicles, we will see upward momentum on our content per car.

This is Yu Jai from HSBC. I have two questions. The first question is about the transition to Level 3 commercialization. Given the favorable policies and the OEMs joining to launch city autopilot functions, could you discuss the content opportunity between Level 3 and Level 2? What is the margin profile difference if we incorporate more value-adding software functions?

When we examine the landscape in the ADAS space, we believe that most applications in the short term will be Level 2 and Level 2+ capabilities. Getting a vehicle capable of Navigate on Autopilot is an exciting opportunity for us. We will continue to broaden the capabilities we offer in our Level 2+ systems, including parking functions. In the near term, we expect most volume to remain in that space. However, we're already working on advanced development programs for Level 3 applications.

Got it. So should we understand that moving to level 3 will likely present more software opportunities?

Exactly. The Level 3 capabilities will bring more software opportunities with additional requirements in both software and computing power. We expect to make further announcements regarding our ADAS portfolio and roadmap, broadening capabilities in this product line. When we evaluate our software teams, our organization focuses on platforming. We aim to maximize reuse of features across current and future products to maximize our competitive offering. That said, when we engage customers on digital cockpit solutions, there is customization required, especially in the UI/UX area, and that's done in close collaboration with our OEM partners.

There are no further questions at the moment.

Okay. All right. Well, maybe we'll wrap the call up. I wanted to say thank you to everyone for joining and for the great questions today. If there are any follow-ups, please feel free to reach out to Adam or Renee for any follow-up questions going forward. But thank you for the call today.

Thank you.