ECARX Holdings Inc. Q3 FY2023 Earnings Call

Good morning and welcome to our Third Quarter 2023 Earnings Conference Call. With me today are ECARX Chairman and Chief Executive Officer; Ziyu Shen, Chief Operating Officer; Peter Cirino, and Chief Financial Officer. So Joe, following their prepared remarks, they will be able to answer your questions during the Q&A session that follows. Please note, today's call is being recorded. Before we start, I would like to refer you to our forward-looking statements at the bottom of our earnings press release which also applies to this call. Further information on specific risk factors that could cause actual results to differ materially can be found in our filings with the SEC. In addition, this call will include discussions of certain non-GAAP financial measures. Please refer to our earnings release which contains a reconciliation of the non-GAAP measure to GAAP measures. With that, I'd like to hand the call over to Ziyu.

Thank you, Renee. Hello, everyone and thank you for joining our third quarter earnings call. Let me start by saying a few words about the China market. This quarter saw again a growing share of vehicles and the trend is clearly accelerating with the global NAV adoption rate reaching a record high at 90.8% in the third quarter. This year, China is well positioned to become a large automotive explorer in the world. This year is also likely to be the first year where domestic brands will outpace foreign brands in China. One of the important wins that we witnessed this quarter was the launch of car-specific mobile phones, seamlessly integrated into the vehicle ecosystems to create a value experience. At ECARX, we delivered another strong quarter of growth with revenue up 50% year-on-year as we continue to benefit from increased spending by OEMs on enhancing the in-car experience and meeting consumer demand for greater creativity and more sophisticated digital cockpit technologies. There are now over 5.6 million vehicles on the road that incorporate our technology across 24 brands offered by our 15 automotive OEM customers. Vehicles on the road equipped with our products increased 8% from last quarter and 31% from the same period last year. With our dedicated team of over 2,000 people, 70% of whom are engineers, we are firmly positioned as the leading tech provider in the industry. I'm pleased to report that we further expanded our customer base outside of JD Group in China during the quarter with a significant joint venture coming onboard as a notable customer in ECARX Holdings Inc. We also added 6 design wins for flagship car models in the third quarter, paving the way for further growth which I will let Peter go over in more detail later. Internationally, Chinese EV makers and technology deployers have truly arrived on the global stage following their massive presence at the IAA mobility model show in Munich in September. We are investing significant resources into growing our business internationally and have several key milestones coming up that will significantly raise our visibility internationally, including the upcoming launch of the Volvo EX30 that will feature our digital cockpit solution. The recent debut of the Lincoln Co-08 SUV equipped with our full stack solution is a great showcase for the full range of technologies we offer as our industry profile continues to grow. We are also attracting increased attention as a technology provider within the mobility space through the ecosystem partnerships we announced with Baidu and Mobileye this quarter. In summary, we delivered a very strong quarter, both from our commercial technology and ecosystem point of view. I will now pass the call over to Peter, who will go through the operating results for the quarter in more detail.

Thank you, Ziyu and good day, everyone. Our innovative product portfolio enabled us to secure a number of new design wins during the quarter. Operationally, we were focused on strengthening our portfolio internationally, expanding our partner ecosystem, and delivering additional product advancements with operations in 11 major locations across 3 continents. Our global footprint facilitates close working relationships with local OEMs and access to a truly global talent pool. As Ziyu mentioned, we have gained significant momentum in the China market by adding 3 additional OEMs to our customer base. We also added 6 new design wins in the third quarter. Three of these will utilize the ECARX Antora 1000 Pro platform, 2 will utilize the ECARX Makalu platform, with the remaining adopting the ECARX Antora 1000 platform. These achievements underscore the increasing demand for software-defined vehicles and enriched in-car experiences, reflecting the significant value proposition and market opportunity for our innovative product portfolio. Our ECARX Antora and Tora series offer customers a high-end digital intelligent cockpit experience at an attractive price point. ECARX is well integrated, and the Antora SoC also enables customers to save on engineering costs and decrease the time needed to bring their vehicles to market. ECARX Makalu, on the other hand, offers clients an ultra-high-end performance digital cockpit computing platform, supported by a powerful AMD SoC and Unreal Engine graphics solutions. With unparalleled 3D graphics, security, and entertainment features, it is one of the most powerful intelligent cockpits available on the market. As Ziyu mentioned, our solutions are now being integrated into Dongfeng Peugeot Hisron automobiles, the new Citroen Tani, Peugeot 4008 compact SUV, and Peugeot's flagship 508L Sedan which began mass production in the first half of August. While we continue to grow in China, we also made significant progress with our global expansion during the quarter. The Volvo EX30, which is equipped with ECARX Cloud Peak, began starter production in late September and will be launched globally later this year. We are confident its launch will significantly raise our international profile and provide customers globally a demonstration of the cutting-edge technology and enjoyable in-car experience we can deliver. To support our expanding international profile, we showcased our ultra-high-end performance digital cockpit capabilities, and more notably, our immersive Makalu platform at IAA Mobility in Munich in September. Our on-site demo allowed visitors to fully experience these innovative solutions and get a taste for the technologies that will shape the vehicle industry for years to come. In November, we will be presenting at the Reuters Automotive USA 2023 industry gathering in Detroit, where we will also meet with many North American prospects. On the technology front, we expanded our product portfolio to include the ECARX Skyland ADAS platforms. ECARX Skylane Pro is our first-generation autonomous driving control unit that integrates automated parking and active driving solutions, such as lane changes on controlled access highways. These ADAS capabilities will allow us to further expand content per vehicle and strengthen customer loyalty by providing a more secure and supportive driving experience. The Peugeot 4008 is the first vehicle to launch which contains our full stack solution. It reflects our ability to drive technological innovation and it is representative of the direction that we are headed. Its digital cockpit is powered by the Antora 1000 Pro platform integrated with the ECARX Cloud Peak software stack and Flame Auto to deliver a smooth and seamless interactive in-car experience. Together with ECARX Skylane Pro ADAS platform and 5R10V sensor configuration, these technologies bring L2S capability to this flagship car. The Lincoln 208 recently received a high score in preliminary ADAS tests under China's new car safety assessment program, NCAP. With such stellar results, we are confident we can leverage the full stack solution for the Lincoln 208 to approach new customers. We continue to carefully invest in the development of new cutting-edge technologies and have a strong development pipeline that we eagerly look forward to updating you on in the months ahead. Let me now share with you some updates on our partnership ecosystem which is helping us develop disruptive technologies that will sustainably drive growth and innovation across the automotive sector. In August, we began collaborating with Mobileye to build a one-box solution, integrating automotive driving and parking features that will enable hands-off and eyes-off self-driving on controlled access highways. This solution will be used in the mass production of the Polestar 4 electric SUV Coupe, the world's first mass-produced car to adopt Mobileye's consumer AV technology. As part of this collaboration, ECARX will be responsible for the development of parking-related algorithms and functions, local production of hardware used in domain control units and quality management and supply chain management. This represents significant progress in terms of both innovation and our go-to-market strategies. Going forward, ECARX and Mobileye will partner on a driver-assisted solution and a cockpit driving parking integrated solution based on the latest IQ-6 automotive-grade SSC. We also expanded our partnership with Baidu Apollo during the quarter which will see us become one of the first automotive technology partners to explore the intelligent cockpit application of its AI large language model. Through this partnership, multiple innovative functions have been integrated into ECARX competing platforms, some of which are expected to be launched on select mass-produced Lincoln models in the near future. This partnership will leverage each party's respective strengths and will usher in a new era of innovative automotive intelligence solutions that will shape the industry at large. We expect these solutions to enable ECARX to help OEMs provide more natural and differentiated speech recognition, offering unique smart experiences and propelling further innovation in automotive intelligence. To further enhance our technological leadership, we will also incorporate LLM capabilities into our integrated intelligent ecosystem. Our strategic partnership with Meizu is also very important. The Flame Auto ecosystem's foundational content is the integration of smartphone computing and storage capabilities into vehicles to create seamless interconnection with unique features such as small window display mode, dynamic effects, and sophisticated in-car climate control. Flame Auto became the first operating system in the automotive industry to receive certification from China's TL Certification Institute for its superior performance, providing customers with a unique and smooth interactive in-car experience. Finally, an update on ECARX Coupe Peak, our cross-domain system developed in collaboration with our joint venture with Volvo. ECARX Coupe Peak was built to meet strict vehicle safety and information security requirements. It supports multiple operating systems and global mobility ecosystems with security protocols that meet both Chinese and international standards. In late August, ECARX Coupe Peak was awarded the EAL4 certification for information security. In closing, as the automotive industry progresses towards software-defined vehicles and thus, from distributed EV architectures to central computing platforms, our innovative solutions and strategic partnerships with some of the world's leading tech companies and OEMs will enable us to build and solidify our market leadership and position ourselves at the forefront of this global transition. Now, I will turn the call over to Phil to review our financial results for the past quarter.

Thank you, Peter and good day to everyone. We delivered another solid quarter of growth which further strengthened our position as a key player in the automotive and technology sectors. Total revenue for the quarter was RMB1.08 billion, a significant increase of 50% year-over-year. Computing hardware goods revenue was RMB734 million, up by 38% year-over-year, driven by an increase in demand for our new digital cockpit solution. We increased penetration into the GD ecosystem brand, smart and Lotus. While our share of wallet in GD auto business remains stable. We have shipped our product and solution offering for the new EV market segment and captured the market growth curve. Software license revenue came in at RMB137 million, an increase of 73% year-over-year and 21% sequentially, primarily due to demand from our two framework agreements with strategic partners, Patio and Meizu. The related demand was high for ECARX and Antora platform software and ECOs automotive service IT licenses which reflects the unique value proposition offered by our cutting-edge solutions. Service revenue maintained strong growth momentum as well, with a surge of 92% year-over-year to RMB209 million. This remarkable increase was primarily due to revenue recognition timing for nonrecurring engineering revenue. As we discussed on our last earnings call, we expected the bulk of lease revenue to be booked in the second half of 2023. Gross profit reached RMB331 million, an increase of 140% year-over-year. This was well above the nearly 29% year-over-year increase in cost of revenue due to timing differences in completing nonrecurring and generating contracts which we plan and manage from a full fiscal year perspective. We expect this as part of the recovery of low year-over-year gross profit growth delivered last quarter. Looking at quarter 4, which is the big season for the industry, we see challenges in maintaining the same level of gross margin considering the fierce competition to drive demand and top-line growth. As well, there may be further pressure on our hardware product margin performance in the coming quarters due to industry-wide price cuts and evolving customer architecture. We will focus on driving software and service revenue growth and improving operating efficiency to mitigate the margin impact. Operating expenses increased 22% sequentially and 36% year-over-year for two main reasons. First, the increase of 27% sequentially and 71% year-over-year as we invested to keep pace with advancements made in technology. Second, our global expansion into Europe and the United States, where we are capitalizing on growing demand as OEMs transition towards new EVs and we are assessing a truly global talent pool. Adjusted EBITDA loss was RMB179 million, an improvement from the loss of RMB181 million last year. This is a slight improvement but we need to be aware that such results have already included our accelerated R&D investments in ADAS solutions and the joint venture with the July Group. If we take out the loss from the joint venture, the profit could be improved by around RMB50 million in quarter 3. However, we certainly believe the investment in ADAS solutions is worthwhile as it will empower our long-term growth. The performance of the ADAS product on Lincoln O08 is quite impressive as an example. The loss per share also improved year-over-year from RMB1.48 to RMB0.79. This is mainly attributed to revenue growth in computing platform products, gross margin improvement, and operating cost control. Cost control did not impede our investments in advanced technology development and global expansion. Moving on to our balance sheet, at quarter end, we had RMB688 million of cash and restricted cash. With a solid foundation for growth now in place, we expect to allocate additional capital to accelerate our growth trajectory. Maintaining a solid balance sheet is of paramount importance, so we will focus on improving operating efficiency across our supply chain, inventory, and cash flow. Looking forward, we will maintain our operational focus on optimizing efficiency and cost management while allocating resources toward opportunities that can enhance future growth prospects and drive innovation. Sustainable and fiscally responsible business practices are the backbone of our long-term financial health. With that, I will turn the call back to Ziyu for some concluding remarks, then we will start the Q&A session.

We are excited about our position in a significant and encouraging market where industry trends are driving robust growth. We are pleased to witness that our customer base has further extended beyond the GD Group. Our unique technology and diverse product offerings have enabled new design wins and fostered strategic ecosystem partnerships. We are committed to continued progress in these areas. Meanwhile, we are predicting allocating resources towards opportunities that can enhance future growth prospects and drive innovation, much like our ongoing efforts to strengthen our international business. Operator, we will now open the floor for questions. Thank you.

First question comes from the line of Yuqian Ding from HSBC.

This is Mike from HSBC. Congratulations on the strong third quarter results. I have 2 questions. The first is regarding the gross margin. We saw the company has maintained a pretty good, stable gross margin quarter-over-quarter despite the very challenging pricing environment. How do we perceive the gross margin outlook going forward? Will the pricing pressure in our clients escalate to us? Could you give us some color on the pricing mechanics with our customers? My second question is regarding the sector. How do you perceive the inflection point in both China and the world? We are seeing the EV players like Xpeng, Lotus, and Zeekr rolling out their non-stringent products. How do we see the inflection point for autonomous driving in China and globally in the next coming 2 to 3 years? Yes, that's my question.

This is Phil. I'm going to take the first question regarding the margin performance. Yes, in quarter 3, we delivered another strong quarter, and we are on track to deliver profitability expectations based on the current momentum. Looking forward, quarter 4 is a traditional peak season in the automotive industry, and all OEMs will work on shipment maximization. There could be a trade-off on pricing, volume, and velocity, and we anticipate that margin erosion will transfer throughout the entire industry chain. But we are ready to catch up to the trend and finish the full year in a strong way. So the profit momentum we built in the first 3 quarters can help us in that regard. We have confidence in delivering our original gross margin goal, which is built on our execution over the first couple of quarters. We will continue to maximize our efforts, focusing on optimizing our software and service portfolio, driving cost optimization, and enhancing vehicle cost efficiency. That said, the market is experiencing fierce price competition for market share gains among OEMs, and price pressures are expected to transfer to Tier 1 vendors, affecting the entire market. Our customers are also working on architectural transformation to enhance digital cockpit capability and cost optimization. Thus, while we foresee hardware profit challenges, we believe in offsetting these issues with the initiatives I just mentioned, and we will also proactively participate in the architectural transformation discussion. We are sure that our technology platform will meet customer demand, and this transitional time is coming soon, expected by the end of 2024. So with that, we are able to mitigate the margin erosion in our hardware solutions while driving further growth in our software and service segments.

I will take the second question, Phil. When we look at the autonomous market, it's certainly still in its initial stages but a dynamic and exciting market for ECARX to participate in. As we talked about earlier in the presentation, the Lincoln 08 is in the market, containing our full stack solution, which includes the digital cockpit as well as our Skylane Pro autonomous system; that's our first significant autonomous launch. The ADAS Level 2+ system will eventually, through OTA features include Navigate Autopilot, and we see that solution being very competitive in features and cost out in the autonomous market. In both the China and global markets, there are a number of leading OEMs deploying systems aggressively, particularly in China, where we expect focus on the Level 2+ space will drive volume in the autonomous market. While some offerings might aim for higher levels, we are excited about our collaboration with Mobileye, which will allow us to launch one of the first SOFR systems on the Polestar 4. We made a detailed announcement about that partnership recently and are collaborating closely with Mobileye to offer unique customizations with the IQ6. Looking at the European and North American markets, we are engaged with several OEMs discussing product launches. However, the adoption rate may be slightly slower in those regions. Overall, we see Level 2+ as the largest volume for a number of years to come, with many investments going on in the autonomous market. We are excited about the opportunity to participate with the products we're bringing first to China and believe we will have opportunities to deploy these products globally.

The next question comes from the line of Luo from BOCI.

Congratulations on the results for this quarter. I have 2 questions. The first one relates to Antora 1004. Feedback on Lincoln 08 has been delivered for some time. Have we received any feedback about the use of Antora 1004 Pro? Can you share any other models that will be equipped with Antora Pro in 2024? The second question is considering that we may have more than 13 new products next year, could you share your budget in R&D for 2024? Do we still maintain the breakeven plan by the end of next year?

I will take the first part of that question concerning the Antora Pro digital cockpit. As we've launched the Lincoln Co-08, it's our first opportunity to put our full stack solution onto a vehicle, which is important because it represents our ability to deliver a product from silicon through cloud services. The Antora Pro digital cockpit computing platform is installed, and the software stack is our full software stack, Cloud Peak, integrated with the classic auto solution. We are seeing very strong demand for that vehicle and anticipate demand in the market will continue to grow. We are excited about continuing to service that vehicle and launching additional features in future over-the-air updates. For future launches, we have additional products planned for next year with all three of our significant products. The Antora and the two Pro series will see a large number of launches in 2024 across various platforms, contributing to significant volume growth going forward.

I will take the second question regarding the R&D investment. Looking at our current trajectory for quarter 2 and quarter 3, R&D expense as a percentage of revenue will be stable at around 30%. We will continue investing in development and product availability for the market. While we may adjust the R&D investment percentage with the scaling of revenue growth, we will keep it at a reasonable level, around 30% based on our general guidelines. We expect significant growth and the possibility of continuing to fix costs. The original guidance on breakeven was based on the company's position at the start of this year. The goal is still in sight, and while breakeven may be pushed further out due to different product portfolio investments, we are still committed to maintaining that aim and ensuring the return on investment as we push towards breakeven for the entire organization.

Our next question comes from the line of Derek Soderberg from Cantor Fitzgerald.

I want to start with the pricing environment. I'm curious how sort of ASPs are moving. As it relates to inflation, do you guys have inflation clauses embedded in your pricing contracts? How quickly are those contracts negotiated each year?

I'm going to address this question. So yes, pricing competition is a reality in the industry, at least during the first 3 quarters. As I mentioned, the pricing of the car will transfer to the entire industry. However, at ECARX, we currently offer full stack solutions, including the computing platform, software operating system, and ADAS solutions, while driving cost optimization. For the contracts we signed with our customers and vendors, we also define flexibility in terms of product exchange. Simultaneously, we provide high value-added services to our customers, allowing us to maintain and incrementally increase ASP while still performing our cost optimization activities.

Got it. As my follow-up, I'm curious if you could talk a bit about the strike in the United States with the auto workers. I'm interested to know if there's any knock-on effects that you're seeing on your end? Additionally, on the macro environment, are you seeing any particular areas of strength or weakness that have changed in the past quarter or two?

Derek, maybe I'll capture that question. We've talked about a number of exciting launches for ECARX that drive our volume, both this quarter and our outlook into next year. We mentioned several electric vehicles seeing strong market demand, such as the Volvo EX30 and our upcoming launches with the Polestar brand, as well as activities beyond our core customers with new products launching with brands like Citroen and Dongfeng. So we have a very strong pipeline. Regarding the impact from the U.S. strike, it doesn't really affect our business at this point. We see significant demand for our products as we progress into Q4 and into 2024.

Our next question comes from the line of Jane from Jefferies.

Congratulations on the strong financial performance. I have 2 questions for management. My first question is about the product pipeline. Can you share more details about the new product, mass production timeline, and guidance on the delivery target of each product line? Also, which customer or car model or platform do you think can be the strongest growth driver next year? My second question is regarding competition from Huawei, especially in terms of smart cockpit solutions. Huawei is expanding its cooperation with smart oncoming cars and plans to launch more new models. How do you view the competition from Huawei, particularly considering we are also developing the operating system with CGM?

Thanks for your question. Let me address both elements. We have numerous new launches planned for 2024, covering all our products. The digital cockpit space with Antora, for example, contains numerous deployments across different brands, with Volvo EX30 being a significant launch for us, delivering vehicles globally in more than 40 countries. The Lincoln Co08 with our full stack solution is a key benchmark product for ECARX and has received excellent feedback. Throughout 2024, we expect to introduce our digital cockpit products and additional launches of the Skylane ADAS system. Given our commitment to product development, we have a robust pipeline. In response to your question about Huawei, we welcome their entry into the market, as they bring a strong technology stack. However, we believe that ECARX stands out with our comprehensive vertical technology stack, covering everything from silicon to cloud services. Our competitive offerings, particularly the Flame Auto integration, showcase our capabilities. We feel confident in our ability to compete effectively moving forward.

Our next question comes from the line of Cheng from CICC.

Congratulations on the results for this quarter. I see some great progress in the software provided by ECARX in this quarter's presentation. I have 2 questions regarding the software products. Firstly, regarding the Cloud Peak which is launched in the Volvo EX30. I believe it is probably launched on a hardware platform that is not produced by ECARX. Can you explain how these products collaborate with other parties? What is the business model, and how is the gross margin structured in this project? My first question. Secondly, on the Skyline Pro system, it has been launched on the Lincoln CO08 but has not been installed in the Lincoln CO06. Could you provide guidance on which projects will be included or excluded? What is the business model for Skyline Pro and are there going to be more projects launching with those capabilities? Lastly, regarding the autonomous driving functions on Skyline Pro, who is responsible for developing these functions? What is the business model?

Thank you for your questions. Let me address them sequentially. Regarding the Cloud Peak solution launched on the EX-30, it showcases ECARX's ability to deliver products on a global scale. We have a substantial number of engineers maturing the product, developed jointly with our Volvo joint venture. Cloud Peak operates with Qualcomm SoC through collaboration with Visteon on the supply chain side. ECARX plays a strong role as a system integrator and software developers while also contributing significantly to hardware design. We function with varying business models to bring solutions to market but primarily focus on software capabilities, including user interfaces. As for the Skyline Pro, it's a significant product launch. The Lincoln 08 has received great feedback, combining our Flame Auto solution with significant cell phone integration to create a differentiated user experience. Numerous launches will be included in the 2024 pipeline, showcasing the strength of our software and system integration capabilities. Lastly, in terms of the autonomous features on the Skyline Pro, both ECARX and our partnerships are involved in software and algorithm development, particularly with some components sourced from partners. We’ll continue to enhance the software stack with more features in the coming quarters, ensuring strong competitive positioning in both the China and potentially global markets.

At this time, there are no further questions from the line. I will now hand the call back to management for closing remarks.

Thank you all for participating in today's earnings call. At ECARX, we are excited about our position in a significant and encouraging market where industry trends are driving robust sector growth. ECARX continues to maintain a strong momentum in business growth and profitability enhancement, and we look forward to talking with you very soon during the Q4 and annual report cycle. Thank you again.

That does conclude today's conference call. Thank you for your participation. You may now disconnect your lines.