Li Auto Inc. Q3 FY2023 Earnings Call

Hello, everyone. Thank you for joining Li Auto's Third Quarter 2023 Earnings Conference Call. Today's call is being recorded. I will now hand it over to your host, Kobe Wang, the Head of Capital Markets at Li Auto. Please proceed, Kobe.

Thank you, operator. Good evening, and good morning, everyone. Welcome to Li Auto's Third Quarter 2023 Earnings Conference Call. The company's financial and operating results were published in a press release earlier today and are posted on the company's IR website. On today's call, we will have our Chairman and CEO, Mr. Xiang Li; our CFO, Mr. Johnny Tie Li, begin with prepared remarks. Our President, Mr. Donghui Ma and the Senior VP, Mr. James Liangjun Zou, will join for the Q&A discussion. Before we continue, please be reminded that today's discussion will contain forward-looking statements made under the safe harbor provision of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, the company's actual results may be different from the views expressed today. Further information regarding risks and uncertainties is included in certain company filings with the U.S. SEC and the Hong Kong Stock Exchange. The company doesn't assume any obligation to update any forward-looking statements, except as required under applicable law. Please also note that Li Auto's earnings release price and this conference call include a discussion of unaudited GAAP financial information as well as unaudited non-GAAP financial measures. Please refer to Li Auto's disclosure, the comments on the IR section of our website, which contains a reconciliation of unaudited non-GAAP measures and comparable GAAP measures. Our CEO will start his remarks in Chinese. There will be English translation after he finishes all his remarks. With that, I will now turn the call over to our CEO, Mr. Xiang Li. Please go ahead.

Hello, everyone, and welcome to today's earnings conference call. In the third quarter of 2023, despite the intense competition in China's NEV market, we maintained strong growth momentum propelled by our compelling product lineup and strong execution. Total deliveries for the quarter surpassed 105,000 vehicles, almost 4x the volume for the same period last year, setting another new quarterly delivery record. By the end of September, we have delivered our 500,000 Li Auto vehicles, becoming the fastest Chinese emerging new automaker to reach this benchmark. Moreover, in October, Li Auto achieved another new milestone with over 40,000 monthly deliveries. According to the insurance registration data of China Automotive Technology and Research Center, Li L9 maintained its position as the full-size SUV sales champion during the quarter, while L7 and L8 continue to occupy the first and second spot in the large SUV market, respectively. We remain one of the top 3 NEV brands priced over RMB 200,000 in China while our market share continued to grow, reaching 15.4% in NEV brands priced over RMB 200,000 in China, compared with 10.9% in the first quarter and 13.7% in the second quarter. We believe that our L series' robust growth momentum, together with deliveries of our upcoming BEV models next year, will enable us to accelerate the large-scale transition from traditional ICE vehicles in 2024. Turning over to our financial performance. Our rapid scale growth has driven continued cost reduction, resulting in steady improvements across multiple financial metrics. Total revenues for the third quarter were RMB 34.68 billion, up 271.2% year-over-year. Our net income and free cash flow increased to RMB 2.81 billion and RMB 13.22 billion, respectively, both heading to new historical highs. Notably, our cash position reached RMB 88.52 billion as of the end of the third quarter. Our healthy operations reaffirm our strong operational capabilities, underpinning our long-term firm commitment to R&D. Our market-leading charging capability for 5C BEV is just one great example of our achievements made through R&D investments. With respect to production, in October, our Changzhou manufacturing base completed its capacity expansion and is now well positioned for its production increase in Q4. In terms of supply chain management, we continue to break through the component supply chain bottleneck via the enhanced supply chain management strategies, improved processes and more efficient collaboration with our suppliers. We expect total deliveries in the fourth quarter to be between 125,000 to 128,000 units. Now I would like to talk about Li MEGA. Li MEGA can gain up to 500 kilometers of driving range with a 12-minute charge and features an industry-leading silhouette. Its market reception has exceeded our expectations. Li MEGA's extremely large interior space meets the travel needs of large Chinese families. At the same time, its unique body style and silhouette are intended to reach the perfect balance between interior space and energy consumption. It is the most aerodynamic MPV in the world with a drag coefficient of only 0.215. Based on our 800-volt BEV platform, MEGA is capable of 5C charging with a peak charging power exceeding 520 kilowatts, higher than any other passenger vehicle in production in the world. Li MEGA is targeted for launch in December 2023. Showroom vehicles are scheduled for debut at our retail stores in January 2024, and deliveries will commence in February. We will share more details about Li MEGA during our product launch event this December. In the meantime, we have been making progress with our 5C supercharging network expansion. To date, we have built and started operating 130 supercharge stations along highways nationwide. We expect to establish 300 highway supercharging stations by the end of this year, covering 4 major economic zones, including the Beijing-Tianjin-Hebei Economic Belt; the Yangtze River Delta region; the Greater Bay Area; and the Sichuan-Chongqing Economic Belt. Going forward, we will further accelerate the rollout to increase nationwide highway coverage while also actively building urban supercharging stations, thereby greatly improving users' energy replenishment experiences across all scenarios. Moving on to autonomous driving. Our city NOA on our AD Max platform continues to progress smoothly. We expect to push the official version of AD Max 3.0 by the end of this year with full scenario NOA functionality. Meanwhile, the AD Pro 3.0's official version will be released in the first half of next year. By then, part of AD Max's algorithm capability will also be available on AD Pro. We're confident that Li Auto will become a market-proven first-tier player in the autonomous driving market in the first half of next year. Turning to the development of our direct sales and servicing network. As of October 31, 2023, we have 372 retail stores in 133 cities. Moving to the fourth quarter, we will continue to accelerate our network expansion, aiming to cover over 400 stores across 140 cities nationwide, further increasing Li Auto's market share in China's new energy automotive market. Last but not least, I would like to share some details regarding our accomplishments in ESG. In September, our company was upgraded to the highest AAA rating by MSCI ESG Research, making Li Auto the first Chinese automaker ever to receive this rating. The rating validates our steadfast efforts across corporate governance, product safety and quality, clean tech development and organization and talent among other areas. Moving forward, we'll continue to uphold our value proposition of providing outstanding products and services that exceed our family users' needs as we constantly push the limits of growth. With that, I will turn it over to our CFO, Johnny, for a closer look at our financial performance.

Thank you, Xiang. Hello, everyone. I will now walk you through some of our 2023 third quarter financials. Due to time constraints, I will address financial highlights and encourage you to refer to our earnings press release for further details. Our total revenues in the third quarter were RMB 34.68 billion or USD 4.75 billion, up 271.2% year-over-year and 21% quarter-over-quarter. This included revenue from vehicle sales, RMB 33.62 billion or USD 4.61 billion, up 271.6% year-over-year and 20.2% quarter-over-quarter, mainly driven by increased vehicle deliveries. Revenue from other sales and services was RMB 1.06 billion or USD 145.7 million in the third quarter, growing 258.7% year-over-year and 56.2% quarter-over-quarter. The increase was mainly due to the increased sales of accessories and provision of services, in line with our higher accumulated vehicle sales as well as the increased sales of charging stalls, in line with higher vehicle deliveries. Cost of sales in the third quarter was RMB 27.03 billion or USD 3.71 billion, up 231.3% year-over-year and 20.6% quarter-over-quarter. Gross profit in the third quarter was RMB 7.62 billion or USD 1.05 billion, growing 546.7% year-over-year and 22.6% quarter-over-quarter. Vehicle margin in the third quarter was 21.2%, compared with 12% in the same period last year and 21% in the prior quarter. Excluding the impact of inventory provision and losses on purchase commitments related to Li ONE in the third quarter of 2022, the vehicle margin remained stable over the third quarter of 2022. Gross margin in the third quarter was 22%, compared with 12.7% in the same period last year and 21.8% in the last quarter. Operating expenses in the third quarter were RMB 5.31 billion or USD 727.1 million, growing 60.2% year-over-year and 15.1% quarter-over-quarter. R&D expenses in the third quarter were RMB 2.82 billion or USD 386.1 million, up 56.1% year-over-year and 16.1% quarter-over-quarter, primarily driven by increased employee compensation as a result of our growing number of staff as well as increased expenses to support our product portfolio expansion and technology advancements. SG&A expenses in the third quarter were RMB 2.54 billion or USD 348.7 million, up 68.8% year-over-year and 10.2% quarter-over-quarter, primarily driven by increased employee compensation as a result of our growing number of staff as well as increased rental expenses associated with our sales and servicing network expansion. Income from operations in the third quarter was RMB 2.34 billion or USD 320.6 million, compared with RMB 2.13 billion loss from operations in the same period last year and growing 43.9% from RMB 1.63 billion income from operations in the last quarter. Net income in the third quarter was RMB 2.81 billion or USD 385.5 million, compared with RMB 1.65 billion net loss in the same period last year and increasing 21.8% from RMB 2.31 billion net income in the second quarter of this year. And now turning to our balance sheet and cash flow. Our cash position remains strong and stood at RMB 88.52 billion or USD 12.13 billion as of September 30, 2023. Net cash provided by operating activities in the third quarter was RMB 14.51 billion or USD 1.99 billion. Free cash flow was RMB 13.22 billion or USD 1.81 billion in the third quarter. And now for our business outlook. For the fourth quarter of 2023, the company expects deliveries to be between 125,000 and 128,000 vehicles, representing an increase of 169.9% to 176.3% from the fourth quarter of 2022. The company also expects fourth quarter total revenues to be between RMB 38.46 billion and RMB 39.38 billion, representing an increase of 117.9% to 123.1% from the fourth quarter of last year. This business outlook reflects the company's current and preliminary view on its business situation and market condition, which is subject to change. This concludes our prepared remarks. I will now turn the call over to the operator to start our Q&A session. Thank you.

Your first question comes from Tim Hsiao with MS.

So my first question is about the margin. Despite third quarter margin beat, Li Auto has been scaling up the vehicle discount and benefits since the late quarter, and most of the promotions similarly continue in the fourth quarter. As there are more competitive models coming to the market in the following months and on the auto, would the company consider to respond with more aggressive promotions or spec upgrade to your current lineup? And would that affect Li Auto's peak margin in the fourth quarter and beyond? So in short, should we still consider 20% plus a reasonable and sustainable level for vehicle gross margin against such a tough competition backdrop? That's my first question.

Thank you, Tim. This is Johnny. I think for every quarter and every year, we will take a full consideration between sales and volume growth and the gross margin when we plan our sales policy and promotion policy. And also every quarter, our sales policy will also add our supply chain efforts, which absolve some of the sales policy promotions. So I still want to emphasize from the company's operations side, each quarter and every year, we want to keep our gross margin above 20%. We believe that will be a healthy margin to keep enough money on hand to invest in either R&D and also the service network expansion for the future. Thank you.

So my second question is about autonomous driving. Li Auto is now attaching greater importance to the development of smart driving and planning to increase the overall investment. So could the management team help us to quantify Li Auto's investment plan in autonomous driving? Like how much you are going to spend in 2024 and '25? And how many people are you planning to hire? And in the meantime, what would be the best way for investors to track the progress? For example, when will Li Auto activate the urban NOA function for whole public users across the cities? And will you keep offering such function for free after a more sizable investment this year? That's my second question.

This is Mr. Ma Donghui. First of all, on a strategic level, the company has always been very focused on investments in autonomous driving. In the fall strategy summit of our company, we had a thorough discussion around autonomous driving and reached consensus to make smart autonomous driving leading in the market our core strategic goal. So the company will continue to increase our investments in autonomous driving. At this point, the R&D team for autonomous driving is around 900 people, and it's expected to reach about 2,000 by the end of 2024 and over 2,500 by the end of '25. As the scale and talent density of our R&D team grows, we will develop technology as well as product simultaneously. On the one hand, we will continue to deploy our AD products across multiple vehicle lines and across multiple scenarios of deploying NOA in multiple scenarios. On the other hand, we will continue to invest in AI algorithms of autonomous driving as well as other cutting-edge technology. In terms of investments, we will continue to increase the amount of investments in vehicles, testing, computing power, and personnel. Our ample cash reserve and cash flow will be a very strong support for our continued investments. In terms of progress, as Li mentioned earlier, we plan to deploy AD Max 3.0 software on all of our vehicles equipped with AD Max, providing full scenario NOA features using the same BEV architecture, and we will also be adding the valet parking feature to our AD Max users. At the same time, in the first half of '24, we will be releasing AD Pro 3.0 to our Pro users. Part of the AD Max algorithms will be deployed on AD Pro, and the capability of autonomous driving will also be significantly improved. We're confident to become one of the top-tier players in the market that is proven by the market. In terms of product lineup strategies, we will continue to make AD standard on all of our vehicles, which allows us to have the largest training fleet of autonomous driving vehicles in the country and also more training mileage, which will accelerate the deployment and iteration of our foundational model algorithms.

Your next question comes from Tina Hou with Goldman Sachs.

Congratulations on a very strong set of results. So I have two questions. The first one is as we are expanding our footprint into more and more cities, how does management view the different types of customer need or demand in higher-tier cities versus lower-tier cities for both EREV products as well as BEV products? And how does Li Auto plan to adjust its marketing and sales strategy to better capture these differentiated demands? The second question is regarding your supply chain as well as cost reduction plan. So wondering if our supply chain bottleneck has been completely resolved at this point. And going forward, how do we best manage the supply chain to be able to fulfill our growing demand? Related to that, do we have any cost reduction plans and targets over the next few years? And lastly, over the next 2 years, what is our capacity plan as well as our CapEx guidance?

Okay, Tina, this is James. I will take your first question. In the SUV market priced over CNY 300,000, our market share in our well-developed cities reached 50% in some of the cities, while our average market share across the whole market is less than 20%, which means there is plenty of room for our future growth. Overall, we will continue to focus on first-tier, new first-tier, and second-tier cities, aiming to increase our market share in these top-tier cities. Currently, we haven't reached market saturation in first-tier and second-tier cities, and we will have huge growth potentials in those cities. In the CNY 300,000 and higher SUV market, the monthly sales of BBA are approximately 55,000 units in total. If we consider the second-tier premium automotive brands, which include BBA and other brands, they are around 90,000 units, which means we have ample room to achieve our next stage of growth. Additionally, we have begun to accelerate our deployment in third-tier cities and speed up our store openings in certain key fourth-tier cities. And let me give you some numbers. As of today, we have more than 300 retail stores nationwide, among which more than 100 retail stores are deployed in third-tier and fourth-tier cities. According to our current progress, we expect to have more than 110 retail stores in third-tier and fourth-tier cities by the end of this year. I hope I have answered your first question. I will hand over to Mr. Ma for the second one.

First of all, regarding the supply chain bottleneck, all of the issues that we have encountered before have been successfully resolved. Regarding new models and our sales target for next year, we have made ample preparations across not only whole vehicle production capacity but also parts supply. We have made medium- to long-term supply chain strategies to make sure that our supply chain is resilient over time. On cost reduction, our overall view is that OEMs should establish long-term stable partnerships with our suppliers to achieve a mutually beneficial relationship for the two sides. For the short term, our short-term cost reduction measures will mostly be focused on business measures through platformization, volume aggregation, and cost accounting to drive our procurement costs to a reasonable level. For the medium to long term, we will look at the entire value chain from end to end to find ways to increase efficiency and reduce costs, including from product, R&D, technology, and innovation to drive down costs. At the same time, we will also work with our suppliers to help them digitize and industrialize to increase the efficiency in the production process and reduce quality-related costs. In terms of overall vehicle production capacity, we have two manufacturing bases in Beijing and Changzhou, three production lines in Changzhou dedicated to our EV models, L9, L8, L7 as well as L6, which will be launched next year. In Beijing, there is one production line dedicated to our BEV products. Our production capacity is sufficient to meet the needs for sales and deliveries for the next 2 years.

Your next question comes from Jiong Shao with Barclays.

Big congrats on the very strong results. I mean competition has been on the top of the mind for many investors with the recent launch by Huawei in auto of the sort of the larger SUVs. And that SUV is also EREV, and also the DENZA, the BYD DENZA brand is launching some of the large SUVs as well. I was wondering, could you share with us your thoughts around competition around customers' buying behavior? You talked about market share earlier. Are you seeing any impact yet on market share and on your market positioning?

Okay, Jiong, this is James. I will address your question. Despite the intense competition in the new energy vehicles market this year, we have once again achieved impressive sales results. Our models have maintained strong sales momentum, and each one is performing exceptionally well. So far, the delivery of all our models, including L9, L8, and L7, has exceeded 100,000 units. Just as of yesterday, our L7 surpassed 100,000 units in under 10 months since its launch in March this year. Additionally, our sales have shown steady and continuous growth, with our share in the NEV market priced over CNY 200,000 rising from 10.9% in the first quarter to 15.4% in the third quarter. As of last month, October, our market share has already reached more than 17%. Currently, the penetration rate of the new energy vehicle market has exceeded 35% as we enter the early stages of mass adoption. The concentration of leading auto companies will become increasingly evident, and our growing user base along with market share will support our further increases in delivery volumes and market share gains. I hope I have answered your questions.

Your next question comes from Xu Yingbo with CITIC Securities.

My first question is how we balance the technology advantage, especially regarding the low drag coefficient, and manage consumer recognition in the market, particularly for blind consumers.

I'll talk about MEGA and all of our BEV products. In terms of traditional values, including safety features and comfort, MEGA will continue to focus on families' needs and make sure that we will be the absolute best or among the absolute best in the industry. On top of that, all of our BEV products will have 3 breakthroughs. The first one is a breakthrough on charging experience. It can provide up to 500 kilometers of range with 12 minutes of charging. We will also be deploying large-scale charging stations on major highways in China. So any consumer can buy one of our BEV vehicles with total confidence about their charging experience. Secondly is a breakthrough on interior room. With our high-voltage pure electric architecture, we will be able to completely redesign vehicle architecture to make sure that the interior space of our products are always the biggest in their modern segment, even reaching the level of the next segment up, which provides the best interior experience for family users. And thirdly, all of our products will have a breakthrough in terms of styling and body style. All of our styling will be redefining each one of the traditional categories, whether it's MPV, SUVs, or sedans. We will be bringing design language from decades down the road and launching our existing vehicles as they come – they are only concept vehicles, but they are actually production vehicles that will launch into the market. Through these 3 breakthroughs, we'll be able to provide 3 very unique values to our customers. The first one is the sense of safety from charging or the experience of charging; and the second is the sense of value from very large interior space; and third is the sense of longing from very exciting styling. All of our BEV products will be following these 3 principles.

My second question is how we see that the EV product becomes more and more differentiated with larger screens, more smart interactions, and controls. How do we make the EV product more differentiated?

I think my earlier response covered a lot of your question. I just want to emphasize that our focus has always been on our core user value, what creates the most value for our users. I think with the intense competition, as you mentioned, incremental changes are definitely taken for granted, whether it's lower price, more features, or more screens. These are things we'll definitely do well in. But when we think about competition, we think the way to stand out is to compete on a higher dimension and to create a real focus on the three values that consumers care about most. Taking 5C charging as an example, in our real-world chart testing, even when the battery state of charge reaches 85%, it can still have a charging power of over 300 kilowatts, which is even higher than the maximum charging rate of many other competitors. This really establishes a new standard for the industry, and that is only the result of years of innovation through product and R&D in our efforts. That is something we will continue to invest in and continue to prove – create value for our users.

Your next question comes from Ming-Hsun Lee with BofA.

So currently, Li Auto has put a lot of charging stations in China. What is the difference of charging stations within the cities and also on a highway? And in terms of your charging technology and also the user experience for your BEV, how do you want to differentiate from maybe your competitors?

Thank you for your questions, Ming. This is James responding. Currently, in urban areas, whether it's public or home charging, consumers have good access to facilities that offer a satisfactory charging experience. Therefore, for battery electric vehicles, it's essential to address the primary issue first, focusing on the need for quick energy replenishment during long-distance travels on highways. By establishing large-scale charging stations along highways, combined with a charging time of 12 minutes to support a driving range of 500 kilometers, we aim to ease any concerns consumers may have about purchasing BEVs. Additionally, as we launch and deliver our BEVs next year, we will also begin constructing charging stations in cities. Regarding product experience, we will consider both hardware and software as a complete package. For instance, when Li Auto car owners search for a charging station, they will be able to check the status of the charging gun and charger through the car's infotainment system. We also offer plug-and-play features and potentially free payment options to enhance user experience. Moreover, for BEVs, the batteries can be preheated remotely. Our goal is to improve the overall charging experience from the user’s perspective. That concludes my answer.

We are observing an increasing number of competitive players entering the market, including well-established companies like Huawei, which has formed various partnerships in China and is achieving notable sales. Xiaomi is also set to launch a new car in 2024. Considering the long-term outlook, how do you view the market dynamics in China's EV sector for automotive companies? What strategies do you think will enable them to differentiate themselves effectively? In your opinion, what is the most crucial factor?

First of all, I think what many people are really asking is, how do we look at the competition from Huawei? This is actually a question we have broad consensus across the company. When we look at Huawei, 80% of what we're thinking is how do we learn from them; and 20% is really respect, and there’s zero complaint in fact. Because as we become a company that has reached the CNY 100 billion revenue benchmark – milestone, we're actually very lucky and impressed to have a role model which has done businesses on a scale of RMB 1 trillion. So we're very excited to have Huawei along the way. When we look internally in terms of how we want to weather the storm and stand out in intense competition, we look at really nine areas across three broad categories. The first category is really the consensus across the company, which includes culture, brand, consumer brand, and strategy. The second category is our business operations, which covers R&D, sales and services, supply chain, and manufacturing. Lastly, is back-office functions, which include HR and organization, IT and processes, and finance and operations. To become a company that can really handle RMB 100 billion of revenue, we need to excel in all areas. There can't be any one shortcoming, and that will be the core foundation for any company that wants to reach the scale of 1 million unit sales annually.

Your next question comes from Jing Chang with CICC.

So my first question is about a short-term question regarding the production ramp-up and profitability of MEGA. As our Beijing BEV platform will be put into production along with the launch of MEGA, how long do we expect to come to steady capacity? And what is the early-stage profitability level of MEGA? And will it be a dragging problem on our gross profit margin in the first and second quarter next year? My second question is about our new product pipeline next year, especially for the BEV models. We know that there are two platforms, wheel and shock, and the former one corresponds to maybe larger and more extensive models. So do you have any more information about their product position in order to launch to the market or the timing of the delivery?

Speaking of challenges, MEGA will be our very first BEV vehicle and also the debut of our BEV platform in a new factory in Beijing as well as a new production line. So there's definitely challenges but, at the same time, we think there are many opportunities for us to overcome the challenge. First of all, we have plenty of experience in rapid production ramp-up. The Li L8, L9, and L7, all these three vehicles have ramped up pretty rapidly and reached very high delivery numbers within a short period of time. As we look back at this experience, we've accumulated a lot of great experience in rapid production ramp-up. At the same time, we've also worked with our suppliers to work through our NUDD parts, namely New, Unique, Different and Difficult. We have created a very detailed quality control and production ramp-up plans. In terms of personnel, we will front-load our recruiting and training to prepare for the start in production. Overall, we are pretty confident that the ramp-up of MEGA will be relatively successful, and it will be able to reach volume immediately after it comes to the market. After that, it will be able to be delivered immediately after the product launch and reach volume quickly following its first delivery. MEGA will be officially launched in December. At the beginning of the production ramp-up, we expect a slight impact on gross margin. However, we believe that as the production rate steadies, gross margin will recover to a very healthy level. Mr. Jing Chang, to answer the question on the product line, next year, we will be launching 4 new completely new models, which creates a record for the company since its beginning. In the first half, we'll be launching another large SUV product catered towards younger families called the L6. In the second half, we'll have 3 BEV models. The rate and the method of launch will be very similar to the successful experience of our previous products.

As we are reaching the end of our conference call now, I'd like to turn the call back over to management for any additional or closing comments.

Thank you once again for joining us today. If you have any other questions, please feel free to contact Li Auto's IR team. Thank you. Have a good one. Bye-bye.

That does conclude our conference for today. Thank you for participating. You may now disconnect.