Earnings Call Transcript - LI Q3 2024

Operator, Operator

Hello, ladies and gentlemen. Thank you for standing by for Li Auto's Third Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. Today's conference call is being recorded. I will now turn the call over to your host, Ms. Janet Chang, Investor Relations Director of Li Auto. Please go ahead, Janet.

Janet Chang, Investor Relations Director

Thank you, operator. Good evening, and good morning, everyone. Welcome to Li Auto's Third Quarter 2024 Earnings Conference Call. The company's financial and operating results were published in our 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; and our CFO, Mr. Johnny Tie Li, begin with prepared remarks. Our President, Mr. Donghui Ma, and Senior Vice President, 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 provisions 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 materially different from the views expressed today. Further information regarding risks and uncertainties is included in certain company filings with the U.S. Securities and Exchange Commission and the Stock Exchange of Hong Kong Limited. The company does not assume any obligation to update any forward-looking statements, except as required under applicable law. Please also note that Li Auto's earnings press release and this conference call include discussions of unaudited U.S. GAAP financial information as well as unaudited non-GAAP financial measures. Please refer to Li Auto's disclosure documents on the IR section of our website, which contains a reconciliation of the unaudited non-GAAP measures to comparable U.S. GAAP measures. Our CEO will start his remarks in Chinese, followed by an English translation. With that, I will now turn the call over to our CEO, Mr. Xiang Li. Please go ahead.

Xiang Li, CEO

Hello, everyone. This is Xiang Li, and thank you for joining today's earnings conference call. In the third quarter, China's new energy vehicle penetration rate reached 50.3%, marking the first time new energy vehicles overtook internal combustion engine vehicles in new vehicle registrations. The market share of leading brands continues to grow, especially in the market for new energy vehicles priced over RMB200,000, where the top three brands combined hold more than 50% of the market share in Q3. Li Auto delivered over 152,000 vehicles in Q3, which is a 45.4% increase year-over-year, raising our segment market share to 17.3% in Q3 compared to 14.4% in Q2. Our historically high quarterly deliveries and market shares reinforce our leadership in this segment. Additionally, our sales in China's overall passenger vehicle market priced over RMB200,000 surpassed several established European premium brands for the first time, positioning us among the top three brands overall and number one among Chinese brands in this segment. With many players entering the electric vehicle market, the Li L-series maintained strong sales performance, partly due to our ongoing innovation and high-quality monthly over-the-air updates that enhance autonomous driving, the smart cockpit, and electric drive. In Q3, the average monthly sales of the Li L-series exceeded 50,000 units. It is important to note that our average battery management system's take rate continues to increase due to our investments in research and development, which have led to rapid innovations in our vehicles' autonomous driving abilities. This deployment reflects user recognition of our technology and improves our overall product offering. In the third quarter, we also upgraded our sales and service network. By the end of September, we had 479 retail stores in 145 cities and 436 service centers, along with Li Auto authorized body and paint shops operating in 221 cities in China. Among them, 165 sales centers are located in major automotive and premium commercial areas, featuring 9 to 11 display spots per store, which drives our total display spots to over 3,000. This supports the sales growth of our existing models and will also prepare us for the launch of our new utility vehicles and SUVs. Regarding our supercharging network, we currently have 1,000 supercharging stations and 4,888 charging stores operating in 175 cities across 31 provinces. Notably, our network includes 582 supercharging stations along highways, the largest network of its kind in China. We are also strengthening our partnerships within the industry. On October 12, we officially partnered with Sinopec to collaborate on charging station construction and platform interconnectivity. Currently, our Li selection supercharging network includes 1,200 high-power, highly stable third-party charging stations. We are on track with our battery vehicle strategy, as charging efficiency and reliability remain top priorities for battery vehicle customers. We will continue to accelerate the expansion of our charging network while exploring new technologies to establish an industry-leading charging infrastructure that covers both highways and urban areas by next year. This initiative will support the launch of our battery utility vehicle electric SUVs and ensure we provide a reliable and convenient charging experience for our growing customer base. Moving on to autonomous driving, since its release in July, our proprietary end-to-end and vision language model autonomous driving solution has been iterating at a rate of 2 to 3 versions per week. In just three months, the amount of training data for each model increased from 1 million video clips to 4 million, while the average mileage per intervention nearly doubled. Our new system one and system two autonomous driving solutions have significantly enhanced user experience with their robust models and deep understanding of traffic environments. On October 23, we began rolling out over-the-air update 6.4 for the Li Mega and BL Series, which includes the new autonomous driving solution that has been fully deployed on over 320,000 80 MAX vehicles, just three months after we launched our nationwide map lease in July. The update also features improved interactions powered by large language models and enhancements to the charging experience, among other improvements. Our substantial amount of real-world training data is a key competitive advantage and drives rapid innovations in autonomous driving. As of October 30, our total real-world training mileage has reached 2.6 billion kilometers, with no intervention mileage hitting 1.39 billion kilometers, and automated parking has been activated 60 million times. Additionally, our active safety features have averted 3.45 million potential accidents, including 516 severe incidents. In Q3 2024, our total revenues reached a record high of RMB42.9 billion, representing a 23.6% year-over-year increase. Our gross margin expanded to 21.5%, with non-GAAP income from operations reaching an all-time high of RMB4.4 billion, and operating cash flow amounting to RMB11 billion. This strong financial performance is attributed to our enhanced product mix, economies of scale, and improved operating efficiency. In October, we celebrated a significant milestone of 1 million cumulative vehicle deliveries in just 58 months, making us the first among emerging new energy vehicle brands in China. This milestone represents a new beginning. Looking ahead, we will continue to innovate through research and development and deliver exceptional products and services while maintaining our efficiency in production and delivery as an industry leader. In Q4 of this year, we expect vehicle deliveries to be between 160,000 and 170,000 units, with total deliveries for the year projected to be between 502,000 and 512,000 units. Lastly, I would like to highlight our ESG performance. In September, we received MSCI's highest AAA ESG rating for the second consecutive year, reflecting our strong performance in corporate governance, product quality, safety, and clean energy technology. We will continue to explore advanced low-carbon technologies and implement green operational management practices while actively fulfilling our social responsibilities. I will now turn the call over to our CFO, Johnny, to discuss our financial performance.

Johnny Tie Li, CFO

Thank you, Xiang. Hello everyone. I will now walk you through some of our 2024 third-quarter financials. Due to time constraints, I will address financial highlights here and encourage you to refer to our earnings press release for further details. Total revenues in the third quarter were RMB42.9 billion or $6.1 billion, up 23.6% year-over-year and 35.3% quarter-over-quarter. It included RMB41.3 billion or $5.9 billion from vehicle sales, up 22.9% year-over-year and 36.3% quarter-over-quarter. The year-over-year and sequential increase was primarily attributable to the increase in vehicle deliveries, partially offset by the lower average selling price mainly due to the different product mix. Cost of sales in the third quarter was RMB33.6 billion or $4.8 billion, up 24.5% year-over-year and 32% quarter-over-quarter. Gross profit in the third quarter was RMB9.2 billion or $1.3 billion, up 20.7% year-over-year and 49.3% quarter-over-quarter. Vehicle margin in the third quarter was 20.9%, relatively stable compared with 21.2% in the same period last year and improved from 18.7% in the last quarter. The sequential increase was mainly due to cost reduction, partially offset by the lower average selling price mainly due to the different product mix. Gross margin in the third quarter was 21.5% versus 22% in the same period last year and 19.5% in the prior quarter. Operating expenses in the third quarter were RMB5.8 billion or USD 825.4 million, up 9.2% year-over-year and 1.5% quarter-over-quarter. R&D expenses in the third quarter were RMB2.6 billion or USD 368.6 million, down 8.2% year-over-year and 14.6% quarter-over-quarter. The year-over-year and sequential decrease was primarily due to reduced design and development costs for new products and technology and decreased employee compensation. SG&A expenses in the third quarter were RMB3.4 billion or USD 478.7 million, up 32.1% year-over-year and 19.3% quarter-over-quarter. The year-on-year and the sequential increase was primarily due to increased employee compensation associated with the recognition of share-based compensation expenses regarding the CEO's performance-based awards in the third quarter of this year as the achievement of the related performance condition was deemed profitable. Income from operations in the third quarter was RMB3.4 billion or USD 489.2 million, up 46.7% year-over-year and 633.4% quarter-over-quarter. Operating margin in the third quarter was 8%. It grew from 6.7% in the same period last year and 1.2% in the prior quarter. Net income in the third quarter was RMB2.8 billion, or USD 401.9 million, up 0.3% year-over-year and 156.2% quarter-over-quarter. Diluted net earnings per ADS attributable to ordinary shareholders was RMB2.66 or USD 0.38 in the third quarter versus RMB2.67 in the same period last year and RMB1.05 in the prior quarter. Turning to our balance sheet and cash flow, our cash position remained strong and stood at RMB106.5 billion or USD 15.2 billion as of September 30, 2024. Net cash provided by operating activities in the third quarter was RMB11 billion or USD 1.6 billion versus net cash provided by operating activities of RMB14.5 million in the same period last year, and net cash used in operating activities of RMB429.4 million in the prior quarter. Free cash flow was RMB9.1 billion or US$1.3 billion in the third quarter versus RMB13.2 billion in the same period last year and a negative RMB1.9 billion in the prior quarter. Now for our business outlook. For the fourth quarter of 2024, the company expects the deliveries to be between 160,000 and 170,000 vehicles, representing a year-over-year increase of 21.4% to 29%. The company also expects fourth quarter total revenues to be between RMB43.2 billion and RMB45.9 billion or US$6.2 billion and US$6.5 billion, representing a year-over-year increase of 3.5% to 10%. This business outlook reflects the company's current and preliminary review of its business situation and market condition, which is subject to change. That concludes our prepared remarks. I will now turn the call over to the operator to start our Q&A session. Thank you.

Operator, Operator

Thank you. Your first question comes from Tim Hsiao with Morgan Stanley.

Tim Hsiao, Analyst

Thank you for taking my question. My first inquiry is regarding the growth potential. The full year target indicates that the average monthly sales of the L series could exceed 53,000 in the fourth quarter. Looking ahead to next year, how much additional growth do you believe the L series still has? If there is significant potential, what opportunities do you see arising—will it be from new models like the L5, faceless options, exports, or deeper market penetration in lower tier cities in China? That's my first question.

James Liangjun Zou, Senior Vice President

Okay, Tim, this is James. I will take your first question. Overall, we hope our sales growth next year will be twice the growth rate of RMB200,000 and higher market. Thank you.

Tim Hsiao, Analyst

Okay. My second question is about autonomous driving. In September, we launched an improved version of point-to-point smart driving with a judgment click. When will this function be fully deployed? Additionally, is there a possibility that Li Auto will introduce the cDNA function on the new Pro version next year?

Xiang Li, CEO

In the past 10 months, we have gone through several major iterations in our autonomous driving features. We went from reducing reliance on maps to mapless to end-to-end, which you've seen today. In the meantime, people's recognition and expectations for our NOA have kept increasing. In terms of parking space at one click, our plan is to launch it to all our AD MAX users by the end of December of this year. Along with this launch, we will also be releasing the feature to pass all ETC toll stations automatically, which relies on our VLN model to recognize ETC toll stations so that our users can drive from highway to urban roads through ETC toll stations without exiting NOA, which provides a more fluid user experience. In terms of whether our city NOA will be released on pro models, because city NOA relies on stronger perception and a larger amount of computing power, the current city NOA features unfortunately won't be provided on our Pro model. As for specifics of future models and information, please stay tuned to our product launch events in the future. Thank you.

Operator, Operator

Your next question comes from Ben Wang with Deutsche Bank.

Ben Wang, Analyst

My first question is about the new upcoming Pure EV products. What is the timing for the first product and what will the pricing range be? What are your expectations for the monthly sales volume, as there have been some local media reports about this. Can you confirm? Thank you.

Xiang Li, CEO

First of all, as for exact information about our launch plan, I will be releasing this information at the appropriate time in a formal product launch event because for automotive products, confidentiality is quite important. Overall, we're still very confident about our best products overall. As you've seen with our L Series REV models, they have performed very strongly in the high-end new energy vehicle market. It is also our goal to make our best SUVs our Tier 1 players in the high-end market.

Ben Wang, Analyst

My question is about share-based compensation for the CEO. I understand that more than 0.5 million units were granted in the past 12 months. Can you clarify how much expense is being recorded in the third quarter and what we can expect for the fourth quarter this year? Thank you.

Johnny Tie Li, CFO

Hi. This is Johnny. Regarding the CEO share-based compensation, as of September 30, the company has the Q4, the fourth quarter delivery plus the delivery in the first three quarters will probably meet the CEO’s performance required for the first batch of share-based compensation, which means the total delivery in the trailing 12 months first reached over 500,000. As a result, we recognize the share-based compensation expenses in the third quarter of RMB593 million. There will be an additional RMB42 million in the fourth quarter, and every batch of the reward, which means the next 500,000 milestone, the expense will be the same as each batch. Thank you.

Operator, Operator

Your next question comes from Tina Hou with Goldman Sachs.

Tina Hou, Analyst

So my first question is regarding our sales policy strategy into the fourth quarter of the year. And then also in relation to that, our fourth-quarter volume guidance seems to be quite conservative incremental volume in 4Q versus 3Q compared to last year. So I'm wondering how we're thinking about the volume and the sales policy?

James Liangjun Zou, Senior Vice President

Okay, Tina, this is James. I will take your first question. First of all, against the competition, sales of the service remain strong. Mainly due to the strengthening momentum of our brand relation with over 1 million deliveries and the rapid breakthrough of autonomous driving capabilities. We are very confident about our sales in the fourth quarter. The competition has been intense since the beginning of this year; against such tough competition, our market share has been continuously increasing. In the third quarter, our market share in the RMB200,000 and above NEV market reached 17.3%, a record high year-to-date. Meanwhile, since the L6 launch, our deliveries have exceeded 25,000 units with cumulative deliveries exceeding 139,000. Li L6 is the best-selling model among the new vehicles released this year. As to sales, we initiated a new round of change in the second half of this year to give more operating autonomy to each region. The person in charge in each province will be responsible for overall operations, not just sales as in the past. With operating autonomy, each province can run region-specific sales and marketing activities according to local market conditions, further increasing brand awareness and market share. If we look at this region by region, the competitive landscape varies for different provinces; we will formulate region-specific sales policies according to the local conditions. Thank you.

Tina Hou, Analyst

My second question is about our plan to expand the sales network. What will our target number of stores be by the end of 2024 and by the end of 2025? Thank you.

James Liangjun Zou, Senior Vice President

Okay. So we expect our retail stores to reach about 500 at the end of this year. Our key channel adjustments we have been implementing this year is to gradually replace lower-performing shopping mall stores in our network with sales centers in leading locations. As a result, the proportion of sales centers in auto parts will increase to over 40% at the end of this year from 24% at the end of 2023. Our total display sports in China is expected to reach over 3,600 at the end of 2024 from over 2,600 at the end of 2023. Meanwhile, we are expanding our coverage in the third-tier cities and some key fourth and fifth-tier cities in terms of sales and service networks. As to the store target next year, we will share that after the first quarter earnings release. Thank you.

Operator, Operator

Our next question comes from Jin Zhong with CICC.

Jin Zhong, Analyst

So my first question is regarding the increasing number of competitors in the EV sector, as Mr. Li Xiang has just mentioned. Considering our L Series, which has been on the market for nearly two years, are there any aspects we can enhance in our products or what significant improvements do we envision?

Xiang Li, CEO

The competition in the automotive industry includes technology, products, supply chain, sales, and service, creating a comprehensive competitive landscape. Our Li technology is a key element among the various technologies, but it's not the entire picture. The Li L Series, over the next few years, is still in its early stage, if we were to compare it to a human being. After consumers purchase our Li Auto vehicles, we will keep enhancing our features and experience through over-the-air updates, which adds value to the products they receive. This combination of software, hardware, user experience, and product integration is what positions Li Auto as an industry leader. In the next three to five years, the biggest factor will be autonomous artificial intelligence, which encompasses AI-driven autonomous driving and AI-powered smart assistants. This will transform the experience for our users, marking the start of a significant change. Since the start of 2024, the Li L6 has been one of the most popular automotive products globally, with our stores delivering over 139,000 units in just six months, and demand continues to outstrip supply, prompting us to expand our production facility by the Spring Festival in 2025.

Unknown Analyst, Analyst

My second question is about the overseas market. Do we have a more aggressive strategy for expanding internationally? If so, what regulations should we take into account? Can you provide a brief overview of our plan, including which markets to target and how to establish product dealerships? Will the overseas market play a crucial role in driving our sales growth as we look towards 2025?

James Liangjun Zou, Senior Vice President

Okay, this is James, and I'll be answering your question. Absolutely, the overseas market is essential to us. Our overseas strategy is different from other automakers. Currently, we have established service networks in several countries and regions. These service stores have also helped us expand our market share in the overseas market. Regarding our choice of overseas regions, the Middle East and Central Asia will be our first target regions. Building on this, we will continuously explore and evaluate other markets with high growth potential to expand our global footprint. However, we are not considering entering Western Europe and North America for the time being. Thank you.

Operator, Operator

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

Ming-Hsun Lee, Analyst

So in October 2024, Li Auto officially launched the latest AD Max functions. How is the user experience so far? And year-to-date, have you noticed significant changes in the sales mix for your AD Max version?

Xiang Li, CEO

Since we launched our end-to-end BLM autonomous driving functionality, we now view autonomous driving not just as a feature for city and highway driving, but as a capability that allows for supervised autonomous driving. This represents a transition from rule-based algorithms to real AI model-driven algorithms. The benefits for users are considerable. For instance, the miles per intervention have consistently increased as we improve our training model parameters and data. This enhancement follows a scaling law, which indicates that companies with high-quality training data hold a significant competitive edge in the industry. Additionally, the miles per accident have also shown a consistent rise. I estimate that with the current end-to-end version, the miles per accident ratio will be 35 times better compared to human drivers. Furthermore, our active safety features such as AEB and AS have significantly advanced, resulting in a substantial decrease in severe accidents. In terms of sales take rate, the AD MAX take rate has steadily grown, not just for cars priced over 300,000 but also for the L6 model, where we have observed a remarkable increase in the AD MAX take rate.

Ming-Hsun Lee, Analyst

So, what is our plan for the charging stations by the end of next year? What is the current breakdown of our own charging stations compared to those operated by third parties? Currently, what is the utilization rate, especially since we have many charging stations but a relatively low number of battery electric vehicles? Does this indicate that many other brands are using our charging stations, meaning our charging station network does not significantly affect our gross margin?

James Liangjun Zou, Senior Vice President

Okay. This is James. I will take your question. Overall, we plan to establish the industry's largest OEM charging network and have been pushing for this before our new BEV models come to market. We expect to have more charging stations than Tesla in key cities before our new BEV models launch. By the time our new BEV model launches, we target to have more than 2,000 charging stations in operation, scaling up to 4,000 by the end of 2025 next year. Our supercharging station network now covers nine national highways totaling over 54,000 kilometers with a coverage ratio of 63% of national highway trunk lines. By the end of 2025, we will build more than 1,200 supercharging stations along highways, covering 90% of national highways. In addition to highway and urban coverage, we will also selectively cover medium and non-distressed self-driving routes to meet the needs of family travel. Our average monthly supercharging station usage in October this year was also high. We expect to achieve end-to-end coverage on national highway 318 by April next year. Regarding the cooperative supercharging station in the city, we have already built more than 500, and we expect by the end of next year, we will also have more than 3,000 cooperative supercharging stations in cities.

Operator, Operator

Your next question comes from Yuqian Ding with HSBC.

Yuqian Ding, Analyst

The first question is about the consolidation in the pricing category above RMB 200,000. We discussed this at the beginning of the year, and the industry consolidation is developing as management anticipated. How do we address the competition from high-end models of mass-market brands and tech brands that are entering the market?

Xiang Li, CEO

Today, even before we launch our pure electric SUVs, we have been steadily increasing our market share every quarter, which has reached 17.3% in Q3. For the longest time, no matter who enters the market, the fundamental challenge is the same for everyone. Can we offer products that provide the most value for our target users in their respective price range? That's the key to everything. Our long-term goal is still to capture over 25% of market share in the NEV market above RMB 200,000 through our BEV and REV products combined. Thank you.

Yuqian Ding, Analyst

The second question is about the segment and boundary. We have observed an increase in model supply among mid to larger size family vehicles, utilities, SUVs, and MPVs. Does the company management believe there are limits to the current segment, or has the family-use market reached a saturation point? What other segments does the company consider to be promising?

Xiang Li, CEO

My view is that we've just begun to explore the family users market, particularly with the advancements in AI related to autonomous driving and smart cockpit experiences. There's significant potential for innovation for family users. In this context, we are not hurried to enter new markets. Another opportunity exists in the purely electric or high-end market. For high-end products priced over RMB300,000, there are no offerings that provide comparable value to our L7, L8, and L9 models. The competition in that segment is insufficient, representing another key opportunity for us. Regardless of whether we focus on AI or the high-end market, we see considerable prospects in terms of large SUVs for family users. This is an area we will continue to investigate before considering other potential markets or niches. In essence, we hold a golden opportunity and should remain focused rather than be sidetracked by other prospects.

Operator, Operator

Your next question comes from Xu Yingbo with CITIC.

Xu Yingbo, Analyst

My first question is about self-driving. Could you provide some insights into the progress and plans in the field of autonomous driving with the speed of self-driving iteration slowing down in the long term? Will this potentially lead to a narrowing of the differences between companies' technology?

Xiang Li, CEO

Our current direction is to continue developing supervised autonomous driving and offer a parking-to-parking autonomous driving experience for a seamless user experience. We are also innovating in human-vehicle interaction within this area. Currently, we are conducting internal tests that we plan to roll out to all users in the near future. In the long term, we have initiated primary research on Level 4 autonomous driving, building on our existing end-to-end BLM model. We are exploring reinforcement learning systems that integrate vehicle models on the car side with world models on the cloud side. I believe that the gap between different players in autonomous driving technology will actually widen over time. This is due to the significant requirements for both car-side and cloud-side computing power necessary for data training and resource investment, which are expected to grow. Additionally, the demands for algorithm capabilities in autonomous driving are high. Overall, I believe this gap will continue to increase.

Xu Yingbo, Analyst

My second question is about future cost reduction. With our increasing sales, how do we envision future cost reductions, including procurement, technology, depreciation, and other aspects?

Xiang Li, CEO

First, overall, we will examine the entire value chain to identify opportunities for improving efficiency and reducing costs, which involves technology innovation, achieving economies of scale in procurement, and minimizing waste related to quality. This also requires collaboration with our partners to enhance their capacity utilization and to improve logistics efficiency. These initiatives demand detailed and skillful operations. For instance, technology innovation plays a crucial role in achieving long-term cost reductions. By integrating our REV system with our electric drive system, we can enhance the competitiveness of our products while also making our costs more competitive. We are establishing a joint innovation platform with suppliers to involve them earlier in identifying better solutions for designs and processes aimed at lowering costs. Our strategy has consistently been based on a win-win approach with suppliers, which supports the long-term growth of the industry. We aim to design parts that utilize the same platform, increasing the volume of each product, which we refer to as hit products. Regarding supplier strategy, we are focused on consolidating volume among a smaller number of suppliers to enhance their capacity utilization and reduce costs over the long term. Finally, we continue to harness digitization and smart technologies in our factories, enabling our partners to minimize waste in manufacturing and increase the operational efficiency of our equipment to lower costs in the long run. Thank you.

Operator, Operator

As we are reaching the end of our conference call now, I'd like to turn the call back over to the company for closing remarks. Ms. Janet Chang, please go ahead.

Janet Chang, Investor Relations Director

Thank you once again for joining us today. If you have further questions, please feel free to contact Li Auto's Investor Relations team through the contact information provided on our website. This concludes this conference call. You may now disconnect your lines. Thank you.