Earnings Call Transcript - NIO Q2 2022

Eve Tang, VP of Capital Markets

Good morning, and good evening, everyone. Welcome to NIO's Second Quarter 2022 Earnings Conference Call. The company's financial and operating results were published in the press release earlier today and are posted at the company's IR website. On today's call, we have Mr. William Li, Founder, Chairman of the Board and Chief Executive Officer; Mr. Steven Feng, Chief Financial Officer; Mr. Stanley Qu, Senior VP of Finance and Miss. Jade Wei, VP of Capital Markets. Before we continue, please be kindly 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 filings of the company with the U.S. Securities and Exchange Commission, the Stock Exchange of Hong Kong Limited and the Singapore Exchange Securities Trading Limited. The company does not assume any obligation to update any forward-looking statements, except as required under applicable rules. Please also note that NIO's press release and this conference call includes discussions of unaudited GAAP financial information as well as unaudited non-GAAP financial measures. Please refer to news press release, which contains a reconciliation of the unaudited non-GAAP measures to comparable GAAP measures. With that, I will now turn the call over to our CEO, Mr. William Li. William, please go ahead.

William Li, CEO

Hello, everyone. Thank you for joining NIO's Q2 2022 earnings call. NIO delivered a total of 25,069 vehicles in Q2 2022, which is a 14.4% increase from the same period last year. In July and August 2022, NIO delivered 10,052 and 10,677 vehicles, respectively, which represents year-over-year increases of 26.7% and 81.6%. During this time, our vehicle production and delivery faced challenges due to the COVID-19 pandemic, extreme weather, and supply chain uncertainties. We are committed to working closely with our supply chain partners to further speed up production and delivery. With the ongoing growth in demand for premium electric vehicles, along with our excellent product and service competitiveness, we anticipate strong vehicle delivery growth in the latter half of 2022. We expect total deliveries in Q3 2022 to be between 31,000 and 33,000 units, supported by the production ramp-up of the ET7, ES7, and ET5 based on the NT2 platform, as well as the upgraded 2022 ES8, ES6, and EC6. In terms of our financial performance, despite a significant increase in battery costs in Q2, vehicle gross margin reached 16.7%, driven by high-specification ET7 deliveries. Some orders incorporated adjusted prices and improved sales management. Now, I'd like to highlight some recent developments in our R&D and operations. The ET7, our first product on the NT2 platform, has shown strong competitiveness in the mid-large premium sedan segment, featuring industry-leading software, hardware platforms, and smart digital experiences. On June 15, we launched the ES7, a mid-large 5-seater SUV based on the NT2 platform, which maintains NIO's high-performance reputation and offers both autonomous driving capabilities and safety features, delivering extraordinary comfort and intelligence. The ES7, which includes an optional electric sunroof, has performed well in user tests since August, with large-scale deliveries starting on August 28. We've also released the 2022 ES8, ES6, and EC6 equipped with a new digital system, enhancing their computing power and overall digital experience, thus increasing competitiveness in the market. The ET5, our midsized smart electric sedan based on NT2, is in full production preparation, with improved performance and configuration. We believe the ET5 will become a favored choice among midsized premium sedans, with production ordering starting on September 9 and the first deliveries scheduled for September 30. We launched the Banyan 1.1.0 digital system update in August, which includes over 60 new features and enhancements, improving parking scenarios, multimedia experiences in the cabin, and suspension comfort. We have upgraded our advanced driver assistance systems to enhance the driving experience and ensure user safety. In production, we have begun rolling out ET5 preproduction vehicles and plan to start mass production this month. Our sales and service network has expanded to 395 locations in 149 cities globally, with 263 service centers and delivery points across 151 cities. Concerning our charging and swapping infrastructure, we established an expressway power swapping system covering major expressways and metropolitan areas in China. We have installed 1,094 swap stations, accomplishing over 12 million battery swaps for our users, along with 1,873 power charger stations that cater to various charging needs. NIO is dedicated to creating a comprehensive power system that provides convenient charging, swapping, and upgrading experiences. This summer, our stations have actively supported power grid demands, and we consistently promote off-peak charging. Our power swap stations will continue to assist in energy savings and optimal charging across regions. On the global front, the new ET7 has started shipping to Europe in August, with deliveries set to begin this year in Germany, the Netherlands, Denmark, and Norway. August 28 was designated by our user community as the host city for NIO Day 2022, and preparations for the event have begun. We look forward to presenting our latest advancements in products and core technologies during this event. As a key player in smart electric vehicles, NIO is committed to corporate social responsibility and supporting global sustainable initiatives. We have supported the Formula Student Electric in China since our inception and began supporting the Formula Student Autonomous in China last year. In August, we officially partnered with Formula Student Germany to develop young talent in the automotive industry. Additionally, we entered a partnership with the United Nations Development Program, collaborating on environmental protection efforts and social initiatives to foster young innovators in biodiversity conservation and ecological protection. The second half of 2022 will be crucial for NIO as we ramp up deliveries and production of new products, which will challenge our supply chains, production capabilities, delivery, and service. Our team will closely collaborate with partners to improve system efficiency and accelerate the mass production and delivery of high-quality vehicles and services. Thank you for your continued support. Now, I will turn the call over to Steven to share financial details for the second quarter.

Steven Feng, CFO

Thank you, William. I will now go over our key financial results for the second quarter of 2022. To be mindful of the length of this call, I'll reference only RMB in my discussion today. I encourage listeners to refer to our earnings press release, which is posted online for additional details. Our total revenues in the second quarter were RMB 10.3 billion, reflecting a 21.8% increase year-over-year and a 3.9% increase quarter-on-quarter. Our total revenues consist of two parts: vehicle sales and other sales. Vehicle sales in the second quarter amounted to RMB 9.6 billion, representing an increase of 21% year-over-year and 3.5% quarter-on-quarter. The increase in vehicle sales year-over-year was mainly attributed to higher deliveries. The quarter-on-quarter increase was driven primarily by a higher average selling price. Other sales in the second quarter were RMB 0.7 billion, marking a 34.6% year-over-year increase and an 8.2% quarter-on-quarter increase. The year-over-year increase in other sales was mainly attributed to revenue from auto financing services, sales of service and energy packages, and sales of used cars. The quarterly increase stemmed mostly from the increased revenue from used car sales and auto financing services. Gross margin for the second quarter of 2022 stood at 13.0%, compared to 18.6% in the second quarter of 2021 and 14.6% from the first quarter of 2022. The decrease in gross margin year-over-year was due to lower vehicle margins and reduced margins from other sales, which resulted from increased investment in our power and service network. The decline in gross margin for the second quarter stems from the decrease in vehicle margins, which was 16.7% compared to 2.3% in the second quarter of 2021 and 18.1% in the first quarter of 2022. The reduction in vehicle margin year-over-year and quarter-over-quarter can primarily be attributed to the increased battery cost per unit, which was partially offset by favorable changes in the sales mix of the ET7. Research and development expenses for the second quarter were RMB 2.1 billion, reflecting a year-over-year increase of 143.2% and a quarter-on-quarter increase of 22%. This increase was driven by heightened patent costs and incremental design and development expenses for new products and technologies. General and administrative expenses for the second quarter totaled RMB 2.3 billion, an increase of 52.4% year-over-year and 13.3% quarter-on-quarter. The increase in SG&A expenses year-over-year was primarily due to higher departmental costs and costs associated with expanding our sales and service network. The quarter-on-quarter increase was primarily attributed to higher personnel costs and expenses related to marketing and promotion, including costs for the latest product launches. Loss from operations in the second quarter was RMB 2.8 billion, representing an increase of 272.8% year-over-year and 30% quarter-over-quarter. The net loss for the second quarter was RMB 2.8 billion, an increase of 360.6% year-over-year and 37% quarter-over-quarter. The net loss attributable to NIO's ordinary shareholders in the second quarter was RMB 2.7 billion, reflecting an increase of 316.4% year-over-year and 50.4% quarter-over-quarter. Cash and cash equivalents, along with restricted cash and short-term investments, totaled RMB 54.4 billion as of June 30, 2022. Now this concludes our prepared remarks. I will now turn the call over to the operator to commence our Q&A session.

Operator, Operator

First question comes from Tim Hsiao from Morgan Stanley.

Tim Hsiao, Analyst

I have two questions. The first concerns the component supply crunch. Given that the supply bottleneck continues to limit the sales potential of models like the ET7, should we be worried about possible production disruptions for models such as the ES7 and ET5 in the coming months? Additionally, with the new developments in operations in China, what steps has the NIO team taken to mitigate risks of potential disruptions to the upcoming models? Looking ahead to next year, we are also expecting the NT2.0 and EC6. What measures have we implemented to prevent such risks to our production? My second question is about chipsets. What is your perspective on the restrictions regarding the export of high-end GPUs from companies like Media and AMD to China? While the immediate impact on the auto industry may be limited, will this situation accelerate our efforts towards semiconductor localization in upcoming models or hasten the in-house development of our own chips for functions like autonomous driving in the future?

William Li, CEO

Thank you, Tim, for your question. In the third quarter, particularly in July and August, we encountered some difficulties in our supply chain. The resurgence of COVID-19 in certain areas of China in September also had an effect on our supply chain. However, based on our experiences from March and April in Shanghai, we feel the impact of COVID-19 is more manageable now. Concerning the macro casting components, the yield rate fell short of our expectations, which affected vehicle deliveries. We have taken several steps to enhance the yield rate of these components, including sending many engineers to our suppliers for assistance, and we are already seeing progress. We have also brought in new partners for the micro-testing components and believe we will resolve these issues by October. While we are mindful of our deliveries in the fourth quarter, we are confident we will achieve our annual delivery targets. There will be challenges ahead, but we are committed to improving our delivery performance in the fourth quarter. Regarding the U.S. shipment linked to the AI training chipset, we anticipate this won't disrupt our business operations. Our current computing power is adequate for our autonomous driving technology and AI training, and we are closely collaborating with NVIDIA while monitoring the situation. Additionally, various AI chipset companies in China are ramping up production of their chipsets, and we are exploring different technical solutions for AI training chipsets. Our aim is to strengthen our core technology capabilities, including chipsets, which we believe will help reduce political and regulatory risks while enhancing our technological strength and improving our gross margins.

Operator, Operator

The next question comes from Ming-Hsun Lee from Bank of America.

Ming-Hsun Lee, Analyst

What is your latest guidance for the SG&A and R&D ratio, considering increased competition in the industry and overall lower sales? Do you have a new target for your point of sales? Your ET5 and ET7 have received very positive feedback during the Chengdu Auto Show. However, with the current rise in competition and product iterations in the industry, will you accelerate your new product launches? Additionally, could you share your plans for new models in 2023? Do you have any plans for introducing a third brand?

William Li, CEO

Thank you for your question. We have noted that many companies are introducing competitive products in the market. However, we intend to stick to our own strategy and pace regarding investments. Our long-term approach focuses on making significant investments in R&D. This year, we have substantially increased our R&D spending to boost our long-term competitiveness. For SG&A, as a percentage of revenue, we believe the long-term trend will decrease. We do not plan to change our pace or strategy in response to external competition; instead, we will keep our focus on our strategy. Concerning the ET5, we have showcased it at several events in Chengdu and other auto shows, where it has garnered considerable attention from users, media, and the public, along with excellent feedback. Next year, we plan to launch more products utilizing the NT2 technology platform and aim to upgrade our parent ADV to technology platform 2.0. We are confident about our market performance by then. While I can't disclose many details about new product launches at this time, I assure you that we will accelerate the introduction of our new products based on the new technology platform. In response to your third question, our goal is to allow more users to experience our products and benefit from our technologies. We are taking into account users' varied needs across different price points, and we will strategically plan based on this.

Operator, Operator

The next question comes from Bin Wang from Credit Suisse.

Bin Wang, Analyst

My first question is about the full-year volume guidance. You previously mentioned that the volume for the second half of this year would be 100,000 units. Based on your guidance for the third quarter, does this suggest that the volume in the last quarter will be approximately 68,000 units? Additionally, during visits with dealers, we found that the wait time for ET5 orders is about three to four months. Can I assume there are approximately 15,000 orders for the ET7 and around 55,000 for the ET5, which brings your total order backlog to around 80,000? Lastly, regarding the margin outlook for the third quarter, you previously indicated a decline in gross margin of 3% to 4% quarter-on-quarter, but it appears that the margin has exceeded expectations. Is this accurate?

William Li, CEO

Thank you for your question. I previously stated that we will do everything possible to meet our delivery target for this year. This means that the fourth quarter will likely experience significant pressure and challenges in terms of delivery and supply. We have already started preparations for deliveries beginning in the third quarter. From the fourth quarter onwards, we expect our production capacity to increase with two factories to better meet delivery demands. In the third quarter, we have also initiated tooling and preparations for large-scale mass production of the ET5 at Factory 2 in NIO Park. Initially, Factory 2's production capacity will be somewhat lower than Factory 1, which is dedicated solely to manufacturing the ET5. However, we anticipate achieving record delivery numbers in December. We are confident that we will reach record-breaking targets for the fourth quarter and are actively working to ensure we meet these objectives. Regarding specific order details, we haven't shared order information for some time due to varying interpretations among companies. Nonetheless, we have a strong order backlog for both the ES7 and ET7. The order performance for the ES7 has exceeded our expectations, while the ET5 has longer waiting periods. The challenge we face is not about demand, but rather production capacity and supply chain limitations. We are making significant preparations, but the main constraint will arise from the supply chain.

Steven Feng, CFO

Regarding the third question about the gross profit margin for Q3 and the second half of the year, the company has implemented several measures to enhance our gross margin. The selling prices of specific vehicle models, including ET7, have seen positive impacts that will manifest in Q3. With most ES7 starting deliveries in Q3, we expect a slight increase in vehicle margin in Q3. However, we continue to face significant uncertainty and challenges surrounding battery costs, which negatively impacts our gross margin.

Operator, Operator

The next question comes from Jeff Chung from Citi.

Jeff Chung, Analyst

My first question is about ET5 production capacity. How many ET5 units can we expect to produce in December? What will the ramp-up pace for ET5 look like from October to December? This is my first question. My second question concerns the overall production ramp-up from September to December. Your guidance suggests that the run rate in September should increase by 15% month-on-month. To meet your full-year target, the monthly growth from October to December needs to be at least 30%. Should we expect a straight-line ramp-up or an accelerating pace?

William Li, CEO

Thank you, Jeff. Yes, increasing production capacity takes time and involves a detailed process, especially for new products. Initially, production will start at a low volume before ramping up to a stable level. We have prepared thoroughly for the mass production of the ET5, and we believe it has the potential to exceed 10,000 units in a month. For December, we aim for ET5 production to surpass this figure. In November and December, we expect to break our previous monthly delivery records, with especially significant peaks anticipated in December. I previously mentioned that supply chain issues would be resolved for the ES7 and ET7, and during that period, we will also increase ET5 production. This means a gradual rise in delivery volume. At this moment, we cannot predict with complete certainty, as there are many external factors we cannot control. However, based on our experiences over the past few years in facing challenges, our team is well-prepared to manage the ramp-up even in difficult circumstances. We are committed to achieving the targets we set for the fourth quarter.

Operator, Operator

The next question comes from Edison Yu from Deutsche Bank.

Edison Yu, Analyst

First, we noticed that William visited the U.S. last month. I wondered what kind of decisions or considerations were taken during that visit regarding perhaps an earlier entry into the U.S. market? The second question relates to an original plan to introduce a solid hybrid battery pack in the fourth quarter, and I would like to know if there are any updates on this and whether it is still on track.

William Li, CEO

Thank you, Edison, for your question. NIO has been established as a global entity from the very start. We set up our San Jose R&D center in 2015. Due to COVID-19, I couldn't visit our colleagues in the U.S. for several years. I took this opportunity to connect with our team in the U.S. and will soon visit our colleagues in Europe. For our entry into the U.S. market, we have been preparing for a long time, having envisioned our strategy since around 2017. We have been considering which products are best suited for the U.S. market, what user experiences we should provide, and the suitable business model for the U.S. market. We now have a clearer plan for entering the U.S. market, as we have made comprehensive preparations according to our strategy. The U.S. market is quite different from the Chinese market, and the regulations also vary from both China and Europe. Therefore, we are taking a long-term view and preparing carefully for our entry into the U.S. We firmly believe that our approach should be thoughtful and patient. While we cannot disclose specific details at this moment, you can be assured that we have a clear strategy for the U.S. market, and we just need to be patient in our execution. Regarding the 150-kilowatt-hour semisolid battery pack, which has a very high power density, we are conducting a thorough evaluation of it. Although we are preparing for production with our partners, our current assessment indicates that we may not be able to provide this service to users in the fourth quarter as initially planned. This battery pack will likely be delayed by a few months. We continue to work with our partners to assess the progress in hopes of improving the situation.

Operator, Operator

The next question comes from Paul Gong from UBS.

Paul Gong, Analyst

I have two questions. First, have you recognized that there may be some orders placed by certain individuals who may not actually intend to purchase the vehicle but are instead looking to sell their orders to others for profit? How do you plan to tackle this issue? My second question is about the preparations for your secondary and tertiary brands, Outpace and Firefly. We have noticed that some orders have been placed with specific suppliers, especially regarding batteries and other components. Can you provide more clarity on this compared to around two quarters ago?

William Li, CEO

Thank you, Paul, for your question. Regarding the first inquiry, while it’s possible that some users might transfer their orders, we have strict policies concerning order transfers. Therefore, we believe that such cases will be rare, and the percentage of transfers will be relatively low. This is largely due to our follow-up mechanisms; after placing a reservation order, we monitor those orders for conversion to actual production orders. Accordingly, the percentage of users placing orders primarily to transfer them for profit should be quite minimal, given our policies. As for our mass-market brand, we have previously discussed our plans for it. Currently, our R&D progress remains on track. Our strategy is to align the launch of the mass-market product with the latest technology platform, which will be the new technology platform 3.0. We plan to introduce mass-market products based on this new technology. Yes, there have been discussions in the media regarding NIO's third brand, and trends in the supply chain have aligned with this discussion. We recognize that accelerating the transition from internal combustion engines to electric vehicles requires providing more products that cater to diverse user segments. Over the past year, we have seen significant growth in electric vehicle demand in the entry-level market segment, which has contributed to increased EV penetration in China. We believe there are unique opportunities for business model innovations, and NIO excels at blending cutting-edge technologies with user experiences and delivering innovative solutions to our users. At this time, we cannot disclose further detailed information, but we are optimistic about the opportunities ahead.

Operator, Operator

This concludes our question-and-answer session. I will now hand the call back to Ms. Eve Tang for closing remarks.

Eve Tang, VP of Capital Markets

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