China XD Plastics Company Limited
Q4 2019 Earnings Call Transcript

Published: 1 Jun 2020

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to Fourth Quarter 2019 China XD Plastics Co. Limited Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your host today, China XD Plastics' IR team, Shaojie Wen. Thank you. Please go ahead, sir.

[Shaojie Wen:]

Hello, everyone. Thank you all for joining us for the China XD Plastics Fourth Quarter 2019 Financial Results Conference Call. Joining me on the call today are Mr. Jie Han, Chairman and CEO; Mr. Qingwei Ma, Chief Operating Officer and Chief Technology Officer; Mr. Taylor Zhang, Chief Financial Officer. Earlier today, China XD Plastics issued a press release announcing the first quarter 2019 results. Before management's presentation, I would like to refer to the safe harbor statements in connection with today's conference call and remind our listeners that management's prepared remarks during the call may contain forward-looking statements, which are subject to risks and uncertainties, and that management may make additional forward-looking statements in response to your questions. All statements other than statements of historical fact contain our forward-looking statements, including, but not limited to, the company's growth potential in the international market, the effectiveness and profitability of the company's product diversification, the impact of the company's product mix shift to more advanced product and related pricing policies, the volatility of the company's operating results and financial condition, the company's projection of performance in 2019 and other risks detailed in the company's filings with the SEC and available on its website at www.sec.gov. These forward-looking statements involve known and unknown risks and uncertainties and are based on current expectations, assumptions, estimates and projections about the company and the industry. The company, therefore, claims the protection of the safe harbor for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ from those discussed today, and we refer you to a more detailed discussion for the risks and uncertainties in the company's filings with the Securities and Exchange Commission. In addition, any projection as to the company's future performance represents management's estimate as of today, November 14, 2019. China XD Plastics assumes no obligation to update these projections in the future as market conditions change. To supplement the financial results present in accordance with US GAAP, management will make reference to earnings before interest expense, income tax, depreciation and amortization, which we refer to as EBITDA. EBITDA is a non-GAAP financial measure reconciled from net income, which the company believes to provide meaningful additional information to better understand its operating performance. A table reconciling net income to EBITDA can be found on the earnings press release issued earlier today. I would like to turn the call over to our Chairman and Chief Executive Officer, Mr. Han. Mr. Han will be speaking in Chinese, and I will translate his opening remarks into English..

[Jie Han:]

[Foreign Language] Our fiscal 2019 results were consistent with the overall slow recovery of China auto industry. The trade tension between China and United States, the stricter environmental protection standards, and the larger reduction of subsidies on new energy vehicles have generated a lot of pressure on the entire auto industry in China, resulting in depressed domestic demand. China XD has taken proactive measures to respond to this change. Since the second quarter of 2019, we have achieved revenue by increased sales of new categories of higher-end products of PA66 and PA6 produced with high-priced raw materials with higher selling price in domestic market and sales of high-priced semi-finished goods in domestic market to accelerate inventory turnover and replenish operating funds. We are pleased to see an overall increase of 45.9% in the average RMB selling price of our products, partially offset the decreased sales volume of 18.8% for the year ended December 31, 2019. At the same time, the company has achieved a rapid increase of customer orders in non-automobile applications, evidenced by our stable sales growth in several domestic regions. [Foreign Language] For 2020, the COVID-19 has caused a sharp fall in production and sales of the Chinese automotive industry, with the risk of supply disruption of some parts of the domestic automobile industry increased. As a result, China XD has responded to start producing raw materials for PPE such as goggles and masks, to help alleviate the pandemic to our communities and mitigate the negative impact of world pandemic on Chinese auto industry. [Foreign Language] We are committed to complete industrial project for upgrading existing equipment for 100,000 metric tons of engineering plastics by the end of second quarter of 2020, and our Qinling Road Project and Jiangnan Road Project for equipment upgrade and factory revamping by the end of the third quarter of 2020, thus bringing the production capacity in Heilongjiang Campus back to 390,000 metric tons. At the same time, we expect to complete additional 10 production lines our Sichuan plant by the end of the third quarter of 2020, thus to bring the total capacity of Sichuan base to 300,000 metric tons. Together with the production capacity ramp up in Dubai, we will continue to remain our ability to make further inroads into more specialized high-end products for various important new markets. [Foreign Language] We will continue to optimize our management structure and enhance our operating efficiency. And we are confident, through our cooperation with Chinese big banks to succeed company's expansion strategy in multiple regions and sectors, and to be confident with our core market positioning and expanded platform for growth. [Foreign Language] With that, I would now turn the call over to Taylor Zhang, our CFO, to walk you through our financials. Taylor?

[Taylor Zhang:]

Thank you, Jie Han. And thank you, everyone, for joining the call today. Before I review the numbers, let me remind you that all figures I discuss are for this reporting period, the fourth quarter of 2019 unless I state otherwise. Additionally, any year-over-year comparison is to the fourth quarter of 2018 and any sequential comparison is to the third quarter of 2019. So, let's go over our fourth quarter results. Revenues were $310.5 million for the fourth quarter of 2019 compared to $349.8 million for the same period last year, representing a decrease of $39.3 million or 11.2%. The year-over-year decrease was primarily as a combined result of a 46.3% decrease in sales volume, a depreciation of RMB against US dollars by 4.2%, and partially offset by a 69.5% increase in average RMB selling price of our products, as compared with those of last year. In domestic markets, for the three-month period ended December 31, 2019, revenues from domestic market decreased by $41.5 million or 12.4% compared with that in the same period of last year, as a combined result of a decrease of 47% in sales volume, a depreciation of RMB against US dollars by 4.2%, and partially offset by an increase of 69.5% in the average RMB selling price of our products, as compared with those of last year. According to the China Association of Automobile Manufacturers, during the fourth quarter of 2019, the decline in China's auto production and sales continues to narrow, but the overall market rebound is slow, witnessed by the increase of 0.03% in auto production, and decrease of 0.03% in auto sales, respectively, compared to the same periods in 2018. Though the company kept its positive efforts to expand our marketing areas and customer bases and to meet their new requirements in domestic markets, the company has achieved sales growth of 232.1% in South China and 6.7% in Central China. We still had sales decrease of 30.3% in Northeast China, 18.7% in North China, 16.1% in Southwest China and 9.5% in East China. As for the RMB selling price, the increase of 69.5% was mainly due to increased sales of new categories of higher-end products of PA66 and PA6 produced with high-priced raw materials with higher selling price in domestic market and sales of high-priced semi-finished goods in domestic markets during the three-month period ended December 31, 2019. In overseas markets, our overseas sales were $16.9 million, accounting for 5.4% of total sales for the fourth quarter of 2019 as compared to $15 million and accounting for 4.3% of total sales for the same period of last year. After a successful trial production at our production base in Dubai in November 2018, the company has established business relationships with new customers in UAE and India, and shipped products to the end users in Europe and Southeast Asia. We are optimistic about the prospect of our business expansion overseas. Gross profit was $43.7 million for the fourth quarter of 2019 compared to $62.4 million for the same period of 2018, representing a decrease of $18.7 million, or 30.0%. Gross margin was 14.1% compared to 17.8% in the fourth quarter of 2018, primarily due to the implementation of low price strategy on higher-end products to penetrate the new markets. G&A expenses were $14.8 million for the fourth quarter of 2019 compared to $8.6 million for the same period of 2018, representing an increase of $6.2 million, or 72.1%. The increase was primarily due to the increase of professional fees, salary, welfare, travelling and transportation and miscellaneous expenses. R&D expenses were $10.8 million for the fourth quarter of 2019 compared to $26.9 million for the same period of 2018, representing a decrease of $16.1 million, or 59.9%. The decrease was mainly due to the decrease of $15.9 million in raw materials consumption. As of December 31, 2019, the number of ongoing research and development projects was 357. Operating loss was $45.3 million for the fourth quarter of 2019 compared to $24.1 million of operating income for the same period last year, representing a decrease of $69.4 million, or 288%. This substantial decrease is primarily due to the decreased gross profit by 30%, a provision of doubtful accounts of $62.8 million for a UAE customer, and higher G&A expenses, partially offset by the lower selling expenses and R&D expenses. Income tax expense was $2.2 million for the fourth quarter of 2019, representing an effective income tax rate of negative 3.5% compared to income tax benefit of $0.5 million in the same period last year, representing an effective income tax rate of negative 3.6%. The increase of effective income tax rate was primarily due to the increased operating loss in Dubai Xinda. Net loss was $65 million for the fourth quarter of 2019 compared to net income of $13 million for the same period last year, representing a decrease of $78 million, or 600%. Basic and diluted loss per share for the fourth quarter of 2019 were both $0.97 compared to $0.20 earnings per share per share for the same period of 2018. The average number of shares used in the computation of basic and diluted losses per share for the three months ended December 31, 2019 was 66.9 million compared to 50.5 million shares for earnings per share in the prior-year period. Earnings before interest, tax, depreciation and amortization was negative $27.3 million for the fourth quarter of 2019 compared of $38.4 million for the same period of 2018, representing a decrease of $65.7 million, or 171.1%. For a detailed reconciliation of EBITDA, a non-GAAP measure, to its nearest GAAP equivalent, please see the financial tables at the end of this release. Now, let's turn to the balance sheet. As of December 31, 2019, the company had $228.4 million in the total amount of cash and cash equivalents and restricted cash, a decrease of $138.6 million or 37.8% as compared to $367 million as of December 31, 2018. Working capital was negative $14.1 million and the current ratio was 1 as compared to the current ratio of 0.9 as of December 31, 2018. Stockholders' equity as of December 31, 2019 was $836.4 million, an increase of 11.7% as compared to $748.9 million as of December 31, 2018, mainly due to the conversion of Series D Preferred Stock into common stock on September 26, 2019. As a result of the outbreak of COVID-19 in the PRC, China auto industry production and sales drastically decreased by 33.4% and 31.14% for the first four months of 2020, according to the China Association of Automobile Manufacturers. It has a ripple effect and impact throughout China auto supply chain, including the company. Due to the fact that the company had temporarily closed its manufacturing facilities and offices in the PRC in accordance with the requirement of the PRC government, the occurrence of the ongoing COVID-19 pandemic has had a material adverse effect on our business operations. In light of these circumstances and continuing uncertainties, the company will not be able to forecast our financial guidance for fiscal 2020 until further notice. Now before we open the call to questions, I would like to note that for any questions directed to management of China, I will translate both their questions and their answers. If you want to ask a question in Chinese, please also ask it in English for the benefit of our other listeners. Please also note that we'll only be able to respond to questions about our financial and operating results. Other matters, including the going-private offer, we refer you to our already issued press releases. We'll not be able to respond to questions that are directed to the principals of the going-private offer about the proportion transaction. With that, we will now open the call to your questions. Operator?

[Operator:]

[Operator Instructions]. Your first question comes from Matt Lawson. Please ask your question.

[Matthew Larson:]

Okay, thanks for taking my question. I've got a lot of them because there's a lot of things going on. I'll start with a positive. You guys crushed your guidance. You did a lot better than your expectation. The last conference call, you had guidance for revenues, the top line of $1.1 billion to $1.3 billion. I pointed out, you had already done more than $1.1 billion after three quarter. So, it was a little strange, just like this quarter strange. You ended up with $1.44 billion. So, you beat your guidance significantly on the top line. The glaring problem is, of course, the large uncollectible, as you call it, billed for some customer in the UAE. All right? You must have known that was uncollectible during the fourth quarter. And that actually in December is when you were able to close on the very, very important financing. So, the banks were willing to lend you money for the first time, these state-owned enterprise banks, even though they knew that there was supposedly some sort of collection problem. So, to me, that's a one-off event. And can you tell us the status of that loan now? Okay? It's in June now, and that was uncollectible as of the end of the quarter. It kind of paints the quarter negatively. But if it's a one-off event, it really doesn't matter going forward. Okay? So, how does that stand now?

[Taylor Zhang:]

All right, Matt. Thank you for the call. Let me translate your question, so management in China can respond. You're welcome. [Foreign Language]

[Jie Han:]

[Foreign Language]

[Taylor Zhang:]

[Foreign Language] Hey, Matt. It's Taylor. So, your answer comes from our Chairman, Mr. Jie Han. So, first of all, we accrue such loss based on the US GAAP. And also, obviously, remember, we're audited by our auditor KPMG. Secondly, we still continue our efforts in collection and we think sometime later this year we'll be able to collect the outstanding amount. Luckily, he doesn't necessarily believe this is linked to the bank or the bank consortium.

[Matthew Larson:]

No, what I was saying was [Multiple Speakers]. I'm sorry, go ahead.

[Taylor Zhang:]

So, yes, we view this as a one-off event.

[Matthew Larson:]

Okay. Then, if you – first of all, I'm still unclear. The sale to some customer in the UAE basically was twice what you did for the whole year. And so, whoever made that sale and approved it, you've got to question what sort of due diligence they did. But it sounds to me you're going to collect it. So, you're going to write that loss back up this year. All right? So, by a one-off event, you just dumped it into the fourth quarter. And the numbers look worse than they are because you're going to be able to recoup that and put it back on as an income item for this year. And the banks lent you the money knowing that, and that's the critical thing because they wouldn't be lending you money for the first time if you were showing some sort of shortfall of that magnitude. But your revenues grew dramatically. Your EBITDA was still very strong. And for long-term shareholders, the key is how's the company going to be doing going forward. Mr. Han obvious believes it will be fine. You see he's trying to buy the company. And I know we're not supposed to ask any questions regarding the offer. But does Mr. Han know? I know he knows this, but does he understand that when he makes an offer after not even reporting 20-F or anything like that at a cyclical low, at like 4% or 5% above the average trading price is $1.10, it is not only insulting, all right, because the offer could have – even if he had offered $1.30 or $1.40, it still would be insulting, but at least it would be 30% or 40% above the price. And what he must realize that shareholders would find that completely unacceptable, particularly if they've been holding the shares all these times. And if you're going to be recovering the unpaid balance, then you're looking at a company that he's made an offer at less than 1 times earnings. It's certainly a lot less than EBITDA. Okay? If you come in at $1.45, even with that poor fourth quarter showing, the $1.10 times 66 million shares is about 70-some-odd-million dollar – it's one half of EBITDA. So, it just makes no sense. And it's inappropriate. And shareholders are rightfully upset about that sort of notion. All right? So, he should know that and he knows that anyway. All right? So, it's something that, in the United States here, nobody would even try because they would realize that there would be – a class action lawsuit would be filed. So, what is the current book value of the company? Can you give me the shareholder equity please?

[Taylor Zhang:]

Okay, Matt. Let me translate your question first. [Foreign Language]

[Jie Han:]

[Foreign Language]

[Taylor Zhang:]

Okay. Hi, Matt. First of all, you asked the shareholder equity value as of the end of last year. It was $836.4 million. And also, the answer comes from our Chairman, Mr. Jie Han. He want to thank you for your understanding of his position as regard to the going-private offer. So, he want to tell you that it's not an easy decision, and there's also pressure associated with it. So, regarding the collection from the UAE customer, we believe that we'll be able to recoup – resolve it sometime later this year.

[Matthew Larson:]

Right. You already said that. So, if you're going to collect that, then the loss last year – or the near loss since you only made – the loss that occurred in the fourth quarter really isn't a loss, all right? It's almost as if it was a new customer. Whoever made the sale to that customer had to have done enough due diligence because it represented over half your foreign sales. And it doesn't make sense you would make a sale to a new customer like that and not get paid. So, it's almost as if it's purposely been delayed, so that the numbers would look bad. I have to tell you that, all right? So, now, after he makes an offer for about the value of the whole sale, $1.10 times 66 million shares, it's about $69 million, $68 million, all right? $70 million. That's the whole amount of the uncollectible that is now going to be collectible this year. So, it just doesn't look very good. And now, he wants to buy the company at the lowest price that it's traded at since he came public for the – brought it public, essentially. So, anybody valuing the company would have to write the value back up based on the collectability of that sale. And since your margins have gone up dramatically because of the higher cost of the goods sold, then the company going forward is going to be significantly more profitable. Your current book value, by the way, I'll point out, is about 12 times what he's interested in buying the company at. Does that seem like a fair assessment of the value of the company, 12 times what the offer is? So, these are things that just don't make any sense. All right? Other than that the company got some – the market knows the company got some very important financing. Your revenues beat by a wide margin your projections for the year. The only reason you're showing reduced income is because of this one sale that you're still not being very clear on. It's some new customer. We don't even know who it is. But that customer is going to be paying you back anyway. And the banks that lent you the money know it, otherwise they would have never closed on the loan. So, I just want Mr. Han to be very aware that this is not lost on investors. And if there's any chance to try and take the company private at $1.10, it's not going to work from the viewpoint of shareholders that are not part of the consortium because there's no point in agreeing to a deal at this level because it's such a low price. One would rather take their chance in courts or just not voting for it to go through. So, I'll just leave you all with that. There's tremendous disappointment on my part and as well as investors that I represent that they feel that this is not a very honest or ethical maneuver by Mr. Han. And he should know that. I think he does. He probably doesn't care, but it needs to be said. And I'm using my opportunity on the phone call right now to say that. So, I'll let somebody else express their opinion. I'll be courteous and say thank you very much for the time.

[Taylor Zhang:]

Sure, Matt. Thank you. Just want to comment, obviously, as to the valuation of the company and the market has a value on it. In addition, the special committee has their counsel advisor, who will be looking after on behalf of the special committee for the shareholders.

[Matthew Larson:]

Well, as long as you brought him up, the last time they made an offer for the company in February of 2017, you hired Duff & Phelps, but you never told us even though you had been asked a number of times on conference calls what Duff & Phelps – what number Duff & Phelps had come up with when you had made the offer years ago. You just never told us. So, when are we going to find out what value the company is assessed at by Duff & Phelps this time around? Are we going to get an opportunity to get this independent appraisal?

[Taylor Zhang:]

I think, Matt, it's very important to note that Duff & Phelps, they're hired by the special committee. They're not working for the company. So, we don't have any dialogue or communication with them regarding the going-private offer. So, I'm sure you know they're a reputed firm. At the appropriate time, they will make the right action. Or at least advise to the special meeting.

[Matthew Larson:]

Well, like they did last time, I guess. All right. Thank you, Taylor.

[Taylor Zhang:]

Thank you, Matt.

[Operator:]

[Operator Instructions]. Your next question comes from Ha Fung [ph] from IMA Investment Management [ph]. Please ask your question.

[Unidentified Participant:]

Hi. Thanks for taking the call. I just have a quick question on your current operations, if you can comment on them. Obviously, Heilongjiang is an area that's still being affected in China and that's where your main production facility is. Are you currently running for operations other than PPE as car production restarted in China? If not, do you have an estimate of when you'll be able to start producing again? And also, maybe just comment on the situation and if you can comment on your profitability of PPE production as well. Thank you.

[Taylor Zhang:]

Sure. Thank you, Ha. Let me translate your question to the management. [Foreign Language]

[Jie Han:]

[Foreign Language]

[Taylor Zhang:]

Hi, Ha. Here's the answer from our Chairman, Mr. Han. So, as you correctly noted, Heilongjiang has resurged of confirmed cases compared to the rest of China. So, it was worsening before doing better. So, during this, we have close down of factory in February and March. So, right now, we are operating at approximately 60% of our capacity for the same period last year. As for your question regarding the margin situation with PPE materials, for example, we had materials for melt blown fabrics. So, the margin has fluctuated a lot recently. That's not only in China, but also in many areas in the world. For example, in April, the gross margin was approximately 50%. Ending in May, it came down to 30%. But annually, in any event, over the long term, we believe it's still a good business. So, the gross margin probably would be normalized at the level of 18% or better.

[Unidentified Participant:]

Okay, that's helpful. Thank you. Maybe just a note for Taylor that maybe when you issue Q1 results or guidance, if you ever do, we would just like to point out the percentage of PPE product sales, just so we know how relevant it is compared to traditional sales [indiscernible]. And then, just have a follow-up questions on maybe your capacity expansion and CapEx. Obviously, in your 10-K, you have around $230 million of cash on hand, but you also had commitments near the end of the fourth quarter for your plant extension. Can you just discuss about – do you plan on delaying some of those projects, make sure you go through 2020 with a healthier balance sheet? We know the company has a lot of debts already. So, I'm very concerned about investing massively in the year consistently. And maybe can management comment on maybe the cash burn that we expect this year? Or do you expect maybe positive cash flow?

[Taylor Zhang:]

Okay, sure. Let me also translate your question.

[Unidentified Participant:]

Thank you.

[Taylor Zhang:]

[Foreign Language] Hi, Ha. So, first of all, Chairman Han want to thank you for your suggestion. And we will do that in the following quarter when we release our results regarding the description of PPE materials. Secondly, for CapEx this year, we'll monitor our cash position, our cash flow as well as potential additional financing when we're proceeding with our CapEx. So, we will conduct our CapEx carefully.

[Unidentified Participant:]

Okay. And maybe just a final comment on the offer. I know you guys can't comment on it. But I think a lot of minority shareholders share the, let's say, the stress over the pricing, but also appreciate what Chairman Han has done with his family to support over the last year, in supporting the company with liquidity. And we hope that when it comes – if it comes down to a vote that like the last offer, you'll allow minority shareholders to vote on the proposal without using his majority stake, obviously, on the offer. And that's it for me today. Thank you.

[Taylor Zhang:]

All right. Thank you, Ha. [Foreign Language]

[Jie Han:]

[Foreign Language].

[Operator:]

[Operator Instructions]. As there are no further questions, I will now hand the conference back to Shaojie Wen for closing remarks. Shaojie, please.

[Shaojie Wen:]

On behalf of China XD Plastics, we want to thank you for your interest and participation in this call. If you would like to speak with us further, please call either myself or Taylor in New York office. The contact numbers for all of us are listed at the end of the press release. Thank you.