China XD Plastics Company Limited
Q1 2018 Earnings Call Transcript

Published: 10 May 2018

[Anna Bin:]

Thank you all for joining us for the China XD Plastics First Quarter 2018 Financial Results Conference Call. Joining me on the call today are Mr. Jie Han, Chairman and the Chief Executive Officer; Mr. Qingwei Ma, Chief Operating Officer; Mr. Taylor Zhang, Chief Financial Officer; Mr. Junjie Ma, Chief Technology Officer; Dr. Kenan Gong, General Manager of the Dubai subsidiary; and Mr. Rujun Dai, General Manager of the Heilongjiang subsidiary. Earlier today, China XD Plastics issued a press release announcing the first quarter 2018 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 the 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 contained are forward-looking statements, including, but not limited to, the company's growth potential in the international markets; the effectiveness and the profitability of the company's product diversification; the impact of the company's product mix shift to more advanced products and the related pricing policies; the volatility of the company's operating results and the financial conditions; the company's projections of performance in 2018; and other risks detailed in the company's filings with the Securities and Exchange Commission are available on the website 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 I will refer you to our 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 filings -- as to the company's future performance represents management estimates as of today, May 10, 2018. China XD Plastics assumes no obligation to update those projections in the future as market conditions change. To supplement the financial results presented in accordance with the U.S. GAAP, management will make additional reference to earnings before interest expenses, income taxes, 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 a 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 now like to turn the call over to our Chairman and the Chief Executive Officer, Mr. Han. Mr. Han will be speaking in Chinese, and I will translate his opening remarks into English. Mr. Han, please go ahead.

[Jie Han:]

Thank you, Anna. Thank you for joining us today. We are pleased with our quarterly results. Both top and bottom line growth as well as the margin improvement. In addition, an improvement in macro economic environment has improved business conditions, and we are well-positioned to execute our strategic plan. We are particularly pleased that you see major revenue contributions from major new growth structures, fostered in large part by the gradual ramp-up of our Sichuan manufacturing facility, a key milestone in our Corporate Development. The new facility also extends our geographical reach and accelerates our market penetration beyond our established Northeast base, evidenced by our strong and consistent growth from Southwest, Central, North and the South China. The Sichuan facility substantially expands the footprint of our Auto business in China and that we are well expect that our automotive applications will continue to be our core business. The new facility includes precision equipment, which will enable us to diversify our product platform into such high-growth verticals as ships, high-speed rail, airplanes, biodegradable materials, medical-grade materials, food packaging, electronic equipment, electrical products, alternative energy applications and power devices, which will help to propel the company's growth. Our new facility in Dubai also extends our specialized high-tech products into an important new market. We are planning to complete installing 45 production lines, with 12,000 metric tons of annual production capacity by the end of May 2018, and an additional 50 production lines with 13,000 metric tons of annual production capacity by the end of 2018. This will bring the total installed production capacity in our Dubai facility to 25,000 metric tons. The Dubai facility will target high-end products for the overseas markets and will ultimately, enable more active inroads into the markets of Europe, the Middle East, Russia and other international regions, with several global top customers in Automotive sector. China XD continues to value our deep working relationships with our customers above all, and is committed to creating value with our culture of hard work and innovation. We anticipate that the continued execution of our strategic plan, supported by an increase in our production capacity, are entry into new markets, our diversified customer base and our diversification with international sales will help to generate a suitable growth for years to come. For fiscal year 2018, we are reiterating our financial guidance of between $1.2 billion and $1.4 billion in revenue and $90 million and $110 million in net income. With that, I will now turn the call over to Taylor Zhang, our Chief Financial Officer, who will walk you through our financials.

[Zhang Dahe:]

Thank you, Mr. Han. Thank you, Anna, and thank you, everyone, for joining the call today. Before I review the numbers, let me remind you that all figures discussed are for this reporting period, the first quarter of 2018, unless I state otherwise. Additionally, in the year-over-year comparison is to the first quarter of 2017 and any sequential comparison is to the first quarter of 2017. So let's go over our first quarter results. Revenues were $310.5 million for the first quarter of 2018 compared to $237.8 million for the same period last year, representing an increase of $72.7 million or 30.6%. The year-over-year increase was primarily due to an increase of 24.4% in sales volume. A depreciation of U.S. dollar against RMB by 8% and it was offset by a decrease of 3% in the average RMB selling price of our products as compared with those of last year. PRC domestic revenue increased by $72.6 million in the first quarter of this year compared to same period of last year, as a result of an increase of 24.4% in sales volume, as we mentioned and so, as depreciation of U.S. dollar against the RMB. According to China Association of Automobile Manufacturers, automobile sales in China increased by 2.8% for the first quarter of 2018 as compared to the same period of 2017. And improvement in macro economic conditions since 2017 has improved business conditions and eased pricing pressures in our industry. Driven by accelerating growth of 7.6% in Northeast China, 184% in Central China, 124% in South China, 89% in Southwest China, 26% in North China and 22% in East China, our domestic sales during the 3 months ended March 31, 2018, increased by 30.5% as compared to the same period last year. As for RMB selling price, the company also implemented a marketing strategy of offering lower-end products with some lower RMB pricing to further penetrate the new regional markets in Central China, Southwest and other areas of China. For the three months ended March 31, 2018, revenues from overseas was $54,854 as compared to zero of that in last year. The company has tried to develop new customers overseas besides the existing customers overseas. The sales with this customer was suspended due to accounts receivable balance overdue situation. As the end of first quarter [indiscernible] the customer has outstanding balance of $48.3 million, including $5.8 million, which was 3 to 6 months past due $32.4 million was overdue for less than 3 months. Customer expected to pay off the outstanding balance for June 2018. As the accounts receivable balance was overdue, the company suspended sales to the customer in the first quarter of this year according to the company's standard policy. Premium products, mainly, PA66, PA6, Plastic Alloy, PLA, POM and PPO, in total, accounted for 81.1% of revenues in the first quarter of this year compared to 81.3% for the same period of last year. Gross profit was $53.9 million in the first quarter ended March 31, 2018, compared to $34.8 million in the same period of last year, representing an increase of $19.1 million or 54.9%. Our gross margin increased to 17.4% for the first quarter of this year from 14.6% for the same period of last year, driven by higher gross margin of higher-end products in the domestic markets for the first quarter of this year. G&A expenses were $8.9 million in the quarter ended March 31, 2018, compared to $7.1 million in the same period of last year, representing an increase of 25.4% or $1.8 million. This increase is primarily due to the increase of $0.9 million salary and welfare, which was due to the increase in the number of management and general staff from supporting departments and an increase of $0.9 million in professional fee. R&D expenses were $5 million for the first quarter of 2018 compared to $5.9 million for the first period of 2017, representing a decrease of $0.9 million or 15.3%. The decrease was primarily due to the decrease of raw material used by HLJ Xinda Group for its research activities. As of March 31, 2018, the number of ongoing Research and Development projects was 326. Operating income was $38.9 million for the first quarter of 2018 compared to $21.3 million for the same period of last year, representing an increase of $17.6 million or 82.6%. This increase is primarily due to increased gross profits, lower R&D expenses, partially offset by a higher G&A expenses and selling expenses. Net interest expense was $10.6 million for the first quarter of 2018 compared to net interest expense of $8.8 million for the same period of 2017, representing an increase of $1.8 million or 20.5%. This increase is primarily due to, first, the increase of average short-term and long-term loan balance in amount of $854.2 million for the 3 months ended March 31, 2018, compared to $785.4 million for the same period last year, partially offset by the decrease of interest expense resulting from average loan interest rate decreased to 4.72% for the 3 months ended March 31, 2018, compared to 4.77% of the same period last year. And third, the increase of average deposit balance in the amount of $626.8 million for the first quarter ended March 31, 2018, compared to $485.3 million for the same period last year. And then number 4, the increase of interest income resulting from the average deposit interest rates increased to 1.5% for the first quarter of this year compared to 1.2% of the same period last year. Income tax expense was $60.2 million for the first quarter of 2018, representing an effective income tax rate of 24.5% compared to income tax expense of $3.6 million in the same period of last year, representing an effective income tax rate of 26.4%. The effective income tax rates reduced from 26.4% for the 3 months period ended March 31, 2017, to 24.5% for the 3-month period ended March 31, 2018, is primarily due to the decrease of continuous operating loss occurred in overseas subsidiaries, and partially offset by the decrease of Sichuan Xinda's profit before tax ratio. The effective income tax rate for the three months ended March 31, 2018, differs from the PRC's statutory income tax rate of 25% primarily due to Sichuan Xinda's preferential income tax rate and R&D 50% additional deduction of major PRC operating earnings. Net income was $19.1 million for the first quarter of 2018 compared to $9.9 million for the same period of last year, representing an increase of $9.2 million or 92.9%. Basic and diluted earnings per share for the 3 months period ended March 31, 2018, was $0.29 compared to $0.15 per basic and diluted shares for the same period last year. The average number of shares used in the computation of basic and diluted earnings per share in the current quarter was $49.7 million compared to 49.5 million shares for the basic and diluted earnings per share in the prior-year period. EBITDA was $49.6 million for the first quarter of 2018 compared to $34 million for the same period last year, representing an increase of $15.6 million or 45.9%. For a detailed reconciliation of EBITDA and non-GAAP measure to its nearest GAAP equivalent, please see the financial tables at the end of our press release issued today. Now let's turn to the balance sheet. As of March 31, 2018, the company had $564.8 million in cash and cash equivalents, restricted cash and time deposits, a decrease of about $43.3 million or 7.1% as compared to $608.1 million as of December 31, 2017. As of the end of first quarter 2018, working capital was $110.1 million and current ratio was 1.1, as compared to the current ratio of one as of December 31, 2017. Stockholder's equity as of March 31, 2018, was $761.6 million, an increase of $48.8 million or 6.8% as compared to $712.8 million at the end of December 31, 2017. Accounts receivable decreased by 36.3% or $108.6 million due to the management efforts to collect outstanding balances due from the domestic customers. Inventories increased by 32.1% as a result of more purchases of raw material and the company's strategy to stock up the finished goods for the upcoming quarters. On the [indiscernible] we gave its financial guidance for 2018 to reach between $1.2 billion and $1.4 billion in revenue. Gross profits in fiscal 2018 is expected to remain stable as compared to that of fiscal 2017. The company projects net income to range between $90 million and $110 million. This is based on the anticipation of steady recovery throughout the Chinese Automotive supply chain and a stabilization of crude oil pricing and its impact on polymer composite materials in this year. This forecast also assumes contribution from Sichuan plants and Dubai second phase projects, which will be completed by the end of second quarter of 2018 and the end of 2018, respectively. It also assumes the average exchange rates of U.S. dollar to RMB at 6.3. This financial guidance reflects the company's preliminary view of its business outlook for fiscal 2018 and is subject to revision based on changing market conditions at any time. Before we open to the call to questions, I would like to note that for any questions directed to management in China, I'll 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 financial and operating results. For other matters, including the going private offer, we refer you to our already issued press releases. We will not be able to respond to questions that are directed to the principles of the going private offer about the proposed transaction. With that, we will now open the call to your questions. Operator?

[Operator:]

[Operator Instructions]. Our first question comes from the line of Jason Cooper.

[Jason Cooper:]

Let me know if you can. First, I'd like to go over the time line with the capacity ramp up I know you mentioned that in Dubai, the first Phase should come online at the end of this month and the second phase at the end of this year. With respect to Sichuan's Phase 1 which is 300,000 metric tons of primarily Automobile capacity, is that still scheduled to come online by the end of this quarter?

[Zhang Dahe:]

Yes, Jason. That is till the schedule that we are taking off.

[Jason Cooper:]

Okay. And what about the upgrading of 100,000 metric ton in carbon, is that still this summer?

[Zhang Dahe:]

Jason, let me confirm with our management in China about this. It is still as we expected and as scheduled previously.

[Jason Cooper:]

Okay. With respect to Phase II of Sichuan, with 300,000 metric tons of biodegradable plastics. Is that coming online by the end of this year?

[Zhang Dahe:]

So, Jason, maybe possibly, some delay on the bio [indiscernible] in Sichuan because of the two reasons

[Jason Cooper:]

Okay. How quickly can you bring this project on because at our last conference call, which is, I think, three few months ago, you were guiding for that to be completed by the end of the year. So are you saying that you can bring on 300,000 metric tons of capacity in, like, less than a year, is that possible if you don't even have the location? Or is it just going to be a [indiscernible] phase rollout of capacity like we saw in the first phase of Sichuan where you had [indiscernible] metric tons and 216 and then 300,000?

[Zhang Dahe:]

Okay. So, Jason, basically just want to make sure I am understanding your question correctly, and also can convey better to the management correctly, is basically, first of all, what's the timeframe, given the new situation. Secondly, how we are going to roll out the project, either it's phased or it's [indiscernible].

[Jason Cooper:]

Correct.

[Zhang Dahe:]

Okay, Jason. So to give you more details on the progress on the biodegradable project. So we're having to the original is we have found, after the survey, we have found that there's some underground lot, which will not only increase the cost but also time consume for us to undertake on the original sites. That's why we are embedding other sites. The government is very supportive and, I think, we will accomplish that. And secondly, we back to the agreement. Basically, the -- it's a settle down PRA production line because this biodegradable and material, there are some new technology available, we want to seek take advantage of that. So, however, the pedestrian line in facility designing has been coming to very close to this [indiscernible] phase. So all in, we are currently looking at probably, the project will be pulled out for a year. However, it will be based within the rollout of our capacity in Sichuan.

[Jason Cooper:]

Okay. So are you telling me that it is put off for a year and that the capacity is ruled out in this stage matter. We might see the full capacity out of Sichuan by the end of 2019?

[Zhang Dahe:]

Correct.

[Jason Cooper:]

Okay. Similarly, can we get some guidance from Harbin with respect to the biodegradable plastics and the cloud facility, is that still on target for July 2019?

[Zhang Dahe:]

So, Jason. For Harbin, the designing phase and also the project scope of [indiscernible] that of Sichuan. So we'll also utilize the new equipment designs. And in addition, the construction in Harbin, because of the severe poor weather in winter, possibly, will be little bit later than Sichuan but we think that will be in time, maybe delayed by a few months. The completion time for Harbin than Sichuan.

[Jason Cooper:]

Okay. And out of the biodegradable facility, are we still expecting gross margin in the high 20s percent

[Zhang Dahe:]

Yes, Jason. We expect to be about 20% the gross margin for biodegradable with the past.

[Jason Cooper:]

Okay. I guess, my next question is with respect to the new international customer that we might see as link up with -- the press release mentioned several top global customers in the Automotive sector. So I was wondering if you could provide any additional guidance about when we might sales to these new customers and progress that you've made in developing them?

[Zhang Dahe:]

So, Jason, with the global customer, for example, [indiscernible] we have started supplying to them in China, already. As for [indiscernible] to them, are we still supplying to them globally we think probably it will take some time, most likely by the end of this year or the next year at the latest.

[Jason Cooper:]

So you'll be able to utilize the capacity, will that be coming from Dubai for the international sales?

[Zhang Dahe:]

So it's basically going to be if we are supplying to their -- to them in China, will be from our Sichuan facility. If overseas, it is most likely going to be from Dubai.

[Jason Cooper:]

Okay. With respect to the current business, how much of your plastic production, as a percent of sales, is nonautomotives?

[Zhang Dahe:]

So in this year or for international?

[Jason Cooper:]

Yes. Do you have any or what the Korean customer the sold nonautomotive sales and do you -- once you've stops providing them plastic products?

[Zhang Dahe:]

I mean, for the Korean customer?

[Jason Cooper:]

Yes.

[Zhang Dahe:]

Okay. Jason, so for the Korean customers, the -- because the material, the product we sold to them are mostly for Automotive and also some Electronics. So sometimes, we can probably look at it from a -- we can get a sense but it's not going to be possible to say, like at least 100% accuracy. So with that, we think that possibly 80% were in all and the rest in other area.

[Jason Cooper:]

Okay. And then, one quick question about another opportunity for you guys. So you're having this non-binding go-private agreement. Have you looked into potentially, listing your CDR in China or in Hong Kong? It seems that they are trying to attract companies over there, specifically in China, companies that are like yours with respect to high-tech manufacturing companies, environments and companies. It seems like the CDR potentially, to generate shareholder value, not only for the buyer consortium but also for the minority shareholders.

[Zhang Dahe:]

We're not looking at those options yet.

[Operator:]

Our next question comes from the line of Glenn Krevlin.

[Glenn Krevlin:]

So the $900,000 of professional fees, is that the final payment in [indiscernible] for independent valuation that we hired them in [indiscernible].

[Zhang Dahe:]

The $900 includes other professional fees, such as the legal, accounting and then, it does not include the final payments to [indiscernible].

[Glenn Krevlin:]

Has [indiscernible] completed their independent valuation?

[Zhang Dahe:]

I open. So as far as the transition, China has some comments. The first of all, the brand consortium is the special committee to speed up their process. So, so far, we understand, first of all, the special committee on behalf of the minority shareholder has taken a very detailed approach in terms of the terms and structure of the proposal to get the best offer for the minority shareholders. Secondly, the bank consortium also undertaking possible financing so there are some change of structure on in order to lower the cost, which also cost some time over there. And lastly, he wants to say that the bank consultant is committed to the nonbanking offer that we issued order last year.

[Glenn Krevlin:]

Okay. Well, you guys had a great quarter. I'd be a lot more excited about it if the company traded on fundamentals and it hasn't. So think its nonbinding proposal and so, I would remind that the special committee as a public company, the board has a fiduciary obligation to maximize shareholder value for all shareholders, not just the insiders that are going to participate and think about it. In the current point of action has the [indiscernible] it's trading below four and zero as we've shown. So I would ask, as a shareholder, that's bearing the expense of the consultant and the that the Special Committee has hired, we are their clients. We are on a deadline, finish the valuation, make that information public, file it as an 8-K, that will validate how and undervalued the stock price currently is, cancel the nonbinding proposal, which is unfair and having been we'll make a revised offer that is fair, that offer was over a year ago. The stock has performed quite well in some things. You can't honestly come back and procure stock I am sure. We'd love to hear from the Special Committee. I silence breeds speculation. Clearly, it hasn't helped the stock price. Not only because it's the right thing to do but they have a fiduciary obligation to tell us what their intent is for this company. Talk to us, tell your shareholders what you are doing. They are doing the independent directors on the Board. We've entrusted you with our capital and there are real consequences for the stock price going down the way it has. So if you can share those comments to the Special Committee, they essentially control their stock price sales. Their earnings don't matter. Frankly, our time is while we're spending as much time talking about the non-management, your share price is completely held hostage to this nonbinding proposal.

[Zhang Dahe:]

It's mission that first, the has done their best and we all continue doing so in the future. Right now, our focus is on getting financing for the transaction. And hopefully, they'll be the best for everybody.

[Operator:]

[Operator Instructions]. Our next question comes from Glenn Krevlin with Glenn Hill.

[Glenn Krevlin:]

Joe, I have three questions. One, what's the projected capital spending now for this year in light of some of the comments that you've made? Second, what's your plan on refinancing the short-term debt? And third, in the press release, there is a reference that overseas sales were about $55 million. Can you give us some context? Was this customers besides the Korean customer that you've had? Cable issues with or was it the same customer that you're now doing business with, and where is this material being sourced from for overseas before Dubai is opened?

[Zhang Dahe:]

So first of all, for the CapEx first. So for this year, the current CapEx of 2018 is expected to be possibly, $409 million. Mostly for our Sichuan, Dubai and also, hearing John production business. For the overseas customer, as it is the same South Korean customer, we have an overdue situation. However, given same situation in the past, we do believe we'll be able to collect the overdue balance in the very near -- in the next few months. And in addition, we have made some progress with some other global customers. Although, current still sales in China, but we anticipate sales will materialize for them by the end of this year or the next year. And for your second question, on the financing, let me turn to the management and get an answer for it. Glenn, for the financing, obviously, we have been -- it's our goal to lower the balance over the short term and increase our long-term debt to fund several projects we are undertaking, and we have been looking for that. And, I think, given some time, we'll be able to our capital structure and make sure the debt structure will be assembled for our project in the timeframe.

[Glenn Krevlin:]

I was a little bit confused in terms of your comments on the Korean customer. To the best of my knowledge, in the last financial statement, you indicated you were -- they had owed you money yet you continued to do business with them in the quarter. That's where I'm confused.

[Zhang Dahe:]

So again, what happened is because the overdue situation is going to our spend there in terms of the customer was such an overdue, we actually suspended additional sales to them, given the first quarter of 2018. So in other words, we're not surprised to them pending products until they bring their balance overdue situation back.

[Glenn Krevlin:]

So we should expect that sales from overseas customers in this current quarter will be substantially less than $55 million?

[Zhang Dahe:]

You mean, for the second quarter?

[Glenn Krevlin:]

Yes.

[Zhang Dahe:]

So, Glenn, we have been looking with the customers from them. We expect that they will open their [indiscernible] currents by the end of the second quarter, and we will resume business with them and with very close monitoring.

[Glenn Krevlin:]

So there will be little sales in the second quarter, but you hope to resume in the third quarter, is that what I'm understanding in overseas sales?

[Zhang Dahe:]

Yes, yes.

[Glenn Krevlin:]

And are you going to limit your sales to this customer teller since they've continued to be overdue several times? Are you going to put limits on the amount of sales because it seems to be a problem, it's happened at least one or twice before.

[Zhang Dahe:]

Yes, Glenn, definitely, as mentioned previously that on one hand, we care our customers but on the other hand, we also want to make sure that for this particular case, we have added additional terms and also restrictions and those terms are being discussed. Obviously, the goal is to make sure that this situation or scenario will not happen again in the future.

[Glenn Krevlin:]

Right. And then, Taylor, can you -- last question, can you give us some sense, since you have Dubai coming online in its higher end product, how much of that capacity do you have still in terms of potential customers, as you phase that in? I think, you said at the end of June and then throughout the year. How do we stay in with customer potential there?

[Zhang Dahe:]

Yes, Glenn, we have -- we are currently testing products with potential customer in Germany and also in Czech Republic.

[Glenn Krevlin:]

So you're confident that, that capacity will get utilized in -- as it comes onstream?

[Zhang Dahe:]

Yes, correct, Glenn.

[Anna Bin:]

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 XD's New York office. The contact numbers for all of us are listed at the end of the press release.

[Operator:]

Thank you. Ladies and gentlemen, this does conclude conference call for today. Thank you for your participation. You may all disconnect.