China XD Plastics Company Limited
Q3 2018 Earnings Call Transcript

Published: 11 Nov 2018

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Third Quarter 2018 China XD Plastics Earnings Conference Call. At this time, all participations are in a listen-only mode. There will be a presentation followed by question-and-answer session. [Operator Instructions] I will now turn the conference over to your first speaker today, Mr. [Indiscernible]. Thank you. Please go ahead.

[Unidentified Company Representative:]

Thank you all for joining us for the China XD Plastics third quarter 2018 financial results conference call. Joining me on the call today are Mr. Jie Han, Chairman and CEO; 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. Earlier today, China XD Plastics issued a press release announcing the third quarter 2018 results. Before management's presentation, I would like to refer to the safe harbor statements in the 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 risk and uncertainties and that management may make additional forward-looking statements in response to your questions. All statements other than statements of historical facts contained our forward-looking statements, including but not limited to the company's growth potential 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 related pricing policies. The volatility of the company's operating results and financial conditions. The company's projection of performance in 2018 and other risks detailed in the company's filings with the SEC 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 the 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 discussions 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 9, 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 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 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 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:]

Our third quarter 2018 results were consistent with unanticipated severe downturn in the auto industry of China, the first year-over-year drop in 28 years. In addition, the reduction of duty on the import vehicles by an average of 46% is expected to have profound impact on the entire auto industry in China. Although, we applaud the implementation of such supply-side reform by the policymakers for the well-being of the long-term benefit of China auto industry, it will have short-term impact on the auto market as companies throughout the supply chain adjust themselves and adapt to such change. On overseas business development front, we are pleased with our successful trial production at our production base in Dubai and remain optimistic about the prospect of our business expansion overseas, especially after positive results and feedbacks after production trials from customers in various countries and regions overseas. On October 31, 2018, the company signed a deleveraging investment framework agreement. We are very pleased to welcome CCB Financial as an important strategic and long-term partner of Xinda. Once materialized, the corporation, under this agreement, will not only help our company deleverage its balance sheet and improve its capital structure but assist the company to solidify its long-term position in this industry. As the second largest bank in the world by assets, CCB is very selective, especially to nonstate-owned enterprises in China. The signing of the agreement reflects CCB's trust to our company after decades of cooperation, reaching a new high level and unwavering support to high-quality enterprise with focus on long-term innovation by the government under the leadership of President Xi. We are pleased that the company's Dubai production base has completed trial production successfully and official commencement is scheduled on November 11, 2018, with 11,250 metric tons annual capacity in 2019. Dubai Xinda primarily offers long chain nylon alloy and other high-end engineering plastics, and it has developed and completed product trials with a number of customers overseas from Spain, Italy, UAE, Malaysia, and India, et cetera. With that, I will now turn the call over to Taylor Zhang, our CFO, to walk you through our financials. Taylor?

[Taylor Zhang:]

Thank you, Mr. 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 third quarter of 2018, unless I state otherwise. Additionally, any year-over-year comparison is to the third quarter of 2017, any sequential comparison is to the second quarter of 2018. So let's go over our third quarter results. Revenues were US$297.2 million in the third quarter ended September 30, 2018, a decrease of US$14.2 million, or 4.6%, compared to US$311.4 million in the same period of last year, as a combined results of first, a decrease of 2.7% in sales volume and second, 2% negative impact from exchange rate due to weakening RMB against U.S. dollars partially offset by an increase of 0.1% in the average RMB selling price of our products. According to the China Association of Automobile Manufacturers, Automobile production and sales in China increased by 0.9% and 1.5%, respectively, for the first nine months of 2018 compared to the same period of last year, and China auto sales dropped 4%, 3.8% and 11.6% in this July, August and September, respectively, compared to the same periods in 2017. Weakening macroeconomic conditions since the summer of 2018 have deteriorated business conditions. Though the company has increased growth of 208.9% in South China, 54.8% in Central China, sales decreased by 7.2% in Southwest China, 11% in North China, 13.6% in Northeast China and 0.2% in East China. As for the increase of average RMB selling price, it was mainly due to more sales of higher-end products of modified PA66, PA6 in China. Overseas sales were US$2,104 in the three-month period ended. This quarter as compared to US$14.1 million in last year. The company has tried to develop new customers overseas besides the existing oversea customer. The sales to this customer was suspended due to the accounts receivable balance overdue situation. Gross profit was US$47.2 million in the third quarter ended September 30, 2018, compared to US$47.3 million in the same period last year. Our gross margin increased to 15.9% during the third quarter from 15.2% in the same quarter last year. Primarily due to more sales of higher-end products of 77.4% as compared to 74.9% for the same period last year. G&A expenses were US$8.1 million as compared to US$10.4 million in the same period last year, decrease by 22.1%, or US$2.3 million. The decrease was primarily due to our approach on optimizing management structure and enhancing efficiency, leading to the decrease of US$2.1 million in salary and welfare; US$0.6 million in miscellaneous expense, US$0.1 million in rental expense and partially offset by the increase of US$0.5 million in stock based compensation. R&D expenses were US$23.3 million for the third quarter, compared to US$9.8 million for the same period last year, representing an increase of $13.5 million or 137.8%. This significant increase was primarily due to our elevated R&D activities to meet the new and higher specification requirements from potential customers, especially those in, from overseas. And increased efforts directed towards applications in new electrical equipments, electronics, alternative energy application, power devices, aviation equipments and ocean engineering in addition to other new products, primarily for advanced application in the automobile sector and in new verticals such as ships, airplanes, high-speed rail, 3D printing materials, biodegradable plastics and medical devices. As of September 30, 2018, the number of ongoing research and development projects was 211. Operating income was $13 million for the third quarter of 2018 compared to $26.2 million for the same period of last year, representing a decrease of $13.2 million or 50.4%. This decrease is primarily due to higher selling expenses and R&D expenses and partially offset by lower G&A expenses. Net interest expense was $13.1 million for the third quarter of this year compared to $9 million in the same period of 2017, an increase of 45.6% or $4.1 million. Due to the increase of interest expense, the increase of average short-term and long-term loan balance in the amount of $936.2 million for the 3 months period September 30, 2018, compared to $808.3 million of the same period last year. Partially offset by the decrease of interest expense resulting from the average loan interest rate decreased to 4.01% for the third quarter as compared to 4.57% of the same period last year. And the decrease of interest income resulting from average interest rates decreased by 1% for the third quarter of this year compared to 1.5% of the same period last year. And a decrease of average deposit balance in the amount of $240.8 million for this quarter as compared to $503.1 million for the same period last year. Net income was $9 million for the third quarter of 2018 compared to $14.1 million for the same period of 2017, representing a decrease of $5.1 million or 36.2%. Basic and diluted earnings per share for the 3 months period ended September 30, 2018, was both $0.13 compared to $0.21 per basic and diluted share 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 $50.9 million compared to 49.6 million shares for basic and diluted earnings per share in the prior year period. EBITDA was $30 million for the third quarter of 2018 compared to $39 million for the same period last year, representing a decrease of $9 million or 23.1%. For a detailed reconciliation of EBITDA and non-GAAP measure to its nearest GAAP equivalent, please see the financial table at the end of press release issued earlier today. Now let's turn to the balance sheet. As of end of the third quarter of this year, the company had $394.7 million in the total amount of cash and cash equivalents, restricted cash and time deposits, a decrease of $213.4 million or 35.1% as compared to $608.1 million as of December 31, 2017. As of September 30, 2018, working capital was negative of $185.8 million, and the current ratio was 0.9 as compared to the current ratio of 1 as of the end of 2017. Stockholders' equity as of September 30, 2018, was $733.2 million, an increase of $20.4 million or 2.9% as compared to $712.8 million as of December 31, 2017. Now moving to financial guidance and outlook. In light of the changing market conditions that Chairman Han mentioned previously, including slowdown of auto sales and reduction of duty on import cars as well as macroeconomic environment in China, the company is reiterating the update and previously disclosed financial guidance for fiscal 2018 to range between $1 billion to $1.2 billion in revenues and net income to range between $70 million to $80 million. It assumes the average exchange rate of U.S. dollar to RMB at CNY6.9. The financial guidance reflects the company's current view of its business outlook for fiscal 2018 and is subject to revision based on changing market conditions at any time. Before we open the call to your questions, I would like to note that for any question directed to the management in China, I will translate both their questions and their answers. If you want to ask your question in Chinese, please also ask it in English for the benefit of our listeners. Please also note that we will only be able to respond question 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 the 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 question. Operator?

[Operator:]

Ladies and gentlemen we will now begin the question-and-answer session. [Operator Instructions] Our first question comes from the line of Peter Siris. Please ask the question.

[Peter Siris:]

Okay. My first question, I guess, is on the inventory. I'm curious why there is -- why you have so much inventory right now?

[Taylor Zhang:]

Okay. Peter, let me translate your question.

[Jie Han:]

[Foreign language]

[Taylor Zhang:]

Peter, so here's the answer from Chairman, Han. So the inventory level mostly is because the -- as you probably noticed, our production in Sichuan has been ramping up currently almost at its optimum level in terms of capacity utilization. So Sichuan factory is moving with full stream. So that's driven the inventory increase. And secondly, the oil price fluctuation also play probably a minor role. But in any events, we expect our inventory level will taper down during the current quarter and also normalized in next year. So I think if we look at this current quarter, we're probably going to trim down by $100-plus million. And then next year, I think, we can approach to very normal level. So it was, indeed, at high level. But then given we have factory coming online and also other situation, so we do think next year we'll be able to return to a normal level.

[Peter Siris:]

Now in terms of demand, there's talk about new incentives for automobiles in China. Do you see demand picking up anytime sooner? Or is this sort of terrible auto sales going to continue?

[Taylor Zhang:]

[Foreign Language]

[Jie Han:]

[Foreign Language]

[Taylor Zhang:]

So Peter, here's the answer from Chairman Han. So basically his view is, first of all, because of the trade war or friction between China and U.S., the reduction of duty on import vehicles has impact domestic car sales. And secondly, because of the changing economic condition in China, consumer is taking a pause on their vehicle or car purchasing decisions. But however, looking forward, we think the trade war, we'll get more clarification on the trade war. We think a friendly resolution will be reached and then consumer confidence will come back. So next year, we think the auto sales will come back up. That's our view. Peter, does that answer your question?

[Peter Siris:]

Yes. Thank you. I just wanted also to ask 2 more quick questions, if there's not too long a queue, or I'll get back in queue and let the next person ask and then I'll come back. How's that?

[Taylor Zhang:]

Yes, I think you can continue with 2 questions first and like to have some…

[Peter Siris:]

Okay. Two quick questions. One is, can you bring us up to date on what's happening in Dubai? It looks like you finally, you think you're going to finally be able to get Dubai off the ground doing business?

[Taylor Zhang:]

[Foreign Language]

[Kenan Gong:]

Hi, Peter, long time no see. I think, thanks for your question. I'm going to answer you with regarding to status of our Dubai subsidiaries. As you probably are aware of the company information from the news release we just released 2 days ago, and we are very happy to inform everyone that our Dubai subsidiary, the first phase of the high-end plastic alloy has been successfully commissioned and I think work beginning from December. And also now we are planning to hold the ceremony, the commissioning ceremony, formal commissioning ceremony on November 11. And in terms of the production capacity, the project is going to reach around 11,250 metric ton per year and the product which focus on very high end to high-margin plastic alloy. And at the same time, as Mr. Han has already mentioned, during this period, we have managed to develop this new customer, Italy, in Malaysia and also in the European countries like in Spain, like in Italy. And so it's safe to say that we're not only have our production commissioned, but we also secure the future demand and the customer as well. So we have pretty good customer base. So we are very confident and the high-end product from the Dubai subsidiaries is going to be sell out very smoothly. Thank you. I hope that answers your question, Peter.

[Peter Siris:]

Yes, great. And finally can you, the 2, what's happening with the 2 new factories? Are you continuing to ramp them up same speed? Are you slowing down, given the new financing? What's happening with them?

[Kenan Gong:]

You mean the Dubai and the other Dubai project.

[Peter Siris:]

No, no. The second factory in Sichuan and the second factory in Dubai.

[Taylor Zhang:]

Let me translate it to, Mr. Han. [Foreign Language]

[Jie Han:]

[Foreign Language]

[Taylor Zhang:]

So Peter, we have 2 300k projects, one each in Heilongjiang and in Sichuan Southwest. So obviously, those 2 projects were based on our auto research and market demand. We are still very confident and believe in. So currently -- let's start with the Southwest. So schedule wise, timing wise, it will be pushed out by possibly new year, mostly because of the tight credit environments in China to fund the project. So we're still to work, but we will do it, for example, which I mentioned in Q1, we'll probably work on the foundation for the factory sites in Southwest. And in Heilongjiang, we also complete the land auction procedure, et cetera. But in general, we will be exercising more physical responsibility. And as you can hear from our previous release, we are working to get long-term capital so that we can minimize risk in current tight credit environment.

[Peter Siris:]

[Foreign Language]

[Operator:]

Thank you. Our next question comes from the line of Matthew Larson from National Securities. Please ask your question.

[Matthew Larson:]

Hi, thanks for taking my call. Can you bring us up to date about the $75 million investment Mr. Han's son's investment company was supposedly going to make? And we were supposed to hear in September, the independent assessment of the fair value of that investment, and we've never heard anything since. So does the new agreement with China Construction Bank just supersede that?

[Taylor Zhang:]

So basically, Matthew, thank you for the question. The parties, basically, they decided not to pursue a definitive agreements because of -- they cannot reach consensus on the terms. So that's why the company returned the capital injection to Junior Mr. Han. So there will be -- you will see from our quarterly -- our 10-Q, there's detailed disclosure about that as well.

[Matthew Larson:]

All right. Wouldn't you think that a news release previous to the Q coming out might have been worthwhile? I mean, one of the problems is we don't get a lot of information. And I've been a long-term investor, and it obviously has not been a good investment. And I'm just kind of wondering why during the biggest boom in auto sales for many years, except for the last few months, the point that China was consuming 30 million cars a year, which is significantly greater than any other country in the world, the stock is at a all-time low, okay. So what should investors take from that? I mean, right now, you're trying to shore up the balance sheet. I mean, why wasn't that done a year ago. And finally, on this comment at least, and I'm not done with my questions, you stated that you can't comment on the going private. I mean, that's almost 2 years old. If you are an investor and you had an offer that was low at the time and still is low and you can't comment on 2-year -- in 2 years, particularly of your partner is a global financial powerhouse, Morgan Stanley, and you still can't comment on it, do you feel that not only competent on your part but fair to investors?

[Taylor Zhang:]

Okay. Matthew, do you have any further questions before I turn to question.

[Matthew Larson:]

Yes. I mean other comments, I mean, the previous caller touched on, maybe not in the depth I would like to. Auto sales have been weak the last few months you stated, but a lot of things have been weak in China. But the government in the PRC has been loosening up credit and also cutting the tax on automobile purchases there. I guess, it's 50% is what I've read. These things should be very positive, I would assume, for auto sales in general. And in addition, just, I guess, last night, there was an announcement that the government is pressuring state-owned banks, the large banks, to make loans available to private companies more. And presumably that would help not only your company but others -- private companies. And so it seems like there will be more credit flowing around and presumably we might have seen the low level of auto sales because when you make changes like that, it generally impacts the consumer very positively. So do you feel that should be the case? And finally, since you want to ask me other questions now, I mean, your book value grew. So the company is now trading -- the book value is 6x what the company is valued at. And the company's valued at less than 2x earnings. I mean, that would never occur in, certainly in the United States. So does that bother you? Or do you find anything strange about the fact that your company could be valued at a fraction of where it would be valued anywhere else in the world. I mean, what does that say about your company? And how it's been handled?

[Taylor Zhang:]

Okay. I'll try to answer your question in order you asked. So first of all, for the, you suggest or imply, we should have a press release on the Junior Han's investment. So basically because the fact that it was a not a definitive, there was never a definitive agreement in place. And he did that only for the benefit of the company to shore up our balance sheets to get bank feel comfortable about the company's financial condition. So I think it's a judgment call. But I think in the future, we'll, even though it's not a requirement, but I think in the future, we will exercise better judgment and also create a news flow to the market. So that's to your first question. And secondly, you asked why we do not shore up our balance sheet earlier. We actually act very early. So as you probably know, these state-owned banks in China so their style, fashion of working is different from the banks in the U.S. or other developed countries. So it's very typical for the banks to work at its own pace. So as company, the only thing we can do is to make sure there's no ball dropped from our parts and moving swiftly, which we have been doing. But I think you saw the release from a couple of days ago, but that was a result of lot of work by our team. So I give credit to my team for that. So at least right now, we feel like we have seen the lights in the end tunnel. That's why we made a release about it. And for the going private, so you said we cannot comment. That's very true. So we did, I think, we fully understand it take too long, but I don't think we are the only situation, I think, there are some other transaction they either aborted because of financing. So typically, I think the biggest holding power is basically financing, as Chairman Han mentioned. So I believe the buyer consortium will need to get commitment of financing before we can proceed. I think they're still working on that. And for auto sales, I think, the, what you observed is, we also think it's very likely to happen. The credit, the government is, I think they're backing to supporting private companies, but I think only on a very selective basis. So I think our framework agreement signed also reflect to some extent the government's efforts. So we think the, auto industry, we think, is very vital to the economy in China. And we think, we believe Chinese governments also realize that. So we think they will not let this industry slide. And that's why Chairman Han commented, next year we do believe it will take turn and also get into a more healthy trajectory. And lastly, for the book value and also other valuation metrics. So no matter what kind of perspective or metrics you use, I think the company is undervalued. And it does bother us, and I think I can't comment for the buyer consortium. But I think for the management, we will continue to work diligently. So we do have very clear priority, first of all, as to shore up capital and getting our balance sheet steady, stable, so we are less subject to any shock from the system or from the economy or changing condition in the industry. I think that's our top 1 priorities. And secondly, we will continue to diversify our business, both geographically and also by different sectors and applications. And I think third, as you mentioned, we will be more proactive in terms of communicating with shareholder and the markets. And I think hopefully, we will be able to show and reflect that in the coming quarters. I hope that answer your questions.

[Matthew Larson:]

You did. And listen, I'll throw, I'll add this too. The agreements that you're working on with China Construction Bank, I mean, seems to me quite a positive because if liquidity is an issue, then having access to it from a major bank like China Construction is a good thing. I'm hoping needless to say that part of the balance sheet issues that this agreement will address, equity hopefully is not going to be part of the deal at these levels. I mean, listen, my complaint is that, I've lost a lot of money here, okay, and people who I'm responsible for have lost a lot of money, all right. And it seems inconceivable that a stock would trade at a level where it's at in less management. And I direct this towards Morgan Stanley also, okay. I worked at Morgan Stanley for 15 years, and they're better than that. The 2 directors, Homer Sun and Jun Xu, I guess, if I'm pronouncing them properly, this is disgraceful, all right, because they invested private equity funds of their own investors, okay, in the Asia Fund IV many years ago at $6, and now it's $2 and change. I mean, job security is, but I know that there is not a lot of it on Wall Street anymore. And if this is an example of their talent, then I've got to question it. And I do so because I'm very frustrated, all right. I have large investments, and I felt that it was a reasonably sound one, particularly with the fact that Morgan Stanley had a 24% interest in the company. And then I'll also just kind of ask for Mr. Han, he owns half the company. Owning half of a $2 -- of a small company, I mean, I just don't understand why there is not a greater effort to elevate the stock price? Because owning half of a company worth $100 million and change is a lot less than owning half of a company that should be worth 5 or 10x what it's valued at. And I just don't -- I just don't understand -- I can't get inside the heads of management or the Morgan Stanley people. But I do know this, and I have to get this up. You all made an offer for the company, which was a conflicted offer at $5.21 almost 2 years ago. Why make the offer, if you're not going to follow through? I mean, when I come from, if you make a good faith offer, you follow through on it, all right, or you don't bother with the offer. So there's a certain amount of ethics that I -- the unethical aspect to it is now lost on me because there's been a ceiling put on a stock, and it just -- it continues to deteriorate. So I'm hoping that we've seen the lows here. And with the banking arrangement you have should probably make investors feel a little better that this company is going to make it through whatever difficulties it presumably is having. Actually, you guys have built it out quite nicely, but the stock price doesn't reflect that. So I just wanted to say that because there's a certain -- fiduciary responsibility is a very, very important stance here in the United States these days when it comes to investments. And Morgan Stanley needs to understand that, that is not lost on investors. So I appreciate you letting me just express the frustration from long-term investors because it's been very expensive experience so far. So I wish you luck going forward, and I'll be following your developments. Thank you.

[Taylor Zhang:]

Sure. Thank you, Matthew. So just a comment to your comments. I think the buyer consortium is still looking on the transaction. So I do believe we cannot comment until we have a commitment funding or other funds. So please understand that. But we totally understand your frustration. We are also equally, if not more, frustrated with the low valuation for years. So we'll keep our heads down and work to the best we can. Thank you.

[Operator:]

Thank you. There are no further questions at this time. I'll hand the call back to today's presenter. Please continue.

[Unidentified Company Representative:]

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

[Operator:]

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.