China XD Plastics Company Limited
Q1 2017 Earnings Call Transcript

Published: 13 May 2017

[Operator:]

Thank you for standing by and welcome to the First Quarter 2017 China XD Plastics Company Limited Earnings Conference Call. At this time all participants are in a listen-only mode. There'll be a presentation followed by a question-and-answer session. [Operator Instructions] I must advise you that this conference is being recorded today, May 10, 2017. I would now like to hand the conference over to your host for today, Ms. Anna Bin. Please go ahead Ms. Anna, thank you.

[Anna Bin:]

Thank you all for joining for the China XD Plastics first quarter 2017 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 2017 results. Before management's presentation, I would like to refer to the safe harbor statements in connection with today's conference call and to 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 international markets, the effectiveness and 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 the financial condition, the company's projections of performance in 2017 and other risks detailed in the company's filings with the Securities and Exchange Commission, are 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 the 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 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, May 10, 2017. China XD Plastics assumes no obligation to update these projections in the future as the 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 tax, depreciation and amortization, which we refer to as EBITDA. EBITDA is a non-GAAP financial measure reconciled from the 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 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:]

We are pleased to report of our first quarter 2017 results as we reflect our strong operating capabilities as well as the result of our strategic initiative. Our domestic sales showed a favorable year over year comparisons as we continued to enter new geographic markets. Our high value added product enable better safety and performance features for our automobile manufacturing customers and have wide applications in numerous verticals as well. However, a contraction in our gross margin occurred in the quarter due to a lower gross margin from higher end products sold in the domestic market and an increase in cost of goods sold resulting for increased depreciation attributable to the expansion of our Sichuan campus. In terms of our international sales, we suspended overseas sales to an international customer due to an account receivable balance overdue situation which will be resumed once the agreed upon terms for payment are met and all overdue balances is collected. After a strong year in 2016, we are beginning to see moderating industry fundamentals in our sector. The China Association of Automobile Manufacturers reports that the growth of auto sales in China slowed in 2017 to date, affected by both the holidays and the Chinese government's restriction on the implementation of the favorable tax deductions for small engine cars. While we anticipate slower growth as compared to last year, we believe that our broad and deep product platform, new geographical positioning and expanding production capabilities will enable us to capture market share from our competitors and maintain solid profitability. We continued to see significant revenue contributions from new growth regions in the first quarter, augmented by the continued ramp of our Sichuan manufacturing facility. Sales in the South China and the Central China regions increased 104.2% and 50.2%, respectively, from the same period in 2016, and our presence in the region has enabled us to secure new customers and improved market penetration. Our Sichuan facility now has 50 production lines with 216,000 metric tons of annual production capacity. The Sichuan facility will ultimately add 300,000 metric tons of annual production to our domestic capacity for a total domestic capacity of 690,000 metric tons. We expect that construction at the complex will be completed by the end of the second quarter of 2017. Although we expect that automotive applications will continue to be our core business, high precision equipment in our new facilities will enable us to diversify our product platform to serve an array of high growth verticals which will help to propel the Company's growth. We are also pleased that our strategic plan to develop diversified products has gained significant traction with the signing of a definitive agreement with the People's Government of Shunqing District, Nanchong City of Sichuan Province for the production of 300,000 metric tons of bio-composite materials and additive manufacturing and 20,000 metric tons of functional masterbatch. The project will add 320,000 metric tons of production capacity and we will also benefit from the favorable tax policies under China's Go West Campaign by locating the project in Southwest China. Our new facility in Dubai also extends our specialized high-tech products into an important overseas market. We plan to complete the installation of 45 production lines with 12,000 metric tons of annual production capacity by the first quarter of 2018, and to complete the installation of an additional 50 production lines with 13,000 metric tons of annual production capacity by the second quarter of 2018. This will bring the total annual production capacity in our Dubai facility to 25,000 metric tons. The Dubai facility will target high-end products for overseas markets and will ultimately enable more active inroads into the markets of Europe, the Middle East, Russia and other overseas markets. We believe that our increased production capabilities, new product offerings and a more diversified customer base form a solid platform which will enable sustainable corporate growth. In addition, our strategic geographical expansion leverages our technical expertise and customer-centric philosophy. Further, our product diversification is reflective of both our industry leadership in China's auto market and the growing demand of high technology sectors as driven by China's new economy. We reiterate our financial guidance for fiscal 2017 and continue to appreciate the support of our shareholders and all of our stakeholders. With that, I will now turn the call over to Taylor Zhang, our Chief Financial Officer, to walk you through our financials. Taylor, please go ahead.

[Taylor Zhang:]

Thank you, Ms. Anna, and thank you, everyone for joining the call today. Before we go to the numbers, let me remind you that all figures that are discussed here are for this reporting period, first quarter of 2017, unless I state otherwise. Additionally, any year-over-year comparison to the first quarter of 2016 and any sequential comparison is to the fourth quarter of 2016. So, let's go over our first quarter results. Revenues were $237.8 million for the first quarter of 2017 compared to $215 million for the same period of 2016, representing an increase of $22.8 million or 10.6%. The year-over-year increase was primarily due to 11.30% increase in sales volume and a 4.8% increase in average RMB selling price of our products. The increase in revenue seen in the first quarter of 2017 was driven by growth in demand for our products in the domestic China market, our efforts to expand our customer base, attributable to our new plants in Sichuan and our efforts to increase overseas sales. We recorded sales increases of 104.2% in South China, 50.2% in Central China, 30.2% in Southwest China, and 14.2% in North China as compared to the same period of last year. In 2017, overseas sales were suspended due to an accounts receivable balance overdue situation with an existing overseas customer. On April 1, 2017, the Company and the overseas customer have reached an agreement on the credit payment methods and product refining costs. We expect to resume sales to this overseas customer after retrieving our previous overdue payments from this customer in the second quarter of 2017. The customer has made a payment of $41.0 million in the first quarter of 2017 and has an unpaid balance of $33.6 million to date. Premium products, including PA66, PA6, Plastic Alloy, PLA, POM and PPO, in total accounted for 81.3% of revenues in the first quarter of 2016, compared to 77.3% for the same period last year. The Company continued to shift its production mix from traditional polymer materials to higher end products due to, first, the greater growth potential of advanced modified plastics in luxury automobile models in China; second, the stronger demand for higher end products as a result of Chinese government's promotion for cleaner energy vehicles; and the third, better end consumer recognition of higher-end cars made by automotive manufacturers from Chinese and Germany joint ventures, and U.S. and Japanese joint ventures, where manufacturers tend to use more and higher-end modified plastics in quantity per vehicle in China. Gross profit was 34.8% million for the first quarter of 2017, compared to $34.8 million for the same period of 2016, representing a stable period to period comparison. Gross margin for 14.6% for the first quarter of 2017, compared to 16.2% for the same period of 2016, primarily due to the lower gross margin of higher-end products sold in the domestic market in the current period as compared to the same period last year. G&A expenses were $7.1 million for the first quarter of this year compared to $5.1 million for the same period of last year, representing an increase of $2 million or 39.2%. This increase was primarily due to the increases in salary and welfare expenses due to the increases in the number of management and general staff. Research and development expenses were $5.9 million for the first quarter of 2017, compared to $4.9 million for the same period of last year, representing an increase of $1 million, or 20.4%. This increase was primarily due to elevated R&D activities to meet the higher quality requirements of potential customers from Europe, and increased R&D efforts directed towards applications in new electrical equipment, electronics, alternative energy applications, power devices, aviation equipment, and ocean engineering. In addition to other new products primarily for advanced industrialized applications in the automotive sector and in new verticals such as ships, airplanes, high-speed rail, 3D printing materials, biodegradable plastics and medical application. An increase in depreciation expenses after R&D equipment was put into use at Sichuan Enterprise Group Company. As of March 31, 2017, the number of ongoing research and development projects was 255. Operating income was $21.3 million for the first quarter of 2017, compared to $24.5 million for the same period of 2016, representing a decrease of $3.2 million, or 13.1%. This decrease was primarily due to higher G&A expenses and higher R&D expenses. Net interest expense was $8.8 million for the first quarter of 2017, compared to net interest expense of $9.3 million for the same period of 2016, representing a decrease of $0.5 million, or 5.4%. Income tax expense was $3.6 million for the first quarter of 2017, representing an effective income tax rate of 26.4%, compared to income tax expense of $4.5 million in the same period of 2016, representing an effective income tax rate of 28.5%. Net income was $9.9 million for the first quarter of 2017, compared to $11.4 million for the same period of last year, representing a decrease of $1.5 million, or 13.2%. Basic and diluted earnings per share in the current quarter was $0.15, compared to $0.17 per basic and diluted share for the same period of 2016. The average number of shares used in the computation of basic and diluted earnings per share current quarter was 49.5 million, compared to 49.4 million shares for basic and diluted earnings per share in the prior year period. Earnings before interest, tax, depreciation, and amortization was $34 million for the first quarter of 2017, virtually unchanged from EBITDA of $34 million for the same period of 2016. For a detailed reconciliation of EBITDA, a non-GAAP measure, to its nearest GAAP equivalent, please see the financial tables at the end of our press release. Now, let's turn to the balance sheet. As of March 31, 2017, the Company had $57.7 million in cash and cash equivalents, $77.8 million in time deposits with commercial banks, negative working capital of $179.8 million and a current ratio of 0.8% -- 0.8 as compared to 1.2 as of December 31, 2016. The decrease in the current ratio was primarily because the Company's cash and cash equivalents, restricted cash and time deposits decreased by 37.8%, and short-term loans increased by 43.4% for the increased prepayment obligations to equipment suppliers for the Company's new Sichuan Nanchong Project. Stockholders' equity as of March 31, 2017 was $648.2 million compared to $634.3 million as of December 31, 2016. Inventories increased by 30.9% to $367.7 million as of the first quarter of 2017 as compared to fiscal year end 2016 as a result of more purchases of raw materials and the Company's strategy to stock up inventory for upcoming orders. Prepayments to equipment suppliers increased by 2,583.1% mainly because of the advances to purchases for the new Nanchong Project. The aggregate short term and long-term loans increased by 18.9% due to the utilization of existing lines of credit to support the expansion of the Sichuan and Dubai facilities. We define the manageable debt level as the sum of aggregate short term and long-term loans, and notes payable over total assets. We expect that we will be able to meet our needs to fund operations, capital expenditures and other commitments in the next 12 months primarily with our cash and cash equivalents, operating cash flows, and bank borrowings. In terms of recent events, our listener can refer our press release issued today. Now, moving to our financial guidance and outlook for 2017, the Company reiterates its financial guidance for fiscal 2017 with revenue to range between $1.2 billion and $1.3 billion, and net income to range between $85 million to $100 million. This is based on the anticipation of continued recovery throughout the Chinese automotive supply chain and a stabilization of crude oil pricing and its impact on polymer composite materials in 2017. This forecast also assumes additional contributions from the Sichuan facility and that overseas sales will be resumed in the second half of 2017. It also assumes the average exchange rates of the U.S. dollar to RMB at approximately 6.8 and the Company will incur interest expenses for loan -- for long-term -- long-term loans and short-term loans. This financial guidance reflects the Company's preliminary view of its business outlook for the fiscal 2017 and is subject to revision based on changing market conditions at any time. Before we open to the part to your question, I would like to note that for any question directed to the management in China, our translator posts their questions and their answers. If you want to ask your question in Chinese, please also ask in English for the benefit of other listeners. Please also note that we'll only be able to respond to question about our financial and operating results. For other matters, including going private offer, we refer you to our already issued press releases. We will not be able to respond to question 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:]

Thank you. [Operator Instructions] We will move to our first question coming from Matthew Larson. Your line is open. Please go ahead.

[Matthew Larson:]

My question is I guess on a subject that I guess we can't ask about which is really the only subject of matter which is the going private offer. It was first made public back in February, it's now May. So, in three months, there is no new news other than you have a special committee considering it. And so in the meantime, shareholders are kind of swinging in the wind here. Meanwhile markets are certainly -- Asian markets, Chinese markets are rising dramatically, so is the game plan just to string this thing out to see how the cycle goes and if the cycle will strengthen, you make the deal, and if it doesn't, you pull it? Because investors do have an option to sell but it's an offer that frankly from a fiduciary point of view, in my judgment is well below what is not fair. And I was hoping to get some more information about any counteroffers or closing dates and is that anything you all can discuss? Because in three months, I would have thought the independent committee would have made some progress.

[Taylor Zhang:]

Hi, Matthew. Thank you for your question. So, obviously, our response will be very limited, but I can -- I can say responsibly is the Special Committee has been working diligently and once we reach to a certain point, they will recommend and also make appropriate public announcement, so I think that that's pretty much all I can say.

[Matthew Lawson:]

All right. I mean but I guess what is the independent committee doing? In three months, they haven't really accomplished anything at least not to the point that you can give any information on it? I mean they haven't hired an advisor. They haven't come up with any new information. Meanwhile, the meter is running I just don't understand.

[Taylor Zhang:]

Oh, yes. The Special Committee, as far as, I know they have been interviewing and also examining and consults with advisers for the Special Committee. I trust that they will do their best to serve their fiduciary duty to the shareholders.

[Matthew Lawson:]

All right, so legal duty too. So, you can understand the frustration, which is going on with long-term investors and today's conference call, investors, I'm sure were hoping to get a little more information, so as soon as you can get it out, I think that would be fulfilling their fiduciary responsibility. Thank you very much.

[Taylor Zhang:]

Yes. So, they are evaluating the final proposals on advisers and they will fulfill both legal and fiduciary duties.

[Operator:]

[Operator Instructions] We will take our next question comes from Jerome Meyer [ph] from Manhattan Realty Group. Your line is open, please go ahead.

[Unidentified Analyst:]

Taylor, about a year ago, we were talking on a similar conference call about how CXD's price was low and management was concerned about that and think about how we could get it up, and one of the things you were talking about was instituting dividend and that the capital of expenditures were going to be larger over at about this time. Instead of sort of following through on what I thought management was saying a year ago, you have levered up further with a lot of short term balance, paid down cash and began large new capital in Nanchong Project, so it seems like there's been a reverse of course here, could you comment on that, please?

[Taylor Zhang:]

Yes, I guess that's -- because of the extremely -- because of our valuation situation, we have very limited financial option of fixing opportunity, the company need to develop its business and its cost to fund the business, so we have very limited option which we have used is to borrow both short-term and long-term. Obviously, longer term, we will make our capital decision more stable so we've been working on that. I guess that's also part of the consideration for going private.

[Unidentified Analyst:]

Well, you don't have enough more options if you had not undertaken the Nanchong Project and instead use some of the cash with your buyer and then using for that to pay a dividend and I think that would have been well received and the price of the stock might have gone up, which would have given you more options or instead you've kind of taken the opposite course, which maybe has the effect of keeping the stock price down and then at the same time management of the principal owner coming in with what is an offer right below book value and above four and a half times earnings, so I mean it seems like they're working on their own behalf and not on behalf of the other shareholders.

[Taylor Zhang:]

Yes, I think dividend policy is a decision to be made by the board of directors as well for company during grow stage, company preferred to pursue business development opportunity versus dividend. So, we don't think we're in that stage yet. Obviously, I think as the company grows to certain size, dividend maybe more appropriate. So, that's just a decision by the board and management to pursue what kind of business development strategy.

[Unidentified Analyst:]

Well, it's just a big change with what it was a year ago because I understand, I mean right now that seems to be totally out of the question. A year ago, it was at least on the table. But I have another question on the redeemable preferred D stock which is listed on the balance sheet here, something over 97 million, but it also says with the redemption amount has increased over the last quarter from 212 million to 219 million, could you explain how that works and what's going on there.

[Taylor Zhang:]

Yes, I just want to clarify you're talking -- you're referring to the redeemable Series D preferred share, right?

[Unidentified Analyst:]

That's correct.

[Taylor Zhang:]

So, the Series D was the investment made by Morgan Stanley Private Equity Asia. So, basically in accounting perspective, we classify it as a permanent [indiscernible] so there is a provision in agreement with Series D investor, basically, they're going to be a 15% ROI accrued every year so that's why you'll see the redemption amount is increasing. I think this is purely like accounting treatment matter. Obviously, there's also a make good [ph] provision which the company needed to perform which we did achieve the three-year profit target, so hopefully that clarified the issue here.

[Unidentified Analyst:]

Well, it doesn't exactly. I mean I don't understand -- you've got the proper targets. You could force conversion. Now, the conversion prices, of course, is higher at $6 then even though the stock is trading but I'm not sure how it benefits the rest of the shareholders by not causing that to confer. That would increase your common equity base and this -- I just hope that this 15% that you're talking about that's going - accrued from one quarter from 212 million to 219 million, I'm not understanding whether that under any circumstance whatever has to be paid because that if it is, it's very expensive, not only there'd be no reason not to force conversion and pay the penalty to get [indiscernible] 11.5% debt, this is even more expense, so I guess it's not clear to me what's going on here.

[Taylor Zhang:]

Okay, so like I said we -- the company has the right to make the conversion happen because we have achieved the profit targets, that's an option to the company. So, I guess before the company makes decision this like I said it's purely accounting treatments. We have to follow U.S. GAAP and we have to accrue based on the provision terms of the agreement. But again, the company has the right to convert because we have achieved the profit targets.

[Unidentified Analyst:]

So, what you're saying with the company will never have to pay that 212 million or 219 million?

[Taylor Zhang:]

Like I said, we can -- we can -- we have the rights to convert the preferred into common because we have achieved the profit targets.

[Unidentified Analyst:]

Well, I would like to ask the Board of Directors to consider making that conversion. I see no advantage to the shareholders particularly when this Morgan Stanley Group is not a party to [indiscernible] dollar offer, which is 3.5% PE and well-below that value, I don't see any reason they should be given this special treatment.

[Taylor Zhang:]

Okay. Your suggestion is well-noted and we will forward it to the Board.

[Operator:]

[Operator Instructions] It appears there are no questions at this time. I will now hand over the call to you Mr. Taylor for any additional or closing remarks.

[Anna Bin:]

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

[Operator:]

This concludes today's conference. Thank you everyone for your participation. You may now disconnect.