China XD Plastics Company Limited
Q2 2013 Earnings Call Transcript

Published: 12 Aug 2013

[Operator:]

Welcome the China XD Plastics’, second quarter 2013 financial results conference call. At this time all participants are in a listen-only mode. Following managements prepared remarks there will be a question-and-answer session. As a reminder, this conference is being recorded and a replay is going to be available shortly after the call. I would now like to hand the call over to your host for today’s call, Tong Ji (ph). Please go ahead.

[Tong Ji (ph):]

Thank you operator. Good morning and good evening and thank you for joining us for the China XD Plastics’ second quarter 2013 financial results conference call. Joining the call today is Mr. Jie Han, Chairman and CEO; Mr. Qingwei Ma, Chief Operating Officer; Mr. Taylor Zhang, Chief Financial Officer; Mr. Junjie Ma, Chief Technology Officer. Earlier today China XD Plastics’ issued a press releases announcing the second quarter 2013 financial results. Before managements presentation I would like to report to the Safe Harbor statement in connection with today’s conference call and remind our listeners that management’s prepared remarks during this call may contain forward-looking statements, which are subject to risks and uncertainties, and then management may make additional forward-looking statements in response to your questions. 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. I will refer you to a more detailed discussion of the risks and uncertainties in the company’s filing with the Securities and Exchange Commission. A more comprehensive description of the company’s forward-looking statements is contained in the company’s filing with the SEC. In addition, any projection as to the company’s future performance represent management’s estimate as of today, August 12, 2013. China XD Plastics assumes no obligation to update those projections in the future as market conditions change. To supplement its financial results presented in accordance with U.S. GAAP, management will make reference to EBITDA, 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 earning press release issued today. I would now like to turn the call over to Mr. Han. Mr. Han will speak in Chinese and I will translate his presentation into English. Mr. Han, please go ahead.

[Jie Han (Interpreted):]

Thank you Tom and welcome to all of you who have joined us today. I’m pleased to report our solid revenue growth and positive business development, especially during the changing and challenging macro environment, affecting different industries in China. Although gross margin declined during the second quarter of 2013, mainly due to our marketing strategy such as discounts on listed price includes some of shipping cost since the fourth quarter of 2012. This strategy has helped us achieve tremendous progress in market penetration, especially in East China, the largest automobile market in China. Revenues from East China and North China during the second quarter of Fiscal 2013 increased by 88.5% and 44.8%, compared to the second quarter of 2012. Furthermore, we initialed our entry to southwest China Market on solid footing with 4.8% revenue contribution from the region, during the second quarter of 2013. As previously reported, during the first quarter’s earnings release, we expected gross margin in the second quarter to improve approximately 18% due to our gradual reduction of the sales discount. The improvement in gross margin during the second quarter speaks volume of our strategy at Q2. The number of end customers increased to 304 to the end of the second quarter of 2013 from 187 as compared to the prior year. As evidenced by the higher volumes shipped, we continue to experience strong demand for our products across our portfolio. As market demand grows in our high-end products, as part of our long-term growth strategy, we remain committed to our investment in research and development, in order to enhance our product offerings, especially for the higher-end applications. We believe this strategy is the key to further strengthening our market position and will help us deliver long-term value for our stockholders. Thanks to our high level of product customization and comprehensive technical support offered to our customers, the substantial switching cost due to our customer turnover and our customer have remained very loyal to us. We are confident in our ability to leverage our bargaining power and to gradually reach our profitability without compromising the growth momentum created by our marketing strategy. For the second quarter of 2013, the company had gross margin at 18.4% as we started retracting our discount. Our effective penetration in East China market serves well our strategy, to make inroad to southwest market, where we plan to build our fourth production base in Sichuan province as previously disclosed and expand our sales network coverage nationwide. 2013 makes an exciting year with both opportunities and challenges for China XD. As previously disclosed, the company had planned to establish its fourth production base with 300,000 metric tons production capacity in Sichuan province. The construction is expected to commence in the second half of this year. Once our southwest production base is up and running, we’ll be able to effectively cover the entire country geographically and reach our goal of 10% market penetration with our major products; with our southwest production base covering southwest and central China and reaching into east China and our northeast production base covering northeast and north China and reaching into east China With all this said, we are confident in future prospects of our business in the market and look forward to strengthening our leading position and delivering significant shareholder value over the long-term. Thank you again, and with that I will 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. Now looking at this quarter as you have seen from our earnings release, we achieved solid top line growth in the second quarter. Revenues for the second quarter of 2013 were $202.2 million, representing an increase of about 39.7% from $144.7 million from a year ago, which was due to 29.8% increase in sales volume and 3.3% increase in average RMB selling price of our products, driven by increase in demand for automotive modified plastics used in the parts of mid and high-end branded automobiles by the company’s major customers. In the second quarter of 2013, gross profit was $37.2 million, increased by 5.4% from $35.3 million in the second quarter of fiscal 2012. Gross margin was 18.4%, compared to 25.4% in the same period of the prior year. So the decrease of our gross margin was primarily due to an average of 6.4% discounts on the listed prices for the three month period ended June 30, 2013, to distributors as part of our marketing initiatives, to increase our market share in East and Southwest China. As a result revenue contribution from East China and Southwest China grew to 29.8% and 4.8% during this quarter, compared to 21.5% and nil in the same period of 2012 respectively. We plan to maintain such discounts for the rest of 2013. The second reason for the decrease of our gross margin was due to the increase in shipping expenses to approximately $3.4 million in the three months ended June 30, 2013 from $2.3 million in the same period of last year. We started managing logistics on our own to better serve our customers in a more timely manner and to better understand our customer demands and control our sales channel from the first quarter of 2013. Such arrangement is expected to continue in the future. G&A expenses were $2.9 million, compared to $2.2 million for the same period of the prior year. This increase is primarily due to the increase of professional fees, primarily resulting from an increase in both average salary and headcounts and bank charges. R&D expenses were $5.8 million, compared to $4.6 million in the same period of the prior year. During the second quarter of 2013 research and development expenses were $5.8 million or 2.9% of total revenue compared to $4.6 million or 3.2% of total revenues in the same period last year. The increase in R&D expenses was due to the company’s ongoing efforts in research and development activities on new products, primarily in consumption of raw materials for various experiments for all applications from automobile manufacturers, as well as other non-auto applications. During the second quarter ended June 30, 2013, the company successfully launched 10 new automobile manufacturers certified products, also know as AMCP, which increased our total number of AMCP to 263 as of June 30, 2013. During the same quarter of 2013, operating income was $28.5 million or 14.1% of revenues, an increase of about 0.4% over operating income of $28.3 million, were 19.6% revenue in the same period of the prior year. This increase is primarily due to higher gross margin, partially offset by higher G&A and R&D expenses. Both net income and net income were available to common stockholders for the second quarter 2013 were $20.8 million, compared to of course $22.8 million for the same period a year ago. Basic and diluted earning per share for the second quarter of 2013 were $0.32 compared to the same period a year ago, which were at $0.36 and $0.33 respectively. EBITDA for the second quarter of 2013 was $36.6 million, an increase of 10.9% from $33.0 million in the same period last year. Turning to the balance sheet, as of June 30, 2013 China XD has $66 million in cash and cash equivalence; $175.2 million in time deposits with commercial banks; $193.4 million in working capital and a current ratio of 1.5. Stockholders' equity as of June 30, 2013 was $304.8 million, compared to $264.4 million as of December 31, 2012. As of June 30, 2013 time deposit increased by 265% as we generally put our cash deposits with commercial banks to generate interests. Accounts receivable increase by 44% as a result of increase in revenues and increase in turnover days from 56 days for the 12 months period ended December 31, 2012, to 83 days for the six-month period ended June 30, 2013 as a result of overall China economic slowdown and its impacts to our industry. Now, it takes really longer to collect from our customer, however our DSO is still below industry average. The average DSO for automobile modified plastic industry is generally 90 days based now on our industry experience. We expect that all of the accounts receivables are collectable and anticipate our DSO to remain at level for the rest of 2013. Inventory increased by 30.8% due to the anticipation of the increase of a customer demand in the following quarters. Certain bank loans increases by 51.2% due to the need to support our future capacity expansion in Southwest China. Accounts payable increased by 947.9% due to the 30 days payment term, we renegotiated with our domestic raw material suppliers, a shift from prepayments to suppliers in the past, in order to strengthen our working capital. Finally, in light of growth momentum in all regions we market our products in the second quarter, with the backdrop of our unscheduled ramp up of the production capacity. We reiterate our annual guidance; we expect revenue for fiscal 2013 to range between $935 million and $1 billion and net income for the fiscal 2013 to range between $100 million and $132 million. This forecast excludes any un-cashed charges related to differed income tax benefit, stock-based compensation and changing of fair value of existing derivative liabilities and is based on constant exchange rates. It reflects the company’s current and preliminary view, which is subject to change. Before we open the call to your questions, I would like to note that for any questions directed to Mr. Jie Han, Mr. Qingwei Ma or Mr. Junjie Ma, I will translate both the questions and the answers. With that, we’ll now open the call to your question. Operator.

[Operator:]

Thank you Mr. Zhang. (Operator Instructions). Your first question comes from the line of Glenn Krevlin from Glenhill Capital. Please ask your question.

[Glenn Krevlin:]

Yes, good morning. I was wondering if you could talk a bit about your strategy in regards to diversification in terms of new customers. You talked regionally, but perhaps you can talk about some new customers, some new potential verticals outside of auto and how you look at the opportunity there?

[Taylor Zhang:]

Hi Glen, thank you for the question. Let me translate your question first. Hi Glen, I have answers from both our COO and CEO. So first of all, we are still committed to all our application, which will be our primary focus in our future, with diversification into other applications, for example aerospace, high-speed rail and ships. So from an R&D standpoint, we are investing more into other higher end application than automobile. As we mentioned in our earlier call, our number of customers has increased dramatically compared to last year from 107 to 304 at the end of the second quarter. So this is mainly due to our aggressive and consistent R&D investments and also our product upgrades. We are also consistently working on to produce, to manufacture, and also develop more high end products, which we offer to our customers.

[Glenn Krevlin:]

Great, thank you for that. One other question, you talked a bit about a change in your logistics strategy and I’m curious whether that is something that is currently a negative drag on the P&L or whether its something that today is actually a positive and how we can look at that going forward.

[Taylor Zhang:]

Okay. I’ll answer this question. So for the logistics, even through we are taking on – for example, second quarter was as I mentioned approximately $3 million. That’s a impact on the P&L or however this tremendous benefits associated with doing that, because we can have a pretty much real time understanding or sense of our customer, they are using our product. So by monitoring that on a consistent basis, we believe we can better serve our customers going forward and also to service them in a more timely manner. It’s also going to help us in the longer term.

[Glenn Krevlin:]

Right. Thank you Taylor.

[Taylor Zhang:]

Thank you.

[Operator:]

Thank you very much. (Operator Instructions). Your next question comes from the line of Peter Siris from Huewai (ph). Please ask your question.

[Unidentified Participant:]

A couple of questions. First, as I look at the Q, your modified Polypropylene business declined by 10% but the engineered plastics and all the other business increased dramatically. Can you just explain what’s modified polypropylene and what are the others, because the modified polypropylene is sort of the basic stuff and the other’s is more high value added stuff?

[Taylor Zhang:]

Okay Peter, let me translate your question first. Hi Peter. The answer from Mr. Ma is modified polypropylene or modified PP is pretty much the lowest value added product of our spectrum, and in engineering plastics and modified PA, which are higher end. For example PA is mostly used in functional components. So the manufacturing process and also the development process is more stringent. It also comes with higher selling price. It’s more difficult to develop and also to make. So this really reflects our consistent shift towards higher end products, to improve our overall product mix and also eventually improve our margin.

[Unidentified Participant:]

So as you switch – I mean you’ve been switching to the higher margin products, higher value added products. That should mean that we should at some point start to see higher margins. Is that reasonable?

[Taylor Zhang:]

Yes, it is reasonable, yes, yes. We’ll continue our product shift to higher end applications.

[Unidentified Participant:]

Okay. I also see that in either the quarter or the six months there’s been a huge increase in sales to what you refer to as distributor-A, from like $18 million to last year of $105 million, $106 million this year. Is distributor-A somebody in East China. Is that a reasonable assumption?

[Taylor Zhang:]

Okay. Let me translate your question. Yes Peter, that’s correct. We’ve seen in Northeast China.

[Unidentified Participant:]

In Northeast China? Then why is this big increase to distributor-A. What are they doing different that they are getting, that they are adding so much business.

[Taylor Zhang:]

Let me translate. So Peter, the answer from Mr. Han and Mr. Ma is as follows. So number, this distributor has been working with us for a pretty long period. We have been very familiar with the industry in terms of both the automobile products and also OEM manufacture. So they are doing very well in the three following areas. Number one, to sell more products to existing customers; and secondly, to increase new customers, and also be able to increase product sales in the higher end applications.

[Unidentified Participant:]

Right, great; and one last question to ask. I’ve been reading stories about the restrictions on automobile sales in China. But that at the same time, because they’ve been restricting sales that people are trading up to more expensive vehicles that there is big demand for BMW, Volkswagen, all these, the better vehicles. Is it reasonable to assume that that’s good for your business, because you tend to sell more at the high-end market?

[Taylor Zhang:]

Okay. Let me translate your question. Hi Peter. The answer comes from Mr. Han. So basically, the answer is yes, because he believes now the audience is China is in a transition from lower end or middle tier automobile to higher end as you mentioned, that their fuel opportunity and also the restriction of cars here in China, kind of pumped the consumer to go for higher end vehicles. So this is beneficial to our company, as we also grasp this opportunity by developing and offering more higher end products, which reflect in our product mix shift from modified PP to other higher end, for example modified PA and engineering prospects. So we believe this is a good opportunity for us, for China XD to develop and also get involved with this positive trend.

[Unidentified Participant:]

Okay.

[Operator:]

Thank you very much Peter. (Operator Instructions). Following the Q&A, I would now like to hand it back to Tong Ji (ph) for closing remarks.

[Tong Ji (ph):]

On behalf of China XD Plastics I want to thank you for your interest and participating in this call. For those interested in meeting this management, please contract China XD Plastics at 1-212-747-1118. Again, thank you for your participation on this call. Operator.

[Operator:]

Thank you. That does concludes the call today. Thank you for participating. You may all disconnect.