China XD Plastics Company Limited
Q1 2014 Earnings Call Transcript

Published: 14 May 2014

[Operator:]

Welcome to the China XD Plastics’ First Quarter 2014 Financial Results Conference Call. At this time all participants are in a listen-only mode. Following management’s prepared remarks there will be a Q&A 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, Tom Zhou. Please go ahead.

[Tom Zhou:]

Thank you, operator. Good morning and good evening and thank you for joining us for the China XD Plastics’ first quarter 2014 financial results conference call. Joining the call today are Mr. Jie Han, Chairman and CEO; Mr. Qingwei Ma, Chief Operating Officer; Mr. Taylor Zhang, Chief Financial Officer and Mr. Junjie Ma, Chief Technology Officer. Earlier today, China XD Plastics issued a press release announcing its first quarter 2014 financial results. Before management’s presentation I would like to refer 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 that 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 and we refer you to a more detailed discussion for the risks and uncertainties in the company’s filings with the Securities and Exchange Commission. A more comprehensive description of the company’s forward-looking statement is contained in the company’s filings with the SEC. In addition, any projection as to the company’s future performance represents management’s estimate as of today, May 14, 2014. 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 the U.S. GAAP management will make reference to EBITDA, a non-GAAP financial measure reconciled from net income, which the company believes, 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 today. I would now like to turn the call over to Mr. Han. Mr. Han will be speaking Chinese and I will translate his presentation into English. Mr. Han, please go ahead.

[Jie Han:]

Thank you, Tom and welcome to all of you who have joined us today. We are pleased to report our solid revenue growth and positive business development for the first quarter of 2014. The year-over-year growth reflected China XD's strong execution of solidifying our leading position in the marketplace. Revenues from Southwest China, East China and North China during the first quarter of 2014 increased by 63.1%, 62.8% and 43.2% respectively, compared to revenues during the first quarter of 2013. Our gross margin increased to 20.9%, an increase of 3.8% from the same period of prior year. The higher gross profit margin during the first quarter of 2014 compared to the same quarter in prior year, primarily due to our continued and steady shift to higher margin products and the suspension of sales discounts in the first quarter of 2014. As evidenced by the higher volumes shipped we continue to experience strong demand for our products across our portfolio. As market demand grows for the -- for our higher-end products and 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 key to further strengthening our market position and will help us deliver long-term value for our stockholders. As we have consistently developed and brought to the market more new products to grow our business we re-categorized our products and our product portfolio now increased to 11 times, compared to six prior to the end of last year. We believe the current categorization better reflects nature and characteristics of our products and the way that our management currently views and analyze our product as well as provides more customized products and solutions to our customers. In conformity with the new categorizations we have adjusted comparable product information in applicable prior periods and also this year. We are confident in the future prospect of our business and market and look forward to leveraging our R&D platform to further broadening our product offerings to our customers and 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 our quarter as you have seen from our earnings release we achieved solid top line growth in the first quarter. Revenues for the first quarter of 2014 were $223.6 million representing a year-over-year increase of 30.8% from $171 million in the first quarter last year. The increase in revenues was due to approximately 12.8% increase in sales volume and 14% increase in average RMB selling price of our products, driven by increasing demand for auto polymer composite materials used in the parts of mid and high-end branded automobiles by the company's major customers. In the first quarter of 2014 gross profit was $46.6 million, up 59.6% from $29.2 million in the first quarter of 2013. Gross margin was 20.9%, compared to 17.1% in the same period of last year primarily due to; first, higher-end product sales accounting for 73.7% of total revenues for the first quarter ended March 31, 2014 as compared to 63.6% of that in the prior year and second; the suspension of sales discounts for the first quarter ended March 31, 2014. During the first quarter of 2014 G&A expenses were $3.8 million, compared to $3.5 million for the same period last year. On a percentage basis G&A expenses in the first quarter of 2014 were 1.7% of revenues compared to 2% in the first quarter of 2013. The increase in G&A expenses is primarily due to the increase of $0.1 million increase of travel and office expenses, and approximately $0.2 million increase of stamp duties, in-line with the business expansion. During the first quarter 2014 R&D expenses were $8.6 million or 3.9% of total revenue compared to $5 million or 3% of total revenues in the same period last year. The increase in R&D expenses was due to the company's ongoing research and developments activities on new products primarily in consumption of raw materials, various experiments for the automotive application from automotive manufacturers as well as other novel applications. At the end of the first quarter of this year the number of ongoing R&D projects was 128. The consumption of raw materials for these products accounted for 90% of total R&D expenses for the quarter ended March 31, 2014. Net interest expense was $5.6 million for the three months period ended March 31, 2014 compared to net interest expenses of $1.8 million in the same period of last year primarily due to $2.9 million increase expenses resulting from the senior notes issues on February 4, 2014 and $2.3 million increased expenses resulting from the increase of bank loans to meet the need of our future capacity expansion in Southwest China. The average loan balance for the three months ended March 31, 2014 was $293 million as compared to $176.8 million for the same period last year. Leading to $2.3 million more interest expense. The increase of net interest expense was partially offset by the increase of interest income as a result of increase of term deposits during the three months ended March 31, 2014. During the first quarter of 2014 operating income was $34.1 million or 15.3% of revenues, an increase of 65.5% over operating income from $20.6 million, or 12.1% of revenues in the same period of last year. This increase is primarily due to higher gross profits, partially offset by higher R&D expenses. Both net income and net income available to common stock holders for the first quarter of 2014 were $22 million, compared to both $14.5 million for the same period of the prior year. Basic and diluted earnings per share were $0.34 compared to last year results, which were at $0.23. Earnings before interest, taxes, depreciation and amortization for the first quarter of 2014 was $43.5 million, an increase of 57.6% from EBITDA of $27.6 million in the same period of last year. Now turning to the balance sheet, we continue to manage our business from position of financial strength. As of March 31, 2014 China XD Plastics had $170.4 million in cash and cash equivalents; $324.1 million in time deposits with commercial banks, $477.5 million in working capital and a current ratio of 2. Stockholders' equity as of March 31, 2014 was $420.6 million compared to $412.3 million as of December 31, 2013. Restricted cash increased by 83.9% as a result of increase of our short-term bank deposits that are pledged as collateral for letter of credit and bills payable relating to purchase of raw materials, and short-term bank borrowings. Inventories increased by 63.6% due to our anticipation of the increase of customer demand in the following quarters. Short-term loans decreased by 23.3% due to the utilization of company's self-generated operating cash inflow to partially repay bank borrowings to reduce our short-term debt ratio as well as the leverage of long-term bank loans of US$27.3 million to meet the need to support our future capacity expansion in Southwest China. Bills payable and accounts payable increased by 104.3% and 12.2%, respectively, due to the increase of purchases from our domestic raw material suppliers. As of March 31, 2014, notes payable was $148.4 million due to the gross proceeds from the issuance of $150 million aggregate principal amount of 11.75% guaranteed senior notes due in 2019, net of discount. Finally in light of the company's strong performance during the first quarter of 2014 and positive outlook on customer demand for our products and business development for 2014 we reiterate revenues for 2014 to range between $950 million and $1.05 billion and net income to range between $100 million to $120 million. This forecast is based on constant exchange rates and the anticipated interest expense associated with both its long and short-term debts and reflects the company's current and preliminary view, which is subject to change. Before we open to the call to your question I'd like to note that for any questions directed to Mr. Jie Han, Mr. Qingwei Ma and Mr. Junjie Ma I’ll translate both questions and their answers. With that, we’ll now open the call to your questions. Operator?

[Operator:]

We’ll now begin the question-and-answer session (Operator Instructions). Your first question comes from the line of George Mayer from Manhattan Realty Group. Your line is open. Please go ahead.

[George Mayer:]

Taylor, you had some substantial increases in sales of vis-à-vis the first quarter of last year, but it looks like your product shipped was down about 40% from the fourth quarter and that was a quarter you were operating probably in excess of sustainable capacity but 40% or thereabouts seems like a more significant drop than I might have expected and at the same time it looked like your inventories almost doubled, I think they were up 90%. So maybe if you could comment on that?

[Taylor Zhang:]

Sure. So first of all, as you know, first quarter there is a long holiday associated with Chinese New Year. So the production, the output volume was decreased by approximately 15,000 metric tons. And secondly, as we remember in the first quarter last year we actually sold more than we produced, because we did have some inventory ticking down and sold those to our customers. So that's accounted for approximately 30,000 metric tons. So the inventory increase is basically most of the increases are actually raw materials and that is a reflection of our belief and confidence in the demand for the following quarters in this year.

[George Mayer:]

Okay, thank you.

[Taylor Zhang:]

You are welcome.

[Operator:]

We will now move on to the next question from the line of [Todd Miffit] from Desjardins Capital. Your line is open. Please go ahead.

[Unidentified Analyst:]

Hi three quick questions. The first one is about the RMB70 million loan that you were supposed to receive last year. It was an interest free loan from the government. Did you ever receive it?

[Taylor Zhang:]

Okay Todd, let me translate the question. [Non English]

[Taylor Zhang:]

Hi, Tom, this is Taylor. Let me translate the answer from both Jie Han and also Mr. Ma. So you are correct we have not received the interest free loan from the government yet. This is really based on certain milestone based on the occurring to the projects how it proceeds. So in addition Ms. Han commented that at this point we probably do not have a need for this loan. And I guess the loan was structured or negotiated in early 2013. So we are talking with negotiating with the government to see if we can support for the company in some other format for example government subsidy or other supports.

[Unidentified Analyst:]

Okay, understood. The second question is about your capacity. How many lines do you have currently and what utilization do you assume to arrive with your annual capacity at how many shifts per day?

[Taylor Zhang:]

Okay. Let me translate question. [Non English]

[Taylor Zhang:]

Hi Todd so the production utilization in Q1 is approximately 74%. It is lower than our optimal or normal utilization rates because of the change in New Year [inaudible] and secondly we have 88 production lines. Of course our three production based in Harbin and our factory operates nonstop from typically the first day of the month to the 25th. And the factory will stop production for the last five days for normal maintenance repair, and we currently have three shifts per day.

[Unidentified Analyst:]

Okay. And the optimal utilization is about 80% or a little bit higher.

[Taylor Zhang:]

85%.

[Unidentified Analyst:]

85%, okay. Okay, final question, first thank you for the new product classification in the 10-Q. It's much easier now to compare your prices to the raw material prices. And I noticed that nylon PA66 you seem to be selling at substantial premium versus the raw material price. So I am wondering what is so special about your particular products, what type of additional material do you add or what kind of special modification do you do to specifically nylon 66? [Non English]

[Taylor Zhang:]

Todd, let me translate the answer from our CTO and also our COO. So basically the PA66 modified products has the, generally have the following characteristics. They have high toughness, high strength and heat resistance. So if you look at the average selling price of PA66 in the international markets they are selling about RMB70,000 to RMB80,000 and ours is approximately in the range of RMB30,000 to RMB40,000. So we are still below the international selling price. And secondly even with the PA66 there is a variety of different products. For example if you want to compare PA66 with high toughness to those with higher strengths, so it's probably not an apple-to-apple comparison.

[Unidentified Analyst:]

Right. So basically if we look at the raw material price of PA66, right now it looks like it's RMB30,000 including the VAT, including VAT tax. So I basically, I shouldn't use this price to compare to yours, is this correct? Because you are quoting about 80,000 so you are [inaudible] 80,000 to modified plastic?

[Taylor Zhang:]

Okay. Let me translate your question. [Non English].

[Taylor Zhang:]

So Todd in addition we do have our process in place to better control the cost. So even for PA66, there is also different source and different I would say formulation we can utilize to control and lower our costs.

[Unidentified Analyst:]

Okay, I will probably ask follow-up later but that's okay. Thank you.

[Taylor Zhang:]

All right, thank you Todd.

[Operator:]

(Operator Instructions). Your next question comes from the line of [Peter Hallsworth from Harrington]. Your line is open. Please go head.

[Unidentified Analyst:]

Hi, good evening gentlemen. Quick question on the outlook for the gross profit margin. What should we be expecting going forward for this year and for the next few years should we expect the 20% level or would it be more in the high-teens level considering the removal of the discount?

[Taylor Zhang:]

Hi, Peter the gross margin in Q1 was higher compared to last year. However it was slightly lower compared to first quarter as you have probably seen. So the reason is that we do have a slightly higher volume from lower end products for example modified polypropylene and modified ABS. But I think that does not reflect the order we have received for the full year. So for the full year we do believe gross margin will be at least at the level of the whole year level of 2013, should be above 21% for the rest of this year. And going forward and as you can see in the product mix we have recategorized, it's mostly R&D driven exercise, so it's our efforts to gradually improve our gross margin beyond 2014.

[Unidentified Analyst:]

Okay, thank you. And then on the update regarding the Sichuan plant can you provide us an update and also in particular if there are any potential issue related to environmental impact and getting a permit related to that? I've seen in China there had been some resistance to batteries and plastics in particular. I mean I was just wondering if this is anticipated in anyway in Sichuan.

[Taylor Zhang:]

Okay, let me translate your question Peter. [Non English]

[Taylor Zhang:]

Hi, Peter so first of all Mr. Han is very pleased to report that we are little ahead of schedule for our [Sichuan] expansion according to our original planning. Secondly the environmental concern as you noticed there are some concerns in China. However in our industry in macro molecular business so there is virtually no chlorine elements produced in the products to most of the -- during the potassium process we have we use water to put down the extrusion materials. So there is some steam, will be emitted but the water and the steam, the design of our factory has sufficient space to absorb the scheme and the water is actually in a recirculation process. So if you compare us to not only to domestic Chinese manufacturer but even at international level we are very confident, we are on par with international standards. So we are not concerned with the environmental process or certification.

[Unidentified Analyst:]

Great, thank you. And one last question regarding the trend for raw material part could you give us a sense of what you are expecting for the rest of the year and in particular I was intersected in why the payables increased so much? Thank you.

[Taylor Zhang:]

Okay, Peter. I will take your question regarding payable. So for payable we are starting from last year. We actually switched from prepayments of settlement method to accounts payable. So last year we stood at about three days and this year we actually went back to our supplier and we actually renegotiated so they agree to a longer term which is to the benefit of the company. So now we think for this year we're going to have account payable days approximately 60 days level. And I will translate your first regarding raw material trend to our CTO. [Non English].

[Taylor Zhang:]

Hi, Peter regarding the trend of raw material cost, so the raw material used is a by-product of petroleum. So it does have certain correlation with petroleum price but very loosely. So we think the raw material price will remain relatively stable for the remaining of this year.

[Unidentified Analyst:]

Thank you, that's very helpful and congratulations on a good 1Q and good luck for the rest of the year. Thank you.

[Taylor Zhang:]

Thank you, Peter.

[Operator:]

(Operator Instructions). We will now move on to next question from the line of [Peter Siris]. Your line is open. Please go head.

[Unidentified Analyst:]

Taylor, how are you? I want to ask I know everybody is mostly focused on the quarter. I want to understand something in long-term. First question how much capacity in Harbin in total?

[Taylor Zhang:]

Hi, Peter this is Taylor. Let me translate your first comments regarding the question, the scope of your question and answer your question. [Non English]

[Taylor Zhang:]

Hi Peter, the current installed capacity we have is 390,000 metric tons per annum.

[Unidentified Analyst:]

Okay. And Sichuan is going to be how big? The capacity in Sichuan will be what, similar?

[Taylor Zhang:]

Going to be similar, slightly lower. We are planning to build with capacity of 300,000 metric tons.

[Unidentified Analyst:]

Okay, and Sichuan will be finished when?

[Taylor Zhang:]

Sichuan will start the earliest we will start producing either by the end of next year are early 2016 and then ramp up gradually to 2016 and '17 we believe, we expect 2017 in Sichuan we will be running at optimal utilization i.e. 85%.

[Unidentified Analyst:]

Okay. So I am -- again I am not asking for projection, I am just trying to understand the possibilities. In 2017, you will then have Sichuan and Harbin assuming the demand is there they are both running at -- if you could get both running at 85% of capacity given that you are selling more high value products et cetera, et cetera that would be roughly twice the size that you have now is that reasonable?

[Taylor Zhang:]

We will closer to [twice our current capacity].

[Unidentified Analyst:]

Okay. Now in terms of getting there will you need more capital if you were twice the size, can you do that on your existing capital or will you need more capital?

[Taylor Zhang:]

We feel confident that we can get there with our existing capital. So obviously, it is true with every products, there may be some up and down for the final money spent on the products but we think given our prior experience excluding our factory in Harbin, even though in Sichuan is different region but we are very familiar with the process. So we think it's just matter of time we can get there. We have what it takes to get there.

[Unidentified Analyst:]

So assuming that's the case and again I am not asking for -- I am just -- since there is no analyst coverage and nobody has any long term estimates and you are building this huge new facility, is it then reasonable to assume that by 2017 everything else being equal that your earnings -- of course your earnings would be roughly twice what they are now?

[Taylor Zhang:]

[inaudible]

[Unidentified Analyst:]

I am sorry, Taylor.

[Taylor Zhang:]

That's correct, Peter.

[Unidentified Analyst:]

Okay. So that if I were making a long term -- there is nothing in terms of margins or anything else in Sichuan that should be significantly different from Harbin, is that correct?

[Taylor Zhang:]

We think in Sichuan, our plan is to focus on two areas, one is a higher end in other application, second is in some another application which will be even higher end compared to auto.

[Unidentified Analyst:]

Okay. So basically what you are looking for is to run your business as efficiently as possible, you are not going to get a huge amount of sales growth going forward because you are at capacity until Sichuan comes along and then everything ramps up in a relatively fast manner, is that a reasonable way to look at company over the next four to five years?

[Taylor Zhang:]

Yeah, that's reasonable. So Peter I think it's very important to note even though we are at our capacity right now for this year and the majority of last year. But there is a still a lot of work we have been doing to prepare ourselves better for the production of Sichuan for example, we are spreading to more customers and also we are focused on customer, the quality of our customer and also focused on customer acquisition with higher end products demand

[Unidentified Analyst:]

Okay, great. Thank you very much. [Non English]. Operator It appears there are no further questions at this time. I will now hand the call back over to Tom Zhou for any additional or closing remarks.

[Tom Zhou:]

On behalf of China XD Plastics we want to thank you for your interest and participation in this call. All those interested in meeting with management please contact China XD Plastics at 1-212-747-1118. Again thank you for participation on this call. Operator?

[Operator:]

That does conclude our conference for today. Thank you for participating. You may all disconnect.