China XD Plastics Company Limited
Q3 2014 Earnings Call Transcript

Published: 13 Nov 2014

[Operator:]

Welcome to the China XD Plastics’ Third Quarter 2014 Financial Results Conference Call. At this time, all participants are in listen-only mode. Following management’s prepared remarks, there will be a question-and-answer section later. 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, Sandy Qin. Please go ahead.

[Sandy Qin:]

Thank you, operator and welcome everyone to the call. Thank you for joining us for the China XD Plastics’ third quarter 2014 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. Mr. Kenan Gong, a graduate to the Board and Mr. (Lou Jintai) Director of Technology. Earlier today, China XD Plastics issued a press release announcing its third quarter 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 the 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 statements 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, November 13, 2014. 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, taxes, depreciation and amortization, which we will call by its abbreviated named EBITDA. EBITDA is 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 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, Sandy and thank you all for joining us today. We are quite pleased to announce our strong sequential growth in the third quarter. We experienced a revenue growth of 19.5% over our second quarter results. This quarter, we experienced an increase in our sales volume as well as higher ASP due to a shift in product mix. Our sales growth continues to be driven by strong domestic demand as well as our successful sales and marketing efforts in Asian markets outside of China, particularly Korea. As we discussed on last quarter’s call, China’s automobile industry is experiencing tremendous growth, which we expect to continue in the years to come. Additionally as Chinese consumers’ purchase power continues to advance, mid-class and luxury car models account for a greater percentage of new cars sold in China. These higher end cars contain more parts built of advanced polymer composite materials than their lower end counterparts. Traditionally, these automotive polymer composite parts have been imported into China by multinational suppliers. However, in recent years, domestic manufacturers have begun to produce customized polymer composite at a cheaper price. China XD and our domestic peers are uniquely positioned to take advantage of this shift in industry dynamics and capture market share from international suppliers. In the future, Chinese automotive industry will keep these healthy development trends with stable growth rate of Chinese economy and faster developing areas in high-speed rail, ships, aircrafts and other high-end peers. This will bring tremendous new growth opportunity. China XD has been well prepared to take advantage of this great opportunity. First, our new manufacturing campus in Sichuan province is strategically located in China Southwest, a region where many auto manufacturers are also setting up operations as well as easier access to markets in Southeast, South China and Central China. We expect the Sichuan campus to be operational in 2016. As you can see from our financial results, we are continuing to focus our resources in R&D efforts. This year, China XD has broadened its product offerings from 6 major categories to 11. The company has achieved the breakthroughs in 3D printing and filed the greater raw materials, which will be gradually put into manufacturing. This has led a great foundation for the company to diversify its product offerings from the automotive applications to other high value and high margin applications in high-speed rail, ships, aircrafts, medical and electronics. In addition, looking towards our international markets during the third quarter of 2014, our sales to Asian market enjoys a significant increase compared with last quarter. We expect this to continue to be a strong growth market for us in the coming quarters and years. Our new manufacturing facility in Dubai, which is currently under construction and will be put into use gradually, will provide additional capacity for other international growth markets for us in the Middle East, Russia and Europe. Based on our strong performance in the first nine months of the year and the exciting growth opportunities we see coming, we remain very optimistic about the prospects for China XD Plastics. Accordingly, we reiterate our guidance for 2014. The company continues to expect full year sales to range between $950 million and $1.05 billion and net income to range between $100 million to $120 million. Now, I will turn the call over to Taylor Zhang, our CFO to walk you through our financials. Taylor?

[Taylor Zhang:]

Thank you, Mr. Han, thank you, Sandy and everyone for joining the call today. Before I review the numbers, let me remind you that all figures we discuss are for this reporting period, the third quarter of 2014 unless I state otherwise. Additionally, any year-over-year comparison is to the third quarter of 2013. And any sequential comparison is to the second quarter of this year. So, let’s review our third quarter results. Revenue of $315.7 million was up 7.7% year-over-year and 19.5% sequentially as a result of gross increased sales volume, the improved pricing. In particular, volume grew 4.1% year-over-year, while average RMB selling price was up 3.9%. The increase in sales volume was driven by a strong demand in the PRC and Asian markets. Additionally, our marketing efforts to develop new customers have proven effective as sales in Korea comprised 18.8% of total revenue compared with 8% in the second quarter of 2014. The increase of average RMB selling price was mainly due to our continued shift of product mix towards higher end products. Turning to margins, gross margin was down to 20.7% from 22.4% in the year ago quarter, but improved from 19.8% sequentially. Gross profits declined 0.5% year-over-year to $65.4 million. The slight decline was primarily due to higher cost due to applying some costly raw material over in April quarter originated for R&D activities. G&A expenses of $5.4 million were invested in building our corporate infrastructure to support growth. We are continuing to maintain a reasonable level of expenses in this category at a no more than 2% of the sales. R&D spending was $5.1 million or 1.6% of sales, consistent with Q3 of 2013. This is a healthy level of research investment at least in line if not better than healthcare’s. We now have up to 128 active research projects compared to 151 in the second quarter. We expect to realize economic benefits of approximately 25% of these projects in the near-term. Operating income was $54.7 million or 17.3% of sales. Operating income was down 2.1% year-over-year, but up 59.5% sequentially. Net interest expense was up meaningfully year-over-year as we continued to borrow to fund growth. Net interest expense was $8.8 million, up from $2.8 million a year ago, primarily due to $4.6 million interest expenses resulting from notes issued on February 1, 2014 as well as increased interest expenses resulting from the increase of bank loans to meet the need of our future capacity expansion both in the Southwest China and in Dubai. Our leverage is still extremely manageable with very high coverage ratios. Taxes were $4.5 million equating to effective income tax rates of 19.5%. This was well below our effective tax rates of 19.8% in the second quarter due to more income generated by our Sichuan sub with an income tax rate of 15% and through the assumption of tax on income from our Dubai sub. Net income for the third quarter of 2014 was $43.2 million compared to net income of $41.1 million for the same period of the prior year. Basic and diluted earnings per share were $0.66 and $0.62 respectively compared to $0.64 for basic and diluted share in the third quarter of 2013. However, as most of you know other income or expenses included gains or losses on the revaluation of our warrants liability and fair value change of our contracts. These gains or losses are non-cash entries that vary each quarter depending on the movements of our stock price, because this is not directly related to results of our business we also present an adjusted net income number that strips out these effects. This is the standard presentation procedure followed by almost all companies with similar warrants and liabilities. Removing the effect of fair value change of warrant and liability and for contract, our adjusted net income was $41.3 million and our adjusted basic and diluted earnings per share was $0.63 and $0.59 respectively. Moving to more cash flow oriented metrics, during the quarter our operating cash flow was $64.1 million, investing cash flow $220.8 million, financing cash flow was $125.6 million. EBITDA was $64.3 million compared with $64.2 million in the same period of the prior year. Now let’s turn to the balance sheet, our balance sheet remain solid even as we fund record growth. Obviously, we are borrowing to fund our growth with the proceeds from borrowing going into or earmarked for capital spending. As of September 30, 2014, our working capital condition has improved from $289 million as of December 31, 2013 to $445.3 million. Day sales outstanding was down to 53 days from 63 days at the end of the second quarter. Although debt is now 52.4% of our total assets as I mentioned that service burden is very manageable. We remain cash flow positive and plan to further reduce our onshore debt to 15% of total assets before the end of the year. We are funding our rapid growth. Before we open to the call to your questions, I would like to note that for any questions directed to Mr. Han, Qingwei Ma or Junjie Ma, 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 other listeners. With that, we open the call to your questions. Operator?

[Operator:]

Thank you. We will now begin the question-and-answer session. (Operator Instructions) Our first question comes from the line of Graham Tanaka from Tanaka Capital. Your line is open. Please go ahead.

[Graham Tanaka:]

Yes, congratulations again for another strong quarter. Taylor and Mr. Han, first off about the major changes we see are the Dubai operations I guess you are saying are producing a plastic now. We are just wondering what the current production rate is in either tons or the dollars of sales and what that production rate might be at full capacity? Thank you.

[Taylor Zhang:]

Hi, Tanaka. This is Taylor. So, just want to clarify, the Dubai facility is still under construction. We currently actually utilizing the arrangement basically our Dubai sub, actually arranging the sales and manufactured by our China sub. So, this is a intermediate step basically all the customers were actually belong to Dubai’s subsidiary, but our manufacturing facility actually allocated a little bit for Dubai’s business.

[Graham Tanaka:]

And when is that facility going to be producing and what will it’s capacity be – it’s annual capacity be? Thank you.

[Taylor Zhang:]

Yes. We expect the Dubai operation to be ready to produce by the end of this year. So, very likely starting from early next year we will be able to see contribution from Dubai and the current capacity we have to be installed is as we have mentioned before 5,000 metric tons.

[Graham Tanaka:]

And what will be the average selling price of the kind of materials shipped out of that facility? Will it be I assume it’s not going to have the entire broad range of products that you produced out of the other facilities? Thank you.

[Taylor Zhang:]

Right. Tanaka, let me defer your question to our R&D colleague, so they can give you more accurate information.

[Unidentified Company Speaker:]

Yes, Taylor, I think I can handle this question.

[Taylor Zhang:]

Okay, go ahead.

[Unidentified Company Speaker:]

Yes. I think your question is very right, I think that the product (indiscernible) is very different with the product that we are manufactured domestically. And that product is at the very end such as the (indiscernible) PA66 and also the long carbon chain that PA12 plastic alloy, which mainly used in specialized and functional cars – in the cars as the few tank, few pipes and also the selling price on the (indiscernible) you just ask it around the $12,000 total.

[Graham Tanaka:]

I have additional questions I can come back if you want or if you want me to ask now, Taylor, so I go ahead.

[Taylor Zhang:]

Yes, sure. Go ahead, yes.

[Graham Tanaka:]

The non-auto sales, what percentage was that in the third quarter and what might that be in the fourth quarter and next year? Thank you.

[Taylor Zhang:]

So, Tanaka, the non-auto is still less than 10%. We think in next year, even though it’s still little early, because we do have the fully visibility for the annual contract next year right now, but we think could probably stay around 10% or a little higher.

[Graham Tanaka:]

And then the other pleasant surprise was the Korea has gone to be such a large consumer, I am just wondering again what that could be next year as a percent of sales? Thank you.

[Taylor Zhang:]

For Korea, we think next year probably can stay at about 20% of sales. Obviously, depends on our penetration and also acquisition of new customer the percentage can vary.

[Graham Tanaka:]

Yes. Is there a cost advantage first to the Korean manufacturers or are you competing with Western manufactures for the Korean market?

[Taylor Zhang:]

Okay. Qingwei, you want to handle this question?

[Qingwei Ma:]

Sure, no problem. And actually, that many competitors in the Korean market were encountered right now as I stated that international big players like (indiscernible) etcetera, etcetera, those kinds of companies that produce various standard rights, the high end part of the companies, but again due to the very excellence that we showed between the performance and the price of our products, our (indiscernible) why our product can penetrate into the Korean market.

[Graham Tanaka:]

Thank you very much.

[Operator:]

Our next question comes from the line of (Robert Zelenka) from Forex Group. Your line is open. Please go ahead.

[Unidentified Analyst:]

Yes. Nice quarter fellows. Good job. A couple of things. One, what’s the status that you can discuss relative to the class action lawsuits?

[Taylor Zhang:]

Hi, Bob, thank you. For the class action, I think still in its preliminary stage. And we have learned from our council that a – it was filed with the Court in New York. And so far we think it’s still a boiler plates templates with very little meaningful information. But as we discussed in our 10-Q we don’t believe there is any merits for these lawsuits and we are confident that we can fully defend ourselves and in addition, we do have sufficient coverage from our insurance.

[Unidentified Analyst:]

It’s my understanding that the Seeking Alpha Bleecker Street Article was reduced, many of the points were removed as a request of council and based on that and since the lawsuit was primarily based on that article, is there a point where the judge will rule over this, do you have any timetable on that?

[Taylor Zhang:]

We definitely hope for the best results. And also we think anyway we can minimize the distraction to the management or Board and also other stakeholders will be beneficial to everyone. But we think still in the U.S. as you know as well, the legal system probably for the timing, our council advice really varies, a certain procedure that Court has to be performed, but definitely the reduction from the – reduction of allocation from Seeking Alpha article would be helpful.

[Unidentified Analyst:]

Okay. You put out a press release this morning regarding the status of the China plant, are there any other approvals that will be pending beside a Certificate of Occupancy for that plant to go forward. I know you are leveling ground, do you need approval to put a shovel into the ground, etcetera. Are there other pending approvals that you can share with us?

[Taylor Zhang:]

Okay, sure. Bob, let me translate your question. Okay. Bob, your answer come from our Chairman, so basically you share with us initially there was slightly delay from the government side to issue the approval. Right now, we have all the necessary approval to go ahead and construct the facility. So, there would be some other follow-on approval, which we will need to obtain, for example for safety, product quality around the progress, but we think – we don’t think that there is going to be any significant delay ahead.

[Unidentified Analyst:]

Thank you so much. Okay, that ends my questions.

[Operator:]

Our next question comes from the line of Peter Sirus from Private Investor. Your line is open. Please go ahead.

[Peter Sirus:]

I have a couple of questions. First, this is the second quarter in a row that you have talked about 3D printing and then you also mentioned biodegradable products, can you explain what that means and how that figures on your business plan?

[Taylor Zhang:]

Sure, thank you, Peter. Let me translate the question and our tech team will give you more color. So, Peter, your answer comes from our COO, Mr. Ma. So, the first part is regarding 3D printing material. So, we actually started research in 3D printing material last year. We have assembled a team to dedicate on this project. So, right now, we have 10 plus products that are viewed very positive results and also received well. So, originally, the idea is basically to help our customer when they develop a new product, for example, new parts. Right now, it’s still in the smaller scale, but this definitely help the customer to reduce their product development cycle by reducing the time they needed for prototype developing and also save them tremendously on the developing cost. So, we think on this even though we have not in a position to commercialize it, but there – we definitely believe there are some other applications outside of our existing customers that we can benefit from. And Mr. Ma has the second part to follow. And Peter, to summarize the way we look at 3D printing material, there is two friends, one is as we talk about which is the value-added service to our customer, which we believe will in turn to enhance the loyalty from a customer; secondly is we are developing for mass-market application in the future. So, these are two segments we are currently looking at.

[Peter Sirus:]

Thank you very much. Very interesting. I want to ask just a long-term modeling question since there are no analysts following the company, the – your capacity you are pretty much at full capacity in Harbin at the moment, correct?

[Taylor Zhang:]

That’s correct. In the third quarter, the utilization is over 90% already.

[Peter Sirus:]

Okay. So, the – and the only – the capacity coming on in ‘15 will be from Dubai?

[Taylor Zhang:]

That’s correct.

[Peter Sirus:]

That will be – so everything being equal, I mean I know that you are working to higher value-add products etcetera, etcetera, but in terms of capacity, you have Dubai, Dubai should be a reasonable contributor in ‘15, right?

[Taylor Zhang:]

That’s correct.

[Peter Sirus:]

And in ‘16, you should start to get some production out of Southwest, but is there any way of – I know it says it’s going to start in ‘16, ‘16 will just be mostly trial production in Southwest?

[Taylor Zhang:]

We – the current planning is we expect in 2016 the Southwest campus, we will bring one third of the capacity, which is (indiscernible) in 2015.

[Peter Sirus:]

So, that you should see a decent bump in sales and earnings in ‘16 and then a bigger bump in sales and earnings in ‘17 when Southwest comes on?

[Taylor Zhang:]

Yes, that’s correct.

[Peter Sirus:]

Okay. And then at the end of ‘17, you should be roughly double your current size, is that correct?

[Taylor Zhang:]

Yes, I think we are close to currently have 390 in Northeast, so 300 is, slightly over 80% additional.

[Peter Sirus:]

Plus Dubai you said was how much?

[Taylor Zhang:]

Dubai is not a volume play. It’s basically only Southern, but the product that Dubai…

[Peter Sirus:]

It’s higher value-added. Okay, so roughly by the end of ‘17, you should have roughly 80% more capacity than you do now, right?

[Taylor Zhang:]

Yes, yes, that’s right.

[Peter Sirus:]

Okay, great. Thank you very much.

[Taylor Zhang:]

Thank you, Peter.

[Operator:]

Our next question comes from the line of (indiscernible). Your line is open. Please go ahead.

[Unidentified Analyst:]

Hi, congrats on the great results. Just couple of questions. The first is I noticed on the results that – the first result, I saw 5.2% year-on-year increase in sales volume and below I saw another 4.1% increase in sales volumes, so which is the right number. Secondly, I missed the Korea sales how much is it as a percentage of total sales? And my last question is could you explain the tax rate again and I wasn’t clear on that part? Thank you.

[Taylor Zhang:]

So the year-over-year gross volume is 5.5%. The overseas sales during the third quarter were approximately 18.9%. The tax rates basically we have three categories. Our most subsidiaries in our Northeast region have tax rates of the regular rates, which is 25%. Obviously, there is (longevity) as eligible for 15%. In our Southwest sub, the tax rate is 15% and in our Dubai sub, the tax rate is zero. So effectively during Q3 our effective tax rate is slightly over 9%.

[Unidentified Analyst:]

Sure, for the average tax rate to be 9% the Dubai sales has to be really substantial probably about half of the net income probably about half of total net income in order for the average blended tax rate to drop so much, am I right?

[Taylor Zhang:]

Yes. There is also another tax benefit from Southwest, the 15% is the popular more prevalent rates in Southwest region or in for company eligible for investing in Southwest. In addition, we will also get 40% back from the local government they are withholding, so effectively in Southwest the tax rate is approximately 9%.

[Unidentified Analyst:]

Yes. Thanks. Just a follow-up on that, currently your Southwest plant is currently being constructed, so you are not producing anything there, for you to have any source that you have to transport the plastic all the way Harbin which is really far away. And yes, did you have one that because I thought the economic radius is about somewhat less than 500 kilometers?

[Taylor Zhang:]

Let me clarify, so the Dubai sub now the customer were acquired by Dubai and also the order was received by Dubai, while we have originally in places, Dubai asking our China sub our Harbin sub to produce on behalf of our Dubai sub before Dubai has contribution in production. So the – in the second and third quarter these sales were actually made in Korea which is not too far from Harbin naturally a lot shorter compared from Dubai to Korea.

[Unidentified Analyst:]

Right. Thank you. And what’s the Korea capacity again, the production capacity?

[Taylor Zhang:]

We don’t have any operational capacity in Korea, but the Dubai the design capacity which we are currently working on is 5,000 metric tons.

[Unidentified Analyst:]

Right. So the Korean sales also comes from Harbin?

[Taylor Zhang:]

That’s correct.

[Unidentified Analyst:]

Right. Thank you.

[Taylor Zhang:]

Thank you.

[Operator:]

It appears to have no more questions. I will now turn the call back to Sandy Qin for closing comments.

[Sandy Qin:]

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 or our IR firm, ICR. The contact numbers for all of us are listed at the end of the press release.

[Operator:]

That concludes our conference for today. Thank you for participating. You may now disconnect.