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Executives

James Mu – IR

Taylor Zhang – CFO

Jie Han – Chairman & CEO

Analysts

Raj Maheshwari – Charlestown Capital

China XD Plastics Co. Ltd. (CXDC) Q3 2012 Earnings Call November 13, 2012 9:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by and welcome to CXDC 3Q FY 2012 earnings conference call. At this time, all participants are in a listen only mode. There will be a presentation followed by a question-and-answer session. (Operator Instructions). I must advice you that this conference is being recorded today, Tuesday the 13th of November, 2012. I would now like to hand the conference over to your first speaker today, Mr. James Mu. Thank you, please go ahead.

James Mu

Thank you operator. Good morning and good evening to those in China and thank you for joining us for the China XD Plastics third quarter 2012 financial results conference call. Joining the call today are Mr. Jie Han, Chairman and CEO, Mr. Qingwei Ma, Chief Operating Officer and Mr. Taylor Zhang, Chief Financial Officer and Mr. Junjie Ma, Chief Technology Officer. Earlier today, China XD Plastic issued a press release announcing its third quarter of 2012 financial results.

Before management’s presentation, I will like to refer to the safe harbor statements in connection with today's conference call and remind our listeners that management’s prepared remarks and the questions and answer session during this call may contain forward-looking statements such as statements reflecting management’s current believes regarding anticipated completion and deployment of additional production lines and capacity, market trends, expansion into different geographic areas and market segments outside automotive sector, revenue and net income guidance and our future growth prospects and market position. These statements by their nature are subject to risk and uncertainties. The company therefore claims the protection of the safe harbor for forward-looking statements that is contained in the Private Security Litigation Reform Act of 1995. Actual results may differ from those discussed today and we refer you to a more detailed discussion of the risk and uncertainties in the company’s filing with the Securities and Exchange Commission also known as the SEC. A more comprehensive description of risk and uncertainties that may impact the company’s forward-looking statements is contained in the company’s filing with SEC. in addition, any projection as to the company’s future performance represents management’s estimates as of today November 13, 2012. China XD Plastic assumes no obligation to update projections in the future as market conditions change. To supplement its financial results, present in the quarter with the US GAAP. Management will make reference to certain non-GAAP financial measures which the company believes provide meaningful additional information to better understand its operating performance. A table reconciling non-GAAP measures to mirrors GAAP equivalent can be found on earnings press release issued today.

I will now like to turn the call over to Mr. Han. Mr. Han will be speaking in Chinese and I will translate his presentation into English. Mr. Han, please go ahead.

Jie Han

[Interpreted]

Thank you James and welcome to all of you who have joined us today. I am pleased to report another quarter of record revenues and profit growth especially during the changing and challenging macro environment affecting different industries in China. The performance of this quarter speaks volume of our proactive of future penetrating our less entrench the north east China markets with a focus on higher end applications used in more luxury car models an increase from 17.8% to 21.1% and 19.5%, 22.28% as a percentage of total revenues as compared to the same period of fiscal year 2011 offsetting the slower growth in our traditional north east china market. In addition, the number of sales distributors was increased by one from second quarter of fiscal 2012 bringing our total number of sales distributors to eight.

Our overall business performance remains very solid and as evidenced by 57.7% increase in volumes shipped to 61,589 metric tons in this quarter up from 39,057 metric tons I the third quarter of 2011. We continue to ship our product mix towards higher value item products which tend to have stronger and increasing market demand. Average selling price increased by 3.6% in the third quarter compared to the same period last year partially resulting from the set factor. We are very pleased with this progress and believe this positive results reflect our ability to take advantage of the growth prospects in our market.

As part of our long term growth strategies, we have continued to increase R&D in developing high value add products and obtaining new certifications from automotive manufacturers. By the end of third quarter 2012, 236 of our product has been certified by automobile manufacturers also known as AM. As many of you know, product certifications are an important part of our business and are leading number of certifications gives us a significant competitive advantage as we continue to expand our customer base in China’s growing high quality modified plastic sector.

Meanwhile with our schedule, the 20 new production lines in our third quarter production base launched in December 2011 contribute a promisedly (ph) 22,825 tons of production during the third quarter of 2012. In addition, the construction of the third additional workshop of three additional workshops has been completed and most of the 30 additional production lines were delivered to our site on schedule for us to complete the installation and trial run in December of 2012 which will further expand our annual capacity potential by promisedly (ph) 135,000 metric tons and support our future growth in 2013.

We believe that our ability to generate strong consistent performance despite recent fluctuations in auto sales in China is testament to our operating model. The factor risk management, our ability to reduce our dependency on overseas market and diversify our market coverage and the successful execution of our long-term growth strategy, certain underlying market trends such as the increasing plastic content per vehicle and increasing demand for modified plastics used by our major customers in mid and high end branded cars, are expected to persist and support growth. In addition, we have been able to consistently gain market shares from importers and foreign and joint venture manufacturers. The development of new product lines and capacity along with our committed investment in R&D are parts of our long-term growth strategy to take advantage of this underlying trends. We continue to shift our product mix to our higher value added product during the third quarter of 2012 and successfully obtained nine new automobile manufacturer product certifications and had 147 additional products under research and development as of September 30th, 2012.

Over the long term, we’ll continue to elaborate the benefits of our expertise and technology platform to take advantage of opportunities, to expand our customer basis, to include industries outside automotive sector. Taken together, this overall strategy allows us to maintain our sturdy growth in revenue and gross margin while helping to show that we stay on leading edge of modified plastic sectors in China.

With all of this then, we are confident in the future prospects of our business and market and look forward to strengthening our position and delivering significant stockholder value over the long term. Thank you all 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 Jie Han and thank you everyone for joining the call today. Now looking at our quarter as you have seen from our earnings release, we delivered solid quarter results driven by increased sales in terms of both volume and product mixture into both existing and new customers. Revenues for the third quarter of fiscal 2012 were $136.3 million representing a year-over-year increase of 57.4% from $103.8 million from a year ago. The increase in revenues was mainly due to the increases in sales volume and average selling price driven by increasing demand from modified plastics from middle and high end cars. The increase of a modified plastic car and the shift in product mix to include a greater percentage of sales of high margin and higher value added products as well as growth of revenue contribution in east china markets.

In our third quarter of 2012, gross profits was $40 million, up 50.9% from $26.5million in the same period of fiscal 2011. Gross margin was 24.5% compared to 25.6% in the same period last year. The year to year decrease in gross margin was mainly attributed to the increase of the price of raw material, increase of depreciation and payroll this year partially offset by our efforts in developing and selling more higher value added other modified plastics towards high end products as a percentage of total sales in third quarter ended September 30th, 2012.

General and administrative expenses were $2.2 million or 1.4% of total revenues compared with $2.3 million or 2.2% of total revenues for the same period over the prior year. During the third quarter of 2012, research and development expenses were $5.5 million, were 3.4% of total revenues compared to $3.5 million or 3.4% of total revenues in the same period last year. The increase in R&D expenses reflected our increased research and development activities on new products primarily in consumption of raw materials for various experiments for all applications from manufacturers as well as other non-applications.

During the third quarter of 2012, the company successfully launched nine new AM certified products which increased our total number of AM certified products to 236 and we finally we have 147 new products in our pipeline. During the third quarter of 2012, operating income was $32.3 million or 19.7% of revenues, an increase of 55.4% over operating income of $20.7 million or 20% of revenue in the same period over the prior year. Earnings before interest, taxes, depreciation and amortization for the third quarter of 2012 was $37.2 million and 58.4% increase from $22.1 million in the same period last year.

Net income for the third quarter of fiscal 2012 was $25.3 million compared to net income of $15.7 million for the same period a year ago. Basic and dilutive earnings per share were $0.40 respectively, a significant increase when compared to last year’s results which were at $0.33 respectively.

Adjusted net income for the third quarter excluding non-cash charges associated with share based compensation deferred income tax benefits and change in fair value of derivative liabilities were $24.5 million.

Turning to the balance sheet. We continue to manage our business for a position of financial strength. As of September 30, 2012 China XD Plastics had $51 million in cash and cash equivalents, $28.5 million income deposits with commercial banks, $188 million in working capital and a current ratio of 2.6. Stockholders as of September 30, 2012 was $244.2 million compared to $173.9 million as of December 31st 2011. As of September 30 2012 accounts receivable was $120.9 million compared to $45.2 million as of December 31st2012 as we adapted to the change of our industry environments and it takes longer to collect from our customers.

Days sales outstanding was 76 days for the nine months ended September 30, 2012 and still well below industry average. The average DSO for the automotive products industry is generated 90 days based on our industry experience. We expect that other accounts receivables are collectible and anticipate our DSO to remain at this level for the remainder of this year and early next year.

The net cash investing operating activities was $12.4 million for the nine month ended September 30, 2012 as compared to $54.5 million provided by operating activities in the same period of last year. The decrease of $66.9 million net cash in operating activities was primarily due to first, the increase of approximately $148.1 million in cash operating expenditures, including raw material purchases, rental and personnel costs.

Second, the increase of approximately $12.1 million income tax payments in the nine month ended September 30, 2012 resulting from the increase in income before tax and income taxes as a result of internal reorganization for the nine months ended September 30, 2012. The increase of cash operating expenditures and income tax payments were partially offset by an increase of approximately $93.3 million in cash collected from our customer in the nine months ended September 30, 2012 resulting from increasing sales (inaudible).

Finally given the company’s solid performance during the third quarter of 2012, along with our successful and proactive strategy adjustment, to adapt to the market change and positive outlook on a customer demand for our products for the remaining 2012. The company refuses this revenues for fiscal 2012 to range between $570 million and $600 million and non-GAAP adjusting net income to range between $85 million and $95 million. Excluding earning non-cash charges related to deferred income tax benefits, stock compensation and changing fair value of existing derivative liabilities. This forecast is from constant (inaudible) and reflects the company’s current and preliminary view which is subject to change.

Now before I open the call to the questions, I would like to note that for any question directed to Mr. Jie Han, Mr. Qingwei Ma or Mr. Junjie Ma, I will translate both the question and their answers. With that, we’ll now open the call to your questions, operator?

Question-and-Answer Session

Operator

(Operator Instructions). All right, your first question comes from the line of (inaudible). Please ask your question.

Unidentified Analyst

Just wondering, can you talk a little bit more on the changes you’ve adopt to regard to the environment change that you mentioned about, especially related to the account receivable, since you’re changing a lot in this quarter. Thank you.

Taylor Zhang

So for the accounts receivable, right now, as you probably learned, the auto industry is slowing down and there is some challenge, so it does take a longer to collect from our customer, but as we mentioned, the collection time is still well below industry average which is negative and for the first three quarters, our DSO is 76 days. So we are accommodating that, we’ll be able to crack those accounts receivable by the end of this year and for the macro change, I'll direct the question to our COO.

Qingwei Ma

[Interpreted]

So, basically as you know, the macro environment in China affects the various industry in China and auto is actually fair little bit better compared to other industry, so this year with industry can grow by about 5% however there is some headwind for example, the inventory of automaker are increasing and also the increase of their cost also reducing their gross margin, as a result, the collection time from our customer which is a product manufacturer from automaker or so, for a little bit, so also, this kind of (inaudible) to us. And in addition, as we grow our market share and our typically our distributor will make a payments, if their customer cannot make the payments on time, so as our sales volume increase, they are also going to take some time to adjust there.

Unidentified Analyst

Okay, so do you see your DSOs kind of stable on the industry average or do you see there you can see you see your DSO increase and also do you see the accounts receivable to come down a little bit in the fourth quarter or is it going to be stay at this level, can you see that historically you AR is pretty much around 15 year and this quarter AR was up to 120. I am just wondering if that's norm or you’re just one quarter for that.

Taylor Zhang

So compared to our peers, our competitors, our DSO is still well below, for example, most of our competitors, their DSO is between 90 to 120 days. So we do expect our DSO to remain below industry average and also remain at a current level above 76 days for the remaining of this year.

Unidentified Analyst

68 days you mentioned?

Taylor Zhang

76.

Unidentified Analyst

So Q4 should be around this number. And then it’s going to be, it’s kind of normal level going forward? Right? I mean unless that's immune to changes.

Taylor Zhang

Okay.

Unidentified Analyst

Okay, so in that case, do you expect you are going to be cash flow positive in the fourth quarter, I mean in terms of operating cash flow.

Taylor Zhang

I think for now, we think it’s still early to tell but that's how it will go.

Unidentified Analyst

All right, so just one last question.

Taylor Zhang

For example, we in the third quarter we have some other items for example, on cash payments also increased, so just some variable we have to adapt which is also part of the operating activities.

Unidentified Analyst

So its proving all those are onetime expenses, if you just take the normal run rate for working capital, things that you need to pay for operation or raw material and based on your current new account receivable term and coupled with your quarter revenue run rate, do you expect that is going to be operating cash flow positive.

Taylor Zhang

Like I said, that's our goal and we care more than anybody else to manage our working capital, to collect from our customer, we need more time in the business. So we will do our best for this quarter and also in the future.

Operator

Thank you. Your next question comes from the line of Graham (inaudible) Asset Management. Please ask the question.

Unidentified Analyst

I was just wondering, if to start out, if you could maybe share with us your outlook on the economy and also for 2013 GDP growth inflation, unemployment that kind of thing as well as separately a comment on the new government leaders and what they might represent as change for your auto industry and for consumer spending in auto sales. Thank you.

Jie Han

[Interpreted]

So first of all, we are confident about the newly shift in China and he’s also feel positive about the coming year. So basically, he believes the core in China’s economy is the GDP per capita is increasing. Also, the consumer demand also is trending higher which is very important in any economy. And secondly, he believes the new leadership in terms of macro economy policy will be clear after the change in leadership and the policy will be directed to appropriate and necessary sector to stimulate growth for China’s economy.

Unidentified Analyst

Just wondering if he could may be estimate what you or your economic consultants estimate GDP growth and auto sales growth might be in 2013?

Jie Han

[Interpreted]

I believe next year, we should have some improvement compared to this year, so anywhere between 7 to 8% conservative speaking of 7% maybe somewhere like 75% or even 8%. As for auto industry I believe, next year is going to be a new place for the sector, so more focus will be on the quality and also branding for different auto maker. So being the extreme conservative view, so 5% should be achievable for auto industry.

Unidentified Analyst

The other thing that I think that many in the west are concerned about is the rising cost of labor and other inflationary cost within Chinese manufacturing sector. So for example, how much did your labor cost go up this year, estimate in 2012, what percent could it go up next year and are you going to be able to pass that through to customers in prices?

Taylor Zhang

As you probably know, labor is a very small fraction of our cost structure, less than 1%. So even though we have some increase in the recent quarters, so we have some reasonable allowed, approximately 30 to 40%, but still the labor cost as a percentage of total costs is still like less than 1%, that's really because of our manufacturer hit up. Our product lines are highly automatic, so labor is just a small input. We cannot speak for other industry, especially those labor intensive practices.

Unidentified Analyst

Great, I am glad that's the case. The other concern I think that many western investors have or many investors have is the currency and to what extent you think the Chinese currency is undervalued as a percent relative to say the dollar, and sort of DuPont near the other competitors coming in with, to what extent do you think the Chinese currency is going to be maybe revalued upwards in the next year and will that hurt still?

Taylor Zhang

Graham, I think this question is not only a macro but also credible. The currency, I mean how much the currency is undervalued is anybody’s call but so far for this year or since the last year, the exchange rate has been pretty stable and narrow wrench. But really (inaudible) we can’t give you our view, probably it doesn't reflect the outcome in the future. Graham because most of our customers are in China of itself, our sales are in China and unless we have substantial business outside China, the currency will not be a major issue of r our company.

Operator

And your next question comes from the line of Peter (inaudible). Please ask the question.

Unidentified Analyst

I actually have two questions. First is just a small follow up to Graham’s question. In the new factories that that I bill is that, they look much more automated, mechanism than the old factories, so in terms of labor, in the new factory, how much is there much lower labor cost than there is in the old factories?

Jie Han

[Interpreted]

So in our new production piece, our number three, so the average person per line is decreasing, but however we do have some consistent investment in R&D and increasing R&D personnel. So we think for the foreseeable future, the payroll will be pretty much the same or expectedly higher.

Unidentified Analyst

But that's because you’re spending more in R&D and less on the production line.

Jie Han

That's correct, yes.

Unidentified Analyst

The next question, I noticed that, in the quarter you spent $72 million on the purchase of land property and equipment and another 28 million on time deposits, so that $100 million, what is that for?

Taylor Zhang

For example, the investments are in the rent and also the building and the equipments we purchased. On their term deposit is just a different name for what we are familiar in that state CD, so look at (inaudible) cash but for some future payments we get some interest while we…

Unidentified Analyst

Okay, so that's a CD. So back to the purchase of land and equipment, is that all the land and equipment, is that all in (inaudible) or some of that's somewhere else?

Taylor Zhang

It’s all in (inaudible).

Unidentified Analyst

Okay, so that's the land and equipment for all those new factories workshop, whatever you want to call them that you are building?

Taylor Zhang

That's correct, yes.

Operator

Thank you, our next question comes from the line of Raj Maheshwari from Charlestown Capital. Please ask your question.

Raj Maheshwari – Charlestown Capital

Can you give us some idea of the CapEx for 2013?

Taylor Zhang

For 2013 basically, we have a some commitment for payments associated with our construction and also production line purchase which are expected to come online in December. So basically we have approximately about $50 million to be paid in 2013.

Raj Maheshwari – Charlestown Capital

And does that constitute the full amount or CapEx or is there additional CapEx in terms of line expansion or any other things?

Taylor Zhang

That would be all we needed for our production expansion.

Raj Maheshwari – Charlestown Capital

The other question I had is, how do you conceptually think about the Morgan Stanley preferred, what are the thoughts about either paying it or the conversion? Is this something we should expect that we should convert given where the share prices or is it something we should expect that will just be paid out of cash, because I don't see how you can pay that off unless you borrow money. So maybe you can help me think through that issue.

Taylor Zhang

So for Morgan Stanley preferred issue, we have a very collaborative and also good relationship with them, not only there being a major investor but also there have been very helpful and instrumental in many area in terms of capital market strategy and also, we bring a lot of industry contacts and involve with our strategic planning. So as for their holding, I think it’s a two way communication and we really, I think they are probably one with the best investor to have for a company with you guys. So we enjoy working with them and for their holding, I think partially up to them and we really appreciate and think of very valuable input from them.

Operator

Thank you. And that's all the time we have for questions today and I would now like to hand the conference back to today’s presenters for closing remarks.

Taylor Zhang

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

Operator

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

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