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China New Borun Corporation (NYSE:BORN)

Q3 2012 Earnings Call

November 16, 2012 8:00 AM ET

Executives

Terence Chen – CFO

Jinmaio Wang – Chairman, President and CEO

Ann Yu – Chief Strategy Officer

Analysts

Rick Lion – DSM Capital Partners

Adonis Lee – Brean Capital

Operator

Good day everyone and welcome to the Third Quarter 2012 Earnings Conference Call for China New Borun Corporation. Today’s conference is being recorded.

Before we get started, I am going to review the Safe Harbor Statements regarding today’s conference call. Please note that the discussions today will contain forward-looking statements made under the Safe Harbor Provisions of the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. To understand the factors that could cause results to differ materially from those in forward-looking statements, please refer to our annual report on Form 20-F filed with the Securities and Exchange Commission on April 6, 2012. The company does not assume any obligations to update any forward-looking statements except as required under applicable law.

At this time, I would like to hand the call over to Mr. Terence Chen, Chief Financial Officer of China New Borun Corporation for opening remarks and introductions. Please go ahead, sir.

Terence Chen

Thank you everyone for joining us for China New Borun’s third quarter 2012 earnings call. Joining me today from management are Jinmaio Wang, Borun’s Chairman and Chief Executive Officer, and Ann Yu, the company’s Chief Strategy Officer. On the call today, Mr. Wang will provide a quick review of current business environment. Following Mr. Wang, Ann will offer more details on our operations. After Ann, I will provide you with our third quarter financial details.

I would like to note that on this call today, all of our financial results will be referred to in Chinese RMB unless otherwise noted.

At this point, I would like to introduce Mr. Wang, Chairman and Chief Executive Officer of China New Borun. Mr. Wang will speak in Mandarin and I will translate. Mr. Wang?

Jinmaio Wang

Hello everyone and welcome to China New Borun’s third quarter 2012 earnings conference call.

This third quarter, despite the tough environment for the entire edible alcohol industry, I’m encouraged that our resilient business model and efficient operations has combined to help us once again develop positive net profits and operating cash flows.

Due to the challenging natural economic conditions, we noticed that many of the chemical players have ceased or significantly reduced their production which caused weaker demand of edible alcohol from the chemical industry. According to the figures released by the National Development and the Reform Commission, the chemical industry in China saw its profits increase [ph] by approximately by 20% year over year in the first nine months of this year. Hence, in addition to our annual scheduled maintenance that will apply [ph] the production hold for 10 days. This quarter we also ramped up production at a slower pace to roughly 26% of [inaudible] packaging.

The weaker demand combined with increasing raw material cost and decreasing selling price have largely squeezed the gross margins in the industry. Our gross margin this quarter was a historical low at 12%. In light of the lower gross profits, we steadfastly controlled our operating expenses and we’re able to earn positive operating cash flows and net incomes during the quarter. Our overall operating expenses in the third quarter improved 3% year over year, and 13% versus the previous quarter. I’d like thank our staff and employees for their continued diligence and discipline to continually improve our operating efficiency.

Although the third quarter was challenging for the entire edible alcohol industry, looking forward, we are encouraged that in October, comp prices are in a downward trend. And we believe these downward pricing trends of comp [ph] will lower our future production cost. In addition, we continue to focus on improving our operating efficiencies as we are using our operating cash to increase our whole inventory in order to reduce storage cost to a local granary. At the same time, during this quarter, we are also reducing our debt level in order to lower interest expenses.

In a word, I’m confident that we are well positioned to not only weather through the tough macro environment but also gain greater market leadership and profitability where market conditions eventually improve.

At this point, I would now turn the call over to Ann Yu for a discussion of our strategic and business development initiative.

Ann Yu

Thank you very much, Mr. Wang and Terence and many thanks to everyone for participating in China New Borun’s third quarter 2012 earnings conference call. As Mr. Wang had just discussed, the market environment during the third quarter was quite tense [ph] and as such we choose to keep production at less than full capacity.

During the third quarter of 2012, our Shouguang facility was running at approximately 80% of capacity and our Daqing facility was running at 173% of the capacity. Currently, our total net revenue decreased by 10.8% year over year to RMB559.2 million or RMB627 million in the same period in 2011. The principal decreased in total net revenue was attributable to lower edible alcohol sales during the quarter, which are primarily due to the combination of the three following factors; first [inaudible], the third quarter is seasonally our slowest quarter as we typically conduct our annual maintenance during the period. During the third quarter of this year, we halted production for about 10 days in our Shouguang and Daqing facilities for the scheduled maintenance.

Secondly, the slowdown in demand due to the macroeconomic revenues especially for our customer in the chemical industry. Overall, during the third quarter of 2012, net revenue of edible alcohol from chemical customers decreased by more than 30% on year-over-year basis. Certainly, given the depressed ASP and the existing tough environment, we adjusted our sales strategy to mitigate the potential collaterality risks by reducing our production capacity and selectively shipping only to our top customers based on their payment terms and order size.

And on the cost side, our cost of corn remains high. The average cost of corn in the third quarter of 2012 increased by more than 12% on a year-over-year basis. And this has resulted in higher cost of [inaudible] and pressure on our gross margins. The encouraging news is that the spot price of corn has come down at the beginning of the fourth quarter this year as China enters into corn harvest season. The rise of corn prices last year had encouraged China’s farmers to expand this year’s planting area and according to usually [inaudible] by the China National Grain and Oil information center that was recently published. The year’s corn yield is estimated to around 200 metric tons, about 4% increased from that in 2011.

Correspondingly, the spot price of corn in October has decreased slightly compared with that in September. So this downward price trend continue, we will benefit from decrease of production cost in the future.

Despite the lower revenue and gross profit during the quarter, we continue to focus on lowering our operating process as our operating expenses decreased by RMB1.8 million from last quarter. And we also closely monitor our working capital needs. During the third quarter, we used our operating cash flow to pay our short-term debt by a total of RMB41 million and consequently, our debt to equity ratio decreased to 26% compared to 44% a year ago.

Now, let me share with our thoughts on the future expansion. Considering the current market environment, we have put on hold our construction plan to expand the policy of liquid carbon dioxide at our Daqing plant. We will continue to evaluate the market and we’ll correlate our future expansion plans economy. Meanwhile, we also continue to monitor the competitive landscape as we anticipate that a number of weaker or smaller producers will be forced to exit industry or seek to be acquired by stronger and more efficient producer just like China New Borun.

That was my part, let me now turn the call over to Terence for a review of the financial in the third quarter of 2012.

Terence Chen

Thanks, Ann. Thanks, Mr. Wang. This third quarter was basically a tough time for the entire edible alcohol industry that forced us all producers to make adjustments. In light of the challenges, I’m pleased that Borun was able to make the necessary adjustments that enabled the company to remain profitable and well positioned for the future.

Let me now review our financial performance. For the third quarter of 2012, our total net revenue decreased by 10.8% year over year to RMB559.2 million from RMB627 million in the same period of 2011. The decrease in sales was mainly attributable to a combination of our production cost and weaker demands from customers in the chemical industry.

Revenue from edible alcohol decreased by 14.6% to RMB381.8 million in the third quarter of 2012 compared to RMB447.2 million in the third quarter of 2011, primarily due to the lower production as a result of weaker demand in grade C edible alcohol from chemical clients. The sales volumes of edible alcohol decreased by 14.5% year over year to approximately 68,760 tons. In the third quarter of 2012, the selling price of edible alcohol decrease slightly by 0.1% year over year to approximately RMB5,550 per ton.

Revenue from DDGS feed increased by 9.6% to RMB123.2 million in the third quarter of 2012 compared to RMB112.4 million in the third quarter of 2011. In third quarter of 2012, sales volume of DDGS feed decreased by 7.1% year over year to approximately 60,000 tons and the selling price increased by 18% year over year to approximately RMB2,050 per ton.

Revenue from liquid carbon dioxide decreased by 10.4% to RMB12.5 million in the third quarter of 2012 compared to RMB14 million in the third quarter of 2011, primarily due to a decrease in selling price per ton.

In the third quarter of 2012, sales volume of liquid carbon dioxide increased by 11.6% to 26,730 tons. And selling price decreased by 19.7% year-over-year to approximately RMB470 per ton.

Revenue from crude corn oil increased by 11.3% to RMB41.7 million in the third quarter of 2012 compared to RMB37.4 million in the third quarter of 2011. The increase was driven by higher sales volume during the quarter and partially offset by a decrease in selling price.

In the third quarter of 2012, sales volume of crude corn oil increased by 17.2% year-over-year to approximately 5,370 tons and selling price decreased by 4% year-over-year to RMB7,760 per ton.

Our gross profit decreased by 40.1% to RMB67 million from RMB111.8 million in the prior year period. Gross margin declined to 12% from compared to 7.8% in the third quarter of 2011, primarily due to corn cost increasing at a faster rate than ASP during this quarter.

Operating income, despite stable operating expenses, decreased by 44.9% to RMB54.4 million in the third quarter of 2012, from RMB98.8 million in the same period of 2011, primarily due to a lower revenue and lower gross profit.

On expenses side, we continue to hold the line on our overhead cost. Selling expenses decreased by 15.8% to RMB0.9 million in the third quarter of 2012 from RMB1.1 million in the same period of 2011, in line with the decrease in revenue during this quarter. Our general and administrative expenses were RMB11.7 million, a slight decrease compared to RMB11.9 million in the same period of 2011.

During the quarter we paid down an additional RMB41 million on our short-term debt which helped to reduced the interest expense by RMB0.9 million to RMB8.3 million in the third quarter of 2012. Income tax expenses in the third quarter of 2012 were RMB11.6 million, representing an effective tax rate of 25%.

Our net income decreased by 48.5% year-over-year to RMB34.8 million from RMB67.5 million a year ago. Basic and the diluted earnings per share and per ADS were RMB1.35 in the third quarter of 2012. The company had 25.725 million weighted average diluted shares outstanding during the quarter ended September 30th, 2012.

Cash flows provided by operating activities for the third quarter of 2012 were approximately RMB151.3 million, primarily driven by our customer selection plan and effective collections on our account receivables. During the quarter we collected a net accounts receivable of approximately RMB80 million. As of September 30, 2012, we have cash and bank deposits of RMB276.4 million as compared to RMB223.9 million at the end of 2011.

Well, that wrapped up the financial review for third quarter. And let me now discuss our business outlook for the fourth quarter of 2012.

Reflecting the continued lower demand from chemical industry as we discussed before, the estimated of revenue for the fourth quarter of 2012 will be in the range of RMB430 million to RMB470 million, a decrease of approximately 44% to 38% over the same quarter of 2011. This forecast reflects our current and preliminary view, which is subject to change.

This concludes our prepared remarks. Operator, we will now open the call up for questions.

Question-And-Answer Session

Operator

Thank you. Ladies and gentlemen, we will now begin the question and answer session. (Operator instructions)

Your first question comes from the line of Andreas Recker [ph] from DSM [ph] Capital Partners.

Rick Lion – DSM Capital Partners

This is Rick Lion [ph] in behalf of Andreas. You mentioned the weakness in the chemical industry. So how much percentage of your edible alcohol revenue is exposed to this chemical industry?

Terence Chen

Thanks for your question. And during this quarter approximately 30% of our edible alcohol goes to the chemical industry.

Rick Lion – DSM Capital Partners

Okay, got it. Thank you. And what is your average cost of corn for the third quarter of this year?

Terence Chen

Our average cost of corn during this quarter is around RMB2,000 per ton.

Rick Lion – DSM Capital Partners

Okay. And now with your first quarter guidance, do you expect yourselves to be possible and the cash flows will be positive, am I right?

Terence Chen

Frankly speaking, we are still facing the pressure from ASP in the fourth quarter. And ASP in October remain stable with this quarter. With our efforts to improve our operating efficiency, we are managing to improve our profitability in the next quarter.

And regarding to the cash flow, we have approximately RMB280 million cash on hand. And our target is to manage our working capital needs in the most efficient way. The next two quarter, as you know are the harvest season for corn and we will use this period to secure enough corn for the production need for the next year in our harvest season. We will use our cash on hand and generally, give the operating cash flow to finish our schedule of corn storage plans.

Rick Lion – DSM Capital Partners

Okay. I got that. It’s very useful. Thank you.

Terence Chen

Thank you.

Operator

Thank you for your questions. Your next question comes from the line Adonis Lee [ph] from Breen [ph] Capital. Please ask your question.

Adonis Lee – Brean Capital

Hey, hello. Thank you for taking my question. This is Adonis Lee from Brean Capital and I have two questions. And the first one is how long do you think at the past edible alcohol pricing situation will proceed and what’s your long-term outlook for gross profit margin? Thank you.

Terence Chen

Thank you for your question. As we have discussed in the previous quarter, we still view this as a short to medium term issue. And the average selling price of edible alcohol still will be under some pressure in the near future. It is very hard to say when the average selling price of edible alcohol is able to keep the pace with the increasing of the price of the corn. Highly in the part, the flat price of edible alcohol is – the cost there would increase the supply of edible alcohol coming from the weaker chemical industry. You know the chemical industry is not good now and those producers are looking for alternate markets. But looking ahead, this is dependent in part upon the price of corn and when the chemical industry carry [inaudible] which could shift the competition from the bio markets now.

And in addition, as Mr. Wang has just mentioned, the downward trend of the corn price in October will definitely lower our production cost in the future.

Adonis Lee – Brean Capital

Okay. Thanks. I have a follow up question. As you said, if you are the most efficient producer of edible alcohol, so what will happen to the other producers in this area? And are you seeing more players quitting industry?

Terence Chen

Let me answer your first question. If we were compared to other large producers, our efficiency is higher and of course gross margin is better. And we have significant comparative advantage of production savings benefiting from our in-house developed Borun Wet method. With the Borun Wet method approximately 3 tons of corn can use 1 ton of edible alcohol which approximately save 5% of the corn cost when compared with the industry average. And we believe this advantage is very meaningful.

And furthermore, our Borun Wet process is able to provide more valuable byproducts. And we can enjoy lower energy consumption.

And to your second question is?

Adonis Lee – Brean Capital

Are you seeing more players quitting the industry?

Terence Chen

Okay. We have actually witnessed more and more players in the industry limited with their production even temporarily ceased their production. The high and low [ph] where few are getting the best timing for any further consolidation.

Adonis Lee – Brean Capital

Okay. Just a quick follow up. Do you think it is a good timing for the industry consolidation? And what’s your outlook for the whole industry?

Terence Chen

As I have just mentioned, we are still assessing the best timing for any further consolidation. And regarding the outlook for the whole industry and the entire edible alcohol industry, it’s very challenging during this period even in the next period. However, it is mostly affected by the tough macroeconomic environment. But as we all know the government did not grant any new license for the edible alcohol production since 2006. Therefore, the whole capacity of the industry is limited.

Whether the markets from vital industry has remained strong once the macroeconomic environment recovers, the demand from chemical industry will definitely improve. I believe it is still a promising industry.

Adonis Lee – Brean Capital

Okay, thanks.

Operator

Thank you. As we do not have any further questions, I would like to hand the call back to the management for closing remarks.

Terence Chen

Once again, on behalf of the entire China New Borun’s management team, we want to thank you for your interest and participation in this call. Thank you for joining us today. And this concludes for our third quarter 2012 earnings conference call. Thank you.

Operator

Thank you, ladies and gentlemen. That concludes the conference call for today. Thank you for your participation. You may now disconnect.

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