Orient Paper, Inc. (NYSEMKT:ONP)
Q4 2012 Earnings Call
March 19, 2013 8:30 AM ET
Zhenyong Liu – CEO
Winston Yen – CFO
Howard Flinker – Flinker & Company
Good morning and good evening, ladies and gentlemen. Welcome to the Fourth Quarter and Full Year 2012 Orient Paper Inc Earnings Conference Call. At this time, I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode.
With us today are Mr. Zhenyong Liu, Orient Paper’s Chairman and Chief Executive Officer; Mr. Winston Yen, the Company’s Chief Financial Officer.
Orient Paper has announced its fourth quarter and full year 2012 financial results through a press release earlier and it is available on the company’s website at orientpaper.com. Mr. Liu will brief you on the company’s key highlights, operational and corporate development over the quarter and the year of 2012 and Mr. Yen will walk you through the company’s financial and business review as well as the Company’s outlook and guidance. After that there will be a Q&A session.
Before we begin I would like to draw your attention to our Safe Harbor statement. This announcement contains forward-looking statements within the meaning of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.
All statements other than statements of historical fact in this announcement are forward-looking statements, including but not limited to, anticipated revenues from the digital photo paper business segment. The actions and initiatives of current and potential competitors; the company’s ability to introduce new products; the company’s ability to implement the planned capacity expansion of corrugate medium paper; market acceptance of new products; general, economic, and business conditions. The ability to attract or retain qualified senior management, personnel, research, and development staff; and other risks detailed in the Company’s filings with the Securities and Exchange Commission.
These forward-looking statements involve known and unknown risks, uncertainties and are based on current expectations, assumptions, estimates, and projections about the companies and the industry. The company undertakes no obligation to update forward-looking statements to reflect subsequent occurring events or circumstances or to change in its expectations except as may be required by law. Although the company believes that the expectations expressed in these forward-looking statements are reasonable, it cannot assure you that its expectations will turn out to be correct, and investors are cautioned that actual results may differ materially from the anticipated results.
There is a presentation document featuring management’s prepared remarks and is now available for download from the company’s website at orientpaperinc.com. Please note there will be discussions on non-GAAP financial measure of EBITDA or earnings before interest, taxes, depreciation, and amortization. Please refer to our press release for complete reconciliations of EBITDA to net income.
As a kind reminder, all numbers in our presentations are quoted in US dollars and all comparisons refer to year-over-year comparisons unless otherwise stated.
I would now like to turn the call over to Mr. Liu. Please proceed.
(Interpreted) Good morning to our investors calling in today. I would like to discuss our fourth quarter and full year 2012 earnings and give everyone an update of our company’s activities.
Please turn to slide 5, where we will have a look at the key highlights for the fourth quarter and the full year.
Last year was a very difficult year for the paper industry and product credit has continued to remain soft in the fourth quarter. However, we’re pleased to record the highest quarterly revenue ever in the history of Orient Paper. Thanks to the successful ramp up of our new CMP production line which boosted our sales volume by 154% in the fourth quarter and 135% in the full year 2012.
As CMP is our core business, we have also started preparing for the renovation of our legacy line as announced earlier. An initiative we’re undertaking in anticipation of increased regulatory concerns on energy efficiencies and to upgrade the quality of our CMP products.
In the last quarter, we have automated a head start progress in our tissue business expansion, by securing the land lease and equipment suppliers to build our production facility in Wei County in Hebei Province. Wei County enjoys good transportation lengths with direct access to three national highways with increasing development of regional economy rising improvement of living standards with the tremendous demand growth that will benefit Orient Paper.
Furthermore, we’re pleased that our cash position has improved significantly. This will give us the necessary fuel to fund our business plan. Since the second quarter of 2012, we are pleased to have initiated three quarterly cash dividends.
Now, I would let our CFO, Winston Yen take it through the financial and business review and our 2013 guidance, and the interpreter will share with you our focus for the year on my behalf.
Okay. Thank you, Mr. Liu. I would like to remind you that all numbers are in US dollars, and all comparisons refer to year-over-year comparisons, otherwise stated. We have also assigned a numbering system for our connector line for easy reference and the table of this is provided in our earnings press release and in the appendix of the presentation on slide 28.
Now, let’s look at the financial performance over Q4 and for fiscal 2012, and please turn to slide 7. Total revenue for Q4 was a record high for the company at $44 million, up 12%. For full fiscal 2012, total revenue was $151 million, a minor increase at 0.2%.
Gross profit for Q4 was $7 million, down 20%. The gross margin was 15% compared to 22%. For full fiscal 2012, gross profit was $27 million, down 18%. Gross margin was 18% compared to 22%.
Income from operations for Q4 was $3 million and operating margin was about 7% while for the full fiscal year income from operations was $21 million and operating margin was 14%. The decline was largely due to the $2.8 million impairment loss we booked in anticipation of the renovation of paper machine One or PM1. Our legacy corrugated medium paper line, which we will discuss shortly.
Net income was $2 million, down 64%. Net margin was 5% compared to 14%. This translates to basic and diluted earnings per share of $0.11. For full fiscal 2012, net income was $50 million and net margin was 10%, which translates to basic and diluted earnings per share of $0.79.
Both our gross and operating margins were affected by in increase raw material cost of for CMP than lower ASP in Q4. Our margins for fiscal 2012 are mainly affected by production disruption and overall week for product pricing.
And we now move down to slide 8 on our cash position. And as Mr. Liu pointed out earlier, our cash position have strengthened significantly. The company continues to be well capitalized and liquids with increased free cash flow and solid cash flows from its operating activities. After completing the installation of PM6 the new CMP production line, our cash and cash equivalents now are up to $13 million at year-end compared to only $4 million one year ago.
For fiscal 2012, we generated as mix cash flow from operating activities of $22 million, up 19%. We also had $15 million in cash expenditures for the construction of ancillary facilities for the new production line, facilities to house the new boiler and additional power substation equipment.
Going back to our point maintaining our cash flow, that allows us to fund execution initiatives as well as business expansion in a credit tight environment.
Now breaking down our revenue by product starting from CNP on slide 9, in Q4, we generated $31 million for this business segment, up 125% taking up 71% of revenue. Sales volume reached 8,000 tons, up 154%. ASP declined by 11% to $369 per ton.
During this quarter the new production line PM6 contributed for 76% of the total CMP sold. For the fiscal year revenue generated was $96 million, up 118% taking up 62% of total revenue. Sales volumes reached 255,000 tons, up 135%. While PM6 contributed 69% of the total CMP sold in 2012. ASP declined by 7% to $377 per ton.
Now turning to slide 10, on our Offset Printing Paper segment. In Q4, revenue generated was $12 million, down 50% representing 27% of total revenue. Sales volume was 17,000 tons, down 22%. ASP declined by 13% to $697 per ton.
For the fiscal year revenue was $49 million, down 50%, representing 33% of total revenue. Sales volume was 68,000 tons, down 45%. ASP declined by 10% to $727 per ton. The revenue decline in the segment was mainly due to the suspension of our trading activities of offset printing papers since the first quarter 2012, which is a decision we took since this the lower ASP made the trading business no longer viable.
As for our digital photo paper on slide 11, in Q4 we had to suspend our life time operations partially due to the increasing restrictions from government urban planning officials to resolve this increasing presence of the residential buildings in the neighborhood. And as a result revenue generated was $900,000, down 53%. Sales volume was 227 tons down 52%. ASP was down 2% to $3,892 per ton.
For the fiscal year, revenue was $6 million, down 25%. Sales volumes were 1,600 tons, down 22%. ASP decreased 4% to $3,858 per ton.
Slide 12, provides a chart of our revenue mix which has been shifting towards CMP which now represents 71% for the fourth quarter revenues and 63% for the full year.
Moving to our operational and business updates on slide 14, we continue our efforts in renting out the new CMP production line PM6. For the fourth quarter, the utilization rate has gone up further to 69% compared to 52% in Q3 and we will continue to ramp up further this year. In fact, we expect a new CMP line PM6 to produce 245,000 to 271,000 tons of paper in 2013.
Slide 15 provides an update on the renewal of 50 CMP line PM1. As mentioned in our earnings call last quarter, we will face out our old 150,000 tons per year CMP line PM1 voluntarily and renovate it into a new 250,000 ton per year production line. So far, we have already commenced the preparation stage earlier this month and we would expect renovation to be completed before the end of 2014. Production will be suspended during the renovation period. This will be offset ramp up our new CMP line PM6 during that period.
The estimated cost of this renovation is between $20 million to $25 million, which would be funded by a combination of loan, lease, and operating cash flows. Upon completion of the renovation, we estimate annual gross revenue of up to $71 million from this line. Product wise, the renovated line will improve the strength and quality of our new CMP paper.
Slide 16, highlights our progress on tissue expansion projects. In Q4, we secured a 15-year usage right for a 200,000 square meters of land in Dubai industrial parts for our tissue paper production facilities. The consideration of this land use right is about $580,000 per year. We also signed a construction and installation contract for PM8, the first tissue paper machine of our two 15,000 tons per year production lines at a consideration of $5 million.
We anticipate that first line would start operating by the end of Q2 of 2014. We estimate future annual revenue from this line to be from $16.5 million to $18.5 million. Total estimated project cost is $44 million and this will also be financed by our cash flows and banks loans. In the meantime we are continuing to form our team for this operation to expand into this new business.
Relocation project and potential sale of properties is on slide 17. We now turn to slide 17 to update you on our proposed relocation plans of our headquarters compound. First, we would like to clarify that a new and old CMP production lines together with our offset printing paper lines are not in the same site as our headquarters and the digital photo paper facilities. Although both are in Xushui County, they are separated by approximately four kilometers apart. Please refer to Map A.
The area that is being designated for the zone in by the government into the residential use is our headquarter compound, and you can see this is in Map B, which is situated in Juli Road, Xushui County, which has in the last 12 months becoming increasingly residential in nature. And please note that our loan base, comprising of our CMP and offset printing paper lines and that’s in Map C and the photo inserted is located elsewhere and is not part of this rezoning plan by the government.
Next on slide 18, and here are the performance of our headquarters compound together with the three staff dormitory buildings. These are the apartments that we completed in 2012 for our administrative and senior management staff. As we check in, it’s different from the other living quarters as the Xushui paper mill for our operational workers who are working on a three shift per day production schedule.
The building is for management level employees who are not in common in China especially for companies which want to attract new talent from Tier 1 and Tier 2 cities like Beijing and Shenzhen to work in a less developed area like the Xushui County.
So, let’s move to slide 19. The government has mainly did plan to rezone the location of our headquarters compound which mainly would require four local manufacturers including Orient Paper to eventually seize all that’s currently conducted within this area. We’re facing intensifying pressure from the residential community and government and already our digital photo paper operations are being curtailed in the night which has resulted in sales volume dropping by around 50% in the fourth quarter from the third quarter.
Since the company has no choice, but to comply with the government mandate, we have initiated the process of relocating our offices and facilities to a new site with the intention of selling the existing property thereby allowing our management to focus on our operations and business expansion plan.
We have entered into negotiation concerning the potential sale with Hebei Fangsheng Real Estate Development Company Limited, a real estate development company currently formed recently formed by Mr. Liu, our Chairman and Chief Executive Officer to specifically redevelop the land at our headquarters compound.
While we intend to continue negotiations with Fangsheng on an arm’s length basis, we are having the asset appraised by the independent appraisal firm designated by the government, and it is the intention of the Audit Committee of the company to engage a second reputable independent appraisal firm as well.
As we have announced, the company will only sell properties to Fangsheng as our Audit Committee is satisfied with all of the trends of the purchase proposal. And we would now like to take this opportunity to update you about the environmental expansion announced earlier. Due to the government mainly covering all manufactures in a wide range of industries in the hold county and please refer to slide 20.
We started preparing for this inspection since late February and had to sustain production of our CMP in offset printing paper in our facilities. The field inspection proceeded smoothly from a shortlist of recommendations to enhance our sewage system.
We started this improvement works immediately, which include covering the open sewage with a concrete conduit pipe line to prevent foreign objects from falling into the open sewage. The works were completed on March 17, and all of our production activities have now resumed as normal.
While the cost of the sewage conduit is estimated to be within $100,000, the suspension of operations for the street works has negatively impacted our earnings for the first quarter for other updates shown on slide 21.
We have also announced a quarterly dividend of $1.25 in December last year through shareholders with a record date on December 17, 2012. The dividends were paid out on December 21, 2012.
In terms of our investor communication initiative, we have completed the initial phase to revamp our investor materials and initiated outreach investors and analysts in Q4. Going forward, we will be attending two Investor Conferences at the end of March and another one in May of this year. We also have plans to collaborate with industry experts to educate the market on North China paper business and would also start planning for the production of a new corporate video.
Last but not least, we will continue updating you on the company’s development and our business activities.
And let’s move onto slide 23, we’d like to discuss our outlook and fiscal 2013 guidance. While the overall economic situation has yet to see significant improvement, the industry is expecting further consolidation and tightening of supply with increasingly strict reinforcement of the environment protection requirements by the government. It is also widely expected that ongoing mandatory closure of outdated capacities by the government will be continued in 2013.
While this will provide us with less competition and more opportunities, our margins on the other hand have been squeezed by customer’s resistance over efforts to raise paper price and rising raw material costs since the fourth quarter of 2012.
We remain cautiously optimistic about the mid-to-long term prospect of the Chinese paper market, but we’ll be closely monitoring our pricing policy and we’ve continuously improved our production efficiency this year. In view of the production disruption for the government environment inspection this month, we also expect revenue to come down for the first quarter of 2013, compared to the corresponding period in 2012.
Therefore for the full year 2013 we’re expecting revenue to be in the range of between $144 million and $159 million, gross profit to be between $17 million and $19 million. Net income to be between $9 million and $10 million, basic and diluted earnings per share are expected to be between $0.51 and $0.56.
Now I would like Mr. Liu share our strategic imperatives for 2013 review, and he will speak through his interpreter.
(Interpreted). Thank you, Winston. Let us now move on to slide 24. While we face some strong short-term headwinds, explained in the last slide, 2013 will be a year of intense execution for Orient Paper. First, we will continue to ramp up the utilization of our new CMP line to a minimum average of 75% utilization and target production of at least 245,000 tons for fiscal 2013.
We will also continue the execution of our tissue business expansion plan and the renewal of our legacy CMP plan within budget and time. Definitely we will continue to enhance our operational and environmental processes and systems. As public awareness and demand for a clean and healthy environment growth is expected at all levels of Chinese Government will elevate their reinforcement of environmental protection standard to further protect the quality of air and water.
Although, production has been affected by inspections in the last few fiscal quarters, we place environmental issues at top priority and we’re confident that our environmental protection message and practices can withstand any public scrutiny. In fact, by leveraging the government elimination of outdated polluting mills, we can reinforce our leadership position at increased market share.
Last but not least, we will relentlessly focus on cost discipline and improving our competitive cost base by extracting greater synergies and cost efficiencies in all aspects of our operations. We will also strive to maintain strong cash flows to support our investment.
This sums up our strategic imperatives for the year what we believe are vital to build up the company’s long-term sustainable growth and reinforce our competitive strength.
With this, we have come to an end of our prepared remarks. We would now like to open the call to your questions. Operator? Hello, operator.
This concludes the management’s prepared remarks. We will now open the floor for questions. (Operator Instructions). Your first question comes from the line of Howard Flinker.
Howard Flinker – Flinker & Company
Winston, I have a question for you.
Howard Flinker – Flinker & Company
Hi. One, what would your depreciation and amortization be this year, will it be about $10 million?
It will be – we had about $8 million for 2012 and I think we’ll probably get to $9 million in 2013.
Howard Flinker – Flinker & Company
Okay. And the second question is, in your expansion are you expanding from 150,000 tons to 250,000 tons or 150,000 tons to 400,000 tons. I wasn’t clear of the wording.
The new renovated production line will have 250,000 tons capacity from that production line, and of course, we have another 360,000 tons from the new production line right now. So, combined we have a 360,000 tons capacity and a 250,000 tons capacity in 2014 if renovation is done.
Howard Flinker – Flinker & Company
But you are adding 250,000 tons, you are not replacing 150,000 tons with 250,000 tons, right?
We are basically tearing down most of the parts of the 150,000 tons production line. We rebuilt a new production line on the foundation of that outline and a new line will have 50,000 ton capacity.
Howard Flinker – Flinker & Company
250,000 tons I didn’t hear.
250,000 tons, yes.
Howard Flinker – Flinker & Company
Okay, not 400,000 tons?
No, no, no. It will not be 400,000 tons.
Howard Flinker – Flinker & Company
Yeah, I wasn’t sure if I should add them or replace them. Okay, those are my questions. Thank you.
Thank you, Howard.
Howard Flinker – Flinker & Company
Your next question comes from the line of Theo Miller.
Yes. The expansion in the tissue paper area is, if I’m not mistaken bi-unit HPOP, but you have stated before, you were trying to stay away from the five units, and I don’t understand this contradiction here?
Theo, so your question is which – and if you will conducted the new tissue paper business?
Right. If you read our 10-K which was filed yesterday, we had a table in the first few pages of the 10-K which is connected by a list of all of our production lines and the new tissue paper line, you could actually see that we have – that we have not decided which entity will be operating or will only be the tissue paper production line. Right now, we have signed construction contracts with suppliers and contractors using HPOP, but I believe by the time everything is said and done, try to push the ownership of the new production lines to the entities that can be directly owned by Orient Paper if they use entity.
Okay, all right. The other question is – the move of your headquarters building. What is the cost involved in the move?
The cost involved in the move is still being investigated by our Audit Committee. So I do not have specific information at this point, but the cost of the move along with the fair market value of all of these that are subject to change will have to be ascertained before our Audit Committee can make a decision on whether or not they want to sell the property, so – because we have a few options now as to where we want to move the office and the digital photo paper operation to. So nothing has been finalized yet. And I believe it’s…
But it will still be un-strategic?
I’m not sure if we will be completing the relocation by the end of this year. We certainly want to move the digital photo paper as soon as possible because, as we have explained, the residents in our neighboring areas, they have a lot of problem with us operating a factory during night time.
So if we could find a suitable space, we will try to move the digital photo paper first. The office building, I’m not sure if we will be able to construct new office building near our other production lines. But my estimate right now is that maybe both the digital photo paper and the office building will not be relocated maybe by the end of this year.
Okay. Thank you.
No problem. Thank you.
Your next question comes from the line of Steve Cheng.
Any kind of compensation from the government because of the forced move or is this entirely an expense that the company will have to bear? And the second related question is, you mentioned that negotiations will take place with Chairman’s newly formed real estate company.
Can you give us sort of an explanation for why the negotiations are taking place with that company and that company alone as opposed to making sort of a open call for bids to negotiate and purchase, just in light of general concerns that have existed in this space for a while about self dealing issues. I personally don’t have any issues, but I know that the perception is out there?
Sure. The first question, I believe, is regarding our government compensation for the relocation. Unfortunately we are not the only company that is affected by this rezoning. The government actually has ordered four major manufacturers along Juli Road to relocate or to change the use of the land within the next few years. And the government is not paying any compensation at this point right now to my knowledge.
And besides Orient Paper, we know that other businesses that are affected are also doing similar things. They are looking for other spaces to move their factories. They are building out new facilities farther away from the center of the town to accommodate their current production activities. So I do not see a good chance that the government will give us any sort of financial compensation for the move.
And as to why we are negotiating with Mr. Liu’s real estate development company, regarding the relocation. The first issue that the management has to assess is whether it makes sense for the companies to develop of the land under the request of the government. We of course could take out the work of developing real estate simply by relocate our office building and change that office building and tear down warehouse and reconstruct utilization units for sale, but that is actually out of management’s expertise.
Our core business is, of course, making paper. And our Board of Directors would like to make sure that Orient Paper’s management does not get distracted from manufacturing paper by running a side real estate business.
And of course, if we do not develop the land by ourselves, then of course, the ownership of the land and the building will probably have to be changed. And Mr. Liu’s proposal comes in first as an acceptable alternative by our initial assessment because one of the things that we have to consider really is the flexibility of any purchase proposal if we sell the property to a third party – to an unrelated third party bidder, which we have not received any right now.
The third party and frankly third parties might not give us a lot of flexibility in terms of when we really need to relocate or vacate the buildings. It is easier for us to find a replacement office building somewhere else. But it’s not as easy to move the digital photo paper facilities because some of the equipment there really requires a lot of training before the relocation. So we have to consider carefully about alternatives, and of course, I can report to you that so far we have not received any other bid besides the proposal from Mr. Liu’s company.
And finally, when we look at the situation, we actually think that the government mandate to resolve the land. Actually it could provide a good opportunity for Orient Paper to liquidate assets on its balance sheet from a less liquid form to cash, which we definitely need this year when we take on the tissue paper construction project and the CMP renovation job.
So yeah, I think all together, our Board of Directors have shown interest to negotiate with Mr. Liu’s real estate development company but of course, like we announced, I can assure you that we will not have any sale to Mr. Liu or any related party unless our Audit Committee finds all of the terms in the proposal to be satisfactory.
Okay. Thank you.
No problem. Thanks, Steve.
(Operator Instructions). At this time, there are no further questions in queue. So I’d like to hand the call back over to Mr. Winston Yen, CFO, for closing remarks.
Thank you, operator. Thank you very much for all of our investors and analysts to come to our earnings call. As we explained, 2013 is going to be a challenge for Orient Paper. We have a renovation project and we have expanded to tissue paper business all in a year when economic forecast is not totally clear to us and in the same time, we’re required by the government to relocate to a different place.
So all these challenges will be dealt with by management of the company and we hope that we’ll be able to provide you with more update in the form of press release or a conference call when we have additional information to report on the company’s business. And finally, thank you very much for attending this conference call.
Ladies and gentlemen, this concludes our presentation. Thank you for your participation. You may now disconnect. Have a great day.
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