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Executives

Jie Han - Chairman and Chief Executive Officer

Taylor Zhang - Chief Financial Officer

Qingwei Ma - Chief Operating Officer

Mr. Junjie Ma - Chief Technology Officer

Analysts

Peter Siris - Hua-Mei

China XD Plastics Company Limited (CXDC) Q4 2012 Earnings Conference Call March 25, 2013 9:00 AM ET

Operator

Welcome to the China XD Plastics’ Fourth Quarter and Fiscal Year 2012 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Following management’s prepared remarks, there will be a Q&A session. As a reminder, this conference is being recorded and a replay is going to be available shortly after the call. I would now like to hand the call over to your host for today’s call, (Tom Zhou). Please go ahead.

Unidentified Company Speaker

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

Before management’s presentation, I would like to refer to the Safe Harbor statement in connection with today’s conference call and remind our listeners that management’s prepared remarks during this call may contain forward-looking statements, which are subject to risks and uncertainties. And then management may make additional forward-looking statements in response to your questions. The company therefore claims the protection of the Safe Harbor of 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 the more detailed discussion of the risks and uncertainties in the company’s filing with the Securities and Exchange Commission. A more comprehensive description of the company’s forward-looking statements is contained in the company’s filing with SEC. In addition, any projection as of company’s future performance represents management’s estimates as of today, March 25, 2013. China XD Plastics assume no obligation to update those projections in the future as market conditions change.

To supplement its financial results present to accordance with the U.S. GAAP, management will make reference to the EBITDA, a non-GAAP financial measure reconciled from net income, which the company believes, provide meaningful additional information to better understand its operating performance. A table reconciling net income to EBITDA can be found on the earning press release issued today.

I would 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

Thank you, Tom, and welcome to all of you who have joined us today. I am pleased to report another year of record revenues and profit. Performance of this year speaks volume of our proactive effort, especially during the changing and challenging macro environment affecting different industries in China. As our traditional Northeast China market phased into slower growth mode, we promptly adjusted our marketing strategy, including offering more relaxed pricing and margin and reducing our post-sales service fees to our distributors in 2012 in order to sustain our long-term growth as well as develop and cultivate our customer base.

Although our ASP increased less than the price of raw materials, our newly implemented marketing strategy yields further penetration to our less entrenched north and east China markets, an increase from 18.4% and 19.2% to 21.1% and 21.9% as a percentage of total revenues compared to the same period in fiscal 2011, offsetting the slower growth in our traditional Northeast China market. As a result, we have achieved our overall business objectives in 2012.

In addition, we added one more sales distributor in 2012, bringing our total number of sales distributors to eight. And as evidenced by the higher volumes shipped, we continue to experience strong demand for our product across our portfolio. The increase in average selling price was partially due to our continued shift in sales mix to non-modified PP, higher value-added products, which are typically sold at higher prices. As market demand grow in higher value-added products, as part of our long-term growth strategy, we remain committed to our investment in research and development. We believe this commitment is the key to future strengthening our market position and will help us deliver long-term value for our stockholders.

In 20 new production lines in our third production base launched in December 2011 contributed approximately 81,350 tons of production during the year ended December 31, 2012. In addition, the construction of the three additional workshops has been completed in our third production base and of the 30 additional production lines were delivered, installed and trial-run completed as scheduled in December of 2012 to further expand our annual capacity potential by approximately 135,000 metric tons to support our future growth in 2013.

Now, moving on to our recent financial results, revenues for the fourth quarter reached $168.6 million, an increase of 48% year-over-year. Annual revenue of fiscal ‘12 were $599.8 million, up 57.2% from 2011. Net income of fourth quarter was $17.3 million, down 6.7% year-over-year. And our net income of fiscal 2012 was $85.9 million, up 41.9% from 2011. Also annual revenues and net income in 2012 are within our guided range. In addition, stockholders to equity increased significantly to $264.4 million as of December 31, 2012, compared with $173.9 million of December 31, 2011. The increase of stockholders’ equity is mainly because the increase in retained earning amounted to $86 million.

Our overall business performance remains very strong and as evidenced by 51.8% increase in shipping volume to 62,292 metric tons, up from 41,289 metric tons in the fourth quarter and 48.1% increase from 151,271 metric tons in 2011 to 223,982 metric tons in 2012. It continued to experience strong demand for our products across our portfolio. The increase of average selling price by 7.5% compared to last year was partially due to our continued shift in sales mix to higher value-added products. We are very pleased with the progress and believe those positive results reflect our ability to taking advantage of this significant growth prospect in our market.

By the end of year 2012, 246 of our products have been certified by Automobiles Manufacturers, AKA, AM. As many of you know, product certifications are an important part of our business and our leading number of certifications give us significant competitive advantage as we continue to expand our custom base in China growing high-quality modified plastic sector.

We have successfully completed our production capacity expansion in our number three production base by end of December 2012, which added 30 new production lines to contribute 135,000 metric tons to our annual production capacity. Once fully ramped up during the second quarter of 2013, it will bring our total annual production capacity to 390,000 metric tons to support our future growth in 2013.

We believe that our ability to generate strong consistent performance despite the slower growth in auto sales in China over the last year is a testament to our operational mode. Risk control management and successful execution of our long-term growth strategy, certain underlying market trends such as the increasing plastic content per vehicle have now diminished and continued demand of modified plastics used by our major customers for mid and high-end brand cars, as expected to proceed and support our growth. In addition, we have been able to consistently gain market shares from imports, foreign and joint venture manufacturers.

The development of new production lines and capacity along with our committed investment in R&D are part of our long-term growth strategy to take the advantage of this underlying trend. We continue to shift our product mix toward higher value-added products during the fourth quarter of 2012. We successfully obtained 10 new AM product certifications. As of December 31, 2012, the company had 38 products in the process of being certified by auto and non-auto manufacturers.

Over the long-term, we will continue to leverage the benefit of our expertise and technology platform to take the advantage of opportunities, to expand our customer base, to include industries outside of auto sector. Taken together, the overall strategy allows us to maintain our steady growth in revenues and stable gross margins while helping to ensure that we stay in the leading edge of the modified plastic sector in China.

In conclusion, it is very exciting time for our business and for us as a management team. To summarize, demand of high-quality modified plastics in China remains strong and has significant growth prospect fueled by China’s auto market, which is the largest in the world. Our leading number of AM product certification and diverse, competitively priced high-quality product portfolio positioned us well compared to other domestic and international manufacturers. And I was to make advantage of market growth opportunities. New production lines with additional production capacity of 135,000 metric tons are now partially utilized and will help us meet the gross demand of our product and expand our product portfolio.

We have gained the market share by replacing imported products based on our competitive pricing, whole process technology service and customized formulation, and development solutions. Our plan to build the fourth production base with 300,000 metric tons annual capacity in Southwest China follows China 12th Five-Year Plan, which promotes green and environmental protection sectors and new materials industries. The company will benefit from favorable tax policies under China’s Western Development Program by locating the project in Southwest China. Once our Southwest production base is completed and in operation, we will be able to effectively cover the entire country geographically and reach our goal of 10% market penetration with our major products, with our Southwest production base covering Southwest and Central China and reaching into East China, and our Northeast production base covering Northeast and North China and reaching into East China.

With all of this said, we are confident in the future prospective of our business and market and look forward to strengthening our leading position and delivering significant stockholder value over the long-term. Thank you again. And with that, I will turn the call over to Taylor Zhang, our CEO (sic) (CFO) walk you through our financials. Taylor, please go ahead.

Taylor Zhang

Thank you, Mr. Han and thank you everyone for joining the call today. Now, looking at our quarter and full year as you have seen from our earnings release, we delivered a solid quarter and the full year results, driven by increased sales in terms of both volume and product mix shift and to both existing and new customers.

Revenues for the fourth quarter of fiscal 2012 were $168.6 million representing a year-over-year increase of 48% from $113.9 million from a year ago. Revenues for fiscal year of 2012 were $599.8 million representing a year-over-year increase of 57.2% from $381.6 million in fiscal year of 2011. The increase in revenues were primarily due to increases in sales volume and ASP driven by increasing demand for modified plastics from middle and high-end cars, the increase of a modified plastic per car and a shift in product mix to include a greater percentage of sales from higher value-added products.

In the fourth quarter of 2012, gross profits was $37.3 million, up 27.4% from $29.3 million in the same period of fiscal 2011. Gross margin was 22.1% compared to 25.7% in the same period last year. In fiscal year of 2012, gross profits was $143.8 million, up 50.1% from $95.8 million in fiscal year of 2011. Gross margin was 24% compared to 25.1% in fiscal year of 2011. The year-over-year decrease in gross margin was mainly attributed to the more relaxed pricing and profit margin offered to our distributors and the intentional decrease of post-sales fees as a result of the company’s adjustments in its marketing strategy in fiscal year of 2012.

During the fourth quarter of 2012, general and administrative expenses were $2.4 million compared to $2 million for the same period of last year. On a percentage basis, G&A expenses in the fourth quarter of 2012 were 1.4% of revenues, compared to 1.7% in the fourth quarter of 2011. In fiscal year of 2012, G&A expenses were $10 million compared to $7.1 million for fiscal year of 2011 and as percentage of revenues decreased to 1.7% from last year’s 1.8%. The increase in G&A expenses is primarily due to the increase of U.S. $1.9 million payroll resulting from increased headcounts and the raised average salary, and of $0.7 million share-based compensation.

During the fourth quarter of 2012, research and development expenses were $9 million, or 5.4% of total revenues, compared to $2.6 million, or 2.2% of total revenues in the same period last year. In fiscal year of 2012, R&D expenses were $21.6 million, or 3.6% of total revenues, compared to $11.6 million, or 3.1% of total revenues in fiscal year of 2011. The increase in R&D expenses was due to the company’s ongoing efforts in research and development activities on new products, primarily in consumption of raw materials for various experiments for auto applications from automobile manufacturers as well as other non-auto applications. During the year ended December 31, 2012, the company successfully launched 35 new AM certified products, which increased our total number of AM certified products to 246.

During the fourth quarter of 2012, operating income was $25.9 million, or 15.3% of revenues, an increase of 4.8% over operating income from $24.7 million, or 21.7% of revenues in the same period a year ago. In fiscal year of 2012, operating income was $111.9 million or 18.7% of annual revenues, an increase of 45.6% over operating income of $76.8 million, or 20.1% of annual revenues in 2011. The decline of operating margin was mainly due to gross margin contraction and the increase of R&D expenses.

Net income for fourth quarter of fiscal 2012 was $17.3 million compared to net income of $18.5 million for the same period a year ago. Net income available to common stockholders for the fourth quarter of fiscal 2012 was $17.3 million compared to $18.5 million for the same period of last year. Basic and diluted earnings per share were $0.36 compared to last year results, which were at $0.29.

Net income for the full year of 2012 was $85.9 million compared to $60.5 million in the full year 2011. Net income available to common stockholder for the full year of 2012 was $85.9 million compared to $60.5 million in the full year 2011. Basic and diluted earnings per share for the full year of 2012 were $1.35 compared to $1.17 and $1.16 respectively in the full year 2011.

EBITDA for the fourth quarter of 2012 was $30.4 million, an increase of 14.2% from $26.6 million in the same period last year. For the fiscal year 2012, EBITDA was $130.7 million, increase of 52.7% from $85.6 million in the same period of the prior year.

Turning to the balance sheet, we continued to manage our business from a position of financial strength. As of December 31, 2012, China XD Plastics had $83.8 million in cash and cash equivalents, $48 million in term deposits with commercial banks, $149.2 million in working capital, and a current ratio of 1.7. Stockholders’ equity as of December 31, 2012 was $264.4 million compared to $173.9 million as of December 31, 2011. As of December 31, 2012, accounts receivables was $143.8 million compared to $45.2 million as of December 31, 2012. As we adapted to change of our industry environments and it takes us longer to collect from our customers.

Days sales outstanding was 56 days for the year ended December 31, 2012 and still well below industry average. The average DSO for the automotive modified plastic industry is generally 90 days based on our industry experience. We expect that all of the accounts receivable are collectable and anticipate our DSO to remain in this level for 2013.

Finally, as a result of our solid year of performance in 2012, we announced our guidance for fiscal year 2013. We expect revenues to range between $935 million and $1 billion and net income for fiscal year 2013 to range between $100 million and $132 million, excluding any non-cash charges related to stock-based compensation and changing fair value of existing derivative liabilities. The current wide net income guidance is a function of the expected sales from our subsidiaries in Sichuan Province. The income tax benefits received from China Western Development’s favorable policies, certain local tax benefits as described in the agreements between the company and the local governments, and the expected tax benefit in Heilongjiang Province. This forecast is based on constant exchange rates and reflects the company’s current and preliminary view, which is subject to change.

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

Question-and-Answer Session

Operator

Ladies and gentlemen, we will now begin the question-and-answer session. (Operator Instructions) Your first question comes from the line of Peter Siris from Hua-Mei. Please ask your question now.

Peter Siris - Hua-Mei

Couple of questions. My first question is about the margins in the fourth quarter, what you did to generate sales slightly lower margins and where you expect to see the margins throughout 2013?

Taylor Zhang

Hi, Peter. This is Taylor. I will take your question. As you noticed, the margin in fourth quarter decreased compared to the same period last year, the reason as we mentioned is basically two reasons. Number one is we are now developing we are focused more on North and East markets, where we have less penetration. So, we gave our distributor more incentive to increase our market share influence in both regions. So, that’s question number one. And number two is we also have the post-sales service fee. We also reduced a little bit also to further incentivize our distributors and customers. So, for 2013, our goal is to maintain this level and we are also committed to R&D to develop more high value-added products to offset any decline from lower margin products.

Peter Siris - Hua-Mei

Well, with the money that you are spending on R&D, I would have thought or I would think that the high value-added products which have higher margins would lead to better margins than you had in the fourth quarter?

Taylor Zhang

That’s a good question. So far, we actually gave our distributor incentive pretty much of, of course, different products. It’s a balance between growth and also margin. For now, we think growth is a little more important as we develop our business. Once we have new customer use our products and accepted, entrenched to it, we will be able to have the pricing leverage and gross margin from there.

Peter Siris - Hua-Mei

Okay. The next question is what’s happening with auto sales now and with the percentage of modified plastics in cars but in the last couple of months, it looks like auto sales have started to get a little better in China?

Taylor Zhang

Okay, Peter I would direct your question to our COO, Mr. Qingwei Ma.

Qingwei Ma

(Foreign Language)

Taylor Zhang

Hi, Peter. This is Taylor I translate Mr. Ma’s answer. So, the China automotive industry in 2012 was as you said fared better compared to 2011. The total number of auto sales exceeded in record level at over 19 million units, a growth of approximately 4.3% compared to 2011. And also the plastic per vehicle continued to grow. So right now, we estimate the plastic use per vehicle is approximately 120 kilogram and continue growing.

Peter Siris - Hua-Mei

And then what is that you expect for 2013?

Taylor Zhang

Let me translate question.

Qingwei Ma

(Foreign Language)

Taylor Zhang

Hi, Peter. This is Taylor. So, Mr. Ma’s answer is we feel very optimistic about 2013 auto industry, the markets in China. So, as we have seen from the data, January and February in China, auto sales has increased 15% compared to 2012, but still we think of this year, the auto sales for the whole year will probably grow at 7.5% or 8% close to the GDP of China. And for middle and high-end vehicles, we think the growth will be even higher between 10% to 15%, and this sector is our focus. As for the plastic content per vehicle, we think 2013 will continue growing, although it take time, it does not happen overnights, I think we will grow beyond 120 kilograms per vehicle this year.

Peter Siris - Hua-Mei

Great. I have some more questions, but I will jump back in the queue and let other people ask.

Taylor Zhang

Okay, thank you, Peter.

Operator

Your next question comes from the line of Mr. (John Weber) from Charleston Capital. Please ask your question.

Unidentified Analyst

Hi, Taylor. Hi everyone. Thanks for the call. I have a couple of questions. One would be about the cash needs of the business for the year, what is the plan on CapEx for this year? And then I will ask a couple of follow-on questions beyond that.

Taylor Zhang

Hi, John. Thank you for your question. For this year, the CapEx will be mostly surrounding our developments in Southwest production base as a way this goes earlier with the SEC filing. So, as we mentioned, the total investment in fixed assets will be approximately $270 million, and we feel confident that we can fund it with our existing cash resources, including cash flow and also debt financing. So, for this year, even still very early in the year, but we think probably we can invest approximately $100 million in fixed assets to initiate the Southwest project.

Unidentified Analyst

And how will that look in terms of the capacity coming online and where will you be at the end of the year in total capacity?

Taylor Zhang

The total capacity will be the Southwest production line will not come into operation until 2015. So, it’s a little longer term projects and the investment for equipments will be staged as we grow on the markets there. So, for this year, our total annual capacity will be 390,000 metric tons.

Unidentified Analyst

Okay. So, you will get to that in the second quarter you should be at that and just stay at that with the rest of the year?

Taylor Zhang

That’s right.

Unidentified Analyst

Okay. And in terms of working capital investment and I wanted to follow-up on what the – to get a little more detail on why the accounts receivable were up so much at the end of the year and what you are expecting for investing in working capital this year?

Taylor Zhang

Okay. So, the accounts receivable as we mentioned in the press release is mostly because it take a little longer for us to collect from our customer, but still if you look at the DSO, days sales outstanding is 56 days, which is well below the industry average 90 days. And also as of Friday last week, we have collected over 97% of the balance, which we have disclosed in the balance sheet. So, I feel confident that we will be able to collect the accounts receivable in just a little longer than previously we did.

Unidentified Analyst

And so as you are growing revenue basically from $600 million to say $950 million or $1 billion something like that this year, what will you need to invest in working capital to get to that level of revenue?

Taylor Zhang

For working capital, in our (indiscernible) we have sufficient funding with the cash we have. In addition, we always have – we still have un-drawn credit line from commercial banks. So, that’s not consumer price at all.

Unidentified Analyst

Okay. So, is there, I mean, can you give us any guidance on what things like inventory and accounts receivable will look like on sort of days sales or percentage of revenue or anything like will you manage that too?

Taylor Zhang

Yeah. I think you probably can expect our DSO to remain at 55 to 75 days throughout the whole year.

Unidentified Analyst

Okay. And can I ask one last question, could you talk about the pieces, the assumptions that are underlying your guidance, so to get from $600 million to $935 million to $1 billion in revenue, what kind of price increases are you assuming, what kind of volume increases are you assuming?

Taylor Zhang

In terms of volume, let me direct your question to our Chief Operating Officer, Mr. Ma.

Qingwei Ma

(Foreign Language)

Taylor Zhang

So, John, the revenue is based on the assumption of approximately 330,000 metric tons.

Unidentified Analyst

Okay.

Taylor Zhang

Let me follow-up with in assumption.

Qingwei Ma

(Foreign Language)

Taylor Zhang

So, the ASP is approximately RMB20,000 per ton.

Unidentified Analyst

Okay. And how does that compare versus, I am sorry I just don’t have it in front of me, year-over-year?

Taylor Zhang

The price will be about 10% to 15% compared to our 2012 level.

Unidentified Analyst

And that as I understand that, that’s more of an acceleration on an ASP than you have had sort of historically, is that right or at least with the market certainly, is that a higher acceleration in the market?

Taylor Zhang

We haven’t noticed the price of our raw material and also our price typically move accordingly has been increased by the end of the year. And also as we said in 2012, the ASP increased as well. In addition, our percentage of high value-added products of total revenue has also continued growing and we also expect the same pattern for 2013.

Unidentified Analyst

Got it, got it. Alright, well I have asked enough questions, so then I don’t want to take everybody else’s time, but thanks, thanks for the call.

Taylor Zhang

Alright, thank you John. You are welcome.

Operator

Thank you. (Operator Instructions) We appear to have no further questions at this time. I would like to hand the call back to the management for any 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 at 1-212-747-1118. Again, thank you for your participation on this call. Operator?

Operator

Thank you. Ladies and gentlemen, that concludes the call for tonight. Thank you for your participation. You may now disconnect the lines.

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