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Zhongpin (NASDAQ:HOGS)

Q1 2013 Earnings Call

May 10, 2013 8:00 am ET

Executives

Sterling Song

Feng Wang - Chief Financial Officer, Principal Accounting Officer, Vice President, Treasurer and Financial Controller

Baoke Ben - Executive Vice President, Secretary and Director

Analysts

Echo Yinghui He - Maxim Group LLC, Research Division

Operator

Welcome to Zhongpin's conference call covering its results for the first quarter 2013. [Operator Instructions] I am pleased to present Mr. Sterling Song. Please begin.

Sterling Song

Thank you, Gerald. Hello from Zhongpin. I'm Sterling Song, very pleased to be with you today. Our team includes Mr. Baoke Ben, our EVP and board member; Warren Wang, CFO; Vivien Sun, Board Secretary. And I'm Sterling Song, the company's Director of Investor Relations.

First, I'll remind you of our forward-looking statements. Our conference call today will include forward-looking statements made under the Safe Harbor provisions of the Private Securities Litigation Reform Act. Although we believe that the expectations reflected in our forward-looking statements are as reasonable as of today, those statements are subject to risks and uncertainties that could cause the actual results to differ dramatically from those projected. There can be no assurance that those expectations will prove to be correct. Further information about these and other risks are included in our filings with the Securities and Exchange Commission. The company doesn't assume any obligation to update any forward-looking statements as a result of new information, future events, changes in market conditions or otherwise, except as required by law.

Yesterday, we issued our earnings release, so we will assume you have read it. First is Warren Wang, our CFO, who will cover our financial results. Warren, please.

Feng Wang

Thank you, Sterling. Here are the general outlook comments that we provided in our earnings release last night. For the year 2013, we expect that the demand for pork in China should remain strong and that Zhongpin's revenues from pork and pork products are likely to increase modestly based on high tonnage sold and lower average prices compared with 2012. We anticipate that our net profit margin in 2013 will decrease due to increased competition in the industry, the expected increase in labor costs and overheads and the expected increase in quality assurance and quality control costs in response to increased importance on food safety placed by the government and the consumers.

Next, I will give you a summary of our financial results starting with cash flow. During the first quarter of 2013, our net cash flow increased cash and equivalents by $117.9 million, bringing total cash and equivalents as of March 31 to $294.3 million. Working capital at March 31 was $31.6 million. Net cash used in operating activity in the first quarter was $16.6 million, primarily from net income that provided $10.6 million. Depreciation and amortization have provided $6.5 million, a provision for bad debt that provided $1.9 million, accounts Receivable and accounts payable that used a net $35.7 million, inventories that provided $3.5 million, deposit from customers that used $2.6 million and other items that used $0.8 million.

Net cash used in investing activity in the first quarter was $7.7 million for construction in progress, additions to land use rights and additions to property and equipment. Net cash provided by financing activities in the first quarter of 2013 was $141.4 million, primarily from the proceeds from loans, notes and bonds net of repayments that provided $107.5 million, proceeds from a capital lease obligation that provided $29.5 million and an increase in restricted cash that provided $4.4 million.

As a result, including the effect from foreign currency exchange rate changes in cash, Zhongpin increased its cash and cash equivalents by USD 117.9 million in the first quarter 2013. Cash and cash equivalents on March 31 totaled $294.3 million compared with $176.4 million on December 31, 2012.

We believe our existing cash and cash equivalents, together with our ability to secure bank borrowings, will be sufficient to finance our investment in new facilities, with budget capital expenditure of about $103.5 million over the next 12 months and to satisfy our working capital needs. We intend to satisfy our short-term debt obligations that mature over the next 12 months through additional short-term bank loans, in most cases by rolling over to maturing loans into new short-term loans with the same lenders.

Our debt to total capital at March 31 was 57%. Our net debt to total capital was 44%, subtracting cash and cash equivalents from both total debt and total capital.

Interest coverage for the first quarter of 2013 was 2.4x our net interest expense. We're near the limit of our debt leverage and interest coverage, so we have very little financial flexibility remaining should we need it. It's important to understand that we intentionally add debt to be sure we can finance the company's pension in the next 12 months even if the credit markets tighten. So our financial flexibility is actually pretty good and is under our control.

Summary points on the first quarter's operations income include sales revenues that were up 2% first quarter-to-first quarter, our tonnage up 10.1%, and average prices per ton, they were lower by 7.1%.

Prepared pork products had the best performance in the first quarter, with tonnage up 43.1%, and the average price per ton was down by 0.7% last year's first quarter.

Gross profit margin increased to 10.1% in the first quarter 2013 from 9.5% in the first quarter 2012. The higher margin came from higher sales of prepared pork products that have higher margins than other products and from a wider spread between hog prices and pork prices.

Operating profit margin was 4.9% versus 5.2% in the last year's first quarter. Net profit margin was 2.8% versus 3.3% in the first quarter 2012. The average assets to lower annualized in the first quarter was 1.2x.

That gives you a summary of Zhongpin's financial results in the first quarter 2013. Next, Sterling Song will cover the industry consolidation, price outlook and our ongoing strategy and plans for 2013. Sterling, please.

Sterling Song

Okay. Thank you, Warren. Pork industry updates. Next, I'll comment about the pork industry and then its consolidation. First, as you remember, Chinese government is requiring the gradual but dramatic elimination of outdated hog slaughtering capacity in the next 5 years. That industry consolidation is accelerating. Many of the smaller slaughtering houses have been or will be forced to close by the local government as part of China's national policy.

Second, since the latter part of 2011, competition in the market has become very aggressive, as the major strong producers battle to win higher market share in a variety of ways and to increase their capacity utilization. The market share they seek can come from the absence of the close in slaughtering houses and from the peer companies. Since long-term survival and expansion, not current profit, tend to be their primary goals, at least until the industry consolidation is finished, the competitive actions has mainly been aggressive promotions in all the distribution channels.

Third, food safety is increasingly important to consumers and the government. We believe that is good for Zhongpin since consumers know that Zhongpin brand means high-quality, safe products. At the same time, our high quality and safety must continue to improve even more, so costs and investments to achieve even higher food safety, along with further improvements in quality assurance and the control safety, will increase for several years.

And the fourth, there is increased likelihood that imported pork will become normal in the Chinese market. Zhongpin will further develop our advantage in international business.

These 4 points are within the context of the intense consolidation in the meat processing industry that is happening today. So the massive consolidation and our actions to benefit from that consolidation will continue probably for about 5 years or so until the industry consolidation has been completed.

The foundation of the industry consolidation starts with the government. In 2012, the Ministry of Industry and Information Technology of China announced the China meat industry development strategy report for 2011 to 2015. In that report, the Industry and Information Technology Ministry provided the target for the meat industry for the coming 5 years. We have provided the detailed sales target to you several times in our past reporting and the conference calls, so I will not read them again today.

The easiest summary is that the number of slaughtering houses in China is expected to decrease during that 5-year period from 21,000 to about 3,000. The decreases will be based on licensing. The 18,000 to be closed will be outdated facilities that will not be able to meet the high standards, so only 14% will survive, and those will be the largest and the most capable facilities and producers. And that will also include new capacity to be built in Central, North, Northeast, East and the Southwest China.

Next are hog and the pork prices in 2013. Due mainly to an abundant supply of hogs, hog prices had been declining since the peak in September and October of 2011, including during the first 3 quarters of 2012, then turned up and increased moderately in the fourth quarter of 2012. Hog prices in the first quarter 2013 declined about 10% to 15% since the end of the fourth quarter 2012. The wider spread came mainly from lower hog prices. Those prices were generally lower than the farmers' break-even points. But there's still a large supply of hogs, so we expect that hog prices will remain at the current relatively low level for much of the year, then begin to increase by the fourth quarter.

Pork prices purely more in parallel with hog prices since most pork producers try to maintain a reasonable spread between their selling price of pork and their buying price for hogs. That spread was pressured in every quarter of 2012, and it is likely that the spread will not recover much, if not -- if at all, for the rest 2013. That is due to the expected higher costs and the intense competition in the market that is resulting from the ongoing industry consolidation.

Zhongpin's growth margin was up 0.6% to 10.1% in the first quarter from last year's first quarter, but maintaining that higher spread in the next several quarters is likely to be challenging.

Our strategy has not changed for 2013. Here, it is in summary form. First, we are focusing on greater use of existing facilities to exploit the potential of our current facilities and optimize our product structure, customer base and supply chain structure. Second, we are developing more byproducts such as sausage casings and the feeder stock for heparin sodium for more profit, high returns and high utilization of our raw materials. Third, we are expanding our cold-chain logistics capacity. And fourth, we will enter several new geographic markets while focusing on Central China, North China, East China and Northeast China, so those new expansions will be within our geographic focus.

Our long-term goals, strategic direction and the execution are next. We have 2 primary goals. In operations, it is to be a major consolidator in the meat industry change during the next 5 years. In finance, it is to increase long-term value for our shareholders. We believe we can do both well simultaneously.

Our strategy and actions to achieve those goals have 6 major points: First, we'll continue to optimize or reconstruct our business model; Second, we'll continue to expand operations on the business in our target regions; Third, we will consolidate resources to create a unified base, efficient collaborative supply chain system; Fourth, we expect to increase our sales of prepared and the processed products and about to maintain the growth rate and the high sales proportion of our chilled products; Fifth, we look for every logical upstream and downstream expansion of our primary business and the increased value-added parts of the industrial value chain by comprehensive processing; Last, we'll always give a priority to the reduction of operations cost, both fixed and variable cost. We also have been expanding our cold-chain logistics system into a new commercial service, and we expect its success to continue.

The details of the expansion in our capacity products and the regions and our near-term plans are provided in our earnings release and 10-Q. So that is the part for our prepared remarks. Now we are happy to answer your questions. Gerald?

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from the line of Echo He from -- of Maxim.

Echo Yinghui He - Maxim Group LLC, Research Division

The main question I want to ask is the market consolidation or the computation like last year, and the -- some of the major pork producers, they had some quality issues. I just want to know what's the situation of pork quality right now and whether that competition is still caused by these quality concerns. And also, what are the major producers' market share right now? And then why they are so aggressive, want to expand their market? And do they also -- I mean, we're -- do they have any problem on keeping margins or utilize their facilities? [Chinese]

Baoke Ben

[Chinese]

Echo Yinghui He - Maxim Group LLC, Research Division

[Chinese] Another question, okay, my second question is I just want to know the -- what are the major policy benefits and like tax benefit or subsidiary or subsidies the company currently is receiving from local government or provincial or national government? [Chinese]

Baoke Ben

[Chinese]

Sterling Song

I'll talk the translation for Mr. Ben's answers to Echo's 2 questions. First, rather food safety issues. Yes, last year, there were several food safety issues, and they -- all of them had negative impact on these companies who had these issues. Some of them are our competitors in the pork industry. Zhongpin, we had no such things happened to the company, that these are due to our given invest on the food safety and quality controls and assurance for these programs we have. And these food safety issues definitely have impact on the market share from these companies, but this impact depends around the size of these food safety issues, the media reports and the coming supervisions on these issues. And there were several big things happened, such as the H7N9, these bird flus, the lamb and the hogs in the rivers. They all had impact on different company in different regions . And with those [ph] and also, we're seeing that for the food safety issues, this has only happened in this certain stage in China because the economic develop in China. We will keep -- invest on for safety, quality control and assurance programs. And we believe that to maintain high-quality products can gain company more consumers and more market share. And for the second question, Echo asked about the government subsidies to the company. And again, as we discussed before, all of agriculture processing companies such as Zhongpin, we can enjoy these government subsidies and tax benefits. For instance, we enjoy tax holidays for our chilled and frozen pork products. And in the first quarter, we have received about USD 700,000 as government subsidies from -- for different projects. That's our brief translation for Mr. Ben's answers.

Operator

[Operator Instructions]

Sterling Song

Gerald, since no other questions, I think we can come into the closing remarks. Gerald?

Now we have come to the end of the Q&A session. Thank you and also, thank you for your interest and your investment in Zhongpin. Like I promised, with some good strength [ph] , we expect have to deliver attractive returns to you. Until we meet again, wish you good health, safety and happiness. Thank you. Goodbye for now. Thank you. Thank you, everyone. Thank you, Gerald. Bye-bye.

Operator

Thank you, ladies and gentlemen. This concludes the call. Thank you all for attending.

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