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China XD Plastics Company Limited (NASDAQ:CXDC)

Q1 2013 Earnings Conference Call

May 14, 2013 09:00 ET

Executives

Jie Han - Chairman and Chief Executive Officer

Taylor Zhang - Chief Financial Officer

Qingwei Ma - Chief Operating Officer

Junjie Ma - Chief Technology Officer

Analysts

Peter Siris - Hua-Mei

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Q1 2013 China XD Plastics’ Conference Call. At this time, all participants are in a listen-only mode. There will be a presentation followed by question-and-answer session. (Operator Instructions) I must advice you that this conference is being recorded today, May 14, 2013.

Now, I would like to hand the conference over to your first speaker today, Mr. (Tom Zhou). Please go ahead.

Unidentified Company Speaker

Thank you, operator. Good morning and good evening. Thank you for joining us for the China XD Plastics’ first quarter 2013 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 its first quarter 2013 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, May 14, 2013. China XD Plastics assumes no obligation to update those projections in the future as market conditions change.

To supplement its financial results represent 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 to 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 - Chairman and Chief Executive Officer

Thank you, Tom and welcome to all of you who have joined us today. I am pleased to report our solid revenue growth and positive business development especially during the changing and challenging macro environment affecting different industries in China. Although gross margin declined during the first quarter of 2013 mainly due to our marketing strategy such as discounts off the original price since the fourth quarter of 2012. This strategy has helped us to achieve tremendous progress in market penetration especially in East China, the largest automobile market in China.

Revenues from East China during the first quarter of 2013 increased by 113.9% followed by 21.5% and 16.9% from Northeast China and North China compared to the first quarter of fiscal 2012. In addition the number end customers increased from 172 to 261 year-over-year. As evidenced by the higher volumes shipped we continue to experience strong demand for our products across our portfolio. As market demand grows for our high-end products as part of our long-term growth strategy, we remain committed to our investment in research and development in order to enhance our product offering especially for the high-end applications. We believe this strategy is the key feature strengthening our market position and will help us deliver long-term value for our stockholders.

Next to our high level of products customization and comprehensive technical support offered to our customers, the substantial switching cost deters customer turnover and our customer have remained very loyal to us. We are confident in our ability to leverage our bargaining power and gradually ratchet up our profitability without compromising the growth momentum created by our marketing strategy. For the second quarter of 2013, the company expects the gross margin to be approximately 18% as we start reflecting discounts. Our effective penetration in East China market serves well our strategy to make inroad to Southwest market, where we planned to build our fourth production base in Sichuan province as previously disclosed and expand our sales network coverage nationwide.

2013 marks an exciting year with both opportunities and challenges for China XD. As previously disclosed, the company has planned to establish its fourth production base with 300,000 metric tons production capacity in Sichuan province by 2015. The construction expected to commence in the second half of this year. Once our Southwest production base is up and running, 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 bases covering Northeast and North China and reaching into East China.

As all of us said, we are confident in the future perspective of our business and the market and look forward to strengthening our leading position and delivering significant structural value over the long-term. Thank you again. And with that, I will turn the call over to Taylor Zhang, our CFO to walk you through our financials. Taylor?

Taylor Zhang - Chief Financial Officer

Thank you, Mr. Han and thank you everyone for joining the call today. Now, looking at our quarter as you have seen from our earnings release, we have achieved solid top line growth in the first quarter. Revenues for the first quarter of 2013 were $171 million, representing a year-over-year increase of 38.8% from $123.2 million from last year driven by 33.4% increase in sales volume and 4% increase in average RMB selling price of our products.

In the first quarter of 2013, gross profits was $29.2 million, a decrease of 6.4% from $31.2 million in the same period of last year. Gross margin was 17.1% compared to 25.3% in the same period last year. The decrease of our gross margin was primarily due to the following two factors. First an average of 7% discounts of the original prices to early paying distributors and customers. The discounts is our proactive marketing initiative to accelerate our market penetration and spend our customer and product offering in East China.

As the largest automobile market in China, East China is of strategic importance to our long-term plan and we will be enriched and supplied by our Sichuan production base once in operation. As a result, revenue contribution from East China grew to 30.1% during the first quarter of 2013 compared to 19.5% in the first quarter of 2012. Also benefit from this marketing initiative, cash flows from operating activities improved dramatically in the first quarter of 2013, providing additional source to fund our capital requirements for our Sichuan project.

Cash flow from operating activities increased to $68.8 million in the three months period ended March 31, 2013 compared to $4.5 million in the same period of 2012. We plan to reduce the discounts close to 5% during this year. The second factor is 1.4% increase in shipping increases as a percentage of revenues during the three months period ended March 31, 2013. In order to obtain timely information of product usage by our customers and to provide a more effective technical support to our customers, such arrangement is expected to continue in the future in order to better serve our customers.

During the first quarter of 2013, general and administrative expenses were $3.5 million compared to $2.4 million for the same period of last year. On a percentage basis, G&A expenses in the first quarter of 2013 were 2% of revenue compared to 1.9% in the first quarter of 2012. The increase in G&A expenses is primarily due to the increase of the payroll resulting from risk increased average salary and headcounts.

During the first quarter of 2013, research and development expenses were $5 million, were 3% of the total revenues compared to $2.5 million or 2% of total revenues in the same period last year. 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 all applications from automobile manufacturers, as well as other non-auto applications.

During the first quarter ended March 31, 2013, the company successfully launched seven new automobile manufacturers, 35 products also known as AMCP, which increased our total number of AMCP to 253 at end of first quarter of 2013. During the first quarter of 2013, operating income was $20.6 million were 12.1% of revenues, the decrease of 21.4% over operating income from $26.2 million were 21.3% of revenues in the same period a year ago. The decline of operating margins was mainly due to lower gross profits and higher G&A and R&D expenses. Both net income and net income available to common stockholders for the first quarter of 2013 were $14.5 million compared to $20.6 million for the same period last year. Basic and diluted earnings per share were $0.20 compared to last year’s results, which were at $0.32. EBITDA for the first quarter of 2013 was $27.6 million, a decrease of 8.3% from $20.1 million in the same period of last year.

Turning to balance sheet, we continued to manage our business from a position of financial strength. As of March 31, 2013, China XD Plastics had $113.7 million in cash and cash equivalents, $111.9 million in time deposits with commercial banks, $168.7 million in working capital and a current ratio of 1.5. Stockholders’ equity as of March 31, 2013, was $280.1 million compared to $264.4 million as of December 31, 2012. As of March 31, 2013, accounts payable was $56 million compared to $7.1 million as of December 31, 2012. The increase of (688.7%) due to the 30 days payments term that we negotiate with our raw material suppliers, a shift from prepayments to suppliers in the past in order to enhance our working capital and cash flows.

Days sales outstanding has increased from 42 days for the three months period ended March 31, 2012 to 80 days for the three months period ended March 31, 2013 as a result of overall China economic slowdown. It takes longer to collect from our customers. Our DSO still remains at a similar level as the first quarter of 2012 and still below industry average. The average DSO for automobile modified plastic industry is generally 90 days based on our industry experience. We expect that all of the accounts receivables are collectable and anticipate our DSO to remain at this level for 2013.

Finally, in light of growth momentum, our regions with markets of products in the first quarter with the backdrop of the unscheduled ramp up of our production capacity, in Harbin, we reiterate our annual guidance. We expect revenues for the fiscal 2013 to range between $935 million and $1 billion and net income for the fiscal 2013 to range between $100 million and $132 million.

As we have mentioned, we expect gross margin of second quarter to be approximately 18% as we start attracting discounts we offered. This forecast excludes any non-cash charges related to deferred income tax benefit, stock-based compensation, and changing fair value of existing derivative liabilities and is based on constant exchange rates reflects the company’s current and preliminary view, which is subject to exchange. Now, before we open the call to your questions, I would like to note that for any questions directed to Mr. Jie Han, Mr. Qingwei Ma, and Mr. Junjie Ma, I will translate both questions and the answers.

With that, we will now open the call to your question. Operator?

Question-and-Answer Session

Operator

Thank you, ladies and gentlemen. (Operator Instructions) Your first question comes from the line of (indiscernible) from GHC Capital. Please ask your question sir.

Unidentified Analyst

Yes, good morning. I was wondering if you could give me some sense of what your gross margin goals are as you continue to evolve the mix of your products as well as trying to move away from the discounting that you mentioned. I just want to clarity you expect to remove 5% of the discount or take it to 5%?

Taylor Zhang

Hi, Glenn, this is Taylor. I will answer your question. So, our gross margin goal for this year is to achieve above 18%. So, the discounts, we will take down close to 5%.

Unidentified Analyst

Okay. And Taylor the longer term goal of gross margins is potentially to get back to where it was before or somewhere in between?

Taylor Zhang

I think for longer term we will be somewhere in between, but I just want to clarify, it’s our marketing strategy to especially targeting the new markets is China and also in 2015 or prior to that in 2014, we will have similar situation to develop and penetrate markets in Southwest. So, we are confident in our revenue power and once our customer use our products, it will stick with us, so, we will be able to create the stickiness with the customer.

Unidentified Analyst

Okay, and then…

Taylor Zhang

Then gradually improve our gross margin over time. And in addition as you are seeing we have been continuing shifting our product mix towards higher margin product categories.

Unidentified Analyst

Right. And it cutout during your presentation, but were there any debt on the company at quarter end?

Taylor Zhang

We added approximately $30 million short-term loan with commercial banks, but other banks we have been working with, we are now working with all the top five commercial banks in China and all these loans are credits only with no (indiscernible).

Unidentified Analyst

And just to clarify your capital spending plan for this year is…

Taylor Zhang

For this year we have the remaining CapEx for our number three production base in Harbin, which is approximately $65 million. So and also we have something, but not fully committed for our second production base as we previously disclosed the total CapEx for Sichuan project is about $190 million in equipments and about $96 million in infrastructure build-up but that is we have some flexibility there and as to when to pay – make the payments. But the construction we plan to start in the second half of this year.

Unidentified Analyst

Great. I’ll let someone else ask some questions. Thank you, Taylor.

Taylor Zhang

Alright. Thank you, Glen.

Operator

(Operator Instructions) Next question comes from the line of Peter Siris from Hua-Mei. Please ask your question.

Peter Siris - Hua-Mei

Taylor, how are you?

Taylor Zhang

Hi Peter.

Peter Siris - Hua-Mei

The – a couple of questions. First sort of competitive situation like who – obviously as you move out of Northeast China and then the East China you have different competitors. So what are you finding there?

Taylor Zhang

So, we actually – the market share we had gained mostly from multinational companies in our industry. So, we are replacing their products with our fresh competitiveness and also our different service model and we give our customer and more customized service approach very different from multinational or joint venture companies in China. And that’s been very successful over the past when we compete with our foreign competitors.

Peter Siris - Hua-Mei

So and how about the domestic competitors, what are you seeing there, they growing like you are?

Taylor Zhang

From our – we have observed Shanghai Pret is probably a closer peer to us because they are also more focusing automobile plastics business. They also grow in similar pattern and but their focus is a less diversified as us. They are more concentrating in Shanghai region. And they have also fewer products offering I think their primary products is in EPS category.

Peter Siris - Hua-Mei

Okay. As you talked a number of times and I can see it in the income statement, you are spending a lot of money on R&D to create higher value-added products. So, why does the margins go down and why is your long-term goal for lower than historical margins if you are creating more value-added products?

Taylor Zhang

So, because right now I think we have a talk about this in prior quarter. And now we are in a phase of expanding outside of Northeastern market. And we are not concerned about discounts we offered because we believe once we have new customer using our products we are very confident they will stick with us. And once we have the stickiness and we will be able to gradually increase our gross margin with the several ways, one is to shift and sell more high margin products and also with the technical support we offer cannot be matched with our foreign competitors and we also have some leverage over there.

Peter Siris - Hua-Mei

Going back to the question Glen asked before. If we were looking three years from now where would margins be?

Taylor Zhang

Okay. Let me consult the question to our Chief Operator Officer Mr. Ma. Hi Peter, both Chairman Han and Mr. Ma, thank you for your questions. And they believe this is a very good question. So, three years from now, that will come to a time that our Sichuan production base is up and running. And we believe over the two years, we will be able to develop and expand our customer base and also offer more products available to the markets. So, in general, we expect gross margin to improve from here. And in addition from a product application side, our plan is to still focusing on automobile application, but supplemented by ships, high-speed train, and aircraft application. So, those are even higher margin applications than automobile. And in addition, we have mentioned that our goal in terms of national market share is to be over 10%. So, with that we are confident that our gross margin three years from now will improve on average about 1% to 2% every year to be at least 20%.

Peter Siris - Hua-Mei

Great. And also in terms you talk about the capital expenditures needed both in (indiscernible) and in Sichuan, do you have enough capital, can you run through how you are going to finance all that?

Taylor Zhang

Yes, we are very confident we have sufficient capital to fund those CapEx. So, for example, the cash and also the bank deposits we have at the end of first quarter is over $200 million, and we expect because we are also taking initiative to improve our cash flow. And we believe with both the cash we have and also cash flow to be generated with some additional bank borrowing. We don’t think there is any problem of timely to fund our expansion both in (indiscernible) and Sichuan.

Peter Siris - Hua-Mei

Great.

Taylor Zhang

Thank you, Peter.

Operator

Thank you for your questions. (Operator Instructions) We have no further questions from the phone line. May I hand the call back to the management for any closing remarks.

Taylor Zhang - Chief Financial Officer

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 conference call today. Thank you for your participation. You may now disconnect the lines.

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