Zuoan Fashion's CEO Discusses Q1 2013 Results - Earnings Call Transcript

Jun. 6.13 | About: Zuoan Fashion (ZA)

Zuoan Fashion Ltd (NYSE:ZA)

Q1 2013 Earnings Call

June 6, 2013, 8:00 am ET

Executives

James Hong - Founder, Chairman of the Board and Chief Executive Officer

John Low - Vice President of Corporate Finance and Investor Relations

Chi Hon Tsang - Chief Financial Officer

Wang Chaoshen - Chief Operating Officer

Analysts

John Sheehy - Private Investor

Jeff Johnson - Lone Star Funds

Operator

Greetings and welcome to the Zuoan Fashion Ltd first quarter 2013 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

With us today are James Hong, Founder and Chairman of the Board and Chief Executive Officer, Chi Hon Tsang, Chief Financial Officer, Mr. Wang Chaoshen, Chief Operating Officer and Mr. John Low, Head of Corporate Finance and Investor Relations. John will be translating for Mr. Wang and Mr. Hong during the question-and-answer session as well.

This call may contain forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1195. These forward-looking statements are based on management's current expectations and observations that involve known and unknown risks, uncertainties, and other factors not under the company's control, which may cause actual results or performance or achievements of the company to be materially different from the results, performance, or expectations implied by these forward-looking statements.

All forward-looking statements are expressly qualified in their entirety by the cautionary statements, risk factors and details of the company's filings with the SEC. Zuoan undertakes no duty to revise or update these forward-looking statements for selected events or circumstances after the date of this conference call.

At this point, I would like to now turn the conference over to Mr. James Hong. Mr. Hong, please go ahead.

James Hong

[FOREIGN LANGUAGE]

Good day, and thank you for joining us on our first quarter 2013 earnings conference call. We are pleased to start out 2013 with a healthy topline and bottomline results in the first quarter. Our sales were primarily driven by growth at the distributor level and through our direct stores as well as high average selling prices achieved as we incorporated higher quality raw materials in to our product offering. Our operating and net income improvements demonstrate the success of our store model transition which helped streamline our operational infrastructure, improved productivity and huge operating expenses.

We are also pleased to announce that the order demand at our May 2013 sales fair was up a respectable 2% to 3% from the same period in the prior year. Looking to the remainder of the year, as China's consumer spending environment continues to stabilize and shows signs of improvement, we are confident our revenue and profitability can continue to grow with the anticipated recovery as well as through our efforts to enhance our distribution network, maximize operational efficiency and increase Zuoan's brand awareness.

At this point, I would like to turn the call over to John Low who will further discuss our operational performance.

John Low

Thank you, Mr. Hong. We are again very pleased with our good start of fiscal year 2013. I will begin with an overview of our first quarter performance and highlight our operational initiatives, then Chi Hon will review our financial results and outlook in more details.

Zuoan reported revenue of RMB296.3 million in the first quarter representing an annual increase of 5.8% in line with our previous guidance. In the first quarter, distributor sales increased by 4.6% to RMB293.1 million while self operated direct store sales declined to RMB3.1 million.

Gross margin was 45.7% which was lower than prior quarters reflecting our store model transition. Consequently, we were very much encouraged by the decrease in selling and distribution expenses and improvement in operating income margin. As a result, our first quarter net income was higher than expected rising to RMB73.8 million or $11.9 million, a 9.5% increase over the prior year first quarter period.

We continue to Zuoan's position as a leading casual menswear brand in China. We serve the market with a nationwide network of 1,362 retail locations covering China's 31 provinces. As Mr. Hong touched upon earlier, we are optimistic that Zuoan can expand its market position in China's fashion casual apparel market in the years ahead as the country's middle class population continues to expand and their levels of consumption are increasing as well.

In the first quarter, we strengthened our design team by adding a Korean designer to reflect the latest fashion elements in our neighbor country which are widely recognized and welcomed in China. We look forward to actively developing products to meet the evolving needs of our customers and capitalizing on our growth opportunities that lie ahead.

We are pleased to increase purchase orders on our May sales fair. The order volume increased by around 2% to 3% compared to the same sales fair last year. In the first quarter, we focused on working with our distributors and subdistributors to reduce inventory in their store channels by means of promotions and discounting. The higher inventory level quarter were mainly due to the time difference of delivery of our goods to distributors. Our accounts receivables decreased favorably as we collected winter collections related accounts receivable in a timely manner.

We remain optimistic about Zuoan's growth prospects in 2013 and beyond and believe we will continue to improve operational efficiencies and are well positioned to broaden the popularity of our brand in the China market. We continue to maintain our full year 2013 revenue growth target of around 5% in spite of the challenging market environment.

At this point, I would turn the call over to Chi Hon to review our financial results as well as provide outlook on our business.

Chi Hon Tsang

Thank you, John. I would like to first review our financial performance in the first quarter. Revenue for the first quarter was RMB296.3 million, a 5.6% increase from RMB279.9 million in the same period last year. The increase was driven by growth at the distributor level and from increased average selling price due to our incorporation of our higher quality raw materials into our product offering.

During the quarter, distributor sales increased by 12.6% to RMB293.1 million from RMB260.4 million in the first quarter of 2012. A total of 53 distributor and sub-distributor stores were opened in the first quarter of 2013, resulting in a total of 1,362 locations as of March 31, 2013, compared to compared to 1,329 store locations at the end of 2012.

Cost of sales increased 6% to RMB160.8 million in the first quarter of 2013 from RMB148.6 million in the same quarter of 2012, mainly as a result of the increase in the sales volume. As a percentage of revenues, cost of sales increased to 54.3% in the first quarter of 2013 from 53.2% in the first quarter of 2012

Gross profit in the first quarter increased 3.3% year-over-year to RMB135.5 million from RMB131.1 million in the same period of 2012. First quarter 2013 gross margin was 45.7% compared to 46.6% in the same period last year. The decrease in gross margin was mainly due to transition of our company's directly operated flagship stores to our distributors in the first quarter of 2012. Gross margin at the company self operated direct stores and distributor stores was 6.4% and 45.6% respectively.

Selling and distribution expenses in the first quarter were RMB26.5 million or 6.9% of revenue, compared to RMB26.5 million or 10.2% of revenue in the same period last year. This percentage decrease was mainly due to the significant decrease in direct store expenses resulting from the transition of our directly operated flagship stores to our distributors.

Administrative expenses in the first quarter was RMB10.3 million or 3.5% of revenue, compared to RMB11.6 million or 4.1% of revenue in the same period last year. This percentage decrease was mainly due to the decrease of rental expenses at the company's new Shanghai headquarters. As the first quarter was very temporarily rent (inaudible) for the company.

The effective tax rate in the first quarter was 25.2% compared to 25.6% in the same quarter of 2012. Net income for the first quarter increased by 9.5% to RMB73.8 million from RMB67.4 million in the same period last year. First quarter net margin was 24.9% compared to 24.1% in the prior year period.

Diluted earnings per ordinary share was RMB0.66 in the first quarter, equivalent to RMB2.65 per ADS, compared to diluted earnings per share of RMB0.61 or RMB2.42 per ADS in the first quarter of 2012. The company's diluted number of shares outstanding were RMB111.3 million in the first quarter ended March 31, 2013.

As of March 31, 2013, the company had cash and cash equivalents of RMB1,130.4 million, compared to RMB918.5 million as of December 31, 2012. Net cash provided by operating activities was RMB208.2 million in the three months ended March 31, 2013, compared to RMB257.1 million in the three months ended March 31, 2012.

Accounts and other receivers were RMB464.9 compared with RMB608.5 million at the end of December 2012, mainly due to subsequent settlement of old debt and no outstanding balance from newer selling types of our spring and summer collection. At the end of March 2013, 75% of our AR was at stable with 90 days. CapEx spending in the first quarter was minimal at RMB9,000 only.

For the second quarter of 2013, the company currently anticipates revenue in the range of RMB304 million to RMB324 million, gross margin of approximately 44% to 46%, net income of approximately RMB58.2 million to RMB62.8 million and basic and fully diluted EPS of approximately RMB0.52 to RMB0.56, equivalent to RMB2.09 to RMB2.26 per ADS. Approximately 20 to 30 new retail stores are expected to be opened by distributors and sub-distributors in the second quarter of 2013.

This concludes our prepared remarks today. Operator, we are now ready to take some questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first, we will hear from John Sheehy as a private investor.

John Sheehy - Private Investor

Well, thank you for taking my question. Congratulations on the really excellent results. I was wondering if you could share some comments about the competitive environment. A lot of your closest fashion casual competitors are private companies. So it is not easy for us to follow their corporate developments.

James Hong

[FOREIGN LANGUAGE]

Wang Chaoshen

[FOREIGN LANGUAGE]

James Low

All right, John. Tell, Mr. Hong and Mr. Wang both spoke on that, both shared on that. Basically, they shared the view that the market and the economy right now it’s at a pretty low point and, I guess, most people would agree that, however, in terms of our competitiveness in this current market situation, we haven’t lost any of our competitiveness.

We are still considered to be one of the leaders in this sector that we are in. It is also because of the positioning that we are currently in as well as the strategy that we are taking, we are able to maintain this competitiveness in the current market environment.

John Sheehy - Private Investor

Okay, thank you. I would like to ask about the new stores that you have opened. When you open these stores, do you pay any of the costs or are all of the costs and all of the financial commitments paid by your distributors?

James Hong

[FOREIGN LANGUAGE]

Wang Chaoshen

[FOREIGN LANGUAGE]

James Low

All right. John, I think that you are referring to the stores that our distributors are opening, right?

John Sheehy - Private Investor

Right.

James Low

In that case, we are still maintaining a policy of subsidized or paying for the renovation which is RMB1,500 per square meter as well as the furniture and fixtures,. The racks and stuff, another RMB1,500 per square meter. That makes a total RMB3,000 per square meter.

John Sheehy - Private Investor

And you record that as an expense on the income statement instead of a capital asset?

Chi Hon Tsang

No, this is expense in our income statement.

John Sheehy - Private Investor

Then like signing the lease and everything like that, that’s the responsibility of the distributor?

James Low

You mean the shop lease, right?

John Sheehy - Private Investor

Right.

James Low

That’s the distributor's responsibility.

John Sheehy - Private Investor

Okay, so they are taking those commitments to help build your business together. So that’s a good signal for you, right, that they are spending money to help expand your business.

James Low

Yes, that’s correct.

John Sheehy - Private Investor

Then, are you considering any expansion like a second brand or M&A or opening international stores?

James Hong

[FOREIGN LANGUAGE]

Wang Chaoshen

[FOREIGN LANGUAGE]

James Low

John, Mr. Hong started off by saying that we are still going to spending asset in increasing and maintaining our competitiveness and our market position in our business. As you can expect that that we are the one of the leaders in our sector but in the current market situation we do need to spend more time and asset on that. Other than that, yes, we do have plans. We are always on the lookout for M&A on brands for the China market. We are looking out for existing good businesses in China. An terms of overseas expansion, there is no immediate plan for now for any overseas expansion.

John Sheehy - Private Investor

Okay, thank you. Then the last point I would like to make is that many Chinese clothing companies listed in Hong Kong pay dividends. Your business is doing relatively well. So I encourage you to consider paying dividends as well. That’s all I have got. Thank you very much.

James Low

You are welcome.

James Hong

[FOREIGN LANGUAGE]

Operator

(Operator Instructions). Next, we will move to Jeff Johnson with Lone Star Funds.

Jeff Johnson - Lone Star Funds

Hello, could you discuss the general state of the consumer environment in China. In the past, you cited little more challenging spending environment and I am just trying to figure out whether or not the situation is improving for the company?

James Low

Sorry, Jeff, is that Jeff? Sorry, we didn’t quite catch that first bit. You mentioned an example. What example was that?

Jeff Johnson - Lone Star Funds

Well, I am trying to understand just the general state of the consumer environment in China and whether or not you see some improvement in your business going forward?

James Hong

[FOREIGN LANGUAGE]

Wang Chaoshen

[FOREIGN LANGUAGE]

James Low

Mr. Hong was commenting about the consumer market, I guess, we will focus on our market segment of the consumer market. Consumers are moving towards better designs and better functionality on their products. It is exactly in this area that we are focusing on at the moment as well. That’s why we are able to maintain our competitiveness in this area.

As long as we are doing that, and as long as we are going after what the consumers are after, we are optimistic that we would fare very well in the short to medium term ahead. Although we do see they are challenging times for the consumer market in general.

Jeff Johnson - Lone Star Funds

Okay, thank you. As a follow-up to that question, can the Chairman discuss some of his new design initiatives between apparel, footwear and your lifestyle collections? What products were most in demand by consumers in the quarter. I am trying to better understand what are some of the sophisticated designs and style trends that led shoppers to purchase products in your stores in the first quarter?

James Low

Sorry, can you repeat that question? Sorry, Jeff.

Jeff Johnson - Lone Star Funds

I am trying to get a sense of what were some of the new products in the stores that were popular amongst consumers between your apparel, footwear and lifestyle collections?

James Hong

[FOREIGN LANGUAGE]

Wang Chaoshen

[FOREIGN LANGUAGE]

James Low

Jeff, Mr. Hong was saying still on the apparel side of the three categories of product invention. Mr. Hong was saying, apparel is still to be the main item that we see moving fast in our stores.

Jeff Johnson - Lone Star Funds

Okay, that’s helpful. Lastly, how can average selling prices trend for the remainder of the year? What kind of impact could this have on your gross margin? Thank you.

James Hong

[FOREIGN LANGUAGE]

Wang Chaoshen

[FOREIGN LANGUAGE]

James Low

Oaky, Jeff, we just want to clarify, when you say ASP, you are talking about retail ASP or our business ASP which is mostly wholesale ASP? Jeff?

Operator

And his line has disconnected.

James Hong

Oh, I see.

Operator

And at this time, there are no further questions. I would like to turn the call over to management for any additional or closing remarks.

James Low

Should we wait for Jeff to come back online, just maybe a few seconds?

Operator

Yes, that’s fine. He has not dialed in at this time.

James Low

All right, okay. Well, once again, on behalf of management, I would like to thank you all for joining this conference call. We look forward to meeting you again in our next earnings call. Good day, and good bye.

Operator

That will conclude today's call. We thank you for your participation.

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