Executives
Crocker Coulson - Investor Relations, CCG
Xiangzhi Chen - Chief Executive Officer
Andrew Chen - Chief Financial Officer
Anhui Guo - Chief Operating Officer
Jenny Yang - Translator, CCG
Analysts
John Ma - Roth Capital
Analyst for Katherine Lu - Oppenheimer
Ping Luo - Global Hunter Securities
ShengdaTech (SDTH) Q3 2009 Earnings Call November 10, 2009 9:00 AM ET
Operator
Good day, ladies and gentlemen, and welcome to the ShengdaTech Q3 2009 earnings conference call. (Operator instructions) I would now like to turn the conference over to your host for today, Mr. Crocker Coulson. Please proceed, sir.
Crocker Coulson
Thank you, Operator. Good morning, ladies and gentlemen and good evening to those of you who are joining us from Asia. I am Crocker Coulson from CCG Investor Relations, the company’s investor relations firm. Joining us from China are Mr. Xiangzhi Chen, ShengdaTech's Chairman and Chief Executive Officer; Mr. Andrew Chen, the company's Chief Financial Officer; and Ms. Anhui Guo, Chief Operating Officer. Also from China and with us today is CCG's Jenny Yang, who will provide translation for your questions and answers.
I'd like to remind our listeners that in this call, management's prepared remarks contain forward-looking statements which are subject to risks and uncertainties, and management may make some additional forward-looking statements in response to your questions. Therefore, the company claims the protection of the Safe Harbor for forward-looking statements that’s contained in the Private Securities Litigation Reform Act of 1995.
Actual results may differ from those discussed today due to various risks, including but not limited to such factors as unanticipated changes in product demand, especially in the tire and PVC industries, the ability to attract new customers, the ability to prepare for growth, planned manufacturing capacity expansion, the ability to increase the company’s product applications, and other information detailed from time-to-time in our filings and future filings with the SEC.
Accordingly, although ShengdaTech believes that the expectations reflected in these forward-looking statements are reasonable, we can provide no assurance that such expectations will prove to be correct. In addition, any projections as to our future performance represent management's estimates as of today, November 10, 2009. ShengdaTech assumes no obligation to update these projections in the future as market conditions change.
For those of you unable to listen to the entire call at this time, we are going to make a recording available via webcast for 90 days and you can find that on ShengdaTech's corporate website.
It is now my pleasure to turn this call over to ShengdaTech's Chairman and CEO, Mr. Chen, who will make some brief opening remarks.
Xiangzhi Chen (Translation)
Thank you, Crocker. It is my great pleasure to welcome all to ShengdaTech Inc.’s third quarter 2009 earnings conference call. During the quarter, we made significant progress to advance our NPCC business with the successful acquisition of a company in the dynamic Yangtze River Delta region of China. We also completed phase one construction of our new NPCC facility in Zibo on schedule, which began shipping to customers during the quarter.
Before I turn the call to Crocker, I am pleased to announce that ShengdaTech had recently been named on Forbes Magazine’s fifth annual list of Asia’s 200 best under $1 billion for the year 2009, which represents the recognition to our profitability, development, and future prospects. The entire ShengdaTech team is very proud of this accomplishment and I can assure our shareholders that we fully intend to remain on this prestigious list by continuing to focus on top and bottom line growth as we execute our strategic plan.
Now, Crocker Coulson will discuss some additional remarks on our operations on my behalf. I will participate in the question and answer session along with Mr. Andrew Chen and Ms. Guo. I sincerely thank you for your continued interest in ShengdaTech. Thank you all. Crocker.
Crocker Coulson
Great. Thank you, Mr. Chen. In the third quarter of 2009, ShengdaTech generated NPCC revenues of $25.4 million, down slightly from the same quarter last year. The decline in NPCC revenue was primarily due to a slight decline in average selling prices compared to the year-ago period, a function of product mix shifts in applications sold to meet customers’ changing needs as they adjust to the current environment. When compared with the second quarter of 2009, we experienced a modest increase in average selling prices but a slight reduction in sales volume of approximately 3.5%. We believe the lower volume was the result of stabilization in the Chinese economy as customers were no longer replenishing inventory as they did during Q2 of 09.
In the fourth quarter, we expect demand to increase from current levels as the benefits of Chinese Government’s economic stimulus plan continues to benefit our key end markets.
During the quarter, we modified our product mix in response to changes in market demand and added a total of 19 new domestic customers compared to only three new domestic customers added in Q2 of 2009. We continue to demonstrate that our greatest advantage over our competitors is attributable to a combination of a diverse range of NPCC applications, superior quality and service, along with our ability to constantly introduce new and innovative applications, all of which serves to expand the market for NPCC and sustain our market leading position.
Sales to our two largest end markets, tires and PVC, declined during the quarter primarily due to economic conditions. However, we were able to replace sales to these markets with sales of newer NPCC applications such as polyethylene, or PE, adhesives, and latex. PE, or again polyethylene, is one of our highest margin NPCC products and sales of this application accounted for 18% of the quarter’s total revenue, up 20% year over year. This was due in large part to the addition of seven new PE customers during the quarter. Sales of adhesives and latex NPCC products increased 24% year over year and accounted for 12.2% of total revenues. We added six new adhesive customers during the quarter. Tires and PVC remain our largest end markets, together accounting for 60% of total NPCC revenue, down from 73.6% in the year-ago period.
Sales to the tire industry declined 18.7% on a year-over-year basis. This was mainly because tire customers are carefully controlling inventory levels, keeping a close eye on current economic conditions. Our NPCC application for tires is mainly used for truck heavy vehicle tires and for passenger car tires, which are mainly supplied to the domestic market .
In light of recent tariffs imposed by the U.S. Government which primarily targets radial tires for cars and light trucks, we have not experienced any major impact on the demand for our NPCC application for tires in both September and October. As the tire manufacturers are striving to develop tires which can deliver high performance at lower cost in order to cater to international high-end markets, we expect that our NPCC, a functional material that has been proven to enhance tire performance and reduce manufacturing cost, will be in high demand by large, domestic tire manufacturers. In fact, we recently added five new tire customers and currently supply our NPCC application for tires to three out of the top 10 tire manufacturers in China.
Sales to the PVC industry declined 19.3% on a year-over-year basis. The decline was due to increased focus on high value-added NPCC applications. Although NPCC for PVC is a good source of returns for the company, we have learned that PVC producers do not experience significant cost benefits from using NPCC when compared to other application areas and therefore our target prospects for this application have narrowed. Consequently, we expect to have a somewhat different application mix of sales contributions going forward, as we turn to other applications where our value proposition has greater impact and acceptance.
Our pipeline of new customers is very strong. We are currently working with 32 prospective customers, including 28 domestic customers, of which 21 are in the testing phase and four international customers, of which three are in the testing phase.
We are aggressively advancing our sales and marketing efforts. While we are already China’s leading supplier of NPCC, our goal is to position ShengdaTech as a true global company and expand our market reach both domestically and internationally. To help focus on that effort, we have established a new sales team of well-qualified and experienced personnel in Shanghai who will focus on international sales and marketing, as well as targeting international customers with a manufacturing base in China.
In support of our expanding NPCC operations, we are in the process of hiring a senior manager for our marketing department to aggressively pursue market expansion and we plan to further expand our international sales team. We also plan to start attending more high profile trade shows both domestically and internationally to promote our NPCC products and gain additional insight into the opportunities in the global NPCC market.
As Mr. Chen mentioned, we recently completed the construction of phase one of our new Zibo facility and began production of NPCC for latex, ink, and PE customers. With the additional capacity from Zibo, our total annual NPCC production capacity will be at 250,000 metric tons, an increase of 32% from 190,000 metric tons previously.
We continue to monitor market demand and general economic conditions to identify the best time to continue the build-out activity at Zibo.
In line with our NPCC expansion strategy, during the quarter we signed an agreement to acquire 100% of the equity interest of Anhui Chaodong Nanomaterials Science and
Technology Company Limited, an inactive NPCC facility with approximately 10,000 metric tons of annual production in China’s highly industrialized Anhui province. The $3.8 million acquisition price includes the existing buildings, equipment and mining rights to approximately 14.25 million tons of very high quality limestone reserves. We have renamed Chaodong to Puxi Nanomaterials Company Limited.
Last week, we received approval from the local government for the acquisition and now are working to obtain the business licenses and registrations necessary to operate the facility. Upon receipt of these required documents, we will invest an additional $2.9 million in Puxi for technological upgrades at the production facility and thereafter commence trial production.
Concurrent with the upgrades of Puxi, we plan to finalize our agreement with the Hanshan County local government to purchase land use rights for approximately 66,767 square meters, or 16.5 acres, of land for the existing facility at an estimated cost of approximately $4.4 million.
We are very excited about the growth opportunities made available to us with the acquisition of Puxi, which provides us an entry point into the Yangtze River Delta region, the home of numerous high quality large scale manufacturers from various industries, many of which are viable prospects for NPCC applications and will be vigorously pursued by our sales force.
Puxi is also strategically located near [Wuhu], a major river port on the Yangzte River, which will result in lower transportation costs and facilitate both domestic and international sales growth.
While the current capacity at Puxi is only 10,000 metric tons per year, our longer term plans including adding another 200,000 metric tons of annual capacity over the next four years, based on market demand. The total investment commitment is approximately $175.7 million, which includes the expansion of production capacity, acquisition of additional land use rights for 84.35 acres of property adjacent to Puxi that can ultimately accommodate the additional production facilities and exclusive rights to an additional $60 million metric tons of high quality limestone.
Securing exclusive rights to high quality limestone suitable for our level of NPCC in this region is a pre-emptive measure of strategic importance, as it represents a serious barrier to competitors who may have considered entering this market. A major factor contributing to our successful track record of growth is the management team’s commitment to R&D our goal to expand the total market for NPCC with new applications in high potential end markets.
Our new NPCC application for asphalt is currently under small scale trial production and we are evaluating feedback from our key customers. Assuming such feedback is positive and meets the customers requirements, we expect to achieve a technological breakthough in Q1 of 2010 which could lead to substantial volumes for that application.
For example, the potential market size for this application is very sizable, as our asphalt application partially replaces SPF asphalt, which based on our estimates, is used in 60% of road pavement asphalt in China.
We are also developing a new NPCC application for high grade paper, which based on preliminary evaluation we believe may hold larger potential than our asphalt application. We continue our steadfast focus on improving and expanding the use of NPCC applications, including adhesives and latex, and we certainly will keep you updated on our progress.
With that, I am now ready to turn this call over to ShengdaTech's CFO, Mr. Andrew Chen, who will have a more detailed discussion of the quarter’s financial results. Andrew.
Andrew Chen
Thank you, Crocker and welcome, everybody. Before I get into our financial results, I would encourage all of you to read our 10-Q filed with the Securities and Exchange Commission and our quarterly press release published yesterday for more detailed financial disclosures.
In addition, we will also be discussing a non-GAAP financial measure, EBITDA, which stands for earnings before interest, taxes, depreciation, and amortization. We present this financial measure as a supplement to our GAAP results because we believe it provides useful information in analyzing and benchmarking the performance of our operations and helps investors in analyzing our year-over-year financial performance. We presented a reconciliation of EBITDA to net income in our press release yesterday.
First, let me go through our quarterly results. Our total revenue for the third quarter of 2009 was $25.4 million, down 48.5% year over year due to cessation of production at our Bangsheng Chemical Facility on October 31, 2008. The ceased production resulted from a mandatory directive from the Tai'an city government due to rezoning of the facility's location into a residential and non-manufacturing area.
Revenue from our NPCC segment decreased 0.6% to $25.4 million. Total volume of NPCC sold during the third quarter of 2009 was up 1.5% to 52,489 metric tons from 51,701 metric tons in the third quarter of 2008. However, the average selling price of NPCC products declined a modest 2.2% to $483 per metric ton, down from $494 per metric ton in the third quarter of 2008, caused primarily by a shift in the overall product mix of applications sold. Our NPCC production capacity utilization rate, excluding Zibo, was 100% during both the third quarter of 2009 and 2008.
NPCC for use in tires and PVC represented 34.7% and 25.3% of NPCC sales for the quarter respectively. NPCC used in PE accounted for 18.5% of NPCC revenue. Sales from NPCC products for use in adhesives and latex were 12.2% of total NPCC revenue during the third quarter. NPCC used in ink, paper, paint, and automobile underbody coatings combined to generate 9.3% of NPCC revenue.
Our gross profit for the third quarter of 2009, all of which was derived from NPCC products, was $10.1 million as compared with gross profit which included the chemical operation of $16.7 million for the third quarter of 2008. Total gross margin was 39.7%, up 5.7 percentage points from 34% during the third quarter of 2008.
Gross profit for the NPCC segment decreased 6.7% on a year-over-year basis. NPCC gross margin was 39.7% in the third quarter, down 2.6 percentage points from the same quarter last year. The decrease in NPCC gross margin was due to the decrease in average selling price, reclassification of certain export freight from related general and administrative expenses to cost of goods sold, and initial production costs at the Zibo facility.
Selling expenses, all of which were attributable to NPCC products, were $0.5 million, or 2.2% of revenue, down 35.8% from $0.9 million, or 1.7% of revenue, for the same period last year. The decline in selling expenses was the result of a lowered sales commission rate effective January 1, 2009 and the reclassification of export freight costs to cost of goods sold for the current period, partly offset by higher salary and benefits expenses due to expansion of the NPCC business.
General and administrative expenses were $1.4 million, or 5.6% of revenue, up from $1.1 million, or 2.1% of revenue, for the same period last year. The increase was mainly due to increased research and development expenditures, higher professional expenses, increases in managerial compensation, and increase in amortization of land-use rights related to our growing NPCC operations. These increases were partly offset by the elimination of certain G&A expenses associated with the chemical business as a result of cessation of production at our Bangsheng Chemical Facility.
Operating income for the third quarter of 2009, all of which was derived from the NPCC segment, was $8.1 million, down 45.3% from $14.8 million in the same period a year ago. Operating margin improved to 32%, compared to 30.1% in the third quarter of 2008.
Interest expense, related primarily to the convertible notes issued in May and June 2008, was $2.8 million for the three-month period ended September 30, 2009, down from $3.5 million a year ago. Interest expense included $1.4 million of contractual coupon interest on the convertible notes, $0.3 million of amortization of debt issuance costs, and $1.5 million of amortization of debt discount. The total interest expense was reduced by $0.3 million of interest cost capitalized during the three-month period ended September 30, 2009.
Income tax expense was $0.6 million for the third quarter of 2009 compared to $2.1 million in the same period last year. The company's effective tax rate decreased to 10.8% from 18.6% for the same period last year, primarily due to the fact that the company applied a higher income tax rate than the enacted rate to the PRC taxable income during the three-month period ended September 30, 2008. The income tax rate was adjusted to reflect the appropriate enacted rate in the three month period ended December 31, 2008.
EBITDA, all of which was derived from the NPCC segment, for the third quarter of 2009 was $9.2 million, down 47.6% from $17.5 million, including the chemical operation in the third quarter of 2008.
Net income, all of which was derived from the NPCC segment, in the third quarter of 2009 was $4.6 million, down 49.5% from $9.2 million in the same period last year. Diluted earnings per share for the third quarter of 2009 were $0.09, compared with diluted earnings per share of $0.17 in the third quarter of 2008. Our diluted weighted average shares outstanding during the quarter were 54.2 million, down 20.7% from 68.3 million in the same quarter last year, primarily due to the exclusion of potential common shares related to the convertible notes from the diluted earnings per share computation because their effect was anti-dilutive for the three-month period ended September 30, 2009.
Next, let’s move on to the balance sheet -- as of September 30, 2009, ShengdaTech had $105.5 million in cash and $109.3 million in working capital. As of September 30, 2009, shareholders' equity was $163.9 million, up 11.5% from shareholder's equity of $147 million as of December 31, 2008. For the first nine months of 2009, we generated net cash flow from operating activities of $17.6 million. Our ability to generate positive cash flows provides stability to our business operations. Such stability, which combined with our current cash position, will continue to provide cash resources to support our business expansion. In case of need for additional financing, we are very confident that we would be able to obtain bank loans from local banks in China based on our strong historical performance and bright business prospects. We expect to incur approximately capital expenditures of $12 million over the next six months, including $3.8 million for the acquisition of Puxi, $2.9 million for Puxi’s technological upgrades, and $5.3 million to build offices and for final payments of equipment for phase one at the newly constructed NPCC facility in Zibo.
When we closed the agreement to purchase the land use rights from the local government of Hanshan County for the existing Puxi facility, we estimated an additional cost of $4.4 million. All the capital expenditures are expected to be funded from cash on hand and cash flow from operations.
In closing, I would like to add that we believe the acquisition and future expansion of Puxi facility in Anhui will allow us to establish a strong foothold in the vital Yangtze River Delta area.
We are also very excited about progress at our newly built Zibo facility, which enables us to meet the increasing demand from our expanding customer base and increasing market penetration. These recent developments have strengthened our position as China’s largest NPCC supplier. We believe that with the revival of the global economy and the impact from the Chinese Government’s economic stimulus plan, we can increase our share of the fast-growing worldwide market for NPCC.
I should add that I will be presenting at the Oppenheimer fourth annual industrial conference on November 18th and at Breen Murray 2009 China Growth Conference on November 20, 2009 in New York City. Interested parties are encouraged to refer to our November 4th press release on the subject, or contact Oppenheimer and Breen Murray directly. I look forward to meeting any of you who may attend.
I would now like to open up the call to any questions you may have for the management. We will take one question from each participant and hope to return back to you in case you have a follow-up question. Operator, please start the Q&A.
Question-and-Answer Session
Operator
(Operator Instructions) Our first question comes from the line of John Ma with Roth.
John Ma - Roth Capital
Just one question -- you have in Chaodong or Puxi a facility and my question is when do you expect that facility will start production?
Andrew Chen
Well, with a slight delay in getting the Anhui Provincial Bureau of Commerce approval for the acquisition of the equity transfer that we are estimating that we will complete the technological upgrades and we will have the 10,000 capacity in place for production by the end of Q1 2010.
Operator
Our next question comes from the line of Katherine Lu with Oppenheimer.
Analyst for Katherine Lu - Oppenheimer
This is [Jan Chen] for Katherine Lu. My question is for the new products and can you tell us what is the status of asphalt development and how many [pelting] customers is [pelting] this product? And how these new products can convert to -- how will affect your revenue in dollar terms? Thank you.
Andrew Chen
Jenny, can you translate for Ms. Guo?
Jenny Yang
Sorry, can you repeat the second part of your question? You asked about the asphalt and what was the second one?
Analyst for Katherine Lu - Oppenheimer
Yes, how asphalt development will affect your revenue in 2010 -- can you give us that number in dollar terms?
Anhui Guo (Translation)
Basically, let us give you a little bit of an update on the development of asphalt. Currently the company has collected different opinions from the customers so they are actually testing, updating the asphalt according to those comments and those comments from their customers, so basically the company hasn’t really done a -- like a revenue projection for the asphalt for 2010 but the company is very confident that there will be a start the production of asphalt and provide a very profitable return for everyone.
Andrew Chen
At the moment, we have not gotten to forecasting exactly what kind of volume we are going to be experiencing for asphalt sales for 2010 but that’s not to say that we are not being optimistic. I think so far as Ms. Guo has indicated that we are making solid progress, we are having trial productions, we are getting positive feedback from customers and we are very confident that this is going to turn into a very positive result for the company. And as soon as we are in the position to provide more updates on specific volumes to be expected for 2010 and going forward, we will do so.
Operator
Our next question comes from the line of Ping Luo with Global Hunter Securities.
Ping Luo - Global Hunter Securities
Thank you for taking my question. Your gross margin is down to 39.7% this quarter from 43% in Q2. You just mentioned a couple of reasons, talking about lower ASPs, sort of higher production costs involved and your shift in Q3 product mix -- these are part of the reasons for the gross margin to come down. I would like to ask you to tell how do we see this gross margin going forward? Is it going to maintain at such a level or is it going to improve in the future, in the next few quarters?
Andrew Chen
The decline of gross margin from Q2 of this year to Q3 of this year is caused by several reasons. The first is the raw material cost that has been on the rise, particularly in [inaudible] facility, there was a significant increase in [androcyte] which is a raw material for mixed with the limestone and you put all this stuff into the furnace to make NPCC. And as a matter of fact, there was a 15% increase in the cost of androcyte from Q2 to Q3 by -- and it was increased by 15% to $162 per ton. And then the fuel, the coal which is used for fuel to produce NPCC was increased by 14% to $69 per ton. And then this significant increase in raw materials is one of the first reasons and the second reason being that the initial production of Zibo naturally has lower gross margins and actually Zibo had a negative gross margin of about 17%. And we have since then taken actions to improve production processes and we are expecting to partially restore gross margin at this facility in the coming quarters. At the same time, we have strengthened our control of raw material purchase to ensure we stock more when prices are low and less when prices are high. And as you know, as we are able to normalize the production at Zibo to a much better level in Q4, we are expecting the combined gross margin to move back up to over 40% and potentially around 41% for Q4. And we are confident on a going forward basis above 40% gross margin will be maintained.
Anhui Guo (Translation)
Just to add additional comments from what Andrew said, Ms. Guo commented that the average selling price, although we cannot really say that it is going to be up or down, it really depends on how the market, on the market demand for the average selling price on the NPCC products that basically as we -- as the company gets more mature at the production, the company will be able to reduce the production cost, which will lead to a maintenance on the gross margin so therefore the company going forward, as Andrew said, the gross margin should be maintained at the level that was -- at the same level as before, around 40%.
Operator
(Operator Instructions) We have a follow-up question from Ping Luo with Global Hunter Securities.
Ping Luo - Global Hunter Securities
Your operation cash flow was down this quarter. It is only about $2.6 million in Q3 compared to $8 million in Q2 and $7 million in Q1. What are the main reasons for the operating cash flow to decline?
Andrew Chen
When comparing the operating cash flows in Q1 and Q2 have been very normal. In Q3, there was a factor which I will explain here, is that due to large amounts of fixed asset purchase, the company incurred large amounts of VAT tax yet to be offset by VAT for sale of products. The increase in Q3 is about $4.3 million. This amount is booked in other receivables. The large increase is the main cause for operating cash flow decrease and we considered this phenomenon to be a timing issue and it will not be repeated in the coming quarters.
So it’s a -- it’s just a temporary thing because you -- Zibo just started production and the large scale sales has yet to happen, and then in order to offset this VAT receivable, you need to generate a lot of sales in order to create the other type of VAT to offset it, to bring it down. So this had to be booked as an other receivable and it causes a big reduction to operating cash flow. So our operations have been normal and I don’t think that this is an indication that there is a permanent decline of our capability to generate operating cash flows.
Operator
There appear to be no further questions so I will turn the call back to Crocker Coulson for closing comments.
Crocker Coulson
Thank you, Operator. On behalf of the entire ShengdaTech management team, we would like to thank all of you for your interest and participation in this call, including your thoughtful questions this morning. If you have any interest in contacting or visiting ShengdaTech, please let us know. We are always happy to arrange site visits for interested investors.
Again, thanks a lot for joining us on the call. We look forward to coming back to you early next year to talk to you about our fourth quarter results. This now concludes ShengdaTech's third quarter 2009 earnings conference call.
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