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Zuoan Fashion Ltd (ZA)

Q3 2013 Earnings Call

December 20, 2013 08:30 AM ET

Executives

Bill Zima - ICR

James Hong - Founder, Chairman of the Board and CEO

Calvin Tsang - CFO

Wang Chaoshen - COO

John Low - Head of Corporate Finance and Investor Relations

Analysts

Jeff Oliver - Lone Star Funds

John Sheehy - Private Investor

Operator

Greetings and welcome to the Zuoan Fashion Ltd third 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.

At this time I will like to turn the conference over to Mr. Bill Zima with ICR. Please go ahead.

Bill Zima

Thank you operator and thank you for joining us for the Zuoan third quarter earnings conference call. With us today are James Hong, Founder and Chairman of the Board and Chief Executive Officer; Calvin 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 Q&A 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 1995. 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 now like to turn the call over to Mr. James Hong. Mr. Hong, please go ahead.

James Hong

Good day and thank you for joining us for our third quarter 2013 earnings conference call.

As we mentioned during the last quarter’s earnings call the softening retail environment in China throughout the course of this year resulted in more challenging market conditions for Zuoan in the third quarter

During the first half of the year there was a build-up of inventory at the distributor level due to softer market conditions which resulted in cancelled orders from our distributors impacting our top line revenue growth. We also lowered the wholesale prices offer to our distributors which impacted our revenue and profitability this quarter as well.

In order to help our distributors clear through the inventory and generate greater consumer awareness and demand amidst a weak retail environment, we increased our advertising and promotional programs which also impacted our margin. We believe our marketing ethics which include targeted campaigns in ten major cities in China are in effective use of our resources and we are hopeful we will experience a gradual improvement in consumer spending on our casual fashion at menswear products in the quarters ahead

In the third quarter we closed a net total of 309 distributor and sub distributor store resulting in a total 1074 store locations at the end of September. This was done in an effort to rid ourselves of underperforming locations. We remain focused on improving our performance going forward.

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. I would discuss some of our operational initiative in the wake of the realities of our current retail environment and then Calvin will review our financial results and outlook in more detail.

We are taking what we believe are the appropriate steps including the implementation of certain marketing initiatives to help our distributors clear through the inventories so that they can be in a better position to augment their orders with us once again. We are also strengthening our communications with our distributors, speaking with them on a daily basis to better understand inventory trends and the performance of their retail store; we're also working together more effectively in the areas of store management and product enhancement in order to improve the customer shopping experience. We believe we can improve efficiencies to our supply chain to reduce our purchasing cost which can possibly offset any whole sale discounts, we implement. This will benefit us as market conditions remain south and also allow us to maintain and even potentially expand our market position. It's a better balance of sales opportunity going forward; we can see an opportunity in the market to develop a store chain that focuses on leather goods and accessory. In the last few years of our business we notice a gradual increase in demand for leather goods and accessory, management realized that this is another area where the company can capture a vast opportunity. We have decided to set up a separate chain of stores with separate operational chains to capitalize on this new business potential, we are targeting to open up around 100 stores by the end of 2014 and these stores will be self operated. We will continue to work towards improving operational efficiencies and maximizing the performance of our distribution network as we continue to close more of our loss in current and underperforming stores, we also intend to be more active with our marketing efforts going forward to maximize sales. Sales through distributed inventory and capture additional market share as we face a challenging period of fierce competition and consolidation that has affected for us for the next several quarters. We believe our strategy including our new leather goods and accessory concept will not only lead us through these challenges but will also leave us better positioned for improved performance in the quarters ahead, at this point I would turn the call over to Calvin to review our financial results as well as provide an outlook on our business.

Calvin Tsang

Thank you, John. I would like to first review our financial performance in the third quarter. Revenue for the third quarter was RMB380.5 million, a 20.1% decrease from RMB476.3 million in the same period last year. The decrease was primarily attributed to a cancellation of sales order of our Fall and Winter collection 2013 back in June, as a result of the economic downturn in the menswear sector during the second half of 2013. During the quarter, distributor sales decreased by 16.0% to RMB378.3 million from RMB450.2 million in the same quarter of 2012. Third quarter 2013 self-operated direct store sales decreased to RMB2.2 million from RMB2.9 million in the same quarter of 2012. A net total of 309 distributor and sub-distributor stores were closed in the third quarter of 2013, resulting in a total of 1,074 store locations as of September 30, 2013 compared to 1,383 store locations at the end of the second quarter.

Cost of sales decreased by 11.1% to RMB224.7 million in the third quarter of 2013 from RMB252.7 million in the same quarter of 2012, in-line with the revenue decrease associated with cancelled sales orders. As a percentage of revenues, cost of sales increased to 59.1% in the third quarter of 2013 from 53.1% in the same quarter of 2012.

Gross profit in the third quarter decreased 30.3% year-over-year to RMB155.8 million from RMB223.6 million in the same period of 2012. Third quarter 2013 gross margin was 40.9% compared to 46.9% in the same period last year. The decrease in gross margin was primarily due to the decrease in the Company's wholesale price discount that was implemented in the third quarter of 2013.

Selling and distribution expenses in the third quarter were RMB108.3 million, or 28.5% of revenue, compared to RMB84.1 million, or 17.7% of revenue in the same period last year. The percentage increase was primarily due to a planned increase in advertising and marketing expenses in the second half of 2013 to create greater consumer brand awareness.

Administrative expenses in the third quarter were RMB14.5 million, or 3.8% of revenue, compared with RMB14.0 million, or 2.9% of revenue in the same period last year.

The effective tax rate in the third quarter was 27% compared to 25.6% in the same quarter of 2012. Net income for the third quarter decreased by 75.3% to RMB23 million from RMB92.8 million in the same period last year. Third quarter net margin was 6% compared to 19.5% in the prior year period.

Diluted earnings per ordinary share were RMB0.21 in the third quarter of 2013, equivalent to RMB0.83 per ADS, compared to diluted EPS of RMB0.83 or RMB3.34 per ADS in the third quarter of 2012. The Company's diluted number of shares outstanding was 111.3 million in the third quarter ended September 30, 2013.

As of September 30, 2013, the Company had cash, cash equivalents of RMB1,287.1 million compared to RMB918.5 million as of December 31, 2012. Net cash provided by operating activities was RMB78.4 million in the three months ended September 30, 2013, compared to a net cash used in operating activities of RMB172.9 million in the three months ended September 30, 2012.

We estimate that our cash flow will trend downward in the second half of the year due to the decrease in cash flow from operating activities. This decrease is mainly due to a decrease in our wholesale price offered to our distributors which is now at 35% compared to 38% offered in the recent quarters, as well as a cancellation of orders from our fall and winter collection.

Accounts and other receivables were RMB479.1 million compared to RMB606.5 million at end of December 2012, mainly due to a decrease in net selling in third quarter of 2013. At the end of September of 2013, 92% of our AR was paid within 90 days. CapEx spending in the third quarter was RMB0.8 million for the [indiscernible] improvement of our direct stores in Shanghai.

For the fourth quarter of 2013, the company currently anticipates revenue in the range of RMB206 million to RMB236 million, gross margin of approximately 42%, net income of approximately RMB15.6 million to RMB20.1 million and basic and fully diluted EPS of approximately RMB0.14 to RMB0.15, equivalent to RMB0.56 to RMB0.72 per ADS. Approximately 30 to 50 retail stores are expected to be closed by distributors and sub-distributors in the fourth quarter of 2013.

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

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session (Operator Instructions). We will take our first question from Jeff Oliver with Lone Star Funds.

Jeff Oliver - Lone Star Funds

Thank you for taking my call. With sales demand weaker in the third quarter purely due to a softer retail environment in China, or do you think it was also related to certain miss-steps in the product design that led to softer sales?

James Hong

Sorry Jeff, you asked about the product, whether it’s being mis-designed or mis-priced of something like that, right?

Jeff Oliver - Lone Star Funds

Correct, was the issue more factory related or did you identify some general product mis-step that led to weaker consumer demand.

James Hong

Jeff, management mentioned that this is purely definitely a macro situation and it’s across the board with a lot of other brands, Mr. Wang just now has listed the example of Septwolves. Septwolves has recently I think closed over 500 stores as well, so it’s not a company problem it’s definitely an economy wide problem here.

Jeff Oliver - Lone Star Funds

Okay, thank you. Can you elaborate on your marketing initiatives you engaged in the third quarter and how do you think these initiatives can drive sales going forward? And for your A&P expenses remain elevated for the next few quarters?

James Hong

Okay. Jeff, in regards to the A&P and the related activities of it Mr. Wang is mentioning about various activity such as we from July onwards we engage a good number over 50 of media companies and advertising companies and then nationwide drive for appetizing in areas such as billboards roadside billboards and also shopping mall billboards as well as we held and intent major cities China we held various activities and events to promote fashion trends and also our collection and these were sort of very focused events that happened during the quarter. And going forward we do not expect these high A&P expenses to keep incurring. And for this year definitely because of the weak market conditions especially in the first and second quarter and third quarter is the winter autumn collection coming out and these are traditionally very important seasons. So that’s why we spend a lot of effort and financial resources in that period to drive sales during that period. And as a result we are actually gradually seeing improvements at least in the excess inventory levels of these distributed as a result of our sales drive and our A&P drive. So we are seeing some effect of all the advertising coming along. So hopefully over the next two-three quarters things will improve but to answer your question we do not expect such high levels of A&P expenses to be incurred over the long term.

Jeff Oliver - Lone Star Funds

Okay, thank you. Lastly, can you provide more details on your leather goods and accessories outlets? Will these be operated by your distributors and how does the opening of 100 stores impact your CapEx spending over the next 12 months?

James Hong

Jeff, these leather goods chain stores or separate line of stores are expected to be all self operated. So, we’ll be operating these stores ourselves and the budgeted CapEx for, or the CapEx would include the renovation, the transfer fees and an inventory as well. So, we worked out to be about RMB1 million per store for these leather goods. So, round about 100 hundreds stores, we’re looking at about 100 million for the next year or so with all the RMB here.

Operator

We’ll move now to [indiscernible].

Unidentified Analyst

I’ve got a question, what kind of company was nearly $10 a share in cash, doesn’t pay a dividend to shareholders that have suffering for years and years and years?

James Hong

Mr. Hong here has mentioned that, yes we will be, we have plans to pay a dividend by the time we announce the fourth quarter full year results and regards to the amount of it that will be decided at that time. So, we do have plans to pay dividend at that time.

Operator

[Operator Instructions] and we’ll move to John Sheehy, Investor.

John Sheehy - Private Investor

First, I’d like to ask about the Spring Summer Sales Fair; how does that go and do you have any results that you could share with us?

James Hong

John, in the latest Spring Summer Sales Fair which was held in September, the performance was that we had a drop in orders as compared to the same period of last year. We’re talking about around 15% drop as compared to the last year.

John Sheehy - Private Investor

And number of stores was down by a larger amount; so that doesn’t seem so bad.

James Hong

Because these stores that were closed were mainly loss making, a very weak performing stores. So, that’s why you see there is a discrepancy there.

John Sheehy - Private Investor

So, that’s a little bit encouraging. Then, I’d like ask about the store network; I think you mentioned that you planned to close an additional 30 to 50 stores, and after those closings, do you think that the network will be stable?

James Hong

Well John, as mentioned a couple of times the reason why we close these stores really, they were loss making and very weak performing stores and after a couple of years a few years of high growth this stage of consolidation is bound to happen and especially in such a weak market. And going forward, we believe after such drastic restructuring of our stores and consolidation of our stores, going forward we do see, we do expect stabilization happening in the near future. But that all depends on of course, depends on whether the market's going to deteriorate furthermore, but as mentioned over the next few quarters we do expect the market to pick up again.

John Sheehy - Private Investor

Okay, thank you and did the company incur any special expenses in closing those retail outlets and what happened to the inventory from those outlets that were closed?

James Hong

Okay John, because these stores are not our stores so there are no special like expenses, or any other extraordinary expenses to be incurred on the closing of these stores, and regarding the inventory because these stores are owned by distributors and self distributors who have also at the same time other stores remaining in their portfolio. So what they do with the inventory is that they would redistribute the inventory to the other remaining stores, these inventory by the way are not our inventory and they cannot inventory to us.

John Sheehy - Private Investor

Okay thank you, then I would like to ask about leather goods stores and the strategic thinking behind the decision to have that as 100% self operated which is different from the apparel stores which are 100% on the wholesale distributor model.

James Hong

So your question would be, why it’s self operated, you mean?

John Sheehy - Private Investor

Why are you using a different strategy for those stores?

James Hong

Well, first of all, we have obtained operating stores experience from our self operated stores previously. So definitely we do have the experience going forward in operating these new leather goods stores. But more importantly it’s really market driven as well because the market is in such weak state, a lot of the distributors are also facing challenges and difficulties and we do not see them as being very competitive in this market condition.

So in order to safeguard the brand and also to really improve the brand equity we do believe self operating these stores going forward is the way to go, at least in the foreseeable future, this is a better direction for us, for this new line.

John Sheehy - Private Investor

So this is your opportunity to use your strong financial condition to invest when the market is weak.

James Hong

Yes, definitely.

John Sheehy - Private Investor

Okay thank you very much, that's all my questions and I appreciate Mr. Hong's promise to pay a dividend next year, I'll look forward to receiving that, thank you very much.

Operator

(Operator Instructions), and we'll take Jim Willis [ph], who is an investor.

Unidentified analyst

Thank you for taking my call. I would like to ask little bit more about the dividend. You said you’ve been update during the fourth quarter or when you announced the earnings at the end of the fourth quarter?

Wang Chaoshen

We will announce together with when we announce the fourth quarter results; that’s when we will announce the dividend payment as well.

Unidentified Analyst

And approximately when that will be, in March some time?

Wang Chaoshen

Typically would be March-April round by that period.

Unidentified Analyst

Now besides paying a dividend, do you have any plans to buyback any shares?

James Hong

Right, at the moment we do not, in the short term and then short term new future anyway we do not have any definite plans for share repurchase.

Unidentified Analyst

Okay. Looking at your cash, at the end of Q2 you had a $192 million. You mentioned that at the end of Q3 you had $210.3 million. Although you said that this quarter you are that in your net cash 12.8 million. So if I add 12.8 million and 192 million it takes you to 204.

But I see you have, you say at the end of Q3 you had 210. So that’s about $6 million more. Is this interest you gain as you having the money sitting at the bank or what?

Wang Chaoshen

Okay, just a minute Jim. We’ll need to do some calculations first. Jim while Calvin is punching in the numbers, do you have any other questions?

Unidentified Analyst

No, that was the last.

Wang Chaoshen

Okay. Then give us a few more seconds please.

Unidentified Analyst

Okay. Well, I had one more questions since we’re waiting. As far as institution investors, did anybody did you gain any new customers at that level or new investors or you have many of the investors leaving because of the depressed price of the stock for so long?

Wang Chaoshen

Well, I wouldn’t comment on why the investors left. But according to our latest records, we don’t have any new well significant anyway significant institution investors through the period.

Unidentified Analyst

Yes, the point if I’m right with the cash may if it adds up to 204 million and then you have 210 million, I mean it seems like a 6 million is interest or something. I mean if you just allocate the small amounts and I don’t say to use your cash but use the small interest you gain on your tremendous amount of cash you have to do some significant, I mean 5% of your cash would or 6 million the difference in interest, you can buy 3 million shares I mean your stock is going to go away through the roof. And you do that over a period of time, that’s the way you reward your customers and your investors. And to gain the trust of investors and you are going to track the no institution investors.

But if you don’t do anything like that and you postpone it from quarter-to-quarter, then people lose faith and the say why this company with all this cash as a price-to-earnings ratio of 1, this is ridiculous I mean it’s unbelievable. I mean it’s, you lose the trust of the investors that’s my point. So hopefully you’re going to do something with it.

James Hong

That was Mr. Hong there. First of all he already undertook to pay dividend at the end of the year or financial year. So, that’s one thing, but the second thing is that we have various plans for initiatives, various initiatives in such a weak market environment. These initiatives that we do believe that they are necessary to expand business, to develop business and to maintain market share and we believe that it is a good time to invest more resources and time and to develop the market and also develop the company. So, on that front there will be a lot of financial resources are in cash that will be needed as well so.

So, that’s why we need to be prudent on how we spend the cash. But in any cash we have undertaken to pay a dividend by the end of the, well, at the end of the financial year when we announce the results.

Operator

That does conclude our question-and-answer session, so at this time I’d like to turn the call back over to management for any additional or closing remarks.

Calvin Tsang

On behalf of the management team, I thank you all again for attending to these earnings conference call. We look forward to meeting you again at our Q4 and full year earnings conference call. Have a happy, joyful and safe holiday season. We also wish you a happy, healthy and prosperous New Year ahead. Good bye.

Operator

Once again, I’d like to conclude today’s conference. Thank you for your participation.

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