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China XD Plastics Company Limited (NASDAQ:CXDC)

Q4 2013 Earnings Conference Call

March 26, 2014 08:30 AM ET

Executives

Tom Zhou - IR

Jie Han - Chairman and CEO

Taylor Zhang - CFO

Analysts

Peter Siris - Hua-Mei

Graham Tanaka - Tanaka Capital

George Mayer - Manhattan Realty Group

Operator

Welcome the China XD Plastics’ Fourth Quarter and Fiscal Year 2013 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Following management’s prepared remarks, there will be a Q&A session. As a reminder, this conference is being recorded and a replay is going to be available shortly after the call.

I would now like to hand the call over to your host for today’s call, Tom Zhou. Please go ahead.

Tom Zhou

Thank you, operator. Good morning and good evening [indiscernible]. And thank you for joining us for the China XD Plastics’ fourth quarter and fiscal year 2013 financial results conference call. Joining the call today are Mr. Jie Han, Chairman and CEO; Mr. Qingwei Ma, Chief Operating Officer; and Mr. Taylor Zhang, Chief Financial Officer. Earlier today, China XD Plastics issued a press release announcing its fourth quarter and fiscal year 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 that management may make additional forward-looking statements in response to your questions. The company therefore claims the protection of the Safe Harbor for 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 a more detailed discussion of the risks and uncertainties in the company’s filings with the Securities and Exchange Commission. A more comprehensive description of the company’s forward-looking statement is contained in the company’s filings with the SEC. In addition, any projection as to the company’s future performance presents management’s estimate as of today, March 26, 2014. China XD Plastics assumes no obligation to update those projections in the future as market conditions change.

To supplement its financial results presented in accordance with the U.S. GAAP, management will make reference to EBITDA, a non-GAAP financial measure reconciled from net income, which the company believes, provide meaningful additional information to better understand its operating performance. A table reconciled in net income to EBITDA can be found on the earnings press release issued today.

I would now like to turn the call over to Mr. Han. Mr. Han will be speaking Chinese and I will translate his presentation into English. Mr. Han, please go ahead.

Jie Han

Thank you, Tom. And welcome to all of you who have joined us today. I am very pleased our significant achievement in our business includes market growth, R&D result, business expansion and solid growth of gross revenues and net profits. I would like to take this opportunity to share some major highlights of our 2013 performance and outlook of our business.

Overall business performance remained very strong as evidenced by 30.5% increase in shipping volume to 337,189 metric tons, up from 223,982 metric tons in the 2012 and 84.5% increase from 62,692 metric tons in the fourth quarter of 2012 to 115,650 metric tons in the same period of 2013.

Thanks to the execution of our well thought out marketing strategy. We continue penetrating East and more China markets. Revenue contribution from those two markets during the fourth quarter of 2013 were up 208.5% and 137.4% respectively compared to the revenue a year ago. In addition we have started generating revenues from Southwest China with 3.7% revenue contribution in 2013 and remain confident with the gross penetrations in the recent for years to come.

We had a temporary gross margin in the first quarter of 2013; we stick with our plans and keep executing the two strategies, with our market acquisitions in East and Southeast China market shift product mix to higher end and higher margin categories. As a result, gross margins stabilized and improved three quarters back-to-back; in 2014 we expect margin recovery to continue driven by our R&D commitment and a shift in products mix to higher margin categories.

In 2013 we compared a thorough review of our R&D strategy advised by leading Macromolecule Material Industry experts and analysis. As a result we recalibrate our R&D direction and expand into non-automotive products, but in higher end applications such as biodegradable plastics, alloys, high performance fiber material and its products, 3D printing special materials, weather resistance, flame resistance and special engineering plastics, which will cover high speed rail, ship, airplane and biomatic and other high end fuels. This reflects our strategy to diversify its product portfolio and further expand our industry coverage and customer base.

In December 2013 we broke ground on the construction of our first production base in Nanchong City, Sichuan Province, the completion by the end of 2015 with additional 300,000 metric tons of annual production capacity across an additional 70 new production lines which will bring total installed production capacity to 690,000 metric tons to support our future business growth. Result is that, we are confident in the future prospect of our business and market and look forward to strengthening our leading position and delivering significant shareholder 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

Thank you, Ms. Han and thank everyone for joining the call today. Now looking at our quarter and full year, as you have seen from our earnings release, we delivered a solid quarter and full year results driven by increased sales in terms of both volume and product mix shift to both existing and new customers. Revenues for the fourth quarter of fiscal 2013 were $384.6 million representing a year-over-year increase of 128.1% from $168.6 million from a year ago. Revenues for fiscal year of 2013 were $1.0 billion, representing a year-over-year increase of 75.2% from $499.8 million in fiscal year of 2012. The increase in revenues was mainly due to increases in sales volume and ASP.

In the fourth quarter of 2013, gross profit was $91.4 million, up 145.2% from $37.3 million in the same period of last year. Gross margin was 23.8% compared to 22.1% in the same period last year. In fiscal year of 2013, gross profit was $223.4 million, up 55.4% from $143.8 million in fiscal year of 2012. Gross margin was 21.3% compared to 24% in fiscal year of 2012. The decrease of our gross margin in fiscal year of 2013 compared to that of 2012 was primarily due to, first, an average of 5.8% discounts on the listed price for 2013 to distributors as part of our marketing initiatives to increase our market share in East China and Southwest China. As a result, revenue contribution from East China and Southwest China grew to 31.2% and 3.7% of our total sales during 2013 compared to 22% and 0% in the same period of last year respectively.

Secondly, an increase in shipping expenses to $16 million in 2013 from $2.1 million in the same period last year. We have started bearing the shipping expenses which is a part of our marketing strategy to grow market shares since the first quarter of 2013. And such arrangement is expected to continue in the future. Gross margin recovered after the first quarter of 2013 due to the increase of revenues contribution from higher-end products, such as engineering plastics, alloy plastics and environmentally friendly plastics as we were able to successfully sell more higher-end products to both existing and new customers. We expect the trend of our gross margin recovery to continue in 2014 as we shift our product mix towards higher-end categories.

During the fourth quarter of 2013, G&A expenses were $5.5 million compared to $2.5 million for the same period last year. On a percentage basis, G&A expenses in the fourth quarter of 2013 were 1.4% of revenues compared to 1.5% in the fourth quarter of 2012. In fiscal year of 2013, G&A expenses were $15.3 million compared to $10 million for the fiscal year of 2012 and as a percentage of revenues decreased to 1.6% from last year’s 1.7%. The increase in G&A expenses is mainly due to the increase of a share based compensation, taxation, fixed assets of depreciation, professional fees, travel and office expenses associated with business expansion.

During the fourth quarter of 2013, R&D expenses were $5.3 million or 1.4% of total revenue, compared to $19 million or 5.4% of total revenues in the same period last year. In fiscal year of 2013, R&D expenses were $21.3 million or 2% of total revenues compared to $21.6 million or 3.6% of total revenues in fiscal year of 2012. The decrease of R&D expenses in 2013 was primarily due to decreased expenses associated with the early conclusion of some research and development experiments after our R&D strategic review and we recalibrated our R&D efforts to target more long-term but higher-end application such as aerospace, high-speed train, biologic fields.

During the year ended December 31, 2013, the Company successfully launched 37 new automobile manufacturers certified products, which increased its total number to 283. During the fourth quarter of 2013, operating income was $80.6 million, or 21% of revenues, an increase of 212% over the operating income of $25.7%, or 15.3% of revenue in the same period last year. In fiscal year of 2013, operating income was $185.6 million or 17.7% of annual revenues, an increase of 65.9% over operating income of $111.9 million, or 18.7% of annual revenues in 2012. This increase is primarily due to higher gross profits offset by higher G&A expenses.

Net income for the fourth quarter of fiscal 2013 was $57.5 million, compared to net income of $17.3 million for the same period a year ago. Net income available to common stockholders for the fourth quarter of 2013 was $57.5 million, compared to $17.3 million for the same period of last year. Basic and diluted earnings per share were $0.89, compared to last year results which were at $0.36. Net income for the full year of 2013 was $133.8 million, compared to $85.9 million in the full year of 2012.

Net income available to common stockholder for the full year 2013 was $133.8 million compared to $85.9 million in the full year 2012. Basic and diluted earnings per share for the full year of 2013 were $2.80, compared to $1.35 in the full year 2012 respectively. EBITDA for the first quarter of 2013 was $88.8 million, an increase of 191.9% from $30.4 million in the same period last year. For fiscal year 2013, EBITDA was $217.2 million, an increase of 166.2% from $130.7 million in the same period of last year.

Now turning to the balance sheet, as of December 31, 2013, China XD Plastics had $95.5 million in cash and cash equivalents, $281.3 million in time deposits with commercial banks, $289.1 million in working capital and a current ratio of 1.5. Stockholders’ equity as of December 31, 2013 was $412.3 million, compared to $264.4 million as of December 31, 2012.

Accounts receivable increased by 96.3% as a result of increase in revenues and increase in days sales outstanding from 56 days for the fiscal year 2012 to 72 days for the fiscal year of 2013. However, DSO decreased in the fourth quarter of fiscal 2013 to 63 days from 64 days in the same period last year and 71 days in the third quarter of fiscal 2013, reflecting our collection efforts and ability to improve our working capital. Inventory increased by 85.1% due to the anticipation of the increase of customer demand in the following quarters.

Accounts payable increased by 1,625.4% due to the extended payment term we renegotiated with our domestic raw material suppliers, a shift from prepayments to suppliers in the past, in order to strengthen our working capital further.

Short-term bank loans increased by 94.1% due to the need to support of our future capacity expansion in Southwest China. Accrued expenses and other current liabilities increased by 62.2% due to the increase of accruals for purchase of profits plans and increments to expand the production capacity.

Finally as a result of our solid year of performance in 2013, we have announced our guidance for fiscal year 2014. We expect revenue to range between $950 million and $1.05 billion. And net income for fiscal year 2013 to range between $100 million to $120 million, excluding any non-cash charges related to stock-based compensation and change in fair value of existing derivative liabilities. The current income guidance is a function of expected sales. The actual interest expenses associated with our long-and short-term debts and expected tax benefits in Heilongjiang province. This forecast is based on constant exchange rates and reflects the Company’s current and preliminary view, which is subject to change.

Before we open to the call to your question, I would like to note that for any questions directed to Mr. Han, Mr. Qingwei Ma, I’ll translate both questions and the answers. With that we’ll now open the call to your questions, operator.

Question-and-Answer Session

Operator

We’ll now begin the question and answer session (Operator Instructions). Your question comes from the line of [indiscernible] Capital, your line is open please go ahead.

Unidentified Analyst

Yes, good morning, Taylor I was wondering if you could just walk us through your -- if I understand it right, your expectations for sales is roughly flat year over year. Can you walk us through whether you’re walking away from some business and this is a reflection of a more negative outlook in terms of your viewpoint of China, but maybe you walk us through your inputs as to why you believe sales are going to be flat for this year.

Taylor Zhang

Okay sure, and thank you for the question. I think in terms of question, first of all it’s only the beginning of the year, we always speak conservatively in the beginning of the year and secondly as you know in 2014 we do not have any additional capacity coming online. So the capacity is pretty much the same as 2013 and in 2013 we pretty much already reached full utilization rates. So we do believe there is going to be some upsides but for now we just want to be conservative. And I think one additional point is, this a great opportunity for the company to focus on the quality of the market share and also customer in terms of how we can further improve our working capital.

Unidentified Analyst

Is the line still open?

Taylor Zhang

Yes, we can hear you.

Unidentified Analyst

So would you expect throughout this year that you might replace some lower margin product with potentially higher margin product in terms of your capacity or you do not have the ability to do that?

Taylor Zhang

That’s exactly our plan as also disclosed in our earnings release. Actually last year we have already done that, so the percentage of high margin has improved, increased dramatically and we do believe the trend will continue in 2014.

Unidentified Analyst

Can you just review for us what your plans are in terms of capital spending for this year and when this capacity, the new capacity is going to begin to come on?

Taylor Zhang

Sure, so our CapEx right now, basically are in two categories. We still have a Harbin CapEx which we initially had thought we’re going to spend in 2013 so there’s some delay with title transfer so we will only accept it upon a 100% satisfactory to our specifics. So Harbin this year we have the remaining balance of approximately $50 million and then the second part is our southward expansion. So as we discussed before, the total CapEx for Citron is approximately $290 million, so approximately $110 million will be -- is earmarked for this year and the remaining 184 to 2015. We expect the southward product punt will begin producing in late of 2015 or early 2016.

Unidentified Analyst

And lastly can you walk through, maybe elaborate a bit of reasons for your change in allocation of R&D towards some of the newer industries such as aerospace, high-speed train. What is the reason of the rationale behind making that change or making that move?

Taylor Zhang

Okay, then let me translate your question first.

Jie Han

Hi Glenn [indiscernible] Mr. Han our Chairman took your question, so first the major reason is as follows; number one is a transition for us to be better positioned in the marketplace; and secondly is a upgrade to our R&D and also our products. So the goal is to achieve -- the goal to achieve is to have more products in the high-end, high-tech and high market shares. And although we will still remain as our foundation in our product portfolios so this is also followed both China and international composite material markets.

Operator

Your next question comes from the line of Peter Hallsworth from [indiscernible] Investments. Please go ahead.

Unidentified Analyst

I have a couple of questions, first on shipping. What should we expect that to produce in terms of cost over the coming years and will the expansion serve to increase or decrease that cost item, that’s my first question.

Taylor Zhang

Okay Peter so for shipping cost in 2013 the total shipping expenses is approximately $60 million as I mentioned. So for this year we do not see any big fluctuation from that because the shipping volume is going to be pretty much in the same just a function of where the customer is and where we deliver them.

Unidentified Analyst

Okay. And then going into with the expansion in ’15 onward, do you anticipate shipping cost to be lower or increased as a result of that what is your guidance on that?

Taylor Zhang

Yes Peter by upon the operating revenue of our sources current, the shipping cost can be expected to be lower.

Unidentified Analyst

As a percentage or in a total now?

Taylor Zhang

As a percentage, yes.

Unidentified Analyst

Okay. And then my next question is regarding certified products I think you’ve been increasing them for autos and with the diversification into other areas. I was wondering do you have any certification of products upcoming this year in the other areas like aerospace, trains, medical, et cetera.

Taylor Zhang

Okay. Let me direct your question to our R&D staff. Hi Peter Mr. Han just took your question. So as I mentioned earlier, 2014 is a year for us to upgrade products and transition to higher end category. So we do expect to have some initial certification from now to application.

Unidentified Analyst

Okay. And then just lastly on the Sichuan expansion, how much of that production would you anticipate to be growing for as non-auto demand?

Taylor Zhang

Okay. Let me translate your question first. Hi Peter so for our Southwest clients, although will remain the majority of our product portfolio however as a percentage our view is and our plan is to achieve 15% to 30% in other higher end applications.

Unidentified Analyst

Okay and that would be -- what order do you think that would be in terms of the share or would it be aerospace being the most of that percentage or trains, which would be the higher percentage?

Taylor Zhang

Okay, I understand. Let me translate first. Peter so the idea for our moving to other area is followed the China infrastructure developments and also the government action. As we all know, high-speed train is booming in China and we actually in 2013 have already a small product sought and used in the area. So we do believe high-speed train will take the lead. Obviously we do, our view -- in our view airplane will be another industry that follows the path of auto industry in China and we do believe there's a good potential there as well.

Unidentified Analyst

Right, okay. Thank you. Operator I’ll return to the queue. Thank you gentleman. Congratulations on a great year and being such in great health recently. Thank you.

Operator

Your next question comes from the line of Josh Meyer from Manhattan Realty Group. Please go ahead.

Unidentified Analyst

Congratulations guys on a great quarter and a great year. I’d like to follow up on an earlier question on your revenue guidance. My understanding is that you are operating pretty much at full capacity in the fourth quarter and on an annualized basis, the fourth quarter revenues would be on the order of 1.5 billion, and yet you’re only projecting something in the neighborhood of 1 billion. For 2014 we’re almost through the first quarter of 2014, have you experienced what would seem to be a significant slowdown in your business if you are really going to be projecting revenues and the fact that two-thirds of the rate that you were running in the fourth quarter. Could you comment on that?

Taylor Zhang

Sure, so I think the business still remain very solid and you can see from various area, for example auto industry has -- the growth of auto industry has been picked up in 2013 after a slowest year in 2012. And we still see the increasing demand for more plastics on a per vehicle basis. And in addition the higher-end where lesser vehicles tend to use more pricing and more plastics. So these demands are still fundamental to our business and not diminished. So like I mentioned it’s still early in the year and in our business we have very good visibility, that's a characteristics of our industry because we typically sign a new contract for the following year in December, so we have already booked, received over 80% of our total capacity by the end of last year. So, I do believe, I do want to stress that we just want to be conservative and as we progress quarter-by-quarter, we can give you more updates and we can go from there.

Unidentified Analyst

Thank you. So, you haven’t to-date experienced any slowdown from the fourth quarter?

Taylor Zhang

No, we do not.

Operator

This phone question from Glenn Cravlin from GHC Capital. Please go ahead.

Unidentified Analyst

My question was answered. Thank you.

Operator

We also have a follow-up question from Peter Hallsworth from [indiscernible] Investment. Please go ahead.

Unidentified Analyst

Thank you. Just on the senior notes that were just raised for US$150 million, do you anticipate any of that being used for operating cash flow?

Taylor Zhang

We currently do not expect any of that goes into operating cash flow, number one. The premier, use of procedure for one is to support our Sichuan expansion, second related to pay down our debt. And I think you can also see from our continually improved working capital metrics for example ARD has been trending down since second quarter of last year and we have been able to stretch the accounts payable. So, we do have great confidence with our liquidity and also cash flow generation ability going forward.

Unidentified Analyst

And do you expect working capital at the end of 2014 to be positive or negative, what’s your outlook?

Taylor Zhang

I beg your pardon. Did you mean working capital or cash flow?

Unidentified Analyst

Yes.

Taylor Zhang

You mean net cash flow right?

Unidentified Analyst

Yes.

Taylor Zhang

Okay. I think given the CapEx plan we have this year, $110 million for Sichuan and $50 million for Harbin, that’s the last CapEx for Harbin, so altogether about $160 million. So, it’s all go to be flat on that.

Unidentified Analyst

Okay. And just lastly if maybe Mr. Han could comment on how he sees this coming year in the context of the development of the company and its interest, is this considered to be an investment year, a transition year and what we can expect in the future for ‘14 and beyond? I'd appreciate that. Thank you.

Taylor Zhang

Sure Peter. Let me translate your question. Hi, Peter, let me translate the answer from Mr. Han. He said it’s a challenging question but he likes challenge. So, first 2014 and above and beyond, we have several goals here. The number one is to increase our scale to achieve more scale. Secondly is, as I mentioned, product upgrades. Thirdly is technology upgrades, so throughout the previous 30 plus years China XD has accumulated a great deal of technology reflected by customer recognition, leading number of segregation. So it is our goal to maintain our leading position in China in the markets.

And secondly, he believes that we're in the markets and also the [indiscernible] market has started to recognizing China XD. And going forward, we will continue to invest in technology to increase the barrier of entry to our business and that will be pretty much the blueprints for the next 10 year for the company.

And one additional comment from Mr. Han is, China XD’s gross plan is under a very rational and stable plan based on our high technology and also the barrier we have built for the business. So we do have a well thought out plan to execute.

Operator

Your next question comes from the line of Peter Siris from Hua-Mei. Please go ahead.

Peter Siris - Hua-Mei

Great year. I just want to make sure I understand a few things. In 2013, during the year you added capacity in Harbin, so that by the end of the year you were full capacity but capacity was coming on during the year, is that correct?

Taylor Zhang

Peter, that’s correct. The capacity was added initially in start in December 2012, so we have a ramp up in Q1 and pretty much reached the optimal level in Q2.

Peter Siris - Hua-Mei

Okay. But in Q2 for example, I think if I remember correctly is your shipments were up by something like 29% and your shipments were much higher in Q4. So that says that the ramp up was stronger. I mean, your metric tons were up 84%, 85% in Q4 and only 29% in Q2, is that because of capacity or something else?

Taylor Zhang

It's because -- so basically you are right. We approached almost optimal capacity by the end of Q2. So in Q3, Q4, we have -- actually looking very hard to slightly above of optimal level, but that is non-sustainable for the maintenance and care of our machineries.

Peter Siris - Hua-Mei

Okay, so that the Q4 level is above full capacity so that the -- you should be able to do significantly better than your estimates, than your guidance, but the level that you came up within Q4 you’re going to need some periods of time just to shut down the machines and retool them and things like that, is that correct?

Taylor Zhang

Yes, that’s correct. For example when you say half, we actually reduced the days typically five days per month for our care and repair. As I mentioned that’s not sustainable on a longer term.

Peter Siris - Hua-Mei

Okay now in Harbin, you have some more -- either more facilities that you’re going to open in that you are building in Harbin or planning to build in Harbin?

Taylor Zhang

No, Harbin is fully invested. We don’t expect any additional capacity from Harbin.

Peter Siris - Hua-Mei

Okay, so all this new capacity will come from Sichuan?

Taylor Zhang

That’s correct.

Peter Siris - Hua-Mei

Okay and you don’t expect any Sichuan contribution until maybe the fourth quarter of 2015?

Taylor Zhang

That’s the earlier estimates for now.

Peter Siris - Hua-Mei

So Sichuan is basically 2016 event?

Taylor Zhang

Yes.

Peter Siris - Hua-Mei

And the capacity in Sichuan could be similar to the total capacity in Harbin?

Taylor Zhang

Close to Harbin we have 390,000 metric tons, Sichuan we will build 300,000 metric tons.

Peter Siris - Hua-Mei

Okay so theoretically when in 2000, once Sichuan is up and operating, your capacity would lead you to $2 billion in revenue. I’m not saying that you would achieve it. I’m saying that’s what your capacity would be.

Taylor Zhang

I will just say somewhere in the future we are on the track to achieve that.

Peter Siris - Hua-Mei

I just want to make sure that I’m not missing any numbers. And given the higher margin products that you’re going to and given the shipment, the one late in the fourth quarter, I’m not asking for guidance, what I just want to make sure I understand is, what -- in 2014, what would your capacity be? It looks to me like your capacity is something like 1.4 billion to 1.5 billion. Would that be reasonable? I'm not saying that’s what you’re going to achieve. I’m saying that’s what your capacity is.

Taylor Zhang

Okay. I think Peter, that’s one of the reasons we give conservative guidance in the beginning of the year because the price -- the price is a function of several factors. So number one the modified project price, they do change. Even though not very volatile, they do change from time to time. Secondly the product mix also play a role here as we all understand. So that’s why I think you know we give guidance based on the capacity instead of any pricing. We do not take any pricing assumption here.

Peter Siris - Hua-Mei

I’m not asking about the guidance. What I’m saying is, is there any reason why your capacity, I’m trying to understand what your capacity could be in 2014, not what your revenues are going to be.

Taylor Zhang

Okay, okay. So ’14 capacity will remain the same. Its 390,000 metric tons. So you can expect our utilization to approximately 85% around the neighborhood.

Peter Siris - Hua-Mei

And is 85% optimal, is 92% optimal? What’s the number that’s optimal for you in terms of wanting your business?

Taylor Zhang

Optimal is basically 85%.

Operator

Your next question comes from the line of Graham Tanaka, from Tanaka Capital. Please go ahead.

Graham Tanaka - Tanaka Capital

Just a few questions to tie things together here. So I just want to understand, you gave us capacity for Harbin and then Sichuan is going to be added. What is the sales breakdown going to be southwest versus Harbin and other areas? Is the proportion of sales going to be the same breakdown of terms of production in two years?

Taylor Zhang

Okay, are you talking about any specific year or just a ball park sense?

Graham Tanaka - Tanaka Capital

Well actually what -- I should have started by asking what might the sales in the southwest be this year versus last year and what would it rise to when the production is coming along and I guess it was 2016, thank you.

Taylor Zhang

Okay, okay. [Foreign Language]. And so Graham so we expect this year the sales in southwest region is expected to be approximately 4% and going forward we do expect the contribution, revenue contribution in the future from Citron Harbin will get closer to a 50 to 50 split.

Graham Tanaka - Tanaka Capital

And what would be the profitability in the southwest province? I would understand -- I wouldn’t be surprised if it's a lower profit margin to begin with and then rise to the corporate average or is it inherently lower higher margin business.

Taylor Zhang

Okay, let me translate the question. [Foreign Language]. Okay. So Graham there is two perspective or two ways to answer your question. Number one, from product structure point of view Sichuan actually started with offering higher end category products. However another moving force is -- whenever you enter into new markets, you always want to make yourself -- we have products more attractive as a marketing strategy. So it is possible we start with Sichuan from lower margin and then gradually move to higher margin. But one thing I think just a stickiness of our businesses -- the after sales service is a very important crucial part of our business. Once our customer, they try to use our products, we’re very confident they will stick with us and come back to us for more.

Graham Tanaka - Tanaka Capital

Great, thank you. The another question I just was wondering if Mr. Han would comment on what he thinks the outlook might be for the economy in China this year and next year as well as the outlook for auto sales -- auto production and auto sales. Thank you.

Taylor Zhang

[Foreign Language] So Graham, so number one, speaking of the macro environment’s economy in China, so Ms. Han believe China now is transitioning from high growth into a stable and steady growth, not 100% company to R&D to GDP. So China right now is focusing on the infrastructure urbanization and also technology. So these areas are clearly direction by the Chinese government. So in his view that China should not have any problem to maintain the current growth rates, and as for auto industry, as we have seen in the past, China has become the largest automobile markets since 2012, surpassed the U.S. and exceeding -- car productions exceeded 20 million units. So he remain very optimistic about auto industry because of -- there is still a lot of growth in second and third tier demand for automobile in China.

Graham Tanaka - Tanaka Capital

And on the non-auto sales, what do you expect in non-auto sales to become as a percent of the mix this year and 2015 relative to 2013?

Taylor Zhang

Okay. [Foreign Language] So Graham this year, as we mentioned as our initial R&D into non fabrications. So it is possible we can achieve single-digit percentage revenue contribution from non-auto, but there may be some opposites [indiscernible].

Graham Tanaka - Tanaka Capital

And are the margins going to be at the company average level higher or lower in the non-auto? Thank you.

Taylor Zhang

[Foreign Language] So for some products we have margin maybe multiple times of auto product margins, and some maybe 20%. So in general those will be higher margin than automobile applications.

Graham Tanaka - Tanaka Capital

Great, and one of the things I think we’ll try to come to grips with is your quarter-to-quarter variation. If you can maybe help us, is the seasonality changing this year -- and or for example in prior years your first quarter was your lowest -- was low, second quarter higher, third quarter higher and then fourth quarter kind of flattish. This last -- that was in prior year. And this last year the fourth quarter went up a lot. So I'm just trying to understand why the fourth quarter went up so much more even after you are at pretty much capacity in the third quarter. And then coming into this year’s first and second quarter is that going to be a weaker period relative to fourth for seasonal reasons or for mandated or for company shutdown? Thank you.

Taylor Zhang

Okay. So Graham, there is very seasonality in our business. The reason is number one, the auto industry is very visible and the auto production is always well planned, even before the year. So the only thing is pretty much general applied to any business in China is the Chinese New Year. So Q1 typically is lower auto quarter. So it basically have been dealing with capacity we have. So to answer your question there is very few scenarios.

Graham Tanaka - Tanaka Capital

That’s great. And the other couple just smaller items, what is your interest expense expected to be now with the new loans that you have? What is the interest expected to be this year versus last year. And in addition, what is your tax rate expected to be? Thank you.

Taylor Zhang

Okay. So the new long-term notes we issued in December this year has a coupon rate of 11.75%. So the increased expenses for that this year is approximately $16.2 million. The tax rates, we do believe we’re going to enjoy the favorable payments from the government. For example at Sichuan we will be able to enjoy 15% compared to 25%. In addition the local tax will be returned in the form of 40%. So Sichuan the effective tax rates will be 9% compared to 25% in Harbin. So overall we think in ideal loans we can achieve close to 9% or 10% tax rates here.

Graham Tanaka - Tanaka Capital

Is that preferential tax rate going to continue for 2015 and ‘16 and beyond or is that just a short-term?

Taylor Zhang

It’s five year and it’s a five year policy.

Graham Tanaka - Tanaka Capital

Five year. And then the last I have is the DSOs accounts receivable. What do you expect the trend is going to be on DSOs this year 2014, ‘15 and ‘16 as you ramp? Thank you.

Taylor Zhang

We do believe at one end, we continue to develop a new market, acquire new customers. We do believe the DSO which will have effect on a deal to the number side, but as we demonstrated in Q2, Q3 and Q4 back to back, so again we do believe DSO for 2014 will stabilize to remain at 70 days level. But again it’s still very hard in a year. So our estimate is just our current and preliminary view.

Graham Tanaka - Tanaka Capital

Okay. So, what is this mean for free cash flow generation for the Company, say in the next two years. Are you going to, I guess you are going to have such a large capital spending, maybe I should just ask you just, what do you expect the free cash flow generation to be this year and next year relative to your capital spending? Thank you.

Taylor Zhang

Okay. So, this year we think we probably going to be -- end up with a flat cash flow, because we do have the majority CapEx trend this year, which is approximately $180 million and $110 million and. On top of that there is a $50 million for the last CapEx for Harbin. So, next year the CapEx will be relatively smaller and the cash flow situation will, is expected to be fully improved. So next year we think we're going to have a better cash flow situation compared to this year.

Graham Tanaka - Tanaka Capital

When you say flat cash flow, I'm just not sure what level of cash flow do you mean, operating cash flow minus working capital spend?

Taylor Zhang

I mean net cash flow.

Unidentified Analyst

So, in other words, did you expect your debt to be higher, your net debt to be higher or lower at the end of this year?

Taylor Zhang

Let me rephrase my answer. We have $160 million CapEx this year. So we do think what is our goal to generally cash flow of the same amount. So we came to a neutral position.

Operator

We have a follow-up question from George Mayer from Manhattan Realty Group. Please go ahead.

George Mayer - Manhattan Realty Group

It sounds like overall growth in China in the automobile industry is positive. Could you comment a little bit on the competitive landscape for the modified plastics industry and specifically as I assume, you are increasing your capacity to meet demand. So perhaps your competitors and do you see a risk of any overcapacity in this industry that could affect pricing going forward?

Taylor Zhang

Okay. George, let me translate your question first. [Foreign Language] Hi, George. So overall, although modified plastics has a very short history, 30 years, compared to develop markets, so in the beginning multinational corporation, they have dominated markets. But recently few middle player, for example China XD, [indiscernible] are picking up and achieved more technology and we are able to compete and also replace products by multinational corporation. So Ms. Han's belief is the core competitive advantage in the business is, number one technology capability, secondly is the name brand recognition or one Company’s market inference.

So China, the auto - modified plastic is a huge market in China, not to mention the [indiscernible] model will use some more plastics on a per vehicle basis and also use more high-end plastics. And also we haven’t talked about alternative vehicle which will for sure be the solution for the environmental concern and pollution in China. So EV we’ll actually use even more plastic in the future. So in this field, the auto - modified plastic business, the future is bright with huge potential. So it is our position to -- as we mentioned previously, our primarily focus will remain in auto with expansion into aerospace, ships and high-speed train in the future.

George Mayer - Manhattan Realty Group

So you don’t see the risk of overcapacity, if you will, has been a large risk -- too many suppliers, too much supply so to speak?

Taylor Zhang

[Foreign Language] So George, we believe China XD is a multinational corporation. We do not view domestic players as a competitive treat. The business as you probably understand has a very high barrier to entry. So it’s very important to have a core technology. Technology position in the industry is a way to secure our market leading position.

Operator

Your next question comes from the line of [indiscernible] Management. Please go ahead.

Unidentified Analyst

[Foreign Language]

Taylor Zhang

[Foreign Language]. Operator, do we have question -- any caller on the queue?

Operator

There are no further questions at this time. Mr. Tom Zhou, please continue.

Tom Zhou

On behalf of China XD Plastics, we want to thank you for your interest and participation in this call. All those interested in meeting with management, please China XD Plastics at 1-212-747-1118. Again thank you for participation on this call. Operator?

Operator

That does conclude our conference for today. Thank you for participating. You may all disconnect.

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