Synutra International's (SYUT) Q1 2015 Results - Earnings Call Transcript

Aug.11.14 | About: Synutra International, (SYUT)

Synutra International, Inc. (NASDAQ:SYUT)

Q1 2015 Results Earnings Conference Call

August 11, 2014, 8:00 am ET


Bill Zima - Investor Relations, ICR

Weiguo Zhang - President

Clare Cai - Chief Financial Officer


Peter Sirrus - Huamei

Kaiyuan Wang - Yiheng Capital


Ladies and gentlemen, thank you for standing by, and welcome to the Synutra International's first quarter fiscal 2015 earnings conference call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. (Operator Instructions).

I would now like to hand the conference over to your host today, Mr. Bill Zima with ICR. Thank you. Please go ahead, sir.

Bill Zima - Investor Relations, ICR

Thank you, everyone and welcome to Synutra International first quarter fiscal 2015 earnings conference call. With us today are Mr. Weiguo Zhang, Synutra's President, and Ms. Clare Cai, Synutra CFO.

Before we begin, I will read the forward-looking statements. During this conference call, the company will make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that are based on the company's current expectations, assumptions, estimates and projections about Synutra International and its industry. All statements other than statements of historical facts in this conference call are forward-looking statements. In some cases, these forward-looking statements can be identified by words or phrases such as anticipate, believe, continue, estimate, expect, intend, is/are likely to, may, plan, should, will, aim, potential or other similar expressions. These forward-looking statements speaks only as the date hereof and are subject to change at any time. The company has no obligations to update these forward-looking statements.

With that said, I would now like to turn the conference over to Synutra's President Mr. Weiguo Zhang. Weiguo, please go ahead.

Weiguo Zhang

Thank you, Bill. Good morning and welcome to the Synutra International's first quarter fiscal 2015 earnings conference call. Today, I will begin with update on our operational initiatives. Then Clare will review our financial results and outlook in more detail. After that we will conduct a question-and-answer session.

Overall, we were quite pleased with our fiscal first quarter results, despite intense market competition, a temporary disruption of operations due to the review of our process production license and updates to our product packaging during this quarter. We achieved 21% year-over-year growth in revenue in our core powdered formula segment. Our continued discipline in controlling discounts helped us to achieve a $2.7 million in gross profit over the prior year period. Net profit was further boosted by an $11.9 gain after taxes from sale of our Zhangjiakou subsidiary, which resulted in 276% of growth in EPS year-over-year to $0.31 per share.

During the June quarter, there were several factors that had an impact on our sales and operations. First we saw increase in promotions and pricing discounts from several of our Leading competitors. Sales in the June quarter traditionally slow following major sales of the Chinese New Year holiday season in the prior quarter and also tends to slow as the weather turns warmer. This year, however, we saw more aggressive discounting than usual from some competitors in the effort to clear out excess inventory and drive sales during the slower periods.

Secondly, as discussed last quarter, our facilities in both Qingdao and Zhangjiakou were recently approved for their manufacturing licenses renewal. However, we had to suspend production in our Qingdao facility for a month during the first fiscal quarter to accommodate the license renewal inspection process. While we were able to ship, some additional production before and after the inspection, there was nevertheless an impact on our manufacturing capability during the quarter.

Thirdly, as we were in the process of updating of packaging design for our line of products under the Super brand, many distributors delayed a portion of their normal orders in the September quarter to wait for products with the new package. The new packaging uses an updated logo and bolder colors to give a product a fresher appearance and make them more easily identifiable on the shelf in the retail outlets, helping to improve brand recognition among customers.

These three factors together contributed to our slight decrease in sales volume during the quarter, compared to the prior year period. However, as the inspection process is now complete, and we have already received our license renewal and we have begun to see orders from retail outlets increase following the release of newly package Super line of products, we anticipate that sales volume will resume their year-over-year growth in the coming quarters.

Despite these challenges, we continue to exercise price control over discounts and efficiently manage our selling and promotion expenses throughout the quarter. These efforts were reflected in our increased average selling prices as well as the decrease in combined selling and distribution expenses and advertising and promotion expenses related to net sales. The 22% increase in ASP helped offset the slight decline in sales volume in the June quarter.

Now to transition to our ongoing project in France. As we discussed last quarter, we have extended the original project which included a drying facility as well as manufacture

powdered milk and fat-enriched demineralised whey protein powder, and also includes dry mixing and canning capability. This promotion will provide 50,000 tons of dry mixing and canning capacity annually on top of the original planned drying capabilities. With these new production capabilities, we will be able to manufacture infant milk formula products that use only premium dairy resources from France and are packaged on-side before being shipped directly to our Qingdao distributors and distribution center.

Currently, the market for higher priced premium milk formula products is growing faster than the overall infant formula markets, as consumers continue to be concerned about product safety and brand image. Our premium products from France will allow us to further capitalize on this industry trend.

In July, we received the final result of the environmental impact study for the construction and operations of our French facility. The results of the study were positive. So we have now received all major approvals necessary from both French and Chinese governments for the construction phase of the project. Construction is on schedule and as we announced last quarter, we anticipate the facility to be open by the end of calendar year 2015.

At this point, I would like to turn the call over to Clare to review our financial results, as well as provide an outlook for our business. Clare?

Clare Cai

Thank you, Weiguo. I would like to start by reviewing our first quarter financial performance. For the first quarter of fiscal 2015, our net sales were $86 million, an increase of 4.6% from $82.2 million for the prior year period. The branded powdered formula segment contributed $82.2 million or 95.6% of net sales in the quarter. This is an increase from $68.1 million or 83% of net sales in the prior year period. This performance was primarily driven by a 22.1% increase in average selling price to $14,473 per ton from $11,852 per ton in the prior year period.

When calculating average selling price, we factor in the discounts and rebates that we provide to retail outlets to help offset their marketing and promotional expenses. ASP is calculated as net sales, which is gross sales less the discounts and rebates divided by sales volume. This quarter's increase in average selling price was largely due to our ability to better control discounts and use them to strategically maximize sales.

Sales volume decreased slightly year-over-year to 5,680 tons in the first quarter of fiscal 2015, compared to 5,744 tons in the same period last year. This decrease was largely due to the factors that Weiguo discussed previously.

Net sales from the nutritional ingredients segment was $1.7 million or 2% of net sales compared to $6.3 million in the prior year period, which accounted for 8% of sales. This segment is primarily comprised of sales of chondroitin sulfate materials to certain international pharmaceutical companies. As shipment of these products are dictated by annual supply contracts, sales in this segment have historically been relatively consistent year-over-year. However, recently, the price of raw materials for these products has significantly increased. As a result, we have suspended major orders while we renegotiate pricing with our customers.

Net sales from other products, which mainly consist of imported whole milk powder and whey protein sold to industrial customers, was $2.1 million or 2.4% of net sales, compared to $7.7 million or 9.4% of net sales in the prior year period. As we noted on previous calls, sales to industrial customers will continue to be opportunistic.

Gross profit in the first quarter was $38.8 million. Gross margin in the period was 45%, an increase from 44% in the prior year. Powdered formula gross margin was 49% compared to 53% in the same quarter last year. This decrease was primarily due to the higher cost of raw milk powder and increased testing and maintenance expenses on machinery during the production license renewal process.

Income from operations was $24.3 million in the fiscal first quarter, which represents a more than 250% increase over $6.9 million in the prior year period. However, this includes a onetime before tax gain of $16 million from the sale of our Zhangjiakou factory.

Selling and distribution expenses were $12.6 million in the first quarter of fiscal 2015, compared with $14.8 million in the prior year period. Advertising and promotional expenses were $9.7 million in Q1, compared to $8.5 million in the prior year period. These two expenses combined decreased as a percentage of sales to 25.9% in the second quarter from 28.2% in the prior year period. This decrease primarily reflects improved sales management and efficiency within our IMF segment.

General and administrative expenses increased to $7.3 million from $6.5 million in the prior period, mainly due to onetime landscaping expenses associated with upgrades to our own production facilities in Qingdao for the manufacturing license renewal.

Net interest expense was $3.1 million, an increased from $2.8 million in the first quarter of fiscal 2014. We saw increased interest expenses in this quarter due to an increased loan balance and banking fees associated with our opening of standby letters of credit. First quarter income tax expenses were $2.8 million compared to $79,000 in the prior year period. This expense is mainly due to taxes incurred on the gain from the sale of our Zhangjiakou facility. While we will continue to be exempt from income taxes on our normal operations through the second quarter, we expect that we will be required to start paying taxes on the net income of our Qingdao facility in the second half of fiscal 2015.

Net income attributable to common stockholders was $17.9 million or $0.31 per share for the fiscal first quarter, compared to net income of $4.8 million or $0.08 per share in the same period last year.

Looking at the balance sheet, we ended the fiscal first quarter with cash and cash equivalents of $41 million and restricted cash of $168.6 million, which includes the current and non-current portions. Total cash including restricted and non-restricted portions was $209.6 million versus $258.7 million at the end of fiscal 2014.

As of June 30, 2014, total debt was $341.4 million, representing a decrease of $26.6 million from the end of the fourth fiscal quarter. While we plan to take on additional debt to fund the French project, we will continue to use our free cash flow to reduce existing debt.

Net account receivable was $14.4 million, a decrease from $17.8 million last quarter. As of June 30, 2014, our inventory position was $77.3 million, compared to $84 million in the prior quarter.

For the fiscal first quarter, cash generated from operating activities was $3.3 million, the same as in the prior year period. Cash flow for capital expenditure in the first quarter was $29.9 million, which mainly represented expenditures for our drying facility project in France.

Now I would like to provide updates on the new strategic marketing assets that we outlined on last quarter's call. This year, we are focused on engaging directly with the end customer and promoting interaction with our brands beyond just the point of sales through our Kangaroo program. As we have discussed, through this program we are training our in-store sales and promotion team to serve as nutritional consultants for customers and maintain relationships with them through our specially designed mobile application. The rollout of the Kangaroo program is currently on schedule.

During the first quarter, we organized a competition for all of our nutritional consultants nationwide to test their knowledge of infant nutrition and child development. We held the final round of competition at our Qingdao facility in May in which over 300 nutritional consultants participated along with almost all of our 600 person sales staff. Our staff's ability to offer sound advice on infant nutrition is an important part of serving our customers and will help differentiate our products from our competitors.

Also during the quarter, each nutritional consultant was assigned his or her own client list from our customer loyalty database. Currently, all of our nutritional consultants are being trained on how to effectively communicate with clients and how to promote our interactive mobile application for further interaction. Once fully implemented, this program will serve as a critical online to offline tool to help us track and promote customer loyalty and drive sales. We are also exploring opportunities to utilize popular online social platforms in China, such as Weibo and WeChat to promote and sell our products.

As we have mentioned in prior quarters, we have eliminated approximately 36,000 underperforming stores from our distribution network over the past year as part of our Gold Mining strategy to improve sales efficiency. We are now in the process of replenishing our store count by entering the highest performing formula sales outlets. During the June quarter, we entered 1,000 stores out of these 2,000 high potential stores we have identified. Our plan is to enter 2,000 to 3,000 new stores in total during fiscal 2015. We have set up strict criteria for new store selection and will closely measure each store sales at first three and six month marks. This is a new, more selectively expansions strategy than we used prior to our implementation of the Gold Mining strategy.

Finally last quarter, we mentioned that we have several new premium products in our product pipeline. We have made solid progress on securing the supply chain for these products and expect to launch them doing the second quarter as we enter the high season for powdered formula sales.

And now I would like to reiterate our outlook for fiscal 2015 which we previously announced. We continue to expect strong topline growth and greater operating leverage in fiscal 2015, with full year revenue growth expected to be at least 20% over fiscal 2014 results or between $450 million to $500 million and net profit growth expected to be at least 60%, or between $50 million to $60 million.

This concludes my prepared remarks for today's call. Operator, please open up the call to questions.

Question-and-Answer Session


(Operator Instructions). Your first question comes from the line of Peter Sirrus from Huamei. Please ask your question.

Peter Sirrus - Huamei

Morning, (inaudible).

Clare Cai

Good morning, Peter.

Peter Sirrus - Huamei

I have a couple of questions. First, a number of months ago the Chinese government de-licensed a number of your domestic competitors. What impact is that having on you? You mentioned that you may be acquired some brands or took over some more. Can you tell us about that?

Clare Cai

Hi, Peter. Thanks for the question. What we know is that out of the 127 licensees that were licensed to produce infant formula before the May renewal of this year, only 81 received the renewal. So 46 were taken out. However those 46 tend to be smaller ones or even dormant ones, so the total volume impact to the market is only 5%. And those smaller ones also tend to be the OEM manufacturing base for what we call the obscure domestic brands. However those distributors or owners of the obscure domestic brands are not exiting the market now yet. They are trying to find OEM base for their brands overseas with the 50 some overseas licensees that have received the approval from the Chinese FDA. So what we see is the disappearance of the domestic obscure brands along with the increase of small obscure brands from overseas that could be newly registered or domestic merchants who have obtained distribution license of small brands in overseas countries who would not consider entering Chinese market without a Chinese merchant approaching them. So overall we haven't really seen the consolidation that the government called for when they announced that they are going to review the licensing and that eliminates the smaller players.

Peter Sirrus - Huamei

Do you think we will see more of that? And also in the same vein, the government said they wanted to increase the share that domestic producers have up to 60%, I believe. What can or will the government do to help the domestic producers against the major international players?

Clare Cai

What we saw ACNielsen statistics, actually from 2013 July of last year, the shares of international brands took over the domestic brands. That's probably due to the swapping of the domestic smaller brands by the international smaller brands. For the leading domestic brands versus international ones, the shares largely, the aggregate are largely the same. And despite the government announced the goal to have the domestic manufacturers occupying 60% of the overall market by, I think, the end of this year, and 80% in two years, we haven't seen any actual policy to support the domestic brands or discourage the international brands. The market remains a fully competitive free market. However the government's education on the consumers and the continuous promotion of manufacturing standards, both within China as well as overseas factories who received a license to import to China does helps to ensure the overall quality environment of this product category, as well as help to restore the safety image of the product.

Peter Sirrus - Huamei

So at the present time, you don't see the government actually doing anything, just they said this is a goal, but you don't see them implementing anything that would benefit the domestic brands?

Clare Cai

We don't see anything on the consumers' end or in the end buyers' chain. We so see government's approval of several aggressive capacity expansions on the production side for some state-owned competitive domestic competitors or partially state-owned competitors.

Peter Sirrus - Huamei

Okay, thanks. I will get back in the queue.

Clare Cai



Thanks for your question. (Operator Instructions). Your next question is a follow-up question from the line of Peter Sirrus from Huamei. Please ask your question.

Peter Sirrus - Huamei

Okay, well, one more question. The guidance for the rest of the year shows strong increases in revenue and profits, Can you overlay or can you tell us where you expect the strength to come from?

Clare Cai

We expect the revenue increase will be supported by our store expansion as well as the launch of several premium products. As we announced last quarter as well as right now, we have identified, we plan to enter to up to 3,000 high potential formula sales stores, which tend to be the mom and baby chain stores in the geographical areas that we sell. And so far we have identified 2,000 such stores where our sales team believes they can meet the three to six month mark that we have set up for those stores. We might even be in those stores before the Gold Mining strategy or program. However we didn't have a clear profit focused operation policy. So we could be losing money as the bottom selling brands in those very successful stores. So now we have set up clear goals for each store and they have to meet certain sales mark by three months and by six months. So that is we will not be losing money in those stores and we will be making profit from the six months on. So we will focus our sales team and best our nutritional consultants as well as headquarter supports on those stores to ensure their success. And revenue wise, definitely we expect to see extra revenue from those stores. And for as to the premium products that we are launching, we have identified several niche category in the infant formula markets as well as the adult formula markets where we see high growth potentials for high premium priced products. And we think the infant formula markets are still heading, the consumers are still favoring the premium priced products. So we are launching our own version of such products and so we expect the second half of fiscal 2015, the sales and net profit will be supported by these two categories. And in the longer term, our Kangaroo program is our primary strategy to serve our customers, directly interact with them and be prepared for any change of the retail business model.

Peter Sirrus - Huamei

Thank you very much. (inaudible).


Thanks for your questions. (Operator Instructions). Your next question comes from the line of Kaiyuan Wang from Yiheng Capital. Please ask your question.

Kaiyuan Wang - Yiheng Capital

Hi, Clare. Thanks for the presentation. I just have one question with the guidance. I know we guided before $450 million to $500 million, but this first quarter due to the inspection, we grew quite modestly. So I guess my question is, was this in the anticipation when we made a guidance last year? And this would also mean that we would have quite a strong growth probably over north of 30% to meet the guidance? How do we think about that?

Clare Cai

Well, I would say this quarter's total revenue growth was below our initial expectation, because of the fall off of the nutritional segment, as well as the other segments. And although the sales from the other segments tend to be opportunistic, but we do see could be potential high inventory level of whole milk powder in the markets. And another reason is that we have not bought any excess whole milk powder since Fonterra's whole milk price increase in the second quarter of last year. So our own inventory for bulk milk powder is also very low. And that can change in the late because half of this year.

In terms of infant formula sales, we are actually on the track, although slightly off our initial projection. But we think we still are pleased with this first quarter's results and we expect our own marketing efforts will help us to gain the growth in the IMF revenue. And we expect the discounting activities of the market could ease off as the whole market enters the high sales season of autumn.

And I probably, like you, eagerly awaits their quickly announcement of our competitors, which will come out in 1 to 15 days.

Kaiyuan Wang - Yiheng Capital

Thank you. One follow-up on the discounting. So as you mentioned, our ASP increase was quite substantial this quarter and that's coming from the decrease or direct control the discounting. I am wondering, at this level now, how much more juice, I guess, from decrease in discounting do we have in the upcoming quarters? Because if you look at the ASP, we had around the same level in the second quarter of last fiscal year. So how much more potential an we get from that?

Clare Cai

I would say from the second quarter of last year, we have already controlled our discounts to the level that we think is sustainable. Or in other words, our target level for our long-term sales model. The pricing change from second quarter of last year were due to a product mix change as we sold more adult formula in the third and fourth fiscal quarters. We might see a minor increase in ASP going forward as we launch more premium priced products. However in terms of discounts, I think we have reached the level that we want to stay on.

Kaiyuan Wang - Yiheng Capital

Thank you.

Clare Cai

Thank you, Kaiyuan.


Thank you for your question. (Operator Instructions). There are no further questions at this time. I would now like to hand the conference back to management. Please continue.

Weiguo Zhang

Well, thank you. Sorry, Clare, go ahead.

Clare Cai

I would like to thank everyone for attending the call today, and if you have any further questions on our company or product or our industry, please feel free to contact ICR or myself and I thank for your continuous interest in our company and wish everyone a good day.


Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may all disconnect.

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