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LJ International: Roth Capital Conference Presentation Transcript

by: Roth Capital Conference February 21, 2007 | about: JADE

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LJ International, Inc. (JADE)
Roth Capital Conference
February 22, 2007 2:00 pm ET

Executives

Haris Tajyar - Managing Partner, Investor Relations International

Presentation

Moderator

Our next presenting company is LJ International. LJ was founded in 1987, and they are a vertically integrated jewelry company, selling jewelry to wholesalers and retailers in the U.S. and Western Europe, and they also have a very fast growing retail chain in China through its ENZO brand.

Here with us today is Haris Tajyar from LJ International.

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Haris Tajyar

Good morning. Thank you for attending. My name is Haris Tajyar of LJ International. I have been with the company for about 4 years, although I have known Lorenzo for about 8 years.

This is the standard forward-looking statement. A quick snapshot of the company, company's symbol is JADE. We went public in '98 with Barron Chase Securities, which is now bankrupt, so we essentially refer to stocks [out-of-favor] rather than as an orphan stock from '98 to about 2006. We are trading at new highs, as of today.

So that our P/E to close to 25. 52-week highs, I think, today we hit 11. Average daily volume now is close to 500,000. 19.7 million, outstanding; market cap is I believe over $200 million now. Insider ownership is about 25%. Yu Chuan Yih, our founder and CEO, owns that almost entire 25%. We currently have 3 analysts covering us. Of course, we have Roth, and we have Maxim and Dutton.

Investment merits. Historically, we've been a wholesale company. We've been a wholesale company operating out of Shenzhen, China for close to 20 years. We realize that the wholesale market in the U.S. is almost saturated, although we are still thinking to cash it out, hence are moving to retail. We have two growth engines that would be in wholesale and now retail.

What differentiates us versus everyone else is our “Mine-to-market” and “Mine-to-consumer” model. Our Mine-to-markets model basically takes our sourcing directly from the mines in Brazil, South Africa, India to our factory in Shenzhen, where we turn it into finished goods, and wholesale it out to the U.S., which gives us margins of roughly about 25%.

Our Mine-to-consumer model takes out even that last -- middleman, and we go directly from the mines to our factory, and directly through our retail stores in ENZO. As a result, we are now experiencing over 50% margin at our ENZO stores.

The biggest difference if anybody wants to know why the stocks has done what it has done recently, is because ENZO historically on '05, '04, and '06 has been a loss. That finally turned into a profit in December of '06, ahead of [acquisitions] that we announced out in early '07. So essentially, you want to take all of ENZO losses for '06, '05, flip it in, and you can come up with your own valuation of what we should be in '07.

Obviously, the positive ENZO swing coupled with our cash cow wholesale business is raising revenues, margins, and earnings growth across the board. We are expecting another record year in terms of revenues, margins, and EPS. And yet even at $11, we still think we are undervalued relative to our future earnings potential.

Our company is headed by Company is headed by Lorenzo Yih; in press releases referred to Yu Chuan Yih. He is the founder, Chairman and CEO, and has been with the company for 20 years. He launched the company together with a second employee, who’s Alfonsa Au, who is the COO. CFO is Ringo Ng, who used to be an auditor, and been with the company for over 10 years. And just recently we hired Sawde Yu to head up our -- or help to head up our retail operations. Sawde came from TSL, which is probably one of our larger domestic competitors, and so far he is doing a great job. So as far as any concern of whether manufacturers can evolve into a retailer, we don’t really have that issue that issue because we are filling internal problems with our domestic competitors, and therefore we are really getting our pick of [the deal, top of the crop] that goes out at those entities, which is down can believe.

What are we doing in China? We’re looking to duplicate the U.S. The global jewelry market is about $150 billion. U.S is over $42 billion; China is about $17 billion, but growing much faster. We've perfected our model in U.S. as far as wholesale goes, but we are looking to take it a step further and launch retail in China, where demand for jewelry is much more significant that it is in U.S., and not to mention the sort of void for what we call affordable luxury jewelry. If you go from TSL and 3D-GOLD, which is traditional Hong Kong, China Mainland based gold companies, up to Tiffany and Cartier, but you have nobody really in the middle and that’s why we are doing so great.

Two growth strategies both working - wholesale and retail. Wholesale for the past five years has grown over 25% on a compounded annual growth rate. In’06, revenue was up 15%. Again our Mine-to-market on the wholesales is providing us with unique capabilities and the highest margins. We’ve diversified away from the U.S. successfully. We were initially a 100% U.S., primarily with QVC. That decreased to 70%; 23% to Europe; 4% to Japan; the remainder Australia and other Asian countries. The key to our success has been our blue-chip client base: QVC, HSN, Wal-Mart, Zale’s, JCPenney. We are in top 7 of the top 10, and top 30 of the top 40, and we are looking to get into the next 60, and that’s a jewelry terms, so let’s call it the top 100, and top 40 and the next 60.

In addition to our unique ability to manufacture in volumes, we are the only company out there that can manufacture say 25,000 pieces of the same identical piece of jewelry, have it sold on QVC’s Today’s Special Value within an hour. No one else can do that, no one else can do it within six weeks lead time, except for LJ International, and that’s because we have 4,000 employees in Shenzhen with the average factory employee being paid $200 a month. So, we do have obviously a huge advantage on the labor side and on the margin side.

In addition to volume and delivery time, we also have world class design and a global recognition for our brand. We have over 20 designers in China, Hong Kong and the U.S. and they are all headed up by a gentleman named Omar Torres whom we just hired, who used to head the design for Bvlgari, and then Movado. If you look at a lot of the ENZO merchandise, it's almost entirely designed by Omar, and he is fully important to the company.

Lorenzo used to be the President of GIA Hong Kong. We were two weeks ago selected as the contributor to the 2007 Grammy Awards. I believe we are a finalist, if not the winner for the American Music Awards and the Country Awards. And there are so many to list but to give you an idea, first and second prize for the earnings of Freestyle Awards and for the Diamond Award in '05.

On the wholesale side we separated [top clients]. You have a silver level, which is the low end, gold level, mid market, platinum level, the higher end. That means silver level would be your Wal-Marts of the world, gold level would be your Targets of the world, platinum would be your Zale’s signature of the world.

We sell to all three channels. There is no channel conflict, but we are looking to penetrate the diamond market, since diamonds really represent 50% of the market. The flipside of that is diamond is a commodity and your margins likely will suffer slightly as you drill into that. But if you really want to be a prominent jewelry retailer, you do need to have a sizable diamond inventory.

In '06 we sold about 51% in rings and on the product side, you can see colored-stone represented about 29% of our revenues. Colored-stone is where we specialize in. We sell in with the largest in the business in colored-stone. Our margins are the highest in colored-stones. In fact, we have some of the competitors buying colored-stone from us. Since we do have first right of refusal on some of the key mines in Brazil, and South Africa and India. We are looking to diversify away from colored-stones and more into diamonds but, at the same time growing both segments.

For the wholesale side, there is so much growth potential as far as Zale’s, Sterling, Fred Meyer, JCPenney, Wal-Mart, goes; these all existing customers, with very service. Wal-Mart, they will cross two years, so you can get a SKU at Wal-Mart. We're doing better at Wal-Mart Sam’s, for example, than we're doing at Wal-Mart, [because it just goes] as far as acceptance, so Wal-Mart incidentally sends out somebody to visit our factory in China and make sure that it's up to their standards, so we're one of the two companies that actually passed.

So as far as growth goes, we definitely grow within existing clients, not only through product expansion, but also through getting into additional stores within each store. For example Wal-Mart, we're only in beta testing mode, and Wal-Mart could be, whatever it could be.

Our best distribution channel continues to be Home Shopping, and that's because again we're the low cost provider, [of QVC], our average price points range from $99 to $199, in fact we're so good that QVC in 2003 said, okay guys, I'll give you $80 million over three years, but you can't sell to HSN and ShopNBC.

What happened was, QVC had their own management issues and they failed to deliver on that $80 million. The very next day we ended up selling to HSN and ShopNBC. So now we sell at QVC, HSN and ShopNBC, both domestically, and in Europe, and in Japan.

Our Push Sales Strategy, we're one of the few companies that actually do this and that's where we used CAM/CAD and designed with our clients, what exactly they are looking for. That helps us in terms of delivering, specifically what they are looking for on-time and it gives us no inventory risk and thus the client gets the designed products. This is ideal and it has been the standard for QVC.

Again we've never lost, the only customer we have ever lost was [Severus Merchandize] due to bankruptcy. Other than that every customer has grown steadily year-over-year, and we are becoming the product here, QVC, ShopNBC, JCPenney, Zale’s, HSN, Wal-Mart, Helzberg, Carrefour in China, Macy's, Ben Bridge and Sterling.. Each relationship averages about 8 years and growing.

The sexy part of the story obviously is ENZO. It's possible that we'll grow in a triple digit from [where we are], it’s a small base obviously. We're up to over $18 million in 2006 from '05 and then our earnings are probably going to be higher this year, than ever and actually due to the mine-to-consumer strategy. We have no middlemen left to eliminate, as far as mine-to-consumers go.

Why China and why are we the largest foreign retailer as far as jewelry goes in China? Three years before China has entered in the WTO, we're the only company that actually invested into setting up the infrastructure and the platform necessary to expand and launch, following the WTO. Jewelry was accepted into the WTO as part of China's entry in 2004. In December of '04, we opened our first store in Hong Kong, and in '05, we were off to a race as far as new store openings.

At the same time, Tiffany, Cartier and Bulgari and other foreign participants were trying to penetrate the market, but weren't quite sure how to do so, and ended up losing a ton of money. For example, our Shanghai store, which is our flagship store, Tiffany's was three stores down, we're profitable they are not. And if so, it really should have driven something.

Well obviously, we have gone through some large [points] in reasonably less than 2 years, we've opened 45 stores in 18 months, which is I think a record and we believe we can continue to grow and at this accelerated rates and that's because we don't have any real foreign competition. Tiffany's just announced an increase from 6 to 8 stores, whereas we increased our fulltime employees to over 100.

The domestic competitors all have their own issues. One has an accounting issue, the other one is franchising, so they are hurting because they can't control their inventories. Another one has a [modern part] internal issue and again ENZO has entered into rising margins and earnings growth.

Our strategy for ENZO. As you can see these are all less known Italian looking advertisements. The Chinese love the West, they will buy anything that's Western. They will stay away from the TSL, the Chow Tai Fook, and the Sang Sang, just because it's Chinese. The Chinese want to look, enact and feel like they are buying an Italian or U.S. brand, which is why in our stores, you will rarely see anything Chinese other than the employees.

Market segmentation, we are looking for demographics, they are between the 25 and 55 year olds. Economically these guys have gone from making $2000 a month to making up towards $10,000 a month, that's how fast the market is growing.

Sales force management. Our sales managers are incentivized on a commission base. Each store has approximately 4 employees; one being the sales manager, three being what we call sales girls.

Branding. As far as branding goes, we are sticking to the same ENZO name across the board. Our price points are the same across the board, whether it’s [Wuxi], Macau or Hong Kong. And beginning this year, we are going to start doing more promotion, more advertising, and maybe as early as next year get our first celebrity endorsement. We do have a membership system.

Distribution channel. This is important as far as relationship goes. We want to establish relationships with the mall owners. Those are the guys that get to think who gets what spot and so forth. China is different than the U.S. in the sense that, your rent isn’t necessarily a fixed cost; it’s 20% of your revenue. So, knowing the right mall owners will get you the premium locations in that particular mall. China is growing, no doubt. China is growing faster than I thought.

Our gross margin is over 50%, again Mine-to-consumer supply chain. We have the lowest cost-operating model particularly in labor. Higher store count will give us enough muscles to take that 20% -- percentage of revenue down to 15, down to 10, down to a fixed rent payment which is what our goal is.

If you want to have an idea what an ENZO store looks like, obviously this is not what a standard China-based store looks like, it looks like a Bulgari, Cartier type of look. It is designed by Omar Torres. It’s consistent whether you're in Macau, whether you're in Chengdu, or you’re in Hong Kong. We have no stores outside of China, it’s important to remember that. We do not want it competing against our U.S. business. These are some of the ads that we place in local Chinese papers. You can see us focus on the East coast, Southeast coast. Obviously that’s where all the money is. Obviously, that’s where the economy is growing. We have a big focus on Shanghai and Beijing and Macau for now, although in order to get to our goal we are willing to accept the second tier and third tier provinces. However, I will tell you, we can open 50 stores just in Shanghai alone. In fact, we have four stores on Nanjing Road, which is [a day or two of] drive, and we are not tantalizing any sales.

Our Macau store, which is on the right, is 10,000 square feet. It’s the single largest store not only in our portfolio, but across all of Asia. We have high hopes for it. What’s happening incidentally is comparable to California and Vegas, there is a 17% VAT Tax in China, so anybody looking to buy say a $50,000 or $100,000 piece of jewelry will go to Macau to save that VAT tax, and if you look at our models that’s primarily why our Macau store is doing so much better then our other stores.

In August, we will be opening our first store at Venetian, and that’s 1,000 square feet, and that was one of the hardest pieces of real estate to grab in Macau. We don’t have a store at Wynn, nor do we intend on having one.

Average sales per square feet in China and the U.S. are two different analysis, it’s obviously due to real estate, but if you look at the trends, and if you look at our '05-’06 numbers, you can see that obviously no matter how you look at it and how you slice it, it’s growing, and it’s growing fast.

If you want to look at a model store, a mature model store, look at our Shanghai flagship store, which is our first store that we opened. This shows you our revenue ramp-up from October '04 when we started to December '06. And obviously, yeah, you can see fluctuations based on Chinese New Year, Golden Week, [National Day], but the overall trend is positive. This store incidentally is profitable.

We have over 45 stores, Cartier is second next of Bulgari, and then Tiffany. We don’t consider them our competition, we consider the domestic players as competition. Chow Tai Fook has over 400 stores but keep in mind that a lot of that’s franchise. TSL which is down to 150 stores, we consider our biggest competitor, because of the branding, the image, and their price points.

Our plan through '08, we've revised this upwards, I think, now three times. Just last week, we announced that rather than opening 80 -- having a total of 80 stores opened this year, we are jumping to a 100 in anticipation of the Beijing Olympics. So obviously, there is a big concentration in Beijing and in Shanghai.

The numbers will blow you away. This is our annual revenue growth, as far as LJI and ENZO combined since '04. Earnings growth is consistent. It's important to see what ENZO does to the group. LJI, lets just say it grows up 5% to 10% which is the wholesale business, U.S. business, we are looking to diversify away from that in case [that is lead on to] U.S. But ENZO is doing almost at triple digits, and by '08-'09 will represent the majority of our revenues at a higher margin.

As far as earnings and EPS growth, you'll see again in '08, it should be about 40-60, 50-50, with EPS growing considerably. Quarterly revenue growth, no matter how you slice it out, we're growing quarterly, sequentially, year-over-year. '07 numbers are -- these are very conservative, this is idea based on trends that we are seeing now, and you are looking at ENZO eventually taking over our wholesale as far as revenues, but you're definitely looking at ENZO taking over wholesale in earnings this year as you can see huge difference. And that's again 50% margins versus 24%, versus a slowing U.S. market, versus a blooming China market, and there is going to be a little bit more shortly.

ENZO on a retail side, 4Q '05 is our last year that we had a loss -- I'm sorry, 3Q '06, and we finally turned the quarter into black. And first quarter of '07, that trend is expected to continue. We gave 4Q guidance, again we raised it just last week. So, we are pretty comfortable with our portfolio and outlook.

ENZO annual revenue growth; we started from the base of zero, again in the retail sector opening 45 stores in less than 18 months is pretty significant. We are extracting over $40 million just from ENZO alone this year.

Sequential revenue growth, this across the base of 45 stores, and if you expand that further based on that trend, from there till '09, we will reach about $40 million a quarter by '09.

Revenue contributions, again from '04 to '09, you can see that ENZO is just essentially going to take over wholesale.

Again, annual earnings will go from a loss in '05 to profitability in '06 and flowing further.

Balance sheet, we have $14 million in cash. Most of that inventory number, which is a huge jump from last year is all ENZO related, not wholesale related. We have 35 million in working capital and a short-term debt price, that's due to the launch of our ENZO stores. At some point, we will restructure that.

So how do we value LJI? Our problem is that we don't have a good peer group in the U.S. Zale's, Signet, Tiffany's, and Blue Nile, which we don't want to compare ourselves to. There isn't really a true jewelry concept doing anything close to us, as far as growth goes. But if you look at the right side, are we comparable to Baidu, no, but are we comparable to a China Play? Sure, we are definitely undervalued relative to them. It is based on forward looking P/E numbers. And other than China Life, I think we have more revenues and more earnings than Baidu and Home Inn for sure. Yet, we are trading lower than them, and that's again because we don't have a Goldman Sachs, Merrill Lynch, Piper Jaffray behind us.

Again, we have been an orphan stock ever since Barron Chase went under.

What's the play here? August of last year, we announced that we would look towards ways of enhancing shareholder value. What might be a potential strategic partnership? Whether it might be a potential partial spin-off for ENZO. Either ways, retail would benefit in a sense that we would spin-off 30% max of ENZO and maintain the 70% of ENZO at the wholesale level.

Now something's wrong, wholesale can still grow and it’s still growing. We are still focusing on wholesale. But our cash flows are being thrown at ENZO since it is a once in a lifetime opportunity to leverage, if we have to dominate the market.

Question-and-Answer Session

Moderator

We will have the questions part. We will take a couple of questions.