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American Dairy, Inc. (NYSE:ADY)

Roth Capital Conference

February 21, 2007 6:30 pm ET


Judy Tu - VP of Operations



In the meantime just want to share with you some info by the Premier of China, Mr. Wen Jiabao. He said that he dreams that someday every Chinese, especially the children, who can drink 500 gram of milk per day. Then think about 231 million metric tons of milk per day, which is about three times the Korean national processing capacity. So obviously their reprocessors have their work cut out for them.

With that said, let me introduce to you the CFO of the company, Mr. Liu Hua. And presenting today is Vice President of Operations, Ms. Judy Tu. Judy?


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Judy Tu

Hi. How are you? Hi, good afternoon. My name is Judy and on behalf of American Dairy and our CFO, Roger Liu, I want to say thank you to Roth Capital for putting this event together and I want to thank all of you for attending. We are excited to be here and as I also want to wish everyone a Happy Chinese New Year.

Before I begin, I wanted to remind everyone that Safe Harbor statement is in effect. Some of the statements made in this presentation constitute forward-looking statements, which inherently containing known and unknown.

I want to first introduce the company a little bit. American Dairy is one of the leading milk powder producers in China. We produce milk powder and we produce soybean powder, walnut powder and other related products.

We were formed in 1962 as a state-owned enterprise, and in 1997 we were privatized. We have grown our presence to 25 out of the 28 Chinese provinces by expanding our distribution channels. For example, we sell to supermarkets across China increasingly, in what we call Tier 2 cities, which are regional cities that have greater markets and [penetration] opportunity.

Keep in mind that a Tier 2 city in China is a city like Nanjing, which has about 5.95 million people and GDP of about 30.16 billion. In anticipation of the growth, we've been increasing our capacity. In 2005, we invested in the acquisition of processing assets from Royal Numico, which is a publicly traded company in Europe, and one of the largest dairy producers.

That expanded our capacity by 50% or about going to be 270 tons. Currently we have a processing capacity of 720 tons and we have an average usage of about 400 to 500 tons. We expect it to be at full capacity by June of this year. Also by the end of this year, we also expect to increase that capacity by another 300 ton.

In January of last year, we also signed a contract with Gannan government, where we are going to build a new processing facility. This agreement gave us land, tax incentives and subsidies for building and also we get exclusive processing and distribution rights to local and subsidized liquid milk.

By 2009 this plant in Gannan will be China's largest milk processing facility by processing 1,000 tons of liquid milk per day, and adding our total to 1,720. So we are going to be China's largest milk processing facility.

Feihe is our leading brand in China and has been around since the beginning of the company, so the brand has been around since 1962. In 2005, the government recognized it as one of China's most recognizable brands. Feihe means a flying crane, which in Chinese culture symbolizes longevity.

Our headquarters are located in Beijing with over 50 administrative personnel. We also have seven plants and packaging facilities. We have a packaging facility in LangFang, which is one of the largest of its kind in China.

Our plants are concentrated in Heilongjiang Province, which is one of the three flat soil zones in the world, so it's one of the most conducive areas for farming and raising dairy cows. Our plants are all in Heilongjiang, China's sixth largest province with the largest producer of soybean and milk. We also have grazing rights in that region of over half a million.

Our primary product line is Feihe and we have it segregated in different infant stages for the different child, as the child gets older we have different products for the child. We have four patented products, and it's all in the three main categories, milk powder, soybean powder and walnut powder.

Our instant formula has been designed by American instant nutritionist specialist in accordance with the Food and Nutrition Board and is also with reference to the UN Committee of Food Quality.

We also produce milk powder for students, pregnant women and middle aged and elderly population. So our market reaches beyond children. Our soybean products are also lactose-free, low in fat, sugar, calories, and high in calcium.

Our walnut powder is a good alternative especially for pregnant women. In 2002, we were granted the product exemption for quality surveillance inspection by the government for our superior products.

There is tremendous growth in China right now for the dairy industry. The market is valued at $10 billion and represents the highest growth potential, with an increase of 25% per year. China has over 1.3 billion people, but it's extremely under penetrated in the various markets, because it only accounts for one-fifth of the world's average.

Historically dairy is not a staple [food] to Chinese diet, so it really wasn’t introduced into the market until the 1980s, was really a young industry. The dairy market in China is also divided into two sectors. There is the liquid milk section and the milk powder section. Milk powder represents about 45% and the other 55% represents liquid milk, yogurt and everything else. So milk powder represents a huge portion. There is no clear leader currently in the milk powder sector, so we've positioned ourselves to take that position.

There are also other reasons for the rise in dairy consumption. There is the per capita income, and so as income increases, more people are purchasing higher quality products, and especially our products are the premium products. Also with increased income people are using milk powder for an extended period of time. Previously they might use it for six months, but now they are able to spend the money and use it for three years and beyond. Also with more women going into the work force, they are less like likely to breast feed and so they are more likely to use milk powder.

The dairy industry also receives tremendous government support. We get subsidized for our taxes, VAT taxes. We pay for the taxes and we get 100% of those subsidized back. The government also runs advertisements, especially about the diary industry and really promotes dairy consumption for all of its citizens. As the wealth of a country increases, naturally they need more to focus on the health of the citizens and so it's really been promoting the dairy.

And just additionally just summing here is the year of the golden pig. I know that some people have heard about it. It's where the Chinese astrological signs; the pig meets one of the five elements, which is gold, and this happens every 60 years and so there has been a sharp increase in the number of toddlers in China for this coming year. Babies born in year of the golden pig have a life of big fortune. So there has been a few.

Domestically, it’s a very highly fragmented market. We are in the premium milk powder, etcetera, and so there is no Chinese competitor who competes with us. Most of the farming households have about same 10 cows or fewer, so it's very fragmented.

Our other competitive strengths include economies of scale and we have well established distribution networks. We are increasing our capacity. We also have the most advanced state-of-the-art equipment that's been imported from Europe.

One of our strengths that we believe that we have against other competitors is our distribution network. We serve by being able to control the supply. We have full contracts with governments and local farmers, where we purchase the right to extract the milk. China's diary industry is different than the US, in the sense that you don't have one farmer who owns a thousand cows. You have one farmer who maybe owns 10 cows, three cows, and so we set milking stations throughout Heilongjiang province and we have the sole rights to that area.

We control the quality of it by working with the diary farmers and signing full contract, and we help them raise the cows and we help teach them how to maintain and make sure that the cows and the milk is -- everything is according to standards. We then have the best equipment and we milk the cows twice a day. Once they come into our facilities, the milk is extracted and within three seconds the milk temperature is lowered to zero to four degrees. And from that point on, it's no longer comes into contact with any air, and so we are able to process it with the highest degree of quality.

Our processing plants are also right next to the milking stations, and so our processing time is about 24 hours to 36 hours. Whereas our competitor who are further away, they have transportation time measured in, so their processing times usually are about three to four days.

Once we process this, we also have a chain of distributors. We have about 300 main distributors that we work with. The way we work with our distributors is, they place the order, they pay for the order and then we send out the product. And the 300 main distributors then work with sub-distributors and we have about 2,000 sub-distributors. From those sub-distributors, they then work with retail chains and currently we sell our products in over 32,000 stores, and that includes Wal-Mart and Carrefour. We are in about half of the Wal-Marts [currently].

We are able to control the quality from not just the distributors, but we want to make sure that the entire distribution chain is setup, especially because [we are individually set].

We also have different programs. We, for example, have television and the health shows and we also hire different sales personnel who are in the actual stores and give demonstrations for the different consumers as they are purchasing the product. We also have full time physicians on staff to answer questions for our customers.

Our growth plans are based on expansion into new territories and we are also planning on diversifying our products and we'll be focusing on sales of even higher profit margin products. Also milk powder products as compared to liquid milk powder products, milk powder products have the much higher profit margin than liquid milk.

We are also looking towards reinforcing our brand identity. Milk powder is different than food milk, in the sense that milk powder is used for children. And when you purchase products for children, clearly brand loyalty is very important and the quality is very important, and that’s why we focus on premium type quality products.

We also price higher than our two other American competitors, which is Wyeth and Mead Johnson, and we were able to command that price because we have the best quality, the best products.

This is our management team. Mr. Leng is our CEO and he has been in the diary industry for over 15 years, and he is also responsible for the research and patent of our liver protection milk powder. Mr. Liu Hua is our CFO and he has over 13 years of experience in the financial industry. He was the CEO of a company before, and him and Mr. Leng are from the same region and so now they are working together. Mr. Zheng is the CEO of Feihe Diary and he was actually the former Branch Manager for Coca-Cola. We are also focusing on brand new talent from different companies so that we expand.

Members of our Board of Directors include Ms. Tracy Lee, who is the Vice President of financial reporting actually at Countrywide. And Kirk Downing, who is a US based attorney who engages in farming, logging and property development. We also recently added Mr. James Lewis, and his key focus is on the transaction of corporate laws.

We have a strong fundamental position and our result have been consistent quarter-after-quarter, specifically our 2006 third quarter revenue increased 129% to $32.6 million versus $14.3 million in the third quarter of 2005. And in 2006, our revenue increased 82% to $68 million versus $37.4 million from previous year.

We have also focused consistently on improving our gross profit and our net income. For example, we increased our net income 154% in the third quarter of last year. And as of last quarter, we had $23.5 million cash on our balance sheet and we are currently in the process of registering around $6 million. This slide shows the consistent financial performance and it includes the net income and a growth of over 60% each quarter.

This slide shows and focuses on our gross profit and keeping our distribution cost consistent as a percentage of revenue.

In October of last year we raised $18.2 million of convertible notes and we already have $5 million of convertible debt. As we stated on November 14th our earnings and our press release, we currently expect full year revenues for 2006 to be $120 million and this should generate a net income of $20 million for the year, an increase of 70% from the previous year.

The results include several assumptions, and I want you to review the press release. The fourth quarter is traditionally a very strong quarter for the company based on seasonality and also we want to continue enhancing our marketing and advertising capacity through 2006. Our guidance assumes that this expenditure will continue in the fourth quarter. And also, as I indicated earlier, the company benefits from the value added tax that we get back in return from the government.

[A quick] conclusion, we are uniquely positioned for rapid growth in addition to expanding our capacity to being one of the largest and most progressing plants in China. We are also continuing to get government support, getting tax incentives and also we are continuing to find exclusive contracts and rights for getting the supply of milk from the government of Gannan.

We are also continuing to expand our distribution network by not only increasing the sales of each of the distribution points, but also expanding the different points throughout China as well. We are also focused on continuing on getting into best equipment and we have imported 10 million of equipment in the third quarter of '04. Thank you.

Question-and-Answer Session


We have 12 minutes for questions.

Unidentified Audience Member

[Question Inaudible]

Judy Tu

We signed exclusive contracts. We also pay the farmers 15% over the market price for the milk. That way we are able to control the quality of how we raise the cows and we are also able to control loyalty. So, that's how we ensure we get the suppliers.

Unidentified Audience Member

[Question Inaudible].

Judy Tu

We have grazing rights. Are you talking about just --

Unidentified Audience Member

[Question Inaudible].

Judy Tu

They are increasing the number of dairy cows in China and they are purchasing their cows from abroad. We are working with the government and by 2008 we would have already signed a contract to get 200,000 more dairy cows. And then we can help process a thousand tons per day, so we are definitely there.

Unidentified Audience Member

[Question Inaudible].

Judy Tu

We have been focusing on increasing our brand awareness in China, so we have been increasing our sales and marketing, especially with this coming year with more input. And also with infant powder for children's brand, strategy is a big part of it, especially brand loyalty, point of purchase of a product for kids, and so we really have been focusing on strengthening and also solidifying our position in this space.

Unidentified Audience Member

[Question Inaudible].

Judy Tu

It's going to increase.

Unidentified Audience Member

[Question Inaudible].

Judy Tu

Walnut powder and everything else represents about 10% and 90% is infant powder.


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