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China New Borun Corporation (NYSE:BORN)

Q2 2012 Earnings Call

August 7, 2012 8:00 am ET

Executives

Jinmaio Wang – Chairman, President, Chief Executive Officer

Terence Chen – Chief Financial Officer

Ann Yu – Chief Strategy Officer

Analysts

Chenyi Lu – Cowen & Co.

Anson Chan – Piper Jaffray

Operator

Good day everyone and welcome to the Second Quarter 2012 Earnings conference call for China New Borun Corporation. Today’s conference is being recorded.

Before we get started, I am going to review the Safe Harbor statement regarding today’s conference call. Please note that this discussion today will contain forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. To understand the factors that could cause results to differ materially from those in forward-looking statements, please refer to our annual report on Form 20-F filed with the Securities and Exchange Commission on April 6, 2012. The Company does not assume any obligation to update any forward-looking statements except as required by applicable law.

At this time, I would like to turn the call over to Mr. Terence Chen, Chief Financial Officer of China New Borun Corporation for opening remarks and introductions. Please go ahead, sir.

Terence Chen

Thank you everyone for joining us for China New Borun’s second quarter 2012 earnings call. Joining me today from management are Jinmaio Wang, Borun’s Chairman and Chief Executive Officer, and Ann Yu, the Company’s Chief Strategy Officer. On the call today, Mr. Wang will provide a quick review of the quarterly highlights and our business environment. Following Mr. Wang, Ann will offer more details on our operations and our business development and expansion plans. After Ann, I will provide you with more financial details.

I would like to note that on this call today, all of our financial results will be referred to in Chinese RMB unless otherwise noted.

At this point, I would like to introduce Mr. Wang, Chairman and Chief Executive Officer of China New Borun. Mr. Wang will speak in Mandarin and I will translate. Mr. Wang?

Jinmaio Wang

(Mandarin)

Terence Chen

Hello everyone and welcome to China New Borun’s second quarter 2012 earnings conference call.

Jinmaio Wang

(Mandarin)

Terence Chen

We believe Borun continues to perform well on many aspects of our business strategy despite the increasing margin from corn prices and the overall macro environment that is currently crippling many of our smaller and less efficient competitors. We are very proud of our reported quarterly revenue of RMB 803.7 million that exceeded our previous stated revenue forecast which was driven by a combination of strong sales volume and higher average selling price. Notably, the strong demand growth came from all key product lines, which provides clear evidence of the continued robust demand for our industry-leading edible alcohol and byproducts in China, and driven by our strong pre-sale success we continue to immediately sell out our entire production and ensure sales for the remainder of 2012, gaining greater operating efficiency.

Jinmaio Wang

(Mandarin)

Terence Chen

However, these volume and revenue gains were not matched by profitability gains as the price of corn, our main input cost, rose faster than our ability to raise prices. Corn continued its price increase trend during this non-harvest season in the second quarter, and we believe this increase in corn price has posed industry-side margin pressure to edible alcohol producers. We still view this as a temporary factor beyond our control and therefore we have taken several initiatives to drive margin expansion, including improving operational efficiencies and optimizing cost structure through efficient sourcing of raw materials, improving our product mix and expanding our customer base. Especially thanks to our preproduction sourcing strategy at the beginning of the year, we are able to source corn at a cost lower than the market spot price and that benefits us with a cost advantage compared with smaller competitors. We believe these initiatives that we took in the quarter will position Borun well in the second half of the year, which Ann will provide you with more details in her discussion.

Jinmaio Wang

(Mandarin)

Terence Chen

Looking ahead to the second half of the year, we are optimistic regarding the overall climate of the edible alcohol market in China. Third quarter is normally our peak consumption season for edible alcohol in China as more public holidays, including the October national holidays and moon festivals typically drive higher demand from (inaudible) producers. Considering the industry market environment and presales indicated from our customers, we are cautiously optimistic that prices for our edible alcohol will also pick up during the period. We believe the increase in average selling price should mitigate further margin contraction.

In summary, I’m pleased that we continue to execute our strategy efficiently in the second quarter, and I’m cautiously optimistic of our operating results in the remainder of the year.

Jinmaio Wang

(Mandarin)

Terence Chen

At this point, I will now turn the call over to Ann Yu for a discussion of our strategic and business development initiatives.

Ann Yu

Thank you very much Mr. Wang and Terence, and my thanks to everyone for participating in China New Borun’s second quarter 2012 earnings conference call. Continuing on (inaudible) top line growth momentum, we are happy to report that we once again posted strong revenue during the second quarter of 2012 and our quarterly revenue reached a new record of RMB 803.7 million with solid growth coming from all of our key product lines. We continue to operate efficiently at all of our existing facilities and increasing the production of our byproducts DDGS Feed, crude corn oil, and liquid carbon dioxide.

In addition to our high production efficiency than many other corn-based edible alcohol producers, we believe Borun also has a significant comparative advantage of production savings benefiting from our in-house developed Borun Wet Process production method. Under the Borun Wet Process, approximately 3.01 tons of corn can yield one ton of edible alcohol, which roughly saves 3% of corn costs when compared with the industry average, according to our internal estimates. We believe this 3% higher yield will generate meaningful cost savings as corn continues its upward trend in prices.

During the second quarter, edible alcohol contributed the most revenue with quarterly revenue reaching RMB 5,652.3 million or roughly 70% of the total revenue, (inaudible) of approximately 100,100 tons of edible alcohol, representing a 6.1% increase over the same quarter a year ago or 7.6% increase over the previous quarter. DDGS Feed generated the highest revenue contribution growth with a (inaudible) increase of approximately RMB 46 million driven by higher volume and higher average selling price. DDGS Feed sales volume increased by 14.1% year-over-year to 85,740 tons and average selling price increased by 21.4% year-over-year to approximately RMB 1,900 per ton.

Revenue for crude corn oil improved by 75.7% due to the implementation of crude corn oil facilities where sales volume increased by more than 76%; however, the cost of corn remained high and this has resulted in higher cost of goods sold and continued pressure on gross profit margin. The average cost of corn was approximately RMB 2,000 per ton in the second quarter of 2012, an increase of 15.2% compared with RMB 1,700 per ton in the second quarter of 2011. We expect corn prices will largely remain high in the near term, and as Mr. Wang just mentioned, we have taken several initiatives aimed at offsetting the pressure for increasing corn prices to drive margin rebound in the second half of 2012.

We are committed to optimizing our cost structure to improve margins. As you know, in China corn prices are generally higher during the non-harvest season than the harvest season, and is the lowest in the northeastern region. To lock in the cost of corn and to achieve better cost stability, we entered into framework agreements with local granaries in China’s northeastern Heilongjiang Province. These local granaries purchase corn on our behalf from local farmers during the harvest season and store the corn for future delivery, which buffers us from potential future inflation as well as gives us a secure corn supply to meet our demand during the non-harvest season. Stipulated by our (inaudible) arrangement, the local granaries storing the corn for us will incur additional expenses, which we call holding costs. Historically we maintain on hand corn inventory equivalent to about 10 days of production requirements. To further mitigate the increase of holding costs of corn in the next quarter, recently we have strategically deployed a portion of our cash balance to increase our carry inventory of corn at our Daqing facility. If you look at our balance sheet, you will notice there is RMB 122 million increase in inventories at the end of the second quarter of 2012 compared to the inventory balance as of December 31, 2011.

We are also gearing up to expand our capacity for additional byproducts as we consider constructing a liquid carbon dioxide facility at our Daqing plant in the second half of the year. Liquid carbon dioxide is produced using the carbon dioxide collected during the production of edible alcohol as the collection of liquid carbon dioxide does not require incremental use of corn. The incremental revenue contribution for liquid carbon dioxide should generate higher gross margins, higher net income, and greater operating cash flow. The CAPEX for this new liquid carbon dioxide is about RMB 100 million with a capacity of 100,000 tons annually.

The construction period of this liquid carbon dioxide facility is expected to be around four months, and we expect this new facility at Daqing to begin generating revenue in early 2013. We expect the 100 million CAPEX and additional working capital needs for this facility to be completely funded by our current cash position and future operating cash flows.

Finally, as we had noted in the prior quarter, our overall efficiency metrics continue to be solid despite a difficult macroeconomic environment. For the past 12 months, we successfully maintained our return on equity and return on assets at 13.5% and 20% respectively.

That wraps up my part. Let me now turn the call over to Terence Chen for a review of the financial performance in the second quarter of 2012.

Terence Chen

Thanks Ann. I’m pleased with our reported quarterly revenue driven by growth from all of our product lines. For second quarter of 2012, our total net revenue increased by 11% year-over-year to RMB 803.7 million from RMB 724.4 million in the same period of 2011. The key factors affecting our results of operations are as follows: revenue from edible alcohol, driven by higher sales volume, increased by 7.3% to RMB 562.3 million in second quarter 2012 compared to RMB 523.9 million in the second quarter of 2011. Due to strong demand for edible alcohol, the sales volume increased by 6.1% year-over-year to approximately 100,000 tons. In second quarter of 2012, selling price of edible alcohol increased by 1.2% year-over-year to RMB 5,617 per ton.

Revenue from DDGS Feed increased by 38.5% to RMB 165.1 million compared to RMB 119.2 million in the prior year period as sales volume increased by 14.1% year-over-year to 85,740 tons. The implementation of crude corn oil production in Shouguang facility further increased the DDGS Feed yield per ton of corn processed. In the second quarter of 2012, selling price of DDGS Feed increased by 21.4% year-over-year to RMB 1,926 per ton.

Revenue from liquid carbon dioxide increased by 4.9% to RMB 16.6 million compared to RMB 15.8 million in the year ago driven by higher sales volume during the period partially offset by a decrease in selling price per ton. Sales volume increased by 21.2% to approximately 36,300 tons and selling price decreased by 13.4% year-over-year to RMB 457 per ton.

Revenue from crude corn oil increased by 75.7% to RMB 59.7 million and sales volume increased by 76.1% to approximately 7,750 tons at a price of approximately RMB 7,700 per ton, a decrease of 0.3% from the second quarter 2011. As a reminder, beginning in March 2011, we began to de-process corn gin into crude corn oil and eliminated corn gin production at Daqing facility. Subsequently in September 2011, we also began producing crude corn oil and eliminated corn gin production at our Shouguang facility. Consequently since the fourth quarter 2011, we no longer sell corn gin.

Our gross profit decreased by 23.6% to RMB 115.5 million from RMB 151.1 million in the prior year period. Gross margin declined to 14.4% compared to 20.9% in the second quarter of 2011 primarily due to corn costs increasing at a faster rate than selling price during this quarter. Our operating income decreased by 25.6% to RMB 101 million from RMB 135.8 million in the same period of 2011 due to higher cost of goods sold.

On the expense side, we continue to hold the line on our overhead costs. Our total operations expenses amounted for 1.8% of our total revenue. This represents a decline of 30 basis points from the second quarter 2011. Selling expenses were RMB 1.2 million in the second quarter of 2012 which was stable compared to the same period of 2011, and our general and administrative expenses were RMB 13.3 million, which was stable compared to RMB 14.1 million in the same period of 2011.

Income tax expenses in second quarter of 2012 were RMB 20.7 million, representing an effective tax rate of 25%.

Our net income decreased by 28.9% year-over-year to RMB 68.1 million from RMB 95.8 million a year ago. Basic and diluted earnings per share (inaudible) were RMB 2.65 in the second quarter of 2012 and the Company had 25,725,000 weighted average diluted shares outstanding during the quarter ended June 30, 2012. Cash flows used in operating activities for the second quarter of 2012 were approximately RMB 4.2 million primarily due to the increased cash payment for corn held in inventory, as Ann has just mentioned.

On the balance sheet side, we have cash and bank deposits of RMB 180.8 million at June 30, 2012 as compared to RMB 223.9 million at the end of 2011. Our net accounts receivable balance of June 30, 2012 was RMB 304.3 million, essentially flat compared to our balance at December 31, 2011 of RMB 300 million.

That wraps up the financial review for the second quarter, and let me now discuss our business outlook for the third quarter of 2012. We estimate that our revenue for the third quarter of 2012 will be in the range of RMB 670 million to RMB 695 million, an increase of roughly 7 to 11% over the same quarter of 2011 Please note that in the third quarter of each year, we need to perform annual maintenance on our production facilities, which will require us to temporarily shut down. During the shut down, we carry out a full-scale inspection and maintenance program for our manufacturing facilities so as to reduce the possibility of system failures. Our forecast assumes 10 days for this regular inspection, maintenance and repair at our manufacturing facilities in Daqing and Shouguang. This forecast reflects our current and preliminary view which is subject to change.

This concludes our prepared remarks. Operator, we will now open the call up for questions.

Question and Answer Session

Operator

[Operator instructions]

Your first question comes from the line of Chenyi Lu of Cowen & Company.

Chenyi Lu – Cowen & Co.

Great, thank you. Actually, I have three questions today. First question – can you discuss the DDGS Feed ASP? This quarter, DDGS Feed ASP was high. Can you tell us the reason why it’s high, and then also can you give us a trend over the next four quarters? That’d be great.

Terence Chen

Thank you for your question, Chenyi. Yes, the increase in the ASP of DDGS is due to the increase in its raw materials during this quarter, such as raw materials of corn, with beans to make DDGS. And regarding the ASP trends, I suppose the trends will continue in the next quarter.

Chenyi Lu – Cowen & Co.

Okay, great. Do you expect to be flat or you expect to be up, or can you give us a little bit more information?

Terence Chen

I suppose the ASP of DDGS will be flat in the next quarter to compare with the current quarter.

Chenyi Lu – Cowen & Co.

Okay. My next question regarding the edible alcohol – also again, the second quarter was up quarter-over-quarter. Can you give us a view of edible alcohol ASP over the next few quarters? That’d be great, and then I have one more question. Thank you.

Terence Chen

Thank you, Chenyi. ASP of edible alcohol, you can see that the ASP of edible alcohol still will be under some pressure and it is very hard to say when the ASP of edible alcohol is able to keep that pace with the increase in the price of corn. And also, this is fact which has decreased our gross margin and in part the flat price of the edible alcohol is because there was increased supply of edible alcohol coming from the chemical and pharmaceutical industry. And you know, the chemical industry is not good and those producers are looking for alternate markets, but as Chairman Wang has just mentioned, in short term run, the next quarter is typically peak season for the—peak consumption season for the (inaudible) market, and we expect it will also drive the ASP of our edible alcohol.

Chenyi Lu – Cowen & Co.

So do you expect the ASP for edible alcohol to be flat or up slightly, or--?

Terence Chen

We expect the ASP of edible alcohol will slightly increase in the next quarter compared with this quarter.

Chenyi Lu – Cowen & Co.

Okay. My last question regarding the new facility which is going to be built for the carbon dioxide in Daqing – can you give us a little bit more information about this construction? When do you think the construction will start, and how much it will cost, and then what is the production capacity, and then you think it most likely will be complete? That’d be great. Thank you.

Ann Yu

Thank you, Chenyi. We expect the whole CAPEX for this new liquid carbon dioxide facility at Daqing plant will be around RMB 100 million, and the annual capacity of liquid carbon dioxide will be 100,000 tons. We expect to start the construction of this facility in the next quarter and it’s expected to be complete by the end of this year.

Chenyi Lu – Cowen & Co.

So that means you’re going to start next quarter and end by probably close—prior to Chinese New Year, right, because after that time the Daqing will be really cold to continue construction.

Ann Yu

We expect it can be complete by this year because some of the equipment can be stored in-house, so we expect this facility can start to generate revenue in early next year.

Chenyi Lu – Cowen & Co.

Okay. And then again, it’s 100,000 tons, right?

Ann Yu

One hundred thousand tons, yes. The annual capacity is 100,000 tons.

Chenyi Lu – Cowen & Co.

Okay, great. Thank you. That’s all my questions.

Ann Yu

Thank you, Chenyi.

Operator

[Operator instructions]

Your next question comes from the line of Anson Chan of Piper Jaffray.

Anson Chan – Piper Jaffray

Hi. Thanks for taking my questions. My questions are first regarding the corn price trend. Maybe Mr. Wang or Ann can comment a bit more on the future trends as we feel that the U.S. drought and other factors may raise the corn price further. That’s the first question; and the second question is regarding more future growth drivers. Aside from the carbon dioxide you just mentioned, is there any other plans or ideas you have to drive revenue because it looks like alcohol capacity expansion is not likely to happen in the near term. Thank you.

Terence Chen

Let me answer your first question, Anson, about the corn price. From my point of view due to the inflation in China, the corn price will continue to increase in near future. On the other hand, to stabilize the corn price is an efficient way for the government wants to stabilize the profit of the farmers. Anyway, the increase in the corn price will not be as significant as 2011, and as you have just mentioned, the corn price increase in the United States, I suppose this will slightly affect the corn price, the domestic corn price.

And your second question is about our expansion plans for next year?

Anson Chan – Piper Jaffray

Yes, for next year, and also maybe other plans you have in hand to drive up revenue aside from the carbon dioxide.

Terence Chen

Yes, just Ann has mentioned in the second half of the year, we plan to construct the liquid carbon dioxide facility of 100,000 tons in Daqing facility, and the CAPEX for the next year perhaps we consider to expand our production volume in Daqing or perhaps we can seek some opportunity for M&A.

Anson Chan – Piper Jaffray

I see. So M&A appears downstream, or any idea?

Ann Yu

Currently we are still evaluate the different plans and we might first focus on the expansion of our capacity, which is as Terence just mentioned might including expand our Daqing facility or do some M&A. That is our current plan for the future.

Anson Chan – Piper Jaffray

I see. All right, thank you.

Ann Yu

Thank you.

Operator

[Operator instructions]

And there are no audio questions. I would like to turn the call over to management for any closing remarks.

Terence Chen

Once again on behalf of the entire China New Borun management team, we want to thank you for your interest and participation in this call. Thank you for joining us today and this concludes our second quarter 2012 earnings conference call. Thank you.

Operator

Thank you for your participation. This concludes today’s conference. You may now disconnect.

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