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Executives

Baoke Ben - Director and EVP

Warren Wang - CFO

Vivien Sun - Board Secretary

Sterling Song - Director of Investor Relations

Analysts

Melody Yiqiao Li - Oppenheimer & Co.

Anson Chan - Piper Jaffray

Echo He - Maxim Group

Alastair Ryan - UBS

Zhongpin Inc. (HOGS) Q2 2012 Earnings Results Conference August 9, 2012 8:30 AM ET

Operator

Welcome to the Zhongpin Conference Call Covering its result for the Second Quarter of 2012. For the first part of this call, all participants will be in listen-only mode. Afterwards, there will be a question-and-answer session.

I’m pleased to present Mr. Sterling Song. Please begin.

Sterling Song

Thank you, Irvin. Hello from Zhongpin. I am Sterling Song. I am very pleased to be with you today. Our team today includes Baoke Ben, our Executive Vice President and the Board Member; Warren Wang, Chief Financial Officer; Vivien Sun, Board Secretary, and I'm Sterling Song, the Company's Director of Investor Relations.

I will remind you about forward-looking information. Our conference call may include forward-looking statements made under the safe harbor provisions of the Private Securities Litigation Reform Act. Although we believe that the expectations reflected in our forward-looking statements are reasonable as of today, those statements are subject to risk and uncertainties that could cause the actual results to differ dramatically from those projected.

There can be no assurance that those expectations will prove to be correct. Further information about this and other risks are included in our filings with the Securities and Exchange Commission. The Company doesn't assume any obligation to update any forward looking statements as a result of new information, future events, changes in market conditions, or otherwise, except as required by law. Yesterday, we issued our earnings release, so we assume you have read it.

First is Warren Wang, our CFO, who will cover our financial results. Warren, please.

Warren Wang

Thank you, Sterling. First, I will briefly cover our financial results for the second quarter of 2012. First, cash flow for the first half of 2012. In the first six months of 2012, our net cash flow increased cash and equivalents by $7.5 million, bringing total to cash and equivalents as of June 30, to a $143.3 million. Working capital at June 30, was a negative $21.3 million. Net cash used in operating activities in the first six months was $23.6 million, primarily from net income that provided $23.2 million, depreciation that provided $11.2 million, purchase deposits that provided $7.1 million, accounts receivable and accounts payable that used a net of $38.3 million, inventories that used $22.4 million.

Net cash used in investing activities in the first six months was $57 million, primarily for construction in progress, deposits for the purchase of land use rights, and additions to land use rights, and property and equipment that together used $57 million.

Net cash provided by financing activities in the first half of 2012 was $88.7 million, primarily from the proceeds from loans and notes, net of repayments, that provided $101.5 million, an increase in restricted cash that used $7.0 million, a repayment of a capital lease obligation that used $3 million, and repurchases of common stock that used $2.8 million.

As a result, including the effect from foreign currency exchange rate changes on cash, Zhongpin increased its cash and cash equivalents by $7.5 million in the first half of 2012. Cash and cash equivalents on June 30, 2012 totaled $143.3 million compared with $135.8 million as of December 31, 2011.

We believe our existing cash and cash equivalents, together with our ability to secure bank borrowings, will be sufficient to finance our investment in new facilities, with budgeted capital expenditures of about $125.2 million over the next 12 months, and to satisfy our working capital needs. We intends to satisfy our short-term debt obligations that mature over the next 12 months through additional short-term bank loans, in most cases by rolling over the maturing loans into new short-term loans with the same lenders.

Our debt to total capital at June 30 was 50.5%. Our net debt to total capital was 42.7%, subtracting cash and cash equivalents from both total debt and total capital. Interest coverage for the second quarter 2012 was 3 times on net interest expense, and interest coverage for the six months of 2012 was 2.9 times on net interest expense.

We are nearly at the limit of our debt leverage and interest coverage, so we have a little financial flexibility remaining should we need it. It’s important to understand that we intentionally adapt that to be sure that we can finance the Company’s expansion in the next 12 months, even if the credit markets tighten. So our financial flexibility is in tact.

Next is an update on our stock repurchase program. In the third quarter of 2011, the Board of Directors increased the authorized amount of our stock repurchase program to $40 million under the repurchase program through March 31, 2012. Zhongpin has purchased a total of 3.2 million of its shares in the open market for $36.2 million, including sales commissions. After Chairman Zhu issued this Non-binding Going Private Proposal on March 27, 2012 the Company’s Board of Directors suspended the repurchase program. So there were no shares repurchased in the second quarter of 2012.

Next is our guidance for the year 2012. We are maintaining our previous guidance. Our guidance for 2012 is based on several assumptions that include Continuation of China's policies designed to stimulate domestic consumption and economic growth. Average hog prices in China are expected to decrease about 15% to 20% in 2012 from 2011, based on the assumed forecasted trend for the supply of live hogs and the increasing cost to raise hogs.

A higher percentage of sales from our higher-margin chilled pork and prepared pork products in 2012 than in 2011, while we plan to continue to increase the sales volumes of processed pork products to optimize our product structure. Average capacity utilization for the year of about 75% for pork products. Increasing distribution efficiencies and reduction in the duration of delivery times by expanding our cold-chain logistics system, networks, and services. Total government subsidies for Zhongpin are expected to be $5 million in 2012. In addition, we have assumed that the more aggressive price competition that we saw in the latter part of 2011 and the first half of 2012 will continue in 2012, especially aggressive promotion efforts by our major competitors.

We have assumed that we will increase our expenses in four areas in 2012. First, we will continue to build our brand and do that more aggressively in 2012 than in 2011. Second, we will increase our investments in human resources, especially in training and recruiting. Third, we will increase research and development for new customized products with different styles and tastes to further satisfy customer needs in different regions, with the objective of capturing more market share for prepared pork products; and fourth, we will advance our information technology and information systems more rapidly to support our cold-chain logistics system, optimize the structure of the supply chain, and to reduce the management cost.

Lastly, we have assumed that the historical trend of increasing costs for labor, energy, environmental protection, and quality assurance and control will continue into the future, including in 2012. Given those comments and assumptions, we are maintaining our prior guidance. For the year 2012, we expect that Zhongpin’s sales revenues should be within a range of $1.55 billion to $1.72 billion. Gross profit margin is expected to be within the range of 8.6% to 10.2%. Net profit margin is expected to be within the range of 3.3% to 4.2%.

Diluted earnings per share for the year 2012 are expected to be within the range of $1.36 to $1.92 per share, assuming average diluted common shares outstanding of about 37.5 million shares in 2012.

Zhongpin believes that China’s meat and food industry will continue to consolidate in 2012 at a more rapid pace than in 2011, which may result in higher market shares for the leading producers. We believe that Zhongpin is equipped to meet the challenge of increasing competition and that our guidance for 2012 can be achieved. So that brings you coverage on Zhongpin’s financial results for the second quarter of this year.

Next Mr. Ben, will cover the industry consolidation price outlook and the ongoing strategy and trend for 2012.

Baoke Ben

Thank you, Warren. I will give you an update on the pork industry and the consolidation just briefly cover our operations in the second quarter. First, the hog slaughtering industry in China has continued to develop systematically to be more standardized and larger scale, China’s central government requiring the gradual elimination of outdated hog slaughtering capacity in the next five years. The consolidation of the slaughtering industry is accelerating increasing – at an increasing rate. And that was certainly true in the second quarter. More and more of the outdated small-scale slaughtering houses have been forced to close by the local governments, as part of China’s national policy.

Second, in late 2011, competition in the market has become very aggressive, as the major strong producer strive to win higher market share and to increase their capacity utilization rate. The market share these days can come from the vacuum created by the closed slaughtering houses and from the peer companies since long-term survival and expansion as their primary goals until the industry consolidation has been completed. The competitive measures have mainly been aggressive promotions in all the distribution channels.

Third, food safety is increasingly important to consumers and the government, we believe that it’s good for Zhongpin because our strong brand gives us a competitive advantage since consumers know Zhongpin means high quality safe products. At the same time, our high quality and safety must have continue to improve even more, so cost and the investment to achieve even higher food safety along with further improvement in quality assurance and the control systems will increase for several years.

And fourth, there is increased likelihood that imported pork will become normal in the Chinese markets. Zhongpin will further develop our advantage in international business. However, in the last quarter of – in the first quarter of 2012, we found that the import business has been slowly, comparing with the last quarter of – comparing with the formal quarter in the last year.

These four points are the main, the context of the intense consolidation in the meat processing industry that is happening today. So the massive and aggressive consolidation and our [safe] actions to benefit from the – that consolidation will continue probably for about five years, until the industry consolidation has been completed.

Let me highlight again the mission of the consolidation. In 2012, Ministry of Industry and Information Technology of China announced the China meat industry development strategy report of 2011 to 2015. In that report the Industry and the Information Technology Ministry provided a target for the meat industry for the coming five years.

First, total tonnage of pork production will be 54 million metric tons, which would account for 63% of our meat production by 2015. For pork, we will be almost 2/3s of all meat produced. Second, increase the sales of chilled pork to around 30% of the total pork sales (indiscernible) above the country level in China by 2015.

By 2015, to eliminate 50% of manual and semi-mechanical outdated facilities in China and for first and the second tier cities eliminate 80% of outdated facilities to build pork and the pork products – the production base in China, north east China, east China and the south west of China.

Next, hog and the pork prices for 2012, due mainly to an abundant supply of hogs, hog prices have declined since the peak in September and October of 2011, including during the first and second quarters of 2012. We believe the hog prices are estimated to decline on average by 15% to 20% in 2012 from 2011 and at present we’re saying the first half of this year is at least that.

Pork prices already moved in parallel with hog prices, it’s mainly the pork producers try to maintain a good spread between their selling price for pork and their buying price for hog. That spread has been pressured in the first and the second quarter this year and although we’re [kind of] optimistic about future, it is likely that a spread may not completely recover in the third and fourth quarters.

We still believe that average pork prices in China are expected to decrease about 15% to 20% in 2012 from 2011, based on the assumed forecasted supply trend for live hogs and the increasing cost to breed, feed and to raise hogs. We hope we will be able to maintain a better spread between the cost of hogs and the price of pork and further control the cost of sales compared to sales, but given the very aggressive competition to gain market share as the industry consolidates, our ability to increase our gross profit margin between the price of pork and the price of hogs maybe difficult in the second half of this year.

Next is strategy for 2012, which has not changed. In 2012, we will focus on greater use of existing facilities through our innovating business model, improving our management model and technology innovation which we believe should help us achieve sustainable growth. So this year, we are working to exploit the potential of our current facilities while optimizing our product structure, customer base and the supply chain structures. We are doing well on that. Our capacity utilization in the second quarter was 78%.

We're also working to develop more by-products such as sausage casing and the feeder stock for heparin sodium for more profit to reiterate trends and higher utilization of our raw materials, and we are expanding our cold-chain logistics capacity. Besides the project we have announced, we will build a new cold warehouses in our Tianjin plant.

Next is the reminder about our long-term goals, strategic directions and execution. We have two primary goals. In operations, it is to be a major consolidator in the meat industry chain during the next five years. In finance, it is to increase margin value for our shareholders. We believe we can do both well, simultaneously.

Our strategy and actions have six major points. First, we continue to optimize or reconstruct our business model. Second, continue to expand operations and the business in our targeted regions. Third, we will consolidate resources to create a unified, safe, efficient, collaborative supply chain system.

Fourth to increase our sales of prepared and processed products and about maintaining the growth rate and the high sales proportion of chilled products. Fifth, we look for every logical upstream and downstream extension of our primary business and increase value-added parts of the industrial value chain by comprehensive processing. Sixth, we will give priority to reduction of operation costs both fixed and the variable cost.

Next I will cover our recent actions. First is capacity expansion. In July we started trial production for our new prepared pork products plant in Changge that has an annual capacity of 50,000 metric tons. In the second quarter of 2012, we expected to open the sire boar breeding joint venture that should provide 20,000 of sire boar each year and a distribution center in Anyang for third-party cold-chain logistics services.

In the fourth quarter we plan to open first phase of cold-chain logistics center in Kunshan and in Jiangsu a by-product processing plant with an annual capacity to produce 100 million meters of sausage casing and the 300 billion unit of raw material to make heparin sodium. We believe our actions in 2012 are based on carefully constructed strategy to boost Zhongpin’s competitive advantage, win more market share and create more long-term value for our shareholders in the next several years. Thank you.

Next we’ll open the floor for the Q&A session.

Question-and-Answer Session

Operator

We’ll now begin our question and answer session. (Operator Instructions) Our first question is, Echo He from Maxim Group. Please go ahead. I am sorry, Echo has disconnected. (Operator Instructions) Our next question is Melody Li from Oppenheimer. Please go ahead

Melody Yiqiao Li - Oppenheimer & Co.

Hi, everyone. Can you hear me?

Warren Wang

Yes.

Melody Yiqiao Li - Oppenheimer & Co.

Hi, this is Melody Li calling on behalf of Ingrid Yin. Thank you for taking my question. So, my first question is regarding the ASP. So, we saw that the ASP for chilled and frozen pork declined 10% year-over-year, but the ASP for prepared pork actually increased 23%. I just want to know, what’s the driver of the increase and should we expect a similar trend to continue?

Baoke Ben

So, to answer your question first there’s the product mix change and second as you said the chilled and frozen pork products their price follow the market trend, but for the prepared pork products there is always on that behalf, meaning when the hog price and – when the chilled and pork products price drop the prepared pork product price will stay, will maintain and then drop like a couple of months later. So this is a kind of make off in industry. And we see that in from actually from the latter part of last year, the chilled and frozen pork price dropped and the prepared pork products price also decreased, but not as I said based on that be continuous to be so chilled product factors. I think that’s the main reason why there’s a different trend.

And as we discussed, we anticipated that the chilled and frozen pork product, their price has reached the bottom for this year and the government has that into the market to build up the government reserve, which we believe is a 5% for the bottom of the price and for the recovery of the market in the second half of this year.

And for the prepared pork product price, I will say it depends on the hogs and or how quick the chilled and frozen pork products can recover. If they recover, I would say in the later third quarter, beginning of fourth it’s possible that the prepared pork products, the price will maintain at current level meaning they won't drop and they’ll recover but just maintain at a current level. Okay, that’s the answer to your question.

Melody Yiqiao Li - Oppenheimer & Co.

Okay. Thank you, very helpful. So, my next question is regarding tax rates. So, management explained that the higher tax rate this quarter is due to the rising sales of prepared products which has 35% tax rate. So, should we expect the tax rate to further increase from current level as prepared pork sales go up, and what kind of tax rate is building in your three year guidance? Thanks.

Baoke Ben

Yes, you’re right. From our product sectors we’ll only need to pay income tax for prepared pork products. The tax rate is 25% and we enjoy tax holidays for our upstream products such as the chilled and frozen products. The overall product mix change, I mean the sales of prepared pork products increased and of our total revenue the total tax rate for the whole corporate will increase as well. And when we gave the guidance for the whole year, we estimate this trend meaning, we has made a net profit margin and slight around 3% to 4% for the whole year. We already calculated the impact from the increased income tax coming with the more sales of prepared pork products. Thank you.

Operator

The next question is Anson Chan from Piper Jaffray. Please go ahead.

Anson Chan - Piper Jaffray

Hi, Warren. Thank you for taking my question. I have two questions; first regarding utilization rates, I think Ben just mentioned the overall taxation rates was 78%, I would like to know if the downstream -- the taxation rate for prepayment it should be a bit lower and how is the trend going forward and the second question is regarding the timeline, after your appointed Barclays as the advisor to the Board, do you have any deadlines or timetable when Barclays will gift you the advise or some proposal?

Warren Wang

So, to answer your first question, yes the overall corporate utilization rate is about 78%. The downstream product utilization rate of the prepared pork products is a little bit lower than that. We expect that for the things we put in the old facility of prepared pork products into operation where we started the trial production in July. So we – generally take us like three to six months to ramp up new facility. So, for the overall utilization rate for the downstream we will be a little bit lower than the 78% we achieved right now. But for the upstream ones we -- that now we’re quite confident that we can achieve more than like 78% utilization rate. So the overall company’s utilization rate will at least maintain at the current level back to 70% -- throughout 75%. For the second question, we haven’t received any, I mean the company -- the special committee haven’t received any like timetable from the Barclays Capital and we cannot comment too much on this topic. So please wait for any press release from the Mr. Zhu or the special committee. Thank you.

Anson Chan - Piper Jaffray

Okay, okay. Just follow-up on the utilization rates. Can we expect certain improvement in the gross margin for prepared pork if utilization rates ramp up?

Baoke Ben

So, we expected the net profit margin of the prepared pork products will increase in the future, but however during the utilization rates ramp up period and that the increase won't happen very quickly and we will see kind of type of having increase the net profit margin. And the most important, the increase of the cost that including the labor cost and the utility cost and will increase, that’s a trend for this industry. Therefore all of our peers and the competitors in the industry they will face the same challenges regarding the net profit margin.

Anson Chan - Piper Jaffray

Thank you.

Operator

The next question is, Echo He from Maxim Group.

Echo He - Maxim Group

Hi, thank you so much for taking my questions. I apologize for pushing the wrong button. Okay, and actually my first question is about the price tool and I want to ask what percentage of such decline is due to the – the supply price, the [easing up] of the supply price and what percentage is due to the competition if you could tell us roughly the range. And then, I would have the second question.

Baoke Ben

Sorry, we can't quantify this.

Echo He - Maxim Group

Okay.

Baoke Ben

But definitely the raw material price cost – raw material cost and also the competition that’s the two most factors to impact our ASP. However, we do not have in fact a percentage on what’s the percentage from the raw material cost and what's the percentage from the competition. So, so far we can say that for the different pork factor products that two factors play the different roles for example for the chilled pork products and we think that the competition plays a – has the more impact on the ASP. However we cannot quantify on that, but we will discuss after this meeting and give you more explanation.

Echo He - Maxim Group

All right, thank you. My second question is about; could you just give an overall comment on the lending environment to non-state owned corporate just like Zhongpin?

Warren Wang

Generally considering the whole economic environment in China in this year 2012, as you say the -- it’s much better than what we saw last year. So you can tell that we increased our short-term and long-term loan balance to support our expenses to finance our CapEx. And we deal with state owned banks such as the Agricultural Bank of China and also we just -- we will build our relation with the China Development Bank and we borrowed RMB125 million from China Development Bank lastly in the second quarter. So, and also we have a significant balance from China Construction Banks. And also we deal with the China Merchants Bank, the (indiscernible) Bank and Citi Bank. So you can tell that as a non-state owned company in this competitive industry, Zhongpin has build up a very good relationship most of the state-owned banks and with non-state owned banks. So, that’s why I said the environment for Zhongpin is quite good.

Echo He - Maxim Group

Okay, understand. That’s all my questions. Thank you so much.

Warren Wang

Thank you.

Operator

(Operator Instructions) The next question is ([indiscernible). Please go ahead.

Unidentified Analyst

My question is, maybe regarding the TP per ton for the chilled pork, I mean also the data shows that the company that Zhongpin we have see declining TP per ton for the chilled pork. So just hoping the management could elaborate more on the causes and maybe comment on the trend looking forward. Thank you.

Baoke Ben

So, we think there are three factors to impact over the profit margin per ton. So the first one is the intense competition due to the accelerated consolidation. During this consolidating period most of the, these large players our peers and they are trying to gain more market share and therefore a lot of the price roll and the competition happened in a lot of the market in China. However and based on our psychology, in Zhongpin we did not play the price more directly with our competitors, so and we are trying to build-up our competitive advantage based on our psychology. However the intense competition gives us a lot of pressure on our margin.

The second one is the economy environment. During the first half of 2012 and the consuming activities in China is not as well as the last year, therefore from the supply end and the consumer side and we feel the pressure and from the light consumption. So third one is the cost increment, such as the labor cost and energy cost and also raised food safety and the quality assurance, and quality control and we also feel the pressure from the increment of the cost.

Operator

The next question is Alastair Ryan from UBS. Please go ahead.

Alastair Ryan - UBS

You’ve been saying for some time that there is a consolidation within the industry and its going to get more intense. Are there any mergers or acquisitions or joining up of any of your larger competition in China?

Baoke Ben

So the status of the China’s pork industry, of slaughtering industry is thus it is very fragmented industry. Therefore the period of consolidation in the most of outdated this manual and semi-mechanical outdated slaughtering houses, these will go out to the company. However, for this kind of asset is not attractive to the major players. So we don’t say this much of appreciation between the big players heightened and also and if it happened – it will happen after in the later period of the consolidation.

Operator

I’m sorry about that. The speaker has disconnected the line. Please wait for a moment. Thank you very much. Thank you. The call starts in a moment. Please hold.

Sterling Song

Hello, operator?

Operator

Yes, please go ahead.

Sterling Song

Yeah, that is all for our prepared remarks. So, I think we come to the end of the Q&A session. And we can ask Mr. Ben for his closing remarks. Mr. Ben, please.

Baoke Ben

As always, we thank you for your attention and your investment. We expect to deliver attractive returns to you and until we talk with you again, I wish you good health, safety, and happiness. From Zhongpin, China, goodbye for now.

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