Agria Corporation Q2 2008 Earnings Call Transcript

Aug.12.08 | About: Agria Corporation (GRO)

Agria Corporation (NYSE:GRO)

Q2 2008 Earnings Call Transcript

August 12, 2008 8:00 am ET

Executives

David Pasquale – SVP

Kenneth Huang – CEO

Gary Yeung – CFO

Analysts

Brian Millberg – Piper Jaffray

Bill Nasgovitz – Heartland Advisors

Operator

Greetings and welcome to the Agria Corporation second quarter 2008 financial results conference call. At this time, all participants are in a listen-only mode. (Operator instructions) As a remainder this conference is being recorded. It is now my pleasure to introduce your host, Mr. David Pasquale, Senior Vice President of Agria Corporation. Thank you, you may begin.

David Pasquale

Thank you, operator. Welcome everyone to today’s call. We’ll be covering financial results for the second quarter 2008. We’ll have time for any questions after a brief review of our results and the outlook. Joining us today from the company are Mr. Kenneth Huang, CEO; and Gary Yeung, CFO.

Before we begin the formal remarks, please note the company’s attorneys advised that today’s conference call contains forward-looking statements. These statements are made under the "Safe Harbor" provisions of the U.S. Private Securities Litigation Reform Act of 1995.

These forward-looking statements can be identified by words or expressions such as “will,” “expects,” “anticipates,” “future,” “intends,” “plans,” “believes,” “estimates,” “confident” and similar statements. Among other things the business outlook and quotations from management on the call as well as Agria Corporation strategic and operational plans contain forward-looking statements.

Agria may also make written or oral forward-looking statements in periodic reports to the U.S. Securities and Exchange Commission on Forms 20-F and 6-K, etc., in its annual report to shareholders, in press releases and in other written materials and in oral statements.

Statements that are not historical facts, including statements about Agria’s beliefs and expectations are forward-looking statements. Forward-looking statements involve inherent risks and uncertainties. A number of important factors could cause actual results to differ materially from those contained in any forward-looking statements.

Potential risks and uncertainties include, but are not limited to Agria’s limited operating history makes it difficult to evaluate our future prospects and results of operations; natural or man-made disasters could damage our seed production which would cause us to suffer production losses and a material reduction of our revenues; outbreaks of disease and livestock and/or food scares in China, would materially and adversely affect our sheep-breeding business.

We primarily rely on arrangements with village collectives to produce our corn seed products and if we are unable to continue these arrangements or enter into new arrangements with other village collectives to increase our production, our total land acreage devoted to corn seed production may decrease and our growth may be inhibited.

Our growth prospects may be materially and adversely affected if we are unable to continue to develop or acquire products to meet the demands of Chinese farmers or to produce our existing products in sufficient quantities and one or more of our distributors may engage in activities that are harmful to our brand and to our business. Other risks are outlined in Agria’s filings with the U.S. Securities and Exchange Commission, including our Form F-1/A filed on November 2, 2007.

All information provided on this call is as of the date of this call. Agria undertakes no obligation to update any forward-looking statement, except as required under applicable law. In addition, several non-GAAP financial measures that we mentioned on this call, information relating to the corresponding GAAP measures and reconciliation of the non-GAAP and GAAP measures can be found in today’s press release on our website at www.agriacorp.com.

At this time, I would now like to turn the call over to our CEO, Mr. Kenneth Huang. Please go ahead sir.

Kenneth Huang

Thank you David, and thank you everybody for joining today’s call. I’m pleased to report that revenue for the second quarter came in above guidance. Several issues that impacted Q1 were not there in Q2, (inaudible). Our sheep breeding business were quite on track in June. As a result frozen semen products we’ve ended for 50% of the total segment, revenue up from zero in Q1. We expect to continue momentum in this area through the second half of the year.

As part of our growth plan, we are focusing our breeder sheep block in Q3. We currently have about 3000 breeders. We plan to purchase 3000 new breeder sheep and we will then sell out about 2000 of the old breeders. Breeders typically remain in service for about five years.

Revenue in our corn seed segment increased in Q2 to RMB 53 million compared to RMB 41 million in Q2 ’07. A normal seasonality trends in our business; revenue was lower in the segment compared to Q1 revenue of RMB 502 million. Going forward we continue to move our forecast to proprietary seeds due to the longer-term trends given in the business.

Our proprietary seeds or fall for [ph] more margin, stability longer-term give us the opportunity to build our brand. In generic seeds, the market will continue to suffer from the ASP pressure making it a live and attractive market. Over the longer-term we see the proprietary seeds and we’re planning to acquire and of course develop new varieties for improved yield and cost, but we will also see expansion into other areas in China such as Northeast and the Middle East and the Southwestern regions of China, another opportunity in the seeds segment exists in other area like flax [ph] seeds. We plan for our R&D to consist of cost (inaudible) within our own facilities and through the collaboration disbursements owned institutions and the universities.

This RMB shift eventually expanded to PML seeds as well over the longer-term. We have already spotted some product problem in this area. We also plan to develop even stronger capabilities in the sheep breeding segment, the goal will be to improve breeding efficiency, quality of the products and the cost stability and the yield in our frozen semen business.

Agria remains in a good position to benefit from the development of Agria solution industry in China. We have strong existing relationships with departments, research institutions and industry. We have a large staff of trained professionals and a strong financial position. This gives us a competitive advantage as we develop our business, reflecting the confidence we have in our business and the positive longer-term trends.

We announced today that our Board has authorized a repurchase of up to $10 million of Agria’s outstanding ADS from time-to-time on open market over the next 24 months. The timing and amount of any repurchase will be determined by our management based on the market conditions, ADS price and other factors and will be subject to the restrictions relating to the volume, price and timing under applicable law. This includes Rule 10b-18 under the SEC Act of 1934.

This reflects our current price levels. Our ADS are attractive investments for the company. Our repurchase program reflects our continued confidence in our business strategy, growth prospects and our commitment to creating shareholder value. Importantly, the repurchase will not effect our commitment to investing in organic growth initiative and to pursuing accretive acquisitions.

Let me turn the call over now to the CFO, Gary Yeung for a review of the financials. Gary please.

Gary Yeung

Thank you, Kenneth. We are pleased with the progress we’ve made in Q2 in effect [ph] that revenue came in ahead of prior guidance. All the figures I mention is in RMB unless otherwise stated.

Q2 was impacted by several operation notices that also impacted Q1 of this year. Certainly Q2 results were impacted by deferred income tax expenses at the rate of 25%. The impact of this in Q2 was 13.7 million. Q2 was also impacted by noncash compensation expenses of RMB 712.7 million, of which all but RMB 10.3 million was related to the agreement between shareholders Brothers Capital and P3A.

Please note the payment from our shareholder, Brothers Capital Limited to P3A was a noncash charge to Agria. Importantly this was a trend, [ph] the final payment charge. Revenue by segment in Q2 was approximately 44%, 33% and 23% of total revenues from our corn seed, sheep-breeding and seedling segments. This compared to approximately 25%, 57% and 18% in the year ago period.

In the second quarter, gross profit was RMB 53.4 million compared to RMB 99.8 million in the second quarter of 2007. Gross margin in Q2 ’08 were 40%, 60% and 51% in our corn seeds, sheep-breeding and seedling segments. This compared to 34%, 73% and 67% in the year ago second quarter.

Net loss was RMB 687.2 million or net loss of RMB 10.87 per basic and diluted ADS. This compared to net income of RMB 92.4 million or net income of RMB 1.85 and RMB 1.84 per basic and diluted share respectively in the year ago period. Excluding the non-cash compensation expense mentioned earlier, net income in Q2, ’08 was RMB 25.5 million or RMB 0.40 per basic and diluted ADS. As of June 30, 2008 Agria had cash and cash equivalents of RMB 1.28 billion.

Let me move onto our outlook for Q3 in 2008. As looked in our Q2 results release it’s a typical seasonality. We expect corn seed sales to be low in the first quarter with a resumption in the sales in the fourth quarter. We are targeting sequential growth through the remainder of the year in sales derived from our sheep breeding segments.

Our typical seasonality, we also expect sales in our sheep breeding segment to decline in the third quarter compared to the second quarter followed by an uptick in the fourth quarter. Based on current business conditions, Agria expects to generate total revenue in the range of approximately RMB 76 million, to RMB 80 million for the third quarter of 2008, representing a year-on-year increase, as compared to the RMB 73 million in the third quarter of 2007.

For the full year 2008, we’re reiterating our prior expectations for total revenue in the range of approximately RMB 738 million to RMB 771 million, representing year-on-year growth in the range by approximately 10% to 15%, respectively.

This forecast affects our current and preliminary view which is subject to change and is expected to be back-end weighed to the fourth quarter, due to normal seasonality of the industry. That concludes our prepared comments. Operator we can open the call up to Q-and-A please.

Question-and-Answer-Session

Operator

(Operator instructions) Our first question comes from Brian Millberg with Piper Jaffray. Please state your question.

Brian Millberg – Piper Jaffray

Good morning or good evening for you.

Kenneth Huang

Good morning

Brian Millberg – Piper Jaffray

Congratulations on the good quarter. I had a quick question on the sales expense. They seem to have dropped significantly for this quarter; would you comment on that? Is that something we can expect or is that something unusual for this quarter?

Gary Yeung

Sales expense? Total selling expense in terms of the amount, has not dropped this quarter compared with the quarter last year.

Brian Millberg – Piper Jaffray

I’m sorry; I meant the general and administrative. I’m sorry. General and administrative numbers are significantly down.

Gary Yeung

General and administrative expenses which is significantly high in this quarter is mainly because of the P3A payment, which including the transfer of share and cash on our shareholders; Brothers capital to P3A team and then the impacted sales for the three months quarter is about RMB 700 million. So this is the major reason.

Brian Millberg – Piper Jaffray

Okay and then at one point I believe you had spoken earlier about perhaps getting into other types of animal breeding; are you still considering that?

Kenneth Huang

Yes, this is Kenneth. We are still looking for the opportunity to get into the other animal breeding areas. Yes.

Brian Millberg – Piper Jaffray

But, no official plans yet, nothing to…?

Kenneth Huang

Yes, we are working on that.

Brian Millberg – Piper Jaffray

Okay, and just one last question. You've now purchased and refurbished the semen collection portion of the sheep breeding and now you’re working on a feed lot, can you comment on what else might be coming in terms of either acquisitions or new facility?

Kenneth Huang

Yes, we identified some opportunity there, so we are still working on that. There is some opportunity there that we identified. That’s at the sheep breeding, the base at the outside Shanxi Province.

Brian Millberg – Piper Jaffray

Okay, I will get offline; I’ll get back in queue, thank you.

Kenneth Huang

Thank you.

Gary Yeung

Thank you.

Operator

Our next question comes from Bill Nasgovitz with Heartland Advisors. Please state your question.

Bill Nasgovitz – Heartland Advisors

Yes, good evening.

Kenneth Huang

Good morning.

Bill Nasgovitz – Heartland Advisors

Regarding acquisitions, what type of hurdle rate are you looking for return on your investment price in general; could you give us some idea of what the range of valuations might be in terms of potential acquisitions that you are looking at?

Kenneth Huang

This is Kenneth. We use the DCF; we look at the acquisition opportunity. We evaluate the company, usually we use the DCF and the rate we give out at the company we would not pay high, so we make sure the acquisition will accrue value for the company and usually we pay the single digit system P/E, and we will not pay higher. We should not – the acquisition should not destroy the company value and the shareholder value, that’s the key point.

Bill Nasgovitz – Heartland Advisors

So, you’re saying that these acquisitions would be accretive and that they would be no higher than a 9 P/E multiple?

Kenneth Huang

Yes you can say that, right.

Bill Nasgovitz – Heartland Advisors

How low might they be? I mean is this a buyers market in China or is it…?

Kenneth Huang

No, it's not. You can’t say this is easy. This is not easy to play in this side of the company. We are going to find some opportunities and we are still working on that, so this is not easy to find. I mean this is not just America, you go there, you get it.

Bill Nasgovitz – Heartland Advisors

Okay, could you also just talk a little about pricing in terms of just in the seed business. What do you see? What trends you see in the pricing arena in terms of corn seed and your product within that overall market?

Kenneth Huang

First of all, the second quarter competition is getting stronger and we see that the prices dropped in the market. So that’s why we intend to sell more proprietary corn seeds than like the generic corn seeds to try to improve our margin. So, generally speaking you see the competition getting stronger and the price dropped for corn seeds.

Bill Nasgovitz – Heartland Advisors

What kind of price drops did you see?

Kenneth Huang

Different corn seeds have different price, so some company drop to 7%, some company’s drop 5%, some company’s drop to 8% difference. Different corn seeds, different price.

Bill Nasgovitz – Heartland Advisors

Okay.

Operator

Thank you. Our next question comes from Brian Millberg with Piper Jaffray. Please state your question.

Brian Millberg – Piper Jaffray

Yes, speaking of the corn seed, I know that one of your goals that you had stated earlier and you just said again was to increase the amount of proprietary seed eventually if you get to 100%. I was wondering, if you could comment on Q2, as to what percentage of seed was generic and what percentage was proprietary?

Kenneth Huang

At the moment of Q2 our sales mix of generic has dropped below 10% and then mostly 80% is from our proprietor seeds and then we also have some tax rating business on proprietary seeds.

Brian Millberg – Piper Jaffray

Very good and then just one last thing; I know that you are not situated near the Schezwan earthquake zone in terms of your sheep breeding, did it affect any of your seed business?

Kenneth Huang

I’m sorry, what was your question, can you repeat it again?

Brian Millberg – Piper Jaffray

Yes, the earthquake.

Kenneth Huang

Okay, okay.

Brian Millberg – Piper Jaffray

I know that it did not affect your sheep breeding, but did it have any impact on your seed business?

Kenneth Huang

We don’t see a big impact. Actually, we see some opportunity in the seed and that was essentially in the last months and because the earthquake destroyed everything and the farmers had to buy seeds again to plant again, so this increased the opportunity.

Brian Millberg – Piper Jaffray

Okay. Thank you.

Kenneth Huang

Thank you.

Operator

Thank you. Our next question comes from Bill Nasgovitz with Heartland Advisors. Please state your question.

Bill Nasgovitz – Heartland Advisors

Yes, Kenneth, in your release you talked about building Agria into a leading company through the development of strong research and developments. Could you give us an indication of, as a percent of sales, what you expect in the last half of the year and then in the year to follow in 2009?

Kenneth Huang

I mean in this year in our business line, we plan to spend RMB 2 million [ph] on the R&D side and the majority in the sheep breeding and the corn seeds developments. In the next three years we plan to spend 1.5% or 2% of total revenue on the R&D side, so that’s our plan.

Bill Nasgovitz – Heartland Advisors

Okay, thank you and then the sheep business and all of the dislocations that we’ve gone through, is that all behind us and could you just amplify on the status of that operation?

Gary Yeung

We are late [ph] on the centralization and the sheep business is back on track since the June timeframe. Did this answer your question?

Bill Nasgovitz – Heartland Advisors

Well, you said back on track, I mean…

Gary Yeung

Due to the centralization in the Q1 first quarter, we lost the frozen semen business and now since to June timeframe with the frozen semen businesses we’ve assumed that the frozen semen business and the whole sheep breeding business is back on track. I mean now you’ll see that all the business was there.

Bill Nasgovitz – Heartland Advisors

Okay, so just since June that’s back on track, so what could that be in terms of revenue going forward, let’s say on a yearly basis?

Kenneth Huang

I will have to forecast there, Gary, can you give some idea about the forecast?

Gary Yeung

We don’t use our official guidance by segment for the frozen semen since (inaudible) of sales in June. If everything is under our control we expect we can catch up the sales level similar to that of last year.

Bill Nasgovitz – Heartland Advisors

Okay, thank you.

Gary Yeung

Thank you.

Operator

Thank you. There are no further questions at this time. I would turn the conference back to management to conclude.

Kenneth Huang

Okay, thank you everybody for joining us on today’s call. So, I’d like to finish it. Thank you everybody. Bye.

Operator

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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