John Capodanno – FTI Consulting
Zishen Wu – CEO
Kelly Wang – Finance Director
Yongye International, Inc. (YONG) Q3 2012 Earnings Call November 9, 2012 8:30 AM ET
Good day, ladies and gentlemen. Welcome to Yongye International third quarter 2012 earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator instructions).
I would now like to turn the conference over to your host for today’s call, John Capodanno. Mr. Capodanno, please proceed.
John Capodanno – FTI Consulting.
Thank you, operator. Good morning and welcome to Yongye International’s third quarter 2012 earnings conference call. I am John Capodanno of FIT Consulting, Yongye’s investor relations advisor. With us today are Mr. Zishen Wu, Yongye’s Chief Financial Officer and Ms. Kelly Wang, Yongye’s Finance Director.
Before we start, I would like to remind our listeners that management’s prepared remarks in this call contain forward-looking statements which are subject to risks and uncertainties and management may make additional forward-looking statements in response to your questions. Therefore, the company claims the protection of the Safe Harbor for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ from those discussed today due to such risks as, but not limited to, fluctuations in customer demand, management of rapid growth, intensity of competition from other providers of plants and animal nutrient products and services, general economic conditions, geopolitical events and regulatory changes and other information detailed from time to time in the company’s filings and future files with the United States Securities and Exchange Commission.
Although the company believes that the expectations in such forward-looking statements are reasonable, there is no reassurance that such expectations will prove to be correct.
On the call today, we will also mentioned adjusted financial measure during the discussion of our performance. Reconciliation of those measure to comparable GAAP information can be found in the third quarter 2012 earnings release that was distributed early this morning. Any projects as to the company’s future performance represent management’s estimates as of today, November 9th, 2012. Yongye assumes no obligation to update these projections in the future as market conditions change.
Having now stated those formalities, I will now turn the call over to Mr. Zishen Wu for a review of the company’s developments in the third quarter 2012.
Zishen Wu – CEO
Thank you, John. Thank you everyone for joining us to day on the call. I have a number of things I would like to discuss but first, I would like to begin with the recent going-private offer that Yongye received in October.
I understand that many shareholders may have questions surrounding this. Unfortunately, we’re not in a position to comment at this time, but did want to reiterate that the Board has formed a special committee to evaluate the proposal and they have engaged experienced legal counsel and advisor to assist them.
It is worth noting, there can be no assurance a transaction will be approved or concatenated and we will provide an update to the market in due course. We thank you and we understand you have this point.
Now I would like to provide an overview of our performance during the third quarter. Revenue increased by 7.7% to 127.7 million in the third quarter of 2011. Gross profit increased 5.9% year over year to 80.5 million. However, gross margin increased 1.2% year over year due primarily to the decreased purchase price of certain raw materials.
Income from operations increased 55% to 22.8 million. Net income attributable to Yongye decreased 57% to 16.8 million from 39.1 million for the same period of 2011.
Diluted earnings per share stood at $0.28, compared to $0.69 for the same period of 2011.
Adjusted net income attributable to Yongye, which excludes the impact of non-cash expenses related to share-based compensation for management and independent directors, the amortization of the acquired Hebei customer list, a change in the fair value of derivative liabilities, and the impairment of good well was $29.7 million or $0.51 per diluted share, compared to adjusted net income of $39.7 million or $0.70 per diluted share in the same period last year.
Cash flow used in operating activities was 52.3 million for the nine months ended September 30, 2012, compared to cash flow used in operating activities of 20.5 million in the same period of 2011.
In the third quarter, we completed a capacity expansion project at the Wuchuan facility. We now have a total of 70,000 tons of the combined annual design production capacity at our Wuchuan facility and the Jiangsu facility.
During the third quarter, we continued expansion of our brand new retailers from 32,015 to 33,298, an increase of 4%. The majority of our new recruited branded retailers are located in Hebei, Henan, Jiangsu, Inner Mongolia, Guangdong and Shanxi provinces.
We remained focused on expanding our distribution networks and deepening our penetration in both new and existing markets.
Yongye shipped 14,251 pounds of solution sold during the quarter, representing a 19.6% increase over the third quarter of 2011.
Let me now turn to the truth of the issues we believe are important to address. First, our current revenue recognition policy and second, a goodwill charge we are seeing this quarter.
First, will you recall from the past few conference calls that we discussed the delayed revenue recognition for certain distributors now put into play starting in the fourth quarter of 2011. To recap, due to the issues that Yongye experienced or the timing of the collection of our company in Sinapore in the first quarter 2011, we adopted a delayed revenue recognition approach in which [inaudible] in terms of revenue is realized on a cash basis rather than a shipment basis. As well the case in the second quarter, the impact of this issue on our third quarter revenue and profit reported under U.S. GAAP was quite significant.
The third quarter, which is historically our second to largest quarter for shipments saw a 19.6% increase in shipments compared to the prior-year period where our steady prices remained stable. However, a significant portion of this revenue was under recognized in the quarter due to the above-mentioned delayed revenue recognition approach.
In addition, a significant amount of profit associated with this [inaudible] revenue was therefore [inaudible]. This delayed revenue recognition approach for some distributors will remain in place until we have sufficient time to prove that the distributors payments are on track. However, in the meantime, it’s important to note that Yongye’s current method of a delayed revenue recognition will cause a fractuation in our quarterly results. Given that the second and third quarters typically account for 70 to 80% of our annual shipment and [inaudible] to our distributors. This means that a significant portion of the second and the third quarter revenue may not get booked until the fourth quarter of 2012 or the first quarter of 2013 when we collect cash form our distributors.
It is important to note that while we are more concerned with revenue recognition for our distributors, our business fundamentals included other shipments and the profitability remains strong.
In terms of collections, we collect all outstanding account receivables at the end of the quarter, about 20 million of that was collected a few days late in October. [Inaudible] in April of this year was provided [inaudible] from our year-end collection in early-January 2013.
Second, I would like to discuss how the write off of 10.7 goodwill from our balance sheet impacted our bottom line for the third quarter. We booked 10.7 million of goodwill in the third quarter 2009 for a restructure project where we issued equity exchange for manufacturing businesses. Each year in the third quarter, we need to re-evaluate the [inaudible] situation. Since goodwill [inaudible] are tied to our stock price and given that our stock price has dropped to lower than a level at which we initially booked goodwill, we decided to write off the goodwill. As such, a goodwill you have a lot of 10.7 million was recognized on the income statement in the third quarter.
This impairment loss does not represent any liabilities or cash payment. The amount of this write-off is insignificant to the Company’s balance sheet, and is representing less than 2% of the Company’s total assets on a post write-off basis.
Before turning the call over to Kelly, who will go over our financials in detail, I would now like to provide an update of the recent business highlights.
Third quarter shipments of [inaudible] increased a healthy 19.6% on a year-over-year basis. We now expect product shipment growth of at least 30% with a total amount of 510 million for the full year 2012.
As a reminder, our two new products, Zhongbaosheng and Qianggenbao, which were launched in the first quarter are used earlier in the C calcium process and therefore are sold only during the first or second quarter months. As a result, there was no sales of our new products during the third quarter.
Another highlight from the quarter is that we completed our capacity expansion project at the Wuchuan factory. We know have – we have now increased our manufacturing capacity by 52% to 70,000 tons compared to the 46,000 ton capacity that we had before this project was initiated.
As we have stated on previous calls, this is consistent with our strategy to expand our product diversity and capacity in order to take advantage of the growing market demand for our product. [Inaudible] and demand for better [inaudible] productivity are key factors that contribute to our long-term goal opportunities.
During the quarter, we also continued to make progress with our minimum resource explosion project in [inaudible], Inner Mongolia, China. As a reminder, we only entered into [inaudible] in 2010 to secure the key material used in the production of [inaudible] product.
A professional third-party conversion company continues to field the work of [inaudible],which consists of [inaudible] and taking samples, among other things from the [inaudible] sites. However, the [inaudible] in Inner Mongolia, China. So the third-party [inaudible] company had halted this process. They will revisit the [inaudible] started in Q2 2013 and expect to complete the project by the end of 2013. Once we have all the requirements [inaudible], we will report to the China’s Ministry of Land and Resource’s for renew.
Our initiatives in this area are part of our long-term strategy to realize the competitive advantages and [inaudible] demand for our product.
With that, I would now like to turn over the call to Kelly Wang, our Finance Director to give you the overview of our financial results in the third quarter.
Kelly Wang – Finance Director
Thank you, Zishen, and good morning, everyone. Thanks for joining us today to discuss our third quarter 2012 results. We are very pleased to announce another strong quarter. As I take you through the numbers, please note that I will only be speaking in U.S. dollar terms and [inaudible] mentioned.
Sales decreased by 10.9 million or 7.7% to 129.7 million in the third quarter of 2012 from 140.6 million for the same period of 2011, reflecting the existing revenue that [inaudible].
In the third quarter of 2012, all [inaudible] sales were slowed [inaudible]. During the third quarter of 2012 the number of branded retailers increased from 32,015 to 33,298, this the majority of newly-recruited branded retailers located in Hebei, Henan, Jiangsu, Inner Mongolia, Guangdong and Shanxi provinces.
Gross profit was $80.5 million in the third quarter of 2012, compared to $85.6 million in the same period of 2011, a decrease of 5.9%.
Gross margin was 62.1% in the third quarter of 2012, compared to 60.9% for the same period of 2011. The increase in gross margin was mainly due to the decreased purchase price of certain raw materials.
Selling expenses increased by $11.4 million, or 44.8%, to $37 million in the third quarter of 2012, from $25.6 million for the same period of 2011. The increase in selling expenses was mainly due to an increase in advertising and the promotion expense and distributors' seminar expenditure of $11.7 million related to marketing and promotional activities in our markets.
General and administrative expenses decreased by $0.03 million, or 0.6%, to $4.82 million in the third quarter of 2012, from $4.85 million for the same period of 2011.
Research and development expenses were $5.2 million in the third quarter of 2012, compared to $4.5 million for the same period of 2011. The R&D expenses mainly consisted of field testing expenses for existing and new products on different crops, and in various geographic markets.
Operating income was $22.8 million in the third quarter of 2012, compared to $50.6 million in the same period of 2011.
Excluding non-cash expenses related to share-based compensation for management and independent directors, the amortization of the acquired Hebei customer list, and impairment loss of goodwill, third quarter 2012 adjusted income from operations was $35.5 million, or 27.3% of sales. The decrease in income from operations was mainly due to the decrease in sales combined with the increase in selling expenses, as well as a $10.7 million goodwill impairment loss.
Net income attributable to Yongye was $16.8 million, or $0.28 per diluted share in the third quarter of 2012, compared to a net income of $39.1 million, or $0.69 per diluted share, in the same period of 2011. Excluding the impact of non-cash expenses related to share-based compensation for management and independent directors, the amortization of the acquired Hebei customer list, a change in the fair value of derivative liabilities, and impairment charge of goodwill. Adjusted net income attributable to Yongye for the third quarter of 2012 was $29.7 million, or $0.51 per diluted share, compared to adjusted net income of $39.7 million, or $0.70 per diluted share in the same period of 2011.*
Revenue for the nine months ended September 30, 2012 increased 7.6% to $371.7 million from $345.5 million for the comparable period in 2011, while gross profit was $224.0 million, compared to $204.6 million in the first nine months of 2011. Gross margin was 60.3% for the nine months ended September 30, 2012, as compared to 59.2% for the same period of 2011.
Operating income in the first nine months of 2012 was $98.2 million, compared to $113.4 million in the first nine months of 2011.
Net income attributable to Yongye for the first nine months of 2012 was $74.3 million, compared to $87.0 million in the prior year period.
In the first nine months of 2012, net income per diluted share was $1.31, as compared to $1.65 diluted earnings per share for the same period of 2011. Excluding the impact of non-cash expenses related to share-based compensation for management and independent directors, the amortization of the acquired Hebei customer list, a change in the fair value of derivative liabilities, and impairment charge of goodwill, adjusted net income attributable to Yongye for the nine months ended September 30, 2012 was $91.0 million, or $1.60 per diluted share, compared to $93.6 million, or $1.78 per diluted share in the same period last year.
Turning to our balance sheet, as of September 30, 2012, the Company had $18.1 million in cash and restricted cash, compared to $81.2 million as of December 31, 2011. Working capital was $354.6 million, compared to $270.4 million at the end of 2011.
The Company had $25.3 million in short-term bank loans and $13.2 million in long-term debt as of September 30, 2012. Stockholders' equity totaled $413.6 million as of September 30, 2012, compared to $331.9 million at the end of 2011.
Inventories increased 24.7 million and was mainly due to the impact of delayed revenue [inaudible] for [inaudible].
As of September 30, 2012, and the December 31st, 2011, finished goods included 38.2 million and 6.3 million respectively of products that were sold and delivered to customers for [inaudible] revenue was not recognized in accordance with our accounting policy of revenue recognition and resulted I increased inventory and [inaudible] over day.
Accounts receivable increased by $140.9 million or 91.7% as of September 30, 2012 compared to $153.6 million as of December 31st, 2011. The increase in accounts receivables was consistent with the company’s strong sales occurred in the second and third quarter of this year due to [inaudible].
Cash flow used in operating activities was $52.3 million and $20.5 million for the nine months ended September 30, 2012 and 2011, respectively. The change was primarily due to the increase of $26.1 million in working capital employed. That was mainly driven by increases of accounts receivable and inventory.
Before I turn the call back over to Zishen, I would like to touch on other business outlook. As Zishen discussed earlier, due to our previously-announced delayed revenue certain distributors' revenue is being recognized on a cash basis rather than a shipment basis. As a results, we cannot know what our revenue will be specifically until collected.
The second and third quarters are the largest quarters for shipments and as the Company provides six-month credit terms, we cannot predict if the revenue will be booked by fourth quarter or in the first quarter of 2013. As a result, we believe it is prudent to temporarily withdraw the previously provided revenue and net income expectations. We intend to update the market in early January 2013 on collections as of year-end 2012.
However, we will now, and going forward, provide more formal expectations on shipments, which is not impacted by the revenue recognition issue mentioned above. The Company expects total shipments in 2012 to increase 30% with a total amount of $510 million over 2011. We also reaffirm that its branded retailer network will be expanded to 35,000 by the end of 2012, which represents a 16.3% increase over the 2011 year-end number of 30,086.
It is important to note that while we are more committed on branded recognition for [inaudible], our business is sentimental, including orders, shipments and profitability [inaudible].
With that, I’d like to turn the call back over to Zishen for final remarks.
Zishen Wu – CEO
Thank you, Kelly. In closing, the underlying fundamentals of our business are strong and we’ll remain focused on positioning Yongye for the true long-term goals. [Inaudible] during the quarter is indicative of the growing demand of our products. Our capacity expansion in [inaudible] also helps to further strengthen our company’s competitive position in the market [inaudible] cannot be replicated in our brand and we will continue to leverage it as well as our strong distribution in retail as we move forward.
Thank you all for the support. With that, I would like to open this call up to questions. Operator?
(Operator instructions). I do have a question from the line of (Albert Novaris).
[Inaudible] the transaction. I wanted to know if you can just give us a sense of timing when the board will make a decision and then after the decision, how long will it take for the company to actually be privatized?
Zishen Wu – CEO
Thank you for the question. As we mentioned in the call, unfortunately, we’re not in a position to comment on the going private offer. I understand that you guys have many questions, but as you know, the Board has formed a special committee [inaudible] and they have engaged legal counsel and [inaudible]. In this call, I won’t be able to take any questions regarding this matter.
However, [inaudible] via email and we will forward to the special committee.
And what about just a sense of timing? Just a timeline?
Zishen Wu – CEO
I’m unable to comment on timing either.
Okay. Thank you. I’ll send an email.
And you have a question from the line of Mike Cowen.
Hello? Hello? Yeah, my question is, I guess I’ve been a holder of Yungye for a long time and you know I was disappointed to see that there’s a purchase offer for the company from the current managing and other shareholders because the rest of the shareholders have held in a long time with holding a very good company that’s been going quickly and the price we all know has not reflected the true value of the company. And I guess putting in my question is, how do we really know that these independents are really going to do a proper job to one, look for other alternatives in terms of other potential acquirers and also two, that they’re really going to look through the valuation, which I, as a shareholder, I cannot believe that the current purchase price, there’s any way to get to that purchase price and say that it’s a fair value. How are we, as the retail investor, going to be able to know that things are being done properly because in other times with these companies when there has been purchases by insiders, in my view, it has not been dealt with fairly.
Zishen Wu – CEO
As I mentioned earlier, the Board has formed a special committee which comprised of only independent [inaudible] and they have engaged, experienced legal counsel and the [inaudible] advisor to assist them for this go-private offer. There’s [inaudible]. Unfortunately, that’s what I can say at this point in time. As I said earlier, any questions on this matter, email and we will make sure special committee receives the comment from the shareholders.
Well, I guess I’d like to know what, you know, what will happen if this offer was turned down by the independents because I think that’s, you know, one of the reasons that I don’t think they’ve been dealt with fairly is that the independents have been sort of [inaudible] to management and large shareholders and they have been to – and they have not been really independent. And I guess that is my worry because, you know, and I guess time will tell if they refuse this offer, not because there’s no way that this offer is fair in my opinion.
Zishen Wu – CEO
I understand [inaudible]. We’ll make sure that all comments and questions will be forward to the special committee. Thank you for that.
[Inaudible] Peter Sirrus.
Hey Zishen. How are you doing?
Zishen Wu – CEO
Good, how you doing?
Good. I’ve got a bunch of questions and I promise I won’t ask you when the deal is going to be closed.
The first question I had is actually something related to the deal but not. Am I under the correct assumption that if in fact the – a deal – a privatization goes through, there is some U.S. tax obligations?
Zishen Wu – CEO
I really cannot comment on those scenarios. The company [inaudible] an offer and [inaudible].
Oh no, I’m not asking about whether the special committee is going to vote yes, I’m not asking whether the special committee…
Zishen Wu – CEO
We don’t have an answer on the tax obligation for the go-private situation. It’s too early at this moment.
The question I’m asking has to do with the [inaudible] write downs and other tangible write downs, that if you take write downs now, you’ re in a position to save U.S. taxes. Can you make a comment on that?
Zishen Wu – CEO
A goodwill write down is a standalone [inaudible]. It has nothing to do with the go-private offer, which the company received as we explained in the earnings release in 2009 and [inaudible].
The second question I had is, you’ve changed this revenue recognition policy so that the impact is to push earnings later in the year. And some of the earnings will go into next year because in last year you would have recorded the revenues when they were shipped, now you’re recording them when they’re received. When the payments are received. The question I have is does the [inaudible] revenue recognition policy impact any of the [inaudible] goods that you have with MSDA?
Zishen Wu – CEO
For the [inaudible] we did have a commission price and [inaudible] and I [inaudible] is calculated on an annual basis based on the last year’s result. We think we have traded the target net income threshold by a margin. This year it seems we, at this moment, we don’t have a very clear view of the year end and U.S. GAAP revenue on net income yet. It’s hard to say at this moment.
So could the change in revenue recognition end up giving Morgan Stanley [inaudible] that under the old revenue recognition policy that might not have been entitled to?
Zishen Wu – CEO
Not necessarily. It depends on the [inaudible] of a company by [inaudible].
Your next question comes from the line of Paul Larger.
Hi. I’m wondering just due to – it looks like you guys had a really strong quarter as far as shipments, growth of stores, pretty much everything. Obviously the revenue recognition changes a little bit on how that shows in your financials but I’m wondering why the report was written in such a way that there’s really no easy comparable for the retail investors to see just how good your results are. Basically the way it’s written is that you guys had a huge drop in sales and you know, everything looks, on first glance, like it is not going so well when just the opposite is true. Can you speak to that on not giving kind of the comparison to what it would have been had you been showing it the way you used to show it last year in 2011?
Zishen Wu – CEO
Thanks for the question. For the reporting format, we have to abide by U.S. GAAP, that’s the most accurate measure [inaudible]. We always show U.S. GAAP measure first. But as you mentioned, we – we do [inaudible]. But also we do show the investor that our shipment is quite strong. [Inaudible].
That’s understandable, but it’s just the entire tone of the actual report, they’re definitely, you know, in the end you do mention that sales were, you know that shipments were increased quite a bit, but it just seemed like this report tends to really focus on all the things that you guys did to affect it negatively. Anyway, thank you.
And you do have a question from the line of James McCarthy.
Good morning. I just had a quick question about the large increase in deposits to suppliers. I see it’s up to about 27 million at the end of the latest quarter compared to about 5 million at the end of September 2011. I’m just wondering is that an indication that the company is ramping up and expecting a significant increase in the new product sales which have their strong sales period in Q1?
Zishen Wu – CEO
We sometimes [inaudible] deposit to make sure we secure an ability and in some cases lock in the price. [Inaudible] and some of that is because we [inaudible] so that we can come up in price. Regarding the increase, I [inaudible].
Thank you. And one other question while I’ve got you. Just regarding the goodwill impairment, I was surprised that would have failed step one of the goodwill impairment test given that the company continues to grow and I would expect that your future year’s projections would be at least as high now as they were a year ago if not increased. Can you tell us anything about what would have caused you to fail step one of the goodwill impairment test?
Zishen Wu – CEO
[Inaudible] for the accounting technical discussion on the goodwill test, but one thing that we did show [inaudible] is since stock price is a factor involved when we issued the equity back in 2009 and given that our stock price has consistently been below that level since then and [inaudible]. I’d also like to mention that the write off is [inaudible] it represents less than 2% of our total assets [inaudible].
And there are no further questions. Management, are there any further remarks?
Zishen Wu – CEO
There are no further questions, I would like to thank everybody for joining this call and we appreciate all the shareholder support to the company. Thank you again and have a good day.
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