China XD Plastics Company Ltd (CXDC) CEO Jie Han on Q4 2018 Results - Earnings Call Transcript

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China XD Plastics Company Ltd (OTC:CXDC) Q4 2018 Results Earnings Conference Call April 15, 2019 9:00 AM ET

Company Participants

Jie Han - Chairman and Chief Executive Officer

Taylor Zhang - Chief Financial Officer

Qingwei Ma - Chief Operating Officer

Conference Call Participants

Graham Tanaka - Tanaka Capital Management

Matthew Larson - National Securities

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Fourth Quarter 2018 China XD Plastics Company Ltd Earnings Conference Call. At this time, all participations are in a listen-only mode. Today's call will include a question-and-answer session [Operator Instructions]. I must advise you that this conference is being recorded today, Monday, April 15, 2019.

I'd now like to hand the conference over to your speaker host today, [indiscernible]. Thank you, sir. Please go ahead.

Unidentified Company Representative

Thank you. Hi, everyone. Thank you all for joining us for the China XD Plastics fourth quarter 2018 financial results conference call.

Joining me on the call today are Mr. Jie Han, Chairman and CEO; Mr. Qingwei Ma, Chief Operating Officer; Mr. Taylor Zhang, Chief Financial Officer; Mr. Junjie Ma, Chief Technology Officer; and Rujun Dai, Deputy General Manager of Heilongjiang subsidiary.

Earlier today, China XD Plastics issued a press release announcing the fourth quarter 2018 results.

Before management's presentation, I would like to refer to the Safe Harbor statements in connection with today's conference call and remind our listeners that management's prepared remarks during the call may contain forward-looking statements, which are subject to risks and uncertainties, and that management may make additional forward-looking statements in response to your questions.

All statements other than statements of historical fact contain our forward-looking statements, including, but not limited to, the company's growth potential in international markets; the effectiveness and the profitability of the company's product diversification; the impact of the company's product mix shift to more advanced products and related pricing policies; the volatility of the company's operating results and financial conditions; the company's projection of performance in 2018 and other risks detailed in the company's filings with the SEC and available on its website at www.sec.gov.

These forward-looking statements involve known and unknown risks and uncertainties and are based on current expectations, assumptions, estimates and projections about the company and the industry.

The company, therefore, 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, and we refer you to a more detailed discussion for the risks and uncertainties in the company's filings with the Securities and Exchange Commission.

In addition, any projection as to the company's future performance represents management's estimate as of today, April 15, 2019. China XD Plastics assumes no obligation to update these projections in the future as market conditions change.

To supplement the financial results presented in accordance with the US GAAP, management will make reference to earnings before interest expense, income taxes, depreciation and amortization, which we refer to as EBITDA. EBITDA is a non-GAAP financial measure reconciled from net income, which the company believes to provide meaningful additional information to better understand its operating performance. A table reconciling net income to EBITDA can be found on the earnings press release issued earlier today.

I would now like to turn the call over to our Chairman and Chief Executive Officer, Mr. Han. Mr. Han will be speaking in Chinese and I will translate his opening remarks into English. Mr. Han, please go ahead.

Jie Han

[Foreign Language]

Our fiscal 2018 results were consistent with the less anticipated severe slowdown in China auto industry, the first drop in 28 years.

In addition, the reduction of duty on import vehicles by an average of 46% is expected to have a profound impact on the entire auto industry in China.

Although we applaud the implementation of such supply side reform by the policy makers for the wellbeing of the long-term benefit of China auto industry, it will have short-term impact to the auto market as companies throughout the supply chain when they are adjusting themselves and adapting to such change.

We are pleased with our successful trial production at our production base in Dubai and remain optimistic about our business expansion overseas, especially after positive results and feedbacks after product trial runs from customers in various countries and regions overseas.

[Foreign Language]

In November 2018, the company had a successful trial production at our production base in Dubai and has tried to develop new overseas customers besides the existing customers.

The company has established business relationships with new customers in UAE and India and shipped product to the end users in Europe in the fourth quarter of 2018. Dubai Xinda primarily offers long-chain nylon alloy and other high-end engineering plastics.

[Foreign Language]

So, the macroeconomic environment for Chinese auto industry is still to be improved, thanks to the Chinese government's current policy to support non-state-owned enterprise in China.

Earlier this year, the company signed deleveraging investment framework agreement with several domestic major banks in China. We are very pleased to welcome those domestic Chinese banks as our important strategic and long-term partners of China XD Xinda.

The collaboration between China XD and those major Chinese banks will not only help our company deleverage its balance sheet and improve its capital structure, but assist the company to solidify its long-term position in its industry.

[Foreign Language]

We believe the successful trial run in Dubai resulting in new production capacity to be added, our expansion into new markets overseas, diversified customer base and escalation of sales categories will strengthen and augment our core automotive business future. Our new development projects, which leverage our technical expertise, will lead to additional new business.

We view ourselves as the leader in the polymer composite sector, which will enable us to provide creative technology solutions for China's modernizing transportation, energy, healthcare and industrial sectors.

In terms of 2019 revenues, we expect revenue to range between $1.3 billion and $1.6 billion in revenue and net income to range between $90 million and $110 million.

[Foreign Language]

With that, I will now turn the call over to Taylor Zhang, our Chief Financial Officer, to walk you through our financials.

Taylor Zhang

Thank you, Mr. Han. And thank you, everyone, for joining the call today. Before I review the numbers, let me remind you that all figures I discuss are for this reporting period, the fourth quarter of 2019 (sic) [2018], unless I state otherwise. Additionally, any year-over-year comparison is to the fourth quarter of 2017 and any sequential comparison is to the third quarter of 2018. So, let's go over our fourth quarter results.

Revenues were $349.8 million for the fourth quarter of 2018 compared to $427.6 million for the same period last year, representing a decrease of $77.8 million or 18.2%. The year-over-year decrease was primarily as the combined results of 19.9% in sales volume, offset by a 5.6% increase in average RMB selling price of our products as compared with those of last year.

According to the China Association of Automobile Manufacturers, automobile production and sales in China in the first quarter continued to follow the declining trend since the third quarter of 2018. China auto sales dropped 11.7%, 13.9% and 13% in our last October, November and December respectively compared to the same periods in 2017.

Weakening macroeconomic conditions since the summer of 2018 have deteriorated business conditions. Though the company has increased growth of 73.9% in Central China and 62.9% in Southwest China, sales decreased by 51.5% in South China, 28.6% in East China, 22.6% in Northeast China and 5.1% in North China.

Premium products in total accounted for 78.3% of revenues in the fourth quarter of 2018, compared to 73.3% in the prior-year period. The company continued to shift its production mix from traditional lower-end products to higher-end products such as PA66, PA6 and PLA.

Overseas sales was $15 million, accounting for 4.3% of total sales for the fourth quarter of 2018 as compared to $35.4 million and accounting for 8.3% of total sales for the same period of 2017.

In 2018, the company suspended sales with existing overseas customer due to its tight funding and accounts receivable balance overdue situation.

The company had a successful trial production at our production base in Dubai in November 2018 and has focused on developing new overseas customers besides the existing customers. The company has established business relationships with new customers in UAE and India, and shipped products to the end users in Europe in the fourth quarter of 2018.

Gross profit was $62.4 million for the fourth quarter of 2018 compared to $91.5 million for the same period of 2017, representing a decrease of $29.1 million or 31.8%. Gross margin was 17.8% compared to 21.4% in the fourth quarter of 2017, mainly due to lower sales of higher-end products by Dubai Xinda.

G&A expenses were $8.6 million for the fourth quarter of 2018 compared to $12.2 million for the same period of 2017, representing a decrease of $3.6 million or 29.5%. The decrease was mainly due to our approach on optimizing management structure and enhancing efficiency, leading to the decrease of $3.5 million in salary and welfare and $0.1 million in share based compensation.

R&D expenses were $26.9 million for the fourth quarter of 2018 compared to $11.6 million for the same period of last year, representing an increase of $15.3 million or 131.9%. This significant increase was primarily due to, first, elevated R&D activities to meet the new and higher specification requirements from potential customers, especially overseas; and second, increased efforts directed towards applications in new electrical equipment and electronics, alternative energy applications, power devices, aviation equipment and ocean engineering, in addition to other new products primarily for advanced industrialized applications in the automobile sector and in verticals such as ships, airplanes, high-speed rail, 3D printing materials, biodegradable plastics, and medical devices. As of December 31, 2018, the number of ongoing R&D projects was 386.

Operating income was $24.1 million for the fourth quarter of 2018 compared to $66.6 million for the same period of 2017, representing a decrease of $42.5 million or 63.8%. This decrease is primarily due to the lower gross margin, higher selling expenses and R&D expenses, and partially offset by lower G&A expenses.

Net interest expense was $13.1 million for the fourth quarter of 2018 compared to net interest expense of $11.2 million for the same period of 2017, representing an increase of $1.9 million or 17%.

Income tax benefit was $0.5 million for the fourth quarter of 2018, representing an effective income tax rate of negative 3.6% compared to income tax expense of $79.8 million in the same period of 2017, representing an effective income tax rate of 134.5%.

The decrease of effective income tax rate was primarily due to: the company recorded a charge of approximately $71.0 million for the repatriation tax on deemed repatriation to the United States of accumulated earnings in the fourth quarter of 2017; the increase of additional deduction of R&D expenses resulted from the new policy issued by China's tax authority in September of 2018 to increase the R&D expenses additional deduction rate from 50% to 75% for PRC entities, effective from January 1, 2018 to December 31, 2020; the increase of Sichuan Xinda's profit before tax percentage within the consolidating entities, and partially offset by the increase of continuous operating losses occurred in overseas subsidiaries such as Hong Kong and US entities.

Net income was $13 million for the fourth quarter of 2018 compared to net loss of $20.5 million for the same period of 2017, representing an increase of $33.5 million or 163.4%. Basic and diluted earnings per share for the fourth quarter of 2018 were both $0.20, compared to $0.31 losses per share per share for the same period of 2017.

The average number of shares used in the computation of basic and diluted earnings per share for the three months ended December 31, 2018 was 50.5 million compared to 49.7 million shares.

EBITDA was $38.4 million for the fourth quarter of 2018 compared to EBITDA of $82.9 million for the same period of 2017, representing a decrease of $44.5 million or 53.7%. For a detailed reconciliation of EBITDA, a non-GAAP measure, to its nearest GAAP equivalent, please see the financial tables at the end of our press release issued earlier today.

Now, let's turn on to the balance sheet. As of December 31, 2018, the company had $367 million in the total amount of cash and cash equivalents, restricted cash and time deposits, a decrease of $241.1 million or 39.6% as compared to $608.1 million as of December 31, 2017.

Working capital was negative $180.2 million and the current ratio was 0.9 as compared to the current ratio of 1 as of December 31, 2017.

Stockholders' equity as of December 31, 2018 was $748.9 million, an increase of 5.1% as compared to $712.8 million as of December 31, 2017.

Inventories increased by 47% as compared to the end of fiscal year 2017 as a result of more purchases of the raw materials and the company's strategy to stock up the finished goods for the upcoming orders.

The aggregate short-term and long-term bank loans decreased by 5.4% due to the loan repayments.

Now, before I open the call to your questions, I would like to note that any questions directed to management, I will translate both your questions and your answers. If you want to ask a question in Chinese, please also ask in English for the benefit of other listeners.

Please also note that we will only be able to respond to questions about our financial and operating results. For other matters, including the going private offer, we refer you to our already issued press release. We will not be able to respond to questions that are directed to the principles of the going private offer about the proposed transactions.

With that, we will now open the call to your questions. Operator?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. Your first question comes from the line of Graham Tanaka. Please ask your question.

Graham Tanaka

Yes. Thank you, Taylor. And congratulations, Mr. Han, on diversifying into other industry verticals for your end products. My question has to do with your assumptions for or projections for total consumption of plastics in the auto industry in China in the 2019 year and then what proportion of your sales will be non-auto versus auto in 2019? Thank you.

Taylor Zhang

All right. Thank you, Graham. Let me translate your question for the management in China to address it.

[Foreign Language]

Jie Han

[Foreign Language]

Graham, the assumption for our 2019 revenue guidance, basically, the auto accounted for less than 80%. So, accordingly, non-auto will represent about 20%.

Graham Tanaka

What proportion of your overall sales will be in China, domestic shipments, and outside of China? Thank you.

Taylor Zhang

Overseas? Okay, sure. Let me translate again.

[Foreign Language]

Jie Han

[Foreign Language]

So, Graham, the majority of the sales, we assume, will come from domestic. Overseas, we estimate, is going to be over 4%.

Graham Tanaka

Over 4% overseas?

Taylor Zhang

Yes.

Graham Tanaka

Yes. We understand that Tesla is building a US electric vehicle company. Tesla is building a very, very large auto assembly plant in China and we're wondering if you are going to be providing [indiscernible] and could that be a significant addition to your growth in 2019?

[Foreign Language]

Jie Han

[Foreign Language]

Hi, Graham. So, we have been in contact with the purchase of equipment person from Tesla. So, we believe this is a positive development and trend, including Tesla and other electric vehicle manufacturer, will eventually benefit a company like us in the future. We also are very interested in participating in this development.

Graham Tanaka

Thank you very much. Could you estimate what change in average selling price you expect in 2019? Will you be continuing to increase the percent in premium products? Thank you.

Taylor Zhang

Graham, just so that I understand your question clearly, basically, you ask, one is the ASP and secondly is our premium products, their contribution will increase. Is that correct?

Graham Tanaka

Yeah. What percent of your products will be premium products in 2019 versus 2018? Thank you.

Taylor Zhang

I'm sorry, Graham. I cannot hear the latter part of your question.

Graham Tanaka

Yeah. I just was wondering both the average selling price increase or decrease this year and then what percent of your products will be premium priced products. Premium in 2019 versus 2018 premium products. Thank you.

Taylor Zhang

Okay, got it. Thank you.

[Foreign Language]

Jie Han

[Foreign Language]

Hi, Graham. So, we expect slight increase both in terms of ASP and also premium high-end products.

Graham Tanaka

That's great. Terrific. My last questions are about the cash flow and balance sheet. What kind of improvement do you expect in your [indiscernible] and what might happen to your leverage? In other words, your total loans versus net loans outstanding versus cash on the balance sheet by the end of this year? Thank you.

Taylor Zhang

Okay. So, your first question is how we see the developments or how the DSO will be trending, right?

Graham Tanaka

The cash flow in 2019 versus – cash flow and then the…

Taylor Zhang

Okay. And leverage.

Graham Tanaka

And cash at the end of this year.

Taylor Zhang

[Foreign Language]

Jie Han

[Foreign Language]

Hi, Graham. So, we expect our cash flow situation will improve in 2019 based on the contract where sales order we received and pattern of – collection patterns of the customers.

In terms of our leverage, we believe we'll maintain the level that we have seen in 2018.

Graham Tanaka

So, you believe you will maintain the same total debt number and will the cash rise in the balance sheet?

Taylor Zhang

Let me confirm before I answer your question.

[Foreign Language]

Qingwei Ma

[Foreign Language]

Graham, here's the answer from Mr. Ma, our COO. In terms of the cash position, I think we'll pretty much remain at the same level in 2019 and the total debt will increase slightly.

Graham Tanaka

And I have one more question. What do you expect – how large will your capital expenditures be in 2019 versus 2018? And what areas will you be in that?

Taylor Zhang

Okay.

[Foreign Language]

Jie Han

[Foreign Language]

Hi, Graham. We are currently still finalizing our 2019 CapEx budgeting in that. Because, in 2018, as you probably know, the nationwide deleveraging initiative by the government has impacted a lot of companies throughout China. So, we want to make sure that we can secure long-term funding before committed to a definitive CapEx budget.

Graham Tanaka

Good luck in the year and thank you very much for your very candid answers. Thank you.

Taylor Zhang

Thank you, Graham.

Operator

Thank you. Your next question comes from the line of Matthew Larson. Please go ahead.

Matthew Larson

Okay. Hi, Taylor. How are you?

Taylor Zhang

Good. Thank you. How are you, Matthew?

Matthew Larson

Good. All things considered, it was a very good fourth quarter in my judgment. You exceeded your revenue estimate and then your projections for 2019 are inspiring, are positive. You're growing your topline. Your book value is growing. But the metric that you're trading at now is extremely frustrating for investors. You know that from previous conversations I've had on conference calls because not only am I a large shareholder, but I represent a lot of retirees, okay, who've been involved in your company for a number of year, primarily because you have a nice company and a good niche, and your competitors in the PRC trade at significantly higher valuation. But also Morgan Stanley's presence has given a certain level of comfort. Since they own such a large percentage and they have some people on the board, there is a certain safety there that we can feel that there's someone looking at you as shareholders there. And frankly, being such a shareholder, they do have a fiduciary responsibility to be sure that they protect or at least treat other public shareholders fairly. It's a fiduciary responsibility. So, there's a conflict of interest they have. They are a private equity firm, at least who has invested in you, MSPEA. And if they were involved in private firms, that's one thing. But if you decide to play in the public markets, the rules are significantly different here. And they've actually gotten to be more – they've changed dramatically as there is a lot of scrutiny by regulators, by politicians and elsewhere that the term fiduciary responsibility has taken on a significantly higher importance level. And so, if they are playing in the public markets, the rules are different. And yet, you guys have grown a company very nicely over the years. You have a nice niche. And the stock is a fraction of what it was many, many, many years ago. Just looking at your metrics today, you did a $173 million EBITDA last year in a down year, and so your company is trading at well below 1 times EBITDA. And then, going forward, if you do $100 million, this thing is trading at 1.3 times earnings. That's just something you would never see. And then, the book value grew, right? So, that metric continues to grow. And your revenues are going to grow. Let's say, you do $1.5 billion. I'm rounding. So, the company is trading at about 12 times its current market valuation. So, by any measure, it's something that just would never occur in the US, and yet this company is listed here.

So, with that being said, I'm just kind of running through things that people – they don't know if they are new to the conference call. It's just – it's frustrating.

And then, I'll just – I'll finish up with this preamble. You all signed up six banks, some of them the largest in the entire world, to make some at least verbal commitments to help fund your refinancing and include the terms for privatization and M&A, mergers and acquisition. And yet, none of that was reported in the United States. Okay? We know about that because that sort of media releases were made in the PRC and some in The South China Post and they were translated by people here. But wasn't that kind of material information that should have been released here in the United States that you had some banks for the first time in many years that were lining up. It's a billion and a half dollars or more. And that seems to me to be extremely material. Can you tell me why there was a suppression or just a reluctance to make that news known because investors can react to that? Some people might have sold stock not knowing that's occurring. Others might actually want to buy your stock and make it go up. Is there a reasons why that extremely material information wasn't released?

Taylor Zhang

Okay, Matthew. Thank you for your question. Let me translate your question for the benefit of management in China.

[Foreign Language]

Jie Han

[Foreign Language]

Hi, Matthew. So, the answer came from our Chairman and CEO, Mr. Jie Han. And so, if we look back to 2018, we have double headwinds. First of all is the decelerating macroeconomic conditions. Secondly, lending environment is not ideal because of the tightening credits in China by the commercial banks. However, fortunately, towards the end of 2018, the central government has its direction 180, which the government directed major commercial banks to basically look for certain industry and high-quality companies to provide funding for those companies, including some non-SOE, which means – which stands for non-state-owned enterprises. We so far appear to be one of the beneficiaries.

And it's not the company does not want to disclose material, significant information. So, at present, all the discussion or intention are basically very similar to letter of intent. So, there's no binding effects from a legal perspective. So, once we enter into the binding definitive agreement with any bank, we will disclose accordingly in accordance with the relevant disclosure requirements.

Matthew Larson

I understand that. Right now, you have President Trump and Mr. Xi discussing trade cooperations, but there's no binding agreement between the two of them. Nothing has been signed, but it's certainly material and it has moved the market. The markets in Shenzhen and Shanghai, they are up dramatically this year, as are markets around the world. So, they are up probably to a great degree that may be a trade agreement might come about. But it isn't definitive or signed, but it's still material. So, people are buying stock based on a good outcome. And so, that's just what I'm saying, is it doesn't have to be signed to material. All right? So, I'll just say that, number one.

And it just seems – I speak with a number of investors, small and large, in your company's stock and there's a feeling that there is an effort to keep the price low, okay, because most managements want to get their price up because they own a lot of stock themselves, so it's self-serving, and that's the whole reason to be listed. You want to grow, okay, because a higher stock price gives you a lot. It grows your own wealth and your shareholders', but also gives you some currency at some point. Just think if your stock was $10. You could deleverage by doing an equity financing, okay? But you can't do it at $2.

So, I'll just say this that Morgan Stanley has $100 million invested in your firm. And Morgan Stanley's business model is to make money, okay? That's it. And they're frankly good at it, all right? So, they're sitting on a 65% loss on this thing. And they're shareholders in their private equity Asia fund. If I was in it, I'd be questioning what are they doing about this, all right? Because I want my money back. It's been well over – that fund frankly had to be extended because of this and a few other investments in it. So, I know, with a great deal of certainty, Morgan Stanley has to get something done, all right? They're under pressure to do so. And their goal is to take it private at some point at the lowest price, I guess, even though it's a conflict. And then, they could either go public again in China – it's been done many times with these smaller companies – or merge. There's any number of things where they could do very well on this. But in the meantime, they're not working hard to do it. So, I'm going to put them on notice that they're creating some animosity out there and some distrust. And I've mentioned on a conference call in the past. I've worked there for half my career. And there's good people there and it's a good firm.

So, with that being said, okay, I just have to get that out because I like to get that out on the record, all right. This is just – it's been very frustrating, okay? And the stock price has no bearing to the true value of your company. Now that you have six banks that literally could fund any privatization at several times your current price just to get rid of us, okay – you don't have to deal with us on this phone call. Since there's only about 12.5 million shares outstanding roughly, that's about a quarter of your current float once Morgan converts its 66 million shares. But that's three times the current price. So, I just feel that it's time to move on because everybody wants to benefit. I'm sure Mr. Han would love to be worth five or six or seven times his current valuation here. The bragging rights of having a US listing probably have some value over in the PRC. But I'm sure having a $2 stock is almost embarrassing, it sounds. It would be for me.

So, listen, next year looks good. Again, you guys have done a good job in a difficult environment, it seems. The numbers speak for themselves. And now that you've got the bank loans, I applaud you for getting those because these are real big banks. And I look forward a very nice year going forward. I've been a holder for so long that I'm not – I'm going to be with you and I'm going to see this thing through because I know for a fact that Morgan Stanley needs to get the money out and they can only go through me and other shareholders. That's it. They've done it before. I was involved in another public company that they lowballed on a price. That was a number of years ago. I won't name it, but people can look it up. And the same type of thing occurred. So, I just want to be on record to say that, that I'm on your team because I'm a shareholder. I've never sold any shares, all right? I've bought a lot down here because I'm either stubborn or I believe in the long term of your company. So, I implore you guys to try and get this thing done.

If it's not the privatization, you could buy back shares. There's any number of things that can get the stock price higher. You have to give confidence to the shareholders here in the US. Larger institutions don't buy companies that have such a small market cap. So, you're really relying on a handful of institutional accounts and the rest are sophisticated retail investors. So, if you can just treat them fairly and try and grow their wealth and your own at the same time, it would be really, really nice and very typical.

So, thanks for your time and thanks, Mr. Han, for his answer.

Taylor Zhang

Thank you, Matthew. And we appreciate your points. We will take them very seriously. As for the disclosure matter, I think I have one thing to add is, in general, the company always follow advice from their legal counsels. So, they have advised us to [indiscernible]. But by and large, as Chairman Han mentioned before, once there is definitive binding agreements in place, we will announce and disclose in a timely fashion. And your point of the political is probably true, but running a public company may be a little different, but your point is very valid and we appreciate it.

Operator

Thank you. That's all the time we have for questions today. I'll now turn the call back to today's presenters for the closing remarks. Please continue.

Unidentified Company Representative

On behalf of China XD Plastics, we want to thank you for your interest and participation in this call. If you would like to speak with us further, please call either myself or Taylor. The contact numbers for all of us are listed at the end of the press release. Thank you.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.

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