Anna Bin - Investor Relations Jie Han - Chairman, Chief Executive Officer and President Zhang Dahe - Chief Financial Officer, Secretary and Director

Glenn Krevlin - GHC Capital

Thank you all for joining us for the China XD Plastics Second Quarter 2017 Financial Results Conference Call. Joining me on the call today are Mr.

Jie Han, Chairman and the Chief Executive Officer; Mr. Qingwei Ma, Chief Operating Officer; Mr.

Taylor Zhang, Chief Financial Officer; Mr. Junjie Ma, Chief Technology Officer; Dr.

Kenan Gong, General Manager of the Dubai Subsidiary; and Mr. Rujun Dai, General Manager of the Heilongjiang Subsidiary.

Earlier today, China XD Plastics issued a press release announcing the second quarter 2017 results. Before management's presentation, I would like to refer to the safe harbor statements in connection with today's conference call and to remind our listeners that the 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 contained are forward-looking statements, including, but not limited to: the company's growth potential in international markets; the effectiveness and 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 the financial condition; the company's projections of performance in 2017. And other risks detailed in the company's filings with the Securities and Exchange Commission are 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 the 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 I will 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, August 9, 2017.

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 U.S.

GAAP, management will make reference to earnings before interest expenses, 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 the Chief Executive Officer, Mr.

Han. Mr.

Han will be speaking in Chinese and I will translate his opening remarks in English. Mr.

Han, please go ahead.

[Foreign language]

We were able to generate a significant top line growth in the second quarter of 2017 as compared to the same period last year as the generally positive macroeconomic conditions in our sector continued from last year. As reported by the China Association of Automobile Manufacturers, for the first six months of 2017, auto production increased 4.6% relative to the same period last year, and we believe that our cutting edge technologies, expanded production capabilities, new geographical positioning and the major new projects will be able to capitalize on this trend.

[Foreign language]

Our strategic initiative to expand our operations into new growth geographies continued to see significant revenue contributions from the South China and the Central China regions in the second quarter, largely contributable due to the continued ramp of our new state-of-the-art Sichuan manufacturing facility. Our Sichuan facility now has 50 production lines with 216,000 metric tons of annual production capacity.

[Foreign language]

We are very pleased with the recent official signing of investment agreements with the Management Committee of Harbin Economic - Technological Development Zone with respect to the industrial project for 300,000 metric tons of biological composite materials, the industrial project for upgrading existing equipment for 100,000 metric tons of engineering plastics and the industrial project for a 3D printing intelligent manufacture demonstration factory and a 3D printing display and experience cloud factory. This follows the signing of a definitive agreement with the People's Government of Shunqing District, Nanchong City of Sichuan Province for the production of 300,000 metric tons of bio-composite materials and the additive manufacturing and the 20,000 metric tons of functional masterbatch.

[Foreign Language]

Our new facility in Dubai also extends our specialized high-tech products into an important overseas market. We plan to complete the installation of 45 production lines with 12,000 metric tons of annual production capacity by the first quarter of 2018, and to complete the installation of an additional 50 production lines with 13,000 metric tons of annual production capacity by the second quarter of 2018.

This will bring the total annual production capacity in our Dubai facility to 25,000 metric tons. The Dubai facility will target high-end products for overseas markets and will, ultimately, enable more active inroads into the markets of Europe, the Middle East, Russia and other overseas markets.

[Foreign Language]

We believe our substantial production increase and geographical expansion via our Sichuan facility solidifies our core automobile sector business. Further, our new investment agreements to undertake major expansion projects will lead to a wider range of product capabilities and a further diversified customer base.

In our view, this represents a further evolution of the company into a multifaceted chemical engineering company that augments our existing capabilities and enables us to engage numerous new verticals. We believe that these strategic initiatives form a platform for sustainable growth for the next several years and well positions us for opportunities presented by China's new economy.

We are excited by this period of dynamic growth and this next evolution of the company. With that, I will now turn the call over to Taylor Zhang, our Chief Financial Officer, to walk you through our financials.

Thank you, Mr. Han, and thank you everyone for joining the call today.

Before we review the numbers, let me remind you that all figures that are discussed are for this reporting period, the second quarter of 2017, unless as stated otherwise. Additionally, any year-over-year comparison is to the second quarter of 2016 and any sequential comparison is to the first quarter of 2017.

So let's go to our second quarter results. Revenues were $313.6 million for the second quarter of 2017 compared to $277.1 million for the same period of 2016, representing an increase of $36.5 million, or 13.2%.

The year-over-year increase was primarily due to a 17% increase in sales volume and 1.8% increase in average RMB selling price of our products. The increase in revenues in the second quarter of 2017 was driven by growth in demand for our products in the domestic China market, our efforts to expand our customer base attributable to our new plants in Sichuan and our efforts to increase overseas sales.

We achieved sales increases of 166.2% in Central China, 76.7% in Southwest China, 49% in South China, and 22.1% in North China, 7.7% in East China and 5.1% in Northeast China as compared to the same period of last year. Overseas sales resumed in the second quarter of 2017 and were $33 million in the period compared to $35.7 million in the same period last year, representing a decrease of $2.7 million or 7.6%.

The overseas customer has an outstanding balance of $65.1 million, of which a balance of $31.9 million was overdue as of June 30, 2017. The overseas customer has made payments of $42.5 million in the first half of this year, and we expect to collect the outstanding balance in the third quarter of 2017.

Premium products, namely Polyamide 66, Polyamide 6, Plastic Alloy, PLA, POM and PPO, in total accounted for 81.4% of revenues in the second quarter of 2017 compared to 80.8% for the same period of last year. The company continued to shift its product mix from traditional polymer materials to higher-end products, thanks to: better end customer recognition of higher-end cars made by automotive manufacturers from Chinese and Germany joint ventures, and U.S.

and Japanese joint ventures; and secondly, the stronger demand for higher-end products as a result of Chinese government's promotion of clean energy vehicles; and third, the greater growth potential of advanced modified plastics in luxury models in China, where manufacturers tend to use more and higher-end modified plastics in quantity per vehicle in China. Gross profit was $63.1 million for the second quarter of 2017 compared to $60.3 million for the same period of 2016, representing an increase of $2.8 million or 4.6%.

Gross margin was 20.1% for the second quarter of 2017 compared to 21.8% for the same period last year, primarily due to the lower gross margin of higher-end products sold in the domestic markets in the current periods as compared to the same period last year. G&A expenses were $8.8 million for the second quarter of 2017 compared to $6.6 million for the same period last year, representing an increase of $2.2 million or 33.3%.

This increase was primarily due to: the increase in salary and welfare expenses resulting from increase in number of management and general staff from our supporting departments and average salary and bonuses; and the increase of professional fee; and the increase of depreciation and amortization, the increase of taxation and the increase of rental fee. R&D expenses were $9.5 million for the second quarter of 2017 compared to $5.9 million for the same period of 2016, representing an increase of $3.6 million or 61%.

This increase was primarily due to: first, elevated R&D activities to meet higher quality requirements of potential customers from Europe; and second, increased R&D efforts directed towards application in new electrical equipments, alternative energy applications, power devices, aviation equipments and ocean engineering, in addition to other new products primarily for advanced industrialized applications in automobile sector and in new vehicles, verticals such as ships, airplanes, high-speed rail, 3D printing material, biodegradable plastics and medical devices; and third, an increase in depreciation expenses after R&D equipments were put into use at our Sichuan company. As of the end of second quarter this year, the number of ongoing R&D projects was 286.

Operating income was $44 million for the second quarter of 2017, compared to $47.4 million for the same period 2016, representing a decrease of $3.4 million or 7.2%. This decrease was primarily due to higher G&A expenses and higher R&D expenses, as we mentioned.

Net interest expense was $11 million for the second quarter of 2017 compared to net interest expense of $9 million for the same period last year, representing an increase of $2 million or 22.2 Income tax expense was $4.1 million for the second quarter of 2017, representing an effective income tax rate of 12.8% compared to income tax expense of $5.3 million in the same period of 2016. Net income was $28.1 million for the second quarter of 2017 compared to $33.3 million for the same period of last year, representing a decrease of $5.2 million or 15.6%.

Basic and diluted earnings per share in the current quarter was $0.43 compared to $0.51 per basic and diluted share for the same period last year. The average number of shares used in computation of basic and diluted earnings per share current quarter was 49.5 million compared to 49.4 million shares for the basic and diluted earnings per share in the prior year period.

Earnings before interest, tax, depreciation and amortization was $54.7 million for the second quarter of 2017 compared to $56.4 million for the same period last year, representing a decrease of $1.7 million or 3%. 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 today.

Now let's turn to the balance sheet. As of June 30, 2017, the company had $559.6 million in cash and cash equivalents, restricted cash and time deposits, an increase of $103.2 million or 22.6% as compared to $456.4 million as of December 31, 2016.

As of the current period, working capital was $185.7 million and the current ratio was 1.2, equivalent to the current ratio of 1.2 as of December 31, 2016. Stockholders' equity as of June 30, 2017 was $690.2 million, an increase of $55.9 million or 8.8% as compared to $634.3 million as of December 31, 2016.

Inventories increased by $82.3 million or 29.3% to $363.2 million as of the second quarter of 2017 as compared to the fiscal year-end 2016, as a result of more purchases of raw materials and the company's strategy to stock up on finished goods for upcoming orders. The aggregate short-term and long-term bank loans increased by $143.5 million or 20.7% due to the utilization of existing lines of credit to support expansion of Sichuan and Dubai facilities.

We define manageable debt levels as the sum of aggregate short-term and long-term loans over total assets. We expect that we'll be able to meet our needs to fund operation, capital expenditures and other commitments in the next 12 months primarily with our cash and cash equivalents, operating cash inflows and bank borrowings.

In terms of recent events, on July 21, 2017, the company issued a press release announcing the official signing of investment agreements between its subsidiary, Heilongjiang Xinda Enterprise Group Company Limited and the management committee of Harbin Economic - Technological Development Zone with respect to projects for 300,000 metric tons of biological composite materials, upgrading existing equipments for 100,000 metric tons of engineering plastics and for a 3D printing intelligent manufacture demonstration factory and a 3D printing display experience cloud factory. These projects will help us expand our product mix into bio-based composites, 3D printing materials and functional master batch materials while maintaining our traditional petroleum-based materials, paving our entry into non-auto applications and further diversifying our business as a key elements of our strategic plan.

The total capital expenditures for the company will be estimated at $592.7 million. On June 5, 2017, the company announced the Special Committee of its Board of Directors has retained Duff & Phelps LLC and Duff & Phelps Securities LLC as the Special Committee's independent financial advisor, Davis Polk & Wardwell LLP as U.S.

legal counsel and Brownstein Hayyat Farber Schreck, LLP as Nevada counsel in connection with its review and evaluation of the preliminary nonbinding proposal letter dated February 16, 2017 from its Chairman and CEO, Mr. Jie Han, XD Engineering Plastics Company Limited, a company wholly owned by Mr.

Han, and MSPEA Modified Plastics Holding Limited, an affiliate of Morgan Stanley Private Equity Asia III, to acquire all the company's outstanding common stock in a going-private transaction for $5.21 per share. The proposal letter states that the buyer will not move forward with the proposal transaction unless it is approved by the Special Committee, and the proposed transaction will be subject to approval by the majority shareholder vote of shareholder other than buyer who owns approximately 74% of company-issued and outstanding shares.

Now moving to our financial guidance and outlook for 2017. The company reiterates its financial guidance for fiscal 2017 with revenue to range between $1.2 billion to $1.3 billion, and net income to range between $85 million to $100 million.

This is based on the anticipation of continued recovery throughout the Chinese automotive supply chain and stabilization of crude oil pricing, and impacts on polymer composite materials in 2017. This forecast also assumes additional contribution from our Sichuan facility and the overseas sales will be resumed for the remainder of the year.

It also assumes the average exchange rate of U.S. dollar to RMB at 6.8 and the company will incur interest expenses for long-term loans and short-term loans.

This financial guidance reflects the company's preliminary view of this business outlook for the fiscal of 2017 and is subject to revision based on changing market conditions at any time. Before we open the call to your questions, I'd like to note that for any question directed to the management in China, I will translate both the questions and the answers.

If you want to ask a question in Chinese, please also ask it in English. So for the benefit of our other listeners, we also note that we'll only be able to respond to questions about financial and operating results.

For other matters, including the going-private offer, we refer you to our already-issued press releases. We'll not be able to respond to your question that are directed to the principal of the going-private offer about the proposed transaction.

With that, we'll now open the call to your question. Operator?

Taylor, I was wondering if you could give us some sense of what total capital spending will be this year. And maybe give us a sense, you've got so many expansions and new projects, just give us some sense of how capacity is going to come online over the next 2 years by the different projects that you've spoken to on this call?

Okay. Glenn, thank you for the question.

I will answer your question about the CapEx for the year and also -- then I'll give further question to my team in China about the capacity on its schedule. Is that okay?

So the CapEx for this year, basically, split between Dubai and our Sichuan company. For Dubai, we budgeted approximately $95 million and for our Sichuan sub, that's for the new project, we anticipate approximately $375 million.

Now I'll translate your -- second part of your question. [Foreign Language]

[Foreign Language]

Glenn, Jie Han just provided a detailed breakdown of capacity on our schedule. So for the biodegradable projects, we have one each in Sichuan and Harbin.

Each is 300k. So we anticipate the production will start early 2019.

The 1/3 of the capacity will be online and sequentially, in 2020 and 2021, 1/3 in each year will contribute to the capacity. And secondly, for our 3D printing projects, we -- because of the it's more sophisticated and it take a little time to develop and build infrastructure, we anticipate that we'll come online in the second half of 2018, little later compared to the biodegradable projects.

So similar capacity on its schedule, we are anticipating 1/3 will be in 2019 and 1/3 in 2020 and the remaining in 2021. For the masterbatch projects, we expect we'll come online in the second half of 2019.

And the last one is the 1,000k engineering plastic [Indiscernible] facility. We expect that will come online, will be completed in the third quarter of 2018.

[Technical Difficulty]

Everybody seems to be dropping on these calls. I'm going to take three pieces.

Glenn was asking about the investment in Heilongjiang. If -- what kind of volume and margins can you -- do you expect to generate from that project, say, 2020?

So Peter, so my answer to -- our Chairman's answer to Glenn about capacity is -- you agree on that, right?

Yes.

You are referring to the production volume we anticipate for 2020.

No, I'm just saying -- here's what I'm trying to understand. The -- if I take, how much -- if I can figure out what you're doing in your current business in Heilongjiang and Sichuan, I'm trying to understand what these two new projects mean, plus Dubai.

I mean, as I look at things -- I mean, as I look at where the company is and I start to add up all these things you're doing, I'm looking at $5 billion in revenues and $10 a share in earnings. And I'm trying to understand what the pieces are.

Peter, can I rephrase your question in this way? Basically, you want to get a picture of the -- put it in volume, maybe I can, because we have provided you with the anticipated capacity we think we're going to have.

So maybe we can get you some information such as the production utilization we expect and then the margin range expect. Is that fair?

Then, I mean, the same thing on the new project in Sichuan. And now Dubai, you spent a lot of money in Dubai.

It's very expensive production. So far you have just one difficult customer.

Can you talk about when you are still talking about adding more capacity, can you talk about what your plans are for Dubai?

Okay. Let me get the answer for the production volume and also margin first.

And then we will let our GM, Dr. Gong from Dubai, to give you more details on our plan on the Dubai facility.

All right?

Okay.

[Foreign language]

[Foreign language]

Peter, here's the answer from our Chairman Han because of our Dr. Gong is actually traveling on an airplane.

So Chairman Han will answer -- will give you an answer on the Dubai expansion plan. So regarding the production volumes, so basically we expect the -- both plants, Sichuan and Heilongjiang, will reach the normal production stage with the optimal production utilization in the time frame of 2 to 3 years.

So our normal utilization ratio is about 80%. In terms of margin -- so we have the breakdown by the different product category.

For biodegradable materials, we expect the margin will fall into the range of 22% to 30%. And for the 3D additive manufacturing or 3D printing materials, we expect the margin will be between 50% to 65%.

Obviously, this is not a volume business, but a very high -- very [height] business. And for our Dubai business, the products you focus is alloy plastics, similar to 3D printing.

It's a very small volume. But it's a very high value-added and high-margin products.

We expect in 2018 we'll be able to produce more locally. And so the total design capacity will be 25K and with margin approximately 40% to 45%.

And I will go back. And Chairman Han will give us some information about the market development plan.

[Foreign Language]

[Foreign Language]

Peter, for the marketing and strategy or plan with our Dubai plans, so since beginning, our foot has been in automotive components. Our vocation in that category was with [Indiscernible] dimensional stability, which is very important, and also some applications in electronics devices.

So we understand there has been some speed bumps with the 2 customers from South Korea. We're actively resolving the issue.

So in addition, we're not totally rely on any single customers. Our Dubai facility is built on a vision and plan to develop our markets in many other regions, such as Europe.

So some of recent developments with the same product we have developed in Dubai, we're working with a potential customer in Spain and Russia for application in oil driven applications. So far, the results seems very promising.

And we think the volume there can easily absorb the capacity of 25K we have. In addition, we also continuing progressing in the certification process with potential customer in France and in Germany.

We anticipate we will be able to obtain the certification in the second or third quarter of 2018. So by then, we believe we'll have 4 to 5 really high-quality and big customers by then.

Thanks. One last question.

For all of these projects, is it reasonable to assume that you're going to finance it somewhere in the local Chinese debt market?

The project will be financed, as we mentioned in the press release, because right now we have cash, cash equivalents and [Indiscernible] of over $5 million. So there's going be a combination of debt, that we're continuing cash flow and also some debt financings too.

I just wanted to continue my other question, Taylor. On the Dubai facility, do you expect any of that to come on line in this calendar year?

And the total investment in Dubai now is how much money? And then lastly, you mentioned the Sichuan project being $375 million.

That's all to be spent in 2017, although it doesn't come onstream until '19, '20, and '21? So I'm little confused by that $375 million spending for this year, if I understood it.

So Glenn, let me answer you on the Sichuan project first. So the $375 million is already budgeted for the year.

Obviously, there's always timing and with deploying capital into work. So that's our preliminary burden at this point.

And for Dubai, as the Chairman mentioned, we're going to have the capacity of about 25k on line in the second or third quarter of next year. So right now we have some capacity.

Around 3,000 are producing locally in Dubai. So that's pretty much the way we are seeing right now.

And the total investment in Dubai is what after the money being spent this year?

The total is -- after this year is going to be slightly north of $200 million.

But very little revenue from this year from the Dubai facility?

At this year, because Q1, we have the payment and also product quality issue. But Q2, we -- the sales resumed.

So we think basically we're going to see better comps in the second half.

And that's being produced in Dubai? Or that's being sold through Dubai, being produced in other places?

It's a combination. So for Dubai, right now it's only a couple -- less than 3,000 being produced from Dubai annually.

So the majority is still produced elsewhere on behalf of Dubai for Dubai's customer.

And then lastly, on the Sichuan plant. How much is currently being used out of the -- I think you built 300,000 potential capacity.

How much is being used now?

You're talking about the Phase I, the previous project, right?

Yes.

The previous one, we have the capacity currently in production is approximately 80,000. And early next year we're going to see more volume coming on line.

So you are not bringing any more capacity on line this year at that facility? The plan initially was to phase it over three years.

You're not adding this year?

I think we can add more capacity this year. But let me get the specific information, the number of production capacity we're going to have this year.

[Foreign language]

[Foreign language]

[Foreign language] Glenn, so for Sichuan plants, the production capacity in 2018, on an annualized basis, will be 215k.

Out of a total of 300 eventually?

Yes. Out of the total of the [indiscernible].

Yes, you did 80 last year, 215 this year, potentially go to 300 next year.

Yes.

On behalf of China XD Plastics, we want to thank you for your interest and patience in this call. If you would like to speak with us further, please call either myself or Taylor in XD's New York office or our investor relations firm.

The contact numbers for all of us are listed at the end of the press release. Thank you.