Origin Agritech Ltd (SEED) 2008 Q1 法說會逐字稿

Greetings, and welcome to the Origin Agritech first quarter fiscal year 2008 conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Dixon Chen with the Global Consulting Group. Thank you Mr. Chen, you may begin.

Thank you, operator. Good morning, everyone. Thank you for joining us today. On the call today are Dr. Geng Chen Han, Chairman, CEO of Origin Agritech, Mr. Liang Yuan, Co-CEO, Veronica Chen, Chief Financial Officer, Irving Kau, Vice President of Finance, and myself and my colleague, Eddie Cheung, Investor Relations Consultant from Global Consulting Group. I hope all of you have had the opportunity to review our first quarter fiscal year 2008 financial press release. Before we start, I would like to remind everyone that this conference call may contain forward-looking statements within the meaning of Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that are not historical facts. Such forward-looking statements based upon current beliefs and expectations of Origin's management are subject to risks and uncertainties which could cause actual results to differ from forward-looking statements. These risks are detailed in Origin's filings with Securities and Exchange Commission. The information set forth herein should be read in such light of risks. Origin assumes no obligation to update the information contained on this conference call.

Before we begin our financial review, we would like to highlight some recent company related events. Besides introducing the first genetically modified phytase corn back in February, we also announced in recent weeks the approval of six new corn hybrids for provincial level distribution, two new corn hybrids for national distribution as well as six rice hybrids for provincial distribution. Our accumulated germplasm will play an increasingly important role for us as we transform ourselves to become the leading domestic biotechnology company in China. We also have recently updated our GMO product pipeline. These traits that are in our pipeline are the same traits that have historically dominated the seed industry globally. Specifically, the herbicide resistant genes and the pest resistant genes have grown at over 50% compound average growth rate since being introduced showing the high value created for farmers. We retain exclusive rights to these traits and have the ability to stack them and expect to be the first company to commercialize in China. Furthermore, the fact that GMO approval process is restricted solely to Chinese domestic companies we are in a strategic standpoint that is second to none. I now turn the call to Eddie Cheung who will review Origin's first quarter fiscal year 2008 financial results. Eddie, you may begin.

During the first quarter of fiscal 2008 we generated revenues of RMB 26.36 million, or U.S. $3.61 million, an increase of 37.03% from RMB 19.24 million or U.S. $2.47 million generated in the three months ended December 2006. Canola seed sales accounted for majority of our sales during the first quarter. Scrap sales for the quarter amounted to about RMB 2.74 million or U.S. dollars $375,406 mainly deriving from the liquidation of seed products from our subsidiary, Jilin Changrong. These sales accounted for about 10.4% of our total revenue. Excluding the scrap sales, our gross margin for the period were 48.34%, 5.9% higher than our 42.5% gross margin achieved during the three months ended December 31, 2006. The scrap sales from Changrong were residual scrap sales from 2007. Based on our current expectations, we do not foresee any sizeable scrap sales in the upcoming quarter.

Total operating expense for the three months ended December, 2007, were RMB 47.01 million or U.S. $6.44 million compared with RMB 36.9 million or U.S. $4.7 million reported for the same period in 2006. Selling and marketing expenses of RMB 14.01 million or U.S. $1.92 million for the three months ended December, 2007, increased 17.4% from RMB 11.93 million or U.S.$1.53 million for the same quarter in 2006. General expense of RMB 23.38 million or U.S. $3.21 million for the first quarter and ended December, 2007 increased 12.5% from RMB 20.79 million or U.S. $2.66 million for the three months ended December 2006. Research and development expenses increased 129.85% to RMB 9.62 million or U.S. $1.32 million for the three months ended December 2007 from RMB 4.19 million or U.S. $540,000 for the like quarter in 2006. The increase in R&D expense was also mainly due to the inclusion of Changrong research and expenses RMB 5.53 million or U.S. dollar $757,800.

Operating loss for the three months ended December 2007 amounted to RMB 43.67 million or U.S. $5.99 million compared with loss of RMB 28.73 million or U.S. $3.68 million for the same period in 2006. Exclusive of our scrap sales from Jilin Changrong, our loss from operations was RMB 27.48 million or U.S. $3.77 million. Net loss for the three months ended December 31, 2007, was RMB 15.37 million or U.S. $2.11 million. RMB 67 cents or U.S. $0.09 per diluted share. As compared to a net loss of RMB 30.66 million or U.S. $3.93 million or RMB 1.31 or U.S. $0.17 cents per diluted share a year ago. For the same period a year ago. Exclusive of our scrap sales from Jilin Changrong, our net gain RMB 722,000, or U.S. $98,657. Our cash equivalent at the end of 2007 was RMB 118.53 million or U.S. $16.25 million with investments in U.S. government agency bonds amounting to RMB 131.27 million or U.S. $18 million. Working capital was RMB 241.4 million or U.S. $33.1 million, and shareholders equity of RMB 285.95 million or U.S. $39.2 million as of December 31, 2007.

Our deferred revenue was RMB 112.1 million, or U.S. $15.36 million for the three months ended December 31, 2007 compared to RMB 163.14 million or U.S. $20.9 million for the quarter -- for the same quarter in 2006. Total revenue represents the value of our crop seeds after evidence of a sales arrangement is confirmed. Delivery to the customer is made and full prepayment from the customer is received but before the final price volume discount is fixed and determined. It is expected that deferred revenue would be recorded on the income statement on the third quarter ended June 30, 2008. It is also expected due to industry seasonality we expect our deferred revenue collection to increase accordingly in the upcoming quarter. Advances from customers increased to RMB 179.71 million or U.S. $24.67 million for the three quarters ended December -- for the three months ended December 31, 2007, from RMB 103.61 million or U.S. $13.3 million for the three months ended December 31, 2006 while cash advances increased on a sequential basis to 97.53 million for the three months ended December, 2007.

Now turning to the outlook for 2008, based on the current outlook and existing and anticipating business conditions, we reiterate the revenue guidance for fiscal year 2008 in the range of U.S. $75 million to U.S. $80 million, and net income range of $0.5 million to U.S. $2 million for the fiscal year ended September 30, 2008. This net income figure is inclusive of roughly $2.7 million in expected non-cash interest expense from our convertible debt offering. Exclusive of this non-cash expense, we expect a net income range of U.S. $3 million to $4.5 million. Now I'll turn the call back to my colleague, Dixon for final comments.

Actually I'm going to take the final comments, this is Irving Kau, Vice President of Finance. But before I do that, I just wanted to make some comments. I'm personally very excited about the strategic position of the company. We have a proven business model, products with exact same characteristics that demonstrate accelerated growth throughout the world. And for that fact, we believe that they add tremendous value to the farmer. There's roughly 250 million makers of herbicide and pesticide resistant crops worldwide and really next to nothing in China. We have exclusive license to these products in China and protection from multinationals in that they cannot approve their products in China as a matter of policy. We have a large market occupying 200 million farmers feeding 1.3 billion people providing the second largest agriculture corn market in the world, and really, from a personal standpoint, you can't ask for a better scenario, and so I just wanted to add that in before we go into the final prepared remarks.

Our operating results for the first quarter 2008 essentially turned out as what we had expected. Our corporate growth strategy remains intact as we seek to expand our hybrid seed portfolio. We also look to build up our infrastructure and position ourselves as a leading domestic agriculture biotechnology company in China. We consistently believe that biotechnology will play an increasingly important role in China we are heavily engaged in developing GMO hybrids because we believe that China will eventually approve GMO hybrids for commercial cultivation as China is in a large shortage of corn. We are the only Chinese crop seed company with an in house biotech center and minority shareholding in the independent biotech research shop. We may take new relationships with numerous academic institutions and state run research programs that give us an opportunity to participate in various government sponsored research. We are extremely pleased by our success in this area thus far and are focused on research and development we believe will pay off short term. Our exclusive rights to five genetic traits in various stages of development fuels our confidence in this. The macro economic environment favors us and we are confident that once the GMO marketplace opens up in China, we will be one of the strongest domestic players to compete in that marketplace. At this point, I'll turn the call back over to Eddie.

At this time, we would like to begin our Q&A portion from the listening audience. Operator?

Thank you. (OPERATOR INSTRUCTIONS) One moment as we poll for questions. Our first question comes from the line of Albert Lee with Maxim Group. Please proceed with your question.

Hi, guys. I'm wondering, first question -- wondering why gross margin came in where it did at 12.5%, yet about 90% of your business -- of your revenue generated a nice 48% gross margin. Is this because you were selling these outdated seeds at huge losses?

That's exactly right. The decrease in the gross margin was mainly caused to the from scrap sales from Jilin Changrong, which was carry over from the year before. Our gross margin was actually 48.34% exclusive of those scrap sales. So actually, we did have a 5%- plus gross margin increase year-over-year if we provided appropriate apples-to-apples comparison.

This is primarily for canola seeds, right? And canola seeds carry higher gross margins than say, corn or rice and cotton, right?

That's right, they're in the --

What percent of your, or how much of your inventory, current inventory is considered scrap seeds today?

We don't anticipate any significant, any sizeable amount of scrap seeds in the future.

I think you've kind of cleaned that away, put that aside and are dealing with updated product?

That is correct, and that's why we scrapped it.

Okay. Moving on, in your '08 guidance, what gross margin level do you think is reasonable and where are you guys kind of -- what are you guys kind of assuming in your numbers, generally speaking, would you say north of 35% is fair? That's the first question.

We are actually in our budgeting forecast. We are expecting roughly around 32% to 33% gross margin. And that may be somewhat conservative as we are seeing the ASP price increases across the board. We are seeing roughly 10% -- 10.8% in corn, 10% in cotton, about roughly another 4% in rice and canola. So we are getting good feedback from the marketplace on the ASP front. So, the -- as far as the gross margin, we've been somewhat conservative in the forecasting that.

So based on your current OPEX plans, in the context what your guidance is right now, are you assuming that the company -- that the company would generate positive EBITDA? Or operating income in the fiscal year and for '08?

The we only provide the guidance for the bottom line. We don't provide the guidance for the EBITDA.

Okay. But I mean, on an operating level, do you guys think you'll be profitable in '08? Is that kind of where your mindset is?

Yes, that's where our mind set, that's what we guided to and --

You've got a, like one time gains, you've got minority interest and you've got miscellaneous one time gains below the operating line.

That's right.

I was curious if, on an operating level, you think that will come in positively based on your --

I could speak to that using another metric. On an operating cash flow basis, we are expecting it to be around 41 million to 75 million in operating cash flow for 2008. And so, that's probably a better metric to speak to exactly how much we are bringing in as a company.

What was that operating cash flow figure you threw out?

41 million RMB to 75 million RMB is our range.

Operating cash flow, right?

That's right.

Okay. And the, moving on to the balance sheet, on the advances from the customers which saw a nice year-over-year increase, can you break down roughly what percent of this growth was attributable to, say, volume, was volume driven year-over-year versus improved pricing and actually, where does the ASP issue currently stand today and do you think the worse of the inventory dumping is pretty much over at this point?

Just let me step back and sort of review to everyone on the call what advances from customers is. Advances from customers is actually, when we (inaudible) the cash payment beforehand, before the actual shipment is made and received by the customer. Once it is made and received by the customer with very little chance of return, then it becomes deferred revenue on our books. So having said that, a lot of the advance from customers we've received, as you can see, the number has doubled almost, and we are happy with that, but a lot of that is unallocated in the sense that we understand that these people are buying corn but the prices we are seeing are roughly, as I mentioned before, corn is higher 10.8%, cotton is higher 10%, and rice is 3.9%, canola is 3.8% higher. And that's --

That's pricing, right?

That's the pricing. That's the pricing. (inaudible) product line, that's what we've seen. We are seeing increases, if you take the average of that, that's roughly -- we are getting roughly about 7% or so increase in price alone. That you can see from the deferred revenue number, if you just take a pure deferred revenue number, the volume is lower because of the 20, 20.9 versus the 14 plus. So that volume number is lower, so far. But we expect some of that to be made up in the next quarter.

So if I'm thinking about this correctly, the deferred revenue that's on your books as of December 31 was at some point during that quarter booked as customer advances, which meant that the initial orders are considerably higher year-over-year, right? And those are advances that were made to the company, seed was delivered on that particular amount to those customers and hence, it's booked as deferred, right?

That is correct, absolutely.

So which is up more than double year-over-year, so isn't that a pretty good indication of how your customers are currently reacting here in the early going, as far as what -- I mean, I'm saying that this is a pretty good sign that the initial orders are up more than double.

We would definitely agree with you. We would definitely agree with you and couple that with the advancement in ASPs, we believe it's going to be a better year. And again, but however, this is not going to be our best year. 2009 is going to be even better. So we are expecting some improvement from 2007, but we are going to continue improving. So --

Okay.

-- from where we're at now.

Scrap sales we only expect minimal in fiscal year 2008. So the worst year is over, which is 2007.

Okay, so you've already written down a good chunk to that, right, of the bad inventory and you took some scrap sale losses here and then you're saying it's pretty much the end of that, right?

It's not -- it's going to be minimal for the rest of the year.

Okay. Lastly then, lastly, on the five phase process for the GMO, just to be clear, just because you have a seed that is approved along this five phase process, it doesn't necessary mean that this product -- that this particular GMO seed is officially commercializable, right, into the marketplace? There still needs to be another approval process that opens that window of opportunity to commercialize the product itself, am I correct there? Or, if the products are approved to the five phase cycle or process, then they are automatically marketable. Is there a two pronged step here as far as what the government has to approve and what they don't have to approve?

We will probably -- Dr. Han would probably be best to address this issue.

Hello, Albert, can you hear me?

Yes.

(inaudible) approval procedure it can produce it small scale as a hybrid (inaudible) approval. product might not need priority approval, is that clear?

I missed the last part, the very last part that you mentioned.

Yes, (inaudible) if we market special products we will not need additional approval.

Okay. For commercialization, that means, okay. So, okay. Is that the way it will kind of work going forward? I mean how do you -- who determines whether or not this is a special product or that doesn't need that additional approval, how do you --?

We have some informal communication with the administrators.

Okay. I see. Great. Thank you.

Our next question comes from the line of [Bill Mascovitz] with the [Harless Funds]. Please proceed with your question.

Yes, good morning. Your R&D increased substantially during the quarter. Can you give us some guidance in terms of what it might be for the year in terms of a percentage of sales or dollar range.

Initially, we guided towards somewhere around 3% to 5% of revenues. And given the preemminence of GMO in the near future, we believe that it could range all the way up to 7% range. So, last year it was in a 5.7% range and that was mainly due to a little bit of shortfall in the revenue, on the revenue basis. But 5% to 7% is a good range.

5% to 7% in 2008?

Yes.

Okay. I was a little bit confused. So in terms of phytase, you will be commercial, when do you expect to commercially be selling this product?

2009 is what we are expecting, 2009, so.

Okay. Alright. Well, I compliment you for doing the call and the quicker you can report ensuing quarters would be appreciated by your public shareholders. Thank you.

Thank you very much, Bill.

Our next question comes from the line of Alex Harbin with Toll Cross Securities. Please proceed with your question.

Hi, guys. I just wanted to -- maybe a bit of clarification on potential time lines for, say, the non-phytase seeds, the ones that you've got in phase II, like the herbicide resistance, the pest resistance and then the stacked ones. Obviously you are trying to get them into phase III for mid 2008. What's the kind of time line to see potential commercialization of those?

Probably best for Dr. Han to handle this one again.

Okay. For the herbicide on the feed (inaudible) normally it's one year can take the (inaudible). So we put the -- I mean there's three and four than can (inaudible). So, the best scenario for us is 2011or 2012 to be commercialized.

Okay, so that's for all the guys that are in phase II, then.

Phase II, yes. Phase II and phase III, yes.

Okay. Alright. That's my only question. Thanks.

Our next question come from the line of Kevin Bird with Raymond James and Associates. Please proceed with your question.

Yes, I wanted to ask what, if anything, you guys are doing to try to get more institutional ownership within the stock? And secondly, it appears to me like you should have a pretty good interest in multinationals coming in for some type of joint alliance or partnerships. Obviously, you can't speak to future events, but just curious on those two fronts if there's been any work done in those two areas.

From a strategic standpoint yes, Dr. Hahn would probably love to handle this question.

At this point we just can't make any comments.

As far as getting more institutional --

We can't give any details in terms of global level of lines, partnership for too many reasons. I hope you understand.

Thank you.

Our next question comes from the line of Bill Mascovitz of the Harless Funds. Please proceed with your question.

Yes, just a follow up on this phytase. So, you indicated this is a $200 million market in China potential and 500 worldwide. Several years down the road, what are you shooting for in terms of market share domestically, and will this product have the capability of being sold abroad into the international markets?

Again, this is a question probably best suited for Dr. Han.

Okay, for this, we mainly focus on the domestic market in China. Since the GMO product (inaudible) like Europe and the U.S., we might need other, another approval procedure from U.S. regulations. So we are having a look at that details at the moment.

Basically we are looking at the domestic market alone. It's already very attractive for us as China is the second largest corn market in the world, we have a major shortage of corn. So at the moment, we are mostly focusing on domestic market. In terms of international market, that's going to be extra approval procedures if we go into Europe or U.S.

Okay. And what is the potential down the road looking ahead two, three years in terms of where you think market share of this $200 million opportunity domestically might be?

We will market aggressively but (inaudible) is a new product before the, all the phytase is produced by the microbiology. (inaudible) GMO is the first product to market. So we do have a record number (inaudible) we should replace all this with GMO corn, (inaudible) corn turned out obviously microbiology production. Since this is produce corn we decide if others they need to produce the corn and then also you would need to produce (inaudible). Definitely we have a lot of advantage in phytase corn.

Just to step back, phytase is an additive for the farmers, hog farmers when they feed the protein mostly the corn to the pigs. And many farmers right now who now are buying corn and phytase separately. The feature we are providing is almost like a bundled product. In many ways we are the only game in town. And it's very efficient. It will help farmers to reduce some of the cost.

Okay. Thank you.

Gentlemen, there are no questions in the queue at this time. I would like to turn the conference call back to you for closing comments.

I just would like to thank everyone for participating. We are very excited about the future. Again, we believe you can't draw up a more favorable scenario. We have a proven business model adding tremendous value to the farmer in a market that is wide open for the taking right now. We have the exclusive license in IP and the protection from multinationals. And so, we are very excited about our future. We are hope you are the same. Please keep in touch, and thank you for participating.

Thank you.

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