Origin Agritech Ltd (SEED) 2008 Q3 法說會逐字稿

Good evening and welcome to the Origin Agritech third-quarter fiscal year 2008 conference call. At this time all participants are in a listen-only mode. The question and answer session with follow the formal presentation. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded.

Please stand by.

Ladies and gentlemen, introducing your host for today, Mr. Eddie Cheung of Grayling Global. Please go ahead.

Hello, everyone, and thank you for joining us today. On the call today are Dr. Geng Chen Han, Chairman and CEO of Origin Agritech; Mr. Liang Yuan, co-CEO of Origin Agritech; Mr. Irving Kau, Vice President of Finance, also from Origin Agritech.

I hope all of you have had the opportunity to review our third-quarter fiscal year 2008 financial press release. Before we get started, I would like to remind everyone that this conference call may contain forward-looking state forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that are not of historical facts. Such forward-looking statement based upon the current beliefs and expectations of Origin management are subject to risks and uncertainties which could cause actual results to differ from the forward-looking statements. These risks are detailed in Origin's filings with the SEC. The information set forth herein should be read in light of such risks. Origin assumes no obligation to update the information contained in this press release or filings.

At this point I would like to turn the call over to Irving Kau, who will review Origin's financial for the third quarter. Irving?

I hope you have all read the press release, and I'll just go right into it.

During the third quarter for fiscal 2008, we generated revenues of RMB490 million, increasing 7.73% from revenue of or under RMB455 million for the three months ended June 30, 2007. This was mainly due to a 6.2% increase in the average [sale] price of our products across all seed types. Volume also has increased 2.2%.

Corn revenues increased 7.75% year over year to RMB336.04 million from RMB339.72 million. The segment accounted for 75% of total sales. This was mainly due to a 10.25% increase in the average sales price (technical difficulty) across corn seed types.

Gross margins for the third quarter improved to 29.36% as compared to 23.91% achieved during the third quarter of 2007, caused by an increase in the average selling price. Total operating expenses for the three months ended June 30, 2008 were RMB45.71 million, a decrease of 7.79% from RMB49.58 million in the same period of the prior year. The decrease was mainly due to our effective internal control over daily operating costs and expenses.

Selling and marketing expenses were RMB16.82 million for the third quarter of 2008, representing a decrease of 7.95% from RMB18.27 million for the same period of last year, which was mainly due to a decrease in advertising expenses.

The marketing focus this year consisted mainly of more effective and cost-efficient field demonstrations, eliminating the spending on advertising and other media expenditures. General and administrative expenses of RMB19.06 million for the third quarter ended June 30, 2008 increased 4.29% from RMB19.92 million for the three months ended June 30, 2007, due to effective control over daily operating expenses again, which should continue to take further effect over the next three quarters.

Research and development expenses during the quarter were RMB9.83 million as compared to RMB11.39 million for the three months ended June 30, 2007. R&D expenditure decreased slightly this quarter, but has increased for the nine-month period as a result of the increased buildout of our in-house biotechnology center [at] Beijing headquarters. We expect to continue building out our research capabilities in an efficient, cost-effective manner.

Income from operations for the third quarter of 2008 amounted to RMB98.38 million, compared with an operating income of RMB59.35 million in the same period in 2007, reflecting a 66.7% increase year over year. Interest expenses for the third quarter of 2008 were RMB10.31 million, representing an increase of 145.29% from RMB4.2 million for the three months ended June 30, 2007, which was primarily attributable to the inclusion of interest expenses on the convertible debt of RMB5.51 million in the third quarter of 2008.

Net income for the third quarter of 2008 rose by 62.98% to RMB60.12 million as compared to the net income of RMB36.89 million in the same period a year ago. Earnings per share on a fully diluted basis were RMB2.62 as compared to RMB1.50 per diluted share in the same period one year ago, reflecting a 74.67% year-over-year increase.

As of June 30, 2008, our balance sheet included cash and cash equivalents of RMB334.66 million versus RMB162.31 million at September 30, 2007. Investments in US government agency bonds during the quarter amounted to RMB12.57 million versus RMB133.97 million on September 30, 2007. We have net working capital of RMB285.96 million as compared to RMB294.98 million for September 30, 2007.

Total shareholders equity increased to RMB332.38 million when compared RMB296.92 million RMB296.92 million for September 30, 2007.

During the quarter we entered into a Notes Repurchase Agreement with Citadel Equity Fund. We repurchased from Citadel a portion of the outstanding 1% Guaranteed Senior Security Convertible Notes due 2012. The Notes Repurchase provides us with an opportunity to increase shareholder equity value while providing flexibility to our operations as well as funding our GMO development through internally generated resources.

Just to give you a brief update on our GMO pipeline, during the quarter we submitted to the Ministry of Agriculture a final application and all related documentations regarding the Phytase corn product. We're hopeful of a final decision to be rendered before the end of the year. Upon approval, the product would be able to be sold into the Chinese marketplace. This would mark the first GMO corn product approved for commercialization in China.

At this point, I want to spend a few minutes discussing guidance for fiscal year 2008. We expect total revenues for the year ending September 30, 2008 will approximate US$75 million to US$80 million. Net income for the year ending September 30, 2008 will approximate US$500,000 to US$2 million. The net income figure is inclusive of roughly US$2.65 million in expected non-cash expense from our convertible debt offering. Exclusive of this non-cash expense, we expect a net income range of US$3.0 million to US$4.5 million. We plan to release guidance for 2009 by fiscal year '08 year end.

As we move beyond our transition year in 2007, our average prices exclusive of scrap sales had rebounded and increased year over year by approximately 6.2%. Volume has also increased 2.2%. In addition to better market conditions, we continued to streamline our marketing efforts. Lowering sales and marketing expense was due to our efforts to focus on more effective on-site demonstration lots for our customer base, yielding higher average price and volumes. We intend to increase in our efforts in this, doubling our demonstration lots from 5000 in fiscal year 2008 to over 10,000 in fiscal year 2009.

Thank you for listening to our prepared remarks. At this time we would like to turn the Q&A portion over to the listening audience. Thank you.

(OPERATOR INSTRUCTIONS) Albert Lee, The Maxim Group.

Curious as to whether or not there were any scrap sales that were recognized during the period, and, if so, what percent of sales and what would gross margin have approximately been?

The scrap sales in the quarter amounted to 3.98% of total sales. The gross margin exclusive of sales -- most all the scrap sales was impaired last year. There's just residual leftover. We just regained some revenue as a result of it.

The gross margin exclusive of the sales would have been 30.59%, so it really didn't have any big effect at all.

You said 30.59%?

30.59%, that's right.

Okay, so of the 50-some-odd million in inventory -- that's fresh inventory? There's no obsolete product there?

That is correct.

Okay, great. With respect to the US$19 million in customer advances, which I take as a good sign, can you help us understand what the makeup of this is, in terms of what's likely to be booked in the September '08 period, and roughly what percent is likely to be carried over to next year?

Our traditional revenue to be booked in the September '09 period is somewhere between USD$3 million to USD$5 million of that, advances from customers. All the rest will be carried over into the '09 period.

Okay, because I don't recall that figure being a high last year. Maybe I'll just double-check that, but okay. Roughly USD$3 million to USD$5 million of that will be recognized in the September period. Do you have an approximate pro forma net income figure for the third quarter?

Pro forma net income figure for the third quarter?

Right.

You mean, as far as without interest expense? Is that what you are referring to?

No, without the -- the exclusion of non-cash-related charges, from the convertible debt.

The convertible debt would have been roughly [750] -- well, actually, it would be about 200,000 for the quarter. You would just add back that amount into the net income [that you get].

Just another housekeeping item here. Can you remind us of what the nine-month revenue and net income totaled?

Sure. The nine-month revenue -- I believe we are at 74 million currently, and we are --

Roughly, just --?

Right, that's the current. And we are at [$0.11] EPS.

For the nine-month period?

For the nine-month period.

How much stock was repurchased during the period?

There was no stock repurchased during the period.

There was none?

Yes.

(OPERATOR INSTRUCTIONS) Peter Butler, Glen Hill Investment Research.

Following up on the last question, don't you guys believe that the seed stock price is kind of depressed here, and why no share repurchases? It sounds like what you know about the Company is a lot brighter -- [seems] a lot brighter future than what these shorts are doing. It looks like naked shorting has depressed your stock. You've got a great balance sheet, you've got cash, you've got some seed approvals coming. Why not more share repurchases?

I agree. I think that we do have a great future, and we definitely are headed in the right direction. What we did, and we definitely added more shareholder value. We did some internal calculations on share repurchase versus repurchasing some of our convertible debt offering back, and it did come out much more positive in an accretive sense to purchase some of the convertible debt offering, which we believe to be considered expensive debt.

Okay. Irving, I take it the vibes are pretty good from the government on the Phytase approval. Could you talk a little bit about the government's attitude towards GMOs? Has it been changing, getting more positive, hopefully? And what sort of sales potential do you see from Phytase? Say, if you introduce it next year, what could the sales be in 2010?

Well, again, 2009, it's going to be in its first year pending approval. And we do believe that it should have some penetration into the marketplace, albeit in an initial year this would be somewhat limited. The overall market potential, we believe, in China to be 200 million for Phytase. We're the only product in the field for corn-based Phytase. So we believe we can penetrate into a significant portion of that marketplace.

The government has voiced significant backing for GMO in the market place. For example, recently, State Council put out some guidelines issuing USD$2.65 billion for a plan backing GMO implementation into the marketplace directly. We feel this is very positive, showing their support, and we continue to feel that this is going to be a trend going to the future.

I know you're deferring giving the official guidance for next year until, I guess, your fourth quarter conference call. But aside from that, what sort of are you folks looking for next year? The market seems to be stabilizing, inventories are down, pricing is good, big demand for food.

Just to give you a rough ballpark, so far, we are expecting continued price increases, in the double digits, and we feel that volumes should continue to grow as well. So, we feel very confident. With our expense base under control, that bodes well.

Getting back to my thought on share repurchases, what you should be telling investors is, as we look for -- at all our investment opportunities, our stock continues to look to be the best investment we can make.

Absolutely, absolutely, I would agree. But on that front, the same thing plays through. We are focused on our strategic initiatives at this point. Also, we are focused on what brings the most value to the shareholder from an accretion standpoint. And so we will continue to do that analysis in-house.

Is there any update on how you are doing in the non-Phytase GMOs? How are -- you have a BT trait and you have a glyphosate-resistant trait. Are they showing good test results this year?

Yes, absolutely. We're moving right along in those test categories. We feel like they are progressing nicely, so we haven't adjusted any time lines for those.

Jim Harvey, Royce & Associates.

Actually, my questions really have been answered, but maybe, I was wondering if we could drill down a little bit further on the potential for GMO approval. To include this language in a press release would imply some optimism and put some hope into that part of the story. Can you just talk about the back and forth that goes on between you and the government that gives you the confidence to say that you are at least hopeful that that would be approved by the end of the year?

Yes. Unfortunately, we can't talk about back and forth. But definitely comment that the government has publicly made overtures either through plans and different initiatives and even backing with dollars, saying that they definitely back GMO in the form of rice, corn, et cetera. And so that has not -- that [has] been public. So I don't think that -- we feel that's very positive.

And you're confident enough to at least include it in the press release, obviously?

Yes.

[Thomas Nicolau], [America Invests].

Why are you not in the nitro business?

Because, actually, our main business is corn seed. We are focused on capturing the corn seed market right now, along with the rice seed as an ancillary market, and we feel there's enough potential there at this point.

Albert Lee, The Maxim Group.

Can you lay out what the ASP improvements, if there were any, look like for the rice market and the volume type trends that you are seeing there?

Sure, no problem. Let me break that down for you. For the ASP for the third quarter year to date, we are looking at roughly a 1%-plus increase in corn -- rice -- prices. But the volume has increased significantly to 25% plus, rice volume increase, because of increased demand of the product.

And what percent of the total did rice contribute? I know corn contributed roughly 75%. What percent of that was rice?

That was roughly (technical difficulty) percent.

It was what?

Actually, a little bit higher than 11%.

Okay And, you talked about how you guys have taken sales and marketing were just basically operating expenses down all across the board. But you also talked about how you plan to double the demonstration lots to 10,000 from 5000. So is that going to be an offsetting factor in terms of sales and marketing costs that have come down recently, or is that --?

No, actually, you know, that fits right in line with our strategy because the advertising and media expenditures are much more costly to our business model. So just take, for example, [common] -- going out to the countryside for a salesperson. If you plan a demonstration lot, you actually go out to the countryside once, you make that trip, a travel expense. Then, you come back and then you wait for it to grow, and then you come back a second time and collect all of the orders after the corn has grown. So your trips actually out to the different provinces are much more limited. If you had to travel back and forth several times, continue to get orders, continue to market, continued to pitch.

And so, actually, it's a much more cost-effective solution for us.

Peter Butler, Glen Hill Investments.

Just following up, when you folks get the Phytase approval, how are you going to roll out the news to shareholders? I presume you're going to do a conference call. Is top management coming to New York later on this year? Do you have any investor events planned?

Definitely, we have been advised of some prominent investor conferences. We definitely plan on attending some of those, and we'll keep you abreast of those through the press releases. We have some scheduled for this year.

And how do you expect to roll down the news on Phytase?

Once it's approved, we should press release it.

No conference call?

That still is to be discussed, and we'll see if -- how that rolls out. But there's a potential for conference call, so we'll see.

You know, because this would be the first, the GMO step, and you could talk not only about the Phytase potential, but also how your other GMOs are progressing in the approval stage.

Right, absolutely, absolutely. Yes, we'll take that under consideration. Thank you.

Fred (inaudible), Edgeport Capital.

(inaudible) I was just wondering, your product lines, these seed GMOs -- how adaptable might there be for possible usage in other regions, either neighboring or further off, in terms of preparedness? And, have you given that any contemplation to perhaps, down the road, expand your marketing and your sales efforts?

First off, definitely we are expanding our sales efforts in the sense that, as mentioned in the press release, we're doubling our demonstration lots. That's our main form of marketing at this point, and along with the after service and all the different services applied to the different farmers.

And how adaptable our corn seed hybrid is to different regions? We take that on a corn-by-corn basis. They have to go through different trials, and so it's actually a long process where you have to determine if it's stable enough that it's ready for agencies to deal with, et cetera. So actually, we definitely have to take that case-by-case. But in general, there are some abilities to take one seed type, and if it's strong in one area, it has the potential to be strong in another area.

That was the thrust of my question, was in terms of other geographies and topographies in the world, in general, how adaptable might that be, how suitable might it be?

Right, right. So, [if] the same climate and soil conditions, then we have to -- it could be very suitable.

There are no further questions at this time. I will turn the conference back over to Irving Kau for closing comments.

Thank you, all, for participating in this year's third quarter fiscal 2008 conference call. We hope you all stay tuned, and we think big things are planned, and we will keep you abreast of all of our developments. Thank you very much and take care.

Thank you. This concludes today's teleconference. All parties may disconnect now. Thank you.