Origin Agritech Limited (SEED) Q3 2016 Earnings Report, Transcript and Summary

Good day, and welcome to Origin Agritech Third Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Mr. Bill Zima of ICR. Please go ahead, sir.

Thank you, Operator. Hello everyone and thank you for joining us on today's call. Origin Agritech announced its quarterly financial results earlier today. An earnings release is now available on the company's website. Today, you'll hear from Origin's Chief Executive Officer, Mr. Bill Niebur; followed by the company's Chief Financial Officer, Mr. Shashank Aurora, who will discuss the financial results. Before we proceed, I would like to remind of our Safe Harbor statement. Conference call may include forward-looking statements made under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Although we believe that the expectations reflected in forward-looking statements are reasonable as of today, those statements are subject to risks and uncertainties that could cause the actual results to differ dramatically from those projected. There could be no assurance those expectations will be proven to be correct. Information of the risks associated with investment in Origin Agritech is included in the company's filings with the Securities and Exchange Commission, which we encourage you to review before making an investment decision. The company does not assume any obligation to update any forward-looking comments or statements as a result of any new information, future events, changes in market conditions, or otherwise, except as required by law. On today's call we also present non-GAAP financial measures as defined by applicable U.S. Securities Regulations which are more thoroughly explained and reconciled below to the most comparable measures reported under Generally Accepted Accounting Principles. You are reminded that the presentation of these non-GAAP financial measures should not be viewed in isolation or as a substitute for our financial results prepared in accordance with U.S. GAAP. We believe that both management and investors may benefit from referring to these non-GAAP financial measures in assessing our performance and when planning and forecasting future periods. These non-GAAP financial measures also facilitate management's internal comparisons to the company's historical performance and liquidity. We believe these non-GAAP financial measures are useful to investors in allowing for greater transparency with respect to supplemental information used by management in its financial and operational decision making. These non-GAAP financial measures have limitations, however, because they do not include all items of income and expenses that impact the company's operations. You are also reminded that these non-GAAP financial measures are not uniformly defined by all companies, including those in the agricultural biotech and seed production industry, and may not be comparable to similarly titled measures presented by other companies. With that said may I'd like to turn the call over to Dr. Bill Niebur, CEO of Origin Agritech. Bill, please go ahead.

Thank you, Bill. Hello everyone and welcome to Origin Agritech's third quarter 2016 conference call. I'm pleased to be joining you for my first earnings call as the CEO of Origin. For this call, we are going to begin by having Shashank Aurora, our new CFO, review our third quarter financial results. And then I would like to spend the next part of the call on three main areas. Firstly, I would like to share my operational observations of Origin over the past 100 days in what I have learned and observed. Second, I will review the current conditions of the China seed market today, then in the future, and how these impact our Origin Company. And third, and finally, I will discuss our future vision for Origin and the new opportunities that we see ahead. We will then open the call up to questions. So with that said, let's start with our quarterly financial review. Shashank, please go ahead.

Thank you, Bill, and hello everyone. I'm pleased to be part of the Origin Agritech team and look forward to engaging with you more proactively going forward. Now, let me walk you through the key P&L items to provide you with greater detail on our performance in the third quarter. Highlights for this quarter include expansion of our gross profit margin, narrowing of our non-GAAP operating loss, continued reduction of inventory levels, positive operating cash flow, and lower debt. Total net revenue for the third quarter of fiscal 2016 increased by 12.1% to RMB82.6 million from RMB73.7 million in the prior year period. The increase was driven primarily by the increased sales of corn hybrid Liyu-16 which was partially offset by lower discount sales from rice business. Liyu-16 sales increased due to strong yield, excellent disease resistance, and high grain quality. While the total planted corn acres in China are expected to decline 10% in 2016 impacting Origin's full year volume and revenue, the company's corn market share held steady. Net revenue from the seeds production and distribution segment increased 11.7% to RMB82.3 million compared to RMB73.7 million in the prior year period. Net revenue from the biotech and product development segment was RMB0.3 million in the third fiscal quarter of 2016, while there was no such revenue recognized in the prior year during this period. The revenue from this segment represents fees for services from the company's collaborators. Deferred revenues increased 4.8% to RMB391.3 million as of June 30, 2016, compared with RMB373.4 million on June 30, 2015, primarily related to higher sales price this season. Final sales will be known when returns will be completed in the fourth quarter of fiscal year. The sum of recognized revenue and deferred revenue as of June 30, 2016, was RMB473.9 million or U.S.$71.5 million, an increase of 6% compared to RMB447.1 million for the same period in fiscal year 2015. The sum of recognized revenue for the first nine months ended June 30, 2016, and the deferred revenue as of June 30, 2016, was RMB485.3 million or U.S.$73.2 million, an increase of 4% compared to RMB466.5 million for the same period in fiscal 2015. Total operating expenses in the third quarter of fiscal 2016 were RMB28.9 million or U.S.$4.4 million, up 54.5% from RMB18.7 million in the same quarter of fiscal 2015. The increase was primarily due to the timing difference associated with the recognition of marketing expenses and a one-time stock compensation expense. Excluding one-time expenses, total operating expenses for the nine months of fiscal 2016 were RMB74.8 million which is similar to the operating expenses of RMB73.8 million for the first nine months in fiscal 2015. Operating loss was RMB15.1 million compared to loss of RMB8.4 million in the same quarter of 2015. Excluding the impact of one-time items, including stock-based compensation expense and other income related to reversal of liabilities aged five years over, the operating loss decreased 23.9% to RMB10.2 million from RMB13.4 million in the same quarter of fiscal 2015. Net loss attributable to the company was RMB18.2 million or RMB0.8 per diluted share compared to RMB11.9 million or RMB0.52 per diluted share in the same quarter of fiscal 2015. Excluding the impact of aforementioned one-time items, the net loss attributable to the company decreased 21.3% to RMB13.3 million, or net loss per diluted share of RMB0.58, from RMB16.9 million or net loss per diluted share of RMB0.74 in the same quarter of fiscal 2015, respectively. Now I would like to address the key items in our balance sheet. As of June 30, 2016, the company had cash and cash equivalents of RMB25.9 million and shareholders' equity attributable to the company of RMB168.7 million. Total borrowings were RMB256.9 million, including short-term borrowings of RMB210 million, and long-term borrowing of RMB46.9 million, representing a decrease of RMB17.5 million compared to the same period last year. Short-term borrowings were mainly for working capital, while long-term borrowings was mainly used in relation with the corn seed production facility in Xinjiang Origin and the company's working capital. The decrease in debt was mostly due to positive cash flow generated for fiscal year 2015, primarily in the fourth quarter as well as for full year 2015. Advances from customers were RMB47.3 million as of June 30, 2016, compared to RMB128 million as of June 30, 2015. The decrease was consistent with industry trends as there was an oversupply of seed in the market and the low commodity prices; farmers are delaying their seed purchases and payments. These advances represent cash receipts for orders in the upcoming selling season. Of note, advances for our newest seed products remain healthy. Inventory decreased by RMB90.6 million as of June 30, 2016, compared to the same period last year, mainly due to improved forecast demand efforts by management and from lower production. As we look ahead to our fiscal fourth quarter, we expect agricultural commodity prices will continue to be at the low-end in the foreseeable future, until either demand accelerates or crop area declines, or there the major negative weather-related event. This concludes my prepared financial commentary for the fiscal third quarter results. Now I will turn the call back over to Bill Niebur. Bill?

Thank you, Shashank. And I too, I'm pleased to be conducting my first conference call since joining Origin and I look forward to developing a closer contact with our investors working with our partner ICR moving forward. As mentioned previously, let me start with my operational observations since I joined the company roughly 100 days ago. I'm thrilled to have joined Origin and believe that the time is right for Origin to make bold moves in three key areas: firstly, to expand the domestic corn and biotech trade business within China; and secondly, to pursue strategic agreements and licensing opportunities with leading global as well as domestic Chinese agricultural companies; and thirdly, to expand our geographic presence into new markets. I will go into more details on these areas later in the call with all of you, but first the company. I come to Origin at an ideal time as the company matures into its next phase of technology and business development. Origin's traditional seed production and distribution approach in China has created a modern professional corn seed business with advanced seed production capabilities and strong distribution channels generating stable cash flow. Importantly over the last 10 years, Dr. Han and his team have wisely invested in industry-leading biotech trade and product development from the free cash flow generated from this modern corn hybrid seed business. After a decade of productive seed biotech development, Origin has made great progress and currently has biotech corn seed products ready for commercialization in China, timed and aligned with the recently released 13th five-year plan by the State Council of the Chinese government calling for biotech commercialization to occur in the future. Let me next shift to the team. The new leadership team has unique qualifications and experience to guide the company in a professional and accelerated manner. To grow Origin globally, we will base our seed products and biotechnology trade development from China providing advanced agricultural seed solutions across the global value chain. In May, Shashank Aurora, joined our team as Chief Financial Officer. Shashank has over 25 years of financial and accounting experience in the agricultural industry and will provide strategic financial and business guidance within the company as well as to our shareholders. We look forward to his contributions ahead. Additionally, in August, we announced the addition of Dr. Jihong Liang to the newly appointed position of Chief Technology Officer. Liang will be located in Beijing, China. He will lead our efforts in science and technology investments and oversee our strategic collaborations. He has nearly 25 years of global experience leading the research and development efforts at several major well known agricultural seed and chemical companies. Liang brings exceptional scientific knowledge of plant breeding and biotechnology as well as global seed leadership experience to the Origin team. This is critical as we pursue a more ambitious China based and International growth agenda. Now allow me to transition to the second area of focus for today, an update on the China market conditions, starting with the latest developments and trends in China's seed industry, a very dynamic industry. China's corn seed market continues to evolve and mature, with the corn seed market being more challenging and difficult today than in the past. These conditions have challenged growth and profitability for both domestic and multinationals operating in China; I can speak to from my experience. As such, modernization of the seed industry remains an important topic for the Chinese government, with continued changes and improvements to regulation and oversight coming in very lately. The 13th five-year plan that I referenced has been released by the State Council earlier this week. This bold plan has called for more resources to be invested on genetic modification over the next five years. Specifically I call out that more research begun on test resistant corn, as well as cotton. The herbicide tolerance soybeans to be developed and that investments in new technologies for food crops should be strengthened. This new five-year plan aligns closely with Origin's strengths and its focus in serving China and the world. Presently the number of seed companies in China is contracted in a wave of industry consolidation due to market economics and government direction, very similar to other markets around the world. For those companies that desire to succeed in China it is critical to find new sources of superior corn products in a manner that fully respects and complies with intellectual property rights. We now see a trend among both multinational and local companies to seek out new partners to develop, register, and commercialize superior new corn hybrids to achieve their growth and profit objectives. Origin will be an ideal partner for companies seeking to license new corn products with the Chinese market. Also Chinese government policy and regulations are favoring companies aligned with the global expansion movement called the one belt, one road policy. New government programs such as GREEN PASS product registration system will offer greater predictability and less uncertainty as we go forward. Both of these new programs will enable Origin to more fully realize the potential of its investments and achievements in the product development pipeline over the last decade. Significant investment in advanced seed breeding and early stage biotechnology across China over the past 15 years is maturing. These high-end technologies targeted to create new growth opportunities within China, and eventually outside China, encourage Origin to partner with strong experienced global players who have commercialized and stewarded biotech traits previously. Let me emphasize. A strong strategic partnership approach will be followed by Origin moving forward. Furthermore the push by the Chinese government for the Yuan's inclusion into the IMF reserve basket by 2020 will lead to arbitrage opportunities to conduct more early stage research in China when the risk profile is high and the cost need to be monitored closely. We believe the approach developed at Origin which entails positioning the R&D function within China and then exporting its successful products to partners around the world for value creation and capture will serve as the optimal model for our future. To conclude my formal remarks today, I will discuss the future vision for Origin. My vision for the transformation of Origin is to become a leading foundation technology company that can expand our two key segments in China and expand into the selected markets globally, enabling greater market access and reach for the traits and products that we develop. I will start with our corn breeding and product development segment within State Harvest which is Origin's research subsidiary. State Harvest possesses a rich and deep corn Germplasm collection that is well adapted to Chinese market requirements. We believe this Germplasm has considerable value both inside and outside of the current proprietary brands in which it is sold. This Germplasm can be licensed to collaborators across the China market. Thus establishing strategic partnerships that generate R&D subscriptions and royalty payments will enable us to modernize and expand our current breeding efforts within China, along with improving access to new emerging technologies such as gene editing and others that are on the horizon. Discussions are ongoing to establish future licensing revenue streams with new partners in the China seed market as we speak today. Our biotech trait and product development segment is well connected to the major Chinese academic laboratories that are leading the way in gene discovery and new trait enablement. These strong relationships paved the way for the creation of novel value added traits that can be added to Origin products and out-license to local seed industry participants generating future revenue growth opportunities as biotech is commercialized in China. With new scientific leadership, we will modernize laboratories and enhance and extend our biotechnology collaborations. We currently have two lead traits in late stage development and a diverse pipeline of new trait opportunities for future relations. We are working with several partners to enable the cultivation of gene traits inside China and ultimately one day in North America. We believe these new approvals will generate meaningful revenue for our business aligned with Chinese approvals of biotechnology products. I repeat that the 13th five-year plan that was released earlier this week suggest the agricultural authority will prioritize commercial cultivation of genetically modified test resistant corn from the 2016 to 2020 timeframe. A few words from the beginning of our third quarter when we announced a strategic collaboration and commercial licensing agreement with DuPont Pioneer to develop new genetically modified crops for Chinese farmers, DuPont is a leading force in the corn seed market in China and a key partner for Origin. This agreement has great potential to help modernize China's agricultural system and improve food security both of which are major priorities for the government. We generated small amount of revenue from this agreement in the third quarter and excellent progress is being made to incorporate additional biotechnology traits into future products enabling greater market access and future royalty payments. And finally, let me talk about geographic expansion. As we look at opportunities outside of China and in markets around the world, the U.S. market remains our top priority for cultivating new businesses. With our office in Iowa serving as North American headquarters, we are developing a business plan for non-GM corn and soybeans. The opportunity we will develop over the next three to five years with the goal of creating a novel system connecting world class products and producers with leading end users. In summary, we are very excited about the direction our business is heading and believe Origin will be an important multinational player in the coming years. We plan to make a number of announcements in the weeks and months ahead that will further explain and present our new direction. This concludes my prepared remarks. Operator, we are now ready to take questions.

Thank you, Dr. Niebur. We will now begin the question-and-answer session. [Operator Instructions]. And your first question will come from Peter Butler of Glen Hill Investments. Please go ahead.

Good morning, good morning. Bill you've been what I hear is that you've been working nearly 24/7 since becoming CEO but you ever have a chance on a weekend to sit down and sip some wine and sorry dream about what the company is going to look like in two, three years. If so what do you see, how is this company going to look?

Thanks Peter. It has been an exciting 100 days, three months plus and we have been able to really invest an significant amount of time in really focusing on the key aspects of our business initially the talent, assessing the technology, setting our timelines, and then really making sure that we're focused on the right targets. And so pursuant to your question as I take that moment and I have great support at home that motivates me to think about this in a broad sense, we really look at the opportunity in China to modernize and drive the formation of a multinational from China. As you know I had the opportunity to spend five years in China as with the multinational and was a dream of mine on completing that attainment to build a multinational from China. And in order to do that we need to have world class science and talent conducting that science and I see that over the next three years, I see as adding just extraordinarily qualified, motivated, energized, focused talent. I see us continuing to expand our relationships from where we are today in terms of sourcing novel biotechnology inventions and discoveries and being able to move those inventions and discoveries through our product pipelines into our partners. And then I see us continuing to partner with the majors, we are small company and we have the audacity to believe that we can do something important but the inability to know where we sit in the overall scheme of things. And so we will as I said pursue a strategic partnership strategy and we will establish new partnerships over these next three years with individuals with similar ethics, similar integrity, similar intensity. And then, finally, we desire to take that one belt one road approach for a Chinese company and move out and establish and build and enhance U.S. China relations both trade and agriculture. I've dedicated the last seven years of my life to ensuring that these two great powers work together most effectively on trade and agriculture. And I believe that I'm in a great position now surrounded by incredible talent to make that a reality. So I -- those are the kinds of things that I think about over the weekend as I sit with my spouse and we have a chance to reflect on the future that we're a part of. So thank you very much.

Okay. It usually takes money to make money. How can you finance your -- it sounds like pretty aggressive expansion plans, how do you intend to finance this? It'd be great, if you could, if the answer is that you're going to have enough positive cash flow to do it. But if not, do you have things like hidden assets that could be monetized and allocate the -- that source into growth programs?

Well, allow me to -- let Shashank take a shot of that and then I'll follow up.

Good morning, Peter. This is Shashank. Great question.

Good morning.

And something which always is running through our minds as to how we can finance future growth. Bill laid out in his strategy as to what are the cornerstones of success for Origin going forward. The way we have been looking into it is evaluating who could be a strategic partner for us who could help us in the future growth, besides the traditional routes which a lot of company would take either by raising further equity or going through the debt route there. We are also looking into how we can optimize the assets, not just the fixed assets that we hold today, but also the Germplasm and the traits that we hold today and how can we monetize them to help funnel some of the growth opportunities that Bill spoke about. So those are the different things that we've been trying to see and help fund our future growth projects.

So I think the only thing I would add to what Shashank has said in, and I agree with everything that he said, is that we are exploring opportunities to partner with companies to share future revenues and share current costs. And we're looking at novel ways in which we might be able to do more with shared projects and to be able to then rethink the way we share royalties in the future in order to be able to make that future a reality more quickly.

Your DuPont partnership could become very, very important. The -- you have a new leadership change in Wilmington. And I think they're going to put an emphasis on expanding their role at chemical business. And they have obviously more than enough financial resources. And they could be a really good partner for you guys.

We would agree. We -- they're very familiar with us and we're very familiar with them. We're also excited about the addition of our new Chief Technology Officer who comes from a different pedigree and a different set of internationally strong and capable companies that are looking for opportunities. So we actually -- we like the diversity in our leadership thing, both cultural as well as experienced based and feel that we're in a great position supported by our very bold and dynamic Chairman Dr. Gengchen Han. And I think that that group of individuals with team below will be an attractive partnership opportunity for others.

Okay. And last thing. Do you guys have any comment on the impact, possible impact of the ChemChina Syngenta deal and the Dow DuPont merger? Are -- can they be a positive for you or how do you see it?

Well, I take on -- let's talk about ChemChina Syngenta. I have a personal relationship with the Chairman of ChemChina and I got to know him while I was in China. The new CEO of Syngenta is a -- an individual I worked with closely throughout my career. We see that that merger should it come to pass, as been a very positive thing for both of those companies. And we think that it will drive further professionalization and modernization of the Chinese seed industry. So we see that as a very, very positive evolution for the Chinese seed market and the global seed market in its entirety. We think that the mergers that are being discussed in with our -- with DuPont and Dow and those things also will lead to situations or opportunities where we can partner with those companies due to our unique position in China, and our relationships, and our ability to participate in all aspects of R&D, and to be working with regulatory officials in a very compliant and productive manner. So we see these evolutionary changes, if they are to come to pass, as being positives for a player like Origin going forward.

[Operator Instructions]. And your next question will be from Paul Zimmer, a Retail Investor. Please go ahead.

Good morning guys. Just to add to that last question regarding ChemChina's acquisition of Syngenta, you kind of touched on this. But how does this effect Origin? How Syngenta's GMO technology is compared to Origin's technology? Are the technologies of these two companies competitive or complementary to each other?

Thanks, Paul, and appreciate you calling in today and asking a question. The ChemChina presence today in China is one that's very light on seed and very long on chemistry and various other industrials. The addition of a strong seed and chemical company we think would allow Chairman Ren to recognize his strategic team of expanding. And so we see that as being a way to bring more investment, more progress, and more positive force into the emerging market that China represents. It's developed and but its moving fast as it attempts to modernize, but not necessarily westernize. It wants to modernize, but it wants to do it in a way that is very Chinese in its approach. And so we see this sort of relationship being a great way to make that happen. To come to your technology question. Syngenta has great technology and we're familiar with that technology. We think that it's complimentary to the technology that's being developed in China today indigenously from the laboratories at the Chinese Academy of Agricultural Sciences for example, and other both academic and private laboratories. We think that the industry in China has learned significantly from the efforts, and the investments, and the scientific capabilities of Syngenta. And we believe that if Syngenta and ChemChina were to move into the market, that there would be opportunities in the future to put these traits, these new novel traits together in ways that we would be able to make superior products for customers and better serve their needs in the future and ensure security, food security, and a more sustainable environmental practices. So we see that it's being complimentary, there will always be some nature of competitiveness but that's the way markets operate most effectively, but we see it as an opportunity.

Great, sounds exciting. One last question. When do you plan on visiting Wall Street?

Well, it's a great question Paul. We -- it's not that we don't want to visit Wall Street; we really want to get out there. But we really felt that we needed to assess and understand and focus on those the talent, the technology, the timelines and ultimately the targets so that we could get out with a great story. And so we plan for the fourth quarter to make our way out to various parts of the country speaking with groups and telling our story.

And our next question will come from Dan Silverstein of Heuristic Management. Please go ahead.

Thank you. Thank you for your comments gentlemen. I'm wondering if you have academic partnerships anywhere in the world. And if you do not, are you interested in developing that?

Dan, thank you very much for that question and again for calling in this morning. Academic partnerships are the foundation for our work in developing biotechnology traits. The current relationship that we enjoy with the Chinese Academy of Agricultural Sciences is foundational to us being able to take their inventions and translate those inventions into innovations in the form of biotechnology traits. We are in process of extending those relationships to other academic institutions for technologies such as genome-editing, molecular breeding, and advanced practices in transgenic trait development, and ultimately regulatory approvals. So we see that healthy mix of academic partnerships and relationships combined with private partnerships along with our internal investments is the way that we develop our portfolio of products as we go forward. So yes, we have a strong orientation towards the academic community believing that they have any significant role to play certainly in markets like China and more globally.

[Operator Instructions]. And seeing that there are no more questions, we will conclude the question-and-answer session. I would like to turn the conference back over to management for the concluding remarks.

Thank you everyone for your participation and ongoing support for Origin Agritech. We look forward to providing you all with additional updates in the weeks and months ahead. Please have a great day and be safe.

Ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.