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China Advanced Construction Materials Group, Inc. (NASDAQ:CADC)

F2Q13 Earnings Call

February 15, 2013 08:00 am ET

Executives

Xianfu Han – Chairman and Chief Executive Officer

Analysts

Operator

Greetings and welcome to the China Advanced Construction Materials Group Incorporated 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 [Jemming Shang]. Thank you miss, you may begin.

Unidentified Company Representative

Thank you. And welcome to China ACM fiscal year 2013 second quarter conference call. I am Jemming Shang, the Board Secretary of China ACM. Before we start, I’d like to remind you that managements prepared remarks contain forward-looking statements that are subject to risk and uncertainties and management may make additional forward-looking statements in response to your questions. Therefore the company claims the protection of the Safe Harbor for forward-looking statement that is contained in the Public Securities Litigation Reform Act of 1995.

Actual results may differ from those discussed today due to such risk facts but not limited to change from anticipated levels of sales, future international or regional economic and a competitive and regulatory condition change in relationships with customers as such to sort out difficulties in developing and marketing new products, marketing existing products, customer acceptance of existing and new products and other factors that may be included in the risk section of our filing with the SEC. Accordingly although the company believes that such expectations reflected in such forward-looking statements are reasonable, there can be no assurance that such expectations will prove to be correct.

In addition, any cost additions as to the Company's future performance represents managements estimates as of today February 15, 2013. We undertake no obligation to correct or update any forward-looking statements provided as a result of new information, further events or even change in our expectations except as required by law.

Joining us on today's call is Mr. Xianfu Han, Chairman and CEO; and Mr. Ken Ren, Independent Director of the Board. Now I have prepared remarks from Mr. Han that has been translated into English and we will now read this on his behalf.

Xianfu Han

Good morning and thank you for joining our call today. Although we're feeling a year-over-year decrease in revenue for the second quarter of fiscal year 2013. Amid this impact from adverse weather, such decrease was principally attributed to lower sales of concrete products due to the slowing down of the housing market and infrastructure developments. In order to curtail future losses, we will continue our efforts to improve the collection of account receivables, optimize our plant network and enhance our client base for the rest of the year.

So revenue; our revenue is primarily generated from sales of our advanced ready-mix concrete products and manufacturing services. For the three months ended December 31, 2012, we generated revenue of $21.6 million compared to $42.6 million during the same period in 2011, a decrease of $21 million or 49%. The decrease in our revenue is due primarily due to decreased revenue from our manufacturing services and concrete sales for the three months ended December 31, 2012.

Our concrete sales revenue was $19.1 million for the three months ended December 31, 2012, a decrease of $20.9 million or 52% from the three months ended December 31, 2011; the decrease in revenues from concrete sales was principally due to the decreased demand of concrete sales in line with slowing down of the housing market and overall economic growth.

China Central government continues to impose restrictions on purchase of residential apartments in order to contain the housing price in China. In addition, China's economic growth has been decelerating in 2012, which has caused adverse impact on construction industry in China.

Revenue from our manufacturing services segment was $2.5 million for the three months ended December 31, 2012, a decrease of $0.1 million or 2% as compared to the three months ended December 31, 2011. Such decrease in revenue was attributable principally to the suspension of operations of certain of our portable plants during the three months ended December 31, 2012, in light of an increase in audit inspections at a high speed rail construction sites around China resulting from the recent heightened public scrutiny of railway safety in China.

So cost of revenue; total cost of revenue, which consists of direct labor, rentals, depreciation, other overhead and the raw materials, including inbound freight charge was approximately $18.4 million for the three months ended December 31, 2012 as compared to approximately $35 million for the three months ended December 31, 2011, a decrease of approximately $16.6 million or 48%. The decrease of cost of revenue was due to the overall decrease in production from our fixed concrete plants in the Beijing area and the decreased production on manufacturing services compared to the three months ended December 31, 2011.

The cost of revenue on concrete decreased approximately $16 million or 49% for the three months ended December 31, 2012 as compared to the three months ended December 31, 2011; such decrease was due to a decrease in our concrete production leading to a smaller base of raw material purchases with lower overall volume of traditional concrete sales.

Cost of revenue with respect to our manufacturing services decreased approximately $0.7 million or 29% during the three months ended December 31, 2012 as compared to the same period during the three months ended December 31, 2011; the decrease in our cost of sales was due to decreased revenue from manufacturing services.

Gross Profit; gross profit was $3.2 million for the three months ended December 31, 2012 as compared to $7.5 million for the three months ended December 31, 2011. Our gross profit for the sale of concrete was $2.3 million or 12% of revenue for the three months ended December 31, 2012 as compared to $7.3 million or 18% of revenue for the same period last year; the decreased gross profit margin reflects lower demand and lower prices for our concrete products in Beijing as compared to the same period last year.

Our gross profit with respect to our manufacturing services segment was $0.8 million, or 34% of revenue, for the three months ended December 31, 2012, an increase of $0.6 million, as compared to $0.2 million, or 8.8% of revenue, for the same period last year. Such increase was principally due to the higher production rates at plants and decrease in costs of transportation for three months ended December 31, 2012.

Provision for doubtful accounts. We incurred provision for doubtful accounts of $0.5 million for the three months ended December 31, 2012, a decrease of $2.9 million, as compared to $3.4 million for the three months ended December 31, 2011. The allowance for doubtful accounts increased to approximately $33.1 million at December 31, 2012, compared to approximately $24.9 million at June 30, 2012.

Selling, General and Administrative Expenses. Selling, general and administrative expenses consist of sales commissions, advertising and marketing costs, office rent and expenses, costs associated with staff and support personnel who manage our business activities, and professional and legal fees paid to third parties. We incurred selling, general and administrative expenses of $2.5 million for the three months ended December 31, 2012, a decrease of $1 million or 30%, as compared to $3.5 million for the three months ended December 31, 2011; the decrease was principally due to a $0.6 million decrease in consulting service and professional expenses, a $0.1 million decrease in salary and employment benefit expense, a $0.2 million decrease in advertising expense and meal & entertainment expense and a $0.1 million decrease in other office expenses.

Research and development expenses; research and development expenses were approximately $0.3 million and $1.8 million for the three months ended December 31, 2012 and 2011 respectively. The $1.5 million decrease was mainly due to the less R&D expenditure in concern with the slowing revenue trend.

Loss from termination of lease; on September 25, 2012, the Company entered an agreement with a third-party to terminate one operating lease, which was originally effective from June 15, 2009 to June 14, 2014. Under the agreement, the fair value of net assets of the related operation were determined to be RMB130.1 million, approximately $20.6 million on September 25, 2012 and were sold for a total consideration of RMB112 million, approximately $17.8 million of which the Company received approximately $1.3 million in cash. The Company recognized approximately $4.1 million loss from the termination of lease for the three months ended December 31, 2012.

Loss from Operations; we recognized loss from operations of approximately $4.1 million for the three months ended December 31, 2012, as compared to loss from operations of approximately $1.1 million for the three months ended December 31, 2011, an increase of approximately $3 million in loss from operations; such increase in loss from operations was primarily due to a $4.1 million increase in loss from termination of lease and $4.3 million decrease in income from operations of our concrete sales and manufacturing services, offset by a $2.9 million decrease in provision of doubtful accounts, a $1 million decrease in general and administrative expenses, and a $1.5 million decrease in research and development expenses.

Other Income, Expense, net; our other income, expense consists of valued added tax exemption from the PRC government, interest income, expense change in fair value of warrants and other non-operating income, expense. We recorded net other income of approximately $0.6 million for three months ended December 31, 2012, as compared to net other income of approximately $1.9 million for the three months ended December 31, 2011, a decrease in other income of approximately $1.3 million or 69%. The decrease in net other income was due to a $0.3 million increase in loss realized from disposal of fixed assets and a $0.3 million decrease in change in fair value of warrants liability.

We also recognized other subsidiary income of approximately $1.3 million for the three months ended December 31, 2012, as compared to $2.5 million for the three months ended December 31, 2011, a decrease of $1.2 million or 48%.

Due to the fact that we use recycled raw materials to manufacture our products, the State Administration of Taxation granted us VAT tax exemption from August 2005 to August 2009, and thereafter a two year extension on the VAT tax exemption from June 2009 to June 2011.

The Company has applied for VAT tax exemption extension and recently received an extension through June 2013. The VAT tax collected during the aforementioned period from our customers is retained by the Company and recorded as other subsidy income. In addition, we had interest expense of $0.7 million for the three months ended December 31, 2012, as compared to $0.4 million for the three months ended December 31, 2011, an increase of $0.3 million related to short-term loans.

The Company also had interest income of $30,627 for the three months ended December 31, 2012, as compared to $112,807 in the three months ended December 31, 2011, a decrease of $82,180 related to short term investments decreased.

Provision benefits for income taxes. Benefit for income taxes amounted to $23,831 for the three months ended December 31, 2012, as compared to $337,376 provision for income taxes for the three months ended December 31, 2011. The Company had a loss from operations since the quarter ended June 30, 2012.

In expecting the loss from operations in the near-term, the Company decided to provide a $1.8 million valuation allowance against the deferred tax assets related to provision for a doubtful accounts as of December 31, 2012, since the deferred tax benefits might not be utilized if the Company continues to have loss from operations.

We have used recycled raw materials in our concrete production since our inception, which entitled us to an income tax rate reduction through June 12, 2012, as granted by the State Administration of Taxation, PRC. Since January 1, 2009, we have been subject to a 15% income tax rate.

In the past, XinAo has paid the corporate income tax on behalf of China ACMH and there could be a potential liability for additional taxes for China ACMH, though at present the Company is unable to determine the extent of such liability, if any. The Company has completed the application process and is waiting for the final certificate of approval of the income tax reductions from 25% to 15% from June 13, 2012 to June 12, 2015.

Net income loss; we recognized net loss of approximately $3.5 million for the three months ended December 31, 2012, as compared to net income of approximately $0.4 million for the three months ended December 31, 2011, a decrease of $3.9 million; such decrease in net income was primarily due to the decrease in gross profits of concrete sales and the manufacturing service, the increase in loss from termination of lease, offset by the decrease in provision of doubtful accounts, selling, general and administrative expenses and R&D expenses.

For a balance sheet overview; China ACM had working capital of $32.5 million at December 31, 2012, including $6.5 million in cash and equivalents, $5.4 million in restricted cash and $74.2 million in total liabilities. Shareholders' equity was $70.2 million compared with $79 million at June 30, 2012. The total number of shares outstanding as of February 12, 2013 was 17.8 million.

Guidance update, due to recent significant fog in Beijing which has adversely affected production at our plants and operation of our transportation vehicles, as well as continuing delays of high speed rail construction projects in China, during the third quarter ended March 31, 2013, the management expects the Company to earn revenue of between $4.5 million and $6.5 million, recognize net loss of between $7.5 million and $9.5 million, and EPS of between $0.42 and $0.53 based on weighted average shares of 17.83 million.

In addition, the Company updates its full year guidance for the fiscal year ending June 30, 2013, and currently expects to earn revenue of between $87 million and $90 million, recognize net loss of $16 million to $19 million, and EPS of $0.9 to $1.1 based on weighted average shares of 17.83 million.

Okay, so now I would like to open the call for questions.

Question-and-Answer Session

Operator

Ladies and gentlemen, we will now be conducting a question-and-answer session. (Operator Instructions) Our first question comes from [John Shaheen], a Private Investor caller. Please proceed with your question.

Unidentified Analyst

Thank you very much. Thank you for hosting the call. I would like to first ask a question about the guidance. You provided third quarter guidance and also full year guidance. So I can just do a little bit of math and it seems like the fourth quarter, you will be estimating revenue of about $30 million and net income of about zero, about breakeven, is that correct?

Xianfu Han

Yes. You are correct that such full year guidance updates and the third quarter guidance we provided in our earning release reflect the management and Company’s outlook for the slowdown in our typical slow quarter, which is current quarter due to holidays and a diverse winter weather. And you mentioned that the fourth quarter and first quarter is typically our high peak sales quarter in every fiscal year and we incorporated their probability that certain delayed orders may be picked up later on during sometimes – during the rest of the year, and the updated current quarter's guidance reflects both effect of that. This quarter is a holiday quarter, it’s a winter quarter most of the construction sites and infrastructure development were halted because of the holidays and the adverse foggy weather in the capital city also impacted our businesses.

For instance the emission got more tightly controlled and certain ready mix concrete stations were notified to be relocated from the major area to more remote suburban area by the municipal government. And in total, the entire capital city has over a 100 number of such stations owned by various construction companies and the construction material suppliers. And any locations within certain natural range will be required to be relocated elsewhere, so that the foggy weather and the air quality in Beijing wouldn’t continue to deteriorate it because of these industrial activities and operations.

Unidentified Analyst

Okay that's great explanation, and do you have an idea when business conditions will return to a more normal level?

Xianfu Han

Okay that's a great question. Overall, like we stated in our earnings statement, we expect that the slowdown in the property markets will continue at this moment and however we opportunistically expected that the markets will recover due to the several facts. The momentum of housing and the property appreciation is picking up as weather reported in media. And the purchase demand had a pickup year-over-year from the beginning of this January.

And we also expect that in summer, the high speed railway network development has slowdown for various reasons such as safety reasons and financing reasons. The efficiency and the convenience and the particularly enormous capacity such efficient or the vast transportation solution provided to liberate the holiday traffic were proven to be a variable solution to solve the massive migration trend which will continue to reoccur periodically and we also optimistically believe that eventually the high railways stations, I am sorry, the high speed railway network development or construction will continue to go and for our business we supply materials and provide services to such segments, the high speed rail projects through our network of both the company-owned concrete plant and the number of plants released from other license holders in both Beijing and various provinces regions because this is a national project.

Nation-wide we provide these materials and operate our activities throughout between 15 – approximately 15 number of stations, and the revenue may incur certain receivables during the time of period up to now. We optimistically expecting that in future that business will come back. This is our outlook for high speed railway segment and management believe that we have the ability in future to very well prepare to capture the share we owned or we deserve as the market recovers.

Unidentified Analyst

Okay, thank you very much for that explanation. And I also want to ask about the receivables from lease termination, you have about $14 million of remaining receivables and I think it’s explained in the 10-Q that you're going to receive that payment in installments over the next two years, so will that be about $1.8 million per quarter?

Xianfu Han

Yes. That’s approximately correct and again the termination of the lease for such plants in Beijing area is due to the relocation notice or the requirement by the municipal government because of the well know weather issue or air quality concern push the current administration to impose more stringent requirement for environmental protection. And concrete production particularly the ready-mix concrete production in metro area will be carefully examined by the authority to ensure that such type of operation will no longer further pollute the air in the natural area.

And the pertaining one was lease termination fall into such category and we liquidated certain related assets including some receivables and we believe that this is a part of a strategy for the management and company to optimize its network of close this plant stations as well as fleet in the developing market and we believe that eventually this industry will supply the ready-mix concrete construction materials to fulfill the demand in the city’s development, in construction development as well as the property market because Beijing is the largest property market in China.

And in total, we have an extensive fleet of over a 100 ready-mix concrete vehicles in the first and also we have approximately 20 pump trucks as well as certain easy access to additional 50 to 60 number of ready-mix concrete vehicles. And once the new location is approved before by the government and we believe that in this highly segmented market, the company is in a advanced position to regain market shares or to regain the business and because such impact is not exceptional for the company, it’s actually applicable to all the industry players in the construction material business and in our case, as one of the leading construction material company in Beijing, the company is anticipating or continuing its strategy to meet such challenge.

Unidentified Analyst

Okay, thank you and my last question. I'd like to ask about company structure, the contractual arrangement structure with variable entity, have you studied changing the company structures and all of the business is owned and operated under wholly-owned foreign enterprises?

Xianfu Han

The legal structure of the company was described and formed when the company got incorporated in United States and variable interest entity is a typical legal structure that was been utilized or employed in many companies listed in U.S. with certain major operations overseas. For instance, Baidu, (inaudible), they are no exceptional and one is particularly the tech companies who are employing such legal structure.

And the VIE, the so called VIE structure, the Variable Interest Entity structure or utilized through a number of legal binding contracts from service agreement, equity pledge agreement and these agreements approved or signed by between a company, between the operating companies and the holding companies ensure that the holding company or the public company is sufficient to consolidate the financial statement or the assets from the operating companies. And these structures is also similar to the financing vehicles utilized by number of U.S. institutions such as Fannie Mae or Goldman Sachs or Freddie Mac. And the agreement is enforced since its filing and it has a number of years to be enforced and over the Company’s operation.

Unidentified Analyst

All right. I just asked because the wholly-owned structure is a little bit simpler and some companies that previously operated VIE structure is now changing to a wholly-owned structure and I think in the quarter you mentioned that there is a possible tax issue related to the variable interest entity. So it would seem that if it was not too difficult to change the structure then that might be something that would be worth studying that's all.

Xianfu Han

We will take your questions and consider your advise or inputs.

Unidentified Analyst

Okay, thank you a much. That's all I wanted to know.

Xianfu Han

Thank you so much, John.

Operator

Our next question comes from (inaudible), a Private Investor caller. Please proceed with your questions.

Unidentified Analyst

Yes, your stock prices have been trading under a $1 dollar for the last 180 days, you've been given notice by the Securities and Exchange Commission to write about this deficiency or risk being delisted from the NASDAQ. Can you comment on what your plans are?

Xianfu Han

We are actively seeking solutions to regain the compliance from the NASDAQ and you mentioned that from last summer we received the notice from the exchange because of the Company’s share price had been just below $1 dollar which is minimum price requirement for NASDAQ listed companies. And the management and the Board would try its best effort to maintain its listing status with NASDAQ and regain our status to be within compliance and we will solve this as soon as possible and we're seeking various solutions and comparing them including but not limited to such as the combining of shares and et cetera number of every solution and we're working with our legal team to fix these deficiencies

Unidentified Analyst

So I can assume given the SEC written notice that you are going to comply with this deficiency.

Xianfu Han

I want to correct that, such notice is not from the commission, it is from the exchange.

Unidentified Analyst

Okay. But you have a February 19 deadline to send written notice to the exchange, have you done that?

Xianfu Han

We are communicating actively with NASDAQ to make sure the company will continue to be listed in NASDAQ exchange. The solution is (inaudible) from we requested a ply for additional grace period to regain the compliance and also to consolidate shares like what has been utilized by some other companies.

Unidentified Analyst

Okay, thank you. One other question. You suffered approximately $4 million loss from the termination of your lease last quarter. Your reports indicated that you’re working to terminate another lease by March 30. Do you expect to incur a similar type loss on this lease?

Xianfu Han

Such expectations had been reflected in our quarterly guidance for the current quarter. If you take a look at our guidance information and because of the municipal government’s requirement for this type of activities to be operated or relocated out of the range of natural populous area to mitigate the foggy air qualities in Beijing City and we may incur some losses like this due to the termination of the lease, early termination of the lease because of the treatment of this related assets. And that we are also looking for new solutions to put these operations back to the network. And again like I said, we consider these as a necessary and an integral part of our comprehensive strategy to re-optimize our station network through alternative city in these changing market environment.

Unidentified Analyst

Okay, thank you. That's all my questions.

Xianfu Han

Thank you

Operator

It appears we have no further questions at this time. I would now like to pass the call back for closing comments.

Unidentified Company Representative

Jing back over to you.

Unidentified Company Representative

Han, can you here me? Hello?

Xianfu Han

Yeah.

Unidentified Company Representative

Okay. Thank you on behalf of myself, our Chairman and CEO, Mr. Xianfu Han; Mr. Ken Ren, the Independent Director and the rest of the China ACM management team. Thank you all for attending our call. Please feel free to contact us with any follow up questions. Thank you.

Operator

Ladies and gentlemen, this concludes the teleconference. You may now disconnect your lines at this time and thank you for your participation.

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