China Gerui Adv Mtals Grp Ltd. (NASDAQ:CHOP)
Q1 2013 Earnings Call
May 31, 2013 09:00 AM ET
Kevin Theiss - Grayling
Mingwang Lu - CEO
Edward Meng - CFO
Greetings. Welcome to the China Gerui First Quarter 2013 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 Kevin Theiss from Grayling. Thank you Mr. Theiss. You may now begin.
Thank you. Good morning ladies and gentlemen and good evening to those of you joining us from China. I’m Kevin Theiss from Grayling. I would like to welcome all of you to China Gerui Advanced Materials Group’s conference call to discuss first quarter unaudited 2013 results. With me today I have China Gerui’s Chairman and Chief Executive Officer, Mr. Mingwang Lu and Chief Financial Officer Mr. Edward Meng. We will translate for Chairman Lu with his opening remarks and help with the Q&A.
I would like to remind our listeners in this call management’s prepared remarks contain forward-looking statements, which 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 statements that is contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ from those discussed today due to various risks including, but not limited to the availability of funds and working capital to finance activities; the actions and initiatives of current and potential competitors; the Company's ability to win new customers, merchants and vendors for its products; the development and acceptance of new steel products, marketing and promotional activities; pricing policies of suppliers and competitors; competition in the steel market; and other risks detailed in the Company's filings with the Securities and Exchange Commission.
Accordingly, although the Company believes that the expectations reflected in such forward-looking statements are reasonable, there can be no assurance that such expectations will prove to be correct. In addition to any projections as to the Company's future performance represents management's estimates as of today March 30, 2013. China Gerui assumes no obligation to update those projections in the future as the market conditions change.
I will now turn the call over to China Gerui's Chairman and CEO, Mr. Mingwang Lu for some brief openings remarks.
Ladies and gentlemen, thank you for joining us today and welcome to China Gerui Advanced Materials Group’s first quarter and unaudited earnings results conference call.
Our financial and operating results in the first quarter of 2013 reflects the ongoing slow economic growth and resulting weak demand for steel products in China, as well as fewest number of operating days in the year due to both the calendar New Year and the Chinese New Year holidays.
Consequently the intense competition has created an ongoing weak pricing environment. While we market primarily based on our reputation for high quality precessions cold-rolled steel and many long-term relationships with our customers, we are still subject to market pricing.
In the first quarter of 2013, our raw material cost declined slightly and our steel prices decreased more due to pricing pressures in the market. Our current pricing model is transitory and as demand for steel increases, we tend to be seeing current concessions that revert back to our premium pricing strategy overtime. We are temporarily restricting the output of certain steel products to maintain the current market supply and demand equilibrium and to avoid an aggressive pricing war with low grade cold-rolled steel producers and large integrated steel producers. All our product lines were in operation in the first quarter of 2013.
The utilization of our 500,000 ton of specialized cold-rolled steel was approximately 68% to 72% in the first quarter of 2012 which approximates the 75% to 80% utilization rate we achieved in the fourth quarter of 2012. The utilization of our higher margin chromium production line was approximately 62% during the first quarter of 2013, up from the 60% utilization rate of the fourth quarter of 2012.
We are evolving China Gerui into a more powerful steel supplier as our new steel lines are now all running at commercial rates. With these new steel products we are targeting high end specialized steel applications with higher margins. These combined steel lines further differentiate Chine Gerui from its competitors and many of them lack these capabilities.
Our new wide strip chromium plated and laminated steel lines are providing new products to sell for new applications to our current customers to increase our penetration of those markets as well as provide access for applications in new markets we could not before.
Just as we are building our steel lines into more comprehensive product line to capture market share and augment our leading position in the high end of the cold-rolled steel market, these new products provide more opportunities to boost our plans to become a global steel supplier.
For example we began making regular shipments to our first three international customers. Two customers are in India and one in Turkey who have purchased both wide and narrow strip high precision chromium plated cold-rolled strip steel. These products are being used in insulating wires and cables manufactured for the telecommunications industry.
The current order rate is running at approximately 3000 tons per year of this higher margin product. We have three other potential customers including one in the United States which is testing our products for use in the large food and beverage packaging industry.
However to create a long term healthy domestic environment, we believe the steel industry must undergo change. We have already noted that some smaller manufacturers have closed down, and expect closures to continue. The new leadership in the Chinese central government has noted that the steel industry among others must reduce it’s over capacity to strengthen pricing and enhance the long term outlook.
The central government is implementing policies to advance to consolidation of the steel industry. As a leader in the cold steel segment we are well positioned to benefit from these actions with more transaction opportunities for us and eventually fewer competitors in the future.
As we believe exports to the global markets can became one of our fastest growth driver in the future, we have hired Cambelle-Inland an investment firm led by our shareholder Craig T. Bouchard to advise us on strategic planning in our global expansion. Mr. Bouchard has a known track record of building companies in steel industry. Notably he was the cofounder and president of Esmark Inc. which grew from $4 million to $3.5 billion in revenue over four years and Esmark’s management acquired nine steel companies.
Esmark was one of the highest appreciating stats for the full year 2008 and we look forward to Mr. Bouchard’s future contributions to help us build a much larger profitable and globalized China Gerui to create shareholder value.
Thank you everyone for joining us. I will now turn the call over to Mr. Edward Meng, our Chief Financial Officer.
Thank you Mr. Lu and thank you everyone for joining us for this conference call. I will present a summary of the first quarter financials. For more details please refer to our earnings Press Release which was distributed earlier today.
Our revenue decreased 33.6% to $45.6 million in the first quarter of 2013 from $68.7 million in the first quarter of 2012. A decrease in revenue was primarily due to a 18.4% decrease in the Company’s average selling price for $733 per ton for the first quarter of 2013 as compared to an average selling price of $898 for the first quarter of 2012, as well as 18.6% decrease in sales volume to approximately 63,240 tons for the first quarter of 2013 as compared to approximately 76,500 tones for the same quarter of last year.
Gross profit decreased 75.8% to $5.2 million in the first quarter of 2013 from $21.5 million in the same quarter of 2012. Gross margin was 11.4% in the first quarter of 2013, compared to 31.3% in the first quarter of 2012, but was higher than 10.7% of the fourth quarter of 2012.
The decrease in gross margin compared with a year ago was due to lower sales as the economic slowdown in China continues and domestic assumption declined in the first quarter of 2013. The resulting reduction, a huge amount continue to drive this severe competition and the pricing pressures currently in the marketplace during the quarter.
Raw material prices in first quarter of 2013 were higher in the same quarter last year, but were slightly lower than at the end of 2012. In addition, we were undergoing the slide (ph) production of the newly launched laminated steel sheets production line. So some of that material for testing proposes also went to the cost for goods sold.
Our operating income decreased 89.1% to $2.1 million in the first quarter of 2013. From operating income of $19 million for the first quarter of 2012. The decrease in operating income in the first quarter of 2013 was primarily due to a 75.8% decrease in gross profits and higher operating expenses as compared to the first quarter of 2012.
Non-GAAP operating income excluding onetime stock based compensation expense of 32,891 (ph) was $2.1 million. Net loss was 20,000 in the first quarter of 2013, or zero per fully diluted share including the impact of a onetime stock based compensation expense of $32,891, compared to a net profit of 14 million or $0.24 per share in the first quarter of 2012.
Non GAAP adjusted EBITDA was $5.1 million in the first quarter of 2013 or 11.1% of revenue compared to $22 million or 32% of revenue in the first quarter of 2012. Non GAAP adjusted EBITDA is defined as earnings before net interest expense, taxes, depreciation, amortization and a onetime stock based compensation expense incurred in the first quarter of fiscal year 2013.
Please see the section in the Press Release entitles use of non GAAP adjusted financial measures and a reconciliation table at the end of the Press Release for an explanation and a positive comparison of the non GAAP measures used in this script to the GAAP equivalent.
As of March 31, 2013, the company has $234 million unrestricted cash, $21.4 million in current certificates of deposits an additional $142.7 million in restricted cash, as compared to $228.9 million in all restrictive cash, $16.4 million in current certificates of deposits and an additional $145.4 million in restricted cash as of December 31, 2012.
Working capital was 150.3 million at March 31, 2013, compared to a $151.7 million at December 31, 2012. The Company's short term debt consisted of notes payable and term loans that totaled $328.5 million at March 31, 2013, compared to $317 million as of December 31, 2012.
The company has no long term liability. Shareholders' equity was $331.1 million at March 31, 2013 as compared to $330.1 million as of December 31, 2012. Net cash provided by operating activities for the three months ended March 31, 2013, were $3.9 million compared with $6.5 million in the first quarter of 2012 but above the 2.1 million in the year ended December 31, 2012.
We will now begin the business update and outlook section to provide better clarity, as to China Gerui's strategies to position itself in a challenging domestic marketplace as we also focus on becoming a global metals processor. Our comprehensive offering of products are enhancing of domestic market position and we are taking our global expansion strategy to a new level.
I will begin with a brief review of China's economy in the first quarter. Economic data indicates that China's GDP growth rate was 7.7% in the first quarter of 2013, below the 8.1% in the year ago quarter and the 7.9% in the fourth quarter of 2012, according to the National Bureau of Statistics. Domestic consumption of goods declined in the first quarter of 2013 as well.
While most economies would be pleased to grow by 7.7%, this slower growth rate is causing serious disruption in China's industrial output. The company believes growth below 8% creates an unhealthy competitive environment within China.
In April 2013, the China Iron and Steel Association issued a warning and an appeal for steel companies to restrict their expansion as approximately one third of all Chinese steel companies reported a loss in the first quarter of 2013 due to ongoing over capacity and poor margins.
The RMB4 trillion stimulus plan is being implemented by the central government to boost economic growth and domestic consumption as well as a program to raise spending on infrastructure. Additional new (inaudible) may emerge from the central leadership to help the Chinese economy recover higher growth over time and increased demand for steel products.
All measures, especially those focused on increasing heavy industry business should positively affect the China steel industry's weak fundamentals and our business as well. We are optimistic that economic activity may begin to rebound in the second half of 2013, thereby positively creating an increasing demand for domestic steel products and that is also the basis for our full year guidance we had given out earlier this year.
Further as the global economy tries to recovers, the amount for steel should arise as we positively, progressively, improve the common excess new capacity and the weak pricing environment as exports increase as well.
The overall underperformance of China’s steel industry is primarily due to limited market demand coupled by excess production capacity. The current market conditions are encouraging consolidation in the Chinese steel industry and the central government is setting policies to help persuade competitors to pursue acquisitions and mergers. Consolidation is already evident in the upper stream of the crude steel production industry. We anticipate consolidation. We’re migrating to lower stream of the steel processing sector in the near future.
As a leading company in China in the cold-rolled steel sector with substantial financial strength, China Gerui is well positioned to benefit from accretive opportunities within China, and we may consider international transaction as well. Consolidation will hesitant the resolution of the current access capacity, intense competition, and predatory pricing condition prevalent in the Chinese steel industry overtime.
Prices for cold-rolled steel in the first quarter of 2013 declined faster enough than the decline in hot-rolled price, which is our raw material for natural processing. Variations in our raw material cost has been exceeding our capacity to particularly match those changes and our prices of real limited prior cost model and a weak market for steel prices. The result is lower gross margins compared to when a steel market condition are more rational. As we have not engaged in price force, we expect we’ll eliminate the recent price concessions and charge higher prices when supply and demands are normalized.
We are hopeful that as demand for steel rebounds begin in second half of 2013, we will be able eventually exhibit stronger gross margins as prices become firmer and the current excess competitor pressures subside.
Our new product offerings are expected to carry higher gross margin as well. In January 2013, China Gerui announced the production of a new laminated steel processing line at existing production facilities in Zhengzhou, China. The new laminated steel processing production line is currently undergoing final trial production and will begin commercial production in later half of second quarter of 2013.
The new laminated production line utilizes our old cold-rolled steel as a raw material to produce a specialized steel material that will be primarily marketed to the food and the beverage packaging, electrical appliances, and the construction and decoration markets.
These markets are more correlated for domestic consumption expenditures than to heavy industry applications thereby further diversifying our products reach and make us less dependent on large scale infrastructure projects.
The new laminated production line is designed to produce up to 30,000 tons per year of laminated steel sheets with room to grow when necessary. Together with the new wide strip-line and the chromium plating line, we have expanded and diversified our product offering to cover captured market share and attract new customers. All three new production lines will be operating our commercial rate in the second quarter of 2013 and then increase of economy of scale for basic metal processing operations.
Our R&D’s ability to develop new products differentiate us versus many of our peers and it creates opportunity to expand our relations with current customers. The plan for R&D is to develop additional new steel product applications to further enter in new markets, enhance our competitive position and distinguish ourselves in the steel industry.
We currently have five series of 20 products and we expect to expand that into seven series of 25 products over the next year focusing on consumption driven industries. Our product diversification further increases the applicability of our products to new uses in the market including exports to foreign markets and it makes us less dependent on our historical domestic customer base.
Given the current onset of market condition in China and our high quality diversified steel products and efficient production, we believe the time is right to ramp up our marketing in the current markets to achieve our global ambitions. The emerging markets will present excellent targets as there is a very limited high precision cold-rolled steel competition. The more mature markets represent the potential of much larger order size.
We have already captured three customers, providing regular orders with additional potential customers reviewing our products. We look forward to using the expertise of Cambelle-Inland and Mr. Craig Bouchard to acquire or merge with other steel companies to attain a significant position in the global markets and build China Gerui into a much larger, global, world-class, high precision metal producer for our shareholders.
China Gerui thanks our investors for their support at the current low price of our stock. As of March 31, 2013, the company has purchased 1,971,529 ordinary shares at an average price about $3.08 per share, for total repurchase price of approximately 6.1 million. During March of the first quarter, during a communication blackout period, China Gerui is now ready to resume the share repurchase program right after today’s earnings announcement.
Due to the recent market conditions, our revenue guidance for the year 2013 is between $280 million to $290 million. We continue to monitor the market conditions, especially the capacity and the pricing movement that provided information and allow business with investors.
Operator, we are now ready for questions.
Thank you. (Operator Instructions). Our first question is from the line of (inaudible) of King Captial.
Thank you for taking my questions. I have several questions and my first one is on the pricing dynamics. You mentioned that your ASP came down by almost 20% year-over-year in the quarter, while your raw material price was actually higher year-over-year. So that was causing you on margin to squeeze. So in that case, it sounds like the competition the hot rolled steel which is your raw material is much less intense compared to your high precision cold-rolled steel but isn’t the hot rolled steel where most of the oversupply exists? So I was just wondering, just can you help me understand better about the pricing dynamic between your raw material and your finished products and do you also see the gross margin continue to squeeze in the second quarter.
Let me put it this way. Well first of all for the movement and also the correlation of the hot-rolled steel and then cold-rolled steel, I would suggest in our view, our investors can give a quick reference to the mysteel.com, you can see the pricing trends. Also you can see they move, they are pretty much in the same trends but they just add different speed and different start curve. But starting from the beginning of the January, the price hesitates a little bit, slightly up until April and then the price has been for both hot-rolled and also for cold-rolled steel, the price has been diving to (inaudible) until I mean as we speak.
So yes, the excess capacity is more in the upper stream in crude steel sector and this means lower-ends metal processing sector will see the competition or the pressure of pricing primarily come from a weaker demand compared with a pricing war where we see the competition, we see the homogenization of the products. Basically a lot of competitors, they are facing the problem of whether they shut it down or just operating at a slight loss, selling the products at lower price. So that’s why we have refrained from releasing our capacity just engaging this pricing war.
So we do see that and we do believe that as the market recovers in the second half we will see the company will be reaching its position in premium pricing and also see a recovering gross margin going forward.
When we provide our guidance for the full year, we have even anticipated a weak first quarter, an improving second quarter but the major reversing of the depressing steel prices, we do see that is going to happen in the second half of the year given the new government, given the new products of the government to cut back on excess capacity as well as to boost economy by encouraging investment in the infrastructure to grow consumption for the industry. Does that answer your question?
Okay, yes so you are seeing the major improvements wont kick in until the second half of this year but have you seen so far in the second quarter the improving ASP, improving pricing dynamics and as well as in demand?
To answer your question actually as I said earlier I mean if you look at the pricing chart of the China steel product prices. The sales decline of the prices for both hot-rolled and cold-rolled steel just started in April and also continued all the way to as we speak first end of May. So we do not see major pricing improvement in the second quarter, but we do see the volume rise in the customer demand is gradually coming back a little. So we are cautiously optimistic of our second quarter.
Got it, thank you, so switching gears…?
Now let me make additional remarks. In this sector of the market for cold-rolled products we do see that China Gerui has been a leading company in terms of the precession and also the let’s say certification of this product. So we have been charging a premium all these years and until last year when the market really declined.
The current market condition I guess even more for a company China Gerui to kind of beef up its R&D assets to look for more diversified product offering in order to differentiate ourselves and elevate ourselves away and above the competition cost so that we have been doing and we are continuingly working on that. As we said earlier the company have been focusing on retaining existing customers, waiting for the market to come back so that we can do premium pricing again and at the same time we have been spending a lot assets in R&D including a recently introducing a laminated steel product.
Okay, I understand. So switching gears let’s talk about your balance sheet. Just wondering why in those payable demand in such high level and I see what they are pricing on prepaid purchase in quarter, when the sales volumes in recent quarters has been on decline. So just remind me again what are those bills payable mainly used for? And you also mentioned now, in the past quarter you did mention about you anticipate to correct some reform from the suppliers for whom you will make that prepayment to. So just wondering what’s the progress on this front and what is this repayment of advance from unrelated third party about $1.6 million as well.
I will take your question now. First one, the notes payable, just that our short term liability consists of short term bank loans as well as notes payable. Most of the notes payable are actually for the purpose of funding our raw material purchases. That means the bank will issue notes payable already have to our new suppliers, raw material suppliers are usually those of six months term. So if the supplier waits for six months and get the full amount or if in they need cash, I mean short term, they can always cash back notes payable of discount from the bank. So, that’s the typical purpose of those.
So the notes payable, I mean as you can see, after six months term and they keep rolling into the next period until they get expired. And then, for China Gerui, in our relationship with local banks we are cutting back on the cash loan available to us. For example the short term loans, those are typically cash loans but we are encouraging the notes payable issuance as a short term lending to the bank.
So if there is any issue for the notes payable the bank will require from 50% to 80% cash guarantee or cash deposit guarantee. So that’s why you see, in the balance sheet of China Gerui you see notes payable. At the same time you see the restricted cash which are typically for our cash deposit for the bank to issue notes payable. So that explains the first part of the question.
And technically talking about prepaid expenses, as I explained earlier in the conference calls, we did arrange to have several suppliers to help us to look at diversified raw material supply within a short term with a lot of flexibility required because we anticipate that going forward we will be offering to the market, not just cold-rolled steel, not just a narrow-strip cold-rolled steel, but also wide-strip cold-rolled steel, laminated steel and then chromium plated which means we used to repurchase from the raw material suppliers just narrow strip hot-rolled steel, but going forward will be a new purchasing, both narrow-strip and wide-strip as well as probably finished cold-rolled steel that can go directly into the chromium plating or laminating process. So that’s one of our plan from last year.
But given the market, I mean the way it was last year, we did have some, more like onsite, we did have let’s say additional surplus ending at prepayment to the supplier. So we have been checking accounts with the suppliers and getting those excess prepayments and refunded to us. So that is something we have been working on, is making great progress. First of all, we don’t see any collectability issue as to prepayment.
So they are coming back. Just at, after the Chinese New Year in February, by the end of March, and by the time we close the book, some of the refunds have been reached but just not received yet. So they still carry out prepayments for the time being. But I do believe that getting to the second quarter, once you see the second quarter financials, they see the prepayment balance is going to come down assuming we are pretty much at the same operating level or the same raw material purchase volume.
So in second quarter are we going to see the prepayment numbers come down because you will be able to collect refund? And is it fair to expect that your notes payable is going to remain at about the same level. As you rose every six months or are you going to continue to maintain at that level?
First of all, we are conscious of managing of leverage. So we are trying to cut back on the short term liability level including notes payable. But as I said, right now in China for the local – right now given the current capital market situations there are only sort of funding for us would be either some or all operating cash generated from operating activity or from the local bank borrowing.
However, the local banks have been very credit conscious. They've been coming back on the loans of available, cash loans available to among state on the company’s side China Gerui but at the same time they have been encouraging the borrowers like China Gerui to depend on the notes payable instead of a new cash loan because as I said, notes payable they got 50% out of 100% I mean cash guarantees to pack it. So the bank is using in this leverage to mitigate their credit risk. So, we do see this is going to continue but we do we take it a very seriously about we were looking at a financing going forward and to having this on a notes payable level under control.
(Operator Instructions). Next question is from line of (inaudible).
What is the current book value per share?
Right now, if you look at the current book value, we’ll be looking at approximately about $1.50 to $2.
At this time, I will turn the call back to management for closing comments.
Thank you for all of your participation in China Gerui's first quarter earnings call. I will now conclude the call and you may disconnect your lines. Thank you very much. Have a good day.
Thank you. Today’s teleconference is ended you may now disconnect your lines. And thank you for your participation.
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