China Gerui Advanced Materials Group Limited (NASDAQ:CHOP)
Q2 2013 Earnings Call
August 28, 2013 9:00 a.m. ET
Mingwang Lu - CEO
Edward Meng - CFO
Echo He - Maxim Group
Greetings and welcome to the China Gerui Advanced Materials Group’s Second Quarter 2013 Earnings 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 Mr. [Swee Yen]. Thank you Mr. Yen. You may now begin your conference.
Thank you, Jesse. Good morning ladies and gentlemen and good evening to those of you joining us from China. Welcome to China Gerui Advanced Materials Group’s conference call to discuss the unaudited financial results of the second quarter of 2013. 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 first 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 its 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, any projections as to the company's future performance represent management's estimates as of today. China Gerui assumes no obligation to update these projections in the future as the market conditions change.
The 2013 second quarter press release and the script includes the use of non-GAAP EBITDA, which is a financial measure that is not defined by the U.S. generally accepted accounting principles, or U.S. GAAP. Non-GAAP EBITDA is defined in the second quarter earnings release and in the script as earnings before interest, taxes, depreciation, and amortization that were incurred in the second quarter of 2013.
I will now turn the call over to China Gerui's Chairman and CEO, Mr. Mingwang Lu for some brief openings remarks. Mr. Lu please.
[Interpreted] Ladies and gentlemen, thank you for joining us today and welcome to China Gerui Advanced Materials second quarter and unaudited financial results conference call. Our financial and operating results in the second quarter of 2013 continued to reflect the weak pricing environment created by slow economic growth, weak demand for steel products and excess steel production capacity in China. China GDP growth declined further to 7.5% in the second quarter of 2013 from 7.7% in the 2013 first quarter and 7.9% in the fourth quarter of 2012 according to the National Bureau of Statistics.
We continued to market our precision cold-rolled steel products in this highly competitive market based on our ability to meet or exceed customers’ expectations. However in this marketplace our customers continued to be price sensitive as our average selling declined by 15.7% to $692 per ton for the second quarter of 2013 as compared to an average selling price of $821 for the second quarter of 2012.
In the second quarter of 2013, a 33% decrease in the steel volume compared with the second quarter last year, combined with our steel prices declining greater than the reduction in our raw material costs caused our gross margin to decline to 8.2% from 25.8% in the second quarter of 2012.
To some extent, we have deliberately limited the output of certain steel products temporarily to maintain the current market supply and demand balance in the market to avoid adding further pricing pressures which would only worsen market conditions. These products have included our main steel products as well as restricting the manufacture and promotion of our newer innovative chromium plated wide strip and laminated products until market conditions improve. We remain very confident that price concessions will be reversed as market conditions improve in the future.
During the second quarter of 2013, we believe we have outperformed most of our competitors in terms of profitability as measured by our EBITDA ratio and have gained our market share in the face of a continued weak demand for steel products in China. All our production lines have been in operation and our steel volume has been stable at approximately 62,000 tons per quarter over the first half of 2013.
The China Iron and Steel Association reported that for the first 6 months of 2013, its members reported a revenue increase of 0.94% with an average gross margin of 0.13%, far below our current month’s margin. And for the month of June, members of the Association reported their first monthly net loss totaling RMB699 million due to decreasing steel prices. On the other hand, we were able to stabilize our production volumes in the first and second quarters as we have retained key customers and we generated a positive EBITDA of $4.0 million.
The utilization of our 500,000 tons of specialized cold-rolled steel was approximately 48% in the second quarter compared with approximately 70% in the first quarter of 2013. Again, some of this capacity is deliberately in use to not exasperate the current weak market conditions further. The utilization of our higher margin chromium production line was approximately 43% during the second quarter of 2013, down from the 62% utilization rate in the first quarter of 2013.
With all our different steel production lines operating at commercial run rates we are close to completing trial production. Part of our plan to transform China Gerui into a more high end specialized steel producer has been accomplished. We have more products to offer our current customers and innovative new products to attract new customers in different markets. Many of our smaller less sophisticated competitors are unable to match our strategic product diversification with our wide strip chromium plated and laminated steel lines. We believe these changes will allow us to capture more market share with higher margins when the steel market returns to a more normal growth pattern.
Our product diversification will provide a competitive advantage as the steel industry is restructuring with the smaller manufacturers ceasing operation and the central government’s policies encouraging further consolidation to build a stronger steel industry for the future. With a more comprehensive product lines focused on the high end of the cold-rolled steel market reflects to continue our leadership in the larger steel market in China. Our new product diversification was also designed as a step to attract customers as part of our globalization strategy.
The large demand for steel, especially specialized steel that can have a very limited production capacity in other countries, provides the opportunity to diversify our markets and increase our production efficiency. We entered the [premium] exports to become a growing proportion of our sales over the next few years as we build out our newer products to enhance our market competitiveness.
We also look to acquisitions and mergers as another step in the advancement of China Gerui for the future. We will be opportunistic to acquire or partner with another company to create an accretive and more powerful operation. With our financial strength, we are well positioned to make significant strategic transactions as the current market environment may provide a number of synergistic opportunities domestically and in foreign markets.
In summary, continued investment in real estate and fixed assets as well as relatively steady demand from certain industries such as automotive and heavy duty equipment offer the prospect of a stronger steel demand in China in the future. We are further positioning China Gerui to become a substantial player in the global steel industry with a much larger global customer base through our comprehensive product mix and the potential future acquisition. By improving our production efficiency, we expect to become an even more effective competitor and benefit from the next recovery in the Chinese steel market. Acquisitions and merger transactions offer the opportunity to quickly transform our company into a larger company capable of becoming a more profitable competitor in the global markets.
Thank you again for joining us. I will now turn the call over to Edward, our chief financial officer, to go over our second quarter results.
Thank you, Mr. Lu and I do appreciate all on the line joining this earnings call. I will present a summary of the second quarter financials. For more details please refer to our earnings press release which was distributed earlier today before the market opened.
In the second quarter of 2013 our revenue decreased 43.9% to $43.1 million from $76.8 million in the second quarter of 2012. The decrease in revenue was primarily due to a 15.7% decrease in our average selling price to $692 per ton for the second quarter of 2013 as compared to an average selling price of $821 for the second quarter of 2012 as well as a 33.2% decrease in sales volume to approximately 62,500 tons for the second quarter of 2013 as compared to approximately 93,500 tons for the same period of last year.
Gross profit decreased 82.2% to $3.5 million in the second quarter of 2013 from $19.8 million in the same quarter of 2012. Gross margin was 8.2% in the second quarter of 2013 compared to 25.8% in the second quarter of 2012. The decrease in gross margin compared with a year ago was due to lower sales as the economic slowdown in China continued and domestic consumption declined in the second quarter of this year. Excess capacity and reduced steel demand continued to create the intense competition and pricing pressures currently in the marketplace during the quarter.
Operating income decreased 93.4% to $1.1 million in the second quarter of 2013, from operating income of $16.8 million for the second quarter of 2012. The decrease in operating income in the second quarter of 2013 was primarily due to an 82.2% decrease in gross profit.
Net loss was $0.64 million in the second quarter of 2013, or nil per fully diluted share, compared to a net profit of $10.3 million, or $0.18 per share in the second quarter of 2012.
Non-GAAP EBITDA was $4 million in the second quarter of 2013, or 9.3% of revenue, compared to $19.8 million, or 25.6% of revenue, in the second quarter of 2012. Non-GAAP EBITDA is defined as earnings before net interest expense, taxes, depreciation, and amortization incurred in the second quarter of fiscal year 2013.
You can see in the press release that we gave out just this morning. There was a section in the entitled "Use of Non-GAAP Adjusted Financial Measures" and the reconciliation table at the end of the press release for an explanation and quantitative comparison of the non-GAAP measures used in this press release to their GAAP equivalents.
Now about the financial condition of the company, as of June 30, 2013, we had $203.6 million in unrestricted cash, $28 million in current certificates of deposits, and an additional $169.8 million in restricted cash, as compared to $228.9 million in unrestricted cash, $16.4 million in current certificates of deposits and an additional $145.4 million in restricted cash as of December 31, 2012.
The company's short-term debt consisted of notes payable and term loans that totaled $377.5 million at June 30, 2013, compared to $317 million as of December 31, 2012. Working capital was $131 million and we had no long-term liabilities at June 30, 2013. Shareholders' equity was $334.4 million at June 30, 2013 as compared to $330.1 million as of December 31, 2012. Net cash used in operating activities for the first six months ended June 30, 2013 was $22.5 million compared with $25 million of net cash flow provided during the first six months of 2012.
We will now begin the business update and outlook to provide better insight into China Gerui's strategies in a difficult domestic marketplace even as we begin to focus on becoming a global metal processor. Our product diversification is a key strategy to both capture market share in China and to position the company for global expansion.
I will begin with a brief review of China's steel market in the second quarter. As we mentioned in the first quarter, in April 2013, the China Iron and Steel Association issued a warning and an appeal for steel companies in China to restrict their expansion as approximately one third of all Chinese steel companies reported a loss in the first quarter of 2013. The Association had also reported in July that for the first 6 months of 2013, its members’ total revenue was RMB1.8 trillion, an increase of 0.94% with net income of RMB2.267 billion. Members’ average gross margin was only 0.13% and these companies recorded the first monthly net loss of RMB699 million in June as steel prices declined.
Now what is interesting is included in the net income of the above mentioned RMB2.267 billion was RMB4.321 billon from profitable investments and RMB3.88 billion income from non-operating activities. It’s more like joke but for example, like (inaudible) steel because of income from non-operating activities. Combining all these components indicated a significant loss from the members’ steel operations. The Association reported that total maximum production of iron increased by 5.7% to 357.45 million tons, crude steel production increased by 7.4% to 389.87 million tons and steel production increased by 10.2% to 516.96 million tons compared with the first half of 2012.
The recent average daily production of crude steel was 2.15 million tons which represented full year manufacturing capacity of approximately 786 million tons. For the first six months of 2013, steel imports declined by 1.8% to 2.83 million tons while iron ore imports rose by 4.9% to 384 million tons with an average import price of 133.24 per ton or a decrease of $0.625 per ton from the same period of last year.
It’s interesting to see our steel exports rose by 12.6% to 30.69 million tons in the first half year of 2013. The net export of crude steel was 25.09 million tons. Exports will face additional challenges in the future as a selective number of foreign governments have launched a number of investigations into steel export from China. We believe China Gerui has nothing to fear from these investigations as some competitors become under greater scrutiny.
Total crude steel consumption in the first half of 2013 was 364.6 million tons, an increase of 23.24 million tons or 6.8% from the same period of last year. However from aboard crude steel production increased by 7.4% to 389.87 million tons creating excess supply in the markets. Steel inventory increased in the first quarter of 2013 to 19.97 million tons but declined to 15.48 million tons by the end of June 2013. This steel high inventory position and it was 30.1% or 3.58 million tons above inventory level at June 30, 2012.
The new central government of China is implementing a urbanization program in the coming 10 years which will result in higher spending on selected infrastructure and housing projects which could increase demand for domestic steel and change in consumption pattern of the formerly rural population. As near as in the second quarter of 2013, growth in fixed asset investments grew by 20.1% but this was a slightly lower growth than in the first quarter of 2013. Real estate investment rose by 20.3% year over year which was a slightly better than in the first quarter of 2013.
As a leader in the domestic steel industry as a premium metal processor, we are well positioned to be a beneficiary of in the new spending of steel in the coming years. Our selling prices for cold-rolled steel in the second quarter of 2013 continued to decline faster than the price decline in our raw material that is hot-rolled steel price. Our cash stock model and a weak market for the steel prices resulted in lower gross margin on the upper stream, our suppliers of raw material of hot rolled steel was reluctant to further reduce the average selling price in the domestic markets since we enjoyed an improved export markets.
On the lower stream, our customers have been resistant to price increases for the last three quarters straight. An excess capacity and overall weak demand for cold rolled steel have pushed the average selling price further southward. As far as our competitor concerns, some state-owned steel producers are leveraging their hot rolled steel production capability to penetrate the volume driven cold rolled steel market such as home appliances and construction and decoration materials. Most of the non-state owned competitors have incurred heavy losses, some even shut down, with negative EBITDA ratio and would directly engage in pricing more to keep their facility running even if at loss. So at least to be able to lease bank loan repayment obligations. Thus competition on pricing has further aggravated the overall unfavourable market condition.
We at China Gerui have had to recognize the price sensitivity of our customers but we have refused to engage in all-out price war. We believe after market improves over time, we can re-establish our premium pricing as supply and demand become even more [different]. As our new advanced product offering contribute a higher proposition of the sales, the higher prices will have to be expected in gross margins. Our R&D program, we continue to improve the efficiency of our production as we have introduced additional new products to further diversify our growing steel products, from pipelines with 20 products to (inaudible) with 25 products and more, primarily targeting consumption of these industries which make us less dependent on large infrastructure projects.
The current weak market conditions and government policies, our encouraging consolidation in the Chinese steel industry both in the crude steel and also in the total steel markets leads us to elevate the current supply over-capacity and the improved market pricing over time. We have seen some consolidation already in the upper stream of the steel production industry and we expect more transactions in the lower stream too. China Gerui is well positioned to benefit from this consolidation either through making accretive transactions or benefitting from the resulting positive changes in supply, pricing, and aggressive competition in the marketplace.
With our high quality diversified steel products and with the efficient production, we are also looking to capture market share in the current markets which lack our specialized steel products. To achieve our global ambition, we believe we have the necessary products and the price values to penetrate mature markets where we can obtain much larger order size. We have already begun this process and captured a number of customers in the emerging markets. We will also consider acquisition and merger transactions outside of China to fulfil our vision of becoming a large more profitable company, building value for our shareholders.
We thank our investors for your support at the current market price of our stock. Since the launch of the share repurchase program in April 2011, as of June 30, 2013 the company had repurchased a total of 2,010,918 ordinary shares at an average price of $3.06 per share for a total repurchase price of approximately $6.2 million.
Given the current market conditions and the volatility of the steel prices and one we have experienced for July and also going the part of August, the company has revised its full year 2013 revenue guidance to the range 165 million to 170 million. The company may adjust the guidance as the changing macro-economic conditions and operational and competitive challenges dictates.
Jesse, operator, we are now ready for questions.
(Operator Instructions) Our first question comes from the line of Echo He with Maxim Group.
Echo He - Maxim Group
Several questions. First of all, the government policy of cutting the surplus of capacity, regarding that point, I have seen that the government already kind of has some state-owned large steel manufacturing partner capacity, is that a part of the [serious] policy, I did want to ask, how that kind of policy is going to be executed and is that going to affect also metal manufacturers like China Gerui? Also the second one I would like to ask whether management have any immediate plan to acquire some other manufacturers internationally or domestically? Also how much revenue from international accounted for the total revenue? And also, the last one is about the credit environment, whether that change in credit environment has affected the company’s daily operation and also how in overall that is going to affect the steel industry going forward? [Foreign Language]
Thank you Echo. Good coverage on the overall industry and also the many governmental competition really affects China Gerui. Let me take your four questions one by one. Now first of all about the reduction of excess capacity efforts driven by the government, you are right. It’s going to be that effort or that drive is going to be carried out in a phased-out periods, it’s going to be carried out within the next couple of years. Also it’s going to be carried out with the focus on -- primarily on the steel producers with – I won’t say obsolete but relatively backward in technology and also with a relatively higher consumption of power and also a evidence of problem environmental protection stress. We believe that’s going to be a factor or essentially music to the ear for cutting the rate because right now that excess capacity reduction efforts primarily on the upper stream in the steel production affect us. So if that gets – once that continues to be carried out, we are going to see a relatively more consolidated number of a large steel producers, more efficient and the price is going to be more stable. They are going to help to drive the equilibrium between supply and demand in the market. As the, let’s say, customer of China Gerui for those steel producers we think that’s going to help us to rapidly recover some of the premium pricing capability that we had until last year. Now that’s the first question.
Secondly, you asked about the purchase or mergers and acquisition that we are looking at. The company has been very actively looking at this issue and very recently as of May, see we have on the press release going out, we have partnered with Cambelle-Inland, a company founded and is driven by and also led by Craig Bouchard and his team to help us to look at the international market, a potential partner or even targets for potential acquisition. Also domestically, we have been actively looking at some potential targets but right now I guess we have been very disciplined in the sense that we will make sure that any acquisition is going to be accretive as soon as possible and also it’s going to be the mix of best use of the cash or financing available to us. So we do anticipate some things could happen and at the appropriate time we will – we are going to share this news with our investors once they become available in the progress.
And thirdly, right now given the current market situation in domestic China we have been looking at the overseas market as a way to digest some of the capacity that we have in China Gerui. In the longer term we are looking at a revenue contribution from overseas or international sales anywhere between 30% to 50%, that will be including the sale from our products from the existing facility of China Gerui as well as from potential acquisitions that’s going to happen in the overseas market. Currently as we said just now in the call, we have achieved some very positive results. We have a very strong interest from potential customers from the overseas markets. Right now we do have some revenue coming but not yet a significant in the sense we look at given the overall top line we have. But we do see that that’s part of the foundation for sustainable growth in this market.
Still for the international sales, right now given the historical low pricing level in the domestic markets which can be easy to use as a reference point for any potential international customer, so we have been very cautious with committing ourselves to any long term large volume international sales now.
Last but not the last, talking about overall credits in China, there has been a very wide media coverage about the banking – overall banking systems credit crunch couple of months ago. Yes, it directly impacted us. I mean the same as with our competitors or [supply and customers]. So there are several impacts, one, we see a relatively higher cost of finance from the banks. We have from the bank, right now we have cash allowance, interest rate decrease and so the bank has not credit availability, or the loan availability to borrow (inaudible). And secondly, for example, if you look at our balance sheet, you see our short term loan, our short term borrowings come – from the short term loans from the bank as well as from the loans payable that we issue to our suppliers. It used to be for the loans payable that we issue, the banks will require anywhere between 50% to 100% on the cash guarantee and now we see the banks most of the case may be asking for 100% cash guarantee now. So that’s going to be challenged but given the current cash position and our overall working capital position, we think – I think we are lucky to enjoy a far better balance sheet than most of our competitors.
(Operator Instructions) Thank you. And at this time we will be concluding our earnings call. I would like to turn the floor back over to Edward Meng for any concluding comments.
Again, thank you very much everybody for attending this earnings call of China Gerui. Again we do appreciate our shareholders for their trust and also their support at the current capital market conditions. And we will do everything we can here in China despite the challenging market conditions, we are continuing to diversify our product mix and also position ourselves as the first company to take off when the market comes backs to a more normal market conditions. We will conclude this call. We appreciate that and you have a good day. Thank you.
Thank you. Ladies and gentlemen this does conclude today’s teleconference. You may now disconnect your lines at this time and thank you for your participation.
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