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Cleantech Solutions International, Inc. (NASDAQ:CLNT)

Q4 2013 Earnings Conference Call

March 31, 2014 9:00 AM ET

Executives

Elaine Ketchmere - Compass Investor Relations

Adam Wasserman - Chief Financial Officer

Ryan Hua - Vice President, Operations

Maple Jong - Compass Investor Relations

Analysts

George Appleyard - Appleyard Investments

Matthew Larson - Morgan Stanley

Operator

Hello, and welcome to the Cleantech Solutions International Fourth Quarter 2013 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 Ms. Elaine Ketchmere with Compass Investor Relations. Please go ahead.

Elaine Ketchmere

Thank you, operator. Good morning, ladies and gentlemen and good evening to those of you joining in from China. I would like to welcome all of you to Cleantech Solutions' earnings conference call for the fourth quarter and full year 2013.

With me today on the call are Cleantech Solutions' CFO, Mr. Adam Wasserman and Vice President of Operations, Mr. Ryan Hua. Also on the call is Maple Jong from Compass Investor Relations, who will provide translation for Mr. Hua.

At this time, I remind our listeners that on this call management’s prepared remarks contain forward-looking statements, which are subject to risks and uncertainties and that management may make additional forward-looking statements in response to your questions. Therefore, the company claims the protection of the Safe Harbor in its forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995.

Actual results may differ from those discussed today and therefore we refer you to a more detailed discussion of the risks and uncertainties in the company's filings with the U.S. Securities and Exchange Commission, including factors described in Risk Factors and Management’s Discussion and Analysis of Financial Conditions and Results of Operations in our Form 10-K for the year ended December 31, 2013.

Any projections as to the company's future performance represent management's estimates that are made as of today March 31, 2014. Cleantech Solutions International Inc assumes no obligation to update these projections in the future as conditions change.

At this point, I would also like to state that on this call, we will be discussing a non-GAAP financial measure, adjusted EBITDA. We present this financial measure as a supplement to our GAAP results, because we believe it provides useful information in analyzing and benchmarking the performance of our operations and assist investors in analyzing our year-over-year financial performance. Please visit our earnings press release, a copy of which is on our website and has been filed with the SEC as an exhibit to our Form 8-K for a complete reconciliation of adjusted EBITDA to the closest GAAP measure.

Now, it’s my pleasure to welcome Cleantech Solutions' CFO, Mr. Adam Wasserman who will deliver management’s prepared remarks, covering operations and financial performance today. Adam, please proceed.

Adam Wasserman

Okay. Thank you, Elaine. Good morning, everyone and thank you for joining us on our call today. We appreciate your continued support and interest in Cleantech Solutions. We closed 2013 with solid financial performance. Our full year revenue exceeded expectations and net income nearly doubled despite the impact of a non-cash impairment charge related to equipment held for operating lease at year end.

The primary driver of our success this year was our dyeing machine segment, which grew 52% in 2013 as the growing number of textile manufacturers who adopted our low-emission airflow dyeing machines.

Sales of our new after treatment compacting machine picked up in the fourth quarter and we sold a total of seven machines in 2013. We also have seen good traction in sales of our higher-end dying machines, which are selling more quickly than our original line of machines.

We saw some softness in sales and customers in the wind power industry, but this was offset by growth in sales of forged products from customers in other industries.

As a company focused on providing environmental-friendly low emission equipment to the textile industry and precision components to a range of clean technology customers, we are excited by the Chinese government's more aggressive stance to clear pollutions.

Earlier this year, Prime Minister, Li Keqiang, declared war on pollution acknowledging the severity of China's pollution problems. This was underscored by the report issued by Chinese Ministry of Environmental Protection last week that said only three of the 74 Chinese cities monitoring by the central government met minimal air quality standards in 2013. While the government will have to balance environmental issues with economic growth, cutting pollution is clearly an important issue.

With strict enforcement of environmental regulations, we anticipate strong order flow from textile manufacturers for our low emissions airflow dyeing machines, after treatment compacting machine, and new higher end dyeing and finishing machines in the year ahead. We are well positioned to meet this demand.

During the fourth quarter of 2014, we bought new equipment online that increased output of our traditional dyeing machines, airflow dyeing machines, and new after treatment compacting machines. We also added equipment to produce new higher end versions of our airflow and traditional dyeing machines made from higher quality parts and materials.

Because we believe that these higher end machines offer superior quality and performance at attractive price related to imported from Germany and the U.S., we expect them to appeal to manufacture to maximize their equipment purchases given tight credit conditions in China.

The near-term impact of China's war on pollution is less certain in the area of wind power. Challenges such as quick connectivity and curtailment persists and tight credit conditions continue to impact the demand for capital equipment.

In 2013, sales of forged products and wind products customers fell 7%. We expect sales to customers in this industry to play a less significant role in our business in the year ahead. However, we are hopeful that the Chinese government's commitment to renewable energy will increase the demand for our forged rolled rings and related components over the long-term.

In terms of solar, although we generated $0.6 million sales in sales from solar industry related product during the fourth quarter, we do not expect any new orders in the near-term. Sales of forged products to non-wind customers rose 19% in 2013, thanks to increased sales efforts and repeat purchases from our diverse customer base.

We remain optimistic that our products for the oil and gas industry will gain traction in 2014, although we have not received any orders to-date and we cannot predict the size or timing of any sales or whether we will receive orders.

Going forward, we expect the dyeing machine segment to generate solid revenue growth and continue to drive profitability in 2014. We hold a positive outlook for our business and plan to continue utilizing our expertise in manufacturing precision product to meet demand in new and existing end markets.

Now let's take closer look at our financial performance. I would encourage you to refer to our 10-K filed with the SEC and our earnings press release which will be issued today. Before discussing the quarterly results, I will briefly highlight our financial performance for full fiscal year 2013.

Our fiscal 2013 revenue was $72.1 million, up 26.1% from $57.2 million in 2012. Gross profit was $17.7 million with gross margin of 24.5%. Thanks to our large-scale and increased utilization, net income rose 95% to $8.2 million or $2.55 per basic and diluted share, up from $4.2 million or $1.65 per basic and $1.58 per diluted share in 2012. Please note that our earnings per share amount has been adjusted to reflect the 1-10 reverse split, stock split effective March 6, 2012.

Turning to our fourth quarter results, our revenue for the fourth quarter of 2013 increased 29.4% to 22.8 million, compared to $17.6 million in the same period of 2012. Our gross margin for the quarter rose 39.8% to $5.9 million compared to $4.2 million for the same period in 2012.

Gross margin improved by 26% during the fourth quarter of 2013 compared to 24.1% for the same period a year ago. The increase in gross margin for the quarter was primarily due to two factors. First, we experienced increased operational cost efficiencies for forged rolled rings and related products segment, including the allocation of fixed costs primarily consisting in depreciation to cost of sales, which we operated at higher production levels.

Second, we saw a slight decrease in raw materials cost in both forged rolled rings and related products and dyeing equipment segment. Operating expenses declined 10.7% to $3.1 million compared to $3.5 million in the comparable period last year.

The decrease was primarily due to a recovery of bad debt and lower depreciation expense resulting from the classification of certain equipment as held for operating lease in the fourth quarter of 2013, and which depreciation was taken in the fourth quarter of 2012, but not the fourth quarter of 2013.

In the fourth quarter of 2013, we recorded a $2.6 million non-cash impairment loss on the ESR equipment compared to a non-cash impairment loss on the same equipment of $2.2 million in the comparable period last year.

In March 2014, we entered into an eight-year operating lease for this equipment, which commences April 1, 2014. Rental payments of approximately $0.2 million per quarter will be recorded as revenue over the lease term as earned and the equipment will be depreciated over its estimated use life starting April 1, 2014.

Selling, general and administrative expenses fell 49.4% to $0.5 million, primarily due to a $0.7 million bad debt recovery, which was partially offset by higher professional fees, payroll and related benefits associated with expanding our business and an increase in research and development expense related to our new dyeing equipment segment. As a result, our operating income was $2.8 million, up from $0.7 million in the same period of 2012.

Income tax expense was $0.7 million compared to $0.2 million in the same period in 2012. At year end, we had $1.2 million in long-term deferred tax assets available to defray future tax payments.

Adjusted EBITDA, a non-GAAP measurement, which adds back to net income interest expense, income taxes, depreciation and amortization was $7.3 million, up from $4.8 million in the fourth quarter of last year.

Net income was $2.1 million or $0.60 per basic and diluted share compared to $0.5 million or $0.17 per basic and diluted share in the fourth quarter of 2012.

Let's turn to our balance sheet. As of December 31, 2012, we had cash and cash equivalents of $1.1 million compared to $1.4 million at December 31, 2012. Accounts receivable was $5.2 million and total current assets was $24 million. We had $3.1 million in short-term bank loans payable, up from $2.2 million at December 31, 2012. Stockholders' equity was $91.5 million at December 31, 2013.

In 2013, we generated an $11.5 million in cash flow from operations. The increase in short-term loans combined with $2.4 million in net proceeds from the sale of shares issued in the second and third quarter of 2013 and cash flows from operations was used to fund approximately $14.6 million in capital expenditures to expand production capacity as a purchase equipment for dyeing and finishing equipment segment.

In conclusion, we hold a positive outlook on our business in the year ahead. We made a significant investment to expand our product line to address new and existing end market, increased capacity of our dyeing equipment segment to position us for future success.

With a more aggressive stance towards pollution by the Chinese government, we expect our dyeing machine segment to generate solid revenue growth and drive profitability in 2014. We will continue to utilize our expertise in manufacturing precision product to meet the needs of heavy equipment and clean technology industries. We want to thank you all, to all our investors for your continued support.

With that, we would now open the call to questions and answers from the audience.

Question-and-Answer Session

Operator

We will now begin the question and answer session. (Operator Instructions) Our first question comes from George Appleyard of Appleyard Investments. Please go ahead.

George Appleyard - Appleyard Investments

Yes. Good morning. I have a couple of quick questions. Number one, how do you feel the Yuan exchange rate being more flexible in the future is going to affect your revenues in terms of the FX exchange?

Maple Jong

[Foreign Language]

Ryan Hua

[Foreign Language]

Maple Jong

Mr. Hua believes that it's a positive news to the company, because you have to achieve a goal - exporting business. Right now, there are still focused on domestic market, but if Chinese iron is going to depreciate, they will help to grow their exporting business.

George Appleyard - Appleyard Investments

I see. Thank you. I have a second quick question, which is what about raising more equity. Is that in the plan for the company seeing that your debt is about three times more than your cash flow level and would that be a possibility of a secondary or warrants or is that something the company is looking into? Then I have one very short follow-up after this one.

Maple Jong

[Foreign Language]

Ryan Hua

[Foreign Language]

Maple Jong

The company currently doesn't have any financing plan. We are having internal discussion about 2014 planning, and this time we do not have any financing plan this year.

George Appleyard - Appleyard Investments

I see. My last follow-up is actually to Mr. Wasserman. Is he available for question?

Adam Wasserman

Yes. Sure.

George Appleyard - Appleyard Investments

Yes. Just as a question, since your company is trying to present itself more as a favorable within the U.S. rules et, cetera, one thing that our company who has invested in yours is concerned about one factor that we are confused that your last earnings were reported, I believe, on November 13, yet there were insider sales from you on November 11th and 12th. Shouldn't that be classified as a quiet period? Just if you have any observations regarding that? Usually one does not see insider sales around the time of earnings, especially day or two before or is this a pre-planned sale?

Adam Wasserman

Basically what I did was added in a - it's like a trust with the broker with outstanding instructions, so I don't really have any control. I had put it in a plan where basically I don't even know, so I have put a lever on there that it sell at a certain price and it just shot up and the broker just sold, so I don't even know it shot up and -

George Appleyard - Appleyard Investments

Fair enough.

Adam Wasserman

I don't have any involvement with it you know?

George Appleyard - Appleyard Investments

I see, so basically this is not something controlled by you, but by a second party or third-party.

Adam Wasserman

That's how I basically set it up, so I don't want to be involved with.

George Appleyard - Appleyard Investments

Right. If you understand my concern about how it kind of looks in the marketplace, that the insider sales and then couple of days later the stock is down 25%, so in any case - well, thank you very much. I wish you success in the growth, and I still think you have ways to go, but hopefully this is a turning point. Thank you.

Operator

Our next question comes from Matthew Larson of Morgan Stanley. Please go ahead.

Matthew Larson - Morgan Stanley

Hi. Good morning everybody. Thanks for the call. You continually commented over the last couple of quarters at least that the restrictive environment from a monetary point of view in China is something that you guys are dealing with.

China has been down - the market for many, many years certainly relative to the global markets, what if they started to be more of - create more liquidity? I mean, would that change your guidance or presumably more positive, but I mean you are basically giving guidance with the idea that it will remain restricted for a while. I am just questioning - comment mainstream thought that China is trying to cap bubbles and things of that nature. Have you built that into your model I guess? Is that there maybe things can actually be more positive than what you are modeling for?

Maple Jong

[Foreign Language]

Ryan Hua

[Foreign Language]

Maple Jong

Okay. Currently, the company is focused on continuing developing their existing product lines and - that the free cash flow is enough to support this part of business, and they didn't think that the credit environment in China will impact their performance this year.

Matthew Larson - Morgan Stanley

All right, I guess, I was just saying that it may not impact your needs, but if your customers find easier credit then they might be more likely to purchase more of your product. I guess I was just commenting on the fact that it's almost given that it's a restrictive policy in China, and what happens if in fact the policy becomes less restrictive? I assume and presume if that would impact your business positively. I guess I was looking for comment from that respect, but there could be more upside to your thoughts.

Maple Jong

[Foreign Language]

Ryan Hua

[Foreign Language]

Maple Jong

Yes. It's correct. If the products in China had - our credit environment has loosened and helping the companies trying to replace their sales or increase their [audits] (ph) and you have the company have to grow their revenue. In addition that if the positive trend will also payment – accelerate the payments from customers.

Matthew Larson - Morgan Stanley

Okay. Thanks so much. Appreciate it.

Maple Jong

Thank you.

Operator

(Operator Instructions) This concludes our question and answer session. I would like to now turn the conference back over to Mr. Adam Wasserman for any closing remarks.

Adam Wasserman

Okay. Thank you, operator. On behalf of the entire Cleantech Solutions International management team, we want to thank you for your interest and participation on this call. Also, if you have any questions or interest in visiting our offices and factory in China, please let us know. We look forward to speaking to you again on our next earnings conference call.

Operator

Thank you. The conference has now concluded and thanks for attending today's presentation. You may now disconnect.

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