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Kingold Jewelry (NASDAQ:KGJI)

Q4 2013 Results Earnings Conference Call

April 1, 2014, 8:30 a.m. ET

Executives

Katherine Yao - Equity Group

Zhi Hong Jia - Chairman and CEO

Bin Liu - Chief Financial Officer

Analysts

Paul Cooney - Maxim Group

Peter Halesworth - di Heng Ren Partners

Operator

Greetings and welcome to the Kingold Jewelry 2013 fourth quarter and year-end financial results. [Operator instructions.] It is now my pleasure to introduce Ms. Katherine Yao of the Equity Group. Thank you, Ms. Yao. You may begin.

Katherine Yao

Thank you, and good morning, everyone. Thank you for joining us. Copies of the press release announcing the 2013 fourth quarter financial results are available on Kingold Jewelry’s website at www.kingoldjewelry.com.

As part of this conference call, the company has an accompanying slide presentation available in PDF format on the company’s website. You’re also welcome to contact our office at 212-836-1600 and we will be happy to send you a copy.

Before we get started, I would like to remind everyone that this conference call and any accompanying information discussed herein contains certain forward-looking statements within the meaning of the Safe Harbor provision of the Private Securities Litigations Reform Act of 1995.

Investors are cautioned that such forward-looking statements involve risks and uncertainties that may affect Kingold Jewelry’s business and prospects and the results of operation. Such risks are fully detailed in Kingold Jewelry’s filings within the Securities and Exchange Commission. The company filed its annual report and Form 10-K yesterday. Regarding the disclaimer language, I will also like to refer you to slide number two of the webcast presentation for the further information.

I would now like to take a moment to outline the format for today’s call. The company’s chairman and CEO, Mr. Zhi Hong Jia, will read a prepared opening statement in Mandarin, which I will then read in English. I will then turn the conference call over to Mr. Bin Liu, Kingold Jewelry’s CFO, who will continue with the presentation and then I will turn the call over to chairman for our outlook for the future.

When he finishes, we will open floor for questions. For the question-and-answer session, please allow us a moment to translate it to Mandarin for the questions and then we will respond to everyone on the call in English. For those who following along with the conference presentation, we will begin on slide number three.

With that, I will turn the call over to Kingold Jewelry’s chairman and CEO, Mr. Zhi Hong Jia. Please go ahead.

Zhi Hong Jia

Thank you, and good morning, everyone. And for those listening in China, good evening. We are very pleased that in 2013 Kingold reported solid operating results during the period. Our net sales increased to $1.2 billion, the highest in our company’s history.

2013 was a big breakthrough year for Kingold, as we worked diligently to adapt to changed conditions in the gold market. Gold prices changed rapidly during the beginning of 2013, with [unintelligible] decline for the second quarter impacting Kingold’s business, along with our peers.

We faced the challenges from the pressure on global gold pricing, and suffered from delayed orders, some writedowns on our inventory and margin pressure. In order to prevent these [unintelligible] from our inventory, we had to shift our product mix and the slowdown of sales at the time. This helped us to alleviate market risk and preserve the value of the reserves. Despite this, we achieved our [unintelligible] guidance of 50 to 60 metric tons processed, with 51.1 metric tons of 24-karat gold products in 2013.

Kingold’s growth accelerated throughout 2013, which we believe was largely the result of our continued push to gain market share from competitors in addition to [unintelligible] gold legal agreements to [unintelligible] capacity.

We also took steps to diversify our company for the long term. We signed an acquisition agreement to acquire 66,667 square meters of industrial land for use in the development of Wuhan Kingold Jewelry International Industry Park. We also structured a partnership with Kuwait Support Service Company, or KSS, to explore the gold market in Kuwait and across the Middle East.

Before I give everyone these updates, I would like to provide all of you the development of our investment gold business. I am pleased to let you know that our investment gold business has speeded up in 2013. We have signed agreements with [Bank of Communication], China Merchant Bank, China CITIC Bank, and the Wuhan [unintelligible] Commercial Bank, where we first started the business model in 2012.

In 2013, we have further extended our relationship with China Construction Bank and the [unintelligible] banks. Our investment gold products are [unintelligible] banks’ retail branches in Beijing, [unintelligible], [unintelligible], [unintelligible], and the [unintelligible] Provinces. We are [unintelligible] that opportunity and expect to expand our investment gold business into more than 4,000 additional retail bank branches across China in the coming years.

In order to provide an adequate supply of gold for an investment gold business expansion, we entered into further gold [fee] arrangements with two major Chinese commercial banks, China Construction Bank and Shanghai Pudong Development Bank Limited in early 2013.

In October 2013, we announced an increase in the credit line established under our previously disclosed Gold Leasing Agreement with China Construction Bank’s Wuhan Jiang’An branch dated December 20, 2012. During 2013, we also signed similar gold leasing agreements with the Wuhan branch of Shanghai Pudong Development Bank and with the Wuhan branch of CITIC Bank Corporation Limited.

We expect to utilize this gold as a way to fuel our growth. We have realized significant benefits from the additional access to gold provided by these transactions. This increased access to gold allows the company much greater flexibility to expand our production capacity at a favorable time in the market cycle. This gold allows us to quickly turn around production and gain significant market share from our best capitalized competitors.

We are also moving forward with the development of Wuhan Kingold Jewelry International Industry Park, which we expect to complete by mid-2015. We believe this industrial park will be an integral part of the company’s long term growth strategy by creating a major hub for the jewelry industry in the central region of China. This park will become a [unintelligible] location to display well known jewelry brands, also serving as the platform for Kingold to sell to new clients. We will keep updating investors on the progress of the construction.

Our recently announced joint venture agreement to move to the Kuwait market is part of the company’s international expansion plan beginning in 2013. The joint venture between Kingold and KSS is expected to combine two companies [unintelligible] and [unintelligible] goals and to develop markets and distribute gold products including gold investment products and gold jewelry products. Again, we will keep updating investors on our progress.

At this time, I would like to turn the call over to our chief financial officer, Mr. Bin Liu. Please go ahead, Mr. Liu.

Bin Liu

Thanks, Katherine, and thank you, Chairman Jia. Good morning, and welcome, everyone, again. Today I will discuss Kingold’s 2013 fourth quarter and year-end financial results. Let’s start with slide six, for those on the line.

During the fourth quarter of 2013, we purchased 14.3 metric tons of 24-karat gold products, compared to 7.6 metric tons for the same period last year. In the full year 2013, we processed 51.1 metric tons of 24-karat gold products compared to 37.8 metric tons in the prior year.

To explain, Kingold’s sales are primarily composed of the sales of branded products and customized products. Kingold sells these products to customers at a price that reflects the market price of base material plus a markup of design and processing fees.

In branded products, we purchase gold directly from Shanghai Gold Exchange once the customer has placed an order, and we recognize revenues on sales of branded products on the [unintelligible]. The cost of gold is recorded as part of our revenue.

In customized production, our customer supplies the raw materials and we create products per the customer’s instructions, and the cost of gold is not recorded as part of our revenue.

For the full year 2013, Kingold processed a total of 51.1 metric tons of gold, of which branded products accounted for 28.6 metric tons and the customized products accounted for 22.5 metric tons.

Moving to the next slide, slide seven, now I’d like to move on to the financials. On slide seven, you will see a summary of the company’s revenue and gross profit at the quarter and the year. The company reported revenues for the 2013 fourth quarter of $317.6 million, increased by 57.7% from $201.4 million from the same period in 2012.

For the year ended December 31, 2013, the company increased revenue by $274.2 million, or 29.9%, to $1.2 billion from $915.7 million, compared to the prior year. The increase in revenue was primarily driven by the increased amount of products sold, offset partially by the increase in the price of gold.

The increase in revenue was positively impacted by the [unintelligible] growth of our investment gold business the chairman just mentioned. We are now partnering with major Chinese national banks and commercial banks. The total revenue from our investment gold business has reached $124 million, which is roughly 10% of total sales of 2013, compared to $45 million in 2012.

For the fourth quarter ended December 31, 2013, gross profit was $15.7 million, compared to $11.7 million in the prior year period. For the year ended December 31, 2013, gross profit was $51.3 million, [unintelligible] increased from $50.9 million in 2012. Gross margin for the year 2013 was 4.3%, compared to 5.6% for 2012. The decrease in gross margin for the fourth quarter and year-end was primarily due to the product mix shifting toward more branded products where the company buys the gold ourselves.

Moving to slide eight, let’s discuss the bottom line. Kingold reported a net income for the fourth quarter of 2013 of $8 million or $0.12 per diluted share, compared to net income of $7.4 million or $0.14 per diluted share in the prior year period. The company reported net income for the year ended December 31, 2013 of $28.3 million or $0.44 per basic and diluted share, compared to $32.7 million or $0.60 per diluted share in full year 2012.

The next slide, slide nine. Moving quickly to the balance sheet, at December 31, 2013, Kingold’s cash and cash equivalents were $2.3 million. Inventories, which is gold in our case, was $174.4 million. Gold [unintelligible] equity was $214.9 million.

With that, I’d like to turn the call over to our chairman again to provide some more detail on our outlook for full year 2014. Please go ahead, Chairman.

Zhi Hong Jia

Thank you, Bin. Based on the company’s existing resources and capacity, we expect to process between 60 and 70 metric tons in 2014. Moving forward, we remain confident about the long term growth in China [unintelligible] gold. And according to the World Gold Council, [unintelligible] in 2013, the global demand for gold in 2013 was 3,756 tons.

We [unintelligible] and focused on our [unintelligible] and the manufacture of the highest quality [unintelligible] gold jewelry products while we diversify our revenue sources and expand our market share domestically and establish our global presence.

[unintelligible] Thank you. [unintelligible] For the question and answer session, please allow a moment for the company to translate each question into Mandarin and then management will respond to everyone in the [unintelligible]. Operator, let’s open it up for questions.

Question-and-Answer Session

Operator

[Operator instructions.] Our first question is from Nathan [Dardek] of Captiva Investment Company.

Nathan [Dardek] - Captiva Investment Company

I’m a loyal shareholder of Kingold. I have two questions. First, can you explain the $52 million on the balance sheet that is due from a related party that represents about $0.85 of the book value of the company?

Bin Liu

The related party, I just want to explain, that’s at the end of the year, and the company, at the request of a [friend] company, they needed short term liquidity, so they wanted to borrow some money from Kingold, and because of the request, Kingold just [unintelligible] to help for a short term loan, and the loan actually was loaned on the last day of 2013, and the loan was returned of to Kingold three days later, actually on January 3.

We recognize that because of this very specific scenario or situation, that’s why the management hasn’t given enough time or notification to the board and the formal approval process by the board, and we realize this could be challenged and we are reporting it voluntarily to the lawyer and to the board after that. And the board had two meetings to discuss this matter and have partial resolution. But going forward, any kind of big cash movement by the management should be notified to the board and should get approval by the board before we have any kind of similar transaction in the future.

Nathan [Dardek] - Captiva Investment Company

Thank you. My second question is if you could explain briefly why the number of outstanding shares increased year over year from 54.7 million to 65.6 million.

Bin Liu

What the chairman just tried to say is that in January, Q1 last year, 2013, we had an issuance of 10 million shares to three individual investors and also we disclosed that. And also, one of the investors exercised 2.5 million warrants. If you put this together, that’s roughly the difference between last year, in 2012, and 2013.

Nathan [Dardek] - Captiva Investment Company

As a follow up question, are there any additional warrants outstanding? And if so, how much, and at what price?

Bin Liu

There are still approximately [a million] warrants remaining at $1.80 exercise price.

Operator

The next question is from Justin Scott of [unintelligible].

Justin Scott

Your forecast for 2014 is 60 to 70 metric tons. And you also announced this joint venture with Kuwait. And my question was, does that forecast include any expected sales through the Kuwait joint venture? And I have a follow up question after that.

Bin Liu

The chairman says that 60 to 70 right now is not including this forecast of 60 to 70 tons for the Kuwait business, the potential from the Kuwait corporation.

Justin Scott

And just on the Kuwait business, what sort of timing if things go average, as opposed to better than average, or less than average, what sort of timing would you expect to start having sales going through the joint venture?

Katherine Yao

We will continue to update you on our progress, and we expect to give more updates on the Q2 conference call.

Justin Scott

Then a question for Bin on the margins and the accounting. During 2013, in a very difficult year for gold price, you did take some inventory charges, and I was wondering what those charges for the year as a whole were, and are they included in the operating cost level, so that if I wanted to try to establish the margin except for those one of charges, I can see that.

Bin Liu

You’re absolutely right. We had a very challenging year dealing with the fluctuation of the gold price, as we disclosed before, in the first three quarters. Most of the chargeoffs that you’ve seen in the first three quarters - actually Q4, we don’t have any, because we actually see the gold price climbing up slightly in Q4.

So the total chargeoff is roughly like $9 million and it is a part of this kind of writeoff and the reporting. And we got a little bit hammered by this kind of writedown. Hopefully in 2014 we won’t have this kind of challenge, but in addition to that, we will also have this kind of product mixed in.

So you can see in 2012 it’s 50-50, roughly even. For 2013 we say [unintelligible] so we have a much bigger percentage of the branded products. Now, hopefully the management wants to expand more into the investment gold business.

As you might understand, we have a slightly better margin in this kind of investment sector, which also has faster growth for the company and for the industry. And we want to capture this unique opportunity, particularly when we sign the [unintelligible] with CCB, China Construction Bank, which is one of the leading banks in the world even. So hopefully we’ll see some changes in 2014.

Justin Scott

So just to make sure I’m doing it roughly right in my head, the gross profit prior to inventory charges would have been around about $60 million and then that took it down to $51 million. My next question relates to that a little bit. In terms of the growth in the forthcoming year, do you expect that to be financed by the leases, or do you expect the inventory to decline further from the $170 million. If you have to have a guess as to what inventory would look like halfway through the year, what would you think it would be?

Bin Liu

Our ideal world is that we still, in China, we only sell the investment gold through the retail branches of the bank, because the customers trust the banks. And we signed with seven banks already. This can grow at a really fast rate, and fast pace. To fuel this growth, ideally we want to get the raw material inventory financed by the banks.

We have intense conversations with the Pudong Development Bank and the Construction Bank, and also CITIC Bank. Both are willing to raise the credit line for us. CITIC Bank has already done that, because for the bank, it’s credibility issue for them as well, because if Kingold can deliver what we are going to do and what we can perform, then they have the trust, and more credit line for Kingold, which is exactly what’s happening right now.

So if I had to make a guess, a very calculated guess is three things, the CITIC Bank, the [unintelligible] Bank, and the China Construction Bank very largely can raise the capital line again for Kingold. So we are expecting to get more leases from them to fund our [unintelligible] growth.

Justin Scott

Right, and my understanding that it’s correct, the higher the percentage of your inventory that is provided by these leasing arrangements, the less susceptible you are to movements in the gold price and the more just a pure manufacturing margin you get.

Bin Liu

You’re absolutely right. I agree.

Operator

And the next question is from Paul Cooney of Maxim Group.

Paul Cooney - Maxim Group

One follow up regarding Mr. Dardek’s initial question about the $52 million that was loaned and then paid back. That $52 million is now in cash, as of now?

Bin Liu

The chairman confirmed, yes, that it was returned back to the company and cash and then we put it into production to buy more gold, because that’s a short term kind of lending, so it’s already being returned back to the company.

Paul Cooney - Maxim Group

So it would be fair to assume then, that next quarter, either your cash balance should be way up, or your inventory balance should be way up? Is that fair?

Bin Liu

The chairman said yes, you’re absolutely right. You will see a significant increase in either the cash or the inventory. Very likely the inventory.

Paul Cooney - Maxim Group

And also, just a follow up to one of Mr. Scott’s questions, with regard to the Kuwaiti deal, which from what I understand is not in your projections, did they give you any kind of indication as to what the potential is for that short and long term? Is there any kind of guidance or projection or just what the potential could be there?

Bin Liu

That’s a fair question. However, the fact is that because both sides agreed, we started to execute our agreement in Q2 2014. To start with, we will participate in the Kuwait International Jewelry Exhibit to be held between April 21 and 26. And then we will have a meeting based on the results of this exhibition. So it’s pretty hard to tell to what extent we can generate additional incremental production or revenue. What we agreed is that we will proceed with our plan step by step. That’s exactly what we are doing, and we will give you an update in our next quarter’s report.

Paul Cooney - Maxim Group

A question regarding the real estate deal. Can you give me an idea, trying to wrap my hands around the potential of this thing, of what the cost is going to be to Kingold as far as the buildout costs per square foot and basically what the real estate market looks like there?

Bin Liu

Just to give you an update, to refresh what we have disclosed, we acquired this land and built the property on top of the land. The total price we paid is RMB1 billion. So we’ve built up to 200,000 square meters. The per-square meter price is, on that base, roughly like RMB1,200, right? And the next question is, what’s going on in the comparables in the nearby communications. So as far as we know, some of the commercial properties were sold for as high as RMB30,000, so our cost is like RMB1,200, right? So you can see, if we can get that to match that price, then the potential can be as big as RMB4 billion.

Paul Cooney - Maxim Group

RMB4 billion is how much U.S.?

Bin Liu

You divide by six, so it’s like 6.5 or 6.8, so $680 million. You divide by 6.1, to be exact.

Paul Cooney - Maxim Group

So you’re talking about a potential profit there of about $600 million, is that what you’re saying? Based on today’s market?

Bin Liu

That’s achievable.

Paul Cooney - Maxim Group

I’ve owned the stock for years, and I keep owning it and I keep on buying it because of everything I see here that you guys are announcing. You’ve got $175 million in gold, you’ve got $50 million in cash, you’ve got one of the healthiest balance sheets around, you have a business that’s relatively easy to understand. You’ve got a projected forecast of growth organically right now of 17% to 40%. You’re trading at half your book value, and you’ve got an elephant here that could net you, in the next two to three years, four to five times your market cap. What am I missing? What’s the market missing as far as valuing your stock?

Bin Liu

I totally agree, and I share exactly the same kind of confusion that you have, because we have been trying our best to deliver the results very constantly year over year, and of course the market has not reacted that way. I’m also very confused.

However, as I mentioned, our focus should be on the operations and to manage the company. Of course we are not very satisfied with what’s going on in the capital markets in terms of the value of the stock, but as the management of the company, we cannot do too much about that in terms of direct comment on this.

However, I can share with you that in the next one to two years, you will see a significant change, a beef up, of the operations for this company. For example, for the [unintelligible] park, we are scheduled to finish up the construction by the middle of 2015 and there will be a grand opening scheduled at the end of 2015.

So that alone will bring a lot of value for this company. And also, we have been following exactly what we agreed with the Kuwait partner to expand into the Middle East market and also globally, and we are very confident that that part will generate incremental revenue and profit for the company.

So all in all, in the next one to two years, you will see, again, the company will be significantly beefed up, and it’s a good company for the investors. So I welcome your support and appreciate your support and hopefully we’ll get more support from you and other investors, and we’ll try our best to manage this company as best we can.

Operator

The next question is from Peter Halesworth of Heng Ren.

Peter Halesworth - di Heng Ren Partners

Just very quickly, I wanted to ask about the Wuhan project and if there is any precedent that gives you confidence that this project will be a success, either with projects in China or around the world.

Bin Liu

This is a very unique project. We are a pioneer in this effort.

Peter Halesworth - di Heng Ren Partners

Okay. And my second question is regarding the gold price and your margins. I was wondering, is there any rule of thumb you could provide shareholders about what level of gold price is usually a comfortable level for Kingold to hit sustainable and comfortable profit margins?

Bin Liu

It’s a lesson for us, to be quite honest, in 2013, because of the gold fluctuating pretty substantially. So it’s really a learning process, and we have learned some experience and we have taken some actions to hedge the risk and to manage the risk.

So going into 2013, as you can see, the gold price is stabilized right now, but regardless, we have to pay close attention to both the gold price change from the international market, and also the demand change from China domestically. So we need to balance this too, and also based on what we have learned in 2013, I believe we are in a much better position to manage the gold price risk in 2014 and going forward.

Peter Halesworth - di Heng Ren Partners

Just a quick follow up on that. It’s less so the price level, and more so the price volatility, which is more impactful on your margins, is that a fair assessment?

Bin Liu

It is, yes. I agree, yes.

Peter Halesworth - di Heng Ren Partners

And my last question is just on this related party loan. It seems on the surface it was done through a party that was under some distress and needed to report a level of cash or liquidity. And I’m just wondering, was this related party a material shareholder of Kingold? And if you can give us any details on who they are and also was there a cost or an interest rate applied to the loan charged by Kingold?

Bin Liu

I’ll try to take your questions. Actually, the money was lent to a company and the company is [unintelligible] in China. Basically the chief rep of this company is a director of Wuhan Kingold, which is the operational company of Kingold Jewelry. So the relationship is this, because he is a director of the operational company of Kingold Jewelry. That was defined as a related party, because they had their liquidity challenge at the end of the year. So it’s a kind of an urgent call and the company stepped up to help that company. And it is a very quick kind of short liquidity, kind of three days long, so basically not too much has been charged.

Operator

The next question is from Justin Scott of [unintelligible].

Justin Scott

I had two questions, and really clarifying earlier questions. The first is, and it was simply because I wasn’t sure about the pronunciation. To understand, your all-in cost for acquiring the land rights and doing the construction, I believe you said it was RMB5,200 per square meter, and you felt that the market in Wuhan, again an approximation, was RMB20,000 per square meter. And my question is, first confirm those numbers, then of the 200,000 square meters, how much of that do you intend to keep for Kingold’s own use, use where you’re using the space for your own operations, and how much do you intend to either sell or to lease or rent out?

Bin Liu

So to give you a ballpark view, out of this 200,000, the company will probably keep 30,000 square meters and that we’ll be using for rental income for the company as well, and also for the company’s own self use. The remaining roughly 150,000 will be sold in different stages or levels of development.

Justin Scott

I can follow up in the next quarter I guess when you know more, but again, of that 50,000, I’m curious how much you’ll actually be operating and how much renting out. But perhaps it’s too early in the process. But I wasn’t sure whether I heard 20,000 or 30,000 for the market value per square meter in Wuhan at the moment.

Bin Liu

If it is a pure commercial property, the comparables in that part of Wuhan, yes it’s higher than RMB30,000 per square meters. It can be as high as that much.

Justin Scott

And finally, to follow up on the previous gentleman’s question, I’m sorry to keep probing on this, the short term three-day loan, you got your cash back, I understand that, over the year end. Could you tell us if not the name of the company you lent it to, the nature of the business that the company is in? What type of business was it involved in?

Bin Liu

In general, that’s an asset management company, and they do mergers and acquisitions as well.

Operator

We have no more questions in queue at this point in time. I would like to turn the floor back over to management for any closing remarks.

Bin Liu

Thanks to all of you for joining us today, and we look forward to speaking with you again in May, after we report our first quarter financial results. As always, we welcome any investors to our facilities in Wuhan, China. Thank you, everybody.

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