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Guanwei Recycling Corporation (NASDAQ:GPRC)

Q1 2014 Earnings Conference Call

May 16, 2014 8:00 AM ET

Executives

Kenneth Donenfeld – IR, DGI Investor Relations

Chen Min – CEO

Lawrence Wan – Financial Team Member

Yang Feng – CFO

Analysts

Nicholas Linfante - ExxonMobil

Mark Miller – Eastwest Network Group

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Guanwei Recycling Corporation 2014 First Quarter Investor Call on the 16th of May, 2014. Throughout today’s presentation all participants will be in a listen-only mode. After the presentation there will be an opportunity to ask questions. (Operator Instructions).

I will now hand the conference over to Kenneth Donenfeld. Please go ahead, sir.

Kenneth Donenfeld

Thank you, operator and thanks to those of you who are on phone and Internet joining us. A link to this conference call will be posted on the company’s website and instructions for accessing the call are included in the earnings release. On the conference call today will be Mr. Chen Min, Chief Executive Officer; Mr. Yang Feng, CFO; Mr. Lawrence Wan, a member of the company’s financial team; and Mr. Richard Sun, who will serve as our interpreter.

Mr. Chen asked that I present his opening comments and then Mr. Lawrence Wan will walk you through the numbers. Mr. Chen, Mr. Yang Feng and the others will then be available to answer your questions with the assistance of myself if there is any need for translation or help. We appreciate your holding any questions you may have until we’ve completed the opening remarks and your patience as we go through the translation process in answering questions.

Before we get started I am going to read a disclaimer regarding forward-looking statements. This conference call may contain, in addition to historical information, forward-looking statements within the meaning of the federal securities laws regarding Guanwei Recycling Corp. Except for historical information contained in our comments the statements we make are forward-looking statements that are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements involve known and unknown risks and uncertainties which may cause our actual results in future periods to differ materially from forecasted results. These risks and uncertainties include among other things, product demand, market competition and risks inherent in our operations. These and other risks are described in our filings with the U.S. Securities and Exchange Commission.

Chen Min

(Interpreted) And now I will proceed with Mr. Chen’s opening comments. Thank you all again. If I were asked to sum up our first quarter of 2014 in one word I am afraid I would have to say disappointment. And while I know it’s another dirty word on Wall Street, another word I’d have to use is surprise. When we ended 2013 we honestly thought and told you that while problems we experienced in the third quarter with respect to new governmental environmental activism were not over the worst seemed behind us. It turns out this was not really the case.

Following the inspections that interrupted our production for nearly two weeks in last year’s third quarter we were hit in the first quarter with a series of smaller issues in the form of changes in our production process that increased our costs and also slowed our production. The major changes related to more thorough color sorting of raw material, a very labor intensive process as well as certain equipment upgrades.

At the same time following the labor shortage situation we experienced in 2013, a situation that was endemic to all of Southern China actually, we took steps in the form of increased wages and training to try to head off the problem in 2014 and also felt reasonably okay. But it turned out this was not enough. Following the Spring Festival in February what we thought might be a small bleed turned out to be more of a mini hemorrhage in terms of the return to work of our experienced workers. Many simply returned to their farm and families while others looked for work elsewhere.

By the end of the quarter the cumulative downtime we experienced as a consequence was serious as was the 27% jump in our labor cost to $61 per tonne year-over-year. The increase in the quarter in raw material cost, a 13.05% year-over-year increase to $866 per ton was not really a surprise, but it was more than the single digit growth in the cost we experienced in the second half of 2013.

Without question though the biggest and potentially most serious problem we had in the quarter and something we rarely have encountered in our history was the reduction in orders pretty much across the board by our fairly diversified client base. The surprise wasn’t in the weakness of the economy; that was fairly clear as we began the year. Really it was the severity of the situation with customers in nearly all industries although most of all in consumer-oriented businesses. As they faced slowdowns our sales were hit too.

And what might almost be called the perfect storm we saw our tonnage sold in the 2014 first quarter go from 11,867 tons in the first quarter last year to 9,275 tons, relieved only by a 1.55% hike in our sales prices which of course was substantially below the increase in manufacturing cost that we experienced. The effect in our bottom line actually was greater than our sales decline, reflecting the fixed costs we have in our business even when there is a reduction in sales volume.

So where does this leave us? I am afraid that over the next quarter or two in a somewhat similar situation. We haven’t heard much optimism expressed by our customers with whom we are now in very close contact about what they are seeing over the next couple of quarters. And this is being confirmed by some of the economic indicators published daily. China is in a slump, the severity and duration of which is not really clear except to the extent that the slump in Europe is affecting demand for exports and consumers in China have gotten very reticent about some of their purchases.

The good news as Lawrence will point out is the company’s financial strength and leadership position in the industry. We are secure it would seem in our ability to purchase raw material at better prices than our competitors, several of whom were hit much harder than us. But we haven’t been able to take advantage of this in a temporarily slow sales environment.

We also are tackling the labor situation where we think we offer a better working environment and competitive wages than others. But of course this is adding to our costs. With respect to environmental issues we remain the most technically advanced in the industry as far as we know, and in a position to tackle the changes being required in our production as of today, although we are not really sure of what further changes maybe ahead.

Perhaps more significantly in this environment is that we are very fortunate to not be burdened with any debt; having operated our business very conservatively our monthly [note] [ph] does not include interest payments. Additionally we have a fair amount of cash, approximately $14.9 million as of March 31, which amounts to about a $1.42 per share. We have been using this cash to reduce the cost of our materials by making bulk purchases direct from dealers in Europe without any middleman costs.

I wish I had better news to report on our near term outlook; but having been surprised once I don’t want you to walk away from this phone conference with expectations that may be unreachable. Longer term, a bet on our company’s success really – companies will be moving out of a current phase of the business cycle in China into a new one. Also that the cost of recycled plastic will continue to stay well below the cost of virgin plastic. There still isn’t any new material that can be expected to replace plastic anytime soon.

At the end of the tunnel will be those companies with the financial wherewithal to keep their heads above water and those nimble enough with experienced management to take advantage of the new opportunities which inevitably are created in an upturn. I have one last thing to cover before handing the mike over to Lawrence and that is the latest round of negative publicity that has surrounded Chinese companies that went public in the U.S.

Most recently our company was in the middle of things due to an SEC action against several individuals who were accused of improperly trading our stock going back to around the time we first started trading here in the U.S. I believe the press release we issued on the matter on May 8 makes clear our position. Namely we endorse all efforts by the SEC to pursue anyone who in anyway has in the past or could bring harm in the future to our shareholders.

Second we ourselves have not been accused of any misdeeds and in fact take our responsibility as a public company to protect our shareholders very seriously. That really is all I want to say about the subject at this time and please understand that I will not say anything more about it in the question-and-answer period following our presentation.

With that let me pass the microphone to Lawrence who will quickly walk you through some of the numbers in the first quarter. Lawrence?

Lawrence Wan

Thank you, Ken. As Mr. Chen has pointed out the results in the first quarter were not very pretty. For those of you who follow us know that our business is very straightforward one; essentially our raw materials are mainly previously used plastics specifically low density polyethylene LDPE which is the key component of plastic wrapping and other plastic products.

We are able to purchase it directly from merchants in Europe where clear strict law cover the disposal of the plastic waste and mandate the sale of the used part in an environmentally sound manner. It is therefore less expensive to ship the used plastic out of the most environmentally conscious countries such as Germany and Holland than it is to dispose of it locally.

However we must adhere to very strict environment standards with those in Germany being perhaps the strictest in the world in order to be able to purchase the raw materials and we have received a special license for this purpose. This give us a price advantage over other recyclers in that we’re able to bypass middlemen and the material itself requires less labor intensive sorting at our end. After receiving and product sorting the raw materials we take it through a process that converts it into four grades of plastic pellets that we sell to more than 150 customers in China who use it in the manufacture of many different industries, from waterproof wiring to toys and sole for shoes.

It can be readily substituted for virgin plastic in most cases but typically is about 40% cheaper than the virgin plastic. Typically we sell off under 10% of our raw materials as non-LDPE products. Also important to note is that we very clearly are allocated by government a quota on the amount of raw materials we may import which is in - the year 2014 in total was 135,000 tonnes vis-à-vis our production capacity of 80,000 tonnes of recycled LDPE.

In the first quarter of 2014 revenues were $11,780,338, down 20.62% from $14,839,806 in the first three months of 2013. Underlying this for the reason Mr. Chen has explained it our sales of recycled LDPE were down 20.64% year-over-year. Breaking this down a bit self-manufactured recycled LDPE sales volume as measured in tonnes was down 21.84% year-over-year to 9,275 tonnes offsetting a small extent by year-over-year increase in our selling prices to $1,242 per tonne, an increase of about 1.55%.

In the quarter we also saw the year-over-year sales of sorted non-LDPE materials decline by nearly 20% to $262,621 coupled with a 5.83% price decrease in to about $323 per tonne compared with the prior year. As Mr. Chen also described the decline in sales was coupled with an increase in most of our key cost in particular raw material costs which has moderated a bit in 2013, climbed up again in 2014 first quarter by just over 13% to about $866 per tonne.

More unusual was the increase in labor cost we experienced in the quarter which was up about 27% year-over-year to about $61 per tonne. This growth in these costs as well as real cost we incur for complying with new environmentally sound manufacturing procedures imposed by various arms of the government, obviously substantially exceeding the small price increases we realized and reduce our gross margin from 26.14% in the first quarter 2015 to 14.07% in the 2014 first quarter.

When combined with the reductions in our sales volume we saw our net income in the 2014 first quarter slip to $756,000 or $0.07 per share compared with $2,365,000 or $0.23 per share in the same period of last year. The per share figure in this year’s first quarter is based on about 10.4 million average diluted common shares outstanding unchanged from 2013. Through all this we manage to end the quarter on March 31, 2014 with cash and cash equivalents of $14,860,475, up from $13,491,880 at the same time last year.

Another measure of financial strength was that we continue to have no bank debt as of the end of the quarter and our working capital was $45,553,532 as of March 31, 2014 which was about $94,000 higher than our working capital on December 31, 2013.

I will be happy to provide any additional information you request in our Q&A session which I think we will soon be starting. Ken, I will turn the microphone back to you.

Kenneth Donenfeld

Okay. Thank you very much Lawrence. Mr. Chen and the management team are ready for any questions. So operator could you please provide our callers with the instructions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) And the first question comes from Nicholas Linfante from ExxonMobil. Please state your question.

Nicholas Linfante - ExxonMobil

Yes, given your obvious financial strength despite like you mentioned the fourth quarter I guess I just was wondering what you are doing I guess to ensure shareholders are more comfortable with your company, especially in light of the fact that, like again was mentioned that your financial strength indicates that you have $1.42 per share in cash alone, book value of your company specifies that it should be trading near $5 a share. I was just wondering if you had any comment on that as far as like [pride goes] [ph] to keep your company like kind of more in the limelight amongst American investors to try to give more confidence.

Chen Min

(Interpreted) Hello sir. What I should say is that the management of GPRC is not happy with our current stock price either. And but however what we can do and what we can tell you is that we are committed to try all our best to improve our performance by which to turn the benefit to our shareholders.

Kenneth Donenfeld

Yes, Nicholas.

Nicholas Linfante - ExxonMobil

Yes.

Kenneth Donenfeld

Did you want to say anything more about what you are asking or…?

Nicholas Linfante - ExxonMobil

I mean I guess yeah I kind of expected that type of answer. I guess it just boils down to the fact that it was more not so much even just a Guanwei Recycling problem, it’s just trying to gain more traction for Chinese small companies as a whole and it’s something as small as like I know you mentioned in the past you are not trying to do any share buybacks right now, you want to utilize your cash for the business and that’s really understandable.

But this is something as small as like insiders like a purchase from the Chairman of x amount of shares instills confidence, especially when your company is trading at the cash value of, I mean no company in their right mind, I guess in the stock market trades at cash value unless the people are questioning their financials and I’m not saying there is anything wrong with your financials just that you need to try to do more to instill confidence among shareholders because no one is going to want to invest in your company. I mean that’s the only thing I had left to say.

Kenneth Donenfeld

I should add, you wanted to share that with management, are there any other questions, operator?

Operator

Yes, there is a question from Mark Miller from Eastwest Network Group. Please state your question sir.

Mark Miller – Eastwest Network Group

Hi, back to November of last year, you purchased a company called – made an investment in a company called [Fuqing Yongye] [ph] and stated it’s a current customer of the company, the Chairman of Guanwei made the investment. Is this company a competitor of yours and what was invested by the Chairman a.k.a GPRC into this investment. Because it states they own 50% of this company and what benefit was it for the shareholders to do this investment?

Lawrence Wan

(Interpreted) Okay. Well, hello Mark.

Mark Miller – Eastwest Network Group

Yes, I’m here.

Lawrence Wan

Mr. Yang, our CFO answered the question on behalf of Mr. Chen. First to your first question, the company that our CFO invested it’s not a competitor of GPRC. Mr. Chen has owned 50% of that company and by this investment it doesn’t [inaudible] produce benefit for the shareholders of GPRC but made the investment with a long term reliable customer for the company.

Kenneth Donenfeld

Does that answer your question Mark?

Mark Miller – Eastwest Network Group

No.

Kenneth Donenfeld

What more did you want to ask?

Mark Miller – Eastwest Network Group

Look the amended 10-K because they originally didn’t put in their original they had to amend this, basically they moved receivables of over $5 million and they settled it up flat, there was no profit made, no loss made. I don’t understand if you make an investment and he didn’t answered what he paid for. If you buy something for 50% did you pay cash, did you pay stock, a promissory note? I mean something has to be given to get 50% ownership. So will you answer that please?

Lawrence Wan

(Interpreted) Mark, this investment is a private behavior of Mr. Chen. So we don’t think we are accountable to disclose such information.

Mark Miller – Eastwest Network Group

It’s on your balance sheet. Put it on his balance not on ours?

Kenneth Donenfeld

Well I think you make…

Mark Miller – Eastwest Network Group

An easier question.

Lawrence Wan

Mark let me add a little bit. So Mr. Chen made the personal investment on this company and this company become a customer of GPRC and then we did disclose the transaction and we disclosed the cost and the revenues, it was related to a sale of raw materials. There’s really no requirement to disclose the amount of our CEO to invest in a customer. So we disclosed the relationship, we disclosed the transactions, this is what is required by that SEC. So I mean that’s what we did.

Kenneth Donenfeld

Yeah, this is Ken. I just wanted to add to that and correct me if I am wrong please Lawrence that typically when the company disposes of raw materials, there the intent is to simply recoup the cost.

Lawrence Wan

Yes, these are not finished products that we are selling them. These are raw materials that we couldn’t finish using because we imported in order to get the volume discount. We imported certain volume and then at the end of the year and there is certain amount that we can’t use we sell at a little margin. We have that every year. So I mean these are not finished products that we are selling to this company.

Kenneth Donenfeld

Okay. Let’s move on. Are there any other questions, operator?

Mark Miller – Eastwest Network Group

Yeah, I have more Ken.

Kenneth Donenfeld

Oh sure, go ahead.

Mark Miller – Eastwest Network Group

Well, I mean if you are in a business to bring – you are risking, your [inaudible] and you are not making any money on it. You will be having all this risk, there is no reward. All right, let’s try an easier question. Are we there?

Kenneth Donenfeld

Yes.

Mark Miller – Eastwest Network Group

Back on the 10-K, there was a line of advances to suppliers of $1 million to $7 million roughly and that [inaudible] it’s roughly about the same, $7 million, I never saw that before. Could you explain what that means this number $7 million, advances to suppliers? Thanks.

Lawrence Wan

The $ 7 million this figure that you read in our 10-K, for our Q1.

Mark Miller – Eastwest Network Group

Your balance sheet. On our balance sheet is a line on asset….

Lawrence Wan

Our balance sheet of our 10-K or our 10-Q?

Mark Miller – Eastwest Network Group

Both of them. It first showed up on your 10-K, on your balance sheet assets the description of advances to suppliers.

Lawrence Wan

Okay.

Mark Miller – Eastwest Network Group

And year-over-year went from $1 million to $7 million. Then in our Q report it’s basically the same, $7 million, what is that?

Chen Min

(Interpreted) Hey Mark, you know we import our materials mainly from the European countries. And for each purchase we need to pre-pay part of the full amount in advance. So that is the advance to the customers.

Kenneth Donenfeld

And to suppliers.

Mark Miller – Eastwest Network Group

Okay, but there was a big jump on the year ending K where it went from $1 million to $7 million. In years past it never was like that. And is this a quarterly purchase or is this a annual purchase, this deposit?

Lawrence Wan

Hey Mark, are you saying there is a big jump from year-end, because I am looking at it, I mean it’s showing $7.4 million at the end of the year and then we have $6.9 million at the end of the quarter.

Mark Miller – Eastwest Network Group

Look at your 10-K in 2012, you had $1.8 million and then in 2013 you went to $7.4 million, that’s the one I want to talk about.

Lawrence Wan

Oh you are talking about 2012 to 2013?

Mark Miller – Eastwest Network Group

Yeah, sure.

Lawrence Wan

Okay.

Chen Min

(Interpreted) Okay. Hey Mark. Okay I will translate the comments to majorly there are two major reasons that by the end of the year 2013, we had a much larger number in the advance to suppliers. There’s two reasons, the first reason is that in the year 2013 we purchased more raw material and the second reason is that in order to get discount from our suppliers we agreed to pay a higher percentage of advance to the suppliers.

Mark Miller – Eastwest Network Group

Okay. What kind of a discount did the company receive, what percent?

Chen Min

(Interpreted) Okay, Mark we cannot tell the precise percentage of how much discount we get from the suppliers because we have several suppliers and we have various purchase agreements with them. And the discount depends on the quality – the quantity we buy and the inventory our suppliers have and also related – it is also related to quality of the product. So there is no fixed discount for every supply.

Lawrence Wan

All right that’s clear.

Mark Miller – Eastwest Network Group

Yeah. I just have one more question.

Lawrence Wan

Sure.

Mark Miller – Eastwest Network Group

The – we have asked you as shareholders and to attract investors and put some kind of confidence out there all this time to buy your stock back and you always said well you don’t have the money and you need every dollar to go for working capital, which is an understandable statement. But I saw in this last quarter that the company invested in capital equipment, they improved the manufacturing facility, bought some land and they bought a car for $97,256. Couldn’t you get a car for $40,000 maybe and taken that extra money and put that into the market. I mean I wanted to get a Lambo, the most expensive but I had to settle for the common one that everybody has. So could you answer that for me please?

Chen Min

(Interpreted) Okay. Well Mark yeah, it’s true that we did buy a car and we bought a good car, because this car is special – it’s for use for our sales and the marketing team who need to travel among the different provinces of China and we need to provide them a best car. And this car is also used to – for our customers.

Kenneth Donenfeld

This is Ken, I think too you – we check the market, the price of cars in China they are considerably greater than they are in the U.S.

Lawrence Wan

Operator do we have any other questions? Operator? Hello.

Operator

There are no questions at this moment.

Kenneth Donenfeld

Okay. I had one other question we’re close to closing time here. The question is relates to raw material cost which are a key component of your cost. What is driving the – what has driven the increase in the cost of raw materials?

Yang Feng

(Interpreted) Hi, Ken. Mr. Yang replies that the major driving force of our raw material cost is because – is the government – our government is applying more strict and higher grade of environmental protection policy. So the result is that we have sort out more material which are not proper, are not good for our production. So that is the major reason and another reason I can add which is not a very significant is that now we have more new workers who are not very highly familiar with our processing.

Kenneth Donenfeld

Okay, all right. If there are no other questions I had one I don’t know if we have time for it. I’ll ask it, among your customers are there some who are doing better than others in this economic environment that you are focusing more on in terms of sales or is it an across the board problem?

Yang Feng

(Interpreted) Mr. Yang’s reply is that the natural economic background of the country is not good for everybody. So and up to now we have not seen any competitor who performs better than us or who have lower cost than ours.

Kenneth Donenfeld

So you are relatively stronger than anyone else that you’re competing with,

Lawrence Wan

That’s yeah, you can say that.

Kenneth Donenfeld

Okay, great. Okay, operator I guess there are no more questions. Operator?

Operator

Sorry, sir. There are no more questions.

Kenneth Donenfeld

I see. Okay, well in that case anyone on the call and listening on the Internet please feel free to call with any further questions you might have after this. We appreciate your interest in the company and we’ll do our best to answer any questions you may have after this. So thank you all again. And that will end this call. Thank you.

Lawrence Wan

Thank you.

Operator

This concludes today’s conference. Thank you all for participating. You may now disconnect.

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