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China Gerui Advanced Materials Group Ltd. (NASDAQ:CHOP)

Q1 2014 Results Earnings Conference Call

May 20, 2014 9:00 AM ET

Executives

Kevin Theiss - Grayling, IR

Mingwang Lu - Chairman and CEO

Edward Meng - Chief Financial Officer

Analysts

Operator

Greetings. And welcome to the China Gerui Advanced Materials Group's First Quarter Fiscal Year 2014 Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Kevin Theiss of Grayling. Thank you. You may now begin.

Kevin Theiss

Thank you. Good morning, ladies and gentlemen, and good evening to those of you joining us from China. I'm Kevin Theiss from Grayling. And I would like to welcome all of you to China Gerui Advanced Materials Group's conference call to discuss the unaudited financial results of the first quarter of the 2014 fiscal year.

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’d like to remind our listeners in this call, management's prepared remarks contain forward-looking statements, which are subject to risks 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 or 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 abilities 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 market conditions change.

The 2014 first quarter press release and the script includes the use of non-GAAP EBITDA, which is a financial measure that is not defined by U.S. generally accepted accounting principles, or U.S. GAAP.

Non-GAAP EBITDA is defined in the 2014 first quarter press release and in this script as earnings before interest, taxes, depreciation and amortization that were incurred in the first quarter of 2014.

I will now turn the call over to China Gerui's Chairman and CEO, Mr. Mingwang Lu for some openings remarks. Mr. Lu, please begin.

Mingwang Lu

Ladies and gentlemen, thank you for joining us today and welcome to China Gerui Advanced Material Group's 2014 first quarter unaudited financial results conference call.

As we previously announced, the first quarter financial results reflected a tumultuous performance of the steel sector in China, as well as a seasonally slow first quarter due to various national holidays that impacted normalized operations.

2014 will continue to be a year of restructuring for China’s steel sector and for China Gerui as well. We faced numerous challenges during the first quarter but we persevered, tightened our physical policy and strategically prepared for identifying new areas of growth.

During the first quarter, we continue to manage those aspects of our business that were within our control, such as unit productivity, controllable costs, product quality, sales and marketing, and certainly, our customer relations.

Despite the challenging microeconomic headwinds affecting China’s steel industry and tightened credit policies, we are reiterating China Gerui’s $175 million to $180 million revenue guidance for fiscal year 2014, assuming we continue to operate under the current business model. Our financial guidance includes our expectations for sequential improvement in the second through fourth quarters.

In this regards, we are focused on our near-term growth strategies with new products and new markets that will enable the company to regain profitability and preserve our integrity with the capital markets.

In the first quarter of 2014, China’s steel industry performed its worst quarter since 2000 according to the China Iron and Steel Association. Its top steel makers recorded a combined loss of $379 million in the first quarter with over 45% of Chinese steel companies suffering losses, 15% higher than the first quarter of 2013.

Further weakness in steel pricing signals a continuing imbalance of excess steel production and steel demand in China. Chinese government policies design to correct this imbalance have been initiated, but will take time before yielding significant impact on the steel industry’s fundamental structure.

The Chinese government's commitment to restructuring the steel industry is best demonstrated by the announced capacity reductions at the end of 2013 in both Hebei and Shangdong provinces, both important steel manufacturing hubs. We anticipate these policies will have a noticeable effect in gradually stabilizing the market equilibrium over the next several quarters in the steel industry.

It has also been announced that two specific Chinese government programs will help bolster steel demand. The first is to improve housing in China with a focus on construction of affordable public housing projects. And the second is commitment to the construction of more high speed rail stations to improve long distance travel. We have started to formulate our product mix and cater to the anticipated market demand change, including ramping up the laminated steel production line initially targeting construction and decoration industries.

During the first quarter of 2014, selling prices were reduced in relation to the declining raw material cost. But we were able to remain competitive and preserve market share with key clients. Production has been maintained at current levels to avoid creating an aggressive pricing environment with lower-grade, cold rolled steel producers or larger scale of steel producers.

Pricing concessions have been difficult to reverse with current market conditions. However, China Gerui believes that with its leading industry position, concessions can be reversed and prices enhanced as market conditions improve over time.

Despite the challenging macroeconomic headwinds, we are encouraged by utilization of our wide and narrow strip cold-rolled steel capacity which we believe was 60% to 62% in the first quarter of 2014 compared with approximately 67% during the fourth quarter of 2013.

On a more important note, the utilization of our chromium plating production lines was approximately 51% in the first quarter of 2014 compared to 49% during the fourth quarter of 2013 and has consistently improved quarter-over-quarter. We are encouraged by this positive trend and expect that chromium plating utilization will continue to rise as the production line is operating at commercial run rates. And major customers continue to reorganize this production operation to incorporate chromium plated steel products.

As we continue to adjust our business in 2014, we believe we are well positioned to benefit as a premier high end specialty steel producer from the government restructuring plans for the steel industry and have put in place strategies to captive growth. First, we are committed to accelerating China Gerui’s business into new higher margin steel sectors including laminated process steel which commenced commercial production during the second quarter of 2014, enabling the company to provide its customers within the food and beverage packaging and home decoration industries with innovative, environmentally friendly material solutions through the more comprehensive portfolio of high value, specialty steel niche products.

As the new laminated products roll out, the company believes it will regain limited pricing power, improve margins and reach optimal utilization by the end of 2014. The company expects to compete in the higher growth steel markets, provide better solutions for customers and further obtain a larger market share.

Second, we continue to cultivate our export business. We have gain interest from new markets such as Taiwan during the first quarter of 2014 to obtain [Technical Difficulty] and geographic reach. We expect our export business to eventually account for 35% to 45% of total revenues over the next five years.

Lastly, we continue to actively pursue viable mergers and acquisitions or strategic partnerships that will enable positive contribution to cash flow, accretive to earnings, broaden end-user applications, provide R&D innovation and complement our product portfolio.

As we enter into 2014, we will build upon new strategy and continue to make progress and add value to China Gerui’s growth, and profitability profile in order to better deliver value to our shareholders and compete effectively in the global marketplace.

Thank you, everyone for joining us. I would now turn the call over to Edward Meng, our Chief Financial Officer.

Edward Meng

Thank you, Mr. Lu, and thank you all on the call. I will present a summary of the 2014 first quarter financials. For more details, please refer to our first quarter press release which was distributed earlier today.

Our revenues decreased 42% to $26.4 million in the first quarter of 2014 from $45.6 million in the first quarter of 2013. The decrease in revenue was primarily due to a 13% decrease in the company's average selling price or ASP to $638 per ton for the first quarter of 2014, as compared to an average selling price of $733 per ton for the first quarter of 2013, as well as a 33% decrease in sales volume to approximately 41,445 tons for the first quarter of 2014 as compared to approximately 62,240 tons for the same quarter of 2013.

Our gross profit decreased 123.9% to a negative $1.2 million in the first quarter of 2014 from a gross profit of $5.2 million in the same quarter of 2013. Gross loss margin was 4.7% in the first quarter of 2014, compared to a gross profit margin of 11.4% in the first quarter of last year. The decrease in gross margins compared with a year ago was primarily due to a lower sales volume pegged against the relatively fixed depreciation and amortization expenses accounted for in the cost of goods sold.

As anticipated, the company recorded lower sales as the economic slowdown in China continued and domestic consumption declined in the first quarter of 2014. The resulting reduction in steel demand continued to drive the severe competition and pricing pressures currently in the marketplace during the quarter.

Operating income decreased 283.6% to a negative $3.8 million in the first quarter of 2014, from operating income of $2.1 million for the first quarter of 2013. The decrease in operating income in the first quarter was primarily due to a 123.9% decrease in gross profit.

Net loss was $4.2 million in the first quarter of 2014, or $0.07 per fully diluted share, compared to a net loss of $0.1 million, or nil per share in the first quarter of 2013. Non-GAAP adjusted EBITDA was a negative $0.2 million in the first quarter of 2014, or negative 0.7% of revenue, compared to $5.1 million, or 11.1% of revenue in the first quarter of 2013.

Non-GAAP adjusted EBITDA is defined as earnings before net interest expenses, taxes, depreciation, amortization for the first quarter of 2014 and a one-time, stock-based compensation expense incurred in the first quarter of fiscal year 2013.

Please see the section in the press release this morning 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 financial conditions, as of March 31, 2014, the company had $230.7 million in unrestricted cash, $18.6 million in current certificates of deposit and an additional $75.5 million in restricted cash, as compared to $237.1 million in unrestricted cash, $24.2 million in current certificates of deposit and an additional $114.8 million in restricted cash as of December 31, 2013.

The company's short-term debt consisted of notes payable, term loans and financing obligation, current portion, that totaled $246 million at March 31, 2014, compared to $282.9 million as of December 31, 2013. The company had long-term debt $11 million in financing obligation at March 31, 2014, compared to $13 million as of December 31, 2013.

Shareholders' equity was $286.6 million at March 31, 2014 as compared to $299.1 million as of December 31, 2013. Net cash provided by operating activities for the three months ended March 31, 2014 was $2.2 million compared to $3.9 million in the first quarter of 2013.

Now about 2014 financial guidance, the company is reiterating full year 2014 revenue guidance in the range of $175 million to $180 million predicated on the launch of its laminated steel products and slightly improved pricing power with an expanded portfolio of specialty products. Please note that the company may adjust such guidance as changing macroeconomic conditions and operating and competitive challenges dictate.

On business update, I would like to begin the business update and outlook session to provide better insight into China Gerui’s strategies in the difficult domestic market, even as we begin to focus on becoming a global metal processor.

I will begin with a brief review of China’s steel market in the first quarter. The steel industry remains in an oversupply situation resulting in a highly competitive pricing environment restricting profitability. Investment in steel fixed assets in China decreased by 3.3% in the first quarter of 2014 which provides limited encouragement as the steel industry struggles to reach a supply and demand balance.

China Gerui's steel output decreased 5.3% in the first quarter of 2014 to 261 million tons representing approximately 50% of the total global production.

The central Chinese government has set new policies to encourage consolidation in the steel industry. The objective is to create stronger balance in steel production and supply to alleviate the highly competitive pricing environment. Additionally, a stronger steel industry with reduced production will also lower emissions from steel companies to help the environment.

An environmental policy from the State Council mandates a reduction in air pollution. Small steel companies and operations using older technologies are the primary targets of the policies. China Gerui has implemented an internal policy to upgrade the quality of air provided for the safety of its employees and will evaluate a broader sustainable policy as a socially responsible corporate citizen.

As a side note, I’ve got question before this conference call from a concerned investor asking whether the Chinese government’s policy of encouraging consolidation coming back on the excess capacity and also the environmental control policies, will that negatively impact China Gerui? The answer is no because that consolidation or excess capacity is primarily targeting the upper stream crude steel production. So for China Gerui as the steel processor, valued-added steel processor we are not impacted and we are not going to as we anticipate.

The banking industry in China has also restricted new loans to the steel industry together with other four major industries at the acquiescence of the central government and are cutting down on size of existing loan facilities once they become due for repayments before renewal which will strongly impact the smaller and the weaker steel companies.

China Gerui will remain fiscally disciplined with its cash resources given the working capital intensive nature of our business.

For your information China Gerui’s current local borrowing facilities consist of three parts. One is short-term cash loans from local banks pledged against the company’s own fixed assets. The other one is short-term cash loans from local banks guaranteed by unrelated third parties, for whom China Gerui will provide similar guarantee under the same terms. And three, notes payables guaranteed by China Gerui’s restricted cash that ranges from 50% to 100% of the face value of notes payable issued. So that we would have focused our operation with the least destruction from China’s credit market fluctuation and tightness. We secured a 3-year sale on leaseback arrangement from 2013 that was fully disclosed in our recently filed annual report on Form 20-F.

Consolidation of China’s steel industry is focused on the upstream of the value chain, as I said, which will beneficially impact the raw material suppliers to China Gerui.

Higher raw material costs were initially crippled and then eliminate smaller and inefficient cold-rolled steel producers. China Gerui will have the opportunity to add market share especially with this high technology, high-end cold-rolled steel products. Once the Chinese steel industry begins to regain the supply and demand balance, our diversified portfolio of high value specialty steel niche products will focus us on high growth steel markets thereby increasing utilization of our capacity and generates greater profitability.

We have become more aggressive with our pricing strategy beginning in the first quarter to protect our market share and improve customer relations. As the industry conditions improve, we expect to reestablish our premium pricing with our newer innovative products. We have less price competition than commodity type steel products.

Higher prices on lower products will improve gross margin as volumes rise. As pricing become less important and purchasing decision for our customers, our ability to provide quicker delivery of high quality steel with precise specifications become of greater importance.

As loss is mounting, customers are more focus on just-in-time delivery, which require cases like China Gerui to accommodate a smaller, more frequent orders, as well as industry managements as a means of cost control.

The control costs and improved gross margins, our R&D is focusing on developing production enhancements to quickly lower unit costs as volume rise. Our wider range of cold-rolled steel products provides a greater number of steel solutions and opportunities to serve our current customers and attract new ones.

We believe we have the management, production, financial, marketing and the product mix to succeed as the current environment becomes more favorable over the next few years.

We appreciate our investors support and recognize your concerns of our China Gerui’s stock performance. Since the launch of the share repurchase program in April 2011 and as of March 31, 2014, the company repurchased a total of over 2 million ordinary shares at an average price of $3.06 per share for a total repurchase price of approximately $6.1 million. We look to review the share repurchase program to support our stock at these levels.

As we continue to adjust our business in 2014, we particularly look forward to the second half of the year as our strategies will begin to yield sequential results. As discussed, commercial production of laminated processed steel commenced in second quarter of 2014. And we continue to evaluate or expand new export markets and assessment of viable strategic partnerships, mergers and acquisitions that may post a positive contribution to cash flow, accretive to earnings, broadened our end-user applications, provide R&D innovation and complement our product portfolio.

In the past year, we have identified and have screened several potential acquisition targets. We were pretty close in few cases but we eventually did not receive those as we would not -- as they would not meet the acquisition criteria with that of profit sales as we mentioned just now ago.

We will continue to work with external consultants and the finance advisors who work full time to see acquisition updated for us, both in and outside of China. All said, we look forward to continuing to build our competencies that differentiate China Gerui in the market place such as superior customer relations, higher premium products and the sound fiscal management.

I will now conclude my comments. Operator, we’re now ready for questions if any.

Question-and-Answer Session

Operator

Thank you (Operator Instructions) Gentlemen, I would like to turn the floor back over to you for additional concluding comments.

Kevin Theiss

Thank you all for all of your participation in China Gerui's 2014 first quarter conference call. We’ll now conclude the call and you may disconnect your lines. I would want to thank you again. Thank you.

Operator

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. And thank you for your participation.

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