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China Precision Steel, Inc. (NASDAQ:CPSL)

Q2 2008 Earnings Call

February 19, 2008 9:00 am ET

Executives

Leslie Richardson - CCG Elite Investor Relation

Dr. Wo Hing Li - Chairman and Chief Executive Officer

Leada Li - Chief Financial Officer

Operator

Good Day ladies and gentlemen and welcome to the China Precision Steel Second Quarter 2008 Earning Conference Call. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (Operator Instruction). I will now turn your call over to Ms. Leslie Richardson from CCG Elite, please proceed.

Leslie Richardson – CCG Elite Investor Relation

Good morning ladies and gentlemen my name is Leslie Richardson from CCG Elite Investor Relations, and I’d like to welcome you to China Precision Steel’s second quarter 2008Conference Call.

Joining us today from China are China Precision Steel’s Chairman and CEO, Dr. Wo Hing Li, and the Company’s Chief Financial Officer, Ms. Leada Li.

I would like to remind our listeners that 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 for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995.

Actual results may differ from those discussed today, due to such risks including, but not limited to, business conditions in China, legislation or regulatory environment, requirements or changes adversely affecting the business in which China Precision Steel is engaged, cyclicality of the steel consumption including overcapacity and decline in steel prices, limited availability of raw material and energy may constrain operating levels and reduce profit margins, environmental compliance or remediation and other risk factors detailed from time-to-time in the company’s filing and future filings with the United States 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 February 19, 2008. China Precision Steel assumes no obligation to update these projections in the future as market conditions change.

For those of you unable to listen to the entire call at this time, a recording will be available via webcast for 90 days. The webcast link is available at the company's corporate website.

And with that, I will now present the management discussion section on behalf of Dr. Li, China Precision Steel’s Chairman and Chief Executive Officer.

Dr. Wo Hing Li –Chairman and Chief Executive Officer

Welcome to all of you, and thank you for joining China Precision Steel’s second quarter 2008 conference call. We are pleased to announce that we successfully reduce much of our inventory that was accumulated in the first part of 2007 and have returned our focus to maximizing gross margin. We are expanding our market penetration in domestic and international markets.

Our revenues for the second quarter 2008 was 11.9 million, down from 20.6% from 15 million in the second quarter of fiscal 2007. The decline in revenue was the result of two issues. First, because of the complexity and longer production times involved with our high margin products. Our overall sales volume declines resulted in lower revenues from a year ago period. Second, we made $2 million adjustment to our VAT and sales taxes during the quarter which reduced our revenues.

High carbon and low carbon products generated 37.9% and 46.9% of total revenue respectively. The balance of 15.2% of the revenue generate from sales of scrap metal and subcontracting income. Experts for the quarter were 26.1% of total revenues.

Sales volumes of our Precision Steel products is 14,010 metric tons, down 28.6% from 19,634 metric tons in the second quarter of fiscal 2007. The year-over-year decline in sales volume reflects our change in sales mix during the quarter to a more high quality, high margin products which require longer production time due to their complexity. Our high precision steel products can take up to several weeks to produce compared to our lower precision products that are now priced to reduce thickness and has shorter production time.

As a result of the changing product mix our gross margins increased 5.7% to 28.4% for the quarter compared to 22.7% from the same period a year ago. At the beginning of November, we successfully raised gross proceeds to 47.9 million in a private placing of our common stock. We believe our Shanghai balance sheet increases our competitors by providing capital to expand our capacity and product offerings. We intend to use the net proceeds for the repayment of certain existing bank debt in the amount of approximately $22 million. Capital expenditures related to the completion of the second reverse rolling mill and annealing furnace and construction of the third reversal rolling mill and related capital expenditures in the amount of approximately $18 million, and the balance for general corporate purposes.

During the quarter we added a new continuous annealing furnace for processing 300 series stainless steel. A continuous annealing furnace anneals steel by passing it through different zones at constant temperatures. During this process the steel is heated in a precision controlled oxygen-free atmosphere to provide the different strength and formability levels required by our customer’s applications. This new furnace allows us to expand our product offering to include high margin precision stainless steel. Targeted end markets include electronic components such as portable DVD players, hard disk cases.

The annealing line is in the chow production and is expected to begin contributing to revenue during the third quarter of fiscal 2008. We have decided to postpone the construction of our third cold rolled mill, originally scheduled for the first quarter of calendar 2008. As mentioned earlier, our goal is to optimize our product mix and gross profit. Therefore, we have decided to focus on our current operations and product mix as we evaluate our growth opportunities. Our second cold roll mill completed in September 2006 is now 50% utilization rate and is expected to reach maximum production capacity in the next two years.

As far as our research and development efforts we have successfully completed the R&D for cold rolled steel using iron and steel rails and in negotiations with potential customers. We are continuing with the R&D for cold rolled steel using double layered welded pipes for various industrial applications. Most of these products are high quality complex products that generate high margins.

In December we were awarded the hi-tech enterprise certification by the science and technology commission of Shanghai that was probably in December 2007. The certification is awarded to hi-tech enterprises with technology-intensive competitive advantages and leading products that utilize advanced corporate management systems. 288 companies and various industries received this certification in 2007. Receiving the hi-tech enterprise certification indicates our products and services to meet the high standard step by the Science and Technology Commission of the Shanghai Municipality. The certification also provides China Precision Steel access to numerous government benefits including certain tax benefits that are subject to further approval to relevant tax authorities and increases of visibility in the precision steel industry.

Now I will turn the call over to Leada, who will discuss financial results for the second quarter in detail.

Leada Li - Chief Financial Officer

Thank you, Leslie. Our revenues for second quarter of fiscal 2008 were 11.9 million; (Inaudible) dropped 15 million in the first quarter of fiscal 2007. The decrease in revenue is attributed to changes in sales mix to high quality and high margin products.

As Leslie mentioned, the complexity and longer production time for the higher margin products resulted in the less volume sold in the second quarter compared to the same quarter a year ago. Revenues were also impacted by cumulative adjustment as a result of an under provision of (ATN) self act in the first quarter of fiscal 2008.

High carbon and low carbon product accounted for 37.9 % and 46.9% respectively, compared to 52.3% and 47.7% respectively in the same period a year ago. Revenues from exports were 3.1 million or 36.1% of total revenue.

Our gross profit in the second quarter of fiscal 2008 was 3.4million and changed from the same period a year ago. Our gross margin increased to 28.4% from 22.7% from the prior year period. The improved gross margin is attributed to the increased sales of higher margin, higher quality products.

Selling expenses were 18,744 of 1.5% of revenues compared to the 64,693 a 0.12% of revenue in the second quarter of fiscal 2007. The increase in selling expenses was the result of the increased transportation expenses and frequency of deliveries from a broader customer base.

Administrative expenses was $846,218 or 7.1% of revenues, compared to $498,737 or 3.3% of revenue in the same period a year ago. The increased administrative expense was due to the cost associated with being public company, as well as increases in wages and salary.

Operating income for the second quarter of fiscal 2008 was $2.3 million compared to operating income of $2.8 million in the same quarter last year. Operating margin improved to 19.4% from 18.9% in the year ago period.

Our net income for the second quarter of fiscal year 2008 was $2.4 million down from $2.9 million in the same period of the prior year. Fully diluted earnings per share was 0.05 compared to 0.11 in the comparable period a year ago. Diluted earnings per share reflects an increase of $16.7 million which is average diluted share outstanding from the year ago period, due to the sale of common stock in February and November 2007. And now briefly covering our balance sheet. As of December 31, 2007, we have $40.2 million cash and cash equivalent for the liabilities of $14.4 million and working capital of $56.8 million.

Account receivables which will include trade receivables and bank acceptance note and other receivables stood at $35.7 million at quarter end, up from $8.3 million as of June 30, 2007. We make a provision for receivables that have not been paid within 90 days. Just under half of our accounts receivables of bank acceptance note that carry a little risk of non-payment.

Our shareholder equity stood at $100.2 million compared to $51.1 million as of June 30, 2007. Our budget for capital expenditure for the calendar year is $16 million for the use of purchasing a new 1700 mm cold rolling mill. We believe that the proceeds from our recent financing provide us with the resources we need to meet our currently requirements and spend on capital expenditure.

Now, Leslie will provide some final remarks before we open up the call for question-and-answer.

Leslie Richardson – CCG Elite Investor Relation

Thanks Leada. I would like to conclude by saying we are continuing to ramp up capacity and expand our product offering for cold rolled precision steel. Our second cold rolled mill is now operating at 50% capacity and we have just added the new continuous annealing line for processing high-margin 300 series stainless steel. The continuous annealing line enables us to expand our product offering for higher margin precision steel product. This completed the development of cold-rolled steel used in rails and expect to complete the development of cold-rolled steel used in double layer welded pipe this quarter.

We believe that the receipt of High-tech Enterprise Certification Award by the Science and Technology Commission Shanghai municipality is a testament to leading technological expertise and competitive position in the precision steel industry. I would like to thank you all for your interest in China Precision Steel and we would look forward to updating you on China Precision Steel’s progress next quarter. We will now open up the to call any questions you may have for Dr. Li and Ms. Leada Li.

Question-and-answer Session

(Operator Instruction). The first question will come from the line of Edward Tim.

Edward has removed himself from the queue. So there are no questions at this time.

Leslie Richardson

Okay. Thank you very much for attending our conference call. You can contact myself, Leslie Richardson and Leada Li if you have any additional questions.

Operator

Thank you for your participation in today’s conference. This concludes our presentation and you may now disconnect. Have a great day.

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