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Lihua International, Inc. (NASDAQ:LIWA)

Q2 2012 Earnings Conference Call

August 09, 2012, 08:00 a.m. ET

Executives

Jianhua Zhu - Chairman and CEO

Daphne Huang - CFO

Analysts

Dmitriy Shapiro - Global Hunter Securities

Steve Emerson - Emerson Investment Group

Operator

Welcome to the Lihua International Second Quarter 2012 Earnings Conference Call. During today’s presentation all parties will be in a listen-only mode. Following the presentation the call will be opened for questions from professional investors. (Operator Instructions) This conference is being recorded today August 9, 2012.

I’d now like to turn the conference over to (inaudible), please go ahead ma’am.

Unidentified Participant

Thank you, operator and good day everyone. This is [Alyssa Akroft] with Investor Relations of Lihua International. Thank you all for joining us today by telephone and over the internet.

Before we begin I’d like to remind you that the comments made during today’s call may contain forward-looking statements that are within the meaning of Section 27A of the Securities Act of 1933 as amended in Section 21E of the Securities Exchange Act of 1934 as amended. All statements other than statements of historical fact that address activities, events for development, the company expects, projects, believes or anticipate will or may occur in the future according and without limitation to statements about Lihua’s business or growth strategy, now industry conditions including the availability of copper or recycled scrap copper, future operating results of the company, capital expenditures, expansion and growth opportunities, bank borrowings, financing activities and other matters are forward-looking statements. Although the company (inaudible) expectations made during today’s call are based on reasonable assumptions or actual results may differ from those projected in the forward-looking statements.

With that said it's now my pleasure to turn the call over to Lihua’s Chairman and Chief Executive Officer, Mr. Jianhua Zhu, who will provide an overview of recent operational highlights in Mandarin, I will then translate Mr. Zhu’s remarks and provide some additional comments on his behalf before turning the call over to Daphne Huang, Lihua’s Chief Financial Officer to discuss the second quarter 2012 financial results. Then we will open the call up to your questions.

Mr. Zhu, please go ahead.

Jianhua Zhu

In the second quarter we continue to grow our sales by capturing new opportunities within the large and growing end markets of our copper alternative products. We achieved another quarter of double-digits sales growth over last year and have set the stage for continued strong performance over the longer term. Although our bottom-line performance was impacted by ongoing ASP pressures, demand for our industry leading copper anode, rod and wire products remains strong and we are well equipped the cash remover of the unmet demand in the market following the launch of our two new copper anode smelters in June.

These two smelters have more than doubled our copper anode capacity to 85,000 tons per year, while increasing total refine copper production capacity by nearly 60% to 135,000 metric tons per year. We produced approximately 1,000 tons of copper anodes from the two new smelters following the launch of production in June, as to reach output close to full capacity at the end of the third quarter.

The (inaudible) completion and longer than anticipated ramp up of the two new smelters as well as a reduced assumption in profitability of our CCA copper wire and copper anode products, we are revising our 2012 guidance to gross profit of 84 to $87 million and non-GAAP net income of 54 to 57 million. While this is softer than our initial expectations, we remain on-track (inaudible) another year of solid growth and have taken additional steps to further solidify our long-term process.

Our copper rod production continues to generate strong sales following it's reintroduction in the fourth quarter of 2011. With 50,000 tons of copper rod production capacity and 20,000 to 25,000 tons of copper wire drawing capacity and our ability (inaudible) pure copper rod to other wire producers will be a meaningful contributor to our top and bottom-line growth.

In addition to our near-term growth objective, we are working on initiatives that will support our company’s sustainable growth for the longer term. We completed the second quarter with a strong balance sheet including approximately $125 million in cash and we are putting the cash to use for investments that will solidify Lihua’s ability to continue growing within our current markets, while introducing new products that will gain entry into new factoring markets that have significant unmet needs for these types of products we produce.

The new CCA cable and wire products are designed to address the cost sensitivities of customers in the electric power delivery and transmission markets, this segment of the market generate sales of [several] billion dollars annually. And there are currently no alternative to pure copper cable and wire for electric power transmission. With our partners at the Shanghai Electric Cable Research Institute, we are going to change this. We plan to introduce bi-metallic cable and wire product comprised approximately 50% copper and 50% aluminum by weight which can provide the same press release even higher connectivity as the pure copper cable and wire currently being used in the under 1000 voltage electric transmission market.

The 50-50 ratio of aluminum to copper differs from traditional CCA and requires an entirely new binding product to produce a product capable of maintaining the required structural integrity and conductivity. We are currently working with our partners at SECRI to secure the necessary patents and establish industry standards for the use of this new bi-metallic CCA cable and wire products. Feedback from prospective customers has been very positive and I’m confident that these products will represent another important growth engines for Lihua.

As you can see we are continuing to grow our business in the near-term while positioning Lihua for longer term success. We have achieved tremendous growth over the last several years through the expansion of our wire product, development of our refined copper business, the introduction of copper anodes and a recent capacity expansion.

Nevertheless, (inaudible) companies face hurdles along the path for prosperity and Lihua is no different. While we have had to overcome very few challenges in our business since becoming public in 2009, the late launch of production on our new smelters was the first such obstacle we have had to overcome. I remained extremely confident on our ability to succeed and look forward to this substantial opportunities that lie ahead.

With that overview I’d now like to turn the call over to our CFO, Daphne Huang, to review our financial results for the second quarter 2012. Daphne?

Daphne Huang

Before I provide an overview of our financial results, I’d like to highlight that all our financials are prepared in accordance with the U.S. GAAP. In addition to GAAP reporting, we will be providing adjusted EBITDA and GAAP net income figures which are non-GAAP measurements. We believe that adjusted EBITDA and non-GAAP net income are important metrics that provide investors with information about our operating trends. We define non-GAAP net income as net income excluding the change in fair value of warrants and other one-time or non-recurring items that are evaluated on individual basis. We define adjusted net EBITDA as net income before depreciation and amortization, interest income expense, income taxes, gain on extinguishment of warrant liabilities, change in fair value of warrants and non-cash share-based compensation expenses.

We continue to demonstrate growth in the second quarter of 2012 with sales increasing 14.4% to $191 million compared with sales of 167 million in the second quarter of 2011. We saw an increase in sales volume across each of our product line as a result of ongoing solid market demand for Lihua’s product.

The production capacity expansion in October last year and June of this year resulted in overall sales volume improvement of 36.5% in the second quarter of 2012 over the same period last year and was partially offset by a year-over-year decline in average price of copper.

The revenue involving breakdown for the second quarter for each of our products is as follows; we sold 11,863 metric tons of CCA and copper wire, which equates to 100.4 million in sales compared with [9,217 tons of $93.5 million] in sales in the second quarter of 2011. We achieved the 28.7% increase in sales volume as a result of additional production quantity per customer order. In addition, the increase in wire volume was supported by growth in the production and sales of the fine wire product, which are processed from copper rod and have a shorter production cycle than our super fine wire products.

Copper anode volume in the second quarter of 2012 totaled 8,979 metrics tons accounting for $78.2 million in revenue compared with 7,912 metric tons or 73.5 million in revenue during the same period last year. The year-over-year improvement in sales volume for copper anodes was due to the increased production achieved as a result of addition of two new copper anode smelters which started production in June of 2012.

Lastly, our copper rod production contributed sales of 20.4 million in volume of 2,545 tons compared to no sales of copper rod in the second quarter of last year. As the product was used exclusively on internal basis as a raw material for the production of fine and super fine copper wires in the second quarter of 2011.

Our gross profit for the second quarter of 2012 was $20.7 million up 5.4% from the same period a year ago. The gross profit breakdown by product category is as follows; CCA copper wire products accounted for $12.5 million of gross profit or 12.5% of sales in the second quarter of 2012 compared with $13.8 million or 14.8% of sales in the same period last year.

Copper anode contributed a total of $7.1 million to gross profit or 10.1% of sales in the second quarter of this year compared with $5.8 million of gross profit or 7.9% of sales in the same period a year ago. Copper rod product accounted for $1.1 million of gross profit or 5.4% of sales in the second quarter of 2012 compared with no sales in the second quarter of last year.

As a percentage of total sales, gross margin declined to 10.8% in the second quarter of 2012 from 11.8% in the same period last year. The year-over-year decrease was due primarily t increased sales of copper anode, copper rods and fine copper wire which carry lower margins than our super fine copper wire and CCA wire product.

Selling, general and administrative expenses for the second quarter of 2012 was $2.6 million compared with $2 million in the same period in 2011. The increase in our SG&A expenses year-over-year was primarily attributable to higher product distribution and insurance cost and increase in shipping and handling cost directly related to our increased business volume and scale of operations as well as our continued investments in R&D.

For the second quarter of 2012, we did not report any interest expense this compares with interest expense of $49,000 recorded for the second quarter of last year. We recorded income tax expense of $4.8 million in the second quarter of 2012 based on the effective tax rate of 26.5%, this compares to an effective tax rate of 24.2% for the same period in 2011. If we exclude the non-taxable gain or loss on warrant and operating loss of our U.S. entity, the effective tax rate would be 25.3% and 25% for the three months ended June 30, 2012 and 2011, respectively.

Net income for the second quarter of 2012 was $13.4 million or $0.45 per share based on 30 million weighted average diluted shares outstanding. This compares with net income of $14.4 million of $0.48 per share based on 30.1 million weighted average diluted shares outstanding in the second quarter of 2011.

Our net income this quarter included a $44,000 non-cash charge due to the changes in fair value of the warrant. If you exclude the impact of these non-cash warrant related items, our net income on a non-GAAP basis for the second quarter of 2012 would have been $13.5 million or $0.45 per share representing 2.5% growth over $13.2 million or $0.44 per share of non-GAAP net income from the same period last year.

Adjusted EBITDA for the three months ended June 30, 2012 was $18.9 million compared with adjusted EBITDA of $18.5 million for the same period in the prior year.

With regard to guidance as Mr. Zhu mentioned earlier, we are revising our 2012 guidance based on the lower than expected contribution from our new copper anode smelters which launched production in June as well as reduced profitability expectation from our CCA and copper wire and copper rod products. As such, our full-year 2012 guidance [now cost] for gross profit of 84 to $87 million representing year-over-year growth of 11 to 15% and non-GAAP net income of 54 to $57 million or 8% to 14% growth over 2011.

Our performance in the second quarter and the upcoming ramp up in production of our two new copper anode smelters give us confidence that we can achieve these results we have outlined for 2012 and more importantly just see further into the future.

Before we open the call to your questions, on behalf of the company and the management team, I’d like to reiterate that we are fully committed to being public U.S. company. We are actively working to drive shareholder value and plan to increase our Investor Relations activities in the second half of the year with an enhanced investor outreach program.

With that we will be happy to take your questions. Operator we are ready for the first question.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Dmitriy Shapiro with Global Hunter Securities. Please go ahead.

Dmitriy Shapiro - Global Hunter Securities

I understand that you have to lower your guidance somewhat because of the sharp decrease in commodity prices globally, but can you talk more about what do you see in terms of the demand for the products?

Jianhua Zhu

The demand for our product remains strong; it involves the wire and copper rod sector as well as the copper anode product. So, across the board for all our products, we don’t see reduction in demand volume wise. The reduction of our outlook really as a result of what we see the profitability on the [commodity] basis, gross profit on [per ton] basis, the pressure that we saw in the second quarter in the wire category as well as copper rods that’s really as a result of overall copper price decline in that quarter.

Dmitriy Shapiro - Global Hunter Securities

And are guys still importing scrap copper directly from the U.S. and can you tell us how much have you imported during the quarter?

Jianhua Zhu

We have actually [left] down our importing volume in the second quarter because interestingly enough the scrap copper price in the second quarter overseas was not cheaper than the domestic scrap copper price. So, it's sort of pricing dynamic change. So, in the second quarter, you will see the prepayment for raw material items on the balance sheet actually reduced from the prior quarter is relatively steady, 24, $25 million to $17 million. In the second quarter, our scrap copper direct import in terms of tonnage is in [few thousand] metric tons.

Dmitriy Shapiro - Global Hunter Securities

And I’m glad to hear that you are planning to concentrate on (inaudible) shareholder value, but can you go into little bit more detail what exactly you guys are planning to do in that regard. And also given that the company (inaudible) trading basically of cash, have you considered resuming your buyback program for cash?

Daphne Huang

I will actually answer this question in two prongs, as I mentioned at the end of my speech, we are committed to being a public company in the U.S. and we obviously that the phase is pretty tough and you guys, all the investment banks really medium to (inaudible) investments banks that use to support this space (inaudible) has pretty much most of them has shied away from this space as we speak. And Global Hunter obviously you guys we have been really appreciate the continued support and coverage over the past couple of years from you guys, but obviously you guys are one of those investment banks that eventually shut the door on the space as of recent. We are aware of the continued market situation and we will as I mentioned before, we will increase our Investor Relations and Wall Street efforts base and efforts to tell the story of the growth.

In terms of immediate actions of whether to reinstitute any heavy market strategies such as share buyback, we are going to revisit sometime in the second half of this year. The situation right now is that the company has experienced tremendous business growth via in the way of capital expansions. And when we see as I mentioned in the prior quarter conferences, we need to preserve cash for a very capital intensive business liquidity. And when we get a couple of quarters of steady state production out of the new smelters and we see some steady state outlook in terms of liquidity, working capital liquidity situation. We will sit down with the board and revisit; obviously we will continue to explore strategic management board to explore strategic opportunities to enhance our shareholder value.

Operator

And our next question comes from the line of (inaudible). Please go ahead.

Unidentified Analyst

I was just wondering what your public company cost are per year overall?

Daphne Huang

Overall in the magnitude of million dollars or sometimes up to million dollars, that actually includes obviously the legal consoles IR, accounting, the auditing.

Unidentified Analyst

And you guys still feel it's worth spending that money versus saving and potentially taking the company private.

Daphne Huang

Collectively, obviously taking private is at the end of the day is the fund or assembly situation, but Mr. Zhu and family is very committed to being a public company in the U.S. space. We understand the market condition is very tough right now, but again going back and this situation is really tough situation in this sector for Chinese companies being looked at it over here is really unprecedented in the U.S. capital market. But we still have enough confidence that, we are going to continue to deliver the fundamental business strong and right through this cycle.

Operator

(Operator Instructions) Our next question comes from the line of Steve Emerson with Emerson Investment Group. Please go ahead.

Steve Emerson - Emerson Investment Group

Daphne, please thank the company principles for continuing to put in a strong effort into being a public company. To understand what’s going on and the fundamentals of the business, I’m trying to separate out the profit per ton on your major areas versus let say last year or prior quarter. How much price spread pressure has there been?

Daphne Huang

I’ll give you a little overview Steve, and by the way thanks and I’ll pass on the message to the [founders]. But in terms of gross profit per ton, I will give you a little overview or analysis of what we saw in the second quarter. In the CCA wire sector which historically, order is the smallest in terms of sales volume product and production capacity product in the overall product makeup. It is still the product category that has the highest gross profit per ton. CCA wire sector what I saw is as appose to the historical average in the $3,000 per ton had reduced down in the second quarter to drop down to a little below $3,000 per ton. In the second quarter because of the copper rod production capacity increase, that we increased the copper rod smelter production capacity to 50,000 tons per annum.

We actually turnout a lot of particular copper wire, basically semi process the copper rod that we produced and part of that to the extent we can, we processed them into particular wire, copper wire and sell together with the excess copper rod to the open market. The fine wire and copper rod have lower gross profit on the per ton basis than the super fine copper wire. But across the board in the copper wire category and copper rod category I’m seeing decline in the second quarter gross profit per ton as well in the magnitude of copper wire. Average gross profit per ton has been historically hovering around $900 on average but in the second quarter it went down to average to little over $700 per ton, but copper rod has second quarter actually has down to somewhere between over $430 per ton which is copper rod side is okay. I really, we just started reintroducing copper rod to the market ever since fourth quarter of last year. So, we have three quarters of selling of copper rod but it's pretty much at average gross profit per ton out of these three quarters.

Steve Emerson - Emerson Investment Group

Well the anode is your main area, so have those margins per ton come in?

Daphne Huang

Actually I’m seeing steady state fluctuation; the copper anode customers typically will give us delayed payment. There is some precious metal s component within the copper anode let’s say (inaudible) delivery, they put the product into process and they tested out how much of precious metals and what kind of precious metals contains in there. So, we usually get this payment in a delayed form. So, what you see in the copper anode gross profit per ton situation is one quarter you get usually in the difference between the frequency of payment that we see from the customers for the precious metal content. So, for instance this quarter I received two payment, the next quarter I received three payments, so you see gross profit that growth factor into the copper anode gross profit per ton. So, typically gross profit per ton for copper anode is down one quarter but then up in the next quarter and then down again. So, in that sequence. So, this quarter is no difference because last quarter our copper anode gross profit per ton was pretty high, it was in the $900 range and this quarter it reduced down to $793 which is very in line with our expectations. We have very steady state major customers for copper anode and we really don’t see any strain in terms of gross profit. They still demand a lot of quantity.

Steve Emerson - Emerson Investment Group

If I hear you right, there has been no real decline in gross profit per ton on a steady state basis and the total miss from expectations is the delay in getting the new anode smelters of the full capacity to startup phase. Am I hearing you correctly?

Daphne Huang

That’s totally correct. At the beginning of the year when we initially put out the guidance we were assuming three quarters of full capacity production out of the two new smelters, copper anode smelters, but obviously there are construction delays and the two new smelters were not put into production until June when it constructed. It's really naming why does delay constructions situation but once the smelters were put into place, these two new smelters if anybody has seen the pictures employed very different equipment and technologies much more advanced than our existing smelters . So, we didn’t anticipate or factor in at the beginning of the year when we put out the guidance that the ramp up of the production is much longer than we expected. Right now we are expecting to run the two smelters up to close to full capacity sometime in September.

Steve Emerson - Emerson Investment Group

And does the two months, three months to fully ramped is in line with expectations?

Daphne Huang

Is in line with current expectations, yes.

Steve Emerson - Emerson Investment Group

Can you give us any, so Q4 will be the first full utilization quarter and we just do the math on $700 of ton times your full capacity and that will come up with a pretty good number, is that correct?

Daphne Huang

That’s approximately right, I’d raise the average gross profit per ton on copper anode little higher than $700 per ton.

Steve Emerson - Emerson Investment Group

What’s the fair range, 800, 790?

Daphne Huang

The historical gross profit per ton on copper anode should be closer to $800 per ton if you average it out.

Steve Emerson - Emerson Investment Group

Can you give us any possible timing on the new CCA product, what is management’s current expectation on when you will be in beta test at possible customers and approximate timings when you could be selling product?

Daphne Huang

Right now we are projecting about one year of outlook timeline until we can commercialize it, but I’m happy to report I think as I mentioned in the press release, we have received the first factory production equipment and we have installed, we completed installation in the first factory and also the test production we just completed has been successful. So, what we are going to do remaining work for this new product is we need to obtain industry standards certification. And then we will go into obviously marketing and promotional and contact customers and get the customer qualification before aggressively start production and sales go into contracting with future customers. So, estimate timeframe is about a year from here on.

Steve Emerson - Emerson Investment Group

And the certification phase, when do you expect that certified or is that highly variable?

Daphne Huang

The time is somewhat uncertain, but we are expecting within a few months.

Operator

And this does conclude today’s question-and-answer session. I’d like to turn the call back to management for any closing remarks.

Unidentified Participant

Thank you once again for joining us on today’s call. As we continue on this path to growth and success, we hope that you will follow our progress as we look forward to what the future holds for Lihua. If you have any further questions or need additional information, please do not hesitate to contact our Investor Relations partners The Piacente Group. On behalf of Mr. Zhu and the rest of Lihua’s management team, I’d like to thank you all for your continued support. Thank you.

Operator

Ladies and gentlemen, this does conclude today’s conference call. Thank you for your participation and you may now disconnect.

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