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Executives

John Mattio - SVP, MZ North America

Pengfei Liu - CEO, Secretary and Director

Marco Ku - Chief Financial Officer

Analysts

Alberto Bassetto - Jayhawk Capital

China Marine Food Group Ltd (OTCPK:CMFO) Q2 2012 Earnings Call August 15, 2012 8:30 AM ET

Operator

Welcome to the China Marine Second Quarter 2012 Earnings Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened up for questions. (Operator Instructions). This conference is being recorded today, August 15, 2012.

I'd now like to turn the conference to over, John Mattio. Please go ahead, sir.

John Mattio

Thank you and good morning, everyone. Joining us today for China Marine second quarter 2012 earnings conference call are the company's Chairman and CEO, Mr. Pengfei Liu, and the company's Chief Financial Officer, Mr. Marco Ku. Mr. Liu and Mr. Ku, we will be giving comments on the financial and operational results for the second quarter. They will then be available to answer questions after the presentation.

I would like to remind everyone though that on this call, prepared remarks may contain forward-looking statements, which are subject to risks and uncertainties and that management may make additional statements in response to your questions. Therefore, the company claims the protection from the Safe Harbor for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995.

Forward-looking statements related to the business of China Marine Food Group and its subsidiaries can be identified by common use forward-looking terminologies and those statements involve unknown risks and uncertainties, including all business related risks that are more detailed in the company's filings on Form 10-K, 10-K and 8-K with the SEC.

For those who are unable to listen to the entire call, we'll have an audio replay that will be available and the call is also being webcast, so you could log in via the internet. That information was provided on the conference call announcement and in the earnings release yesterday.

At this time, I would like to turn the call over to Mr. Liu, the Chairman of the company. He will provide opening remarks that will be translated by Marco Ku.

Chairman, Liu? The floor is yours.

Pengfei Liu

Thank you, John. Good morning and thank you for joining us, for China Marine's second quarter 2012 earnings conference call. Our second quarter results reflect a rebound in demand for our products and gradual improvements in each of our core businesses. Brand, seafood snacks, Hi-Power beverages and marine catch.

We have worked diligently over the past year to overcome the short-term challenges caused by outside factors such as the Japan nuclear disaster and the beverage contamination incident happened in Taiwan last year. While underlying demand continues to rise from depressed levels, total consumer demand remains well below levels prior to these adverse events.

Nevertheless, we are pleased to see positive results from our investments in advertising, promotions and consumer education. The more improved sequential revenue in our seafood snacks in Q2 2012 and 42% year-over-year increase in Hi-Power revenue reflect an improvement in our competitive position versus smaller competitors that have lost their market share during the same period of time.

Another important milestone we achieved is the grand opening of our new 20,000 tons cold storage facility. This is the most advanced and largest cold storage facility in Shishi port in nearby area. It will not only increase the amount of raw materials to retail store for our seafood snack business, but also generate recurring revenues by leasing the excess space and some other services such as ice making to other fishermen in the area. This new facility further strengthens our position as an efficient and diversified consumer products and marine catch company.

Thanks for your interest in China Marine. We are yet to be satisfied with the financial results over the past few quarters, however we believe our strategy is sound and that worst is behind us.

Our CFO, Marco Ku, will now discuss our financial results for the second quarter of 2012. I will be available to answer your questions after he finishes his presentation. Thank you.

Marco Ku

Thank you, Mr. Liu, and good morning everyone. This is Marco Ku, the CFO of China Marine. I will begin by reviewing our results for the second quarter end June 30, 2012. Please be aware that all the growth figures that I will reference reflect year-over-year growth compared to the second quarter of 2011.

Total consolidated revenues were $61.3 million, up 177.7% from $22.1 million in prior year's period. Total revenue totaled $52.3 million in the quarter, or 85.4% of net revenues. Cost of revenue consists of raw materials, packaging materials, direct labor and manufacturing overhead. We produced seafood snack foods at our dedicated production facility in Shishi, where Hi-Power production is outsourced to the third-party, branding and bottling facilities in Fujian province.

Consolidated gross profit and gross margin were $9 million, a 14.6% in the same quarter compared to $7.2 million and 32.4% in the same period a year ago, respectively. The primary reason for the year-over-year decline in gross margin was greater contribution from our marine catch business in the second quarter of 2012, which generated lower margins in the seafood snack and Hi-Power beverages businesses.

A look at our business segments' performance for the second quarter of 2012, our Seafood Snack Food segment, sales of our May conference Seafood Snack Food, generated $10.7 million in revenue, down 20.6% compared to the same period last year and accounted for 17.4% of total revenues in the second quarter of 2012.

Sales were negatively impacted by ongoing consumer concerns regarding the safety of seafood products. However, we are glad to see stabilization in our retail sales, particularly in our home province of Fujian.

Gross margin for our Seafood Snack Food segment improved 120 basis points to 26.4%, compared to 27.2% in the same period a year ago as a result of cost reduction efforts and a favorable mix of sales in products with lower packaging costs.

Hi-Power beverages generated second quarter revenues of $12.3 million, up 42.2% with strong sales in both markets of Fujian and Zhejiang provinces. Our advertising and promotions over the past several quarters are beginning to drive trials from our new customers and also those orders from our existing retailers.

We sell Hi-Power beverages through major international retailers such as Walmart, China-based supermarkets like Trust-Mart, convenience stores, bars, restaurants, school canteens and local corner stores which competes with Hi-Power beverages as a functional drink side-by-side with those local and well known international brands.

Gross margin for beverages was 38.2% in the second quarter compared to 40.4% in the same period last year due to higher raw materials and packaging costs. We spent approximately $8.1 million on advertising and promotions in the second quarter of 2012, which increased packaging, promotions, sponsorship of sporting events and outdoor and T.V. advertisements in Fujian and Zhejiang province. Definitely, we continue to build our competent sales and marketing team on a on an opportunistic basis ending the quarter with 96 employees in total.

Our last business segment Marine Catch had a very strong quarter generating sales of $38.3 million. Prior to the completion of our new cold storage facility, we historically generate the vast majority of our marine catch sales in the second half of the year.

With additional storage space, we will be able to capitalize on favorable market opportunities to purchase and sell marine catch to local market going forward. Gross profit and gross margin in our marine catch business was $1.2 million and 3.3%, respectively, in the second quarter of 2012.

I will now discuss the rest of line items over our consolidated second quarter results. Selling, general and administrative expenses were $10.6 million, compared to $5.9 million in the prior year's period.

Sales and marketing increased by $4.8 million to $8.7 million in the second quarter of 2012 as a result of $3.7 million in advertising campaigns and $4.4 million in promotional costs to strengthen the brand position and improve market awareness.

We believe these investments have already been commenced to generate positive results. We have an operating loss of $1.6 million in the second quarter of 2012, compared to a $1.2 million operating income in the same period of last year.

Excluding the $0.6 million non-cash amortization expense related to the Hi-Power acquisition, operating loss was $1 million in the second quarter of 2012. GAAP net loss for the quarter end June 30, 2012, was $1.6 million compared to $1 million net income the prior year corresponding period. Adjusted non-GAAP net loss including the non-cash expenses was $1 million, representing $0.03 per share loss.

As of June 30, 2012, we have $17.4 million in cash compared to $0.6 million as of December 31, 2011. The short-term borrowing as of June 30, 2012, was a balance of $7.2 million. Cash flows from operations for the first six months of 2012 were $12.9 million as a result of improved accounts receivable collection partially offset by the negative net income.

Working capital was $67.3 million, down from $70.2 million as of December 31, 2011. The current ratio was 4.9 to 1 on June 30, 2012, compared to 9 to 1 on December 31, 2011. Accounts receivable were $57.3 million, compared to $68.6 million as of December 31, 2011.

We have collect majority of the accounts receivable in July and also through the first half of August, so latest cash balance as of to-date should be over $30 million as a result of all collection. Shareholders' equity was $127.3 million as of June 30, 2012.

I will conclude my financial review by providing some highlights for the first half of 2012. Net revenues increased to 56.7% to $76.4 million. Gross profit was down 19% to $13.6 million. Reported net income and earnings per share were a loss of $3.7 million and $0.12 per share loss, whereas non-GAAP net income and earnings per share were a loss of $1.8 million and $0.06 per share loss.

On behalf of the entire China Marine management team, we want to thank you for your interest and participation in this call. Please visit our website at www.china-marine.cn. We look forward to updating you on our progress on our next quarterly conference call in November. Thank you.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. (Operator Instructions). The first question comes from Alberto Bassetto of Jayhawk Capital.

Alberto Bassetto - Jayhawk Capital

Good evening Marco, and good evening, Mr. Liu.

Marco Ku

Morning.

Alberto Bassetto - Jayhawk Capital

Here is the first question. Can you help us to understand how we should look at the current, which is the September quarter both, for the seafood and also algae drink?

Marco Ku

Thanks for the question. I think, right now based on what we've seen in July and also the pre-orders for the august, we believe that both segments moderately improving especially the drink, because December time will be the peak season for the drink business, so definitely we believe that the third quarter performance will be moderately better than what we've seen in Q2.

Alberto Bassetto - Jayhawk Capital

Okay. With regarding the marketing and selling expenses, the number that came out to be around $8.4 million for the second quarter. Can you help us to understand that how you see the number going forward for the next two quarter? Staying at that level, are they going down? And if they're going down, by much? Can you bring some light on that too?

Marco Ku

Yes. Sure. I think that every one of us is going to believe that. We have to firstly invest into the printing and advertising campaigns to educate those people especially for such a beverage which is brand new and without any competition in market, so you're going to somehow effect in the sales and market expenses to let those people understand what are the benefits of the drink.

After the prior year, actually we invested a lot and you can see that we gradually increased the number, the amount of sales and marketing expenses as well around the past year, so right now it's a kind of a consolidation stage for us to reconsider what we are going to do that in that respect.

Right now, I believe the T.V. commercial is very efficient way to communicate with the consumers and that's why we will continue to invest, but definitely we will have to choose what kind of channels, what will be airtime, something like that to try to have the level of T.V. advertising to spend wisely going forward. That's point number one.

The other major area for us to spend will be the subsidies or the promotional products that we support our distributors. Definitely, the program is pretty costly to us as you can see, but going forward actually we will try to reduce the level of promotions which will be supported to our distributors going forward actually, and that's why I think that going forward in terms of the promotional costs, in terms of those products that we offer to our distributors will be substantially reduced.

So, go back to your question I believe that is [shelf space] rent publicly the sales and marketing expenses will be more or less at a similar level, but in medium to long run definitely you will see a kind of decrease in the amounts of our sales and marketing expenses to be expensed.

Alberto Bassetto - Jayhawk Capital

Okay. Thank you. The last question on the cold storage facility, when do you think that we'll start seeing some revenue coming out with that operation?

Marco Ku

Definitely, you will see those revenues coming in starting from the third quarter. Actually, we are right now selling ices to those fishermen.

Alberto Bassetto - Jayhawk Capital

Okay. All right. Thank you very much.

Operator

The next question comes from Ross [Bryant] of UBS Financial Services.

Unidentified Analyst

Thank you for taking my question. One of my questions has been answered. When will your construction in progress go to plant and equipment? I think you have finished your cold storage facility. Isn't that what your construction in progress is?

Marco Ku

It's already completed, so you will see the transfer from CIT to the property and plants during the third quarter.

Unidentified Analyst

Okay. Very good. Are you happy with your cold storage capacity and usage so far?

Marco Ku

Yes. It just kind of beginning, so we can't say that we are happy with that, but definitely we are glad to see that is being completed after a long year.

Unidentified Analyst

Is it working to your expectation as far as the facility itself?

Marco Ku

Yes.

Unidentified Analyst

Good. Okay. Thank you.

Marco Ku

Thank you.

Operator

The next question comes from [Patrick McMullan].

Unidentified Analyst

Hi. I just have two questions. First, actually you spent about $4.1 million more this quarter than last quarter on advertising and marketing, and I wondered if you could give us a rough breakdown of how much of that was on spent on the drink line and how much of that spent on the seafood snack line?

Marco Ku

I think, majority of them almost. Maybe around 80% will spent on the drink and the rest will be on the food.

Unidentified Analyst

Okay. And my second question is more general. It looks like from your couple of statements in your couple of quarterly reports that the company is focusing more on the drink line and less on the seafood snack line. I see that in terms of headcount, in terms of sales and expenses, et cetera, is that where the company is going, and if so can you explain why that decision is made to shift more resources t the drink line?

Marco Ku

That's a very good question. Actually, we are not really shifting our resources to the drink. Actually the drink business is being operated by a separate sales team, so put it this way. You do see more comments going to the drink business. The reason is because, right now, our major marketing expenses are being spent over the drink business and that's why we comment to explain why we are doing that.

Frankly speaking, for the food business actually it is much more mature than the beverage business and that's why the beverage business, the growth rates over there will be very significant, and therefore we like to spend more time to explain to share with you about our experience and what's going on in the market on the beverage business.

Unidentified Analyst

All right. Just one more quick question, you've mentioned with the cold storage facility that you will be selling storage space to fishermen and then you mentioned other services. What kind of other services will you be selling to the third-parties interaction with the cold storage facility?

Marco Ku

Yes. Thanks a lot. Actually, there are all together three business streams that could be coming from the cold storage facility. One is, the ice making that we are selling ices to the fishing boats. The other one is the renting of those space that we can when we have extra storage capacity, then we can rent out to those distributors or whatever one who have the raw materials in hand. The third one is the frost breathing.

Before you can put your raw materials into the cold storage, you have to go through a process we name it as frost breathing to make those raw materials hot enough in a block to be stored in a cold storage.

Unidentified Analyst

Okay. Thank you very much.

Marco Ku

Thanks.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Marco Ku for any closing remarks.

Marco Ku

Thank you. Thank you for everyone joining us today. As mentioned by Chairman Liu, we believe that the worst situation is already behind us and we will continue to invest in series of sales and marketing campaigns to further strengthen our brand position and market awareness. So right now with the new cold storage facility, we will be able to bargain for better prices at bulk purchases with local fishermen and thus improve our profit margins. In addition, we can capture more creating opportunities given this extra storage capacity.

We will be more than happy to see you all around our new facility in Shishi port and further discuss with you about our business plans in the near-future, so thank you all again.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

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