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China Gerui Advanced Materials Group Limited (NASDAQ:CHOP)

Q2 2012 Earnings Call

August 15, 2012 10:00 am ET

Executives

David Rudnick – CCG Investor Relations

Mingwang Lu – Chairman and Chief Executive Officer

Edward Meng – Chief Financial Officer

Analysts

Echo He – Maxim Group

Operator

Good morning. My name is Melia, and I will be your conference operator for today. At this time I would like to welcome everyone to the China Gerui Materials Group Second Quarter 2012 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator instructions)

Thank you. David Rudnick, you may begin your conference.

David Rudnick

Thank you, Melia. Good morning, ladies and gentleman, and good evening to those of you joining from China. I'm David Rudnick from CCG Investor Relations. I would like to welcome all of you to the China Gerui Advanced Materials conference call to discuss second quarter 2012 results. With me today, I have China Gerui's Chairman and Chief Executive Officer, Mr. Mingwang Lu; and Chief Financial Officer, Mr. Edward Meng.

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 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 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 ability to win new customers, merchants and vendors for its products; the development of new steel products, marketing and promotional activities, pricing policies of suppliers and competitors, increased 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 represents management's estimates as of today August 15, 2012. China Gerui assumes no obligation to update these projections in the future as market conditions change.

I will now turn the call over to China Gerui's Chairman and CEO, Mr. Mingwang Lu for some brief openings remarks. CCG’s (inaudible) will be translating for Mr. Lu. Mr. Lu, please.

Mingwang Lu

[Foreign Language]

Dear gentlemen and ladies, thanks for joining us today to the earnings conference call.

[Foreign Language]

We achieved a reasonable level of revenue and cash flow generation in the second quarter of the year, despite a very weak pricing environment, and challenging domestic and international market condition. Our second quarter saw further utilization of our 2200 tons of chromium plating capacity and the steady ramp up of production from our added specialized cold-rolled wide-strip steel capacity.

[Foreign Language]

While the current market environment has been challenging, we believe that our competitive advantages enable us to uniquely meet our customers' needs, which will enable us to generate continued solid results. We will closely monitor the market economic conditions in China, and seek to diversify our customer base by exploring new export markets, as well as enrich our product mix, by expanding the range of our end-use product and materials.

[Foreign Language]

We believe that our adoption of a wider customer base fits our strategy of being a high-end global steel producer will enable us to fully optimize our new capacity and specialized value-added capacity.

[Foreign Language]

Although the rest of the year 2012 continues to look challenging, we are confident that our strategies already in place will enable us to weather current market condition, and to testing our specialized steel segment in the long term. We are intent on executing upon our initial so as to leverage our new capacities and technologies already in place as well as those currently being developed.

[Foreign Language]

I thank you again for joining us, and we'll now turn the call over to Edward, our CFO. Edward?

Edward Meng

Thank you, Mr. Lu, and thanks to all online attending this earnings call. Looking at the queue of listeners, I do appreciate people from the West Coast getting up early, and also people from Europe and China.

To begin, a summary of the second quarter’s financials. For more details, please refer to our earnings press release earlier today.

Our revenue decreased 10.8% to $76.8 million in the second quarter of 2012 from $86.1 million in the second quarter of 2011. The decrease in revenue was primarily due to an 18.2% decrease in the Company’s average selling price or ASP to $820 per ton for the second quarter of 2012 as compared to an average selling price of $1004 for the same period of last year. This was partially offset by a 9.2% increase in sales volume to approximately 93,500 tons for the second quarter of 2012 from approximately 85,600 tons for the same period of 2011.

Gross profit decreased 16% to $19.8 million in the second quarter of this year from $23.6 million in the same period of last year. Gross margin was 25.8% compared to 27.4% in the first quarter of 2011. The decrease in gross margin was due to a weak domestic price environment as China’s economic growth has continued to slow in 2012, and in addition there was an impact from the testing associated with continued ramp up of the added 100,000 tons specialized steel production line.

Operating income decreased 19.5% to $16.8 million or $0.18 per share in the second quarter of 2012, as compared to $20.8 million or $0.24 per share in the same period of 2011.

Turning to the balance sheet, as of June 30, 2012, the Company had $282.2 million in unrestricted cash and an additional $144.9 million in restricted cash, as compared to $246.6 million and $118.1 million, respectively, as of fiscal year end 2011. Our short-term debt consisted of notes payable and short-term term loans that totaled $293.1 million as of June 30, 2011, compared to $298.4 million at the end of 2011.

The net cash provided by operating activity for the six months ended June 30, 2012 was $25.1 million compared to $40.6 million in the same period of last year.

And now for our business update, after the full session, we are going to have a Q&A session and so we are open to questions. But before that, I would like to address some of the macroeconomic factors that are affecting our industry in China, as well as the Company-specific issues that have been impacting our business for the first six months of the year.

We will also look to give you some clarity as to where things are heading and the steps that China Gerui is taking to optimize our market opportunities in the currently challenging market environment.

On the macroeconomy side, economic data released last week in China indicated that the country’s economy grew at a 7.6% clip in the second quarter. While such a rate would be spectacularly high in the developed world, this represents China’s slowest quarterly growth in three years. And as many of you know, many sectors including the steel sector have been impacted negatively by this relatively slower growth rate, as well as the expectation for slower growth to continue towards the end of the year.

This includes the commodity steel sector in China, which has been hit very hard this year, with profits virtually nil for the first six months, with many steel companies now pricing products at their cost of production. Further given the global clout, it is highly unlikely that China can export its way out of this problem though initiatives still exist through export tax rebates.

The principal call to this rebate and what is not so widely known is that many of China’s state-owned steel enterprises have cut back on production. Some companies are calling that major maintenance so as to restrain capacity and bring the industry supply and demand proportions back into the line.

Now let us look at China’s steel industry’s overall performance for the first half of the year. This will help us and you better understand the challenges facing steel producers and the processes on both the upper and the lower stream of the steel industry value chain. According to China Steel Industry Association, its member steel companies, mostly large state-owned producers, recorded a meager $318 million profit in the first half of 2012.

That is a 95.8% decrease, again this is 95.8% decrease, from the same period of last year. The average profit margin fell to 0.13% in the first half of 2012, as compared to 3.06% in the same period of last year.

Domestic steel prices continued to decline in the face of declining overall demand for steel products. As I said, many state-owned steel companies are forced to plan for maintenance downtime so as to manage reduced production. Some long state-owned state companies have decided to completely shut down production until the market shows signs of price improvement.

Actually to our best knowledge, some of our competitors in this niche cold-rolled steel market decided to shut down and sit idle until the market comes back. A number of factors contributed to the current depressive steel market in China. Number one, the current economic depression in both China and abroad resulted in sharply reduced demand from industries in the lower stream of the value chain, auto making, shipbuilding, real estate, boat construction, just to name a few.

As a result, steel consumption shrink highlighted the problem of oversupply and overstocking of steel products. Number two, historically and for a prolonged period of time China’s economic growth has been driven by investment in capital intensive larger scale infrastructure projects and real estate. With the economy growth at over 8% and it generated strong demand, the drawback of this growth strategy did not seem immediate and obvious.

However, given the EU crisis and the slowdown in China economy, export was restricted, domestic demand declined and the structure problem of the economy was demonstrated by the overcapacity and oversupply in the steel sector. While iron core cost continued to account for a disproportionately high percentage of overall steel product cost of China producers, these steel producers in China have to rely on price cuts to manage their excessive capacity inventory, thus resulting in continuously depressed selling price.

Now let us examine China Gerui’s performance in relation to its peers. Clearly though, relative to the overall market environment China Gerui as you can see from the operating results we released this morning, the company is performing relatively well as our gross margin of 25.8% is still much higher than any of the commodity steel producers out there, and still even higher than our niche sector competitors.

Thanks to the newly added capacity starting from last year, our volume continued to be strong, up 9.2% year-over-year and up 22.2% sequentially. Our product mix is continuing to optimize as more chromium plated products comprise of total products. So what are we doing to sustain our volume, and insure ourself against further average selling price or ASP declines?

On the volume front, we continue to service our customers extremely well. All of our six production lines are in full operation. When our customers come to our plants to pick up the products, they see a very busy and productive plant, and they can be assured that their orders will be delivered in a typically highly precise manner according to their customized specs and further that their delivery will be timely.

And we have tasked our sales and marketing team to be more proactive in securing export business first through the typical trial testing process, and then locking down sustainable order flow. For those of you who follow China Gerui’s news on export orders, you will notice that the specifications required by those trial orders indicate that the products for export are primarily for precision wire and cable manufacturing, and wide stripped steel specs in those orders shows that we have fine-tuned and successfully adjusted our newly added wide strip production line to design fitness among others.

We are also working on very specific product initiatives, which are still a bit too early to talk about right now in too much detail, but we do believe that and we trust that these technological and product enhancements due out as early as the fourth quarter will further extend our volume and add even further specialization to our product that will grow our customer base.

We are intent upon becoming a global specialized steel company, and our presence at industry associations, and our major sponsorship at the largest industry conference of steel companies, the American Metal Markets, AMM, Steel Conference are just a couple of the things we are doing as part of a comprehensive, fully integrated approach we have towards becoming a major worldwide enterprise.

This is not to say that the business and the operating environment in which we engage will not continue to be challenging for the rest of the year, actually it will be. A few days ago China Gerui revised its full-year guidance. We lowered our revenue guidance to be in the $290 million to $305 million range, below the previously announced revenue guidance range of $395 million to $410 million.

China Gerui has also lowered the earnings per share guidance range for 2012 to $0.75 to $0.85 per share below the previously announced guidance of $1.32 to $1.37 per share. Now the key assumptions right now supporting the guidance revision are as following, on the supply side price for hot-rolled steel coil experienced a steep dive starting from October 2011.

Between March and April of 2012 hot-rolled coil price stabilized somewhat, which led industry experts and steel companies to expect a gradual price recovery starting to the 2011 level. That is also when China Gerui reviewed our full-year outlook and decides to maintain the previously announced guidance.

However, starting from mid-May, steel price fell like a rock to its current low level, recording a year-to-date 16% decline. There is no assurance that the pricings range will revert any time soon before October 2012. Secondly, China Gerui adopts a cost plus method of pricing for its finished cold-rolled steel products. Since China Gerui’s average selling price moves in tandem with raw material or hot-rolled steel price, we expect continued average selling price pressure for the rest of the year.

Number three, on the demand side, China’s economic growth slow down led to weak demand for steel products in a number of key industries, as I mentioned real estate, auto making, home appliances, road construction, shipbuilding et cetera. On top of that, the economic weakness in Europe in particular forced Chinese steelmakers to cut back on their export and turn around to China domestic market to digest this overstock and oversupply of capacity.

As a result, we are seeing across-the-board price cuts in the steel industry, forcing many steelmakers and processors to reduce average selling price, cut back on the output, plan for major maintenance downtime to restrain capacity utilization, or in some cases to shut down production completely.

To deal with the declining demand and to ensure full production line operation, we have choose to reduce the price markup from approximately 30% to 25.8% in Q2, and we expect further erosion of gross margin if without sustainable market environment improvement (inaudible).

Number four, although we do not usually subject the cold-rolled steel production lines of China Gerui to major downtime for maintenance, we do plan for maintenance of the chromium plating production line in July, and beginning of August due to the technical nature of this chromium plating production line. This would impact the margin contribution by chromium plating products on a full year basis.

Number five, China Gerui will continue for the rest of the year to manage the capacity utilization so as to secure highest average selling price possible in the face of a challenging market and to maintain premium steel processing standards. The last thing we want to do is to dump our premium products to the market at an unreasonable low price only to find that customers eventually regard us as a commodity cold-rolled steel producer, and then at that time we would have permanently lost the pricing war -- pricing power, when the market recovers to the better.

Our revised revenue and EPS guidance reflects to the best of our knowledge as to an adjusted business environment. We are being conservative, and hope to do better. But we’re in a very price sensitive environment now, and although we believe that our volume levels are sustainable and we have more good news on the immediate horizon, we need to be optically clear as to current market conditions.

We along with many Chinese companies continue to face headwinds due to a general slowdown in the China economy, however, we at China Gerui feel that we can be more adaptive and that our specialized product is much more sustainable than the steel sector at large.

China Gerui’s chromium plating production is running right now at a 55% utilization rate, and normal testing requirement procedure has continued for another 100,000 tons of cold-rolled steel production line that was added last year. And we see the overall cold-rolled steel production, the utilization rate, right now is about 75%.

As you all know, chromium plated products usually commands a much higher margin than our plated ones, therefore with the new 200,000 tons of chromium plating line we added and put into production last year. We plan to have plated products account for an increasingly higher percentage of final output and to enhance overall margin of the company.

This is kind of interesting, I would like to share with you some operating data for the second quarter to show you the progress we achieved in terms of continuously optimizing our product mix. Now in second quarter of 2011, last year, chromium plated products accounted for 22% of the Company’s total sales volume. Getting to the first quarter of this year, that percentage increased from 22% to approximately 30%, and in last quarter, second quarter, we were glad to see a further improvement to 40%, which to a brief extent, helped to offset margin erosion pressure from the unplated product.

We will also pursue additional growth and expansion ideas opportunistically and softly, consider potential acquisition opportunities. This is a good time to look at depressed companies that might be good acquisition targets, but we would only look at an opportunity if it is earning for present very quickly, and ensure that the target is a good fit with our existing business.

Finally, we appreciate investors supporting our stock at these undervalued levels, given the surrounding China Company U.S. listed space and to support our stock. We have continued to engage in share repurchase program during the second quarter. As of June 15, 2012, we have repurchased 1,423,000 ordinary shares at an average price of about $3.58 per share for a total repurchase price of approximately $5.1 million.

We plan upon participating in the investor conferences as well as industry conferences in the month ahead, so as to convey the compelling China Gerui story. We also welcome investors to visit the Company in Zhengzhou, anytime so you can see the sophisticated and the value-added business in which we engage.

With that, we’ll now open up the call to questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Echo He.

Echo He – Maxim Group

Hi, thank you so much for taking my questions Lu and Edward.

Edward Meng

Hi, Echo.

Echo He – Maxim Group

Hi. The first question and just to follow up -- just to make it clear of whatever just said about this operation -- operating data, the 22%, 30%, or 40% of chromium plated products, you are talking about is percentage, is volume percentage right?

Edward Meng

Yes.

Echo He – Maxim Group

Okay. And then you just talked about the markup and the second-quarter price markup down from 30% to 25%, that is the average price markup right, it is not the cold-rolled steel markup only, isn’t that what you were talking?

Edward Meng

Yes, historically the company has been sustaining a 30% gross margin. So, yes, the 30% is the average gross margin for ore products, plated or unplated, and then the 25.8% that was actually the actual gross margin that we achieved in the second quarter.

Echo He – Maxim Group

Right, and could you talk about the average, I mean, or approximate what was the markup for unplated or chromium plated products? Do you have that approximate number?

[Foreign Language]

Edward Meng

Yes, good question. For -- let me talk a little bit about the historical, historically the unplated cold-rolled steel products whether it is going to be I mean narrow strip or wide strip, the average gross margin is about 27%, 28%.

Echo He – Maxim Group

Okay.

Edward Meng

And then the chromium plated, this is going to be a range because that depends on the feed material adjusting to that chromium plating process, specifically it come out with about 35%, in certain cases we are seeing about 38% to 40%.

Echo He – Maxim Group

Okay. That is the historical, but right now each of them decreased, already right in the past quarter?

Edward Meng

Right. There is a decrease in both the, across the board, I mean for both plated and unplated because we do not see the second quarter as more, more market consuming condition. So, first of all there is a very severe pricing pressure from the competitor and also weak demand. So we see the margin can be -- see more declining in the unplated cold-rolled steel with the narrow and wide strip, but the gross margin for the plated product continued to be only 30% in the second -- so that makes up some of the margin erosion caused by the unplated ones.

Echo He – Maxim Group

So, the unplated one is facing even higher pricing pressure, I believe.

Edward Meng

Yes, yes.

Echo He – Maxim Group

Okay. I got it. And also, when you talk about the difficulties, a lot of the manufacturers who are end-stage customers are facing -- do you expect any more bad debt in the receivables in the future?

[Foreign Language]

Edward Meng

A simple question -- sorry, a simple answer to your question will be no. First of all historically our bad debt is pretty much close to zero. And secondly, right now given the overall pressure on the ASP, average selling price, given the pressure for China Gerui, probably more for the competitors, to get the products out of the door, yes we did offer some price advantage for some of our customers, but I mean, as I said earlier in the presentation, that decision to grant some credit is only to a very small selected number of customers, and after a thorough in-house analysis of their creditworthiness. So going forward, we do not see this to continue -- or bad debt is going to be an issue.

Echo He – Maxim Group

Okay.

Edward Meng

Again, let me repeat again, I mean right now we for the majority of the order, we still are expecting a 30% of down payment from the customer, and then upon delivery or exit from our facility we accept the balance, or as I said to a small selected number of customer we granted some credit.

Echo He – Maxim Group

Okay, and the down maintenance time that you were just talking about starting in August, how long you plan to maintain the equipment, is it for months, or longer time?

Edward Meng

Good question. let me elaborate a little bit on this answer, first of all, for the typical chromium plating -- sorry, for the cold-rolled steel production line, right now we got six plus lines, those are operating at full speed. We don’t have major maintenance downtime because we’re coming for the machine tuning of the roller is actually done on a daily basis. So that is not an issue.

Now coming down to chromium plating lines, we do expect that on a yearly basis, we have downtime for maintenance. First of all that maintenance is completed already, as I said back -- we mentioned this for the second half of July and early August. So that was done. So I mean, as you can see later when we release the Q3 number that in July and August the percentage of chromium plated products as a percentage of the overall output is going to be just a bit lower, I mean in the prior -- I mean second quarter. So when revising our guidance this downtime issue has been fully accounted for.

Echo He – Maxim Group

Okay. I got you. That makes sense, and just give me some sense that who are all the typical end-users of these chromium plated products?

[Foreign Language]

Edward Meng

For chromium plated cold-rolled steel specifically go to food and beverage packaging, first of all, and secondly to the home appliances. Some small amount goes to construction material, and most importantly goes to the ore, metal wrapping or insulation wrapping metal for the wire and cable manufacturing, that needs to be chromium plated.

Echo He – Maxim Group

Okay. Okay, got you. And the last question maybe for both of you, and I know you are extending to overseas, and what is the rationale, what would make you think like think that you would improve the situation when a lot of exports turn to the domestic market, and what kind of margins in the future for overseas business, you would expect?

[Foreign Language]

Edward Meng

Even before the market situation deteriorated in the last two quarters, I mean we stick to the principle that we will not resort to export unless export products will fetch us the same, if not better margins, I mean as domestic. So, I think we’re happy. This is more in hindsight, we are happy that over the years we have established a recognition there is a good -- let us say, word of mouth passage, and assuming future our Company’s exposure to the international steel market as a result of our listing in NASDAQ. So, we are getting a very active increase.

Secondly, if you see so far we are exporting on a trial production basis by the customer

to Turkey, India, and also to the States. Those are primarily for wire and the cable manufacturing. So, we’re going to take a couple of months to do the set-up and production at the customer base, and then they are going to send the finished product to their customer, which is the wire and the cable operators to make sure that they verify and provide consent to the utilization of the material from China Gerui.

We are very confident that it is going to be part of this and then that eventually leads to the timing of continuous orders. The margins from the export business is actually -- if you look at it, it is actually better than what we have right now, I mean if we sell it to China. And I want to mention again if you look at the -- if you dive into the details of the export order as we announced in the press release, the specifications of the wide strip chromium plated, they are actually -- they have reached the 0.155 millimeter in thickness, which is the desired and target thickness for the newly added wide strip production. So, we are very happy we have achieved the precision adjustment as we scheduled.

Echo He – Maxim Group

Okay. That is right, yes, I noticed that. So you are going to export cold-rolled steel product, not chromium plated, right?

Edward Meng

Some of those are actually chromium plated.

Echo He – Maxim Group

Okay. So it is a mix?

Edward Meng

Yes.

Echo He – Maxim Group

Okay. That is all my questions. Thank you so much Edward and Mingwang.

Edward Meng

Thank you, Echo. Very good questions, thank you.

Operator

(Operator instructions) Your next question comes from the line of (inaudible).

Unidentified Analyst

Hello.

Edward Meng

Hi, hello (inaudible). We couldn’t hear you. Please go ahead.

Unidentified Analyst

Hi, good morning Chairman Lu, and I guess I should say good evening, Chairman Lu, and good evening Edward, Edward, I just had a few quick questions if you don’t mind, my first question was any thought on any kind of strategic M&A activity, I think there was some talk earlier in the year that maybe that some things might be coming up? Did that landscape look any different or is it the same?

[Foreign Language]

Mingwang Lu

Good question, (inaudible). Now, coming to the company’s I mean M&A strategy, as we stated, you know, over the last couple of quarters we have proactively looking at and screened I mean a couple of acquisition opportunities. Now, our basic principles are the following. Number one, the -- any acquisition or merger has to be earning some credits in the shortest term possible, and secondly the acquisition has to be able to bring into full play of our core competency.

I mean, that is the operating excellencies and also the ability to play in a niche market with -- to win with the quality of products and also the service to the customer. We are actually not reducing any momentum on this initiative, however given the current market situation, given the fact that the equity market, I mean in the US for small and micro cap Chinese stock is -- let me put it that way not so active right now. We've got to be very careful. We want to make sure that any M&A activity will fall in line with our cash allocation strategy going forward. So we will continue to control the pace of any M&A initiative going forward.

Unidentified Analyst

So does that mean that we can rule out 2012 has any kind of a transformative acquisition?

Edward Meng

I wish I can give a definite timeline here, but this is -- we want to make sure right now we don't not get into any M&A for that purpose of M&A only, but really find a perfect fit for us, and make sure that we have line up any other success factors around any acquisition.

Unidentified Analyst

Okay and just one other follow-up question on a different…

Edward Meng

Sure.

Unidentified Analyst

We’ve been reading in the newspapers and so forth that there has been some move towards greater convertibility of the yuan or the RMB, is that progressive, are you seeing that, is that true?

[Foreign Language]

Edward Meng

Good question, actually this is a very good question. I mean especially with the background that China Gerui has right now, I think will continue and also increasingly engage in export business given the weak market right now in China, yes I mean I can give you a very definitive answer, yes. I mean we see the Chinese government, I mean, we call that a safe administration of foreign exchange.

We are very active right now to increase the convertibility of RMB with -- right now is with the neighboring countries including Japan, Russia, and also in Mongolia, some Middle East country, but gradually we see that kind of convertibility of Chinese RMB is going to be universal, but if you ask me for a -- if you ask me to put that in a time line, I think give us another 2, 2.5 years.

I think we are very optimistic to see full convertibility of Chinese RMB. So how that is going to benefit us, first of all that will be making our export business more flexible and secondly we will be making the let’s say, the so called cash strap issue longer this time. So the cash generated from our China-based operating entity will be more ready to be having offloaded offshore for a number of initiatives including, for example, [EnerSys] acquisition including less evident payout or share repurchase, things like that. Well, hopefully you don't really have to go there.

Unidentified Analyst

Okay, and then the final question relates to, as you look forward to 2013 what is the ideal capital structure. You know, what makes sense given all the macro headwinds and given all the issues, does this sound like a right capital structure or if there are some way to reaching that perhaps, you know, perhaps re-look at the capital structure that makes sense to the company given you know, given all of the various concerns and various issues today?

[Foreign Language]

Edward Meng

We don't think our existing capital structure is the most optimal one for China Gerui. I mean, actually personally I would hope that we see a relatively lower leverage ratio even if they are short-term, we don't have long term debt, and secondly I think going forward I think we're going to see more Capex investment, capital spending investment. That is because first of all going through this I mean, let's say, I mean depression of the Chinese steel industry and also given our experience, I mean over the last couple of quarters for the demand of the Chinese customer, we do realize that for a company, for example, like China Gerui although we are a leader in this niche market of precision cold-rolled steel, no company can stay ahead of the competition unless it continues to explore and invest in new products based on judgment of the demand from the market.

I think that's something we have been doing, and we continue and actually increasingly invest in this aspect. So as I said right now we are in the process of several initiatives and we will make an announcement when it becomes material, and I believe, I'm confident that our investors will see that the company has been committed to and will deliver actual seeable results in terms of product optimization.

Unidentified Analyst

Okay, thank you very much Chairman Lu and Edward. Thank you again.

Edward Meng

Thanks a lot for getting on the line. Thank you.

Operator

We now have time for one last question from the line of (inaudible).

Unidentified Analyst

Hi good evening. A couple of quick questions, following up on what you're discussing Edward, you said that the level of notes payable you have is I think you said less than ideal with your -- with selling prices for raw materials coming down so significantly over recent months, should we expect the level of notes playable that you’ve had to carry in recent quarters, is there a likelihood that that will diminish?

[Foreign Language]

Edward Meng

Good question [Pete]. I guess the answer is really, yes, I mean going forward we are continuing to I mean reduce our leverage to the optimal level. So notes payable as part of the short term debt of the company are going to come down. Let me elaborate a bit on the situation here, I mean the relationship we have with the local banks.

Now given the overall China economy slowdown, the banks has -- becoming more cautious in terms of extending loans. So notes payable is actually one form of financing from the local banks. Notes payable issued by the local banks they actually will get the less income from the interest or handling fees, but they provide a much higher let’s say I mean flexibility for the bank because from those favorable activity up to, 50% up to 100% of cash guarantee for the bank to issue that on behalf of a company.

But if you're talking about a short-term loan from the bank that will be right now given the current situation, probably I think the banks will be a little bit concerned. So that's why we see banks are [hopping down] on the short-term, pure short-term loans made available to companies, however they are encouraging notes payable because especially if the company uses cash, it is cash out guarantee, or you know, what you see in the registered cash account.

Unidentified Analyst

Okay, second question. The selling proposition to some of your perspective or recent overseas customer Turkey, US, et cetera, I understand your answer to the earlier question that you require that it provides with equal or greater gross margin, but to those customers is the selling proposition to them that they are receiving product of equal, presumably equal quality at a lower price and if so how much lower might their price be given they are currently in their domestic market?

[Foreign Language]

Edward Meng

Right now, I mean if you look at the press releases I mean we are exporting on a trial basis to India, Turkey and the States. These three, I mean, potential customers they are different in a sense that some of those are actually purchasing too much for the first time from China Gerui because in their home country the supply of high precision chromium plated cold-rolled steel, the capability is either non-existent or not sufficient to meet their demands, and secondly some of the other -- one of the -- of the three customers, they actually right now, they are purchasing via an agent, China Gerui’s product.

So by purchasing from China Gerui maybe for them they are actually reducing their cost, but for China Gerui it is pretty much the same selling price, assuming the other -- the market condition is the same. So we do see that they have expressed a willingness to purchase directly from us, and secondly we talked about some of the other initiatives China Gerui is engaged in in terms of new production initiatives.

So they are very interested in first of all purchasing from China Gerui and secondly allowing China Gerui to further, to engage in further value added purchasing of the products I mean before delivering to the potential customers. So we are very optimistic. Usually it takes, I mean a couple of months for them to finish the trial period, but actually right now we do believe that for some of the three, we’ve not rushed the first time, to apply China Gerui’s product. So we are very confident that some of those China orders are going to convert into continuous standard regular orders from the board.

Operator

There are no further questions at this time. I would now turn the conference over to David Rudnick.

David Rudnick

Thank you very much. On behalf of the entire China Gerui management team, we want to thank all of you for your interest and participation in this call. Additional questions can be presented to Edward directly. This concludes China Gerui's second quarter 2012 earnings call. Thank you very much.

Edward Meng

Thank you for your time. Take care.

Operator

This does conclude today's conference call. You may now disconnect.

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