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China Precision Steel, Inc. (NASDAQ:CPSL)

F4Q12 Earnings Call

October 16, 2012 9:00 am ET

Executives

Leslie Richardson - IR, Elite IR

Leada Li - Chief Financial Officer

Scott Kline - Pillsbury Winthrop Shaw Pittman LLP

Analysts

Timothy Stabosz - Individual Investor

Dr. Pataki - Biscayne Americas

Operator

Good day, ladies and gentlemen and welcome to the China Precision Steel fourth quarter, year-end and 2012 earnings conference call. My name is Patrice and I will be your operator for today.

At this time, all participants are in listen-only mode. Later we will conduct a question and answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to your host for today, Ms. Leslie Richardson from Elite IR. Please proceed.

Leslie Richardson - IR, Elite IR

Good morning, ladies and gentlemen. My name is Leslie Richardson from Elite Investor Relations, and I would like to welcome you to China Precision Steel’s fourth quarter and year-end fiscal 2012 conference call. Joining us today is China Precision Steel’s Chief Financial Officer, Ms. Leada Li.

I would like to remind our listeners that management’s prepared remarks during this call contain forward-looking statements, which are subject to risks and uncertainties faced by the company, 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.

Due to such risks, actual results may differ from those discussed today 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 changes in steel prices, limited availability of raw material and energy may constrain operating levels and reduce profit margins, environmental compliance or remediation, projections regarding the ability of China's stimulus program to continue stimulating the demand for the company's products and other risk factors detailed from time to time in the company’s filings 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 represents management’s estimates as of today, October 16, 2012. China Precision Steel assumes no obligation to update these projections in the future as market conditions may 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 management's discussion section on behalf of Mr. Hai Sheng Chen, China Precision Steel’s CEO.

So welcome to you all and thank you for joining China Precision Steel's fourth quarter and year-end fiscal 2012 earnings conference call. Ever since the global economic crisis of 2008, our industry has been in a new era of greater volatility and less predictability and throughout fiscal 2012 we continued to experience the fallout of this very challenging economic global environment as demand for precision steel softens as steel prices decline.

Our revenue for the fourth quarter of fiscal 2012 was $37.6 million, down 16.6% from $46.0 million in the fourth quarter of fiscal 2011. Sales volume for the quarter declined 3.9% to 47,212 tons from 49,104 tons in the fourth quarter of fiscal 2011. On a sequential basis, revenue increased 6.1% from $29.5 million in sales and sales volume increased 21.4% from 38,898 tons in the third quarter of fiscal 2012. The increased revenues in third quarter is primarily due to stronger demand for our high carbon steel products and continued demand for our low carbon, cold-rolled steel products.

Our gross loss for the quarter was $3.0 million for gross margin of negative 7.8%. Net loss was $9 million for a net loss of per share of $2.32. For the fiscal year 2012, lower sales volume combined with lower average sales price resulted in our revenue per year declining 5.4% to $143 million from record revenue of $151.2 million in fiscal year 2011. Gross loss for the year was 5.8 million for gross margin of negative 4.1%. Net loss for the fiscal year 2012 was $17 million for net loss of per share of $4.37.

One quick note before I review our operations for fiscal year 2012. On August 27, 2012 China Precision Steel completed the reverse stock split of its common stock at a ratio of 1 share of common stock for every 12 shares to resolve with efficiency and regain compliance with the NASDAQ minimum bid requirements. Since the reverse stock split, the bid price for the company's common stock has been above $1.00 per share.

The slowdown in China, the world's largest steel producer and consumer, ongoing sovereign debt issues in Europe and the fragile U.S. recovery continues to impact the global steel industry as demand for steel has declined and steel prices have sharply fallen causing many steel makers around the world to struggle with losses or sharp declines in profits. China, specifically, has experienced a worse than expected slowdown in steel demand this year with the World Steel Association lowering forecast from 4% growth to 2.5% for the full year, calendar year 2012.

Responding to the slowdown, the Chinese government has launched a series of pro growth policies and fast track infrastructure projects to start later this year and in 2013. As a result, a modest pickup in activity is expected in the fourth quarter of calendar year 2012. The China's GDP growth is expected to be around 8% for the full year and some analysts are forecasting a rebound in early 2013.

As steel prices have sharply declined 30% in the third consecutive month up to September 2012, our profitability has been severely and negatively impacted. While we have been working on reducing our higher cost inventory, we have not always been able to recover the full cost of our raw material resulting in a decrease in our gross loss for the quarter and full year. For the fourth quarter, our average cost per ton was $868 while our average selling price was $797. For the full year 2012, our average cost per ton was $867 while the average selling price was $833.

Given the difficult near term market conditions facing the industry, we recognize the need to lower our cost and to focus on more competitive high-carbon products instead of lower end, lower margin products. We are working very hard to make this happen. We have begun to implement a series of measures to costs and increase overall profitability including initiating additional sales and marketing efforts to the same customer base and to increase our total demand, strategizing our product mix to refocus on our niche capabilities including the ultra-thin, low carbon and high strength, high carbon products, streamlining production and reducing the number of workers, hiring professionals and technicians to improve production management and increase quality controls, continue carrying out R&D to improve profitability of existing products and launch new high value added products and improve working capital efficiency by increasing turnover of advances to suppliers and accounts receivables.

Regular competitiveness is essential to improving our earnings and cash flow. However, eventually we will need to experience sustained economic recovery, characterized by increased demand, higher shipments and improved selling prices, increasing manufacturing and increased consumption both in China and abroad. While we believe our recovery will come eventually we can't control exactly when that will occur. In the meantime, we are controlling the things what we can and are executing our business strategy, as mentioned above, to make China Precision Steel more sustainable and endure through this period of uncertainty.

With that, I would like to turn the call over to our CFO, Ms. Leada Li to discuss our financial results for the quarter in detail.

Leada Li

Thank you, Leslie. For the first quarter of fiscal year 2012, we generated $37.6 million in revenue, down 18.2% from $46 million in the fourth quarter of fiscal year 2011. Sales volume in the fourth quarter of fiscal year 2012 decreased 3.9% to 47,212 tons from 49,104 tons, period-on-period, while average selling price per ton declined 15% from $938 to $797, period-on-period. The decrease in revenue and sales volume period-on-period is primarily due to softening demand for the company's high carbon, cold-rolled steel used in the production of automobile components, due to a slowdown of the Chinese automobile industry during the year, combined with the sharp decline in average selling price.

Sequentially, revenue increased 27.6% from $29.5 million in the third quarter of fiscal year 2012 and sales volume increased 21.4% to 47,212 tons. High carbon and low carbon products accounted for 23.2% and 75.6% of sales, respectively, compared to 28.3% and 64.9%, respectively, from the same period of the prior year.

Gross loss in the fourth quarter was $3 million, compared to gross profit of $1.7 million in the fourth quarter of fiscal year 2011. Gross margin was negative 7.8%, compared to a gross margin of 3.7% in the same period a year ago. The decline in gross margin is due to the declined average selling price per ton of 15%, period-on-period, while the average cost per ton declined only 4.1%, period-on-period, resulting in a compression of our gross margin. The high average cost per ton is a result of the raw material purchased from our advance contracts during the past twelve months. We have been renegotiating with some of our major suppliers to get a partial refund of our advances to suppliers in an effort to mitigate the locked-in raw materials cost.

Selling expenses for the fourth quarter of fiscal year 2012 were $38,000 or 0.1% of revenue, compared to $62,000, or 0.1% of revenue, in the fourth fiscal quarter of 2011. Administrative expenses were $677,000 or 1.8% of revenue, compared to $331,000 or 1.9% of revenue in the same period a year ago. Our policy is to make a 50% provision for our accounts receivable that are over 180 days positive and 100% provisions for all accounts receivable of over one year past due. As such, we recorded a provision for accounts receivable bad debt of $2.2 million during the fourth quarter.

Tightened credit and slowing growth in China have caused our accounts receivable to rise sharply during the year ended June 30, 2012 (inaudible) for those of the companies in the coal and steel sectors in China in the past year.

While we make provision in accordance to accounting policy, we have also strengthened our efforts in recovering the outstanding balance. To minimize our credit risk, we regularly perform business and credit reviews of customers and suppliers and confront with our customers that they are committed to fulfilling their obligations to the company as of June 30, 2012. Additionally, we wrote off two (inaudible) for advance to suppliers' provision for bad debt. We have been renegotiating with some of our major suppliers for a partial refund as we mentioned earlier in an effort to mitigate the locked-in environment to our cost.

Depreciation and amortization expenses for the quarter were $54,000, or 0.1% of revenue, down from $80,000, or 0.2% of revenue, in the same period a year ago. Our operating loss for the fourth quarter was $8.2 million, compared to operating income of $1.2 million in the same period a year ago. Our net loss for the fourth quarter of fiscal year 2012 was $9 million, compared to a net income of $0.3 million in the same period of the prior year. Fully diluted loss per share were $2.32, compared to $0.07 in the fourth quarter of fiscal year 2011, after adjusting for the 1 to 12 reverse stock split which effected on August 27, 2012.

And now moving to the balance sheet. As of June 30, 2012, we had $1.6 million in cash and cash equivalents, total liabilities of $66.7 million and working capital of $48.9 million. Apparently, we are in discussions with our lenders, DEG and RZB regarding the restructuring of our loans for repayments and hope to come to a new agreement subject to the banks' approval. Stockholders' equity was $118.9 million, compared to $133.5 million as of June 30, 2011. Net cash provided by operating activities was $1.8 million for the year ended fiscal 2012.

We do not have any transformative or capital expenditures at this time, as the company has already completed most of its major expansion plans. As discussed earlier in the call, we continue to experience a lot of uncertainty in the markets which limits our visibility for the next few quarters. However, China will have its leadership change at the end of this year. I would believe this will pave the way for positive governmental measures to implement (inaudible) programs in calendar year 2013.

With that, I would turn the call back to Leslie for concluding remarks.

Leslie Richardson - IR, Elite IR

Thank you, Leada. While there a number of tensions in the global economy including the sovereign debt crisis, the structural imbalances and elections in several key countries keeping the risk in Europe and U.S. high, we do believe that China will mainly (inaudible). The global steel industry is expected to gradually improve in 2013 on the basis that the eurozone crisis can be contained and U.S. successfully deals with the fiscal tightening during 2013, with economic stimulant measures, and secure and soft landing in China.

Furthermore, in the longer term we believe that there will be opportunities to revive our growth as demand is expected to strengthen in line with urbanization in China and the new Chinese leaders take the necessary step to reinvigorate the economy and bolster the steel industry. Meanwhile, our management team remains focused on resolving the current challenges of lower selling prices and higher input costs by actively working to improve our top line to optimizing our sales portfolio as well as improve our cost position and the bottom line to enable us to sustain and grow the company in addition to enhancing value for our shareholders over the long terms.

I would like to thank you all for your support of China Precision Steel during these uncertain times and we look forward to updating you on China Precision Steel's progress next quarter. We will now open the call up to any questions you may have for Ms. Leada Li.

Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Timothy Stabosz. Please proceed.

Timothy Stabosz - Individual Investor

Good morning, ladies. Can you hear me?

Leada Li

Good morning, yes.

Timothy Stabosz - Individual Investor

Is there a gentleman there too? Or just ladies today?

Scott Kline

Yes, Timothy, this is Scott Kline, counsel to the company. Thank you.

Timothy Stabosz - Individual Investor

Hi, Scott, and I didn’t listen to the call. So, I apologize. Here is my question. Can you talk more, Leada about liquidity? What type of agreement do we hope to come to with the bank? Are we currently in violation of any covenants? Does the agreement expire soon? Can you provide a little more detail on that area?

Leada Li

First of all, thank you for dialing in, Timothy. Okay, basically we have explained, there are more details in our 10-K. So I will just briefly summarize here. Basically, the company right now is in default of two loans. We carry two loans in our balance sheet. One is a short term revolving loan, revolves on an annual basis. That was due in July this year and that one was not successfully renewed. So right now, we are in default of that loan. That’s a short term loan.

Then we also carry a long term loan which was originally to mature in 2016. That is $18 million loan which we already repaid $1.8 million. So $16.2 million is the balance of the loan which was supposed to be repaid half annually and mature in 2016.

So we carry two loans in our balance sheet and currently we are in default of those loans as we have disclosed in the 10-K. So right now, we are in negotiation, or basically in discussion with both banks. They understand what we are discussing with them is that we have, and I think not just us, because the banks, they also deal with a lot of other steel companies and unfortunately right now, it is especially challenging time for our steel and coal sector. I think not just within China but China is probably one of the most serious because of high expectation.

So the bank understands the difficulties the steel companies are going through right now and so far they have shown support to continue to carry on discussion with the company and I think one factor that can reflect that is that they have given us time to deal with our annual report and 10-K first and then now that the 10-K is filed we will go back to discussion with the banks.

The goal that we are trying to achieve is that we try to work out repayments, restructure with the banks. In that, say for example, for a period of time, say half a year or nine months, we don’t pay interest or principle. Basically the law is inhospitable. We still have accessible loan and then say, nine months later when the company performance picks up, when the general economy picks up, we start to repay interest with partial repayments over a period of time.

So this is what we are working on. The basis of what we are working on with the banks. Of course, as we disclosed, this is subject to the bank's approval, but right now, the banks have shown support and they understand what's going on in the steel industry.

So we are still in discussion with them and then of course, if any agreement is reached, we will make further announcements.

Scott Kline

Yes, Timothy, I think that the indicator of that the banks are in discussion is that they have really taken none of the accrual actions in China that a lender could have taken in the United States if the relations were contentious. So that is, in and obviously, we would have disclosed any such actions they would have taken in China, but they have not.

Okay, the next question?

Operator

(Operator Instructions) Your next question comes from the line of Dr. Pataki of Biscayne Americas. Please proceed.

Dr. Pataki - Biscayne Americas

Hi, Leslie, how are you?

Leslie Richardson

Hi, Dr. Pataki.

Dr. Pataki - Biscayne Americas

Are you taking any action because this is internal problems, in terms of negotiating loans and restructuring and so on, due to the fact that we had a bad economy or slowdown? I understand that. But are you doing something in order to increase exports to countries that really need under the margins will be lower because I believe you have a strong capacity to deliver. Are you doing something Hong Kong, the Far East or something marketing wise and really to increase the level of customers and the level of sales?

Leada Li

Yes, Dr. Pataki, and thank you for your time to listening to our call. Well, in the fourth quarter our exports increased from third and again also increased period-over-period from the same period of last year. So I believe that now with actual supply in China, the current price level is actually of advantage to our company in that we have more competing power in the recessing market. So again, the recession market is just as well as highly and uncertain as what's going on in China with a lot of things going in the U.S. and Europe but definitely at the current price levels we are in a more competitive position that before and again, this increased results can be reflected in our product sales breakdown.

So exports is up, quarter-to-quarter and also sequentially as well. In terms of taking actions to combat this uncertainty and difficulty, as we mentioned in the call earlier, we are taking a lot of measures and steps to improve our business notwithstanding what is going on in the economy but basically we are finding ways to improve ourselves among this difficult environment. For example, we are strategizing our product mix and we are doing more active sales and marketing.

Although the debt market is very difficult right now, we believe there is still might be ways to penetrate more into customers that we did not work with before or customers who are looking to replace imports. So in addition to that, our sales and marketing are also looking we are also looking to cut our own costs, try to minimize our operating cost as possible.

So we believe that our business is sustainable. It is just that, right now, it’s a very challenging environment. So we are taking a lot of measures and steps to improve ourselves within this current environment and then we believe that if there are measures in place and if the economy grows over a little bit there will be positive signs for our business as well.

Scott Kline

Okay, next question?

Operator

(Operator Instructions) Your next question comes from the line of Timothy Stabosz of China Precision. Please proceed.

Timothy Stabosz – Individual Investor

I am not of China Precision. I do own 2.5% of the company. I am a private shareholder but thank you. Just for clarification. Thanks for this follow-up chance here. Leada, could you talk a little bit more about the ability to raise money from working capital as you have talked about and if the bank has expectations with regard to that, that is the suppliers and I do note that you had almost no capital expenditures in the year to speak of and $8 million or $9 million of depreciation and amortization. So clearly we are generating.

Leada Li

Hello.

Scott Kline

I am sorry. I think we just lost Timothy. Timothy, if you can hear us, we lost your question.

Operator

(Operator Instructions) Okay, looks like we lost Mr. Stabosz. He did queue up again, so I am going to go ahead and put him through so he can ask his question. Please proceed.

Timothy Stabosz – Individual Investor

Perfect. Am I being heard or no?

Leada Li

First off, I think I heard half of the question. You were saying of advance to suppliers.

Timothy Stabosz – Individual Investor

Talk to me about liquidity in terms of does the bank have any expectations as to your ability to raise liquidity and I have been impressed by the small amount of capital expenditures and depreciation and amortization of $8 million or $9 million generated a fair amount of cash. That’s fairly heartening to me, the shareholders. So can you talk more broadly about liquidity and how you can shift the items on the balance sheet to generate cash?

Leada Li

Right, okay. So basically, I think we briefly talked about just now that we are trying, we are strengthening our efforts to increase turnover of accounts receivable and advance to supplier. I believe that is very important and critical to our business right now. Like you said, cash and operating cash, especially, is very important.

So I think, as a result of our results, this was reflecting our positive operating cash for the year which is very important for the business to continue going on. As to raising capital, right now, we don’t have any plans to do that and we believe that even if we have the basis to do that, we will further dilute the current shareholder synergy. I am not sure if that’s what shareholders want.

But right now, the banks do not require us to raise any capital. Instead they are just working with us to overcome this difficult period and for the company, for our own efforts, what we are trying to do is we are not relying on the capital market and as mentioned earlier, we don’t have any capital commitments right now. We don’t have any capital commitment.

So we just cut down all capital expenditures as possible and then the current mills, they are perfectly operating. So we don’t expect any material maintenance expenditure as well. So we will just be focusing on maximizing the operational efficiency of our mills and then try to increase the turnover to improve our cash flow

Timothy Stabosz – Individual Investor

Thanks.

Operator

Okay. There are no further questions at this time.

Scott Kline

Perfect. Okay, Leada and Leslie, if you would like to, or Leada if you would like to provide any follow-up comments. Otherwise we can terminate the call.

Leslie Richardson - IR, Elite IR

I would just like to thank again for joining us on the call this morning. If you need additional information comments from management, please contact me. My contact information is on the press release issued this morning and Leada, would you wrap up the call?

Leada Li

Yes, just understand this is a very challenging period and we are going through a rough time, especially us and I believe we are at the lowest, trying to correlate to the western market but understand it’s a very difficult. So thank you very much for the support and for your time to listen this morning. Have a good day.

Scott Kline

Thank you.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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