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Lihua International, Inc. (NASDAQ:LIWA)

Q3 2012 Earnings Call

November 9, 2012, 8:00 a.m. ET

Executives

Alisha (Erga) – IR

Jianhua Zhu - Chairman and CEO

Daphne Huang - CFO

Analysts

Steve Emerson - Emerson Investment Group

Operator

Good day ladies and gentlemen and thank you for standing by. Welcome to the Lihua International third quarter 2012 earnings conference call. (Operator Instructions)

I would now like to turn the conference over to Alisha (Egra). Please go ahead, Ma'am.

Alisha (Egra)

Thank you, Operator and good day everyone. This is Alisha (Egra) with the investor relations [inaudible] relations of Lihua International. Thank you all for joining us today via telephone and over the internet.

Before we begin, I would like to remind you that comments made during this interview may contain forward-looking statements that are within the meaning of Section 27A of the Securities Act of 1933 as amended in section 21C, the Securities and Exchange Act of 1934 as amended. All statements other than statements of historical facts that [inaudible] activities, events, or developments the company expect, project, believe, or anticipate will or may occur in the future including and without limitation to statements about the web business or growth strategy, general industry conditions, including the availability of proper or recycled scrap copper, future operating results [inaudible], capital expenditures, expansion, and growth opportunities, change borrowing, financing activities, and other such matters are forward-looking statements. Although this company believes that its expectations made during today's call are based on reasonable assumptions, our actual results may differ from those projected in the forward-looking statements.

With that said, it is 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 and [inaudible]. [Inaudible] will translate Mr. Zhu's remarks and provide the additional comments on the behalf before turning the call over to Ms. Daphne Huang, Lihua's Chief Financial Officer to discuss the third quarter, 2012 financial results. Then we will open the call up for your questions. Mr. Zhu, please go ahead.

Jianhua Zhu – Chairman, CEO

[Foreign speech]

Alisha (Egra)

Thank you, Mr. Zhu. I will now provide some translated comments on Mr. Zhu's behalf.

In the third quarter, we continued to grow our sales by capturing new opportunities within the large and growing end market of our copper alternative products. We have seen another quarter of double-digit year-over-year growth across each of our key operating metrics including 54% in revenue growth and 27% growth in net income.

While commodity prices declines are causing ASP pressure, demand for our CCA and copper products remain strong and continue to grow. And importantly, it has taken new steps during the quarter to position Lihua for ongoing long-term success.

Our second and third copper anode smelters, which commenced following production in June reached approximately 4,200 metric tons of output in the month of September. The near full capacity of 50,000 tons on an annualized basis.

Customer demand for copper anodes continues to exceed Lihua's capacity. And we recently laid the foundation for our fourth dedicated copper anode smelter. Once construction is complete, the smelter will give us another 25,000 metric tons of annual capacity enabling us to better meet the needs of our growing customer base.

In addition, we are in the process of transferring our first copper anode smelter to the anode production facility on the new [inaudible] side.

Having all four copper anode smelters in a single location will help us improve production efficiency as the craft copper being refined into anodes can be clean, separated, and stored in a single location rather than occupying multiple warehouses on those campuses.

Copper rods continue to generate strong sales following a [inaudible] introduction to materials customers in the fourth quarter of 2011. As a result of the enhancements through our copper rods smelter, which doubled capacity to 50,000 tons per year. This [inaudible] expansion required a limited investment on our part. And has already generated in meaningful returns for incremental revenue and growth profit contributions within our client copper wire and copper rod production segments.

During the third quarter, we continued construction of eight new facilities on our 30 acre plant site including five factories and include warehouses. We will continue construction on the remainder of the sites in 2013. And we are on track to meet our goals including the build-out in 2013.

In addition to expanding production capacity for our existing products and enhancing our research and development capabilities, the new plant site will give us the necessary resources to continue moving towards commercialization of our new CCA cable and wire products, which is scheduled to launch in the second half of 2013.

In the third quarter, we completed trial production. And in the fourth quarter as some products tested and qualified by Shanghai Electric Cable Research Institute.

With proud production and qualifications complete, we are now taking steps to begin marketing of products while we continue to work on improving the manufacturing process. And ultimately increase the yield while insuring optimum quality of high demand power grid and related applications. We are continuing to work closely with our partners in Shanghai Electric Cable Research Institute to establish industry standards for this revolutionary product.

We have received positive responses from potential customers. And our excitement over this process continues to grow. We anticipate volume production in commercial availability in the second half of next year. And remain confident that this new CCA product will become another important catalyst for Lihua's growth over the long term.

With over $130 million in cash and cash equivalents as of September 30th, we remain well capitalized that these keys and other key growth initiatives prove to completion. We are now seeing the full effects of the capacity expansion and R&D effort made during the last several years. And we believe these upcoming initiatives will take Lihua to the next stage of growth and success.

We are confident that our diverse product portfolio will enable us to extend Lihua's leadership position in the markets we serve and further establish the company as a value-added provider of high quality cost effective copper alternative products in the fast growing Chinese market.

These indications from the market, we expect another quarter of growth to close out the year in our end position to meet our 2012 guidance. In light of the two new proper anode smelters and the plant launch of the CCA cable and wire products, we expect eve greater financial and operational growth in 2013.

With that overview, I would now like to turn the call over to our CFO, Daphne Huang to review our financial results for the third quarter, 2012. Daphne.

Daphne Huang - CFO

Thanks, before I provide an overview of our financial results, I'd like to highlight that all of our financials are prepared in accordance with U.S. GAAP. In addition to GAAP reporting, we will be providing adjusted EBITDA and non-GAAP net income, 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 changes per value of [inaudible] and other one-time or known occurring items that are evaluated on an individual basis. We define adjusted EBITDA as net income before depreciation and amortization, interest income, or expense, income taxes, gain on extinguishment of foreign liabilities, change of fair value of [inaudible], and non-cash share based compensation expenses.

We continued to demonstrate growth in the third quarter of 2012. With sales increasing 53.5% to $238.8 million, comparable sales of $155.6 million in the third quarter of 2011. We saw an increase in sales volume across each of our product lines as a result of ongoing solid market demands for Lihua products. This growth was primarily driven by increased sales across all of our product [inaudible] as a result of increased production volume and strong market demand for our products. And the addition of copper anodes and copper rod sales as a result of capacity expansion initiatives we have undertaken over the past year.

These capacity increases resulted in a sales volume increase of 82.6% in the third quarter of 2012 over the same period last year, which was partially offset by year-over-year decline in the average price of copper.

The revenue involving the breakdown for the third quarter for each of our products is as follows.

We sold 12,015 metric tons of CCA and copper wire, which [inaudible] to $101.2 million in sales compared with 7,199 metric tons or $77.2 million in sales in the third quarter of 2011.

An increase in sales volume of 58.6% year-over-year, this increase in wire volume was supported by relevant production in sales of thicker [inaudible] wire products, which are semi-process from copper rods and have a shorter production schedule than our super fine wire products.

Copper anode volumes in the third quarter of 2012 totaled 15,431 metric tons. Accounting for $118.2 million in revenue compared with 8,292 metric tons or $78.4 million in revenue during the same period last year. The year-over-year improvement in sales volume for copper anodes was due to increased copper anode production capacity as a result of the addition of the two new smelters, which started production in June of 2012.

Following the October, 2011 capacity extension, we were once again selling copper rods to outside customers. In the third quarter of 2012, copper rods contributed sales of $19.3 million allowing a [inaudible] 2,441 tons compared to no sales of copper rod in the third quarter of last year. And the product was used exclusively on an internal basis as a raw material in the third quarter of last year exploded production of fine and super-fine copper wire.

Our gross profit for the third quarter of 2012 was $25.3 million, up $29.8 million, I'm sorry, up 29.8% from the same period a year ago. The gross profit breaks down by product category is as follows.

CCA and copper wire products accounted for $12.8 million of gross profit, or 12.6% of sales in the third quarter of 2012 compared with $12.1 million or 15.7% of sales in the same period last year.

Copper anodes contributed a total of $11.4 million to gross profit or 9.7% of sales in the third quarter of this year compared with $7.4 million of gross profit or 9.4% of sales in the same period a year ago.

Copper rod products accounted for $1 million of gross profit or 5.4% of sales in the third quarter of 2012 compared with no sales in the third quarter last year.

In the percentage of total sales, gross margin declined to 10.6% in the third quarter of 2012 from 12.5% in the same period last year. The year-over-year decrease was due primarily to increased sales of copper anodes, copper rods, and fine copper wire, which carry lower margins than our super-fine copper wire and CCA wire products.

Selling, general, and administrative expenses for the third quarter of 2012 were $2.8 million compared with $2.1 million in the same period of 2011. The increase in our SG&A expenses year-over-year was primarily attributable to higher product distribution and insurance products, and increases in shipping and [inaudible] products directly related to our increased business volumes, and the scale of increasing operations as well as our continuing investments in R&D.

For the third quarter of 2012, we did not record any interest expense. This compares with interest expense of $39 recorded for the third quarter of last year.

We recorded income tax expense of $5.9 million in the third quarter of 2012 based on the effective tax rate of 25.4%. This compares to an effective tax rate of 24.6% for the same period in 2011. Due to an impactful gain or loss [inaudible] and the operating loss of our U.S. entity, the effective tax rate will be 25.1% and 24.9% for the three months ended September 30th, 2012, and 2011 respectively.

Net income for the third quarter of 2012 was $17.2 million or $0.58 per share based on $29.9 million weighted average diluted shares outstanding. This compares with net income of $13.5 million or $0.45 per share based on $30 million weight average diluted shares outstanding in the third quarter of 2011. Our net income this quarter included $450,000 non-cash gain due to the change of the fair value of the [inaudible]. If you exclude the impact of these non-cash [inaudible] diluted items, our net income on a non-GAAP basis for the third quarter of 2012 would have been $15.8 million or $0.56 per share representing 30% growth over $12 million or $0.43 per share of non-GAAP net income from the same period of last year.

Adjusted EBITDA for the three months ended September 30th, 2012, was $23.6 million compared with adjusted EBITDA of $17.6 million for the same period in the prior year.

With regard to guidance as Mr. Zhu mentioned earlier, we are reiterating our 2012 guidance and expect gross profits to be up $84 to $87 million representing year-over-year growth of 11% to 15%. And non-GAAP net income to be $54 to $57 million or 8% to 14% growth over 2011.

Our performance in the third quarter and the planned initiatives for the fourth quarter gave us confidence that we can achieve our full-year objectives while positioning the company for growth and success in 2013 and further into the future.

Question-and-Answer Session

Operator

(Operator instructions). And our first question comes from the line of Steve Emerson with Emerson Investment Group. Please go ahead.

Steve Emerson - Emerson Investment Group

First of all, please congratulate Mr. Zhu with the – for the excellent financial results of the company during a period of slowdown in China.

Secondly, how much of the 140 million is needed for working capital of the business? And of course, the follow-on question is, what are the plans to either distribute excess cash to shareholders or buyback shares considering the stock is barely above cash?

Daphne Huang - CFO

Steve, thanks for – I’ll take your question and I’ll ask Mr. Zhu to obviously provide any insight from your second part of your question. In terms of working capital needs for the business, obviously we are very well positioned as you can tell. We just had another quarter of positive cash flow generation, adding about 5 million more to the cash balance. And we are still growing our capacity. The working capital needs on the short-term basis will grow as well, but as I mentioned before, - you know, I’m not in the position to provide a detailed analysis of working capital needs going forward, but we will be very, very well positioned in terms of self-supplementing the working capital needs.

I would just touch a little bit on the – on the second part of your question and I’ll translate for Mr. Zhu. Currently we are [inaudible] the business very, very aggressively and we’re making inroads in terms of a product, actually, I have to say in terms of the new CCA cable and wire product. And we’re hopeful that, you know, once we complete the marketing process, we’re able to commercialize this product soon. And there’s also another element of the political situation which I’ll let Mr. Zhu touch a upon before he answers the question.

[Foreign conversation]

Mr. Zhu’s answer was, we actually, in China, the political governing party just started yesterday, the very – it’s sort of a historical meeting, it’s called Number 18 meeting. Within this meeting, this meeting is going to last for about a week and in this meeting they’re going to come out with the next generation of leaders in China. And also more importantly, they will set the tone for the economic policies.

So Mr. Zhu is like all the other enterprise business CEOs and founders, he’s watching very, very closely in terms of what kind of business – economic notion policy that’s going to come out of this meeting, which is very vital to the survivalness and the growth potential in the next five years for all the –especially the private business enterprises. So even though I’m providing a long explanation to his answer because I want everybody to understand what this Number 18 meeting, what the meeting is. But his answer is we will look into, seriously into any sort of capital market strategy, including share buyback after we get clarity from this governmental meeting. You know, essentially, trying to get the [inaudible] of the government economic policy for the next, you know, the new government.

Steve Emerson - Emerson Investment Group

Okay. A couple of other questions and I’ll get back in queue. When should the third smelter be up and running for anodes?

Daphne Huang – CFO

We are actually planning to start building the third smelter by as early as next – the beginning of next year. So you know, it’s old infrastructures are already completed, if I can give everybody a visual, it’s actually within the same smelter plant that we constructed which already had a very advanced and complete recycling matching ability outside of this plant.

So you know, if everything goes smoothly, the construction of the service smelters should go around 3 to 4 months.

Steve Emerson - Emerson Investment Group

Excellent.

Daphne Huang – CFO

So if we start, you know, after the Chinese New Year, you know we can realistically look at getting up and running sometime between May and June next year.

Steve Emerson - Emerson Investment Group

Okay, and how much capital expenditures and working capital requirements will be needed by the third smelter and then the CCA project?

Daphne Huang – CFO

The third smelter shouldn’t need a lot of – because all the infrastructure for the – you know, the roof over it is – the foundation is already there. So you know, I’m estimating about another 3 to $4 million for the third smelter just – we’re really talking about putting all the, you know, the equipment that we support and putting them together, putting the smelter together.

But until the working capital, [inaudible] 25,000 tons of annual capacity, on a monthly basis, I have to give a hypothetical assumption of the square copper which is the raw material price. My estimate is somewhere between 10, 15 – 10 to $15 million on a monthly basis for the third smelter, additional, assuming 25,000 tons per annual production capacity.

Steve Emerson - Emerson Investment Group

And for the CCA project, assuming you get the orders, what CapEx and working capital needs?

Daphne Huang – CFO

The CCA, we only have a first batch of production equipment custom made and stripped over to our site, which enabled us to do the past run of the samples and sent over to get the product tested and qualified for industry and company [inaudible]. But in terms of overall cost, of all the equipment, we’re planning to sell the remainder of two more factories actually. Well, existing factories is still not filled yet, so the majority of the production equipment order will come in later after we’re, you know, we’re done with identifying all of – or getting customer qualifications.

So the cost of the product, the raw material costs for the new CCA product will be very hard to guessamate at this point because you know, it’s kind of still at least half-year way. Hopefully we’ll get more clarity, but I can ask Mr. Zhu what, you know, what’s his best guessamate of what’s profitability on this new product. I’ll ask him.

[Foreign conversation]

Steve, Mr. Zhu’s best guessamate, at the initial stage, with all the promotion marketing costs, the gross profit for this new product is probably somewhere between 25% or a little up. So it is a much higher value-added product comparing with all the other products in our current product combination or category.

Steve Emerson - Emerson Investment Group

Okay, I’ll get back in queue. Thank you very much.

Operator

Actually, Mr. Emerson, if you have follow-up questions, please go ahead.

Steve Emerson - Emerson Investment Group

Okay, when does Mr. Zhu think we should obtain orders? How long will this qualification process be for CCA?

Daphne Huang – CFO

Okay, let me translate the question for Mr. Zhu.

[Foreign conversation]

Steve, Mr. Zhu’s estimate is the marketing of the new product will take about 6 to 9 months. Obviously it all depends on how long once we identify the customer, how long does this take for them to qualify our product, and you know, hence the commercialization of this new product will be around 6 to 9 months later. That’s the best guessamate.

Steve Emerson - Emerson Investment Group

Okay. And the capital expenditures required to go into full production?

Daphne Huang – CFO

The CapEx will be mainly the fixed cost part of it. Assumption for the remainder of the production equipment order and to be made will be around somewhere between 10 to $15 million, that’s the fixed CapEx required.

Steve Emerson - Emerson Investment Group

Okay. And then back to your excellent fundamentals, it looks like there was no squeeze in gross profit margin per ton in any area other than the mix shift in wire. Perhaps you can give us gross profit per ton for anodes versus last quarter?

Daphne Huang – CFO

Gross profit per ton for copper anode for this quarter is about $740 per ton. Last quarter, in second quarter was $793 per ton. So it still is in line within our copper anode [inaudible] historical gross profit per ton [inaudible]. That’s your question, right, Steve?

Steve Emerson - Emerson Investment Group

Okay, did I hear you right, $740 a ton versus $798 or 708?

Daphne Huang – CFO

793.

Steve Emerson - Emerson Investment Group

Okay, excellent. And by wire categories, same gross profit per ton? You did mention there’s a mix shift, but I’m curious if gross profit per ton in the wire and CCA if there was any major decline?

Daphne Huang – CFO

No. We actually – the gross profit per ton, the CCA, the wire category really kind of caps a pretty steady stay from the last quarter. So obviously we see – we did see a decline in profitability in the wire category last quarter but it has – it has stabilized this quarter.

Steve Emerson - Emerson Investment Group

Okay. And are you planning on increasing your importation of copper from the rest of the world or are gross margins still too low to do that?

Daphne Huang – CFO

Right now, I think I have to make it clear to everybody is, whether we import directly for our copper or not, it always depends on the, really the pricing difference between – or the pricing benefit we can get from the copper price domestically in China versus let’s say a direct import from overseas, U.S or Europe.

In the past, the reason we went ahead with a quantity of direct importing in the past few quarters was we did see a pricing benefit because the scrap copper price in China, the number one and number two scrap copper we require for our production are – were higher, materially higher. But now every since the last quarter and also this completed third quarter, the second and third quarter, we really haven’t seen much pricing benefit through direct imports. The scrap copper pricing in China has come down. So if you take a look at our financial, especially the balance sheet and cash flow statement, you’ll be able to tell that we didn’t do as much direct import these past few quarters.

Steve Emerson - Emerson Investment Group

Okay. Thank you very much. Again, please thank Mr. Zhu and the rest of the management team for an excellent quarter. We are looking forward to his and the Board’s decision to use excess capital to benefit the stock of the company. Thank him again.

Daphne Huang – CFO

Thanks. I’ll do a brief translation for Mr. Zhu.

[Foreign conversation].

Okay. Mr. Zhu – Steve, Mr. Zhu said thank you for your continued support and care about Lihua’s business and please rest assured that management and the Board will make the decision – the right decision in terms of the capital markets as quickly as we can.

Steve Emerson - Emerson Investment Group

Thank you.

Daphne Huang – CFO

You’re welcome, Steve.

Operator

Thank you. And I’m showing no additional questions. I’ll turn the call back to Ms. Huang for closing remarks.

Daphne Huang – CFO

Okay. Thank you once again for joining us on today’s call. As we continue on this path to grow the 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. On behalf of Mr. Zhu and the rest of Lihua’s management team, I would like to thank you all for your continued support. Thank you.

Operator

Ladies and gentlemen, this does conclude our conference for today. We thank you for your participation. You may now disconnect.

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