China Gerui Advanced Materials Group's CEO Discusses Q3 2013 Results - Earnings Call Transcript

| About: China Gerui (CHOP)
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China Gerui Advanced Materials Group Limited (NASDAQ:CHOP)

Q3 2013 Earnings Call

November 27, 2013 8:00 AM ET


Vivian Chen - Grayling

Mingwang Lu - Chairman and CEO

Edward Meng - CFO


Jim Richards - GE Capital

Greetings and welcome to the China Gerui Advanced Materials Group’s Third Quarter 2013 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Vivian Chen from Grayling. Thank you, you may now begin.

Vivian Chen

Thank you, Jesse. Good morning ladies and gentlemen and good evening to those of you joining us from China, Vivian Chen from Grayling and I would like to welcome all of you to China Gerui Advanced Materials Group’s conference call to discuss the unaudited financial results of the second quarter of 2013.

With me today I have China Gerui’s Chairman and Chief Executive Officer, Mr. Mingwang Lu and Chief Financial Officer Mr. Edward Meng. We will translate for Chairman Lu with his opening remarks and help with the Q&A.

I would like to first 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 abilities to win new customers, merchants and vendors for its products; the development and acceptance of new steel products, marketing and promotional activities; pricing policies of suppliers and competitors; 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 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 represent management's estimates as of today November 27, 2013.

China Gerui assumes no obligation to update these projections in the future as market conditions change.

The 2013 third quarter press release and the script includes the use of non-GAAP EBITDA, which is the financial measure that is not defined by the U.S. generally accepted accounting principles, or U.S. GAAP. The non-GAAP EBITDA is defined in the third quarter earnings release and in this script as earnings before interest, taxes, depreciation, and amortization that were incurred in the third quarter of 2013.

I will now turn the call over to China Gerui's Chairman and CEO, Mr. Mingwang Lu for some brief openings remarks. Mr. Lu, please.

Mingwang Lu

Ladies and gentlemen, thank you for joining us today and welcome to China Gerui Advanced Materials Group’s third quarter unaudited financial results conference call.

Our third quarter results came in at below expectations reflecting ongoing slow economic growth and weak demand for steel products in China. However, we are confident that our previously issued guidance for the full fiscal year ended 2013 will be met.

We continue to be highly attentive to market conditions and we are being especially disciplined and strategic in terms of how we deploy our specialized steel lines so as to balance our well earned market share with overcapacity in the sector resulting from intense competition. We continue to be well positioned to bring to market a portfolio of new steel products in a strategic manner that we believe will optimize our return on investment.

Our revenue guidance for the full fiscal year 2013 was $165 million to $170 million and we expect our financial results for the year to fall within these parameters. Despite our third quarter results which reflected lower margins than recorded historically stemmed from overcapacity that negatively impacted pricing in the sector and which substantially lowered our average selling price.

We believe that steel pricing could be at an inflection point due to likely changing fundamentals in our sector. In addition, based on our preliminary operating results for the fourth quarter 2013 we believe that market demand for our products is gradually picking up, although it may still be some time before we see substantial margin improvements.

We achieved another quarter of positive cash flow with $0.7 million in EBITDA with reasonably stable volume given this highly challenging environment. Revenue from the sale of approximately 8,000 tonnes of cold-rolled steel was not recognized in the third quarter as two customers delayed their third quarter pickup which will now fall into the fourth quarter.

The China Iron and Steel Association reported that for the first nine months of 2013, its members reported an average gross margin of only 0.41% while for the month of September, 34% of members of the Association reported net losses due to decreasing steel prices.

We estimated that the utilization of its wide-and-narrow-strip cold-rolled steel capacity was 44% in the third quarter of 2013 compared with approximately 47% during the second quarter of 2013. Our utilization chromium plating production lines was approximately 38% in the 2013 third quarter compared to 43% during the second quarter of 2013.

Judging from our preliminary production schedule the fourth quarter will see our overall capacity utilization at approximately 65% on a blended basis, similar to how we performed in the first quarter of 2013. We plan to deploy our more specialized steel lines as market conditions dictate.

Our investment thesis continues to be strong as we offer a greater range of cold-rolled steel products to the market that can compete with higher priced imports. And we can now provide steel solutions to new customers we could not service before. Our more comprehensive steel product line differentiates us from many smaller steel producers who do not have the technology, financial resources, or customer relationships to effectively compete with us.

Beginning in the fourth quarter of 2013 we have determined to revise our previous strategy and act to more aggressively fulfill customer orders and compete based on price when appropriate. This will enable the Company to solidify its market share, although profit margins will likely continue to be mediated in the short-term.

We also plan to continue to expand our international sales in 2014 with the addition of international sales representatives, a global corporate business-to-business marketing and advertising strategy and the formation of an internal strategy of business and development group.

Based on our preliminary operating results for the fourth quarter of 2013, we believe that sales volume and ASP per tonne will be improved over the third quarter of 2014. From our preliminary production scheduling, the fourth quarter will see our overall capacity utilization at approximately 65% similar to the utilization rate in the first quarter of 2013, as we believed and managed gradually increasing for our products.

With a more diversified line of steel products we can provide more solutions to help our customers reach their goals. Our innovative new products are attracting new customers in different markets to diversify our customer base as well. Many smaller less sophisticated competitors are unable to compete with our product diversification strategy as we have added wide-strip chromium plated and laminated steel lines.

We believe these changes will allow us to capture more market share overtime. We expect that future acquisitions or mergers will also propel China Gerui into a more significant global competitor.

Thank you everyone for joining us. I will now turn the call over to our CFO, Edward for an overview of the third quarter results.

Edward Meng

Thank you, Mr. Lu and thank you everyone for joining us. I will now turn the call over -- I will take the call over and present a summary of the third quarter financials. For more details please refer to our earnings press release, which was distributed earlier today.

Our revenue decreased 44.9% to 30.9 million in the third quarter of 2013 from 56.1 million in the third quarter of 2012. The decrease in revenue was primarily due to a 3.4% decrease in the Company's average selling price or ASP to $674 per tonne for the third quarter of 2013 as compared to an average selling price of $698 for the third quarter of 2012, as well as a 43% decrease in sales volume to approximately 45,797 tonnes for the third quarter of 2013 as compared to approximately 80,386 tonnes for the same quarter of 2012.

And it should be noted that the third quarter is seasonally a slow period in the Chinese economy due to reduced business activity during the summer months and scheduled maintenance in certain industries.

Gross profit decreased to 700,000 in the third quarter of 2013 from 8.8 million in the same quarter of 2012. Gross margin was 2.4% in the third quarter of 2013 compared to 15.7% in the same period of 2012. The decrease in gross profit compared with the third quarter last year was due to lower domestic consumption of steel in the third quarter of 2013 resulting in higher per unit production costs. The steel industry is still exhibiting the results of excess capacity and reduced steel demands creating intense price competition.

The operating loss was 2.3 million in the third quarter of 2013 compared to operating income of 5.9 million for the third quarter of 2012. The decrease in operating income in the third quarter of 2013 was primarily due to a 91.5% decrease in gross profit.

Net loss was 4.4 million in the third quarter of 2013, or nil per fully diluted share, compared to a net profit of 2.4 million, or $0.04 per share in the third quarter of 2012. Non-GAAP EBITDA was 0.7 million in the third quarter of 2013 or 2.3% of revenue, compared to 8.7 million or 15.4% of revenue in the third quarter of last year. Non- GAAP EBITDA is defined as earnings before net interest expense, taxes, depreciation, and amortization incurred in the third quarter of fiscal year 2013.

Please see the section in the press release entitled, Use of Non- GAAP Adjusted Financial Measures and a reconciliation table at the end of the press release for an explanation and quantitative comparison of non- GAAP measures used in this press release to their GAAP equivalents.

Now looking at the nine months accumulative 2013 results, revenue for the nine months ended September 30, 2013 was 119.6 million, a decrease of 40.7% as compared to 201.6 million from the nine months ended September 30, 2012. Gross profit was 9.5 million, down 81.1% from 50.1 million in the nine months ended September 30, 2012.

Gross margin was 7.9% compared to a 24.9% in the same period of 2012. Non-GAAP EBITDA was 9.8 million adjusted for non-cash stock compensation expenses, down 80.5% from 50.3 million in the same period of 2012. As far as the financial condition of the Company is concerned, as of September 30, 2013, we have 192.9 million in unrestricted cash, 26.9 million in current certificate of deposits, and additional 156.7 million in restricted cash, as compared to 228.9 million in unrestricted cash, 16.4 million in current certificates of deposit and an additional 145.4 million in restricted cash as of December 31, 2012.

The company's short-term debt consisted of notes payable and term loans that totaled 341.9 million plus 6.6 million of the current portion of secured long-term debt at September 30, 2013.

This is compared to 317 million as of December 31, 2012. Secured long-term debt were 14.6 million at September 30, 2013 compared to nil at December 31, 2012. Working capital increased to 143.5 million in the third quarter of 2013 from 131 million in the second quarter of 2013. Shareholders' equity was 304.3 million at September 30, 2013 as compared to 330.1 million as of December 31, 2012.

The reduction in shareholders' equity was partially due to a reclassification of certain costs related to the acquisition of the Zhengzhou Company as described below. Net cash used in operating activity for the first nine months ended September 30, 2013 was 25.5 million compared with 29.4 million of net cash used during the first nine months of 2012.

We will now begin the business update and outlook section to provide better insight into China Gerui's strategies in a challenging domestic marketplace even as we begin to focus on becoming a global metals processor. An important element in the conditions on the ground is the political and economic climate which is beginning to experience some changes due to the new government now in place.

At the Third Plenary Session of the Eighteenth Central Committee, the central government has determined to further open up a number of key domestic industries including steel-making, chemical and automobile and manufacturing to foreign capital. This demonstrates the Chinese government's resolution to deepen reform and transform key domestic industries by leveraging foreign capital.

Introducing foreign capital to the traditionally closed capital-intensive steel industry would help further cultivate an increasingly market-driven steel environment in China, resulting in enhanced competitiveness of domestic players without traditional government support, an increased implicit technological content of steel products and an improved overall balanced demand and supply equation.

We are beginning to see some small and encouraging signs of improvements as reviewed by a recent data of the steel sector. By the end of September economic efficiency got improved from the first six months of the year. According to the China Iron and Steel Association statistics from January to September, medium sized iron and steel enterprises realized total sales revenue of RMB2.72 trillion this is a 2.2% above last year's same period. These member companies realized the profit of RMB11.3 billion and a gross margin of 0.41% this is increase of 0.63% from last year.

Approximately 33.7% of the member companies of the China Iron and Steel Association were reporting a loss at the end of September 2013, but this an improvement from the first two quarters of the year. From the profit’s positive point of view, iron and steel industry are still in loss if net investment income and other earnings is considered.

In September, medium-sized steel enterprises realized sales of RMB306.2 billion, a decrease of RMB2.56 billion from August, down 0.83%. These trends realized a profit of RMB3.27 billion, an increase of RMB150 million or 4.8%.

September investment income and operating income of RMB2.8 billion in total, an increase of RMB1.42 billion or 102.9%. For China Gerui we have refrained from engaging in price awards while serving our customers. Further, our thinking was that supply and pricing imbalances would only worsen the current disparity in the market in the near-term to medium-term. Over the long run, we continue to believe we can reestablish a premium pricing with our newer innovative products which do not face the same market imbalance severity.

However, over the short-term as indicated by Chairman Lu just now, beginning in the fourth quarter of 2013 China Gerui has determined to revise its strategy, adjusted strategy in fact and absolutely more aggressively fulfilled customer orders and compete based on price where and when appropriate.

A part of our strategy is to make us less dependent on large infrastructure projects and to take market share in consumption-driven industries. This is strategy is consistent with and we’ll take advantage of the central government's policies to promoting internal or domestic consumption in China and reduce the country's dependence on exports and infrastructure projects as the main drivers of the country's growth going forward.

We are progressing in our plans to leverage our diversified lines of high quality steel and knowledge of steel technology to capture market share in attractive iron and steel markets to further take market share in the global market. We believe our high quality products and value enhancing prices will promote our position in more mature markets to gain sizable orders.

The emerging market is another growth channel as we already captured number of customers and our outlook remains very positive. In addition, in this market conditions and the new governance policies encourage consolidation to improve the current excess capacity and enhance market prices overtime.

Some consolidation past analysis and expect contractions to gain acceleration soon. And it should be noted that many of the Chinese steel operators are government-owned or state-owned making consolidations more complex as more of an economic and a business strategist coming to the decision making process. However, China Gerui is well positioned to benefit from the anticipated improvements in a few market dynamics and/or to participate in expected coming consolidation through making impressive transactions in the domestic markets or in foreign markets.

Potential consolidation and transactions outside of China we present opportunities to quickly become a larger profitable Company competing globally to add value for the shareholders. We are in early stages of reviewing potential targets, Cambelle-Inland as the careful screening has provided a short list of recommended potential M&A targets to China Gerui which Cambelle-Inland believe are appropriate to fulfill our global growth strategy. We are reviewing the list to prioritize the candidates and possibly begin the transaction process in the very near future.

Before we go on to the Q&A session, I'd like to mention that we have filed an amendment to annual reports and revised the 2013 second quarter and first six months financial information to reflect the change in certain items. These items are non-cash in nature. Please refer to our recent SEC filing on September 21st and also our newly released press release this morning for more details.

We understand investor concerns and we appreciate your thoughts. Since the launch of the 10 million on the share repurchase program in April 2013. As of September 30, 2013 the Company has repurchased approximately 2 million ordinary shares at an average price of $3.06 per share for a total repurchase price of approximately 6.2 million. 3.8 million of this 10 million authorized, remained in the share repurchase program.

Given the currently challenging market conditions, we are pleased the Company reiterates its full year 2013 revenue guidance in the range of 165 million to 170 million. As always, the Company may adjust the guidance as the changing macroeconomic conditions and operational and competitive challenges dictate.

Before we go on, I mean I would actually like to address a few questions we received before today from the investors who I think are of co-interests and concerns and need clarification from the management to help our investors understand our business strategy and a competitive landscape that we are in.

One of the questions is about with both domestic and international new entrants into the precision cold-rolled steel markets how will China Gerui continue to expand its market share and market leadership position. Will the marketing erosion be the new norm for CHOP going forward?

To that question I would say that, first of all with the new leadership of the Chinese government that is widely expected that China's formally restricted markets of critical national economic importance such as steel, finance et cetera will be welcoming foreign capital injection to an extent unprecedented before since the 70s.

The China steel processing sector, future competition will be more intense than it has been so far. However, we in China Gerui see as those challenge as cashing center. New international entrants will enter the sector of the steel industry of China, with not only capital, but a much desired advanced processing technology as well.

When this new international players start their China Ventures, they would be eager to find a local partner with knowledge of the China market, an existing and a mature pipeline of customers and proven track-record of executing growth strategy in an expedited and a steady manner. China Gerui will be the indisputable choice in this regard. China Gerui commands relatively competitive advantage over its domestic competitors in this niche position cold-rolled steel market.

This is due to its years of dedication for R&D, its solid and growing customer base, technical capability to customize its production to individual customer needs, and a proven track-record of executing strategy in a disciplined manner.

And the other thing we have considered is over the last two years when the cold-rolled steel market in China experienced the most severe depression since the beginning of the century. We have seen many competitors at smaller scale went bankrupt or shutdown their operations. When the market recovers China Gerui will have survived this prolonged winter of the industry, strong and lean ready to meet renewed customer demands with a portfolio of diversified products and a strong balance sheet.

Last but not least I'm sure that our investors who are concerned with China Gerui have read widely about Chinese media coverage of the domestic steel industry. But I do want to remind you that please do not get misled by the available public statistics on China's cold-rolled steel market.

The cold-rolled steel market of China is majorly dominated by producers of the automobile industry for their auto sheets which so far accounts for a very small percentage of CHOP's revenue. They mostly serve customers from food and industrial packaging, high-end silicon and electronics industry with outsourcing high precision products. We believe the market demand for our product will recover relatively faster than other commodity type products such as construction materials or investor price. And we’ll continue to enjoy pricing and marketing advantage the most other product players, small or large.

The other question we received from the investor before this call as were asking, how will China Gerui try to defend and support the stock price?

With that overall macroeconomic condition in China into -- China Gerui will continue to do a couple of things. First of all, to build on the fundamentals of China Gerui, to build a even solid, even more solid balance sheet. Secondly adapt a business strategy in a timely manner through changing market situation, in terms of pricing, capacity release, new territory penetration and supply chain management.

Third we are going to beef up our international sales efforts to develop new channels to digest our existing capacity and achieve a balanced international or domestic sales going forward. Defusing the impact of potential weakness of demands in either markets where we actually seek after international and domestic merger and acquisition opportunities so as to expand our sales channel and our ability to serve customers with unique needs in our diversified territories.

Lastly we’ll continue our share repurchase program whenever -- it is in progress to demonstrate the management of believe that the Company's stock is undervalued and enhance investor value.

The last question we received is investor was asking us to shed some light on the Company's prepaid purchases accounts and was asking whether at China Gerui our borrowing condition has changed over the last quarter?

To make it -- and a long story short our prepaid purchases accounts is what that Company pays to our suppliers for raw materials that we anticipate will be required to support the preliminary procurement indication from our customers. We're pre-paying to our suppliers to help and support our suppliers to build a effective inventory, so as to meet the need of China Gerui for its increasingly diversified demand for raw materials. And secondly the illustration of the increased industry build up of our customers in the fourth quarter, beginning in the first quarter of 2014 we will be having the Chinese New Year.

So I mean you will see that by the time we report our fourth quarter results or the full year results, to see the fourth quarter, we're going to see, I mean a relatively increased sales from the activity, coming to meet the increasing demand from the customers.

As long as the borrowing conditions of China Gerui is concerned. Yes, it is true that over the last 1.5 years, we have seen the local banks tighten up the credit availability to non-state-owned enterprises, including a private Company like China Gerui.

If you look at the balance sheet of the Company, you will see that our short-term cash loans has reduced. And this is the truth and in the case, I mean across the board and in the country. And this is also one of the reasons that leads to the bankruptcy of some of the smaller cold-rolled producers across the board. I mean over the last couple quarters.

However, I mean for China Gerui our cash and working capital position is stronger and most competitive. We believe that we'll be one of the final survivors when the market warms up and factors its norm.

Operator, we are now ready for questions.

Question-and-Answer Session


Thank you. Ladies and gentlemen, we’ll now be conducting our question-and-answer session. (Operator Instructions) Thank you. Our first question is coming from the line of Jim Richards with GE Capital. Please proceed with your question.

Jim Richards - GE Capital

Just a few questions, can we consider that the margin erosions will be the new normal for CHOP in the foreseeable future. And has this pricing environment eliminated your ability to (inaudible) cost to customers?

Mingwang Lu

Thank you, Jim. I mean good question. I mean I think. Good question, I mean I think (inaudible) a little bit on that with the three submitted questions from the investors, but first of all if you look at last three quarters and the first and second and third quarter of China Gerui for 2013. If you see the market erosion is pretty severe. For China Gerui we see that's going to be, obviously that's temporary and short-term for the long run I would say when the market I mean warms up and also demand of the customer comes back we will see we will continue to achieve a margin which is way better than what we are seeing right now.

The other thing is right now if you look at the overall value chain, we will see the -- some of the suppliers, first of all we purchase raw material from both trading company as well as the crude steel producers. Right now we see the larger crude steel producers for the most of it is state-owned they're extending their value chain into the lower stream of cold-rolled steel, but those are primarily for the larger scale driven sectors such as automobile (inaudible).

Right now given the pressure to limits the excess capacity they are more focusing on supplying their own cold-rolling production within their own I mean territory, one of them I mean going our I mean supply that to the external customers. So in this case we do not enjoy that advantage of negotiating for the better price for the raw materials.

So in the long run I mean we currently -- over the last three quarters we are seeing the raw material cost increases faster than the price increased for our product. But when the price comes down, the raw material and the price drop is slower than the top of the -- I mean our average selling price.

In the downstream for China Gerui, we see the customer demand continues to be weak over the last three quarters and then with a weak demand, pricing pressure and then a relatively unbalancing, I mean, supply chain that is actually what really contributes to the marketing erosion, I mean as we have seen from the last three quarters.

And we do anticipate that with, as I said, some of the smaller competitors going out of business or shutdown their production, and then the customers are coming back for warm up, I mean as you know, for the high precision cold-rolled steel. We see that margin is going to improve, but it might take some time, but we do believe that our position as the leading provider of high precision cold-rolled steel will continue to be very valid, Tory?


Thank you. We have reached the end of our question-and-answer session. I will now turn the floor back over to Mr. Meng for any concluding comments.

Edward Meng

Thank you all investors for your time and also I mean your interest for China Gerui and the continued financial performance. We thank you and have a good day and we wish you have a very good Thanksgiving holiday. Thank you.


Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. And thank you for your participation.

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