UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended December 31, 2007
or
o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from to
Commission file number 000-23039
CHINA PRECISION STEEL, INC.
(Exact name of registrant as specified in charter)
Delaware |
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14-1623047 |
(State or other jurisdiction |
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(IRS Employer |
8th Floor, Teda Building, 87 Wing Lok Street, Sheungwan
Hong Kong, The Peoples Republic of China
(Address of principal executive offices)
+852-2543-8223
Registrants telephone number, including area code:
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.
Large accelerated filer o Accelerated filer o Non-accelerated filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
As of February 14, 2008, there were 45,896,288 shares of the Companys common stock outstanding.
China Precision Steel, Inc.
Index to Quarterly Report
on Form 10-Q
Quarter Ended December 31, 2007
Part I - Financial Information
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Condensed Consolidated Balance Sheets at, December 31, 2007 (unaudited) and June 30, 2007 (audited) |
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Managements Discussion and Analysis of Financial Condition and Results of Operations |
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China Precision Steel, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
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(Unaudited) |
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December 31, |
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June 30, |
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Notes |
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2007 |
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2007 |
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Assets |
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Current assets |
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Cash and equivalents |
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$ |
40,205,111 |
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$ |
5,504,862 |
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Accounts receivable |
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Trade, net of allowances of $955,086 and $273,461 at December 31, and June 30, 2007, respectively |
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19,888,272 |
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8,242,044 |
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Bank acceptance notes |
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15,383,562 |
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Other |
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469,925 |
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85,708 |
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Inventories |
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5 |
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10,671,635 |
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15,723,704 |
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Deposits |
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68,493 |
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82,758 |
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Prepaid expenses |
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326,065 |
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Advances to suppliers, net of allowance of $2,368,805 and $3,502,184 at December 31, and June 30, 2007, respectively |
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10,256,715 |
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11,699,918 |
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Total current assets |
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97,269,778 |
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41,338,994 |
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Property, plant and equipment |
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Land use rights |
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1,795,461 |
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1,124,583 |
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Property and equipment, net |
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6 |
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32,305,573 |
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29,238,227 |
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Construction-in-progress |
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7 |
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11,503,835 |
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10,355,763 |
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45,604,869 |
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40,718,573 |
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Goodwill |
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13 |
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99,999 |
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99,999 |
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Total assets |
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$ |
142,974,646 |
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$ |
82,157,566 |
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Liabilities and Stockholders Equity |
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Current liabilities |
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Accounts payable and accrued liabilities |
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$ |
6,196,315 |
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$ |
4,855,932 |
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Advances from customers |
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8 |
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3,807,354 |
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1,720,812 |
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Other taxes payables |
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2,946,169 |
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716,554 |
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Current income taxes payable |
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3,171,889 |
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1,892,866 |
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Deferred income taxes payable |
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12 |
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1,981,121 |
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1,064,028 |
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Amounts due to directors |
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9 |
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2,543,019 |
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Current portion of long-term debt |
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3,086,758 |
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6,163,445 |
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Notes payable |
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10 |
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16,713,720 |
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9,842,520 |
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Total current liabilities |
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40,446,345 |
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26,256,157 |
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Long-term debt, net of current portion shown above |
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11 |
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2,315,069 |
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6,878,714 |
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Stockholders equity: |
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Preferred stock: $0.001 per value, 8,000,000 shares authorized, no shares outstanding at December 31, and June 30, 2007; |
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Common stock: $0.001 par value, 62,000,000 shares authorized, 45,896,288 and 37,378,143 issued and outstanding December 31, and June 30, 2007 |
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45,896 |
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37,378 |
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Additional paid-in capital |
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14 |
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73,701,004 |
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31,867,063 |
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Accumulated other comprehensive income |
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4,196,499 |
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2,192,160 |
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Retained earnings |
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22,269,833 |
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17,008,238 |
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Total stockholders equity |
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100,213,232 |
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51,104,839 |
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Amounts due from directors |
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9 |
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(2,082,144 |
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Total liabilities and stockholders equity |
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$ |
142,974,646 |
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$ |
82,157,566 |
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The accompanying notes are an integral part of these financial statements.
1
China Precision Steel, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations
For the Three and Six Months Ended December 31. 2007 and 2006
(Unaudited)
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Three Months Ended |
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Six Months Ended |
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December 31, |
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December 31, |
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December 31, |
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December 31, |
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Notes |
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2007 |
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2006 |
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2007 |
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2006 |
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Revenues |
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Sales revenues |
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$ |
11,913,718 |
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$ |
15,007,582 |
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$ |
37,226,416 |
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$ |
25,510,930 |
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Cost of goods sold |
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8,528,852 |
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11,594,852 |
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28,773,987 |
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18,394,950 |
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Gross profit |
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3,384,866 |
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3,412,730 |
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8,452,429 |
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7,115,980 |
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Operating expenses |
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Selling expenses |
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180,744 |
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64,693 |
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281,449 |
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104,390 |
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Administrative expenses |
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846,218 |
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498,737 |
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1,332,595 |
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684,925 |
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Provision for bad debts |
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25,782 |
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651,780 |
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Depreciation and amortization expense |
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15,798 |
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10,845 |
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29,430 |
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21,262 |
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Total operating expenses |
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1,068,542 |
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574,275 |
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2,295,254 |
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810,577 |
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Income from continuing operations |
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2,316,324 |
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2,838,455 |
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6,157,175 |
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6,305,403 |
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Other income (expense) |
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Other revenues |
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783,255 |
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792,410 |
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Interest and finance costs |
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(316,860 |
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(114,743 |
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(759,001 |
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(318,082 |
) |
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Total other income (expense) |
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466,395 |
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(114,743 |
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33,409 |
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(318,082 |
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Net income from continuing operations before income tax |
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2,782,719 |
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2,723,712 |
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6,190,584 |
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5,987,321 |
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Provision for (benefit from) income tax |
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Current |
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12 |
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194,873 |
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(34,057 |
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11,896 |
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895,313 |
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Deferred |
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12 |
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226,977 |
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389,604 |
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917,093 |
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(85,405 |
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Total income tax expense |
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421,850 |
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355,547 |
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928,989 |
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809,908 |
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Net income before discontinued operations |
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2,360,869 |
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2,368,165 |
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5,261,595 |
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5,177,413 |
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Net income from discontinued operations |
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16 |
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519,879 |
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639,072 |
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Net income |
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$ |
2,360,869 |
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$ |
2,888,044 |
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$ |
5,261,595 |
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$ |
5,816,485 |
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Basic earnings per share |
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15 |
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From continuing operations |
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$ |
0.05 |
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$ |
0.09 |
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$ |
0.13 |
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$ |
0.19 |
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From discontinued operations |
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$ |
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$ |
0.02 |
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$ |
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$ |
0.03 |
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Total |
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$ |
0.05 |
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$ |
0.11 |
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$ |
0.13 |
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$ |
0.22 |
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Basic weighted average shares outstanding |
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43,031,346 |
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26,981,916 |
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40,204,745 |
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26,981,916 |
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Diluted earnings per share |
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15 |
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From continuing operations |
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$ |
0.05 |
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$ |
0.09 |
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$ |
0.13 |
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$ |
0.19 |
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From discontinued operations |
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$ |
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$ |
0.02 |
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$ |
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$ |
0.03 |
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Total |
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$ |
0.05 |
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$ |
0.11 |
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$ |
0.13 |
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$ |
0.22 |
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Diluted weighted average shares outstanding |
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43,639,342 |
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26,981,916 |
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40,809,437 |
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26,981,916 |
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The Components of comprehensive income: |
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Net income |
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$ |
2,360,869 |
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$ |
2,888,044 |
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$ |
5,261,595 |
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$ |
5,816,485 |
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Foreign currency translation adjustment |
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|
557,213 |
|
557,213 |
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2,004,339 |
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654,985 |
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Comprehensive income |
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$ |
2,918,082 |
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$ |
3,445,257 |
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$ |
7,265,934 |
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$ |
6,471,470 |
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The accompanying notes are an integral part of these financial statements.
2
China Precision Steel, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
For the Six Months Ended December 31, 2007 and 2006
(Unaudited)
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2007 |
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2006 |
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Cash flows from operating activities |
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Net Income |
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$ |
5,261,595 |
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$ |
5,816,485 |
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Adjustments to reconcile net income to net cash provided by (used in) operating activities |
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Depreciation |
|
992,570 |
|
617,405 |
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Less income from discontinued operations - Oralabs, Inc |
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(639,072 |
) |
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Allowance for bad and doubtful debts |
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651,780 |
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Net changes in assets and liabilities: |
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Accounts receivable, net |
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(27,990,004 |
) |
4,059,814 |
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Inventories |
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5,195,155 |
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(8,207,665 |
) |
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Deposits |
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15,018 |
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(3,661 |
) |
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Prepayments |
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(326,065 |
) |
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Advances to suppliers |
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1,549,672 |
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(4,410,823 |
) |
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Accounts payable and accrued expenses |
|
1,296,194 |
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4,622,396 |
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Advances from customers |
|
2,070,883 |
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2,919,124 |
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Other taxes payable |
|
2,223,094 |
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(152,086 |
) |
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Current income taxes |
|
1,261,798 |
|
937,307 |
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Deferred income taxes |
|
907,410 |
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(85,405 |
) |
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Net cash (used in) provided by operating activities |
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(6,890,900 |
) |
5,473,819 |
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Cash flows from investing activities |
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Purchases of property and equipment including construction in progress |
|
(5,508,327 |
) |
(10,212,328 |
) |
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Net cash (used in) investing activities |
|
(5,508,327 |
) |
(10,212,328 |
) |
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Cash flows from financing activities |
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Sale of common stock |
|
44,433,222 |
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|
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Capital and restructuring contributions |
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|
558,797 |
|
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Advances from directors, net |
|
2,053,348 |
|
(3,237,243 |
) |
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Notes payable proceeds |
|
16,446,667 |
|
7,748,990 |
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Repayments of notes payable |
|
(17,424,050 |
) |
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|
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Net cash provided by financing activities |
|
45,509,187 |
|
5,070,544 |
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||
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|
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Effect of exchange rate |
|
1,590,289 |
|
654,985 |
|
||
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|
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|
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Net increase in cash |
|
34,700,249 |
|
987,020 |
|
||
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|
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Cash and cash equivalents, beginning of year |
|
5,504,862 |
|
186,955 |
|
||
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|
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Cash and cash equivalents, end of year |
|
$ |
40,205,111 |
|
$ |
1,173,975 |
|
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|
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Supplemental disclosure of cash flow information |
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|
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Interest paid |
|
$ |
759,001 |
|
$ |
318,082 |
|
Taxes paid |
|
$ |
|
|
$ |
|
|
The accompanying notes are an integral part of these financial statements.
3
China Precision Steel, Inc. and Subsidiaries
Condensed Consolidated Statements of Changes in Stockholders Equity
For the Year Ended June 30, 2007 and the Six Months Ended December 31, 2007 (Unaudited)
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Accumulated |
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|
|||||
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Additional |
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Other |
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Total |
|
|||||
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Ordinary Shares |
|
Paid-in |
|
Comprehensive |
|
Retained |
|
Stockholders |
|
|||||||
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Share |
|
Amount |
|
Capital |
|
Income |
|
Earnings |
|
Equity |
|
|||||
Balance at June 30, 2006 |
|
24,283,725 |
|
24,284 |
|
1,375,716 |
|
745,583 |
|
9,535,577 |
|
11,681,160 |
|
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|
|||||
Sale of common stock |
|
7,451,665 |
|
7,451 |
|
22,347,543 |
|
|
|
|
|
22,354,994 |
|
|||||
Syndication fees |
|
|
|
|
|
(3,028,116 |
) |
|
|
|
|
(3,028,116 |
) |
|||||
Stock issued for syndication fees |
|
2,798,191 |
|
2,798 |
|
(2,798 |
) |
|
|
|
|
|
|
|||||
Anti-dilution rights stock |
|
827,962 |
|
828 |
|
(828 |
) |
|
|
|
|
|
|
|||||
Conversion of debt to stock |
|
2,016,600 |
|
2,017 |
|
6,773,759 |
|
|
|
|
|
6,775,776 |
|
|||||
Warrants issued for consulting |
|
|
|
|
|
447,993 |
|
|
|
|
|
447,993 |
|
|||||
Capital contribution from waiver of dividend |
|
|
|
|
|
3,953,794 |
|
|
|
|
|
3,953,794 |
|
|||||
Foreign currency translation adjustment |
|
|
|
|
|
|
|
1,446,577 |
|
|
|
1,446,577 |
|
|||||
Net income |
|
|
|
|
|
|
|
|
|
8,304,109 |
|
8,304,109 |
|
|||||
Less discontinued operations sold to former shareholder |
|
|
|
|
|
|
|
|
|
(831,448 |
) |
(831,448 |
) |
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Balance at June 30, 2007 |
|
37,378,143 |
|
37,378 |
|
31,867,063 |
|
2,192,160 |
|
17,008,238 |
|
51,104,839 |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Sale of common stock |
|
7,100,000 |
|
7,100 |
|
44,498,650 |
|
|
|
|
|
44,505,750 |
|
|||||
Syndication fees |
|
|
|
|
|
(72,528 |
) |
|
|
|
|
(72,528 |
) |
|||||
Make good shares |
|
2,000,000 |
|
2,000 |
|
(2,000 |
) |
|
|
|
|
|
|
|||||
Exercise of warrants |
|
189,205 |
|
189 |
|
(189 |
) |
|
|
|
|
|
|
|||||
Cancellation of stock |
|
(771,060 |
) |
(771 |
) |
(2,589,992 |
) |
|
|
|
|
(2,590,763 |
) |
|||||
Foreign currency translation adjustment |
|
|
|
|
|
|
|
2,004,339 |
|
|
|
2,004,339 |
|
|||||
Net income |
|
|
|
|
|
|
|
|
|
5,261,595 |
|
5,261,595 |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Balance at December 31, 2007 |
|
45,896,288 |
|
$ |
45,896 |
|
$ |
73,701,004 |
|
$ |
4,196,499 |
|
$ |
22,269,833 |
|
$ |
100,213,232 |
|
The accompanying notes are an integral part of these financial statements.
4
China Precision Steel, Inc.
Notes to the Condensed Consolidated Financial Statements
1. Description of Business
On December 28, 2006, China Precision Steel, Inc. (the Company or we), under our former name, OraLabs Holding Corp., issued 25,363,002 shares of common stock in exchange for 100% of the registered capital of Partner Success Holdings Limited (PSHL), a British Virgin Islands Business Company pursuant to a Stock Exchange Agreement, dated March 31, 2006. Subsequent to the closing of that transaction, on December 28, 2006, the Company redeemed 3,629,350 shares of its common stock in exchange for all of the common stock of OraLabs, Inc., a wholly-owned operating subsidiary. The Company issued 100,000 shares of its common stock to OraLabs, Inc. in exchange for $450,690, and received additional cash payments in the aggregate amount of $108,107 in payment of an estimated $558,797 tax liability to be incurred by the Company in connection with the spin off of OraLabs, Inc. and the supplemental payment received. The Company then changed its name to China Precision Steel, Inc.
These transactions were treated for financial reporting purposes as a recapitalization, with prior OraLabs, Inc. operating activities reflected on the statements of operations as income (loss) from discontinued operations. The $558,797 estimated tax liability incurred in connection with the spin-off of OraLabs, Inc. was treated as a transaction cost for financial reporting purposes and was treated as a reduction in additional paid-in capital to the extent of the additional cash received which was also $558,797.
PSHL, registered on April 30, 2002 in the Territory of the British Virgin Islands, had registered capital of $50,000 as of June 30, 2007 and 2006. It has three wholly-owned subsidiaries, Shanghai Chengtong Precision Strip Company Limited (Chengtong), Shanghai Tuorong Precision Strip Co., Limited (Tuorong), and Blessford International Limited (Blessford).
In the year ended June 30, 2007, we added three indirect subsidiaries to our corporate structure. On April 9, 2007, we purchased Shanghai Tuorong Precision Strip, Limited, or Tuorong, through PSHL. The sole activity of Tuorong is the ownership of a land use right with respect to facilities utilized by Chengtong. On April 10, 2007, PSHL purchased for $100,000 Blessford International Limited, a British Virgin Islands company. Blessford International Limited does not conduct any business, but it owns a single subsidiary, Shanghai Blessford Alloy Company Limited, that is a wholly-foreign owned enterprise chartered in China. We intend to hold Blessford International Limited as a shell subsidiary that may be used in the future to facilitate optimization of the tax structure of the Groups activities.
Chengtong was registered on July 2, 2002 in Shanghai, in the Peoples Republic of China (PRC) with a registered capital of $3,220,000 and a defined period of existence of 50 years from July 2, 2002 to July 1, 2052. Chengtong was classified as a Sino-foreign joint venture enterprise with limited liabilities. On August 22, 2005, the authorized registered capital was increased to $15,220,000 and on December 11, 2007, the authorized registered capital was further increased to $42,440,000. Pursuant to the document issued by the District Council to Xuhang Town Council on June 28, 2004, the equity transfers from China Chengtong Metal Group Limited and Eastreal Holdings Company Limited to PSHL was approved and the transformation of Chengtong from a Sino-foreign joint investment enterprise to a wholly foreign owned enterprise (WFOE) was granted.
As used herein, the Group refers to the Company, PSHL and Chengtong, Tuorong and Blessford on a consolidated basis.
The Companys principal activities are conducted through its principal subsidiary, Chengtong. Chengtong is a niche precision steel processing company principally engaged in the manufacture and sales of cold-rolled and hot-rolled precision steel products and plates for down-stream applications in the automobile industry (components and spare parts), kitchen tools and functional parts of electrical appliances. Raw materials, hot-rolled de-scaled (pickled) steel coils, will go through certain cold reduction processing procedures to give steel rolls and plates in different cuts and thickness for deliveries in accordance with customers specifications. Specialty precision steel offers specific control of thickness, shape, width, surface finish and other special quality features that compliment the emerging need for highly engineered end use applications. Precision steel pertains to the precision of measurements and tolerances of the above factors, especially thickness tolerance.
2. Basis of Preparation of Financial Statements
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and related notes. The accompanying unaudited condensed consolidated financial statements and related notes should be read in conjunction with the audited consolidated financial statements of the Company and notes thereto for the year ended June 30, 2007.
5
In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (which include only normal recurring adjustments) necessary to present fairly the balance sheets of China Precision Steel, Inc. and subsidiaries as of December 31, 2007 and June 30, 2007 and the results of their operations for the three and six months ended December 31, 2007 and 2006, and cash flows for the six months ended December 31, 2007 and 2006. The results of operations for the three and six months ended December 31, 2007 and 2006 are not necessarily indicative of the results to be expected for the entire year.
3. Summary of Significant Accounting Policies
The following is a summary of significant accounting policies:
Cash and Equivalents - The Company considers all highly liquid debt instruments purchased with maturity period of three months or less to be cash equivalents. The carrying amounts reported in the accompanying consolidated balance sheet for cash and cash equivalents approximate their fair value.
Accounts Receivable - The Company provides an allowance for doubtful accounts equal to the estimated uncollectible amounts. It is reasonably possible that the Companys estimate of the allowance will change. At December 31, 2007 and June 30, 2007, the Company had $955,086 and $273,461 of allowances for doubtful accounts, respectively.
Inventory - Inventory is stated at the lower of cost or market. Cost is determined using the weighted average method. Market value represents the estimated selling price in the ordinary course of business less the estimated costs necessary to complete the sale.
The cost of inventories comprises all costs of purchases, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. The costs of conversion of inventories include fixed and variable production overheads, taking into account the stage of completion.
Advances to Suppliers - In order to insure a steady supply of raw materials, the Company is required from time to time to make cash advances when placing its purchase orders. Cash advances are shown net of allowances for unrecoverable advances of $2,368,805 and $3,502,184 at, December 31, 2007 and June 30, 2007, respectively.
Property, Plant and Equipment - Property, plant and equipment are stated at cost less accumulated depreciation. The cost of an asset comprises its purchase price and any directly attributable costs of bringing the asset to its present working condition and location for its intended use.
Depreciation is computed on a straight-line basis over the estimated useful lives of the related assets for financial reporting purposes. The estimated useful lives for significant property and equipment are as follows:
Buildings |
|
25 years |
Office equipment |
|
5 years |
Motor vehicles |
|
5 years |
Machineries |
|
10 years |
Repairs and maintenance costs are normally charged to the statement of operations in the year in which they are incurred. In situations where it can be clearly demonstrated that the expenditure has resulted in an increase in the future economic benefits expected to be obtained from the use of the asset, the expenditure is capitalized as an additional cost of the asset.
Property, plant and equipment are evaluated annually for any impairment in value. Where the recoverable amount of any property and equipment is determined to have declined below its carrying amount, the carrying amount is reduced to reflect the decline in value. There were no property and equipment impairments recognized during the years ended June 30, 2007 and 2006.
Capitalized Interest - The Company capitalizes interest cost on borrowings incurred during the new construction or upgrade of qualified assets. Capitalized interest is added to the cost of the underlying assets and is amortized over the useful lives of the assets. During the six months ended December 31, 2007 and 2006, the Company capitalized $0 and $497,686, respectively, of interest to construction-in-progress.
Construction-in-Progress - Properties currently under development are accounted for as construction-in-progress. Construction-in-progress is recorded at acquisition cost, including land rights cost, development expenditure, professional fees and the interest expenses capitalized during the course of construction for the purpose of financing the project. Upon completion and readiness for use of the project, the cost of construction-in-progress is to be transferred to properties held for sale.
6
Construction-in-progress is valued at the lower of cost or market. Management evaluates the market value of its properties on a quarterly basis by comparing selling prices of its properties with those of other equivalent properties in the vicinity offered by other developers reduced by anticipated selling costs and associated taxes. In the case of construction-in-progress, management takes into consideration the estimated cost to complete the project when making the lower of cost or market calculation.
Contingent Liabilities and Contingent Assets - A contingent liability is a possible obligation that arises from past events and whose existence will only be confirmed by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the Company. It can also be a present obligation arising from past events that is not recognized because it is not probable that outflow of economic resources will be required or the amount of obligation cannot be measured reliably.
A contingent liability is not recognized but is disclosed in the notes to the financial statements. When a change in the probability of an outflow occurs so that outflow is probable, the contingency is then recognized as a provision.
A contingent asset is a possible asset that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain events not wholly within the control of the Company.
Contingent assets are not recognized but are disclosed in the notes to the financial statements when an inflow of economic benefits is probable. When inflow is virtually certain, an asset is recognized.
Advances from customers - Revenue from the sale of goods or services is recognized at the time that goods are delivered or services are rendered. Receipts in advance for goods to be delivered or services to be rendered in a subsequent period are carried forward as deferred revenue.
Revenue Recognition - Revenue from the sale of goods and services is recognized on the transfer of risks and rewards of ownership, which generally coincides with the time when the goods are delivered to customers and the title has passed and services have been rendered and invoiced. Revenue is reported net of all VAT taxes. Other income is recognized when it is earned.
Foreign Currencies - The Companys principal country of operations is in the PRC. The financial position and results of operations of the Company are determined using the local currency (Renminbi or Yuan) as the functional currency. The results of operations denominated in foreign currencies are translated at the average rate of exchange during the reporting period. Assets and liabilities denominated in foreign currencies at the balance sheet date are translated at the market rate of exchange ruling at that date. The registered equity capital denominated in the functional currency is translated at the historical rate of exchange at the time of capital contribution. All translation adjustments resulting from the translation of the financial statements into the reporting currency (US Dollars) are dealt with as an exchange fluctuation reserve in shareholders equity.
Taxation - Taxation on overseas profits has been calculated on the estimated assessable profits for the year at the rates of taxation prevailing in the country in which the Company operates.
Provision for the PRC enterprise income tax is calculated at the prevailing rate based on the estimated assessable profits less available tax relief for losses brought forward. The Company does not accrue taxes on unremitted earnings from foreign operations as it is the Companys intention to invest these earnings in the foreign operations indefinitely.
Enterprise income tax
Under the Provisional Regulations of the Peoples Republic of China Concerning Income Tax on Enterprises promulgated by the State Council which came into effect on January 1, 1994, income tax is payable by enterprises at a rate of 33% of their taxable income. Preferential tax treatment may, however, be granted pursuant to any law or regulations from time to time promulgated by the State Council. Specialty state companies enterprise income tax rate was reduced to 27%. The Group is currently enjoying a 50% reduction in the statutory rates due to the classification of Chengtong as a Wholly Foreign Owned Enterprise. This reduced rate applies to the fiscal years ended June 30, 2007, 2008, and 2009. Subsequent to June 30, 2009, Chengtong will be subject to enterprise income taxes at the prevailing statutory rates. The Enterprise Income Tax Law was passed on March 16, 2007, and became effective on January 1, 2008. The new law introduces fundamental changes to the Chinese tax system for both domestic and foreign-owned entities. A new unified general income tax of 25% will be applicable to enterprises in China. Entities subject to a tax holiday prior to January 1, 2008, are expected to be able to retain the benefits of the reduced rates for the remaining term.
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets, including tax loss and credit carry forwards, and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred income tax expense represents the change during the period in the deferred tax assets and deferred tax liabilities. The components of the deferred tax assets and liabilities are
7
individually classified as current and non-current based on their characteristics. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
In 2006, the Financial Accounting Standards Board (FASB) issued FIN 48, which clarifies the application of SFAS 109 by defining a criterion that an individual income tax position must meet for any part of the benefit of that position to be recognized in an enterprises financial statements and provides guidance on measurement, derecognition, classification, accounting for interest and penalties, accounting in interim periods, disclosure and transition. In accordance with the transition provisions, the Company adopted FIN 48 effective January 1, 2007.
The Company recognizes that virtually all tax positions in the PRC are not free of some degree of uncertainty due to tax law and policy changes by the State. However, the Company cannot reasonably quantify political risk factors and thus must depend on guidance issued by current state officials.
Based on all known facts and circumstances and current tax law, the Company believes that the total amounts of unrecognized tax benefits as of December 31 and June 30, 2007, are not material to its results of operations, financial condition or cash flows. The Company also believes that the total amounts of unrecognized tax benefits as of December 31 and June 30, 2007, if recognized, would not have a material effect on its effective tax rate. The Company further believes that there are no tax positions for which it is reasonably possible, based on current Chinese tax law and policy, that the unrecognized tax benefits will significantly increase or decrease over the next 12 months producing, individually or in the aggregate, a material effect on the Companys results of operations, financial condition or cash flows.
Value added tax
The Provisional Regulations of the Peoples Republic of China Concerning Value Added Tax promulgated by the State Council came into effect on January 1, 1994. Under these regulations and the Implementing Rules of the Provisional Regulations of the Peoples Republic of China Concerning Value Added Tax, value added tax is imposed on goods sold in or imported into the PRC and on processing, repair and replacement services provided within the PRC.
Value added tax payable in the PRC is charged on an aggregated basis at a rate of 13% or 17% (depending on the type of goods involved) on the full price collected for the goods sold or, in the case of taxable services provided, at a rate of 17% on the charges for the taxable services provided, but excluding, in respect of both goods and services, any amount paid in respect of value added tax included in the price or charges, and less any deductible value added tax already paid by the taxpayer on purchases of goods and services in the same financial year.
Retirement Benefit Costs - According to the PRC regulations on pension, Chengtong contributes to a defined contribution retirement scheme organized by municipal government in the province in which Chengtong was registered and all qualified employees are eligible to participate in the scheme. Contributions to the scheme are calculated at 23.5% of the employees salaries above a fixed threshold amount and the employees contribute 2% to 8%, while Chengtong contributes the balance contribution of 21.5%% to 15.5%. The Group has no other material obligation for the payment of retirement benefits beyond the annual contributions under this scheme.
For the three and six months ended December 31, 2007, the Companys pension cost charged to the statements of operations under the plan amounted to $72,059 and $132,658, respectively, all of which have been paid to the State Pension Fund (2006: $39,466 and $74,163, respectively).
Fair Value of Financial Instruments - The carrying amounts of certain financial instruments, including cash, accounts receivable, other receivables, accounts payable, accrued expenses, and other payables approximate their fair values as at December 31 June 30, 2007 because of the relatively short-term maturity of these instruments.
Adjustments - In the opinion of management, all adjustments that are necessary for a fair presentation for the periods presented have been reflected as required by Regulation S-X, Rule 10-01. All such adjustments are of a normal, recurring nature.
Use of Estimates - The preparation of financial statements in accordance with generally accepted accounting principles require management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
8
Recent Accounting Pronouncements
The Financial Accounting Standards Board recently issued the following standards which the Company reviewed to determine the potential impact on our financial statements upon adoption.
In September 2006, the FASB issued Statement No. 157, Fair Value Measurements (SFAS No. 157). SFAS No. 157 addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles. SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands the required disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, with earlier adoption permitted. Management is assessing the impact of the adoption of SFAS No. 157.
In September 2006, the FASB issued Statement No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans (SFAS No. 158), an amendment of FASB Statements No. 87, 88, 106 and 132(R). SFAS No. 158 requires (a) recognition of the funded status (measured as the difference between the fair value of the plan assets and the benefit obligation) of a benefit plan as an asset or liability in the employers statement of financial position, (b) measurement of the funded status as of the employers fiscal year-end with limited exceptions, and (c) recognition of changes in the funded status in the year in which the changes occur through comprehensive income. The requirement to recognize the funded status of a benefit plan and the disclosure requirements are effective as of the end of the fiscal year ending after December 15, 2006. The requirement to measure the plan assets and benefit obligations as of the date of the employers fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. SFAS No. 158 has no current applicability to the Companys financial statements.
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 (SAB No. 108). SAB No. 108 addresses how the effects of prior year uncorrected misstatements should be considered when quantifying misstatements in current year financial statements. SAB No. 108 requires companies to quantify misstatements using a balance sheet and income statement approach and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. When the effect of initial adoption is material, companies will record the effect as a cumulative effect adjustment to beginning of year retained earnings and disclose the nature and amount of each individual error being corrected in the cumulative adjustment. Complying with the requirements of SAB No. 108 had no impact on the Companys financial statements.
In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS No. 159), an amendment of FASB Statement No. 115. SFAS No. 159 addresses how companies should measure many financial instruments and certain other items at fair value. The objective is to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007, with earlier adoption permitted. Management is assessing the impact of the adoption of SFAS No. 159.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS 141(R)). SFAS 141(R) will change the accounting for business combinations. Under SFAS No. 141(R), an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. SFAS No. 141(R) will change the accounting treatment and disclosure for certain specific items in a business combination. SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. SFAS 141(R) will impact the Company in the event of any future acquisition.
In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statementsan amendment of Accounting Research Bulletin No. 51 (SFAS 160). SFAS 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008. The Company does not believe that SFAS 160 will have a material impact on its consolidated financial statements.
4. Concentrations of Business and Credit Risk
The Company provides credit in the normal course of business. The Company performs ongoing credit evaluations of its customers and clients and maintains allowances for doubtful accounts based on factors surrounding the credit risk of specific customers and
9
clients, historical trends, and other information. Trade accounts receivable totaled $19,888,272 and $8,242,044 as of December 31,
2007 and June 30, 2007, respectively.
The Companys list of customers whose purchases exceeded 10% of total sales during the six months ended December 31, 2007 and 2006 is as follows:
Customers |
|
December 31, |
|
% to |
|
December 31, |
|
% to |
|
Shanghai Changshuo Steel Company, Ltd |
|
11,076,780 |
|
30 |
|
|
|
|
|
Shanghai Shengdejia Metal Products Limited |
|
6,492,562 |
|
17 |
|
|
|
|
|
Shanghai Ruixuefeng Metals Co., Limited |
|
|
|
|
|
9,254,127 |
|
36 |
|
Sinosteel Company Limited |
|
|
|
|
|
3,219,796 |
|
13 |
|
5. Inventories
Inventory consisted of the following:
|
|
December 31, |
|
June 30, |
|
||
Raw materials |
|
$ |
3,560,539 |
|
$ |
13,026,530 |
|
Work in progress |
|
2,403,644 |
|
|
|
||
Finished goods |
|
4,707,452 |
|
2,697,174 |
|
||
|
|
$ |
10,671,635 |
|
$ |
15,723,704 |
|
6. Property and Equipment
Property and equipment, stated at cost less accumulated depreciation, consisted of the following:
|
|
December 31, |
|
June 30, |
|
||
Plant and machinery |
|
$ |
19,053,914 |
|
$ |
21,087,245 |
|
Buildings |
|
17,568,240 |
|
11,361,207 |
|
||
Motor vehicles |
|
345,350 |
|
283,534 |
|
||
Office equipment |
|
66,268 |
|
85,560 |
|
||
|
|
37,033,772 |
|
32,817,546 |
|
||
Less: Accumulated depreciation |
|
(4,728,199 |
) |
(3,579,319 |
) |
||
|
|
$ |
32,305,573 |
|
$ |
29,238,227 |
|
Depreciation expense related to manufacturing is included as a component of cost of goods sold. During the three and six months ended December 31, 2007, depreciation totaling $483,482 and $961,462, respectively, was included as a component of cost of goods sold (2006: $345,669 and $596,143, respectively).
7. Construction-In-Progress
Construction-in-progress consisted of the following:
|
|
December 31, |
|
June 30, |
|
||
Construction costs of plant and machinery |
|
$ |
11,503,835 |
|
$ |
10,355,763 |
|
Construction-in-progress represents construction and installations of the new plant and machinery and factory buildings.
8. Advances from Customers
Advances from customers represent advance cash receipts from new customers and for which goods have not been delivered or services rendered as of the balance sheets dates. Advances from customers for goods to be delivered or services to be rendered in the subsequent period are carried forward as deferred revenue. As of December 31, 2007 and June 30, 2007, there were advances from customers of $3,807,354 and $1,720,812, respectively.
10
9. Transactions with Related Parties
Amounts due to (from) directors are as follows:
Name |
|
December 31, 2007 |
|
June 30, 2007 |
|
||
Wo Hing Li |
|
$ |
2,120,596 |
|
$ |
(2,590,763 |
) |
Hai Sheng Chen |
|
422,423 |
|
408,619 |
|
||
|
|
$ |
2,543,019 |
|
$ |
(2,182,144 |
) |
Amounts due are unsecured, non-interest bearing and have no fixed repayment terms.
Wo Hing Li, a director and the President of the Company, executed an agreement with the Company and certain other parties, dated as of February 13, 2007, as amended (the Debt Conversion Agreement), such that, upon the occurrence of the transfer to Chengtong of Tuorong, he contributed $3,953,794 as additional paid in capital to the Company and agreed to convert current debt outstanding and payable to him of $6,775,776 into shares of the Companys common stock at a price of $3.36 per share. This transaction was completed on May 19, 2007. When Chengtong acquired Tuorong, Tuorong had a preexisting receivable from Wo Hing Li, and the Group offset remaining amounts owed to Wo Hing Li against this receivable.
In conjunction with the Companys final audit of the Tuorong acquisition, certain post-closing adjustments were required. In light of such adjustments and consistent with the purposes and intentions of the Debt Reduction Agreement, dated February 13, 2007, as amended February 20, 2007, it was determined that 771,060 shares of the Companys Common Stock issued to directors pursuant to such Agreement would be required to be cancelled in order to eliminate the $2,590,763 reflected on the June 30, 2007 audited financial statements as amounts due from directors. Such cancellation was effected on November 8, 2007.
10. Short-Term Loans
Short-term loans consisted of the following:
|
|
December 31, |
|
June 30, |
|
||
Bank loan dated September 22, 2005, due December 31, 2007 with a interest rate of 15% over the standard market rate set by the Peoples Bank of China for Renminbi loans, secured by land, buildings and machinery |
|
$ |
|
|
$ |
9,842,520 |
|
|
|
|
|
|
|
||
Bank loan dated August 1, 2007, due in one year with a interest rate of the Singapore Interbank Offered Rate (SIBOR) plus 3% (7.73% at December 31, 2007) |
|
5,300,000 |
|
|
|
||
|
|
|
|
|
|
||
Bank loan dated August 1, 2007, due in one year with a interest rate of 13% over the standard market rate set by the Peoples Bank of China for Renminbi loans, secured by land, buildings, plant and machinery (8.24% at December 31, 2007) |
|
2,701,391 |
|
|
|
||
|
|
|
|
|
|
||
Bank loan dated July 26, 2007, due in one year with a interest rate of 15% over the standard market rate set by the Peoples Bank of China for Renminbi loans, secured by land, buildings, plant and machinery (8.38% at December 31, 2007) |
|
8,712,329 |
|
|
|
||
|
|
|
|
|
|
||
|
|
$ |
16,713,720 |
|
$ |
9,842,520 |
|
The weighted average interest rate on short-term loans at December 31, 2007 was 8.15%.
11. Long-Term Debts - Secured
|
|
December 31, |
|
June 30, |
|
||
Long-term debts: |
|
|
|
|
|
||
|
|
|
|
|
|
||
Bank loan dated October 14, 2004, due July 31, 2007, at an interest rate of 3% over the 10% of the standard market rate set by the Peoples Bank of China for Renminbi loans, secured by land, buildings and machinery |
|
$ |
|
|
$ |
6,163,445 |
|
|
|
|
|
|
|
||
Bank loan dated September 22, 2005, due August 31, 2009, at an interest rate of 15% the standard market rate set by the Peoples Bank of China for Renminbi loans, secured by land, buildings and machinery (8.38% at December 31, 2007) |
|
5,401,827 |
|
6,878,714 |
|
||
11
Total long-term debt |
|
5,401,827 |
|
13,042,159 |
|
||
Less: Current portion of long-term debts |
|
3,086,758 |
|
6,163,445 |
|
||
|
|
|
|
|
|
||
Long-term debts |
|
$ |
2,315,069 |
|
$ |
6,878,714 |
|
Maturities on long-term debt for each of the next five years and thereafter are as follows:
2008 |
|
$ |
3,086,758 |
|
2009 |
|
2,315,069 |
|
|
2010 |
|
|
|
|
2011 |
|
|
|
|
2012 |
|
|
|
|
2013 and after |
|
|
|
|
|
|
$ |
5,401,827 |
|
12. Income Tax
For enterprise income tax reporting purposes, the Company reports income and expenses on a tax basis and is required to compute a 10% salvage value when computing depreciation expense. For financial reporting purposes, the Company reports income and expenses on the accrual basis and does not take into account a 10% salvage value when computing depreciation expense.
No accrual for deferred taxes was required for the fiscal year ended June 30, 2005 as the Group benefited from Chengtongs 100% tax holiday during the two fiscal years ended June 30, 2006 and all material timing differences would reverse within one year with the exception of depreciation which resulted in a small deferred tax asset which was deemed to be immaterial by the Company and was not recorded at that time.
As of June 30, 2006, Chengtong had utilized all of its 100% tax holiday, therefore any timing differences reversing within the next three years would be taxed at 50% of the statutory rate of 27%.
The tax holiday resulted in tax savings as follows:
|
|
Three months ended December 31, |
|
Six months ended December 31 |
|
||||||||
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
||||
Tax savings |
|
$ |
459,759 |
|
$ |
367,701 |
|
$ |
1,005,469 |
|
$ |
806,669 |
|
|
|
|
|
|
|
|
|
|
|
||||
Benefit per share |
|
|
|
|
|
|
|
|
|
||||
Basic |
|
$ |
0.01 |
|
$ |
0.01 |
|
$ |
0.03 |
|
$ |
0.03 |
|
Diluted |
|
$ |
0.01 |
|
$ |
0.01 |
|
$ |
0.02 |
|
$ |
0.03 |
|
Significant components of the Groups deferred tax assets and liabilities as of December 31, 2007 and June 30, 2007 are as follows:
Deferred tax liabilities: |
|
December 31, |
|
June 30, |
|
||
|
|
|
|
|
|
||
Book depreciation in excess of tax depreciation |
|
$ |
86,306 |
|
$ |
39,918 |
|
|
|
|
|
|
|
||
Timing differences resulting form cash basis reporting for tax purposes |
|
(2,067,427 |
) |
(1,103,946 |
) |
||
|
|
|
|
|
|
||
Net deferred income tax (liability) |
|
$ |
(1,981,121 |
) |
$ |
(1,064,028 |
) |
12
A reconciliation of the provision for income taxes with amounts determined by the U.S. federal income tax rate to income before income taxes is as follows.
|
|
Three months ended |
|
Six months ended |
|
||||||||
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
||||
Computed tax at the federal statutory rate of 34% |
|
$ |
946,124 |
|
$ |
926,062 |
|
$ |
2,104,799 |
|
$ |
2,035,689 |
|
Less adjustment to EIT statutory rate of 27% |
|
(194,790 |
) |
(190,660 |
) |
(433,341 |
) |
(419,112 |
) |
||||
Tax effect of US losses not deductible in PRC |
|
130,275 |
|
|
|
263,000 |
|
|
|
||||
Benefit of tax holiday |
|
(459,759 |
) |
(379,855 |
) |
(1,005,469 |
) |
(806,669 |
) |
||||
|
|
|
|
|
|
|
|
|
|
||||
Income tax expense per books |
|
$ |
421,850 |
|
$ |
355,547 |
|
$ |
928,989 |
|
$ |
809,908 |
|
Income tax expense (benefit) consists of:
|
|
Three months ended |
|
Six months ended |
|
||||||||
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
||||
Income tax expense (benefit) for the current year PRC |
|
$ |
194,873 |
|
$ |
(34,057 |
) |
$ |
11,896 |
|
$ |
895,313 |
|
Deferred income tax expense (benefit) PRC |
|
|
226,977 |
|
|
389,604 |
|
|
917,093 |
|
|
(85,405 |
) |
Income tax expense per books |
|
$ |
421,850 |
|
$ |
355,547 |
|
$ |
928,989 |
|
$ |
809,908 |
) |
13. Blessford International Limited
On April 10, 2007, the Company purchased for $100,000 Blessford International Limited, a British Virgin Islands company. Blessford International Limited does not conduct any business, but it owns a single subsidiary, Shanghai Blessford Alloy Company Limited, that is a wholly-foreign owned enterprise chartered in China. The purchase price was allocated $1 to cash and $99,999 to goodwill.
14. Equity
In connection with a Stock Purchase Agreement, dated February 16, 2007 (the Stock Purchase Agreement), on February 22, 2007, the Company issued warrants to the placement agents to purchase an aggregate of 1,300,059 shares of Common Stock as partial compensation for services rendered in connection with the Private Placement. The value of the warrants was considered syndication fees and was recorded to additional paid-in capital.
On February 22, 2007, the Company issued warrants to purchase up to 100,000 shares of Common Stock to the Companys investor relations consultants valued at $447,993. The value of these was considered syndication fees in association with the Private Placement and was recorded to additional paid-in capital.
On November 6, 2007, in connection with a Subscription Agreement, dated November 1, 2007 (the Subscription Agreement), the Company issued to certain institutional accredited investors warrants to purchase 1,420,000 shares of Common Stock valued at $5,374,748. In connection with the transaction, Roth Capital Partners, LLC, as placement agent, received warrants to purchase 225,600 shares of Common Stock valued at $887,504.
Information with respect to stock warrants outstanding is as follows:
Exercise Price |
|
Outstanding |
|
Granted |
|
Expired or |
|
Outstanding |
|
Expiration Date |
|
|
$ |
3.00 |
|
1,300,059 |
|
-0- |
|
(275,000 |
) |
1,025,059 |
|
02/22/2011 |
|
$ |
3.60 |
|
100,000 |
|
-0- |
|
-0- |
|
100,000 |
|
02/22/2010 |
|
$ |
8.45 |
|
-0- |
|
1,420,000 |
|
-0- |
|
1,420,000 |
|
11/06/2010 |
|
$ |
7.38 |
|
-0- |
|
225,600 |
|
-0- |
|
225,600 |
|
11/06/2010 |
|
Pursuant to Section 5.1 of the Stock Purchase Agreement, the Company agreed to reserve for issuance to investors in the private placement an aggregate of 2,000,000 shares of Common Stock if the Companys net income for the fiscal year ending June 30, 2007 was less than US$10.4 million, as set forth in the Companys audited financial statements as filed with the SEC in the Companys Annual Report on Form 10-K for the fiscal year ended June 30, 2007. As the Companys net income as set forth in its audited financial statements for the year ended June 30, 2007 was less than US$10.4 million, the Company was required to issue the 2,000,000 shares of Common Stock to such investors. Such issuance was effected on October 15, 2007. No additional consideration was received by the Company in connection with this issuance of shares of Common Stock.
In conjunction with the Companys final audit of the Tuorong acquisition, certain post-closing adjustments were required. In light of such adjustments and consistent with the purposes and intentions of the Debt Reduction Agreement, dated February 13, 2007, as
13
amended February 20, 2007, it was determined that 771,060 shares of the Companys Common Stock issued to directors pursuant to such Agreement would be required to be cancelled in order to eliminate the $2,590,763 reflected on the June 30, 2007 audited financial statements as amounts due from directors. Such cancellation was effected on November 8, 2007.
Pursuant to the Subscription Agreement, on November 6, 2007, the Company agreed to issue and sell in a registered direct offering (the Offering) an aggregate of 7,100,000 shares of its common stock (Common Stock) at a price of $6.75 per share (the Purchase Price) and an aggregate of 1,420,000 warrants to purchase shares of its Common Stock (Warrants and, together with the Common Stock, the Securities). The Warrants have an exercise price of $8.45 per share. The Warrants may not be exercised prior to May 6, 2008. The Securities (including the shares issuable upon exercise of the Warrants) are registered under the Securities Act of 1933, as amended (the Act), pursuant to the Companys existing effective shelf Registration Statement on Form S-3. In connection with the offer and sale of the Securities, the Company filed on November 1, 2007, a Registration Statement on Form S-3 pursuant to Rule 462(b) promulgated under the Act to register an additional $10 million of its securities relating to its shelf Registration Statement.
The Company closed the Offering on November 6, 2007 (the Closing Date). The net proceeds of the offering were approximately $44 million, after deducting underwriting commissions and discounts and other fees and expenses relating to the offering. The warrants were valued at $5.3 million and were recorded to additional paid-in capital. The Company intends to use the net proceeds for repayment of certain existing bank debt in the amount of approximately $22 million, capital expenditures related to the completion of the second reverse rolling mill and annealing furnace and construction of the third reverse rolling mill and related capital expenditures in the amount of approximately $18 million, and the balance for general corporate purposes.
On the Closing Date, pursuant to a Placement Agency Agreement entered into between the Company and Roth Capital Partners LLC on October 31, 2007, Roth Capital received an amount in cash equal to 7.0% of the gross proceeds of the Offering and warrants to purchase an amount of Common Stock equal to 3.0% of the total number of shares of Common Stock sold in the Offering (the Placement Warrants), or 225,600 shares of Common Stock valued at $887,504 and were recorded as syndication fees offsetting additional paid-in capital. Such Placement Warrants have an exercise price per share of 120% of the closing price per share of the Companys Common Stock on the Closing Date, or $7.38, and are not exercisable prior to May 6, 2008. Thereafter, the Placement Warrants are exercisable at any time until the third anniversary of the date of issue.
15. Earnings Per Share
SFAS 128 requires a reconciliation of the numerator and denominator of the basic and diluted earnings per share (EPS) computations.
For the six months ended December 31, 2007 , dilutive shares include outstanding warrants to purchase 1,025,059 shares of common stock at an exercise price of $3.00; 100,000 shares at an exercise price of $3.60; 1,420,000 shares at an exercise price of $8.45; and 225,600 shares at an exercise price of $7.38. There were no dilutive shares outstanding at December 31, 2006.
The following reconciles the components of the EPS computation:
|
|
Income |
|
Shares |
|
Per Share |
|
||
|
|
(Numerator) |
|
(Denominator) |
|
Amount |
|
||
For the three months ended December 31, 2007: |
|
|
|
|
|
|
|
||
Net income |
|
$ |
2,360,869 |
|
|
|
|
|
|
Less Net income from discontinued operations |
|
$ |
|
|
|
|
|
|
|
Basic EPS income available to common shareholders |
|
$ |
2,360,869 |
|
43,031,346 |
|
$ |
0.05 |
|
Effect of dilutive securities: |
|
|
|
|
|
|
|
||
Warrants |
|
|
|
607,996 |
|
|
|
||
Diluted EPS income available to common shareholders |
|
$ |
2,360,869 |
|
43,639,342 |
|
$ |
0.05 |
|
|
|
|
|
|
|
|
|
||
For the three months ended December 31, 2006: |
|
|
|
|
|
|
|
||
Net income |
|
$ |
2,888,044 |
|
|
|
|
|
|
Less net income from discontinued operations |
|
$ |
(519,879 |
) |
|
|
|
|
|
Basic EPS income available to common shareholders |
|
$ |
2,368,165 |
|
26,981,916 |
|
$ |
0.09 |
|
Effect of dilutive securities: |
|
|
|
|
|
|
|
||
Warrants |
|
|
|
|
|
|
|
||
Diluted EPS income available to common shareholders |
|
$ |
2,368,165 |
|
26,981,916 |
|
$ |
0.09 |
|
|
|
Income |
|
Shares |
|
Per Share |
|
|
|
|
(Numerator) |
|
(Denominator) |
|
Amount |
|
|
For the six months ended December 31, 2007: |
|
|
|
|
|
|
|
|
Net income |
|
$ |
5,261,595 |
|
|
|
|
|
Less Net income from discontinued operations |
|
$ |
|
|
|
|
|
|
14
Basic EPS income available to common shareholders |
|
$ |
5,261,595 |
|
40,204,745 |
|
$ |
0.13 |
|
Effect of dilutive securities: |
|
|
|
|
|
|
|
||
Warrants |
|
|
|
604,692 |
|
|
|
||
Diluted EPS income available to common shareholders |
|
$ |
5,261,595 |
|
40,809,437 |
|
$ |
0.13 |
|
|
|
|
|
|
|
|
|
||
For the six months ended December 31, 2006: |
|
|
|
|
|
|
|
||
Net income |
|
$ |
5,816,485 |
|
|
|
|
|
|
Less net income from discontinued operations |
|
$ |
(639,072 |
) |
|
|
|
|
|
Basic EPS income available to common shareholders |
|
$ |
5,177,413 |
|
26,981,916 |
|
$ |
0.19 |
|
Effect of dilutive securities: |
|
|
|
|
|
|
|
||
Warrants |
|
|
|
|
|
|
|
||
Diluted EPS income available to common shareholders |
|
$ |
5,177,413 |
|
26,981,916 |
|
$ |
0.19 |
|
16. Discontinued Operations
The operations of OraLabs Inc prior to December 28, 2006 are shown in the financial statements as income from discontinued operations as these operations were transferred to a former shareholder in exchange for the redemption of his common stock. The consolidated financial statements have been reclassified to conform to discontinued operations presentation for all historical periods presented.
Summarized selected financial information for discontinued operations for the three and six months ended December 31, 2007, and 2006 is as follows:
|
|
Three months ended |
|
Six months ended |
|
||||||||
|
|
December 31, |
|
December 31 |
|
||||||||
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
||||
|
|
($ 000) |
|
($ 000) |
|
($ 000) |
|
($ 000) |
|
||||
Revenues |
|
$ |
-0- |
|
$ |
5,019 |
|
$ |
-0- |
|
$ |
9,404 |
|
Income before tax |
|
-0- |
|
676 |
|
-0- |
|
831 |
|
||||
Income taxes |
|
-0- |
|
156 |
|
-0- |
|
192 |
|
||||
Income from discontinued operations |
|
$ |
-0- |
|
$ |
520 |
|
$ |
-0- |
|
$ |
639 |
|
As of December 31, 2007, there were no assets or liabilities associated with OraLabs, Inc.
17. Commitments
As of, December 31, 2007, the Company had $4,235,722 in commitments for capital expenditures for contractual commitments of the construction projects related to expansion of Chengtongs production facilities.
18. Other events
On November 12, 20007, at the Annual Meeting of the Companys shareholders, the Companys shareholders approved the reincorporation of the Company in the state of Delaware. The reincorporation was effected on November 16, 2007 through a merger with and into the Companys wholly-owned subsidiary.
15
ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
This Quarterly Report on Form 10-Q contains statements that constitute forward looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. The words may, will, expect, anticipate, continue, estimate, project, intend, and similar expressions are intended to identify forward-looking statements. These statements appear in a number of places in this document and include statements regarding the intent, belief or expectation of the Company, its directors or its officers with respect to events, conditions, and financial trends that may affect the Companys future plans of operations, business strategy, operating results, and financial position. Persons reviewing this Quarterly Report on Form 10-Q are cautioned that any forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties and that actual results may differ materially from those included within the forward-looking statements as a result of various factors. More information on these risks and uncertainties, many of which are beyond the Companys control, is set forth under Part II, Item 1A, Risk Factors, in this Quarterly Report.
While these forward-looking statements, and any assumptions upon which they are based, are made in good faith and reflect the Companys current judgment regarding the direction of its business, actual results will almost always vary, sometimes materially, from any estimates, predictions, projections, assumptions or other future performance suggested herein. The Company undertakes no responsibility or obligation to update publicly these forward-looking statements, but may do so in the future in written or oral statements. Investors should take note of any future statements made by or on behalf the Company.
The following discussion should be read in conjunction with our unaudited consolidated financial statements and the related notes that appear in Part I, Item 1, Financial Statements, of this Quarterly Report. Our unaudited consolidated financial statements are stated in United States Dollars and are prepared in accordance with United States Generally Accepted Accounting Principles. The following discussion and analysis covers the Companys consolidated financial condition at December 31, 2007 (unaudited) and June 30, 2007, the end of its prior fiscal year, and its unaudited consolidated results of operation for the three and six month periods ended December 31, 2007 and 2006.
Introduction
Managements discussion and analysis of financial condition and results of operations is intended to help provide an understanding of China Precision Steel, Inc. and our subsidiaries (together, the Group) financial condition, changes in financial condition and results of operations. This discussion is organized as follows.
· Overview of the Companys Business - This section provides a general description of the Groups business, as well as recent developments that have either occurred during the six months ended December 31, 2007 and are important in understanding the results of operations and financial condition or disclose known trends.
· Results of Operations - This section provides an analysis of our results of operations for the three and six months ended December 31, 2007 and 2006. This discussion includes a brief description of significant transactions and events that have an impact on the comparability of the results being analyzed.
· Liquidity and Capital Resources - This section provides an analysis of the Groups cash flows for the six months ended December 31, 2007 and 2006. Included in this section is a discussion of the Groups outstanding debt and the financial capacity available to fund the Groups future commitments and obligations.
OVERVIEW OF THE COMPANYS BUSINESS
We are a niche and high value-added steel processing company principally engaged in the manufacture and sale of high precision cold-rolled steel products, in the provision of heat treatment and in the cutting of medium and high-carbon hot-rolled steel strips. We use commodity steel to create a specialty premium steel intended to yield above-average industry gross margins. Specialty precision steel pertains to the precision of measurements and tolerances of thickness, shape, width, surface finish and other special quality features of highly-engineered end-use applications.
We produce and sell precision ultra-thin and high strength cold-rolled steel products ranging from 7.5 mm to 0.03 mm. We also provide heat treatment and cutting of medium and high-carbon hot-rolled steel strips not exceeding 7.5 mm fineness. Our process puts hot-rolled de-scaled (pickled) steel coils through a cold-rolling mill, utilizing our patented systems and high technology reduction processing procedures, to make steel coils and sheets in customized thicknesses according to customer specifications. Currently, our specialty precision products are mainly used in the manufacture of automobile parts and components, plane friction discs, appliances, food packaging materials, saw blades, textile needles, microelectronics, and packing containers.
We conduct our operations principally in China through our wholly-owned operating subsidiary, Shanghai Chengtong Precision Strip Co., Limited, or Chengtong, which, in turn, is a wholly owned subsidiary of our direct subsidiary, Partner Success Holdings Limited,
16
or PSHL. Most of our sales are made domestically in China; however, during fiscal 2007, we began exporting our cold-rolled steel products to Indonesia and the Philippines and, to a lesser extent, Nigeria and Thailand. We intend to expand into additional overseas markets in the future, subject to suitable market conditions and favorable regulatory controls.
Over the course of the past two years, we have begun to alter our product mix to meet market demands in our primary market, China, as well as to expand into overseas markets. We continue to focus on the production of higher margin products, although we have increased production of certain of our lower margin products due to market demand. These changes in our strategy have created increased capital requirements as we have sought to construct additional rolling mills to accommodate our planned growth. In addition, our workforce has increased and, in particular, we have faced a growing need for experienced executive and technical staff.
Our market is highly competitive, although we have focused on a niche market that we consider allows us to compete effectively as we continue to grow our business. We face significant competition for raw materials, especially crude steel, and our financial results may be impacted by changes in the market prices for these materials. Given our size, we do not have the ability to influence the prices at which we must purchase raw materials. However, the nature of our products enable us to pass on all or part of the price fluctuations in raw materials to our customers.
In the year ended June 30, 2007, we added three indirect subsidiaries to our corporate structure. On April 9, 2007, we purchased Shanghai Tuorong Precision Strip, Limited, or Tuorong, through PSHL. The sole activity of Tuorong is the ownership of a land use right with respect to facilities leased to Chengtong. On April 10, 2007, PSHL purchased for nominal consideration Blessford International Limited, a British Virgin Islands company. Blessford International Limited does not conduct any business, but it owns a single subsidiary, Shanghai Blessford Alloy Company Limited, that is a wholly-foreign owned enterprise chartered in China. We intend to hold Blessford International Limited as a shell subsidiary that may be used in the future to facilitate optimization of the structure of the Groups activities.
RESULTS OF OPERATIONS
Three Months Ended December 31, 2007 Compared to Three Months Ended December 31, 2006
Net income before tax increased by $59,007, or 2%, period-on-period to $2,782,719 for the three months ended December 31, 2007 from $2,723,712 for the three months ended December 31, 2006 and gross profit decreased by $27,864, or 1%, period-on-period.
Gross Profit
Gross profits in absolute terms decreased by $27,864, or 1%, period-on-period to $3,384,866 for the three months ended December 31, 2007 from $3,412,730 for the three months ended December 31, 2006, while gross profit margin increased to 28.4% for the three months ended December 31, 2007 from 23.0% for the three months ended December 31, 2006. The increase in gross profit margin principally resulted from production of higher quality products with more complexity and higher margins, which is also associated with longer production times and thus a lower volume.
Sales Revenues. Sales volume decreased by 5,624 metric tons, or 28.6%, period-on-period to 14,010 metric tons for the three months ended December 31, 2007 from 19,634 tons for the three months ended December 31, 2006. As a result, sales revenues decreased by $3,093,864, or 20.6%, period-on-period to $11,913,718 for the three months ended December 31, 2007 from $15,007,582 for the three months ended December 31, 2006. We believe that the decreases in sales and sales revenues are a direct result of changes in our sales mix during the quarter to focus on high quality high margin products, and thus less volume was produced due to the complexity and longer production times required for the higher margin products. The decrease in sales revenue was also attributed to an under provision of VAT and sales tax during the first quarter of fiscal 2008 in the amount $1,991,671, which was accounted for in the second quarter.
Average cost of production per ton increased to $609 for the three months ended December 31, 2007 compared to an average cost of production per ton of $591 for the three months ended December 31, 2006, representing an increase of $18 per ton, or 3%, period-on-period. The 1400 mm cold-roll mill which became operational at the beginning of October 2006 is now operating at approximately 50% of design capacity and will likely take two to three years to reach its maximum production capacity.
Sales by Product Line. A break-down of our sales by product line for the three months ended December 31, 2007 and 2006 is as follows:
17
|
|
Three Months Ended December 31, |
|
|
|
|||||||||||
|
|
2007 |
|
2006 |
|
Period-on-period |
|
|||||||||
Product category |
|
Quantity |
|
$ Amount |
|
% of sales |
|
Quantity |
|
$ Amount |
|
% of |
|
Qty. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Low carbon cold-rolled |
|
3,442 |
|
2,478,690 |
|
20.8 |
|
11,836 |
|
7,146,805 |
|
47.6 |
|
(8,394 |
) |
|
Low carbon hard rolled |
|
4,897 |
|
3,110,265 |
|
26.1 |
|
1,724 |
|
18,721 |
|
0.1 |
|
3,173 |
|
|
High-carbon cold-rolled |
|
3,520 |
|
3,706,176 |
|
31.1 |
|
936 |
|
4,759,443 |
|
31.8 |
|
2,584 |
|
|
High-carbon hot-rolled |
|
1,171 |
|
814,223 |
|
6.8 |
|
5,138 |
|
3,082,613 |
|
20.5 |
|
(3,967 |
) |
|
Sales of Scrap Metal |
|
|
|
391,735 |
|
3.3 |
|
|
|
|
|
|
|
|
|
|
Subcontracting income |
|
980 |
|
1,412,629 |
|
11.9 |
|
|
|
|
|
|
|
980 |
|
|
Total |
|
14,010 |
|
11,913,718 |
|
100.0 |
|
19,634 |
|
15,007,582 |
|
100 |
|
|
|
|
There were various changes in the break-down of sales among our product lines over the three months ended December 31, 2007 as we are now operating an additional mill and are in the process of developing new products and new markets. High-carbon hot-rolled steel products only accounted for 6.8% of the current sales mix at an average selling price of $695 per ton for the three months ended December 31, 2007 compared to 20.5% of the sales mix at an average selling price per ton of $600 for the three months ended December 31, 2006. The lower priced low-carbon cold-rolled steel products accounted for 20.8% of the current sales mix at an average selling price of $720 per ton for the three months ended December 31, 2007 compared to 47.6% of the sales mix at an average selling price per ton of $604 for the three months ended December 31, 2006. Low carbon hard-rolled steel, which is also our exported precision steel products, was 0.1% of sales during the three months ended December 31, 2006, accounted for $3,110,265, or 26.1%, of the current sales mix at an average selling price of $635 per ton for the three months ended December 31, 2007.
We strive to find an appropriate sales mix that provides us with the stability and cash flows of the low-carbon cold-rolled steel products along with the higher margin provided by high-carbon cold-rolled products. Management continues to take appropriate action to optimize our product mix without adversely affecting overall sales volume and margins. Management believes that there are high barriers to entry in the Chinese domestic precision steel industry and that our unique capabilities give us a competitive advantage to grow sales of higher margin products as we continuously carry out R&D and strive to launch new products that could potentially lead to new segments and customers
|
|
Three Months Ended |
|
||||||
Average selling prices |
|
2007 |
|
2006 |
|
Variance |
|
||
|
|
$ |
|
$ |
|
$ |
|
% |
|
Low-carbon cold-rolled |
|
720 |
|
604 |
|
116 |
|
19.2 |
|
Low-carbon hard rolled |
|
635 |
|
11 |
|
624 |
|
> 100 |
|
High-carbon cold-rolled |
|
1,053 |
|
5,085 |
|
(4,032 |
) |
(79.3 |
) |
High-carbon hot-rolled |
|
695 |
|
600 |
|
95 |
|
15.8 |
|
Subcontracting income |
|
1,441 |
|
|
|
1,441 |
|
100 |
|
The average unit selling price per ton generated increased to $850 per ton for the three months ended December 31, 2007 compared to the corresponding period in 2006 of $764, representing an increase of $86, or 11.3%, period-on-period. This increase was due to changes in our sales mix during the quarter to focus on high quality high margin products, and thus less volume was produced due to the complexity and longer production times required for the higher margin products.. Sales of high-carbon cold-rolled steel products have increased by 2,584 metric tons,or 276%, period-on-period to 3,520 metric tons for the three months ended December 31, 2007 compared to 936 metric tons for the three months ended December 31, 2006. While the volume of high-carbon cold-rolled steel increased, the average sales price declined $4,032, or 79.3%, to $1,053 in the three months ended December 31, 2007 as compared to an average selling of $5,085 in the three months ended December 31, 2006. This product accounted for $3,706,176, or 31.1%, of the total sales mix for the three months ended December 31, 2007 compared to $4,759,443, or 31.8%, of the sales mix for the three months ended December 31, 2006.
18
Sales Breakdown by Major Customer.
|
|
Three Months Ended December 31 |
|
||||||
Customers |
|
2007 ($ ) |
|
% to sales |
|
2006 ($ ) |
|
% to sales |
|
|
|
|
|
|
|
|
|
|
|
Shanghai Changshuo Steel Company Ltd |
|
2,370,370 |
|
20 |
|
|
* |
|
* |
Shanghai Shengdejia Metal Products Limited |
|
3,181,709 |
|
27 |
|
|
* |
|
* |
Beijing Beimo Aircraft Material Technology Ltd Co |
|
85,468 |
|
1 |
|
|
* |
|
* |
Hangzhou Relian Company Limited |
|
266,970 |
|
2 |
|
648,757 |
|
4 |
|
Shangdong Province Boxing County Longhua Material Limited |
|
381,227 |
|
3 |
|
|
* |
|
* |
Shanghai Ruixuefeng Metals Co. Ltd |
|
|
* |
|
* |
5,365,141 |
|
36 |
|
Nuoying International (HK) Co. Limited |
|
|
* |
|
* |
1,582,510 |
|
11 |
|
Sinosteel Company Limited |
|
|
* |
|
* |
2,137,467 |
|
14 |
|
Shanghai Xin Zhong Da Trading Co. Limited |
|
|
* |
|
* |
933,762 |
|
6 |
|
|
|
6,285,744 |
|
53 |
|
10,667,637 |
|
71 |
|
Others |
|
5,627,974 |
|
47 |
|
4,339,945 |
|
29 |
|
Total |
|
11,913,718 |
|
100 |
|
15,007,582 |
|
100 |
|
* Not major customers for the relevant periods
Sales revenues generated from the top five major customers as a percentage of total sales decreased to 53% for the three months ended December 31, 2007 as compared to 71% for the three months ended December 31, 2006. With the exception of Hangzhou Relian Company Limited, the top five major customers were different period-on-period. The change in customer mix reflects our shift in product focus during the course of the period.
Cost of Sales.
|
|
Three Months Ended December 31, |
|
||||||
|
|
2007 |
|
2006 |
|
Variance |
|
||
|
|
$ |
|
$ |
|
$ |
|
% |
|
Cost of sales |
|
|
|
|
|
|
|
|
|
- Raw materials |
|
6,362,758 |
|
10,618,130 |
|
(4,255,372 |
) |
(40.1 |
) |
- Direct labor |
|
167,926 |
|
184,467 |
|
(16,541 |
) |
(8.9 |
) |
- Factory overhead |
|
1,998,168 |
|
792,255 |
|
1,205,913 |
|
152.2 |
|
|
|
8,528,852 |
|
11,594,852 |
|
(3,066,000 |
) |
(26.4 |
) |
|
|
|
|
|
|
|
|
|
|
Cost per units sold |
|
|
|
|
|
|
|
(28.6 |
) |
Total units sold |
|
14,010 |
|
19,634 |
|
(5,624 |
) |
|
|
Average cost per unit sold |