UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: June 30, 2009

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to _____________

Commission File No. 000-23039

CHINA PRECISION STEEL, INC.

(Exact name of registrant as specified in its charter)

  
Delaware
14-1623047
 
(State or other jurisdiction of incorporation or
organization)
(I.R.S. Employer Identification No.)

18th Floor, Teda Building
87 Wing Lok Street, Sheungwan, Hong Kong
People’s Republic of China
 (Address of principal executive offices)

852-2543-2290
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
 
 
Title of each class
 
Name of each exchange on which registered
 
Common Stock, par value $0.001 per share
 
The NASDAQ Capital Market

Securities registered pursuant to Section 12(g) of the Exchange Act: None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.       Yes ¨ No x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.       Yes ¨ No x
 
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 ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).         Yes ¨ No ¨
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.x
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large Accelerated Filer  o
Accelerated Filer o
Non-Accelerated Filer    o (Do not check if a smaller reporting company)
Smaller reporting company  x
 
Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Act).       Yes o No x
 
The aggregate market value of the 31,013,715 shares of voting stock and non-voting common stock held by non-affiliates of the registrant as of December 31, 2008 was $36,906,321, based upon the last sale price of the registrant’s common stock on December 31, 2008 (the last business day of the registrant’s most recently completed second fiscal quarter) of $1.19 per share, as reported by the NASDAQ Stock Market, Inc.
 
There were a total of 46,562,955 shares of the registrant’s common stock outstanding as of September 21, 2009.
 
DOCUMENTS INCORPORATED BY REFERENCE 

None.
 


 
 
 
CHINA PRECISION STEEL, INC.

FORM 10-K
FOR THE FISCAL YEAR ENDED JUNE 30, 2009

TABLE OF CONTENTS
 
 
PART I
   
       
Item 1.
Business.
 
3
       
Item 1A.
Risk Factors.
 
14
       
Item 1B.
Unresolved Staff Comments.
 
32
       
Item 2.
Properties.
 
32
       
Item 3.
Legal Proceedings.
 
32
       
Item 4.
Submission of Matters To a Vote of Security Holders.
 
32
       
 
PART II
   
       
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
 
33
       
Item 6.
Selected Financial Data.
 
35
       
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
36
       
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk.
 
57
       
Item 8.
Financial Statements and Supplementary Data.
 
58
       
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
 
58
       
Item 9A.
Controls and Procedures.
 
58
       
Item 9B.
Other Information.
 
59
       
 
PART III
   
       
Item 10.
Directors, Executive Officers and Corporate Governance.
 
60
       
Item 11.
Executive Compensation.
 
64
       
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
 
70
       
Item 13.
Certain Relationships and Related Transactions, and Director Independence.
 
72
       
Item 14.
Principal Accounting Fees and Services.
 
73
       
 
PART IV
   
       
Item 15.
Exhibits, Financial Statement Schedules.
 
74

 
 

 

Special Note Regarding Forward Looking Statements

This Annual Report on Form 10-K and the documents incorporated by reference herein include “forward-looking statements” within the meaning of Section 27A of the United States Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the United States Securities Exchange Act of 1934, as amended, or the Exchange Act. Any statements about our expectations, beliefs, plans, objectives, assumptions or future events or performance are not historical facts and may be forward-looking. These statements are often, but not always, made through the use of words or phrases like “anticipate,” “estimate,” “plans,” “projects,” “continuing,” “ongoing,” “target,” “expects,” “management believes,” “we believe,” “we intend,” “we may,” “we will,” “we should,” “we seek,” “we plan,” the negative of those terms, and similar words or phrases.   We base these forward-looking statements on our expectations, assumptions, estimates and projections about our business and the industry in which we operate as of the date of this Form 10-K.  These forward-looking statements are subject to a number of risks and uncertainties that cannot be predicted, quantified or controlled and that could cause actual results to differ materially from those set forth in, contemplated by, or underlying the forward-looking statements.  Statements in this Form 10-K and in documents incorporated herein describe factors, among others, that could contribute to or cause these differences. Actual results may vary materially from those anticipated, estimated, projected or expected should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, including, but not limited to, our critical accounting policies and statements relating to, among others: plans to expand our exports outside of China; plans to increase our production capacity and the anticipated dates that such facilities may commence operations; our ability to obtain additional funding for our continuing operations and to fund our expansion; our ability to meet our financial projections for any financial year; our ability to retain our key executives and to hire additional senior management; continued growth of the Chinese economy and industries demanding our products; our ability to produce and sell cold-rolled precision steel products at high margins; our ability to secure at acceptable prices the raw materials we need to produce our products; political changes in China that may impact our ability to produce and sell our products in our target markets; general business conditions and competitive factors, including pricing pressures and product development; and changes in our relationships with customers and suppliers.

Because the factors discussed in this Form 10-K or documents incorporated by reference could cause actual results or outcomes to differ materially from those expressed in any forward-looking statement made by us or on our behalf, you should not place undue reliance on any such forward-looking statement. Further, any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for us to predict which will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statement. Except as required by law, we undertake no obligation to publicly revise our forward-looking statements to reflect events or circumstances that arise after the date of this Form 10-K or the date of documents incorporated by reference herein that include forward-looking statements.

Use of Terms

Except as otherwise indicated by the context, all references in this annual report to (i) the “Company,” the “Group,” “we,” “us” or “our” are to China Precision Steel, Inc., a Delaware corporation, and its direct and indirect subsidiaries; (ii) “PSHL” are to our subsidiary Partner Success Holdings Limited, a BVI company; (iii) “Chengtong” are to PSHL’s subsidiary Shanghai Chengtong Precision Strip Company Limited, a PRC company; (iv) “Tuorong” are to PSHL’s subsidiary Shanghai Tuorong Precision Strip Company Limited, a PRC company; (v) “Blessford International” are to PSHL’s subsidiary Blessford International Limited, a BVI company; (vi) “Shanghai Blessford” are to Blessford International’s subsidiary Shanghai Blessford Alloy Company Limited, a PRC company; (vii) “Securities Act” are to the Securities Act of 1933, as amended; (viii) “Exchange Act” are to the Securities Exchange Act of 1934, as amended; (ix) “RMB” are to Renminbi, the legal currency of China; (x) “U.S. dollar,” “$” and “US$” are to the legal currency of the United States; (xi) “China,” “Chinese” and “PRC” are to the People’s Republic of China; and (xii) “BVI” are to the British Virgin Islands.

 
2

 

PART I
 
ITEM 1.
BUSINESS.

Overview

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 and in the provision of heat treatment and 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 conduct our operations principally in China through our wholly-owned operating subsidiaries, Chengtong and Shanghai Blessford. Most of our sales are made domestically in China; however, during fiscal 2007, we began exporting our cold-rolled steel products to Thailand, Nigeria and Ethiopia. We intend to expand into additional overseas markets in the future, subject to suitable market conditions and favorable regulatory controls.
 
We produce and sell precision ultra-thin and high strength cold-rolled steel products with thicknesses ranging from 7.5 mm to 0.03 mm. We also provide heat treatment and cutting and slitting of cold-rolled steel strips not exceeding 7.5 mm thickness. 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, steel roofing, plane friction discs, appliances, food packaging materials, saw blades, textile needles and microelectronics.
 
As of June 30, 2009, we had an annual production capacity of approximately 120,000 tons.  Our first rolling mill, which has an operating capacity of 60,000 to 70,000 tons depending on the thickness of the steel processed, primarily manufactures low carbon precision cold-rolled steel products.  Our second cold-rolling mill, which has been operating since October 2006 with a production design capacity of 100,000 tons, has achieved 60% of its design capacity as of June 30, 2009. We have completed construction of our third cold rolling mill and are currently in the stage of testing and commissioning. Each mill takes approximately three to four years to reach its full operating capacity. The second and third mills have similar capacities and will focus on the production of high carbon, high strength cold-rolled steel products and the production of more complex precision steel products that cannot be manufactured in our first rolling mill. Due to reduced orders on hand, our two rolling mills were running at approximately 70% utilization rate as of June 30, 2009.
 
During the fiscal years ended June 30, 2009, 2008 and 2007, we earned net loss of $408,338, and net income of $18,583,111 and $7,472,661, respectively.  At June 30, 2009, we had total assets of $163,409,114. Chengtong and Shanghai Blessford currently have approximately 331 employees, including 45 senior management and technical staff members, and operate in 20,000 square meters of production facilities in Jiading District, Shanghai, the PRC, on four acres of leased land.

Corporate History and Structure

We are a Delaware company. We became a public company in May 1997 through a reverse merger with SSI Capital Corporation. At that time, we changed our name to OraLabs Holding Corp. and our principal business was the production and sale of consumer products relating to oral care and lip care and the distribution of nutritional supplements through our wholly-owned subsidiary, OraLabs, Inc. In December 2006, we merged with PSHL, a BVI company, which owns Chengtong. In connection with that transaction, we subsequently redeemed all of the shares of our outstanding common stock owned by our former President, Gary Schlatter, in exchange for all of the issued shares of OraLabs, Inc. Thereafter, we renamed ourselves China Precision Steel, Inc. to reflect our continuing operations.

 
3

 
 
In the year ended June 30, 2007, we added three indirect subsidiaries to our corporate structure.  On April 9, 2007, we purchased Tuorong, a PRC company, through PSHL’s indirectly owned PRC subsidiary, Chengtong.  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 Blessford International, a BVI company, for nominal consideration. Blessford International does not conduct any business, but it owns a single subsidiary, Shanghai Blessford, that is a wholly-foreign owned enterprise chartered in China. 

The following chart reflects our organizational structure as of the date of this report:


Our business is conducted principally through Chengtong and through Shanghai Blessford in Shanghai, PRC. Both Chengtong and Shanghai Blessford are Wholly Foreign Owned Enterprises, or WFOEs, under Chinese law.

Our corporate headquarters are located at 18th Floor, Teda Building, 87 Wing Lok Street, Sheung Wan, Hong Kong, and our telephone number is (011) 852-2543-2290. Although we maintain a website at www.chinaprecisionsteelinc.com, we do not intend that information available on our website be incorporated into this filing.

Growth Strategy
 
We aim to maintain our position as the leading supplier of high strength and ultra-thin cold-rolled premium specialty steel products in China, while building brand awareness and demand for our products internationally. We have identified six factors critical to the achievement of this goal:

 
4

 

 
·
Focus on Rapidly Growing Niche Segment. We will continue to focus on niche markets. According to publicly available information, the demand for precision cold-rolled steel products has been growing at a rate of 20% annually over the past five years in China. Export demand, coupled with domestic Chinese demand for automobile parts and components, steel roofing, plane friction discs, appliances, food packaging materials, saw blades, textile needles and microelectronics, is expected to continue, thereby increasing demand for high precision steel products. Moreover, new applications of steel products are continually being developed. Our research and development efforts are focused on advancing processing techniques and production of high strength and ultra-thin, cold-rolled precision steel products to enhance our product offerings and expand our market share.

 
·
Leverage Our Strengths to Compete Effectively with Imports. Specialty precision steel is a relatively new industry in China with the majority of precision steel imported from Japan, Korea, the European Union and the United States. As a result, the average quality and standards of China’s high precision steel industry lags behind the international norm. We believe that our lower cost base allows us to sell our products at an average of 5 to 10% below our international competitors and our manufacturing in China gives us an advantage of shorter delivery time to users in China. We will leverage our lower operating cost base, our state-of-the-art patented manufacturing system and process, and our strategic relationships with our major suppliers to produce cold-rolled steel products with quality similar to international standards at lower cost than international competitors.

 
·
Focus on High Margin Products. We will continue to manufacture products with high sustainable margins. We increased our gross margin from 5.8% in 2004 to 10.1% in 2009. The average gross margin of our high carbon steel products ranges between 20 and 40% while the same for our low carbon steel products ranges between 10 and 30%. We will provide additional services such as heat treatment and cutting and slitting to further enhance our margins. We believe these high gross margins are sustainable despite fluctuations in steel prices because of the specialty of the end product which allows price increases of raw material to be substantially passed directly to our customers.

 
·
Expand Manufacturing Capacity. We will increase our production capacity by commencing construction of a third cold-rolling mill with a design capacity of 100,000 tons, based on the current range of specifications we produce, in calendar year 2010. This will increase our total production capacity to a total of approximately 260,000 tons in four years from now when all three mills are operating at full capacity.

 
·
Compete Internationally. We intend to expand our exports to compete in the international marketplace. We believe that at present we are the only non-Japanese company able to compete in the global marketplace with low carbon precision cold-rolled steel products in the thickness range between 0.1 to 0.2 mm used for steel roofing. In addition, we are not aware of any other company that currently manufactures high strength high carbon cold-rolled steel with a width of or exceeding 1400mm. These products provide us with a unique opportunity to compete in the global marketplace.

 
·
Retain Key Personnel. The Chinese market is highly competitive for experienced and talented executives and we will strive to retain our key executives, including our Chairman, Wo Hing Li, and the General Manager, Hai Sheng Chen. Their experience in strategic expansions and in steel manufacturing, respectively, is critical to our continued growth and success.
 
Overview of the Chinese Steel Industry
 
The following industry information has been obtained from various publicly available sources. We believe it is the most current information available on this subject, and that it is widely available and reliable.
 
According to The World Steel Association, China is the largest steel producing country, producing over one-third of the world’s steel. In 2008, China produced 500 million tons of steel, up 2.2% from 2007. The China Iron and Steel Institute estimates that China’s steel demand for 2009 will be between 490 million tons to 520 million tons and demand will exceed 600 million tons by 2011, while global steel demand is projected to be 1.2 billion tons and reach over 1.45 billion tons, respectively.  China has increased its steel exports from 7 million tons in 2003 to 60.5 million tons in 2008, making it the number one ranked steel exporter globally. However, while China is a net exporter of crude steel, it is a net importer of higher value precision cold rolled steel products such as those produced by the Company.

 
5

 
 
Steel products can be categorized as low-end (long products such as pipes, tubes, wires and rods) and high end (flat products such as hot-rolled steel or cold-rolled steel strips). Based upon information we obtained from the China Metallurgical Industry Planning and Research Institute, or CMI, we believe that approximately 65% of China’s steel production are low-end long products and approximately 35% are high-end high value cold-rolled steel strips. The Company operates in the high-end category of this market with its niche precision steel processing and produces and sells high precision cold-rolled steel products.

The Chinese government has historically provided a subsidy by means of a value added tax, or VAT, rebate to exporters of steel products. This rebate was reduced in April 2007 in response to international pressure on China to curb its exports. The subsidy has been eliminated for 83 products, including hot-rolled, thin plate, steel wire, section, bar and H-beam, despite which, a 5% tax rebate currently applies to the high value-add cold-rolled steel products the Company produces.
 
We expect that the Chinese government will continue to impose additional controls on domestic steel producers in order to reduce pollution and further restrict exports. For more information on Chinese regulations, see “Regulation” below.

Products
 
Cold-rolled specialty precision steel is a relatively new industry in China. Manufacturers of products that use specialty precision steel products have traditionally imported precision steel products from Japan, Korea, the European Union and the United States. We believe that generally, to date, the average quality and standards of China’s high precision steel industry lag behind the international norm. Nonetheless, during the last five years, we believe that we have begun to develop and establish a nationally recognized brand in China.  Despite having exported 21,009 tons of precision cold-rolled steel products to Thailand, Nigeria and Ethiopia during the year ended June 30, 2009, we are not yet an internationally widely known brand for cold-rolled precision steel products.
 
For the year ended June 30, 2009, we sold 84,001 tons of high precision steel products with over one hundred specifications. We currently produce high strength and ultra-thin cold-rolled precision steel coils and sheets with reduced thickness ranging from 7.5 mm to 0.03 mm. We also provide heat treatment and cutting and slitting of steel strips not exceeding 7.5 mm thickness. Our precision steel products and services can be categorized into four major categories:

Categories
 
Uses
 
Thickness
1. Low carbon steel
(cold-rolled, hard-rolled)
 
Steel roofing, food packaging, dry batteries, electronic devices, kitchen tools
 
0.03-6.0mm
         
2. High carbon steel
(cold-rolled, hot-rolled)
 
Automobile parts and components, grinding pieces, saw blades, weaving needles
 
0.5-7.5mm
         
3. Steel processing
 
Tailor made cold rolled steel products according to customer specifications
 
0.03-7.5mm
         
4. Steel services
 
Heat treatment of hot-rolled steel coils; cutting and slitting
   

In 2006, we made a strategic decision to switch our product mix from a concentration in low carbon cold-rolled steel products with comparatively lower margins to a combination of low carbon and higher end, higher margin, high-carbon cold-rolled steel products as a result of continuous research and development and accumulated experience. We produce our high strength and ultra-thin cold-rolled precision steel strips using a process that utilizes our proprietary know-how and certain patented technology. The finished products have a reduced thickness ranging from 7.5 mm to 0.03 mm, and a width between 1000 mm to 1400 mm. We also provide heat treatment and cutting and slitting services for high carbon hot-rolled steel coils with thicknesses not exceeding 7.5 mm. To the best of our knowledge, we are not aware of any other company in China that currently manufactures high carbon high strength cold-rolled steel with a width of or exceeding 1400 mm.

 
6

 
 
Cold-rolled steel products are manufactured from hot-rolled de-scaled (pickled) steel coils which are processed by cold reduction through a cold-rolling mill to customer specified thicknesses. The process does not involve heating and the primary feature of cold reduction is to reduce the thickness of the steel coils. However, because the cold reduction operation induces very high strains (work hardening) into the steel sheet, the precision steel sheet not only becomes thinner, but also becomes much harder, less ductile and very difficult to form. In order to make the cold-reduced steel products soft and formable, they are annealed, or heated to high temperatures. Cold-rolled sheet products are used in a wide variety of end applications, such as appliances (refrigerators, washers, dryers, and other small appliances), automobiles (exposed as well as unexposed parts), steel roofing, food packaging materials, electric motors, microelectronics and food packaging.
 
Hard-rolled steel represents steel products manufactured from cold reduction to the desired thinness without annealing. The product is very stiff and is intended for flat work where deformation is very minimal. This type of hard-rolled steel is most often applied to further processing for applications such as continuous galvanizing.
 
Hard-rolled or cold-rolled steel with low carbon has a carbon content of less than 0.1%.  It is a very versatile and useful material, easily machined and worked into complex shapes, is low in cost and has good mechanical properties. Hard-rolled or cold-rolled steel with medium carbon has a carbon content of 0.3%. It is a typical engineered steel product. Hard-rolled or cold-rolled steel with high carbon has a carbon content of 0.8% or more. This precision steel product is very hard and quite brittle and is much less ductile than low carbon steel. High carbon steel has good wear resistance and is used for railways as well as for cutting tools. Acid wash steel is also known as acid pickling and refers to the process of using liquid acids, for example hydrochloric acid, to remove rust or oxides from the surface of steel. Removing rust prepares the surface for a protective coating.
 
Products with greater width have more applications and intended uses. Width is an important differentiating factor because certain end products, such as washers and automobiles, require materials with a certain minimum width. Although materials with smaller width could also be used for these applications through jointing, this increases production costs. As a result, wider products are more flexible and cost efficient which further reduces the end user’s overall cost.

Production Facilities
 
Cold Rolling Mills

As of June 30, 2009, we had an annual production design capacity of approximately 120,000 tons, comprised of:

 
·
one 1100 mm 12-high cold rolling mill, with an operating capacity of 60,000 tons, and

 
·
one 1400 mm 12-high cold rolling mill, with an operation capacity of 100,000 tons and a 70% utilization rate at June 30, 2009.

Construction of a third mill, a 1450mm 4-high cold rolling mill, is currently in the testing stage and expected to commence production in calendar year 2010. This mill will have a design capacity of 100,000 tons, based on our current product specifications, increasing our total production design capacity to approximately 260,000 tons in four years. The production facilities for the second and third mills were completed in August 2006 and added approximately 10,000 square meters of production area. These production facilities will primarily focus on high carbon, high strength cold-rolled steel products and more complex precision steel products that cannot be manufactured in our first rolling mill, which will primarily dedicate to low carbon cold-rolled steel products.

 
7

 
 
Each mill takes approximately three to four years to reach full operating capacity due to the break-in and tuning period required for the equipment. Operating capacity, or actual tonnage, may differ from design capacity due to modifications required to accommodate different production processes, as well as product mix which influences processing time. For example, the design capacity of the 1100 mm rolling mill is 100,000 tons. However, it is now operating at its full production capacity of 60,000 tons since it is manufacturing products with a much reduced thickness than those contemplated by the original design. The 1400 mm rolling mill, which began production in October 2006, was operating at 60% of its 100,000 ton design capacity at June 30, 2009 and is expected to reach its full operating capacity in calendar year 2011.
 
Hydrogen Annealing Furnace

Our state-of-the-art annealing furnaces automatically control the complete annealing process. The furnace uses pure hydrogen as protective gas to make the steel surface clean and smooth with no carbon-off post-annealing. The furnace also includes an oxygen station. In addition to the cold-rolling mills and annealing furnaces, we also have a 1250 mm cleaning line, a 1000 mm cutting and slitting line and a 1200 mm tension leveller.

Raw Materials and Suppliers
 
We are not dependent on any one single supplier for supply of hot-rolled coils. Several Chinese steelmakers supply hot-rolled coils to us. Our largest supplier for the year ended June 30, 2009 was BaoSteel Steel Products Trading Co. Ltd..

Below is a list of our principal suppliers during the fiscal years ended June 30, 2009, 2008 and 2007:

   
2009
   
2008
   
2007
 
Principal Suppliers
 
$
   
% to
consumption
   
$
   
% to
consumption
   
$
   
% to
consumption
 
BaoSteel Steel Products Trading Co. Ltd
    15,805,702       21       16,439,918       30       4,633,054       14  
Hangzhou Relian Company Limited
    - *     - *     11,050,813       20       8,598,117       25  
Shanghai Pinyun Steel Co., Limited
    9,349,480       13       10,025,183       18       6,355,445       19  
Shanghai Changshuo Steel Company Ltd
    - *     - *     - *     - *     3,408,301       10  
 
* Not major suppliers for the relevant years

Based upon information obtained by us from the CMI, during our financial year ended June 30, 2009 the price of steel generally decreased. However, the cost of imported iron-ore increased substantially. This apparent anomaly was due to excess supplies arising from excess capacities of the steel producers and, as a result of the downwards pressure on the price of steel, the cost of steel rolls have generally decreased within the relevant year. The CMI website may be viewed in English and the website URL is www.metal.net.cn. Although selling prices generally decreased, as of June 30, 2009, there is a Chinese export tax of 5% on exports of certain steel products, including the precision cold-rolled steel products that we produce. This has increased the competitiveness of our products in the international marketplace.
 
The prices of steel coils are very competitive, very volatile and dependent on supply and demand. We have made bulk purchases in the past after taking into account customers’ orders on hand at the time when steel supply was tight and prices were high, in order to secure sufficient supply of raw material for necessary production. As steel rolls have an extremely long shelf-life, obsolescence is not a major concern. However, due to the decreases in steel prices during the year ended June 30, 2009 and therefore selling prices of our products, the raw materials we had built up some time ago in the high demand season consequentially has an adverse impact on our margins.

 
8

 

Customers

All of our production is based on confirmed sales orders. Generally, for new customers, an initial deposit (approximately 30% of the aggregate contracted sales amount) is pre-paid when the contract is signed. We have approximately 350 customers with domestic customers primarily located in East China and overseas sales reaching Thailand, Nigeria and Ethiopia. Our location in Shanghai with a well developed transport network is particularly advantageous for meeting with customers from inside and outside of China for product design discussions and customer service. In addition, the delivery time is shorter and our products have lower associated cost than international competitors. We intend to increase our customer base by further expanding into North China, where the automotive industries are concentrated, and globally.
 
Below is a list of our principal customers during the fiscal years ended June 30, 2009, 2008 and 2007:

   
2009
   
2008
   
2007
 
Customers
  $
 
 
% to
sales
    $    
% to
sales
    $    
% to
sales
 
Salzgitter Mannesmann International GMBH
    14,275,799       19 %                            
                                             
Shanghai Changshuo Steel Company, Ltd
    10,999,692       14 %     18,513,819       21       5,428,110       10  
Shanghai Bayou Industrial Co. Ltd
    *     *     10,494,752       12       *     *
Shanghai Shengdejia Metal Co. Ltd
    *     *     10,414,545       12       *     *
Shanghai Ruixuefeng Metals Co., Limited
    *     *     *     *     12,192,219       23  
 
* Not major customers for the relevant years

Sales and Marketing
 
Our high precision steel products are sold both to components manufactures and directly to the end-users in various parts of China and international marketplace such as Thailand, Nigeria and Ethiopia. Due to the nature of the industry and our ability to process quality high end cold-rolled steel, we do very little formal marketing. The majority of new orders come from current customers reducing imports and new customers who contact us directly or through trading agents or current customers.
 
Competition 

Our business is concentrated in the niche low carbon ultra-thin cold-rolled precision steel and high-carbon, high strength cold-rolled steel processing and is not in direct competition with large Chinese steelmakers such as Baosteel Group Corporation and Magang Group. China’s large steelmakers concentrate on the production of crude steel and hot-rolled steel from iron ore imported from Brazil and Australia. Hot-rolled steel coils produced by these steelmakers are then supplied as raw materials to high precision steel manufacturers, such as us, for cold reduction processing to the desired thickness and applications. Cold-rolled steel products are then sold to manufacturers and other customers in industries such as automobile and food packaging.

 
9

 
 
Our business is becoming increasingly competitive and capital intensive, and competition comes primarily from importers. Some of our competitors have financial resources, staff and facilities substantially greater than ours and we may be at a competitive disadvantage compared with larger steel companies. Our domestic competition in China’s ultra-thin cold-rolled precision steel segment mainly comes from Qinghuangdao Longteng Precision Strip Co., Limited, or Longteng. However, we understand that Longteng’s production capabilities are for cold-rolled steel with widths of approximately 400 mm, whereas our cold-rolled steel mills have a width of 1000 mm to 1400 mm (or up to 1450 mm with the planned addition of the third cold-rolling mill). Consequently, Longteng’s products are sold in a different market segment than ours and are not considered to be direct competition. In the high carbon cold-rolled steel products segment, we mainly compete with imports from Shinwha Steel Co., Ltd. in Korea. Further, there are potential competitors who are currently constructing mills that are expected to produce precision and specialty steel products both in China and internationally.
 
Although there is intense competition in China’s steel industry, this affects mostly low-end or long steel products. We are currently the only supplier of high carbon, high strength cold-rolled steel products with a thickness up to 6.0 mm in China. We are not aware of any other Chinese manufacturer processing high carbon cold-rolled steel products with this specification. In addition, the low carbon precision cold-rolled steel products in the thickness range between 0.1 to 0.2 mm are traditionally dominated by Japanese manufacturers with higher production costs. We started exporting low carbon products in this range during fiscal 2007. We are not aware of any other manufacturer currently competing in this specific low carbon segment in the global market that is from a non-Japanese background.

Research and Development

As of June 30, 2009, we had three experienced engineers and technicians in the Research and Development Department. The Research and Development Department focuses on new product development, and the advancement and improvement in quality and manufacturing technique of ultra-thin and high-strength cold-rolled steel strip. In addition to the traditional research and development activities, our engineers frequently interact with customers to detect changes in “patterns” and customers’ specifications arising from constantly changing industry needs.
 
Further, we are working on research and development projects involving coiled springs for automotive seat belts and steel for igniters in automotive air bag inflation devices. The amount spent on research and development activities each year is approximately 1% of our revenue for such year. We have budgeted 1% of revenues to be spent for research and development activities for fiscal 2010.

Quality Control
 
Following the accreditation of the International Organization for Standardization, or ISO, on October 8, 2004, we implemented the Quality Handbook in October 2004. This Quality Handbook was prepared on the basis and standards of the ISO/TS16949 specifications, which ISO Technical Specifications are compatible with existing American (QS-9000), German (VDA6.1), French (EAQF) and Italian (AVSQ) automotive quality systems standards within the global automotive industry. Together with ISO 9001:2000, ISO/TS 16949 specifies the quality system requirements for the design, development, production, installation and servicing of automotive related products.

Intellectual Property
 
On December 8, 2004, the State Intellectual Property Office in China granted a ten-year patent right to the “Environment-Conscious Mill Bearing with Inner Circulation Lubricant” to Chengtong and Shanghai Te’an-Yikai Bearing Co., Limited. The patented bearing is installed in our existing cold-roll mill and, together with our internal know-how complementary to the patented bearing, we believe we address a number of issues associated with the bearing lubrication in cold-rolling and ensure smooth and effective operation of the cold-roll mill. There is no direct or indirect affiliation between us and Shanghai Te’an-Yikai Bearing Co, Limited. We and Shanghai Te’an-Yikai Bearing Co., Limited jointly developed the environment-conscious mill bearing with inner circular lubrication. Shanghai Te’an-Yikai Bearing Co., Limited retains the proprietary right to the technology while we have the exclusive right to the application of the technology.

 
10

 
 
We have elected not to register any other patents and internally developed know-how because of the uncertainty over the ability to enforce intellectual property rights in China. We also protect our internally developed know-how and production process (such as system pressure, cleanliness of the lubrication, temperature control, appropriate allocation of oil supply and retrieving which are vital in providing a radical solution to the difficulties associated with lubricating rolling mills’ backing bearing) by requiring all key personnel (production engineers and management staff members) to sign non-disclosure and confidentiality contracts.

There can be no assurance that third parties will not assert infringement or other claims against us with respect to any of our existing or future products or processes. There can be no assurance that licenses would be available if any of our technology was successfully challenged by a third party, or if it became desirable to use any third-party technology to enhance our products. Litigation to protect our proprietary information or to determine the validity of any third-party claims could result in a significant expense and divert the efforts of our technical and management personnel, whether or not such litigation is determined in our favor.

While we have no knowledge that we are infringing upon the proprietary rights of any third party, there can be no assurance that such claims will not be asserted in the future with respect to existing or future products or processes. Any such assertion by a third party could require us to pay royalties, to participate in costly litigation and defend licensees in any such suit pursuant to indemnification agreements, or to refrain from selling an alleged infringing product.

Employees
 
As of June 30, 2009, we employed a total of 331 full-time employees. The following table sets forth the number of our employees by function.
 
Function
 
Number of Employees
 
Senior Management
 
10
 
Equipment & Maintenance
 
46
 
Production
 
184
 
Sales and Marketing
 
9
 
Logistics
 
38
 
Quality Control
 
9
 
Research & Development
 
3
 
Human Resource & Administration
 
26
 
Accounting
 
7
 
Total
 
331
 

Each employee must enter into multiple employment contracts, including a non-competition agreement, which are then filed with the municipal government. All employees receive a base monthly salary. Management are entitled to a year-end bonus up to 100% of their annual salary based upon our overall performance results, seniority and individual performance and contribution to the Company. Production employees are entitled to a monthly bonus calculated on the basis of the quality of the products produced, and their respective contribution to volume, safe production, correct use of equipment and energy saving.  Our production employees are not subject to collective bargaining agreements.

Our employees in China participate in a state pension plan mandated by Chinese municipal and provincial governments. Benefits include social security, pension benefits, and medical insurance. These benefits are paid in full by us and equate to approximately 40% of our annual salary expenditures.  We believe that we are in material compliance with the relevant PRC laws.

We maintain a satisfactory working relationship with our employees, and we have not experienced any significant labor disputes or any difficulty in recruiting staff for our operations.

 
11

 
 
Regulation
 
The Chinese legal system is based upon a civil law system of written statutes. Unlike the common law system in the United States, prior court decisions may be cited for reference but are not binding on subsequent cases and have limited value as precedent. Since 1979, the PRC legislative bodies have promulgated laws and regulations dealing with economic matters such as foreign investment, corporate organization and governance, commerce, taxation and trade. We are subject to numerous Chinese provincial and local laws and regulations, which may be changed from time to time in response to economic or political conditions and have a significant impact upon overall operations. Changes in these regulations could require us to expend significant resources to comply with new laws or regulations or changes to current requirements and could have a material adverse effect on our operations and financial results.
 
The China Central Government has promulgated a series of ongoing macro-control policies which focus on the improvement of the country’s investment structure, with the goal to secure a fast and sound development of the national economy. Excessive investment in certain sectors is placed under stringent control while incentives are given to other sectors.
 
Environmental Laws

We are currently subject to numerous Chinese provincial and local laws and regulations relating to the protection of the environment. These laws continue to evolve and are becoming increasingly stringent. The ultimate impact of complying with such laws and regulations is not always clearly known or determinable because regulations under some of these laws have not yet been promulgated or are undergoing revision.
 
The State Environmental Protection Administration Bureau is responsible for the supervision of environmental protection, the implementation of national standards for environmental quality and discharge of pollutants, and supervision of the environmental management system in China. Environmental protection bureaus at the county level or above are responsible for environmental protection within their jurisdictions. The laws and regulations on environmental protection require each company to prepare environmental impact statements for a construction project to the environmental protection bureaus at the county level. These must be prepared prior to when the construction, expansion or modification commences.
 
The Environmental Protection Law requires production facilities that may cause pollution or produce other toxic materials to take steps to protect the environment and establish an environmental protection and management system. The system includes the adoption of effective measures to prevent and control exhaust gas, sewage, waste residues, dust and other waste materials. Entities discharging pollutants must register with the relevant environmental protection authorities.
 
Penalties for breaching the Environmental Protection Law include a warning, payment of a penalty calculated on the damage incurred, or payment of a fine. When an entity has failed to adopt preventive measures or control facilities that meet the requirements of environmental protection standards, it may be required to suspend its production or operations and pay a fine. Material violations of environmental laws and regulations causing property damage or casualties may also be subject to criminal liabilities.
 
We believe that our current production and operating activities are in compliance with the environmental protection requirements. We are not subject to any admonition, penalty, investigations or inquiries imposed by the environmental regulators, nor are we subject to any claims or legal proceedings to which we are named as defendant for violation of any environmental laws and regulations. To the best of our knowledge, our cold-rolled mills produce no impermissible emissions. Our pickling process is outsourced to a local company which is wholly-responsible for any failure to comply with applicable law. In addition, our production facilities in Shanghai are on land formerly used for rice farming. We have no reason to believe that such land has been subjected to any prior contamination.

 
12

 

Patent Protection

The PRC’s intellectual property protection regime is consistent with those of other modern industrialized countries, although enforcement of rights may prove difficult and complex. China has domestic laws for the protection of rights in copyrights, patents, trademarks and trade secrets. The PRC is also a signatory to most of the world’s major intellectual property conventions, including:

 
·
Convention establishing the World Intellectual Property Organization (WIPO Convention) (June 4, 1980);

 
·
Paris Convention for the Protection of Industrial Property (March 19, 1985);

 
·
Patent Cooperation Treaty (January 1, 1994); and

 
·
The Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPs) (November 11, 2001).

Patents are governed by the China Patent Law and its Implementing Regulations, each of which went into effect in 1985 and have been amended subsequently. China is a signatory to the Paris Convention for the Protection of Industrial Property, in accordance with which any person who has duly filed an application for a patent in one signatory country shall enjoy, for the purposes of filing in the other countries, a right of priority during the period fixed in the convention (12 months for inventions and utility models, and 6 months for industrial designs).

The Patent Law covers three kinds of patents, i.e. patents for inventions, utility models and designs. The Chinese patent system adopts the principle of first to file. This means that, where more than one person files a patent application for the same invention, a patent can only be granted to the person who first filed the application. Consistent with international practice, the PRC only allows the patenting of inventions or utility models that possess the characteristics of novelty, inventiveness and practical applicability. For a design to be patentable, it should not be identical with or similar to any design which, before the date of filing, has been publicly disclosed in publications in the country or abroad or has been publicly used in the country and should not be in conflict with any prior right of another.

PRC law provides that anyone wishing to exploit the patent of another must conclude a written licensing contract with the patent holder and pay the patent holder a fee. One rather broad exception to this, however, is that where a party possesses the means to exploit a patent but cannot obtain a license from the patent holder on reasonable terms and in a reasonable period of time, the PRC State Intellectual Property Office, or SIPO, is authorized to grant a compulsory license. A compulsory license can also be granted where a national emergency or any extraordinary state of affairs occurs or where the public interest so requires. SIPO, however, has not granted any compulsory license up to now. The patent holder may appeal such decision within three months from receiving notification by filing a suit in the People’s Court.
 
PRC law defines patent infringement as the exploitation of a patent without the authorization of the patent holder. A patent holder who believes his patent is being infringed may file a civil suit or file a complaint with a PRC local Intellectual Property Administrative Authority, which may order the infringer to stop the infringing acts. A preliminary injunction may be issued by the People’s Court upon the patentee’s or the interested parties’ request before instituting any legal proceedings or during the proceedings. Evidence preservation and property preservation measures are also available both before and during the litigation. Damages in the case of patent infringement is calculated as either the loss suffered by the patent holder arising from the infringement or the benefit gained by the infringer from the infringement. If it is difficult to ascertain damages in this manner, damages may be reasonably determined in an amount in excess of the license fee under a contractual license. The infringing party may be also fined by Administration of Patent Management in an amount of up to three times the unlawful income earned by such infringing party. If there is no unlawful income so earned, the infringing party may be fined in an amount of up to RMB500,000, or approximately $62,500.

 
13

 

Currency

The value of the Renminbi, the main currency used in China, fluctuates and is affected by, among other things, changes in China’s political and economic conditions. The conversion of Renminbi into foreign currencies such as the U.S. dollar has been generally based on rates set by the People’s Bank of China, which are set daily based on the previous day’s interbank foreign exchange market rates and current exchange rates on the world financial markets. The official exchange rate had remained stable over the past several years. However, China has adopted a floating rate with respect to the Renminbi, with a 0.3% fluctuation and is expected to appreciate against other currencies, including the U.S. dollar.
 
In addition, the Renminbi is not a freely convertible currency at this time. Except for export sales revenues in United States dollars, we receive all of our local sales revenues in Renminbi. Payments of dividends and other expenditures in foreign currencies outside China by us will require the conversion of Renminbi into other currencies. We are able to make payments (including dividends) in foreign currencies upon presentation of business documents through banks in China authorized to conduct foreign currency transactions without the prior approval from the PRC State Administration of Foreign Exchange, or SAFE. The Chinese government has indicated that it will consider allowing the free conversion of Renminbi into other currencies. However, there is no assurance that it will not impose foreign exchange controls on normal transactions in the future.

Labor Laws

The new Labor Contract Law took effect January 1, 2008 and governs standard terms and conditions for employment, including termination and lay-off rights, contract requirements, compensation levels and consultation with labor unions, among other topics. In addition, the law limits non-competition agreements with senior management and other employees with knowledge of trade secrets to two years and imposes restrictions or geographical limits
  
ITEM 1A.
RISK FACTORS.

We operate in a highly competitive environment in which there are numerous factors which can influence our business, financial position or results of operations and which can also cause the market value of our common stock to decline. Many of these factors are beyond our control and therefore, are difficult to predict. The following section sets forth what we believe to be the principal risks that could affect us, our business or our industry, and which could result in a material adverse impact on our financial results or cause the market price of our common stock to fluctuate or decline.

RISKS RELATED TO OUR BUSINESS

The global economic crisis could further impair the demand for our products and affecting the overall availability and cost of external financing for our operations.

The continuation or intensification of the global economic crisis and turmoil in the global financial markets may adversely impact our business, the businesses of our customers from whom we generate revenues and our potential sources of capital financing.  The global economic crisis harmed most industries and has been particularly detrimental to the real estate, construction, automobile and consumer product industry.  Since our steel products serve as key components in construction and building materials, automobiles and household products, our sales and business operations are dependent on the financial health of the these industries and could suffer if our customers experience, or continue to experience, a downturn in their business.  In addition, the lack of availability of credit could lead to a further weakening of the Chinese and global economies and make capital financing of our operations more expensive for us or impossible altogether.  Presently, it is unclear whether and to what extent the economic stimulus measures and other actions taken or contemplated by the Chinese government and other governments throughout the world will mitigate the effects of the crisis on the industries that affect our business.  These conditions have not presently impaired our ability to access credit markets and finance our operations.  However, the impact of the current crisis on our ability to obtain capital financing in the future, and the cost and terms of same, is unclear.  Furthermore, deteriorating economic conditions including business layoffs, downsizing, industry slowdowns and other similar factors that affect our customers could have further negative consequences for the real estate, construction, automobile and consumer product industry and result in lower sales, price reductions in our products and declining profit margins. The economic situation also could harm our current or future lenders or customers, causing them to fail to meet their obligations to us. No assurances can be given that the effects of the current crisis will not damage on our business, financial condition and results of operations.

 
14

 

Steel consumption is cyclical and worldwide overcapacity in the steel industry and the availability of alternative products has resulted in intense competition, which may have an adverse effect on our profitability and cash flow.
 
Steel consumption is highly cyclical and generally follows general economic and industrial conditions both worldwide and in various smaller geographic areas. The steel industry has historically been characterized by excess world supply. This has led to substantial price decreases during periods of economic weakness, which have not been offset by commensurate price increases during periods of economic strength. Substitute materials are increasingly available for many steel products, which may further reduce demand for steel. Additional overcapacity or the use of alternative products could have a material adverse effect upon our results of operations.

The risk that we could suffer unrecoverable losses on our accounts receivable may be increased by our practice of offering extended customer credit and payment terms to our customers, together with the current negative global economic conditions.  Any such unrecoverable losses could adversely affect our financial results.
 
We operate our business in China. Credit periods vary substantially in China across industries, segments, types and size of companies.  We operate in a niche of the China steel industry, specifically in the manufacture and sale of high precision cold-rolled steel products and in the provision of heat treatment and cutting of medium and high carbon hot-rolled steel strips.  Our customers are also niche operators, including manufacturers of automobile parts and components, steel roofing, plane friction discs, appliances, food packaging materials, saw blades, textile needles and microelectronics.  Because of the nature of our business, our business cycle and that of our customers is relatively long.  As a result, the credit and payment terms that we extend to our customers in the normal course of business are also relatively long. We offer credit to our customers for periods of 60 days, 90 days, 120 days and 180 days, with the longer credit terms generally offered to longstanding recurring customers with good payment histories and sizable operations. Our management determines the collectability of outstanding accounts by maintaining quarterly communication with such customers and obtaining confirmation of their intent and ability to fulfill their obligations to the Company. In making this determination, our management also considers past collection experience, our relationship with customers and the impact of current economic conditions on our industry and market and the financial condition of the customer, to the extend discoverable.  Until June 30, 2009, we did not have a policy of writing off or reserving a specific dollar amount or percentage of accounts receivable based on aging of such accounts.
 
The following table reflects the aging of our accounts receivable as of June 30, 2009 and 2008, after taking into consideration credit periods offered to our customers.  As of June 30, 2009, apart from one major customer who accounted for 38% of accounts receivable which were past due over 180 days, the remaining 62% of our accounts receivable over 180 days is spread among approximately 27 different customers.

June 30, 2009
 
US$
 
Total
   
Current
   
1 to 30
days
   
31 to
90 days
   
91 to 180
days
   
181 to 360
days
   
over
1 year
 
TOTAL
    25,970,961       14,497,258       405,769       1,639,027       7,061,774       2,168,481       198,652  
%
    100       56       2       6       27       8       1  

 
15

 

June 30, 2008
 
US$
 
Total
   
Current
   
1 to 30
days
   
31 to
90 days
   
91 to 180
days
   
181 to 360
days
   
over
1 year
 
TOTAL
    34,816,553       32,711,335       313,936       1,414,991       157,578       111,863       106,850  
%
    100       94       1       4    
<1
   
<1
   
<1
 

We have not previously determined it appropriate or necessary to write-off or specifically reserve for any aged accounts receivable based on a determination of uncollectability, other than a write-off of accounts receivable of $3,835,124 during the fiscal year ended June 30, 2009.  This charge reflects a write-off of accounts receivable due to a dispute between the Company and one of our customers regarding a special stainless steel product processed by the Company and delivered to the customer during the third and fourth quarters of the year ended June 30, 2008. Revenues for these products were initially recognized as services had been rendered and the goods had been delivered, and collectability was reasonably assured as the goods were delivered in accordance to the terms of the contract and management had no reason to believe that the customer would object to the goods and services provided.  However, in the months following such delivery, a dispute arose during the use of such products by the customer, which was followed by discussions between us and the customer regarding the technical aspects of the products and the possibility of reprocessing the products. After a few rounds of negotiation with the customer regarding the products and payment, our management determined as of June 30, 2009, that this account receivable is uncollectible. The Company does not have any other accounts receivable related to this product.

As of June 30, 2009, all our customers confirmed that they were committed to fulfilling their obligations to the Company and we were aware of no other basis for reclassifying any such accounts as uncollectable.  As a result, we determined that an allowance for doubtful accounts of $830,127 as of June 30, 2009, was appropriate, as compared to $1,033,479 at June 30, 2008. To date, we have collected approximately $0.9 million, or 40% of our accounts that were over 180 days old at June 30, 2009. We believe there was no material deterioration of the accounts receivable at June 30, 2009.

We note, however, that we experienced delays in customer payment of accounts receivable during the fiscal year ended June 30, 2009.  Approximately 9% of our accounts receivable as of June 30, 2009 was over 180 days past due, compared to 1% of our accounts receivable being over 180 days past due as of June 30, 2008.  Our customers, for example the high-carbon cold-rolled steel customers in the auto industry, had high inventory balances on hand at the time due to build up during the sales boom immediately before the global crisis, and had indicated delay in payments due to slower turnaround. These delays have caused a much smaller decrease in the accounts receivable balance as compared to the decrease of sales revenue in the fiscal year ended June 30, 2009. However, the Chinese government has been implementing measures and macro-economic policies aimed to stimulate the Chinese economy since the start of 2009, and as one of the pillar industries under support, our customers in the auto industry have indicated to us that they were seeing increased orders during the second and third quarters of 2009 as a result of the stimulus packages and have indicated to us that they were committed to settling their respective outstanding accounts receivable. There are similar cases with our other customers who have also expressed confirmation for settlement as they have been seeing increased orders and collection themselves as the stimulus package is implemented. We also note the continuation or intensification of the current worldwide economic crisis may have negative consequences on the business operations of our customers despite the efforts of the Chinese government and may adversely impact their ability to meet these financial obligations to us, resulting in unrecoverable losses on such accounts receivable.  Although we believe that our current reserves for doubtful accounts are adequate in light of current market conditions, and we are not aware of any specific increases in doubtful accounts, we have nevertheless elected to prepare for the potential worsening of the global economic downturn, and the slowdown in the steel industry in China in particular, by increasing such reserves for 2009. To reserve for potentially uncollectible accounts receivable, management has made a 50% provision for all accounts receivable that are over 180 days past due and full provision for all accounts receivable over 1 year past due for the year ended June 30, 2009. The Company had $830,127 and $1,033,479 of allowances for doubtful accounts, respectively; and provision for bad debts of $3,831,478 and $686,955, respectively, for the year ended June 30, 2009 and 2008.

 
16

 

From time to time we will review credit periods offered, along with our collection experience and the other factors discussed above, to evaluate the adequacy of our allowance for doubtful accounts, and to make changes to the allowance, if necessary, including reducing such allowances if uncollectable accounts do not actually increase and the other factors we consider in determining the collectability of accounts do not deteriorate.  However, if our actual collection experience with our customers or other conditions change, or the other factors that we consider indicate that it is appropriate, a further provision for doubtful accounts may be required, which could adversely affect our financial results.

We provide advances to suppliers when placing purchase orders in the ordinary course of our business.  If we must write-off a material amount of these advances for any reason, or if we are unable to obtain delivery of raw material from suppliers to whom we have paid advances for any reason, our financial results will be negatively impacted.

In order to insure a steady supply of raw materials, the Company is required from time to time to make cash advances to its suppliers when placing purchase orders, for a guaranteed minimum delivery quantity at future times when raw materials are required. The advance is seen as a deposit to suppliers and guarantees our access to raw materials during periods of shortages and market volatility, and is therefore considered an important component of our operations.  Contracted raw materials are priced at prevailing market rates agreed by us with the suppliers prior to each delivery date and the balance of our advances decrease when we take down contracted material at a future date.  Balances decrease at a slower rate during periods when raw material prices are decreasing or when we take fewer deliveries from our suppliers. During the fiscal year ended June 30, 2009, lower steel prices coupled with reduced orders and therefore take down of contracted raw materials from the advances paid led to a slower decrease of such balance. We had therefore obtained a cash refund from one of our major suppliers in the amount of $5.0 million in view of the above.

Advances to suppliers are shown net of an allowance which represents potentially unrecoverable cash advances at each balance sheet date. Our allowances for advances to suppliers are subjective critical estimates that have a direct impact on reported net earnings, and are reviewed quarterly at a minimum to ensure the appropriateness of the allowance in light of the circumstances present at the time of the review.  Such allowances are based on an analysis of past raw materials receipt experience and the credibility of each supplier according to its size and background. For example, we do not generally provide allowances against advances paid to state owned companies as we believe that there is minimal risk of default.  It is reasonably possible that the Company’s estimate of the allowance will change, such as in the case when the Company becomes aware of a supplier’s inability to deliver the contracted raw materials or meet its financial obligations.  At June 30, 2009 and 2008, the Company had allowances of advances to suppliers of $1,631,557 and $2,522,837, respectively. Approximately 48% of our advance to suppliers was greater than 180 days as of June 30, 2009, the majority, or 74% of which, is attributable to our advances to a single supplier, a subsidiary of a state-owned company in China. We believe that advances paid to state-owned companies are ultimately collectible because they are backed by the full faith and credit of the PRC government. As such, we do not provide allowances against such advances. During the fiscal year June 30, 2009, we have also received a $5.0 million cash refund of supplier advances of over 180 days from one of our major suppliers, representing 23% of advances to suppliers as of June 30, 2009.

Allowances for advances to suppliers are written off when all efforts to collect the materials or recover the cash advances have been unsuccessful, or when it has become known to the management that there is no intention for the suppliers to deliver the contracted raw materials or refund the cash advances.  To date we have not written off any advances to suppliers.  If any material advances to suppliers must be written-off, or if we can not secure delivery of raw materials that have pre-paid with such advances, then our financial results will be negatively impacted.

Rapidly growing demand and supply in China and other developing economies may result in additional excess worldwide capacity and falling steel prices, which could adversely impact our results.
 
Over the last several years steel consumption in China and other developing economies such as India has increased at a rapid pace. Steel companies have responded by developing plans to rapidly increase steel production capability in these countries and entered into long-term contracts with iron ore suppliers in Australia and Brazil. Steel production, especially in China, has been expanding rapidly and could be in excess of Chinese demand depending on continuing growth rates. Because China is now the largest worldwide steel producer, any significant excess in Chinese capacity could have a major impact on domestic and international steel trade and prices.

 
17

 
 
Environmental compliance and remediation could result in substantially increased capital requirements and operating costs.
 
Our operating subsidiaries, Chengtong and Shanghai Blessford, are subject to numerous Chinese provincial and local laws and regulations relating to the protection of the environment. These laws continue to evolve and are becoming increasingly stringent. The ultimate impact of complying with such laws and regulations is not always clearly known or determinable because regulations under some of these laws have not yet been promulgated or are undergoing revision. Our consolidated business and operating results could be materially and adversely affected if our operating subsidiaries were required to increase expenditures to comply with any new environmental regulations affecting its operations.
 
We may require additional capital in the future and we cannot assure that capital will be available on reasonable terms, if at all, or on terms that would not cause substantial dilution to stockholdings.
 
The development of high quality specialty precision steel requires substantial funds. Sourcing external capital funds for product development and requisite capital expenditures are key factors that have and may in the future constrain our growth, production capability and profitability. To achieve the next phase of our corporate growth, increased production capacity, successful product development and additional external capital will be necessary. There can be no assurance that such capital will be available in sufficient amounts or on terms acceptable to us, if at all. Any sale of a substantial number of additional shares of common stock or securities convertible into common stock will cause dilution to the holders of our common stock and could also cause the market price of our common stock to decline.
 
We face significant competition from competitors who have greater resources than we do, and we may not have the resources necessary to successfully compete with them.
 
We are one of a few manufacturers of specialty precision steel products in China. Differences in the type and nature of the specialty precision steel products in China’s steel industry are relatively small, and, coupled with intense competition from international and local suppliers, to a limited extent, consumers’ demand can be price sensitive. Competitors may increase their market share through pricing strategies that adversely impact our business. Our business is in an industry that is becoming increasingly competitive and capital intensive, and competition comes from manufacturers located in China as well as from international competition. Our competitors may have financial resources, staff and facilities substantially greater than ours and we may be at a competitive disadvantage compared with larger companies.
 
We produce a limited number of products and may not be able to respond quickly to significant changes in the market or new market entrants.
 
Cold-rolled specialty precision steel is a relatively new industry in China; Chinese manufacturers of durable goods previously relied solely on imports from Japan, Korea, the European Union and the United States. We believe the average quality and standards of products of China’s high precision steel industry lags behind the international norm. During the last four years, we have developed a nationally recognizable brand, however, we are not yet an internationally recognizable brand for our specialty steel products. Although we offer high precision cold rolled steel products in over 100 specifications, there are many other specialty precision steel products of similar nature in the market, even though none currently compete directly with our products. If there are significant changes in market demands and/or competitive forces, we may not be able to change our product mix or adapt our production equipment quickly enough to meet customers’ needs. Under such circumstances, our narrow band of precision steel products and/or new market entrants may negatively impact our financial performance.

 
18

 
 
Increased imports of steel products into China could negatively affect domestic steel prices and demand levels and reduce profitability of domestic producers.
 
Based on our understanding, China’s total production capacity of precision cold-rolled steel coils was over two million tons as of June 30, 2009.  However, domestic production continues to be insufficient to meet demand. As a result, China continues to import a significant portion of its steel products. Foreign competitors may have lower labor costs, and are often owned, controlled or subsidized by their governments, which allows their production and pricing decisions to be influenced by political and economic policy considerations as well as prevailing market conditions. Import levels may also be impacted by decisions of government agencies, under trade laws. Increases in future levels of imported steel could negatively impact future market prices and demand levels for our precision steel products.
 
We are dependent on our Chinese manufacturing operations to generate the majority of our income and profits, and the deterioration of any current favorable local conditions may make it difficult or prohibitive to continue to operate or expand in China.

Our current manufacturing operations are located in China, our administrative offices are in Hong Kong and we have additional establishments in the British Virgin Islands. The geographical distances between these facilities create a number of logistical and communications challenges, including time differences and differences in the cultures in each location, which makes communication and effective cooperation more difficult.  In addition, because of the location of the manufacturing facilities in China, our operations in China could be affected by, among other things:

 
·
economic and political instability in China, including problems related to labor unrest;

 
·
lack of developed infrastructure;

 
·
variances in payment cycles;

 
·
currency fluctuations;

 
·
overlapping taxes and multiple taxation issues;

 
·
employment and severance taxes;

 
·
compliance with local laws and regulatory requirements;

 
·
greater difficulty in collecting accounts receivable; and

 
·
the burdens of cost and compliance with a variety of foreign laws.

Moreover, inadequate development or maintenance of infrastructure in China, including adequate power and water supplies, transportation, raw materials availability or the deterioration in the general political, economic or social environment could make it difficult, more expensive and possibly prohibitive to continue to operate or expand our facilities in China.

Our operations are international and we are subject to significant worldwide political, economic, legal and other uncertainties that may make it difficult or costly to collect amounts owed to us or to conduct operations should materials needed from certain places be unavailable for an indefinite or extended period of time.  

We have subsidiaries in the British Virgin Islands and China. We manufacture all of our products in China and substantially all of the net book value of our total fixed assets is located there. However, we sell our products to customers outside of China as well as domestically. As a result, we have receivables from and goods in transit to locations outside of China. Protectionist trade legislation in the United States or other countries, such as a change in export or import legislation, tariff or duty structures, or other trade policies, could adversely affect our ability to sell products in these markets, or even to purchase raw materials or equipment from foreign suppliers. Moreover, we are subject to a variety of United States laws and regulations, changes to which may affect our ability to transact business with certain customers or in certain product categories.
 
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In China, our operating subsidiaries Chengtong and Shanghai Blessford are subject to numerous national, provincial and local governmental regulations, all of which can limit our ability to react to market pressures in a timely or effective way, thus causing us to lose business or miss opportunities to expand our business. These include, among others, regulations governing:

 
·
environmental and waste management;

 
·
our relationship with our employees, including: wage and hour requirements, working and safety conditions, citizenship requirements, work permits and travel restrictions;

 
·
property ownership and use in connection with our leased facilities in China; and

 
·
import restrictions, currency restrictions and restrictions on the volume of domestic sales.

The end-use markets for certain of our products are highly competitive and customers are willing to accept substitutes for our products which could reduce our results of operations.
 
Buyers of certain cold-rolled steel products are in highly competitive markets. Cold-rolled precision steel competes with other materials, such as aluminum, plastics, composite materials and glass, among others, for industrial and commercial applications. Customers have demonstrated a willingness to substitute other materials for cold-rolled steel. The willingness of our customers to accept substitutes for cold-rolled steel products could have a material adverse effect on our financial results.
 
We may not be able to pass on to customers the increases in the costs of our raw materials, particularly crude steel. 

We require substantial amounts of raw materials in our business, consisting principally of steel slabs and strip steel. Any substantial increases in the cost of crude steel could adversely affect our financial condition and results of operations. The availability and price of crude steel depends on a number of factors outside our control, including general economic conditions, domestic and international supply and tariffs. Increased domestic and worldwide demand for crude steel has had and will continue to have the effect of increasing the prices that we pay for these raw materials, thereby increasing our cost of goods sold. Generally, there is a potential time lag between changes in prices under our purchase contracts and the point when we can implement a corresponding change under our sales contracts with our customers. As a result, we can be exposed to fluctuations in the price of raw materials, since, during the time lag period, we may have to temporarily bear the additional cost of the change under our purchase contracts, which could have a material adverse effect on our profitability. If raw material prices were to increase significantly without a commensurate increase in the market value of our products, our financial condition and results of operations would be adversely affected.

Although we are dependent on a steady flow of raw materials for our operations, we do not have in place long-term supply agreements for all of our material requirements.
 
Although a substantial portion of our raw material requirements is met by BaoSteel Steel Products Trading Co., Ltd. for the year ended June 30, 2009, we are not dependent on any one single supplier for supply of hot-rolled coils as these coils are generally available in the market. However, we do not currently have long-term supply contracts with any particular supplier, including BaoSteel Steel Products Trading Co., Ltd., to assure a continued supply of the raw materials we need in our operations. While we maintain good relationships with these suppliers, the supply of raw materials may nevertheless be interrupted on account of events outside our control, which will negatively impact our operations.
 
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We have substantial indebtedness with floating interest rates and the cost of our borrowings may increase.
 
We are subject to interest rate risk on our non-derivative financial instruments. We do not hedge our interest rate risk. At June 30, 2009, our total bank debt outstanding was $22,489,031, all of which was interest-bearing. Substantially all of the bank debt was floating-rate debt with interest rates which vary with changes in the standard rate set by the People’s Bank of China for RMB loans and SIBOR for USD loan. A change in the interest rate or yield of fixed rate debt will only impact the fair value of such debt, while a change in the interest rate of floating rate, or variable rate, debt will impact interest expense as well as the amount of cash required to service such debt. To the extent interest rates increase, we will be liable for higher interest payments to its lenders. We anticipate that annual interest on loans for the fiscal year ending June 30, 2010, will be approximately $1.2 million. The impact of a 1% increase in interest rates will increase interest expense by approximately $225,000. As our short-term loans mature in July 2010, we will be required to either repay or refinance these loans. An increase in short-term interest rates at the time that we seek to refinance short-term borrowings may increase the cost of borrowings, which may adversely affect our earnings and cash available for distribution to our stockholders.
 
At June 30, 2009, the aggregate fair value of our financial instruments with exposure to interest rate risk was approximately $22.5 million. The potential change in fair value for these financial instruments from an adverse 10% change in quoted interest rates across all maturities, often referred to as a parallel shift in the yield curve, would be approximately $2.5 million at June 30, 2009.
 
The loss of any key executive or our failure to attract and retain key personnel could adversely affect our future performance, strategic plans and other objectives.
 
The loss or failure to attract and retain key personnel could significantly impede our future performance, including product development, strategic plans, marketing and other objectives. Our success depends to a substantial extent not only on the ability and experience of our senior management, but particularly upon our Chairman, Wo Hing Li; the General Manager of Chengtong, Hai Sheng Chen; and Chief Financial Officer, Leada Tak Tai Li. We do not currently have in place key man life insurance on Wo Hing Li, Hai Sheng Chen or Leada Tak Tai Li. To the extent that the services of these officers and directors would be unavailable to us, we would be required to recruit other persons to perform the duties performed by Wo Hing Li, Hai Sheng Chen and Leada Tak Tai Li. We may be unable to employ other qualified persons with the appropriate background and expertise to replace these officers and directors on terms suitable to us.
 
We may not be able to retain, recruit and train adequate management and production personnel. We rely heavily on those personnel to help develop and execute our business plans and strategies, and if we lose such personnel, it would reduce our ability to operate effectively.

Our continued operations are dependent upon our ability to identify and recruit adequate management and production personnel in China. We require trained graduates of varying levels and experience and a flexible work force of semi-skilled operators. Many of our current employees come from the more remote regions of China as they are attracted by the wage differential and prospects afforded by Shanghai and our operations. With the economic growth currently being experienced in China, competition for qualified personnel is substantial, and there can be no guarantee that a favorable employment climate will continue and that wage rates we must offer to attract qualified personnel will enable us to remain competitive internationally. The inability to attract such personnel or the increased cost of doing so could reduce our competitive advantage relative to other precision steel producers, reducing or eliminating our growth in revenues and profits.    
 
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We may not be able to protect adequately our intellectual property from infringement or unauthorized use by third parties.
 
Except for a patent on the Environment-Conscious Mill Bearing with Inner Circular Lubrication, we have no patents or licenses that protect our intellectual property. Unauthorized parties may attempt to copy aspects of our processes and know-how or to obtain and use information that we regard as proprietary. Policing unauthorized use of our processes and know-how is difficult. Our experienced key engineers and management staff are extensively involved in all facets of research, design, craftwork, styling and development of the specialty precision products. Potential risks on the divulgence of skills and the development of new products increase should these employees resign, as we rely heavily on them. We have elected to protect internally developed know-how and production processes (such as system pressure, cleanliness of the lubrication, temperature control, appropriate allocation of oil supply and retrieving, which are vital in providing a radical solution to the difficulties associated with lubricating rolling mills’ backing bearing) by requiring all key personnel (production engineers and management staff) to sign non-disclosure and confidentiality contracts. However, this means of protecting our proprietary rights may not be adequate. In addition, the laws of some foreign countries do not protect our proprietary rights as extensively as do U.S. laws. Our failure to protect adequately our proprietary rights may allow third parties to duplicate our products, production processes or develop functionally equivalent or superior technology. In addition, our competitors may independently develop similar technologies or design around our proprietary intellectual property.
 
We are subject to risks associated with changing technology and manufacturing techniques, which could place us at a competitive disadvantage.

The successful implementation of our business strategy requires us to continuously evolve our existing products and services and introduce new products and services to meet customers’ needs. Our designs and products are characterized by stringent performance and specification requirements that mandate a high degree of manufacturing and engineering expertise. We believe that our customers rigorously evaluate our services and products on the basis of a number of factors, including, but not limited to:

 
·
quality;

 
·
price competitiveness;

 
·
technical expertise and development capability;

 
·
innovation;

 
·
reliability and timeliness of delivery;

 
·
product design capability;

 
·
operational flexibility;

 
·
customer service; and

 
·
overall management.

Our success depends on our ability to continue to meet our customers’ changing requirements and specifications with respect to these and other criteria. There can be no assurance that we will be able to address technological advances or introduce new designs or products that may be necessary to remain competitive within the precision steel industry.
 
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We depend upon our largest customers for a significant portion of our sales revenue, and we cannot be certain that sales to these customers will continue. If sales to these customers do not continue, then our sales may decline and our business may be negatively impacted.
 
We currently supply high precision steel products to five major customers in the Chinese domestic market. For the years ended June 30, 2009 and 2008, sales revenues generated from the top five major customers amounted to 50% and 62% of total sales revenues, respectively; sales to the largest single customer for the same years amounted to 19% and 21% of total sales revenues, respectively. We do not enter into long-term contracts with our customers and therefore cannot be certain that sales to these customers will continue. The loss of any of our largest customers would likely have a material negative impact on our sales revenues and business.
 
Defects in our products could impair our ability to sell products or could result in litigation and other significant costs.
 
Detection of any significant defects in our precision steel products may result in, among other things, delay in time-to-market, loss of market acceptance and sales of its products, diversion of development resources, injury to our reputation, litigation or fines, or increased costs to correct such defects. Defects could harm our reputation, which could result in significant costs and could impair our ability to sell our products. The costs we may incur in correcting any product defects may be substantial and could decrease our profit margins. 
 
Failure to optimize our manufacturing potential and cost structure could materially increase our overhead, causing a decline in our margins and profitability.     

We strive to utilize the manufacturing capacity of our facilities fully but may not do so on a consistent basis. Our factory utilization is dependent on our success in, among other things:

 
·
accurately forecasting demand;

 
·
predicting volatility;

 
·
timing volume sales to our customers;

 
·
balancing our productive resources with product mix; and

 
·
planning manufacturing services for new or other products that we intend to produce.

Demand for contract manufacturing of these products may not be as high as we expect, and we may fail to realize the expected benefit from our investment in our manufacturing facilities. Our profitability and operating results are also dependent upon a variety of other factors, including, but not limited to:

 
·
utilization rates of manufacturing lines;

 
·
downtime due to product changeover;

 
·
impurities in raw materials causing shutdowns; and

 
·
maintenance of contaminant-free operations.

Failure to optimize our manufacturing potential and cost structure could materially and adversely affect our business and operating results.
 
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Moreover, our cost structure is subject to fluctuations from inflationary pressures in China and other geographic regions where we conduct business. China is currently experiencing dramatic growth in its economy. This growth may lead to continued pressure on wages and salaries that may exceed our budget and adversely affect our operating results.

Our production facilities are subject to risks of power shortages which may adversely affect our ability to meet our customers’ needs and reduce our revenues.
 
Many cities and provinces in China have suffered serious power shortages since the second quarter of 2004. Many of the regional grids do not have sufficient power generating capacity to fully satisfy the increased demand for electricity driven by continual economic growth and persistent hot weather. Local governments have occasionally required local factories to temporarily shut down their operations or reduce their daily operational hours in order to reduce local power consumption levels. To date, our operations have not been affected by those administrative measures. However, there is a risk that our operations may be affected by those administrative measures in the future, thereby causing material production disruption and delay in delivery schedule. In such event, our business, results of operation and financial conditions could be materially adversely affected. We do not have any back-up power generation system. Although we have not experienced any power outages in the past, we may be adversely affected by power outages in the future.
 
Unexpected equipment failures may lead to production curtailments or shutdowns.
 
Interruptions in our production capabilities will adversely affect our production costs, products available for sales and earnings for the affected period. In addition to equipment failures, our facilities are also subject to the risk of catastrophic loss due to unanticipated events such as fires, explosions or violent weather conditions. Our manufacturing processes are dependent upon critical pieces of equipment, such as our various cold-rolling mills, as well as electrical equipment, such as transformers, and this equipment may, on occasion, be out of service as a result of unanticipated failures. We have experienced and may in the future experience material plant shutdowns or periods of reduced production as a result of such equipment failures.
 
Our insurance may not be adequate if our production facilities were destroyed or significantly damaged as a result of fire or some other natural disaster.
 
All of our products are currently manufactured at our existing facilities located in the Jiading District in Shanghai, China. Fire fighting and disaster relief or assistance in China may not be as developed as in Western countries. While we maintain property damage insurance aggregating approximately $53.7 million covering our inventories, equipment, plant and buildings and another $35.1 million insurance against equipment damage, we do not maintain business interruption insurance. Material damage to, or the loss of, our production facilities due to fire, severe weather, flood or other act of God or cause, even if insured, could have a material adverse effect on our financial condition, results of operations, business and prospects.

Our holding company structure may limit the payment of dividends.
 
We have no direct business operations, other than our ownership of our subsidiaries.  While we have no current intention of paying dividends, should we decide in the future to do so, as a holding company, our ability to pay dividends and meet other obligations depends upon the receipt of dividends or other payments from our operating subsidiaries and other holdings and investments.  In addition, our operating subsidiaries, from time to time, may be subject to restrictions on their ability to make distributions to us, including as a result of restrictive covenants in loan agreements, restrictions on the conversion of local currency into U.S. dollars or other hard currency and other regulatory restrictions as discussed below.  If future dividends are paid in RMB, fluctuations in the exchange rate for the conversion of RMB into U.S. dollars may reduce the amount received by U.S. stockholders upon conversion of the dividend payment into U.S. dollars.
 
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Chinese regulations currently permit the payment of dividends only out of accumulated profits as determined in accordance with Chinese accounting standards and regulations.  Our subsidiaries in China are also required to set aside a portion of their after tax profits according to Chinese accounting standards and regulations to fund certain reserve funds.  Currently, our subsidiaries in China are the only sources of revenues or investment holdings for the payment of dividends.  If they do not accumulate sufficient profits under Chinese accounting standards and regulations to first fund certain reserve funds as required by Chinese accounting standards, we will be unable to pay any dividends.

Failure to comply with the U.S. Foreign Corrupt Practices Act could subject us to penalties and other adverse consequences.

We are subject to the U.S. Foreign Corrupt Practices Act, or FCPA, which generally prohibits United States companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. In addition, we are required to maintain records that accurately and fairly represent our transactions and have an adequate system of internal accounting controls. Foreign companies, including some that may compete with us, are not subject to these prohibitions, and therefore may have a competitive advantage over us. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in the PRC, and our executive officers and employees have not been subject to the FCPA prior to our reverse merger in December 2006. We can make no assurance that our employees or other agents will not engage in such conduct for which we might be held responsible. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties and other consequences that may have a material adverse effect on our business, financial condition and results of operations.

We may be exposed to potential risks relating to our internal controls over financial reporting and our ability to have those controls attested to by our independent auditors.

As directed by Section 404 of the Sarbanes-Oxley Act of 2002, or SOX 404, the SEC adopted rules requiring public companies to include a report of management on the company’s internal controls over financial reporting in their annual reports, including Form 10-K.  In addition, an independent registered public accounting firm must also attest to and report on the operating effectiveness of the company’s internal controls.  We can provide no assurance that we will comply with all of the requirements imposed thereby.  There can be no positive assurance that we will receive a positive attestation from our independent auditors.  In the event we identify significant deficiencies or material weaknesses in our internal controls that we cannot remediate in a timely manner or we are unable to receive a positive attestation from our independent auditors with respect to our internal controls, investors and others may lose confidence in the reliability of our financial statements.

We may incur significant costs to ensure compliance with U.S. corporate governance and accounting requirements.
 
We may incur significant costs associated with our public company reporting requirements, costs associated with applicable corporate governance requirements, including requirements under the Sarbanes-Oxley Act of 2002 and other rules implemented by the SEC and requirements in connection with the listing of our common stock on The NASDAQ Capital Market. We expect all of these applicable rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly. We also expect that these applicable rules and regulations may make it more difficult and more expensive for us to obtain director and officer liability insurance and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors or as executive officers.
 
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Our officers and directors have limited experience with the regulatory requirements for U.S. public companies, which could impair our ability to satisfy public company filing requirements and could increase our securities compliance costs.

All of our officers and most of our directors do not have any prior experience as officers and directors of a U.S. publicly traded company, or in complying with the regulatory requirements applicable to a U.S. public company. As a result, we could have difficulty satisfying the regulatory requirements applicable to U.S. public companies, which could adversely affect the market for our common stock. At present, we rely upon outside experts to advise us on matters relating to financial accounting and public company reporting. While we believe that it will be possible to satisfy our public company reporting requirements through the use of third party experts, our general and administrative costs will remain higher until we have developed or acquired internal expertise in these matters

RISKS RELATED TO DOING BUSINESS IN CHINA

Adverse changes in political and economic policies of the PRC government could impede the overall economic growth of China, which could reduce the demand for our products and damage our business.
 
We conduct substantially all of our operations and generate most of our revenue in China.   Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China.  The PRC economy differs from the economies of most developed countries in many respects, including:
 
 
·
a higher level of government involvement;

 
·
a early stage of development of the market-oriented sector of the economy;

 
·
a rapid growth rate;

 
·
a higher level of control over foreign exchange; and

 
·
the allocation of resources.
 
As the PRC economy has been transitioning from a planned economy to a more market-oriented economy, the PRC government has implemented various measures to encourage economic growth and guide the allocation of resources. While these measures may benefit the overall PRC economy, they may also have a negative effect on us.
 
Although the PRC government has in recent years implemented measures emphasizing the utilization of market forces for economic reform, the PRC government continues to exercise significant control over economic growth in China through the allocation of resources, controlling the payment of foreign currency-denominated obligations, setting monetary policy and imposing policies that impact particular industries or companies in different ways.
 
Any adverse change in economic conditions or government policies in China could have a material adverse effect on the overall economic growth in China, which in turn could lead to a reduction in demand for our services and consequently have a material adverse effect on our business and prospects.
 
Uncertainties with respect to the PRC legal system could limit the legal protections available to you and us.
 
We conduct substantially all of our business through our operating subsidiaries in the PRC. Our operating subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to foreign-invested enterprises. The PRC legal system is based on written statutes, and prior court decisions may be cited for reference but have limited precedential value. Since 1979, a series of new PRC laws and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since the PRC legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involve uncertainties, which may limit legal protections available to you and us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.  In addition, all of our executive officers and all of our directors are residents of China and not of the United States, and substantially all the assets of these persons are located outside the United States.  As a result, it could be difficult for investors to affect service of process in the United States or to enforce a judgment obtained in the United States against our Chinese operations and subsidiaries.
 
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If we are found to have failed to comply with applicable laws, we may incur additional expenditures or be subject to significant fines and penalties.
 
Our operations are subject to PRC laws and regulations applicable to us. However, many PRC laws and regulations are uncertain in their scope, and the implementation of such laws and regulations in different localities could have significant differences. In certain instances, local implementation rules and/or the actual implementation are not necessarily consistent with the regulations at the national level. Although we strive to comply with all the applicable PRC laws and regulations, we cannot assure you that the relevant PRC government authorities will not later determine that we have not been in compliance with certain laws or regulations.  Our failure to comply with the applicable laws and regulations in China could subject us to administrative penalties and injunctive relief, as well as civil remedies, including fines, injunctions and recalls of our products. It is possible that changes to such laws or more rigorous enforcement of such laws or with respect to our current or past practices could have a material adverse effect on our business, operating results and financial condition. Further, additional environmental or safety issues relating to matters that are not currently known to management may result in unanticipated liabilities and expenditures.
 
The PRC government exerts substantial influence over the manner in which we must conduct our business activities.

The PRC government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership.  Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property and other matters.  We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements.  However, the central or local governments of the jurisdictions in which we operate may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations.

Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof and could require us to divest ourselves of any interest we then hold in Chinese properties or joint ventures.

Restrictions on currency exchange may limit our ability to receive and use our sales revenue effectively.

Most of our sales revenue and expenses are denominated in RMB. Under PRC law, the RMB is currently convertible under the “current account,” which includes dividends and trade and service-related foreign exchange transactions, but not under the “capital account,” which includes foreign direct investment and loans. Currently, our PRC operating subsidiaries may purchase foreign currencies for settlement of current account transactions, including payments of dividends to us, without the approval of the State Administration of Foreign Exchange, or SAFE, by complying with certain procedural requirements. However, the relevant PRC government authorities may limit or eliminate our ability to purchase foreign currencies in the future. Since a significant amount of our future revenue will be denominated in RMB, any existing and future restrictions on currency exchange may limit our ability to utilize revenue generated in RMB to fund our business activities outside China that are denominated in foreign currencies.
 
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Foreign exchange transactions by PRC operating subsidiaries under the capital account continue to be subject to significant foreign exchange controls and require the approval of or need to register with PRC government authorities, including SAFE. In particular, if our PRC operating subsidiaries borrow foreign currency through loans from us or other foreign lenders, these loans must be registered with SAFE, and if we finance the subsidiaries by means of additional capital contributions, these capital contributions must be approved by certain government authorities, including the Ministry of Commerce or their respective local counterparts. These limitations could affect their ability to obtain foreign exchange through debt or equity financing.
 
Fluctuations in exchange rates could adversely affect our business and the value of our securities.

The value of our common stock will be indirectly affected by the foreign exchange rate between U.S. dollars and RMB and between those currencies and other currencies in which our sales may be denominated. Because substantially all of our earnings and cash assets are denominated in RMB, fluctuations in the exchange rate between the U.S. dollar and the RMB will affect the relative purchasing power of these proceeds, our balance sheet and our earnings per share in U.S. dollars. In addition, appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue that will be exchanged into U.S. dollars as well as earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.
 
Since July 2005, the RMB has no longer been pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future PRC authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.
 
Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies.
 
Currently, some of our raw materials and major equipment are imported.  In the event that the U.S. dollars appreciate against RMB, our costs will increase.  If we cannot pass the resulting cost increases on to our customers, our profitability and operating results will suffer.  In addition, since our sales to international customers are growing rapidly, we are increasingly subject to the risk of foreign currency depreciation.

Restrictions under PRC law on our PRC subsidiaries’ ability to make dividends and other distributions could materially and adversely affect our ability to grow, make investments or acquisitions that could benefit our business, pay dividends to you, and otherwise fund and conduct our businesses.
 
Substantially all of our revenues are earned by our PRC subsidiaries. However, PRC regulations restrict the ability of our PRC subsidiaries to make dividends and other payments to their offshore parent company. PRC legal restrictions permit payments of dividend by our PRC subsidiaries only out of their accumulated after-tax profits, if any, determined in accordance with PRC accounting standards and regulations. Each of our PRC subsidiaries is also required under PRC laws and regulations to allocate at least 10% of our annual after-tax profits determined in accordance with PRC GAAP to a statutory general reserve fund until the amounts in said fund reaches 50% of our registered capital. Allocations to these statutory reserve funds can only be used for specific purposes and are not transferable to us in the form of loans, advances or cash dividends. Any limitations on the ability of our PRC subsidiaries to transfer funds to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends and otherwise fund and conduct our business.
 
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Under the New EIT Law, we may be classified as a “resident enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC shareholders.

On March 16, 2007, the National People’s Congress of China passed a new Enterprise Income Tax Law, or the New EIT Law, and on December 6, 2007, the State Council of China passed the Implementing Rules for the New EIT Law, or the Implementing Rules, which took effect on January 1, 2008. Under the New EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes.  The Implementing Rules define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise.

On April 22, 2009, the State Administration of Taxation issued the Notice Concerning Relevant Issues Regarding Cognizance of Chinese Investment Controlled Enterprises Incorporated Offshore as Resident Enterprises pursuant to Criteria of de facto Management Bodies, or the Notice, further interpreting the application of the New EIT Law and its implementation with respect to non-Chinese enterprise or group controlled offshore entities.  Pursuant to the Notice, an enterprise incorporated in an offshore jurisdiction and controlled by a Chinese enterprise or group will be classified as a “non-domestically incorporated resident enterprise” if (i) its senior management in charge of daily operation reside or perform their duties mainly in China; (ii) its financial or personnel decisions are made or approved by bodies or persons in China; (iii) its substantial properties, accounting books, corporate chops, board and shareholder minutes are kept in China; and (iv) ½ directors with voting rights or senior management often resident in China.  Such resident enterprise would be subject to an enterprise income tax rate of 25% on its worldwide income and must pay a withholding tax at a rate of 10% when paying dividends to its non-PRC shareholders.  However, it remains unclear as to whether the Notice is applicable to an offshore enterprise incorporated by a Chinese natural person.  Nor are detailed measures on imposition of tax from non-domestically incorporated resident enterprises are available. Therefore, it is unclear how tax authorities will determine tax residency based on the facts of each case.

However, as our case substantially meets the foregoing criteria, there is a likelihood that we are deemed to be a  resident enterprise by Chinese tax authorities. If the PRC tax authorities determine that we are a “resident enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations. In our case, this would mean that income such as interest on financing proceeds and non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Second, although under the New EIT Law and its Implementing Rules dividends paid to us from our PRC subsidiaries would qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes.  Finally, it is possible that future guidance issued with respect to the new “resident enterprise” classification could result in a situation in which a 10% withholding tax is imposed on dividends we pay to our non-PRC shareholders and with respect to gains derived by our non-PRC shareholders from transferring our shares.  We are actively monitoring the possibility of “resident enterprise” treatment and are evaluating appropriate organizational changes to avoid this treatment, to the extent possible.

If we were treated as a “resident enterprise” by PRC tax authorities, we would be subject to taxation in both the U.S. and China, and our PRC tax may not be creditable against our U.S. tax.
 
29

 
The M&A Rule establishes more complex procedures for some acquisitions of Chinese companies by foreign investors, which could make it more difficult for us to pursue growth through acquisitions in China.

On August 8, 2006, six PRC regulatory agencies, including the China Securities Regulatory Commission, promulgated the Provisions Regarding Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rule, which became effective on September 8, 2006. The M&A Rule establishes procedures and requirements that could make some acquisitions of Chinese companies by foreign investors more time-consuming and complex, including requirements in some instances that the PRC Ministry of Commerce be notified in advance of any change-of-control transaction and in some situations, require approval of the PRC Ministry of Commerce when a foreign investor takes control of a Chinese domestic enterprise. In the future, we may grow our business in part by acquiring complementary businesses, although we do not have any plans to do so at this time. The M&A Rule also requires PRC Ministry of Commerce anti-trust review of any change-of-control transactions involving certain types of foreign acquirers. Complying with the requirements of the M&A Rule to complete such transactions could be time-consuming, and any required approval processes, including obtaining approval from the PRC Ministry of Commerce, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.
 
You may have difficulty enforcing judgments against us.
 
We are a Delaware holding company and most of our assets are located outside of the United States. Most of our current operations are conducted in the PRC. In addition, most of our directors and officers are nationals and residents of countries other than the United States. A substantial portion of the assets of these persons is located outside the United States. As a result, it may be difficult for you to effect service of process within the United States upon these persons. It may also be difficult for you to enforce in U.S. courts judgments on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors, most of whom are not residents in the United States and the substantial majority of whose assets are located outside of the United States. In addition, there is uncertainty as to whether the courts of the PRC would recognize or enforce judgments of U.S. courts. Courts in China may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based on treaties between China and the country where the judgment is made or on reciprocity between jurisdictions. China does not have any treaties or other arrangements that provide for the reciprocal recognition and enforcement of foreign judgments with the United States. In addition, according to the PRC Civil Procedures Law, courts in the PRC will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates basic principles of PRC law or national sovereignty, security or the public interest. So, it is uncertain whether a PRC court would enforce a judgment rendered by a court in the United States.

RISKS RELATED TO THE MARKET FOR OUR STOCK GENERALLY

The market price for shares of our common stock could be volatile and could decline.
 
Our common stock is listed on The NASDAQ Capital Market under the symbol “CPSL.” The market price for the shares of our common stock may fluctuate in response to a number of factors, many of which are beyond our control. In some cases, these fluctuations may be unrelated to our operating performance. Many companies with Chinese operations have experienced dramatic volatility in the market prices of their common stock. We believe that a number of factors, both within and outside of our control, could cause the price of our common stock to fluctuate, perhaps substantially. Factors such as the following could have a significant adverse impact on the market price of our common stock:

 
·
our ability to obtain additional financing and, if available, the terms and conditions of the financing;

 
·
our financial position and results of operations;

 
·
period-to-period fluctuations in our operating results;

 
·
changes in estimates of our performance by any securities analysts;

 
·
substantial sales of our common stock pursuant to Rule 144 or otherwise;

 
·
new regulatory requirements and changes in the existing regulatory environment;

 
·
the issuance of new equity securities in a future offering;
 
30

 
 
·
changes in interest rates; and

 
·
general economic, monetary and other national conditions, particularly in the U.S. and China.

The trading market in our common stock is limited and illiquid and may cause volatility in the market price.
 
As of June 30, 2009, 67%, or 31,013,715 shares, of our issued and outstanding common stock were owned by non-affiliates, and 31,098,819 of our issued and outstanding common stock were unrestricted and free to trade. The market price for our common stock is subject to volatility and holders of common stock may be unable to resell their shares at or near their original purchase price or at any price. In the absence of an active trading market:

 
·
investors may have difficulty buying and selling;

 
·
market visibility for our common stock may be limited; and

 
·
a lack of visibility for our common stock may have a depressive effect on the market for our common stock.
 
One stockholder, who is our Chief Executive Officer, exercises significant control over matters requiring shareholder approval.
 
Wo Hing Li, our Chief Executive Officer, had voting power as of June 30, 2009 equal to approximately 33% of our voting securities. As a result, Wo Hing Li, through such stock ownership, exercises significant control over all matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership in Wo Hing Li may also have the effect of delaying or preventing a change in control or other transactions that may otherwise be viewed as beneficial by shareholders other than Wo Hing Li.

We may be required to raise additional financing by issuing new securities with terms or rights superior to those of our shares of common stock, which could adversely affect the market price of our shares of common stock.
 
We may require additional financing to fund future operations, develop and exploit existing and new products and to expand into new markets. We may not be able to obtain financing on favorable terms, if at all. If we raise additional funds by issuing equity securities, the percentage ownership of our current shareholders will be reduced, and the holders of the new equity securities may have rights superior to those of the holders of shares of common stock, which could adversely affect the market price and the voting power of shares of our common stock. If we raise additional funds by issuing debt securities, the holders of these debt securities would similarly have some rights senior to those of the holders of shares of common stock, and the terms of these debt securities could impose restrictions on operations and create a significant interest expense for us.
 
We do not intend to pay dividends for the foreseeable future.

For the foreseeable future, we intend to retain any earnings to finance the development and expansion of our business, and we do not anticipate paying any cash dividends on our common stock. Accordingly, investors must be prepared to rely on sales of their common stock after price appreciation to earn an investment return, which may never occur. Investors seeking cash dividends should not purchase our common stock. Any determination to pay dividends in the future will be made at the discretion of our board of directors and will depend on our results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law and other factors our board deems relevant.
 
31


ITEM 1B.
UNRESOLVED STAFF COMMENTS.

Not Applicable.

ITEM 2.
PROPERTIES.

All land in China is owned by the State. Individuals and companies are permitted to acquire rights to use land or land use rights for specific purposes. In the case of land used for industrial purposes, the land use rights are granted for a period of 50 years.  This period may be renewed at the expiration of the initial and any subsequent terms. Granted land use rights are transferable and may be used as security for borrowings and other obligations.

We currently have land use rights to approximately 48.38 acres consisting of manufacturing facilities, warehouse and office buildings in Shanghai, China. The chart below lists all facilities owned by us.

Location
 
Type of Facility
 
Size of Land (acre)
Jiading District, Shanghai
 
Manufacturing facilities, warehouse and office buildings
 
21.34
Jiading District, Shanghai
 
Manufacturing facilities
 
27.04

In October 2004, Tuorong agreed to purchase a land use right from the Shanghai Labor and Economic Development Council with respect to a 20-acre parcel for a lease period of 50 years at a cost of $472,441. Additionally in November 2005, Chengtong agreed to purchase a land use right from the Shanghai Xuhang Industrial Development Co., Ltd. with respect to a 27.04-acre parcel for a lease period of 50 years at a cost of $497,795. In November 2006, Chengtong entered into an agreement with the Shanghai Labor and Economic Development Council which supersedes the aforementioned Tuorong agreement to purchase a total of 21.34-acre parcel for a lease period of 50 years at an aggregate amount of $672,126. In December 2006, Tuorong entered into a Compensation Agreement with the Shanghai Jiading Housing, Land and Resource Management Bureau to pay an aggregate amount of $637,294 in connection to the two aforementioned parcels.

ITEM 3.
LEGAL PROCEEDINGS.

From time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business.  However, litigation is subject to inherent uncertainties and an adverse result in these or other matters may arise from time to time that may harm our business.  We are currently not aware of any such legal proceedings or claims that we believe will have a material adverse affect on our business, financial condition or operating results.

ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

On June 16, 2009, we held an annual meeting at which a majority of our stockholders elected six directors and approved the ratification of Moore Stephens, Certified Public Accounts as our independent accountants for fiscal year 2009.
 
The following table sets forth the matters voted upon at the annual meeting and the results of the voting on each matter voted upon:
 
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Matter Voted Upon
 
Votes For
 
Withheld
 
Votes
Against
 
Abstentions
 
Broker
Non-Votes
Election of Wo Hing Li to Board of Directors
 
23,727,537
 
-
 
49,939
 
-
 
-
Election of Tung Kuen Tsui to Board of Directors
 
24,067,151
 
-
 
110,325
 
-
 
-
Election of David Peter Wong to Board of Directors
 
24,065,085
 
-
 
112,391
 
-
 
-
Election of Che Kin Lui to Board of Directors
 
24,063,082
 
-
 
114,394
 
-
 
-
Election of Hai Sheng Chen to Board of Directors
 
23,723,122
 
-
 
454,354
 
-
 
-
Election of Daniel Carlson to Board of Directors
 
23,731,295
 
-
 
446,181
 
-
 
-
Approval of Moore Stephens, Certified Public Accounts as the Company’s independent accountants for fiscal year 2009
 
24,112,726
 
-
 
44,538
 
-
 
-

Each of the above matters was approved by the stockholders at the annual meeting.

PART II
 
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Market Information

Our Common Stock has been trading on the NASDAQ Capital Market under the symbol “CPSL” since December 29, 2006 and was previously trading on that market under the symbol “OLAB.”  The CUSIP number for our common stock is 16941J106.

The following table sets forth, for the periods indicated, the available high and low closing prices for our common stock. Prices reflect inter-dealer prices, without retail mark-up, mark-down or commissions and may not represent actual transactions.

   
Closing Prices (1)
 
   
High
   
Low
 
Fiscal Year Ended June 30, 2009
           
1st Quarter
  $ 5.49     $ 0.86  
2nd Quarter
  $ 3.14     $ 0.95  
3rd Quarter
  $ 1.80     $ 0.86  
4th Quarter
  $ 3.24     $ 1.20  
Fiscal Year Ended June 30, 2008
               
1st Quarter
  $ 12.65     $ 2.81  
2nd Quarter
  $ 11.45     $ 4.20  
3rd Quarter
  $ 6.22     $ 3.30  
4th Quarter
  $ 8.48     $ 3.50  

(1) The above tables set forth the range of high and low closing prices per share of our common stock as reported by www.quotemedia.com for the periods indicated.

Approximate Number of Holders of Our Common Stock

As of June 30, 2009, there were approximately 863 stockholders of record of our common stock. The number of record holders does not include persons who held our common stock in nominee or “street name” accounts through brokers.
 
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Dividends

We have never declared or paid a cash dividend.  Any future decisions regarding dividends will be made by our board of directors.  We currently intend to retain and use any future earnings for the development and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future.  Our board of directors has complete discretion on whether to pay dividends, subject to the approval of our stockholders.  Even if our board of directors decides to pay dividends, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant.

Securities Authorized for Issuance Under Equity Compensation Plans

The information required by the item relating to “Securities Authorized for Issuance Under Equity Compensation Plans” is set forth under that heading in Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” and is incorporated herein by reference.

Stock Performance Graph

The following graph provides a comparison of the cumulative total return on our common stock for the period beginning at the market close on June 30, 2004, through and including June 30, 2009, with the cumulative total return for (i) the Nasdaq Stock Market (U.S. Companies) Index (the “Nasdaq Index”) and (ii) a peer group selected by us that consists of companies with a similar line-of-business and in the same industry. These companies are Steel Dynamics, Tarpon Industries, Arcelor Mittel, Nucor Corp., and Olympic Steel (the “Peer Index”). Total return values were calculated based on cumulative total return assuming the investment, on June 30, 2004, of $100 in each of our Common Stock, the NASDAQ Index and the Peer Index and are based on share prices plus any dividends paid in cash, with the dividends reinvested on the date they were paid. The calculations exclude trading commissions and taxes. Cumulative total returns for the period beginning at the market close on June 30, 2004, through and including December 28, 2006, relate to our prior operations under our former name of OraLabs Holding Corp. We do not believe that such historical information prior to December 28, 2006 is relevant to our continuing operations and is not necessarily indicative of the results to be expected for any future period. On December 29, 2006, our Common Stock began trading under the symbol “CPSL”.
 
 
34


The information contained in this Item 5 of this Annual Report on Form 10-K under “Stock Performance Graph” is not deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C under the Exchange Act or to the liabilities of Section 18 of the Exchange Act, and will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent we specifically incorporate it by reference into such a filing.

Recent Sales of Unregistered Securities

We have not sold any equity securities during the fiscal year ended June 30, 2009 that were not previously disclosed in a quarterly report on Form 10-Q or a current report on Form 8-K that was filed during the 2009 fiscal year.

Purchases of Equity Securities

No repurchases of our common stock were made during the fourth quarter of our fiscal year ended June 30, 2009.

ITEM 6.
SELECTED FINANCIAL DATA.

Selected consolidated financial data are set forth below as of June 30, 2009 and for the years ended June 30, 2009, 2008, 2007, 2006 and 2005 and should be read in conjunction with our audited consolidated financial statements and related notes thereto, and with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”  In conjunction with the consummation of the Stock Exchange Agreement on December 28, 2006, we changed our fiscal year from December 31 to June 30. The historical data presented below and in our historical consolidated financial statement is not necessarily indicative of the results to be expected for any future period.

The scope of our continuing business is substantially different from that conducted by us prior to January 1, 2007. You should not view our historical consolidated financial statements or the financial data derived therefrom as predictive of our future financial position or results of operations.

   
Fiscal Year Ended June 30,
 
   
2009
   
2008
   
2007
   
2006
   
2005
 
Statement of Operations Data
                             
Sales revenues
    76,281       87,739       53,960       34,881       53,145  
Cost of goods sold
    68,549       65,242       38,926       24,892       45,562  
Gross profit
    7,732       22,497       15,034       9,989       7,583  
Net (loss)/income before discontinued operations
    (408 )     18,583       7,473       7,514       6,366  
Net income/(loss) from discontinued operations
    -       -       831       900       (341 )
Net (loss)/income
    (408 )     18,583       8,304       8,415       6,026  
(Loss)/earnings per share from continuing operations
                                       
Basic
    (0.01 )     0.43       0.26       0.31       0.26  
Diluted
    (0.01 )     0.43       0.26       0.31       0.26  
Income/(loss) per share from discontinued operations
                                       
Basic
    -       -       0.03       0.04       (0.01 )
Diluted
    -       -       0.03       0.04       (0.01 )
Net (loss)/income per share
                                       
Basic
    (0.01 )     0.43       0.29       0.35       0.25  
Diluted
    (0.01 )     0.43       0.29       0.35       0.25  
Shares used in per share calculation
                                       
Basic
    46,561,229       43,044,420       28,438,313       24,283,725       24,283,725  
Diluted
    46,561,229       43,256,434       28,759,553       24,283,725       24,283,725  
                                         
Balance Sheet Data (at year end)
                                       
Current assets
    84,032       108,134       41,339       23,154       13,028  
Total assets
    163,409       165,535       82,158       45,571       25,489  
Working Capital
    41,226       62,905       14,574       (7,584 )     (1,326 )
Long-term debt
    -       -       6,878       3,152       7,713  
Total Stockholder’s equity
    120,603       120,306       51,105       11,681       3,421  
 
35


ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following management’s discussion and analysis should be read in conjunction with our financial statements and the notes thereto and the other financial information appearing elsewhere in this report. In addition to historical information, the following discussion contains certain forward-looking information. See “Special Note Regarding Forward Looking Statements” above for certain information concerning those forward looking statements. Our financial statements are prepared in U.S. dollars and in accordance with U.S. GAAP.

Introduction
 
Management’s 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 Company’s Business - This section provides a general description of the Group’s business, as well as recent developments that have either occurred during the fiscal year ended June 30, 2009 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 fiscal year ended June 30, 2009. 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 Group’s cash flows for the fiscal year ended June 30, 2009. Included in this section is a discussion of the Group’s outstanding debt and the financial capacity available to fund the Group’s future commitments and obligations.

Overview of Our 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 and slitting of medium and high-carbon hot-rolled steel strips. We use commodity steel to create a high value-added specialty premium steel. 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 and slitting of medium and high-carbon hot-rolled steel strips not exceeding 7.5 mm thickness. 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, steel roofing, plane friction discs, appliances, food packaging materials, saw blades, textile needles, and microelectronics.
 
36


We conduct our operations principally in the PRC through our wholly-owned operating subsidiaries, Chengtong and Shanghai Blessford, which are wholly owned subsidiaries of our direct subsidiary, PSHL. Our products are sold domestically in China as well as in overseas markets such as Thailand, Nigeria and Ethiopia. We intend to further expand into additional overseas markets in the future, subject to suitable market conditions and favorable regulatory controls.

Fiscal 2009 Financial Performance Highlights

During the 2009 fiscal year, we saw slower demand and lower steel prices compared to last year as a result of the impact of the persisting global crisis. There were decreases in order and sales volume over the year as we are faced with multiple challenges due to the global economic downturn. We have seen weaker demands and reduced orders from existing customers, especially in the high-carbon cold-rolled steel segment, which are mainly used in auto components manufacturing, due to excess capacity and high inventory levels in the industry. Excess capacity, low industrial concentration and a lack of access to natural resources have long plagued China’s steel sector, and these problems have been exacerbated by the impact of the global financial and economic crisis.  Our two cold-rolling mills are now operating at approximately 70% utilization rate due to reduced orders on hand.

During the fiscal year ended June 30, 2009, we sold a total of 84,001 tons of products, a decrease of 5,121 tons from 89,122 tons a year ago, due to slower demand and reduced orders on hand. We believe that such decrease was mainly caused by decreases in product orders from auto components manufacturers and from the Chinese auto industry that experienced weak demand and excess capacity during the year ended June 30, 2009. Lower sales and high raw material costs have led to a gross profit of $7,732,195 and a net loss of $408,338 for the fiscal year ended June 30, 2009.

The RMB400 billion economic stimulus package formulated jointly by the Chinese government’s National Development and Reform Commission and the Ministry of Industry and Information Technology in November 2008 is now planned to focus mainly on nine pillar industries, which include steel, automobiles, shipbuilding, petrochemicals, light industry, textiles, non-ferrous metals, machinery, and information technology, all with serious production surpluses in the whole industrial system. Automobiles and steel sectors have been given priority and are the two main industries out of the nine pillars for which the government is expected to announce specific support packages and further details. On January 14, 2009, China’s State Council approved a “rejuvenation plan” to support the steel industry, with the immediate aim to deal with the effects of the global financial and economic crisis and to also ease the industry’s long-term structural problems. The steel industry plan includes eliminating obsolete capacity, speeding up innovation, promoting alliances and mergers and cutting export tariffs. The government will also subsidize loans of about RMB15 billion to encourage technological upgrading and product rationalization to better meet demand.

Although the series of measures adopted by the Chinese government to promote economic growth have achieved some results, it is currently unclear whether and to what extent the economic stimulus measures and other actions taken or contemplated by the Chinese government and other governments throughout the world will mitigate the effects of the crisis on the industries that affect our business. We expect to continue to experience volatilities in demands in both domestic and international markets in the foreseeable future. Furthermore, deteriorating economic conditions, including business layoffs, downsizing, industry slowdowns and other similar factors that affect our customers could have further negative consequences on our business operations.  For the foreseeable future, we expect a continuation of weak demand and volatility in both domestic and international markets across all product segments, and significantly adverse impacts on our gross margin due to a decrease in sales of our high margin high carbon cold rolled steel used mainly in auto components manufacturing.  However, due to the nature of our niche segment and high-end products, we have been able to keep quality customers and negotiate new contracts with a total of 123 new customers during the year. Management continues to be in talks with potential customers whose past orders we had been unable to fill due to full capacity.  If these talks are successful, we could see additional sales from a broadened customer base which would further mitigate the impact of the current global slowdown on our business and results of operations. Total company backlog as of June 30, 2009 was $9,278,675.
 
37


We also continue to take appropriate actions to perform business and credit reviews of customers and suppliers and reduce exposure by avoiding entry into contracts with countries or customers with high credit risks. We strive to optimize our product mix, prioritize higher margin products, and strengthen collection of accounts receivable in the existing business environment with the goal to maintain overall healthy sales volume, margins and cash positions. We believe that there are high barriers to entry in the Chinese domestic precision cold-rolled steel industry because of the level of technology expertise required for operation. Although we continue to face volatilities in demand and overall steel industry, the medium to long term prospects remain highly optimistic and we believe that our unique capabilities and know-how give us a competitive advantage to grow sales and build a globally recognized brand as we continue to carry out R&D and expand to new segments, customers and markets.

The following are some financial highlights for the 2009 fiscal year:

 
·
Revenues: Our revenues were approximately $76.3 million for the 2009 fiscal year, a decrease of 13.1% from last year.

 
·
Gross Margin: Gross margin was 10.1% for the 2009 fiscal year, as compared to 25.6% in 2008.

 
·
Income/(loss) from operations before tax: Loss from operations before tax was approximately $0.4 million for the 2009 fiscal year, as compared to income from operations before tax of $19.2 million last year.

 
·
Net Income/(loss): Net loss was approximately $0.4 million for the 2009 fiscal year, a decrease of 102.2% from a net income of approximately $18.6 million last year.

 
·
Fully diluted Income/(loss) per share: Fully diluted loss per share was $0.01 for the 2009 fiscal year compared to a fully diluted earnings per share of $0.43 last year.
 
Taxation

United States
 
China Precision Steel, Inc. is incorporated in the State of Delaware and is subject the tax laws of United States at a tax rate of 34%. No provision for income taxes in the United States has been made as China Precision Steel, Inc. incurred no taxable income for federal tax purposes. In addition, no deferred tax on undistributed earnings of its non-U.S. subsidiaries was provided, as it is our current policy to reinvest these earnings in non-U.S. operations.
 
British Virgin Islands
 
PSHL and Blessford International were incorporated in the BVI, and, under the current laws of the BVI, are not subject to income taxes.
 
PRC
 
On March 16, 2007, the National People’s Congress of China passed The Enterprise Income Tax Law, or the New EIT Law,, and on December 6, 2007, the State Council of China passed the Implementing Rules for the EIT Law, or the Implementing Rules, which took effect on January 1, 2008. The New EIT Law and Implementing Rules impose a unified enterprise income tax, or EIT, of 25% on all domestic-invested enterprises and foreign invested entities, or FIEs, unless they qualify under certain limited exceptions. Therefore, nearly all FIEs are subject to the new tax rate alongside other domestic businesses rather than benefiting from the old FIE tax laws, and its associated preferential tax treatments, beginning January 1, 2008.

The New EIT Law gives the FIEs established before March 16, 2007, or Old FIEs, a five-year grandfather period during which they can continue to enjoy their existing preferential tax treatment. During this five-year grandfather period, the Old FIEs which enjoyed tax rates lower than 25% under the original tax law shall gradually increase their enterprise income tax rate by 2% per year until the tax rate reaches 25%.  In addition, the Old FIEs that are eligible for the “two-year exemption and three-year half reduction” or “five-year exemption and five-year half-reduction” under the original tax law, are allowed to remain to enjoy their preference until these holidays expire.
 
38

Chengtong has been entitled to preferential tax advantages in China, including full tax exemption on the enterprise income tax that was generated in the first two years after the recoveries of previous losses and a one-half reduction in the prevailing enterprise income tax rate for the next 3 years. The full tax exemption for the enterprise income tax expired on December 31, 2005 and the right to a one-half reduction on the enterprise income tax expired on December 31, 2008.  Chengtong is therefore subject to the 25% income tax rate from January 1, 2009.

Shanghai Blessford has also been entitled to preferential tax advantages in China, including full tax exemption on the enterprise income tax that was generated in the first two years after the recoveries of previous losses and a one-half reduction in the prevailing enterprise income tax rate for the next 3 years. The full tax exemption for the enterprise income tax will expire on December 31, 2009 and the right to a one-half reduction on the enterprise income tax will expire on December 31, 2012.  Shanghai Blessford will therefore be subject to 12.5% or one-half of the prevailing tax rate from December 31, 2009 until December 31, 2012.

Substantially all of our income may be derived from dividends we receive from our PRC operating subsidiaries described above.  The New EIT Law and its Implementing Rules generally provide that a 10% withholding tax applies to China-sourced income derived by non-resident enterprises for PRC enterprise income tax purposes.  We expect that such 10% withholding tax will apply to dividends paid to us by our PRC subsidiaries, but this treatment will depend on our status as a non-resident enterprise.  For detailed discussion of PRC tax issues related to resident enterprise status, see “Risk Factors — Risks Related to Doing Business in China — Under the New EIT Law, we may be classified as a “resident enterprise” of China.  Such classification will likely result in unfavorable tax consequences to us and our non-PRC shareholders.”

Results of Operations

The following table sets forth key components of our results of operations for the years ended June 30, 2009, 2008 and 2007 and as a percentage of revenues.
 
(All amounts in U.S. dollars)

   
2009
   
2008
   
2007
 
   
Amount
   
% of
Revenues
   
Amount
   
% of
Revenues
   
Amount
   
% of
Revenues
 
Revenues
    76,281,621       100.0 %     87,739,326       100.0 %     53,960,243       100.0 %
Cost of sales (including depreciation and amortization)
  $ 68,549,426       89.9 %   $ 65,241,825       74.4 %   $ 38,925,987       72.1 %
Gross profit
    7,732,195       10.1 %     22,497,501       25.6 %     15,034,256       27.9 %
Selling and marketing
    1,679,283       2.2 %     608,060       0.7 %     245,695       0.5 %
Administrative expenses
    2,238,088       2.9 %     2,758,536       3.1 %     1,863,994       3.5 %
Allowance for bad and doubtful debts
    3,831,478       5.0 %     686,955       0.8 %     3,775,645       7.0 %
Depreciation and amortization
    196,793       0.3 %     64,253       0.1 %     44,375       0.1 %
(Loss)/Income from continuing operations
    (213,447 )     (0.3 )%     18,379,697       20.9 %     9,104,547       16.9 %
Other income
    1,397,258       1.8 %     2,006,777       2.3 %     103,388       0.2 %
Interest and finance costs
    (1,228,665 )     (1.6 ) %     (1,231,040 )     (1.4 )%     (312,222 )     (0.6 )%
Income/(loss) from continuing operations before income taxes
    (44,854 )     (0.1 )%     19,155,434       21.8 %     8,894,351       16.5 %
Income taxes
    (363,484 )     0.5 %     572,323       0.7 %     1,421,690       2.6 %
Net income/(loss) before discontinued operations
    (408,338 )     (0.5 )%     18,583,111       21.2 %     7,472,661       13.9 %
Net income from discontinued operations
                                831,448       1.5 %
Net (loss)/income
  $ (408,338 )   $ (0.5 )%   $ 18,583,111     $ 21.2 %   $ (8,304,109 )   $ 15.4 %
Basic earnings/(loss) per share
                                               
From continuing operations
  $ (0.01 )           $ 0.43             $ 0.26          
From discontinued operations
  $ 0.00             $ 0.00             $ 0.03          
Total
  $ (0.01 )           $ 0.43             $ 0.29          
Diluted earnings/(loss) per share
                                               
From continuing operations
  $ (0.01 )           $ 0.43             $ 0.26          
From discontinued operations
  $ 0.00             $ 0.00             $ 0.03          
Total
  $ (0.01 )           $ 0.43             $ 0.29          

 
39

 

Fiscal Year Ended June 30, 2009 Compared to Fiscal Year Ended June 30, 2008
 
Sales Revenues. Sales volume decreased by 5,121 tons, or 5.7%, year-on-year to 84,001 tons for the year ended June 30, 2009 from 89,122 tons for the year ended June 30, 2008 and, as a result, sales revenues decreased by $11,457,705, or 13.1%, year-on-year to $76,281,621 for the year ended June 30, 2009 from $87,739,326 for the year ended June 30, 2008. The decrease in sales revenues is mainly attributable to a decrease in demand for high-carbon cold-rolled products used in automobile components production due to the slowdown of the automobile industry, as well as lower average sale prices during the year ended June 30, 2009.
 
Sales by Product Line 

A break-down of our sales by product line for the years ended June 30, 2009 and 2008 is as follows:

   
2009
   
2008
   
Year-on-Year
 
Product Category
 
Quantity
(tons)
   
$ Amount
   
% of
Sales
   
Quantity
(tons)
   
$ Amount
   
% of
Sales
   
Qty.
Variance
 
Low carbon hard rolled
    21,009       21,051,186       28       18,612       15,959,415       18       2,397  
Low carbon cold-rolled
    38,526       29,774,589       39       35,163       27,497,894       32       3,363  
High-carbon hot-rolled
    5,499       5,487,958       7       6,790       6,291,036       7       (1,291  
High-carbon cold-rolled
    7,755       11,305,674       15       17,754       29,029,418       33       (9,999  
Subcontracting income
    11,212       6,392,815       8       10,803       6,425,008       7       409  
Sales of scrap metal
    -       2,269,399       3       -       2,536,555       3       -  
Total
    84,001       76,281,621       100       89,122       87,739,326       100       (5,121  

There were different trends of demand across various product categories during the year ended June 30, 2009. High-carbon cold-rolled steel products only accounted for 15% of the current sales mix at an average selling price of $1,458 per ton for the year ended June 30, 2009, compared to 33 % of the sales mix at an average selling price per ton of $1,635 for the year ended June 30, 2008. This was a result of the slow down of the automobile industry as a large quantity of the products in this category is sold to automobile components manufacturers. Low-carbon cold-rolled steel products accounted for 39% of the current sales mix at an average selling price of $773 per ton for the year ended June 30, 2009, compared to 32% of the sales mix at an average selling price per ton of $782 for the year ended June 30, 2008. Low-carbon hard-rolled steel products accounted for 28% of the current sales mix at an average selling price of $1,002 per ton for the year ended June 30, 2009, compared to 18% of the sales mix at an average selling price per ton of $857 for the year ended June 30, 2008.  Subcontracting income revenues decreased slightly to $6,392,815, or 8%, of the sales mix for the year ended June 30, 2009 as compared to $6,425,008, or 7%, of the sales mix during the year ended June 20, 2008.

 
40

 

   
2009
   
2008
   
Variance
 
Average Selling Prices
 
($)
   
($)
   
($)
   
(%)
 
Low-carbon hard rolled
    1,002       857       145       17  
Low-carbon cold-rolled
    773       782       (9 )     (1 )
High-carbon hot-rolled
    998       927       71       8  
High-carbon cold-rolled
    1,458       1,635       (177 )     (11 )
Subcontracting income
    570       595       (25       (4  

The average selling price per ton decreased to $908 for the year ended June 30, 2009, compared to the corresponding year in 2008 of $984, representing a decrease of $76, or 7.8%, year-on-year. This decrease was mainly due to decreases in steel prices and therefore selling prices due to volatilities in the industry, as well as a decrease in percentage of high-carbon cold rolled steel products during the year.  High-carbon cold-rolled steel products have the highest selling prices among all product categories, and only accounted for 15% of the current sales mix, compared to 33% of the sales mix year-on-year.  There was also been a decrease in the average selling price of high-carbon cold-rolled steel products to $1,458 per ton for the year ended June 30, 2009, from $1,635 for the year ended June 30, 2008.

Sales Breakdown by Major Customer

   
2009
   
2008
 
Customers
 
$
   
% of Sales
   
$
   
% of Sales
 
Salzgitter Mannesmann International GMBH
    14,275,799       19       *       *  
Shanghai Changshuo Stainless Steel Co., Ltd.
    10,999,692       14       18,513,819       21  
Shanghai Shengdejia Metal Co., Ltd
    4,827,675       6       10,414,545       12  
Zhangjiagang Gangxing Innovative Construction Material Co., Ltd.
    4,413,512       6       *       *  
Unimax and Far Corporation
    3,777,196       5       7,695,294       9  
Shanghai Bayou Industrial Co., Ltd.
    *       *       10,494,752       12  
Baosteel Steel Products Trading Co., Ltd.
    *       *       6,758,976       8  
      38,293,874       50       53,877,386       62  
Others
    37,987,747       50       33,861,940       38  
Total
    76,281,621       100       87,739,326       100  
 
* Not major customers for the relevant years

Sales revenues generated from our top five major customers as a percentage of total sales decreased to 50% for the year ended June 30, 2009, compared to 62% for the year ended June 30, 2008. Sales to two new major customers, Salzgitter Mannesmann International GMBH and Shanghai Changshuo Stainless Steel Co., Ltd., for the year accounted for 33% of our sales revenues. The change in customer mix reflects management’s continuous efforts in expanding our customer base and geographical coverage during the course of the year.
 
Cost of Goods Sold. Cost of sales increased by $3,307,601, or 5.1%, year-on-year to $68,549,426 for the year ended June 30, 2009, from $65,241,825 for the year ended June 30, 2008. Cost of sales represented 89.9% of sales revenues for the year ended June 30, 2009 compared to 74.4% for the year ended June 30, 2008. Average cost of production per ton increased to $816 for the year ended June 30, 2009, compared to an average cost of production per ton of $732 for the year ended June 30, 2008,  representing an increase of $84 per ton, or 11.5%, year-on-year. 

 
41

 

   
2009
   
2008
   
Variance
 
   
($)
   
($)
   
($)
   
(%)
 
Cost of goods sold
                       
- Raw materials
    57,401,094       57,019,804       381,290       1  
- Direct labor
    1,205,070       946,770       258,300       27  
- Manufacturing overhead
    9,943,262       7,275,251       2,668,011       37  
      68,549,426       65,241,825       3,307,601       5  
                                 
Cost per unit sold
                               
Total units sold (tons)
    84,001       89,122       (5,121 )     (6 )
Average cost per unit sold ($/ton)
    816       732       84       11  

The increase in cost of sales is represented by the combined effect of:

 
·
an increase in cost of raw materials per unit sold of $43, or 6.7%, from $640 for the year ended June 30, 2008 compared  to $683 for the year ended June 30, 2009;

 
·
an increase in direct labor per unit sold of $3, or 27.3%, from $11 for the year ended June 30, 2008 compared to $14 for the year ended June 30, 2009;          

 
·
an increase in factory overhead per unit sold of $36, or 43.9%, from $82 for the year ended June 30, 2008 compared to $118 for the year ended June 30, 2009.

The cost of raw materials consumed increased by $381,290, or 0.7%, year-on-year, to $57,401,094 for the year ended June 30, 2009 from $57,019,804 for the year ended June 30, 2008. This increase was mainly due to increases in raw material prices year-on-year, offset by decrease in total units sold.

Direct labor costs increased by $258,300, or 27.3%, year-on-year, to $1,205,070 for the year ended June 30, 2009, from $946,770 for the year ended June 30, 2008. The increase was due to increases in wages during the year following the lifting of the minimum monthly wage in Shanghai, as well as increases in related pension costs resulting from the additional base wages.
 
Manufacturing overhead costs increased by $2,668,011, or 36.7%, year-on-year, to $9,943,262 for the year ended June 30, 2009, from $7,275,251 for the year ended June 30, 2008. The increase was mainly attributable to the combined effect of an increase in depreciation of $1,529,348, or 75.8%, year-on-year to $3,547,453 for the year ended June 30, 2009, from $2,018,105 for the year ended June 30, 2008, an increase in utilities of $538,415, or 21.8%, year-on-year to $3,005,366 for the year ended June 30, 2009, from $2,466,951 for the year ended June 30, 2008 due to increased consumption of natural gas associated with the production of 2,397 additional tons of low carbon hard rolled steel year-on-year, and an increase in low consumables by $967,693, or 52.3%, year-on-year to $2,816,436 for the year ended June 30, 2009, from $1,848,743 for the year ended June 30, 2008.

Gross Profit. Gross profit in absolute terms decreased by $14,765,306, or 65.6%, year-on-year, to $7,732,195 for the year ended June 30, 2009, from $22,497,501 for the year ended June 30, 2008, while gross profit margin decreased to 10.1% for the year ended June 30, 2009, from 25.6% for the year ended June 30, 2008. The decrease in gross profit is mainly attributable to a 13.1% year-on-year decrease in sales revenues, as well as a 5.1% year-on-year increase in cost of goods sold. The decrease in gross profit margin principally resulted from the higher cost per ton sold of raw materials as we are taking down raw materials from inventories we purchased some time ago at higher prices during restricted supplies, as well as a decrease in average selling prices due to the decrease in steel prices during the 2009 fiscal year.

Selling Expenses. Selling expenses increased by $1,071,223, or 176.2%, year-on-year, to $1,679,283 for the year ended June 30, 2009 compared to the corresponding year in 2008 of $608,060. The increase was mainly attributable to increases in sales commission paid to export agents based on increased tonnage exported during the year, and transportation and custom clearing charges in relation to such export sales year-on-year. Our export precision products, the low carbon hard-rolled steel, accounted for $21,051,186, or 28%, of the sales mix for the year ended June 30, 2009, compared to $15,959,415, or 18% of sales during the year ended June 30, 2008. 

 
42

 

Administrative Expenses.  Administrative expenses decreased by $520,448, or 18.9%, year-on-year, to $2,238,088 for the year ended June 30, 2009 compared to $2,758,536 for the year ended June 30, 2008. This decrease was chiefly associated with lower SEC compliance costs and professional fees as there was no financing activity during the year ended June 30, 2009 and lower legal and advisory fees as we become more familiar with the rules and regulations as a listed company. 

Provision for bad debt. Provision for bad debt increased by $3,144,523, or 457.7%, year-on-year, because of bad debt expense in the amount of $3,831,478 recognized during the year. This charge reflects a provision for doubtful accounts due to a dispute between the Company and one of our customers regarding a special stainless steel product processed by the Company and delivered to the customer during the third and fourth quarters of the year ended June 30, 2008. Revenues for these products were initially recognized as services had been rendered and goods had been delivered in accordance to the terms of the contract, collectability was reasonably assured and management had no reason to believe that the customer would object to the goods and services provided.  However, in the months following such delivery, a dispute arose during the use of such products by the customer, which was followed by discussions between the Company and the customer regarding the technical aspects of the products and the possibility of reprocessing. After a few rounds of negotiation with the customer regarding the products and payment, our management determined that this accounts receivable was uncollectible. The Company does not have any other accounts receivable related to this product.

Income from Operations. Income from operations before income tax decreased by $18,593,144, or 101.2%, year-on-year to a loss of $213,447 for the year ended June 30, 2009 from income of $18,379,697 for the year ended June 30, 2008, as a result of the factors discussed above.

Other revenues.  Our other income decreased $609,519, or 30.4%, to $1,397,258 for the year ended June 30, 2009 from $2,006,777 for the year ended June 30, 2008.  As a percentage of revenues, other income decreased to 1.8% for the year ended June 30, 2009 from 2.3% for the year ended June 30, 2008. Such percentage decrease in other income was primarily due to lower cash balances and decrease in interest rate year-on-year.

Interest Expense.  Total interest expense decreased $2,375, or 0.2%, to $1,228,665 for the year ended June 30, 2009, from $1,231,040 for the year ended June 30, 2008 due to an increase in loan balances offset by a lower weighted average interest rate year-on-year.

Income Tax. For the year ended June 30, 2009, we recognized income tax expense of $363,484, compared to an income tax expense of $572,323 for the year ended June 30, 2008. Other than a lower income from operations year-on-year, the income tax expense for the year ended June 30, 2008 reflects a reversal of deferred tax liabilities in the amount of $1,064,028 which had substantially decreased the total income tax expense for the year.

Net Income(loss). Net income decreased by $18,991,449, or 102.2%, year-on-year, to a net loss of $408,338 for the year ended June 30, 2009 from net income of $18,583,111 for the year ended June 30, 2008. The decrease in net income is attributable to a combination of factors discussed above, including a decrease in tons of goods sold due to weakened demand amid the current global economic downturn, which in turn led to a decrease in sales revenue, and lower average selling prices year-on-year.  The decrease in net income is also attributable to a decrease in gross margin, largely due to higher raw material costs and the recognition of a $3,831,478 bad debt expense for the year ended June 30, 2009.

Fiscal Year Ended June 30, 2008 Compared to Fiscal Year Ended June 30, 2007

Sales Revenues. Sales volume increased by 22,101 tons, or 33%, year-on-year to 89,122 tons for the year ended June 30, 2008 from 67,021 tons for the year ended June 30, 2007 and, as a result, sales revenues increased by $33,779,083, or 62.6%, year-on-year to $87,739,326 for the year ended June 30, 2008 from $53,960,243 for the year ended June 30, 2007. We believe that the increases in sales and sales revenues are a direct result of increases in our capacity and the building of our brand both in China and overseas among users of cold-rolled precision steel products.

 
43

 

Average cost per unit sold increased to $732 for the year ended June 30, 2008, compared to an average cost per unit sold of $581 for the year ended June 30, 2007, representing an increase of $151 per ton, or 26%, year-on-year. The increase in average cost per unit sold is mainly attributable to the increase in raw material prices.

Sales by Product Line. A break-down of our sales by product line for the years ended June 30, 2008 and 2007 is as follows:

   
2008
   
2007
   
Year-on-Year
 
Product Category
 
Quantity
(tons)
   
$ Amount
   
% of
Sales
   
Quantity
(tons)
   
$ Amount
   
% of
Sales
   
Qty.
Variance
 
Low carbon cold-rolled
    35,163       27,497,894       32       37,066       22,072,438       41       (1,903 )
Low carbon acid wash
    -       -       -       14       5,732       -       (14 )
Low carbon hard rolled
    18,612       15,959,415       18       1,149       782,835       1       17,463  
High-carbon cold-rolled
    17,754       29,029,418       33       5,287       5,529,717       10       12,467  
High-carbon hot-rolled
    6,790       6,291,036       7       11,918       9,176,414       17       (5,128  
High end cold-rolled
    -       -       -       865       14,618,831       27       (865 )
Sales of Scrap Metal
    -       2,536,555       3       -       851,742       2       -  
Subcontracting income
    10,803       6,425,008       7       10,722       922,534       2       81  
Total
    89,122       87,739,326       100       67,021       53,960,243       100       22,101  
 
There were various changes in the break-down of sales among our product categories over the year ended June 30, 2008 as we have been ramping up the capacity of the second mill since October 2006 and are in the process of developing new products and new markets. High-carbon cold-rolled steel products accounted for 33% of the sales mix at an average selling price of $1,635 per ton for the year ended June 30, 2008 compared to 10% of the sales mix at an average selling price per ton of $1,046 for the year ended June 30, 2007, as we continued to see our customers of the high-carbon hot-rolled products switch to the high-carbon cold-rolled products. The low-carbon cold-rolled steel products accounted for 32% of the sales mix at an average selling price of $782 per ton for the year ended June 30, 2008 compared to 41% of the sales mix at an average selling price per ton of $595 for the year ended June 30, 2007. This is a result of increased production of the low carbon hard rolled steel category, which is our exported precision steel product, from 1% of sales during the year ended June 30, 2007 accounting for $782,835, to 18% of the sales mix, accounting for $15,959,415, at an average selling price of $857 per ton for the year ended June 30, 2008.
 
   
2008
   
2007
   
Variance
 
Average Selling Prices
 
($)
   
($)
   
($)
   
(%)
 
Low-carbon cold-rolled
    782       595       187       31  
Low-carbon acid wash
    -       409       (409 )     (100 )
Low-carbon hard rolled
    857       681       176       26  
High-carbon cold-rolled
    1,635       1,046       589       56  
High-carbon hot-rolled
    927       770       157       20  
High-end cold-rolled
    -       16,900       (16,900 )     (100 )
Subcontracting income
    595       86       509    
> 100
 

The average selling price per ton generated increased to $984 for the year ended June 30, 2008 compared to the corresponding year in 2007 of $805, representing an increase of $179, or 22.3%, year-on-year. This increase was due to both changes in our sales mix during the year to focus on high quality high margin products and rising raw material prices.

 
44

 

Sales Breakdown by Major Customer

   
2008
   
2007
 
Customers
 
$
   
% of Sales
   
$
   
% of Sales
 
Shanghai Changshuo Stainless Steel Co., Ltd.
    18,513,819       21       5,428,110       10  
Shanghai Bayou Industrial Co., Ltd.
    10,494,752       12       - *     - *
Shanghai Shengdejia Metal Co. Ltd
    10,414,545       12       - *     - *
Unimax and Far Corporation
    7,695,294       9       - *     - *
Baosteel Steel Products Trading Co., Ltd.
    6,758,976       8       - *     - *
Shanghai Ruixuefeng Metals Co. Ltd
    - *