XFRA:3CP1 Annual Report 10-K Filing - 6/30/2012

Effective Date 6/30/2012

 

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, 2012

 

  ¨ 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 (I.R.S. Employer Identification No.)
organization)  

 

  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   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 Website, 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  ¨ Accelerated Filer ¨
Non-Accelerated Filer  ¨ (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 ¨ No x

 

As of December 31, 2011 (the last business day of the registrant’s most recently completed second fiscal quarter), the aggregate market value of the shares of the registrant’s common stock held by non-affiliates (based upon the closing sale price of such shares as reported on the NASDAQ Capital Market) was approximately $15.8 million. Shares of the registrant’s common stock held by each executive officer and director and each by each person who owns 10% or more of the outstanding common stock have been excluded from the calculation in that such persons may be deemed to be affiliates of the registrant. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

 

There were a total of 3,880,866 shares of the registrant’s common stock outstanding as of September 28, 2012.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

None.

 

 
 

 

 

CHINA PRECISION STEEL, INC.

 

Annual Report on FORM 10-K

 For the Fiscal Year Ended June 30, 2012

 

 

 

TABLE OF CONTENTS

 

Item 1. Business 3
Item 1A. Risk Factors 12
Item 1B. Unresolved Staff Comments 26
Item 2. Properties 26
Item 3. Legal Proceedings 26
Item 4. Mine Safety Disclosures 26
     
  PART II  
     
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 27
Item 6. Selected Financial Data 27
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 28
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 40
Item 8. Financial Statements and Supplementary Data 40
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 40
Item 9A. Controls and Procedures 41
Item 9B. Other Information 41
     
  PART III  
     
Item 10. Directors, Executive Officers and Corporate Governance 42
Item 11. Executive Compensation 46
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 47
Item 13. Certain Relationships and Related Transactions, and Director Independence 48
Item 14. Principal Accounting Fees and Services 48
     
  PART IV  
     
Item 15. Exhibits, Financial Statement Schedules 49

 

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Special Note Regarding Forward Looking Statements

 

In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We use words such as “believe,” “expect,” “anticipate,” “project,” “target,” “plan,” “optimistic,” “intend,” “aim,” “will” or similar expressions which are intended to identify forward-looking statements. Such statements include, among others, those concerning market and industry segment growth and demand and acceptance of new and existing products; any projections of sales, earnings, revenue, margins or other financial items; any statements of the plans, strategies and objectives of management for future operations; and any statements regarding future economic conditions or performance, as well as all assumptions, expectations, predictions, intentions or beliefs about future events. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, as well as assumptions, which, if they were to ever materialize or prove incorrect, could cause the results of the Company to differ materially from those expressed or implied by such forward-looking statements. Potential risks and uncertainties include, among other things, factors such as: 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 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. Additional disclosures regarding factors that could cause our results and performance to differ from results or anticipated performance are discussed in Item 1A, “Risk Factors” included herein.

 

Because the factors discussed in this report 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, except as required by law. 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.

 

Use of Terms

 

Except as otherwise indicated by the context, all references in this report to:

 

  · “CPSL,” “Company,” “Group,” “we,” “us” or “our” are to China Precision Steel, Inc., a Delaware corporation, and its direct and indirect subsidiaries;
  · “PSHL” are to our subsidiary Partner Success Holdings Limited, a BVI company;
  · “Blessford International” are to our subsidiary Blessford International Limited, a BVI company;
  · “Shanghai Blessford” are to our subsidiary Shanghai Blessford Alloy Company Limited, a PRC company;
  · “Chengtong” are to our subsidiary Shanghai Chengtong Precision Strip Company Limited, a PRC company;
  · “Tuorong” are to our subsidiary Shanghai Tuorong Precision Strip Company Limited, a PRC company;
  · “SEC” are to the United States Securities and Exchange Commission;
  · “Securities Act” are to the Securities Act of 1933, as amended;
  · “Exchange Act” are to the Securities Exchange Act of 1934, as amended;
  · “RMB” are to Renminbi, the legal currency of China;
  · “U.S. dollar,” “USD,” “US$” and “$” are to the legal currency of the United States;
  · “China,” “Chinese” and “PRC” are to the People’s Republic of China; and
  · “BVI” are to the British Virgin Islands.

 

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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, 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. To fully utilize the additional capacity from our 2nd and 3rd mills, and to meet the robust demand from the home appliances segment and roofing materials used in domestic construction in the past two years, we have diverted away from our niche focus of producing only high value-added products.

 

We conduct our operations principally in China through our wholly-owned operating subsidiaries, Chengtong and Shanghai Blessford, which are wholly owned subsidiaries of our direct subsidiary, PSHL. Most of our sales are made domestically in China; however, we began exporting during fiscal 2007 and our overseas market currently covers Indonesia, Thailand, the Caribbean, Nigeria and Ethiopia. We intend to further expand into additional overseas markets in the future, subject to suitable market conditions and favorable regulatory controls.

 

To remodel our business to make it sustainable, we are putting in place a series of measures to cut cost and increase overall profitability. These measures include: (1) initiating additional sales and marketing efforts to expand customer base and increase total demand; (2) strategizing our product mix to re-focus on our niche capabilities including the ultra-thin low-carbon and high-strength high-carbon products; (3) streamlining production and reducing the number of workers; (4) hiring professionals and technicians to improve production management and increase quality control; (5) continue to carry out research and development (“R&D”) to improve profitability of existing products and launch new high value-add products; and (6) improve working capital efficiency by increasing turnovers of advances to suppliers and accounts receivables. We will also continue to take appropriate actions to perform business and credit reviews of customers and suppliers with the downward pressure in the PRC economy which has caused many difficulties faced by businesses.

 

 History and Corporate Structure

 

We are a Delaware company. We became a public company in May 1997 through a merger with SSI Capital Corporation, a Colorado corporation. We changed our name to OraLabs Holding Corp. and engaged in 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, and its sole subsidiary at the time, Chengtong, a PRC company, renamed ourselves China Precision Steel, Inc. to reflect our continuing operations. In September 2007, we reincorporated to the State of Delaware by merging into China Precision Steel, Inc., a subsidiary that we established in Delaware to effect the reincorporation.

 

In 2007, we added three indirect subsidiaries to our corporate structure. On April 9, 2007, we purchased Tuorong, a PRC company, through 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 is the holding company for Shanghai Blessford,  a wholly-foreign owned enterprise in China, engaged in steel processing.

 

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

 

 

 

Our business is conducted principally through Chengtong and Shanghai Blessford, both of which 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.

 

Current Environment and Our Growth Strategy

 

During the year ended June 30, 2012, we saw a reduction in demand for our cold rolled steel products together with rising costs. Inflation and especially high raw material costs have substantially and adversely impacted our gross margin compared to the prior fiscal year. In addition, tightened credit and slowing growth in China have caused our accounts receivable to rise sharply for the year ended June 30, 2012, a trend that is strongly correlated to those of the companies in the coal and steel sectors in China during the past year.

 

Despite a difficult time for China’s steel industry at present, our goal is 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 four factors critical to the achievement of this goal in the past, and will continue to focus on these factors in the long run:

 

  · 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 an average rate of 16% annually between 2007 and 2011 in China. Despite the slowdown in demand in the past year, we believe that export and domestic 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 in the medium- to long-run, thereby creating demand for high precision steel products. Moreover, new applications of steel products are continually being developed. We will focus our research and development efforts 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.
     
  · Expand Manufacturing Capacity. We operate three cold rolling mills as of June 30, 2012. Our first rolling mill has an operating capacity of approximately 100,000 tons and is operating at full capacity. Our second cold-rolling mill, which has been operating since October 2006, has achieved 100% of its 80,000 tons design capacity as of June 30, 2012. We also commenced production at our third cold rolling mill on January 1, 2010. The new mill has a design capacity of 80,000 tons based on our current product specifications, and had achieved 70% of its design capacity as of June 30, 2012. The average mill is expected to take approximately three to four years to reach its full operating capacity, so we expect our total production capacity to increase to a total of approximately 260,000 tons by calendar year 2014.
     
  · Compete Internationally. We intend to continue building our brand awareness and expand our exports to compete in the international marketplace. We believe that we have already established our presence in the international market for low carbon precision cold-rolled steel products in the less than 0.1 mm to 0.2 mm used for steel roofing. We will continue to look for other product opportunities and compete on the ones where we believe that we have a competitive advantage.

 

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  · 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 Board Chairperson and Chief Financial Officer, Ms. Tak Tai Leada Li, our Chief Executive Officer, Mr. Hai Sheng Chen and our Chief Operating Officer, Mr. Zu De Jiang. 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. During calendar year 2011, China’s share of world crude steel production increased to 45.5% from 44.7% in 2010, with a total production of 695.5 million tons. China’s steel production declined along with steel prices into calendar year 2012. China's steel industry has seen a major slowdown in the first half of 2012, according to the China Iron and Steel Association, or CISA. According to CISA, total industry profits were down by RMB54.55 billion (or $8.59 billion), or 95.81 percent year-on-year, to a mere RMB2.39 billion ($376.4 million). Around one third of the major Chinese steelmakers reported losses in the first half of the year.

 

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 4% tax rebate currently applies to the 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.

 

 Our 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. Over the last ten years of operation, we believe that we have begun to develop and establish a nationally recognized brand in China. We have also exported to various countries and regions including South East Asia, Africa and the Caribbean. Although we have been exporting the low-carbon ultra thin roofing materials for a number of years now, we are not yet an internationally known brand for cold-rolled precision steel products.

 

For the year ended June 30, 2012, we sold 171,565 tons of precision steel products. We currently produce cold-rolled precision steel coils and sheets with 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
· Low carbon steel (cold-rolled, hard-rolled)   Steel roofing, food packaging, dry batteries, electronic devices, kitchen tools   0.03-6.0mm
· High carbon steel (cold-rolled, hot-rolled)   Automobile parts and components, grinding pieces, saw blades, weaving needles   0.5-7.5mm
· Steel processing   Tailor made cold rolled steel products according to customer specifications   0.03-7.5mm
· Steel services   Heat treatment; cutting and slitting    

 

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We produce our 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 of between 1000 mm and 1450 mm. We also provide heat treatment and cutting and slitting services for steel coils with thicknesses not exceeding 7.5 mm. 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.

 

Our low carbon products have a carbon content of less than 0.1%.  Low carbon steel is a very versatile and useful material with good mechanical properties.  It is easily machined and worked into complex shapes, and is low in cost. Our high carbon products have a carbon content of 0.3% and are typically engineered steel products. 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.

 

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 home appliances (refrigerators, washers, dryers, and other small appliances), automobiles (exposed as well as unexposed parts), steel roofing, electric motors, microelectronics and food packaging.

 

Production Facilities

 

Cold Rolling Mills

 

As of June 30, 2012, we had an annual production capacity of approximately 236,000 tons, comprised of:

 

  · one 1100 mm 12-high cold rolling mill, with a current operating capacity of 100,000 tons;
  · one 1400 mm 12-high cold rolling mill, with a current operation capacity of 80,000 tons; and
  · one 1450 mm 4-high cold rolling mill, with a current operation capacity of 56,000 tons.

 

Our first rolling mill primarily manufactures low carbon precision cold-rolled steel products. The second and third mills focus on the production of high carbon, high strength cold-rolled steel products and the production of more complex and higher strength precision steel products that cannot be manufactured in our first rolling mill.

 

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 as well as the time we require to train quality mill operators. 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 1450 mm rolling mill, which began production in January 2010, was operating at 70% of its 80,000-ton design capacity at June 30, 2012 and is expected to reach its full operating capacity in calendar year 2014.

 

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, 2012 was Dachang Huizu Baosheng Steel Products Co., Ltd.

 

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Below is a list of our principal suppliers during the years ended June 30, 2012 and 2011:

 

   2012   2011 
Suppliers  $   % to
purchases
   $   % to
purchases
 
Dachang Huizu Baosheng Steel Products Co., Ltd.   31,035,606    26    28,878,126    24 
Hebei Nuojin Trading Co., Ltd.   28,581,403    24    -    * 
Wuxi Hangda Trading Co., Ltd.   14,389,057    12    18,700,715    16 
Zhejiang Wuchan Metal Group Co., Ltd.   -    *    15,962,338    13 

 

* Not major suppliers for the relevant years

 

The price of steel coils is competitive, volatile and dependent on supply and demand. We have seen sharp increases in our raw material prices over the past two years due to inflation in China and subsequently decreases in steel prices due to weak demand and a downturn of the Chinese economy.  In order to secure sufficient supply of raw material for necessary production, we have made bulk purchases in the past after taking into account customers’ orders on hand and steel supply at the time. As steel coils have a long shelf-life, obsolescence is not a major concern. However, due to steel price volatilities, the advance contracted prices of these purchases could adversely impact our margins during a downward trend in steel prices.

 

Customers

 

We have approximately 260 customers, with domestic customers primarily located in East China and overseas sales reaching Thailand, Nigeria, Ethiopia and the Caribbean. 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. 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 years ended June 30, 2012 and 2011:

 

   2012   2011 
Customers  $   % to sales   $   % to
sales
 
Shanghai Shengdejia Metal Co. Ltd   17,829,967    12    32,261,653    21 
Shanghai Changshuo Steel Company, Ltd.   14,842,069    11    23,410,550    16 

 

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, Ethiopia and the Caribbean. We do limited marketing by listing our company information on global and Chinese steel websites and 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.

 

Our business is becoming increasingly competitive and capital intensive due to rising operating costs in China, and competition comes from imports and other domestic manufacturers that have emerged in recent years. 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 companies, particularly the state owned enterprises. Our domestic competition in China’s ultra-thin cold-rolled precision steel segment comes from a few manufacturers scattered around different parts of China. However, we understand that these manufacturers mainly produce cold-rolled steel with widths of 400mm or less, whereas our products have a width between 1000 mm to 1450 mm. Consequently, their 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.

 

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Although there is intense competition in China’s steel industry, this affects mostly the low-carbon product segment. We believe we are still currently the leading supplier of high carbon, high strength cold-rolled steel products with a thickness up to 7.5 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 also where we have our technological expertise and competitive strength. Since fiscal 2007 we have been exporting low carbon products in this range and we are not aware of any other Chinese manufacturer currently competing in this specific low carbon segment in the global market.

 

Research and Development

 

As of June 30, 2012, we had 2 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. We have budgeted 0.5% of revenues to be spent for research and development activities for fiscal 2013.

 

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, or Te’an-Yikai. 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 Te’an-Yikai. We and Te’an-Yikai jointly developed the environment-conscious mill bearing with inner circular lubrication Te’an-Yikai retains the proprietary right to the technology while we have the exclusive right to the application of the technology.

 

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.

 

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Employees

 

As of June 30, 2012, we employed a total of 251 full-time employees. The following table sets forth the number of our employees by function.

 

Function  Number of Employees 
Senior Management   9 
Equipment & Maintenance   30 
Production   138 
Sales and Marketing   12 
Logistics   32 
Quality Control   8 
Research & Development   2 
Human Resource & Administration   15 
Accounting   5 
Total   251 

 

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. Executive employees are also eligible for a discretionary year-end bonus 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.  However, 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.

 

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.  The Company contributes approximately 37% of annual salaries to the pension plan on behalf of all qualified employees.

 

We believe that we are in material compliance with relevant PRC labor laws.

 

Regulation

 

General Regulation of Business

 

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.

 

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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 local companies which are 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.

 

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.

 

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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 $74,000.

 

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.

 

Taxation

 

On March 16, 2007, the National People’s Congress of China passed the Enterprise Income Tax Law, or the EIT Law, and on November 28, 2007, the State Council of China passed its implementing rules, both of which took effect on January 1, 2008. The EIT Law and its implementing rules impose a unified earned income tax, or EIT, rate of 25.0% on all domestic-invested enterprises and foreign invested enterprises, or FIEs, unless they qualify under certain limited exceptions. As a result, our PRC operating subsidiaries are subject to an earned income tax of 25.0%. Before the implementation of the EIT Law, FIEs established in the PRC, unless granted preferential tax treatments by the PRC government, were generally subject to an EIT rate of 33.0%, which included a 30.0% state income tax and a 3.0% local income tax.

 

In addition to the changes to the current tax structure, under the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a resident enterprise and will normally be subject to an EIT of 25% on its global income. The implementing rules define the term “de facto management bodies” as “an establishment that exercises, in substance, overall management and control over the production, business, personnel, accounting, etc., of a Chinese enterprise.” If the PRC tax authorities subsequently determine that we should be classified as a resident enterprise, then our organization’s global income will be subject to PRC income tax of 25%. For detailed discussion of PRC tax issues related to resident enterprise status, see Item 1A, “Risk Factors – Risks Related to Doing Business in China – Under the New Enterprise Income Tax 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 stockholders.”

 

Foreign Currency Exchange

 

All of our sales revenue and expenses are denominated in RMB. Under the PRC foreign currency exchange regulations applicable to us, RMB is convertible for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions. 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 PRC State Administration of Foreign Exchange, or SAFE, by complying with certain procedural requirements. Conversion of RMB for capital account items, such as direct investment, loan, security investment and repatriation of investment, however, is still subject to the approval of 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 PRC Ministry of Commerce, or MOFCOM, or their respective local branches. These limitations could affect our PRC operating subsidiaries’ ability to obtain foreign exchange through debt or equity financing.

  

Dividend Distributions

 

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 such fund reaches 50% of its registered capital. These reserves are not distributable as cash dividends. Our PRC subsidiaries have the discretion to allocate a portion of their after-tax profits to staff welfare and bonus funds, which may not be distributed to equity owners except in the event of liquidation.

 

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In addition, under the EIT Law, the Notice of the State Administration of Taxation on Negotiated Reduction of Dividends and Interest Rates, which was issued on January 29, 2008, and the Notice of the State Administration of Taxation Regarding Interpretation and Recognition of Beneficial Owners under Tax Treaties, which became effective on October 27, 2009, dividends from our PRC operating subsidiaries paid to us through our subsidiaries may be subject to a withholding tax at a rate of 10%. Furthermore, the ultimate tax rate will be determined by treaty between the PRC and the tax residence of the holder of the PRC subsidiary. Dividends declared and paid from before January 1, 2008 on distributable profits are grandfathered under the EIT Law and are not subject to withholding tax.

 

The Company intends on reinvesting profits, if any, and does not intend on making cash distributions of dividends in the near future.

 

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

 

Demand for our products has decreased and there can be no assurance it will increase in the foreseeable future.

 

During the year ended June 30, 2012, we saw a reduction in demand for our cold rolled steel products together with rising costs. Inflation and especially high raw material costs have substantially and adversely impacted our gross margin compared to the prior fiscal year. In addition, tightened credit and slowing growth in China have caused our accounts receivable to rise sharply for the year ended June 30, 2012, a trend that is strongly correlated to those of the companies in the coal and steel sectors in China during the past year. If demand for our products does not increase, it would have a material adverse effect upon the Company and our results of operations.

 

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. The Company maintains an allowance for doubtful accounts based on its assessment of the collectability of the accounts receivable. Our management determines the collectability of outstanding accounts by maintaining at least 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.

 

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The following table reflects the aging of our accounts receivable as of June 30, 2012 and 2011, after taking into consideration credit periods offered to our customers. As of June 30, 2012, our accounts receivable over 180 days is spread among approximately 29 different customers.

 

June 30, 2012

 

US$  Total   Current   1 to 30 days   31 to
90 days
   91 to
180 days
  181 to 360
days
   over
1 year
TOTAL   62,348,544    24,573,802    4,167,802    9,451,142   18,940,851   3,964,416   1,250,531
%   100    40    7    15   30   6   2

 

June 30, 2011

 

US$  Total   Current   1 to 30 days   31 to
90 days
   91 to 180 days  181 to 360
days
   over
1 year
TOTAL   42,399,379    20,132,384    1,570,163    6,829,813   12,801,682   94,799   970,538
%   100    48    4    16   30   <1   2

 

As of June 30, 2012, all our customers confirmed that they were committed to fulfilling their obligations to the Company and we were aware of no basis for reclassifying any such accounts as uncollectable. As a result, we determined that an allowance for doubtful accounts of $3,231,613 as of June 30, 2012, was appropriate, as compared to $1,063,620 at June 30, 2011. We believe there was no material deterioration of the accounts receivable at June 30, 2012.

 

Approximately 8% and 3% of our accounts receivable as of June 30, 2012 and 2011 were over 180 days past due. We note the global recovery from the 2008 global economic crisis remains fragile, and the recent financial turbulence in the European market may have negative consequences on the business operations of our customers and may adversely impact their ability to meet these financial obligations to us, resulting in unrecoverable losses on such accounts receivable. 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 100% provision for all accounts receivable over 1 year past due for the year ended June 30, 2012. The Company had $3,231,613 and $1,063,620 of allowances for doubtful accounts, respectively; and provision for accounts receivable bad debts of $2,150,984 and $19,992, respectively, for the years ended June 30, 2012 and 2011.

 

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 ensure 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 when the advance purchase contracts are entered into and the balance of our advances decrease when we take down contracted material at a future date. Balances decrease at a slower rate when demand is low as we take fewer deliveries from our suppliers.

 

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. 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, 2012 and 2011, the Company had allowances of advances to suppliers of $4,623,323 and $1,724,275, respectively. Approximately 81% of our advance to suppliers was more than 180 days as of June 30, 2012 and attributable to our advances to our long-term suppliers. We believe that these advances are ultimately collectible and do not provide specific allowances against such advances.

 

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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 cannot secure delivery of raw materials that have pre-paid with such advances, then our financial results will be negatively impacted.

 

Excess supply in China and other developing economies has resulted in additional excess worldwide capacity and falling steel prices, which is adversely impacting our results and may continue to do so in the future.

 

During previous years steel consumption in China and other developing economies such as India increased at a rapid pace. Steel companies responded by increasing steel production capacity in these countries and entering into long-term contracts with iron ore suppliers in Australia and Brazil. During the past year demand for steel in China decreased significantly. The excess manufacturing capacity in China and worldwide has resulted in an excess supply of steel, which has in turn resulted in falling prices for steel and steel products. Our operating results have been materially and adversely affected, and we expect that we will continue to be impacted in the future. Although we are implementing a series of strategies to help improve our operating results, there can be no assurance that we will be able to return to profitability.

 

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.

 

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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, 2012. However, domestic production continues to be insufficient to meet demand due to limited processing capability and product offerings. 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.

 

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:

 

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  · 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 margins. 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 was met by Dachang Huizu Baosheng Steel Products Co., Ltd. for the year ended June 30, 2012, 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 Dachang Huizu Baosheng Steel Products 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.

 

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, 2012, our total outstanding bank borrowings amounted to $43,446,477, all of which were 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 and LIBOR for USD loans. 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 our lenders. We anticipate that annual interest on loans for the fiscal year ending June 30, 2012, will be approximately $2,825,680. The impact of a 1% increase in interest rates will increase interest expense by approximately $432,806. 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.

 

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We are dependent on our borrowing facilities to meet our operating needs. Our failure to cure an ongoing default on repayment obligations under certain outstanding loans could have a material adverse impact on our business and operations.

 

On January 29, 2010, Shanghai Blessford entered into a Senior Loan Agreement with DEG -Deutsche Investitions-Und Entwicklungsgesellschaft Mbh, or “DEG,” for a loan amount up to $18,000,000 at an annual interest rate of 4.5% above the six-month USD LIBOR rate. The loan is secured by a mortgage on the new cold rolling line and annealing furnaces at Shanghai Blessford’s facilities and guaranteed by the Company. The loan was to have been repaid semi-annually over five years starting on December 15, 2011, but the Company defaulted on its semi-annual principal and interest repayment obligation in June 2012. Further, the Company has not met its financial covenants under the DEG loan agreement including the Debt Service Coverage Ratio and the Interest Bearing Debt/EBITDA ratio. The Company is currently in discussions with DEG regarding the restructuring of the loans for repayment but has not yet agreed on specific terms. On June 29, 2011, the Company entered into two short-term loan agreements with Raiffeisen Zentralbank Osterreich AG, or "RZB", pursuant to which the Company borrowed an aggregate of $27,246,477 at an annual interest rate of 1.15 times the standard market rate set by the People's Bank of China. The loans are secured by inventories, land use rights, buildings and plant and machinery, and are guaranteed by PSHL and our former Chairman, Mr. Wo Hing Li. Mr. Li also undertook to maintain a shareholding percentage in the Company of not less than 33.4% unless otherwise agreed to with RZB. Principal and interest under the loans were to be repaid in full on July 31, 2012, but the Company has defaulted on this repayment obligation. The Company is currently in discussions with RZB regarding the restructuring of the loans for repayment but has not yet agreed on specific terms. Any restructuring will be subject to approval by RZB's governing bodies, and to the Company's ability to meet certain conditions and requirements that may be imposed by this bank.

 

There can be no assurance that the Company will be able to successfully work out a repayment plan with DEG and RZB or otherwise fulfill its obligations under any of the loans. Until such agreement is reached, DEG has the right to cancel the total outstanding commitment of the loan, demand immediate repayment of all or part of the loan with accrued interest, and/or terminate the loan agreement. Each of DEG and RZB also have the right to take possession of the collateral (which collectively constitute substantial assets of the Company) granted in connection with their respective loan agreements, which action would have a material adverse impact on the Company.

 

We may not be able to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.

 

If we are unable to successfully work out a repayment plan for our defaulted bank loans, we may be forced to sell assets, seek additional capital or restructure or refinance our indebtedness. These alternative measures may not be successful and may not permit us to meet our outstanding debt service obligations. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. Our secured bank loans restrict our ability to dispose of assets and use the proceeds from the disposition. We may not be able to consummate those dispositions or to obtain the proceeds that we could realize from them, and these proceeds may not be adequate to meet any debt service obligations then due.

 

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 Chairperson and Chief Financial Officer, Ms. Tak Tai Leada Li, our Chief Executive Officer, Mr. Hai Sheng Chen, and our Chief Operating Officer, Mr. Zu De Jiang. We do not currently have in place key man life insurance for these executive officers. To the extent that the services of these officers would be unavailable to us, we would be required to recruit other persons to perform the duties performed by them. 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.

 

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, 2012 and 2011, sales revenues generated from our top five major customers accounted for 47% and 55% of total sales revenues, respectively, with sales to the largest single customer accounting for 12% 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.

 

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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.

 

Moreover, our cost structure is subject to fluctuations from inflationary pressures in China and other geographic regions where we conduct business. China has experienced dramatic growth in its economy in the past years. 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 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 $83.7 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.

 

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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.

 

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.

 

We may be exposed to liabilities under the Foreign Corrupt Practices Act, and any determination that we violated the Foreign Corrupt Practices Act could have a material adverse effect on our business.

 

We are subject to the Foreign Corrupt Practice Act, or FCPA, and other laws that prohibit improper payments or offers of payments to foreign governments and their officials and political parties by U.S. persons and issuers as defined by the statute for the purpose of obtaining or retaining business. We have operations, agreements with third parties and make sales in China, which may experience corruption. Our activities in China create the risk of unauthorized payments or offers of payments by one of the employees, consultants, sales agents or distributors of our Company, because these parties are not always subject to our control. It is our policy to implement safeguards to discourage these practices by our employees. Also, our existing safeguards and any future improvements may prove to be less than effective, and the employees, consultants, sales agents or distributors of our Company may engage in conduct for which we might be held responsible. Violations of the FCPA may result in severe criminal or civil sanctions, and we may be subject to other liabilities, which could negatively affect our business, operating results and financial condition. In addition, the government may seek to hold our Company liable for successor liability FCPA violations committed by companies in which we invest or that we acquire.

 

We may be exposed to potential risks relating to our ineffective internal controls over financial reporting which could have a material adverse effect on our results of operations and our stock price.

 

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. As required by Rule 13a-15 under the Exchange Act, our management evaluated the effectiveness of our internal controls over financial reporting as of June 30, 2012. Based upon, and as of the date of that evaluation, our management concluded that our internal control over financial reporting was not effective because our accounting staff lacked sufficient accounting skills and experience necessary to fulfill our public reporting obligations according to U.S. GAAP and the SEC's rules and regulations. Effective internal control is necessary for us to produce reliable financial reports and is important to help prevent financial fraud. If we cannot remediate this material weakness in our internal controls in a timely manner, investors and others may lose confidence in the reliability of our financial statements, which in turn could have a material adverse effect on our business, operating results and the trading price of our Common Stock.

 

The Company’s Independent Auditor issued a Going Concern opinion for our June 30, 2012 consolidated financial statements.  

 

The independent auditor’s report accompanying the Company’s audited June 30, 2012 consolidated financial statements contains an explanatory paragraph expressing substantial doubt about the Company’s ability to continue as a going concern. There can be no assurance that the Company will be able to generate sufficient positive cash flow from operations to address all of its cash flow needs, and to continue as a going concern. If the Company does not continue as a going concern, it will have to cease operations and you would likely lose all of your investment in the Company.

 

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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;

  · an 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.

 

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.

 

In addition, our facilities and products are subject to many laws and regulations. Our failure to comply with these and other 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, health or safety issues relating to matters that are not currently known to management may result in unanticipated liabilities and expenditures.

 

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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 effectively.

 

The majority of our revenues will be settled in RMB and U.S. dollars, and any future restrictions on currency exchanges may limit our ability to use revenue generated in RMB to fund any future business activities outside China or to make dividend or other payments in U.S. dollars. Although the Chinese government introduced regulations in 1996 to allow greater convertibility of the RMB for current account transactions, significant restrictions still remain, including primarily the restriction that foreign-invested enterprises may only buy, sell or remit foreign currencies after providing valid commercial documents, at those banks in China authorized to conduct foreign exchange business. In addition, conversion of RMB for capital account items, including direct investment and loans, is subject to governmental approval in China, and companies are required to open and maintain separate foreign exchange accounts for capital account items. We cannot be certain that the Chinese regulatory authorities will not impose more stringent restrictions on the convertibility of the RMB.

 

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 the U.S. dollar and RMB and between those currencies and other currencies in which our revenues may be denominated. 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.

 

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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 business.

 

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 dividends by our PRC subsidiaries only out of their accumulated after-tax profits, if any, determined in accordance with PRC accounting standards and regulations. Our PRC subsidiaries are also required under PRC laws and regulations to allocate at least 10% of their annual after-tax profits determined in accordance with PRC generally accepted accounting principles 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.

 

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. Almost all of our 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. Although the recognition and enforcement of foreign judgments are generally provided for under the PRC Civil Procedures Law. 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.

 

Our auditor, like other independent registered public accounting firms operating in China and Hong Kong (to the extent their audit clients have operations in China), is not permitted to be subject to inspections by the Public Company Accounting Oversight Board and, as such, our investors may be deprived of the benefits of such inspections.

The independent registered public accounting firm that issues the audit reports included in our filings made with the SEC, as an auditor of companies that are traded publicly in the United States and a firm registered with the Public Company Accounting Oversight Board (United States), or PCAOB, is required by the laws of the United States to undergo regular inspections by the PCAOB to assess its compliance with the laws of the United States and professional standards.  However, our operations are mainly located in the PRC, a jurisdiction where PCAOB is currently unable to conduct inspections without the approval of relevant PRC authorities. Our auditor, like other independent registered public accounting firms operating in China and Hong Kong (to the extent their audit clients have operations in China), is currently not subject to inspections conducted by the PCAOB.


Inspections of other firms that PCAOB has conducted outside of China and Hong Kong have identified deficiencies in those firms' audit and quality control procedures, which may be addressed as part of the inspection process to improve the quality of future audits.  The inability of PCAOB to inspect independent registered public accounting firms operating in China and Hong Kong makes it more difficult to evaluate the effectiveness of our auditor’s audit and quality control procedures compared to those conducted by auditors outside of China and Hong Kong that are subject to the PCAOB inspections.  As a result, our investors may be deprived of the benefits of the PCAOB inspections.

 

Failure to comply with PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident stockholders to personal liability, limit our ability to acquire PRC companies or to inject capital into PRC subsidiaries, limit our PRC subsidiary's ability to distribute profits to us or otherwise materially adversely affect us.

 

In October 2005, SAFE issued the Notice on Relevant Issues in the Foreign Exchange Control over Financing and Return Investment Through Special Purpose Companies by Residents Inside China, generally referred to as Circular 75, which required PRC residents to register with the competent local SAFE branch before establishing or acquiring control over an offshore special purpose company, or SPV, for the purpose of engaging in an equity financing outside of China on the strength of domestic PRC assets originally held by those residents. Amendments to registrations made under Circular 75 are required in connection with any increase or decrease of capital, transfer of shares, mergers and acquisitions, equity investment or creation of any security interest in any assets located in China to guarantee offshore obligations. In the case of an SPV which was established, and which acquired a related domestic company or assets, before the implementation date of Circular 75, a retroactive SAFE registration was required to have been completed before March 31, 2006. Failure to comply with the requirements of Circular 75 may result in fines and other penalties under PRC laws for evasion of applicable foreign exchange restrictions. Any such failure could also result in the SPV’s affiliates being impeded or prevented from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to the SPV, or from engaging in other transfers of funds into or out of China.

 

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We have asked our stockholders who are PRC residents as defined in Circular 75, to register with the relevant branch of SAFE as currently required in connection with their equity interests in us and our acquisitions of equity interests in our PRC subsidiary. However, we cannot provide any assurances that they can obtain the above SAFE registrations required by Circular 75. Moreover, because of uncertainty over how Circular 75 will be interpreted and implemented, and how or whether SAFE will apply it to us, we cannot predict how it will affect our business operations or future strategies. For example, our present and prospective PRC subsidiaries' ability to conduct foreign exchange activities, such as the remittance of dividends and foreign currency-denominated borrowings, may be subject to compliance with Circular 75 by our PRC resident beneficial holders.

 

In addition, such PRC residents may not always be able to complete the necessary registration procedures required by Circular 75. We also have little control over either our present or prospective direct or indirect stockholders or the outcome of such registration procedures. A failure by our PRC resident beneficial holders or future PRC resident stockholders to comply with Circular 75, if SAFE requires it, could subject these PRC resident beneficial holders to fines or legal sanctions, restrict our overseas or cross-border investment activities, limit our subsidiaries' ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.

 

Under the New Enterprise Income Tax 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 stockholders.

 

On March 16, 2007, the National People’s Congress of China passed the EIT Law and on November 28, 2007, the State Council of China passed its implementing rules, both of which took effect on January 1, 2008. Under the 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 of the EIT Law 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 EIT Law and its implementation against 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 “domestically incorporated resident enterprise” if (i) its senior management in charge of daily operations 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 assets and properties, accounting books, corporate chops, board and shareholder minutes are kept in China; and (iv) at least half of its directors with voting rights or senior management often resident in China. A resident enterprise would be subject to an enterprise income tax rate of 25% on its worldwide income and its non-PRC stockholders would be subject to a withholding tax at a rate of 10% when dividends are paid to such non-PRC stockholders. 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 enforcement of PRC tax against 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.

 

We may be 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 EIT Law and its implementing rules dividends paid to us from our PRC subsidiary 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 stockholders and with respect to gains derived by our non-PRC stockholders 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.

 

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RISKS RELATED TO THE MARKET FOR OUR STOCK

 

The market price for shares of our common stock could be volatile and could decline.

 

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;

  · changes in interest rates; and

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

 

Securities class action litigation is often instituted against companies following periods of volatility in their stock price. This type of litigation could result in substantial costs to us and divert our management’s attention and resources. Moreover, securities markets may from time to time experience significant price and volume fluctuations for reasons unrelated to operating performance of particular companies. For example, in July 2008, the securities markets in the United States, China and other jurisdictions experienced the largest decline in share prices since September 2001. These market fluctuations may adversely affect the price of our common stock and other interests in our company at a time when you want to sell your interest in us.

 

Although publicly traded, the trading market in our common stock has been substantially less liquid than the average trading market for a stock listed on the NASDAQ Capital Market and this low trading volume may adversely affect the price of our common stock.

 

Our common stock is listed on the NASDAQ Capital Market under the symbol “CPSL”. The trading volume of our common stock has been comparatively low to other companies listed on NASDAQ. Limited trading volume will subject our shares of common stock to greater price volatility and may make it difficult for you to sell your shares of common stock at a price that is attractive to you.

 

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: repayment of debt, our future operations and working capital requirements, development and exploitation of existing and new products, and expansion 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.

 

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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.

 

On March 15, 2012, the Company received notice of a complaint filed by Mr. Haining Zhang and China Venture Partners, Inc. in the U.S. Southern District Court of New York on March 9, 2012, against several defendants, including the Company, as successor to OraLabs Holding Corp.  In the complaint Mr. Zhang is alleging, among other things, breach of contract by the Company and certain of our former officers, directors and control persons, in connection with our December 2006 acquisition of Partner Success Holdings Limited. Among other things, Mr. Zhang alleges that the defendants breached an agreement to compensate him for services he allegedly performed in connection with seeking out a merger candidate for the Company. The Company believes that the suit is without merit and intends to vigorously defend its interests in the case. The Company was granted court permission to file a motion to dismiss the action as against it.  Prior to filing the motion to dismiss, plaintiffs amended their complaint. Accordingly, the Company filed a motion to dismiss the amended complaint.  That motion has now been fully briefed by the parties. The court has not yet advised whether it will permit oral argument on the motion prior to issuing a decision.  An estimate of any potential loss cannot be made at this time.

 

Except with respect to the foregoing proceeding, 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. MINE SAFETY DISCLOSURES.

 

Not Applicable.

  

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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 16941J205.

 

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

 

   Closing Bid Prices(1) 
   High   Low 
Year Ended June 30, 2012          
1st Quarter  $1.17   $0.52 
2nd Quarter   0.57    0.33 
3rd Quarter   0.69    0.35 
4th Quarter   0.47    0.24 
          
Year Ended June 30, 2011          
1st Quarter  $1.26   $1.86 
2nd Quarter   1.47    1.96 
3rd Quarter   1.61    2.17 
4th Quarter   0.90    1.71 

 

 

(1) The above table sets 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 September 28, 2012, there were approximately 10,833 holders of record of our common stock. This number excludes the shares of our common stock owned by stockholders holding stock under nominee security position listings.

 

Dividend Policy

 

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

 

See Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters — Securities Authorized for Issuance Under Equity Compensation Plans.”

 

Recent Sales of Unregistered Securities

 

We have not sold any equity securities during the fiscal year ended June 30, 2012 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 2012 fiscal year.

 

Purchases of Equity Securities

 

No repurchases of our common stock were made during the fourth quarter of 2012.

 

ITEM 6. SELECTED FINANCIAL DATA.

 

Not Applicable.

 

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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, 2012 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, 2012. 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, 2012. 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 the Company’s 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 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 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. To fully utilize the additional capacity from our 2nd and 3rd mills, and to meet the robust demand from the home appliances segment and roofing materials used in domestic construction in the past two years, we have diverted away from our niche focus of producing only high value-added products.

 

We conduct our operations principally in China through our wholly-owned operating subsidiaries, Chengtong and Shanghai Blessford, which are wholly owned subsidiaries of our direct subsidiary, PSHL. Most of our sales are made domestically in China; however, we began exporting during fiscal 2007 and our overseas market currently covers Indonesia, Thailand, the Caribbean, Nigeria and Ethiopia. We intend to further expand into additional overseas markets in the future, subject to suitable market conditions and favorable regulatory controls.

 

To remodel our business to make it sustainable, we are putting in place a series of measures to cut cost and increase overall profitability. These measures include: (1) initiating additional sales and marketing efforts to expand customer base and increase total demand; (2) strategizing our product mix to re-focus on our niche capabilities including the ultra-thin low-carbon and high-strength high-carbon products; (3) streamlining production and reducing the number of workers; (4) hiring professionals and technicians to improve production management and increase quality control; (5) continue to carry out R&D to improve profitability of existing products and launch new high value-add products; and (6) improve working capital efficiency by increasing turnovers of advances to suppliers and accounts receivables. We will also continue to take appropriate actions to perform business and credit reviews of customers and suppliers with the downward pressure in the PRC economy which has caused many difficulties faced by businesses.

 

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Recent Developments

 

On September 16, 2011, we received notice from the Listing Qualifications Department of the NASDAQ Stock Market, LLC indicating that, for the last 30 consecutive business days, the bid price for our common stock had closed below the minimum $1.00 per share required for continued inclusion on the NASDAQ Capital Market (“NASDAQ”) under NASDAQ Listing Rule 5550(a)(2). The notification letter stated that we would be provided 180 calendar days, or until March 14, 2012, to regain compliance with the minimum bid price requirement. In order to regain compliance, shares of our common stock must maintain a minimum bid closing price of at least $1.00 per share for a minimum of ten consecutive business days. On March 15, 2012, the Company received a second letter from NASDAQ notifying the Company that it had not regained compliance during the initial 180-day grace period, but that NASDAQ was granting the Company an additional 180-day grace period, or until September 10, 2012, to regain compliance. On August 27, 2012, we completed a reverse stock split of our common stock at a ratio of 1 share of common stock for every 12 shares, to resolve the deficiency and regain compliance with the NASDAQ minimum bid price requirements. Since the reverse stock split, the bid price for our common stock has been above $1.00 per share.

 

On August 13, 2012 and on October 9, 2012, respectively, each of Che Kin Lui and Daniel Carlson resigned from their respective positions as members of the Company’s Board of Directors for personal reasons and not because of any disagreement with the Company on any matter relating to the Company’s operations, policies or practices. While Mr. Carlson served as a non-executive and non-voting Director, Mr. Lui served as an independent member of the Board and also served on the Company’s Audit Committee, Compensation Committee and Corporate Governance and Nominating Committee. The Company’s Board of Directors is in the process of vetting suitable candidates to fill the vacancies created by Mr. Lui’s departure and will announce any such appointment as soon as it is complete.

 

Fiscal 2012 Financial Performance Highlights

 

During the year ended June 30, 2012, we saw a reduction in demand for our cold rolled steel products together with rising costs. Inflation and especially high raw material costs have substantially and adversely impacted our gross margin compared to the prior fiscal year. In addition, tightened credit and slowing growth in China have caused our accounts receivable to rise sharply for the year ended June 30, 2012, a trend that is strongly correlated to those of the companies in the coal and steel sectors in China during the past year.

 

During the year ended June 30, 2012, we sold a total of 171,565 tons of products, a decrease of 3,763 tons from 175,328 tons a year ago, due to a decrease in demand in the domestic market. Such decrease was mainly driven by decreases in demand from the food packaging and automobile components markets in connection with the slowing growth of the Chinese economy during the year ended June 30, 2012. Despite a downward trend in steel prices during the year, our average cost per unit sold increased 4.7% while average selling prices decreased 3.4% along with steel prices year-on-year, mainly due to our lock-in of raw material prices at higher levels in our advance purchase contracts. Decreased volume and sales coupled with rising costs led to a gross loss of $5,806,796 and a net loss of $16,949,145 for the year ended June 30, 2012.  Total company backlog as of June 30, 2012 amounted to $6,629,115. The Company has also been renegotiating with its major suppliers to get a partial refund of our advances to suppliers in an effort to mitigate the lock-in raw material cost.

 

In June and July 2012, we defaulted on the repayment obligations of our short-term and long-term bank loans totaling $43,446,477. We are currently in discussions with our banks regarding the restructuring of these loans for repayment but have not yet agreed on specific terms. Any restructuring will be subject to approval by the banks’ governing bodies, and to our ability to meet certain conditions and requirements that may be imposed by the banks. There can be no assurance that the Company will be able to successfully work out a repayment plan or otherwise fulfill its obligations under the loans. We are implementing a series of measures, discussed above, to remodel our business to make it sustainable, and as part of the ongoing discussions with banks to potentially restructure our bank loans.

 

We believe that high barriers to entry in the Chinese domestic precision cold-rolled steel industry still exist because of the level of technological expertise and the amount of capital required for operation. Although we expect slowing demand and volatilities in both domestic and international markets, and a difficult operating environment due to high inflation and rising costs which could have adverse impacts on our gross margins in the near future, the medium to long term prospects of our niche remain optimistic. 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 year:

 

· Revenues: Our revenues were approximately $142.9 million for the year, a decrease of 5.4% from last year.

 

· Gross Margin: Gross margin was (4.1)% for the year, compared to 3.9% last year.

 

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· Loss from operations before tax: Loss from operations before tax was approximately $16.9 million for the year, compared to approximately $0.8 million of income last year.

 

· Net Loss: Net loss was approximately $16.9 million for the year, compared to approximately $0.3 million of net income last year.

 

· Fully diluted (loss)/earnings per share: Fully diluted (loss) per share was $(4.37) for the year, compared to fully diluted earnings of $0.07 last year.

 

Results of Operations

 

The following table sets forth key components of our results of operations for the fiscal years ended June 30, 2012 and 2011 and as a percentage of revenues.

 

(All amounts in U.S. dollars)

 

   2012   2011 
   Amount   % of
Revenues
   Amount   % of
Revenues
 
Revenues   142,973,631    100.0    151,199,711    100.0 
Cost of sales (including depreciation and amortization)   148,780,427    104.1    145,234,370    96.1 
Gross (loss)/profit   (5,806,796)   (4.1)   5,965,341    3.9 
Selling expenses   209,793    0.1    263,537    0.2 
Administrative expenses   2,684,432    1.9    2,039,072    1.3 
Allowance for bad and doubtful debts   5,022,138    3.5    19,992    0.0 
Depreciation and amortization   216,444    0.2    224,350    0.1 
(Loss)/income from operations   (13,939,603)   (9.7)   3,418,390    2.3 
Other income   89,604    0.1    3,454    0.0 
Interest and finance costs   (3,104,207)   (2.2)   (2,628,567)   (1.7)
(Loss)/income from operations before income tax   (16,954,206)   (11.9)   793,277    0.5 
Income tax (benefit)/expense   (5,061)   (0.0)   536,327    0.4 
Net (loss)/income   (16,949,145)   (11.9)   256,950    0.2 
Basic (loss)/earnings per share   (4.37)        0.07      
Diluted (loss)/earnings per share   (4.37)        0.07      

 

Sales Revenues 

 

Sales volume decreased by 3,763 tons, or 2.1%, year-on-year, to 171,565 tons for the year ended June 30, 2012, from 175,328 tons for the year ended June 30, 2011 and as a result, sales revenues decreased by $8,226,080, or 5.4%, year-on-year, to $142,973,631 for the year ended June 30, 2012, from $151,199,711 for the year ended June 30, 2011. The decrease in sales revenues year-on-year is attributable to the decrease in demand for high-carbon products and decrease in average selling prices. 

 

Sales by Product Line 

 

A break-down of our sales by product line for the years ended June 30, 2012 and 2011 is as follows:

 

   2012   2011   Year-on- 
Product Category  Quantity
(tons)
   $ Amount   % of
Sales
   Quantity
(tons)
   $ Amount   % of
Sales
   Year Qty.
Variance
 
Low carbon hard rolled   10,126    7,512,713    5    5,309    4,369,979    3    4,817 
Low carbon cold-rolled   133,055    105,893,793    74    114,935    100,643,375    66    18,120 
High-carbon hot-rolled   5,064    6,138,916    4    7,013    7,034,615    5    (1,949)
High-carbon cold-rolled   19,796    20,043,175    14    28,997    28,128,342    19    (9,201)
Subcontracting income   3,524    1,144,270    1    19,074    8,314,173    5    (15,550)
Sales of scrap   -    2,240,764    2    -    2,709,227    2    - 
Total   171,565    142,973,631    100    175,328    151,199,711    100    (3,763)

 

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There were different trends of demand across various product categories during the year ended June 30, 2012. Low-carbon cold-rolled steel products accounted for 74% of the current sales mix at an average selling price of $796 per ton for the year ended June 30, 2012, compared to 67% of the sales mix at an average selling price per ton of $876 for the year ended June 30, 2011. The increase in demand in this category was a result of increased orders of steel used in the production of home appliances and steel roofing materials as a result of growth in domestic consumer spending in these segments during the year. Low-carbon hard-rolled steel products accounted for 5% of the current sales mix at an average selling price of $742 per ton for the year ended June 30, 2012, compared to 3% of the sales mix at an average selling price per ton of $823 for the year ended June 30, 2011, due to an increase in demand in the export market year-on-year as a result of our more competitive prices in the global market.  High-carbon cold-rolled steel products accounted for 14% of the current sales mix at an average selling price of $1,012 per ton for the year ended June 30, 2012, compared to 19% of the current sales mix at an average selling price of $970 for the year ended June 30, 2011. The products in this category are mainly used in the automobile industry and the decrease in sales volume year-on-year was a result of the slowing growth of automobile sales in the PRC market. Subcontracting income revenues accounted for $1,144,270, or 1%, of the sales mix for the year ended June 30, 2012, a decrease from $8,314,173, or 5%, of the sales mix for the year ended June 30, 2011. The products in this category are mostly high-carbon products and mainly used in electrical engineering and industrial grade tooling materials, for which we received limited orders during the year ended June 30, 2012.

 

 

   2012   2011   Variance 
Average Selling Prices  ($)   ($)   ($)   (%) 
Low-carbon hard rolled   742    823    (81)   (9.8)
Low-carbon cold-rolled   796    876    (80)   (9.1)
High-carbon hot-rolled   1,212    1,003    209    20.8 
High-carbon cold-rolled   1,012    970    42    4.3 
Subcontracting income   325    436    (111)   (25.5)

 

The average selling price per ton decreased to $833 for the year ended June 30, 2012, compared to $862 in 2011, representing a decrease of $29, or 3.4%, year-on-year. This decrease was mainly due to decreases in general steel prices and therefore our selling prices during the year. During the year ended June 30, 2012, there were decreases in average selling prices across all product categories except for high-carbon products.  

 

Sales Breakdown by Major Customer

 

   2012   2011 
Customers  $   % of 
Sales
   $   % of 
Sales
 
Shanghai Shengdejia Metal Co., Ltd   17,829,967    12    32,261,653    21 
Shanghai Changshuo Steel Co., Ltd.   14,842,069    11    23,410,550    16 
Hangzhou Cogeneration Co., Ltd.   13,101,996    9    *    * 
Changshu Jiacheng Steel Plate Co., Ltd.   11,169,785    8    *    * 
Zhejiang Yongfeng Steel Co., Ltd.   10,408,914    7    *    * 
Shaoxing Wancheng Metal Plate Co., Ltd.   *    *    9,988,522    7 
Wuxi Xingyu Thin Plate Co., Ltd.   *    *    9,804,985    6 
Zhejiang Aoguan Thin Plate Co., Ltd.   *    *    7,865,907    5 
    67,352,731    47    83,331,617    55 
Others   75,620,900    53    67,868,094    45 
Total   142,973,631    100    151,199,711    100 

 

 * Not major customers for the relevant years

 

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Sales revenue generated from our top five major customers as a percentage of total sales was 47% and 55% for the years ended June 30, 2012 and 2011, respectively. Sales to Hangzhou Cogeneration Co., Ltd., Changshu Jiacheng Steel Plate Co., Ltd. and Zhejiang Yongfeng Steel Co., Ltd., new major customers for the year ended June 30, 2012, accounted for 24% 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 $3,546,057, or 2.4%, year-on-year, to $148,780,427 for the year ended June 30, 2012, from $145,234,370 for the year ended June 30, 2011. Cost of sales represented 104.1% of sales revenues for the year ended June 30, 2012, compared to 96.1% for the year ended June 30, 2011. Average cost per unit sold increased to $867 for the year ended June 30, 2012, compared to $828 for the year ended June 30, 2011, representing an increase of $39 per ton, or 4.7%, year-on-year.  

 

   2012   2011   Variance 
   ($)   ($)   ($)   (%) 
Cost of goods sold                    
- Raw materials   135,715,619    132,876,698    2,838,921    2.1 
- Direct labor   585,332    576,834    8,498    1.5 
- Manufacturing overhead   12,479,476    11,780,838    698,638    5.9 
    148,780,427    145,234,370    3,546,057    2.4 
                     
Cost per unit sold                    
Total units sold (tons)   171,565    175,328    (3,763)   2.1 
Average cost per unit sold ($/ton)   867    828    39    4.7 

 

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

 

· an increase in cost of raw materials per unit sold of $33, or 4.4%, from $758 for the year ended June 30, 2011, to $791 for the year ended June 30, 2012;
   
· an increase in factory overhead per unit sold of $6, or 9.0%, from $67 for the year ended June 30, 2011, to $73 for the year ended June 30, 2012.    

 

Despite a downward trend in steel prices during the year, the cost of raw materials consumed increased by $2,838,921, or 2.1%, year-on-year, to $135,715,615 for the year ended June 30, 2012, from $132,876,698 for the year ended June 30, 2011. This increase was primarily due to our obligations under advance purchase contracts pursuant to which we have locked in the price of raw materials at the higher prices then prevailing. This increase was partially offset by a decrease in total units sold.

 

Direct labor costs increased by $8,498, or 1.5%, year-on-year, to $585,332 for the year ended June 30, 2012, from $576,834 for the year ended June 30, 2011. Manufacturing overhead costs increased by $698,638, or 5.9%, year-on-year, to $12,479,476 for the year ended June 30, 2012, from $11,780,838 for the year ended June 30, 2011. The increase was mainly attributable to the combined effect of an increase in depreciation charged to manufacturing overhead of $897,761, or 16.5%, year-on-year, to $6,351,180 for the year ended June 30, 2012, from $5,453,419 for the year ended June 30, 2011 and partially offset by a decrease in utilities of $281,827, or 7.9%, year-on-year, to $3,277,956 for the year ended June 30, 2012, from $3,559,783 for the year ended June 30, 2011. The decreased units sold, year-on-year, have led to an increase in average manufacturing overhead cost per unit sold of 9.0% due to decreased economies of scale.

 

Gross Profit

 

Gross profit in absolute terms decreased by $11,772,137, or 197.3%, year-on-year, to a loss of $5,806,796 for the year ended June 30, 2012, from profit of $5,965,341 for the year ended June 30, 2011, and gross profit margin decreased to (4.1)% for the year ended June 30, 2012, from 3.9% for the year ended June 30, 2011. The decrease in gross profit margin is mainly attributable to the combined effect of an increase in average cost per unit sold of 4.7% due to the lock in of raw material prices under our advance purchase contracts and a 3.4% decrease in average selling prices, year-on-year, due to falling steel prices during the year ended June 30, 2012.

 

Selling Expenses

 

Selling expenses decreased by $53,744, or 20.4%, year-on-year, to $209,793 for the year ended June 30, 2012, from $263,537 in 2011. The decrease was mainly attributable to less selling expenses associated with lower sales revenues year-on-year.  

 

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Administrative Expenses 

 

Administrative expenses increased by $645,360, or 31.6%, year-on-year, to $2,684,432 for the year ended June 30, 2012, compared to $2,039,072 for the year ended June 30, 2011. This was chiefly due to an inventories write down in the amount of $350,635 during the year ended June 30, 2012. 

 

Allowance for Bad and Doubtful Debts

 

Allowance for bad and doubtful debts increased by $5,002,146 year-on-year. Allowance recognized for the year ended June 30, 2012 was in the amount of $5,022,138 in accordance with our policy for allowance for bad and doubtful debts set forth under the “Critical Accounting Policies and Estimates” heading in this report.

 

Income from Operations

 

Income from operations decreased by $17,357,993, or 507.8%, year-on-year, to a loss of $13,939,603 for the year ended June 30, 2012 from $3,418,390 for the year ended June 30, 2011, as a result of the factors discussed above.

 

Other Income  

 

Other income increased $86,150, or 2,494.2%, to $89,604 for the year ended June 30, 2012 from $3,454 for the year ended June 30, 2011.  As a percentage of revenues, other income increased to 0.1% for the year ended June 30, 2012 from less than 0.1% for the year ended June 30, 2011. The increase in other income was primarily due to gain on disposal of a motor vehicle during the year ended June 30, 2012. 

 

Interest Expense  

 

Total interest expense increased $475,640, or 18.1%, to $3,104,207 for the year ended June 30, 2012, from $2,628,567 for the year ended June 30, 2011 due to increases in interest rates year-on-year and the accrual of penalty interest resulting from our loan default during the year ended June 30, 2012. 

 

Income Tax

 

For the year ended June 30, 2012, we recognized an income tax benefit of $5,061, compared to income tax expense of $536,327 for the year ended June 30, 2011. The decrease of $541,388, or 100.9%, was due to a net loss in the year ended June 30, 2012 and tax refund received as a result of the net loss, as compared to net income in 2011.

 

Net Income

 

Net income decreased by $17,206,095, or 6,696.3%, year-on-year, to net loss of $16,949,145 for the year ended June 30, 2012, compared to net income of $256,950 for the year ended June 30, 2011. The decrease in net income is attributable to a combination of all the factors discussed above, the major factors being an increase in the average cost per unit sold and a decrease in gross margin.

 

Liquidity and Capital Resources

 

Our business is capital intensive and requires substantial expenditures for, among other things, the purchase and maintenance of equipment used in our operations. Our short-term and long-term liquidity needs arise primarily from capital expenditures, working capital requirements and principal and interest payments related to our outstanding indebtedness. We have historically met these liquidity requirements with cash provided by operations, equity financing, and bank debt. As of June 30, 2012, we had cash and cash equivalents of approximately $1.6 million.

 

The following table provides detailed information about our net cash flows for all financial statement periods presented in this report:

 

CASH FLOWS

 

   Year Ended June 30, 
   2012   2011 
Net cash provided by/(used in) operating activities  $1,832,228   $(20,926,588)
Net cash (used in) investing activities   (284,149)   (5,998,122)
Net cash (used in) financing activities   (2,697,352)   (837,525)
Net cash flows   (1,104,949)   (26,328,952)

 

- 33 -
 

 

Net cash flows provided by operating activities for the year ended June 30, 2012 were $1,832,228 as compared to net cash flows used in operating activities of $20,926,588 for the year ended June 30, 2011, for a net increase of $22,758,816. This increase was mainly due to an increase in cash inflows from advances to suppliers of $46,021,492 due to management’s efforts in lowering such balance, an increase in cash inflows for inventories of $4,789,906, and an increase in cash inflows from accounts payable and accrued expenses of $6,986,649, offset by a decrease in cash inflows from accounts receivable of $24,939,159 during the year ended June 30, 2012.

 

For the year ended June 30, 2012, sales revenues generated from the top five major customers as a percentage of total sales were 47%, compared with 55% for the prior year. The loss of all or portion of the sales volume from a significant customer would have an adverse effect on our operating cash flows. In addition, tightened credit and slowing growth in China have caused our accounts receivable to rise sharply during the year ended June 30, 2012, a trend that strongly correlates to those of the companies in the coal and steel sectors in China in the past year. We note that the continuation or intensification of the worldwide economic crisis and downturn of the Chinese economy may have negative consequences on the business operations of our customers and adversely impact their ability to meet their financial obligations to us, resulting in unrecoverable losses on our accounts receivable. We will continue to strengthen our collection activities and closely monitor any changes in collection experience and the credit ratings of our customers.  From time to time we will review credit periods offered, along with our collection experience and the other relevant factors, to evaluate the adequacy of our allowance for doubtful accounts, and to make changes to the allowance, if necessary. Delays or non-payment of accounts receivable would have an adverse effect on our operating cash flows. 

 

Investing Activities

 

Our main uses of cash for investing activities during the year ended June 30, 2012 were for the purchase of property, plant and equipment related to the addition of annealing furnaces at our Shanghai Blessford facilities.  We believe this capital investment increases our capacity, expands product lines, improves product qualities and creates synergies with our existing production facilities, thereby creating opportunities to grow sales, enter new markets and further strengthen our leading position in the niche cold rolling segment that we operate in.

 

Net cash flows used in investing activities for the year ended June 30, 2012 was $284,149, as compared with $5,998,122 for the year ended June 30, 2011. Cash flows used in investing activities substantially decreased as we did not have any material construction commitments during the year.

 

We forecast lower capital expenditures in the coming years as the Company has already completed most of its major expansion plans and all the construction costs relating to our third cold rolling mill have been paid for as at June 30, 2012.

 

Financing Activities

 

Net cash flows used in financing activities for the year ended June 30, 2012 were $2,697,352, as compared to $837,525 for the year ended June 30, 2011, for a net increase of $1,859,827. During the year ended June 30, 2012, the Company made repayment of loans in the amount of $2,697,352 and received no additional loan proceeds.

 

On December 30, 2008, we filed a universal shelf registration statement with the SEC, which was declared effective on December 10, 2009. The shelf registration will permit us to issue securities valued at up to an aggregate of $40 million and provides us the flexibility to issue registered securities, from time to time, in one or more separate offerings or other transactions with the size, price and terms to be determined at the time of issuance.  Although we do not have any commitments or current intentions to sell securities under the registration statement, we believe that it is prudent to have a shelf registration statement in place to ensure financing flexibility should the need arise.

 

Our working capital requirements and the cash flow provided by future operating activities will vary from quarter to quarter, and are dependent on factors such as volume of business and payment terms with our customers. As such, we may need to rely on access to the financial markets to provide us with significant discretionary funding capacity. However, the current uncertainty arising out of domestic and global economic conditions, including the continuing disruption in credit markets, poses a risk to the economies in which we operate and may adversely impact our potential sources of capital financing. The general unavailability of credit could make capital financing more expensive for us or impossible altogether.  Even if we are able to obtain credit, the incurrence of indebtedness could result in increased debt service obligations. In June and July 2012, we defaulted on the repayment obligations of our short-term and long-term bank loans totaling $43,446,477. We are currently in discussions with our banks regarding the restructuring of these loans for repayment but have not yet agreed on specific terms. There can be no assurance that the Company will be able to successfully work out a repayment plan or otherwise fulfill its obligations under the loans. Further, each of these lenders has the right to take possession of the collateral (which collectively constitute substantial assets of the Company) granted in connection with their respective loan agreements. The unavailability of debt financing as a result of economic pressures on the credit and equity markets could have a material adverse effect on our business operations.

 

- 34 -
 

 

Going Concern

 

Historically, we have funded our operations and expansion expenditures from cash generated by operating activities, bank borrowings and issuance of common stock. We believe that we have the financial resources needed to meet business requirements for the next twelve months if we are able to work out a repayment plan acceptable to us with our banks for the defaulted loans. The uncertainty surrounding the successful restructuring of our bank loans and our current lack of readily available liquidity provided by other third party sources raise substantial doubt about our ability to continue as a going concern. Our consolidated financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern.

 

Current Assets

 

Current assets decreased by $5,830,454, or 4.8%, year-on-year, to $115,579,839 as of June 30, 2012, from $121,410,293 as of June 30, 2011, principally as a result of a decrease in advances to suppliers of $12,649,906, or 25.3%, year-on-year, a decrease in cash of $1,104,949 or 40.8%, year-on-year, and a decrease in inventories of $9,561,229 or 38.1%, year-on-year, offset by an increase in accounts receivable of $17,781,172, or 43.0%, year-on-year.

 

Accounts receivable, representing 51.1% of total current assets as of June 30, 2012, is a significant asset of the Company. We offer credit to our customers in the normal course of our business and accounts receivable is stated net of allowance for doubtful accounts. Credit periods vary substantially across industries, segments, types and size of companies in China where we operate our business. Because of the niche products that we process, our customers are usually also niche players in their own respective segment, who then sell their products to the end product manufacturers. The business cycle is relatively long, as well as the credit periods. The Company offers credit to its customers for periods of 60 days, 90 days, 120 days and 180 days. We generally offer longer credit terms to long-standing recurring customers with good payment histories and sizable operations.

 

Our management determines the collectability of outstanding accounts by maintaining at least quarterly communication with such customers and obtaining confirmation of their intent 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. We note that the continuation or intensification of the current global economic crisis and downturn of the Chinese economy may have negative consequences on the business operations of our customers and adversely impact their ability to meet their financial obligations. To reserve for potentially uncollectible accounts receivable, for the year ended June 30, 2012, our 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 one year past due.  From time to time, we will review these credit periods, 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. If our actual collection experience or other conditions change, revisions to our allowances may be required, including a further provision which could adversely affect our operating income, or write back of provision when estimated uncollectible accounts are actually collected.

 

The following table reflects the aging of our accounts receivable based on due date as of June 30, 2012 and 2011:

 

June 30, 2012

 

US$   Total     Current     1 to 30 days    

31 to

90 days

    91 to 180 days    

181 to 360

days

   

over

1 year

 
TOTAL     62,348,544       24,573,802       4,167,802       9,451,142       18,940,851       3,964,416       1,250,531  
%     100       40       7       15       30       6       2  

 

June 30, 2011

 

US$   Total     Current     1 to 30 days    

31 to

90 days

    91 to 180 days    

181 to 360

days

   

over

1 year

 
TOTAL     42,399,379       20,132,384       1,570,163       6,829,813       12,801,682       94,799       970,538  
%     100       48       4       16       30       <1       2  

 

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Management continues to take appropriate actions to perform business and credit reviews of any prospective customers (whether new or returning) to protect the Company from any who might pose a high credit risk to our business based on their commercial credit reports, our past collection history with them, and our perception of the risk posed by their geographic location. For example, we have halted since the year ended June 30, 2011 all our sales transactions directly with customers in the Philippines as we consider the associated credit risk to be relatively high. Based on publicly available reports, such as that issued by A.M. Best, there is a high risk that financial volatility may erupt in that country due to inadequate reporting standards, a weak banking system or asset markets and/or poor regulatory structure. We expect to resume such exports when conditions improve.

 

Current liabilities increased by $15,841,981, or 31.2%, year-on-year, to $66,675,876 as of June 30, 2012, from $50,833,895 as of June 30, 2011. The increase was mainly attributable to an increase in the current portion of the long-term loan of $12,600,000, or 350%, year-on-year. We have classified all of the remaining balance of our long-term loan as current liabilities as we have defaulted on the principal and interest repayment obligations of such loan in June 2012. The Company is currently in discussions with its bank regarding the restructuring of the loans for repayment but has not yet agreed on specific terms. Until such agreement is reached, the bank has the right to cancel the total outstanding commitment of the loan, demand immediate repayment of the loan or any part thereof together with accrued interest, and/or terminate the loan agreement.

 

As of June 30, 2012, we also had $27,246,477 in short-term loans. Principal and interest under the loans were to be repaid in full on July 31, 2012, but the Company has defaulted on this repayment obligation. The Company is currently in discussions with its bank regarding the restructuring of the loans but there can be no assurance that the Company will be able to successfully work out a repayment plan or otherwise fulfill its obligations under the loan.

 

Capital Expenditures

 

During the year ended June 30, 2012, we invested $340,155 in purchases of property, plant and equipment, and construction projects in relation to the new annealing furnaces.

  

Loan Facilities

 

The following table illustrates our credit facilities as of June 30, 2012, providing the name of the lender, the amount of the facility, the date of issuance and the maturity date:

 

All amounts in U.S. dollars

 

Lender   Date of Loan  

Maturity 

 Date

  Duration   Interest Rate    

Principal 

Amount

 
Raiffeisen               1.15 times of     $ 7,891,943  
Zentralbank Österreich   June 29, 2011   July 31, 2012   1 year              
AG (“RZB”)               the PBOC rate     RMB (50,154,084
Raiffeisen   June 29, 2010   July 31, 2012   1 year   1.15 times of the     $ 19,354,534  
Zentralbank Österreich AG               PBOC rate     RMB (123,000,000
                      $ 27,246,477  
                           
DEG – Deutsche               6 month USD     $ 16,200,000  
Investitions – und   June 29, 2010     June 15, 2016   6 years              
Entwicklungsgesellschaft mbH               LIBOR + 4.5%     RMB (102,952,620 )
                      $ 16,200,000  
                           
Total                     $ 43,446,477  

 

On January 29, 2010, Shanghai Blessford entered into a Senior Loan Agreement with DEG -Deutsche Investitions-Und Entwicklungsgesellschaft Mbh, or “DEG,” for a loan amount up to $18,000,000 at an annual interest rate of 4.5% above the six-month USD LIBOR rate. The loan is secured by a mortgage on the new cold rolling line and annealing furnaces at Shanghai Blessford’s facilities and guaranteed by the Company. The loan was to have been repaid semi-annually over five years starting on December 15, 2011, but the Company has defaulted on this repayment obligation, as well as on repayment of the June 15, 2011 installment. The Company is currently in discussions with DEG regarding the restructuring of the loans for repayment but has not yet agreed on specific terms. Until such agreement is reached, DEG has the right to cancel the total outstanding commitment of the loan, demand immediate repayment of the loan or any part thereof together with accrued interest, and/or terminate the loan agreement. DEG may also take possession of the collateral granted in connection with their respective loan agreements, which would have a material adverse impact on the Company. There can be no assurance that the Company will be able to successfully work out a repayment plan with DEG or otherwise fulfill its obligations under the loan.

 

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On June 29, 2011, the Company entered into two short-term loan agreements with Raiffeisen Zentralbank Osterreich AG, or "RZB," pursuant to which the Company borrowed an aggregate of $27,246,477 at an annual interest rate of 1.15 times the standard market rate set by the People's Bank of China. The loans are secured by inventories, land use rights, buildings and plant and machinery, and is guaranteed by PSHL and our former Chairman, Mr. Wo Hing Li. Mr. Li also undertook to maintain a shareholding percentage in the Company of not less than 33.4% unless otherwise agreed to with RZB. Principal and interest under the loans were to be repaid in full on July 31, 2012, but the Company has defaulted on this repayment obligation. The Company is currently in discussions with RZB regarding the restructuring of the loans for repayment but has not yet agreed on specific terms. Any restructuring will be subject to approval by RZB's governing bodies, and to the Company's ability to meet certain conditions and requirements that may be imposed by the Bank. Until such agreement is reached, RZB has the right to take possession of the collateral granted in connection with the loan agreement, which action would have a material adverse impact on the Company. There can be no assurance that the Company will be able to successfully work out a repayment plan with RZB or otherwise fulfill its obligations under the loan.

 

Obligations under Material Contracts

 

Below is a table setting forth our material contractual obligations as of June 30, 2012, including the foregoing debt obligations comprised of principal and interest payments:

 

   Payments Due By Year 
   Total   Fiscal Year
2013
   Fiscal Year
2014-2015
   Fiscal Year
2016-2017
   Fiscal Years
2018 and
Beyond
 
Contractual obligations:                         
Short-Term Debt Obligations  $29,223,618   $29,223,618   $-   $-   $- 
Current Portion of Long-Term Debt Obligations  $17,048,540   $17,048,540   $-   $-   $- 
   $46,272,158   $46,272,158   $-   $-   $- 

 

Recent Accounting Pronouncements

 

In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income, ("ASU 2011-05"). ASU 2011-05 requires that all non-owner changes in shareholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. In December 2011, the FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No 2011-05, ("ASU 2011-12"). The amendments in ASU 2011-12 defer certain changes in ASU 2011-05 that relate to the presentation of reclassification adjustments out of accumulated other comprehensive income. The adoption of ASU 2011-05 and ASU 2011-12 is effective for the Company in fiscal year 2013 beginning July 1, 2012 but is eligible for early adoption. The Company is currently evaluating the effect of the presentation options of ASU 2011-05 and ASU 2011-12 on its financial statement presentation of comprehensive income.

 

In September 2011, the FASB issued ASU No. 2011-08, Intangibles-Goodwill and Other (Topic 350)-Testing Goodwill for Impairment, ("ASU 2011-08"), to simplify how entities test goodwill for impairment. ASU 2011-08 allows entities to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If a greater than 50 percent likelihood exists that the fair value is less than the carrying amount then a two-step goodwill impairment test as described in Topic 350 must be performed. ASU 2011-08 is effective for the Company in fiscal year 2013 beginning July 1, 2012 but is eligible for early adoption. The Company does not believe adoption of this new guidance will have a significant impact on its consolidated financial statements. 

 

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In December 2011, the FASB issued ASU No. 2011-11, Disclosures About Offsetting Assets and Liabilities, ("ASU 2011-11"). The amendments in ASU 2011-11 require entities to disclose information about offsetting and related arrangements to enable users of financial statements to understand the effect of those arrangements on an entity's financial position. The amendments require enhanced disclosures by requiring improved information about financial instruments and derivative instruments that are either (i) offset in accordance with current literature or (ii) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with current literature. ASU 2011-11 is effective for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. This standard will become effective for the Company beginning July 1, 2013. The Company does not believe adoption of this new guidance will have a significant impact on its consolidated financial statements.

 

In July 2012, the FASB issued ASU No. 2012-02, Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment ("ASU 2012-02"). ASU 2012-02 amends Topic 350 by establishing an optional two-step analysis for impairment testing of indefinite-lived intangibles other than goodwill. This update allows an entity the option to first assess qualitative factors to determine whether it is necessary to perform the quantitative impairment test. Under that option, an entity no longer would be required to calculate the fair value of the intangible asset unless the entity determines, based on that qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. ASU 2012-02 is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012 and early adoption is permitted. This standard will become effective for the Company beginning July 1, 2013. The Company does not believe adoption of this new guidance will have a significant impact on its consolidated financial statements.

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires our management to make assumptions, estimates and judgments that affect the amounts reported in the financial statements, including the notes thereto, and related disclosures of commitments and contingencies, if any. We consider our critical accounting policies to be those that require the more significant judgments and estimates in the preparation of financial statements, including the following: 

 

Functional Currency and Translating Financial Statements

 

The Company’s principal country of operations is the PRC. Our functional currency is Chinese Renminbi; however, the accompanying consolidated financial statements have been expressed in USD. The consolidated balance sheets have been translated into USD at the exchange rates prevailing at each balance sheet date. The consolidated statements of operations and cash flows have been translated using the weighted-average exchange rates prevailing during the periods of each statement. The registered equity capital denominated in the functional currency is translated at the historical rate of exchange at the time of capital contribution. All translation adjustments resulting from the translation of the financial statements into the reporting currency are dealt with as other comprehensive income in stockholders’ equity.

 

Revenue Recognition

 

Revenue from the sale of goods and services is recognized on the transfer of risks and rewards of ownership, which generally coincides with the time when the goods are delivered to customers and the title has passed and services have been rendered. Revenue is reported net of all VAT taxes. Other income is recognized when it is earned.

 

Accounts Receivable

 

Credit periods vary substantially across industries, segments, types and size of companies in China where we operate our business. Because of the niche products that we process, our customers are usually also niche players in their own respective segment, who then sell their products to end product manufacturers. The business cycle is relatively long, as well as credit periods. The Company offers credit to its customers for periods of 60 days, 90 days, 120 days and 180 days. We generally offer longer credit terms to long-standing recurring customers with good payment histories and sizable operations. 

 

Accounts receivable is recorded at the time revenue is recognized and is stated net of allowance for doubtful accounts. The Company maintains an allowance for doubtful accounts based on its assessment of the collectability of the accounts receivable. Management determines the collectability of outstanding accounts by maintaining regular communication with such customers and obtaining confirmation of their intent to fulfill their obligations to the Company. Management also considers past collection experience, our relationship with customers and the impact of current economic conditions on our industry and market. However, we note that the continuation or intensification of the current global economic crisis may have negative consequences on the business operations of our customers and adversely impact their ability to meet their financial obligations. 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. From time to time, we will review these credit periods, 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. If our actual collection experience or other conditions change, revisions to our allowances may be required, including a further provision which could adversely affect our operating income, or write back of provision when estimated uncollectible accounts are actually collected. At June 30, 2012 and 2011, the Company had $3,231,613 and $1,063,620 of allowances for doubtful accounts, respectively.

 

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Bad debts are written off for past due balances over two years or when it becomes known to management that such amount is uncollectible. There was a provision for accounts receivable bad debts of $2,150,984 and $19,992 recognized for the years ended June 30, 2012 and 2011, respectively. The current year charge reflects a provision for doubtful accounts based on our policy described above. Our management is continually working to ensure that any known uncollectible amounts are immediately written off as bad debt against outstanding balances.

 

Advances to Suppliers

 

In order to ensure 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 when the advance purchase contracts are entered into. Advances to suppliers are shown net of an allowance which represents potentially unrecoverable cash advances at each balance sheet date. 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. In general, we do not provide allowances against advances paid to those PRC state-owned companies as there is minimal risk of default. 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 reflect changes from our historic raw materials receipt experience and to ensure the appropriateness of the allowance in light of the circumstances present at the time of the review. 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. As of June 30, 2012 and 2011, the Company made allowances of advances to suppliers of $4,623,323 and $1,724,275, respectively. There was a provision for advances to suppliers bad debts of $2,871,154 and $nil recognized for the years ended June 30, 2012 and 2011, respectively.

 

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.

 

Inventories

 

Inventories are stated at the lower of cost or market. Cost is determined using the weighted average method.

 

Intangible Assets

 

Intangible assets represent land use rights in China acquired by the Company and are stated at cost less amortization and impairment, if any. Amortization of land-use rights is calculated on the straight-line method, based on the period over which the right is granted by the relevant authorities in China. The Company acquired land use rights in August 2004 and December 2006 for 50 years that expire in August 2054 and December 2056, respectively. The land use rights are amortized over a fifty-year term. Amortizable intangible assets of the Company are reviewed when there are triggering events to determine whether their carrying value has become impaired, in conformity with ASC 360. The Company also re-evaluates the periods of amortization to determine whether subsequent events and circumstances warrant revised estimates of useful lives. As of June 30, 2012, as the Company’s market capitalization was lower than the carrying value of its assets, management performed an impairment test in accordance with ASC360. As the fair market value substantially exceeds the carrying value of our land use rights due to appreciation in the value of land use rights in China in the past decade, no impairment charges were recognized for the relevant year. As of June 30, 2012, the Company expects these assets to be fully recoverable based on the result of the impairment test.

 

Property, Plant and Equipment

 

Property, plant and equipment are stated at cost less accumulated depreciation. The cost of an asset comprises its purchase price and any directly attributable costs of bringing the asset to its present working condition and location for its intended use. Depreciation is computed on a straight-line basis over the estimated useful lives of the related assets for financial reporting purposes. The estimated useful lives for significant property and equipment are as follows:

 

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Buildings 10 years
Plant and machinery 10 years
Motor vehicles 5 years
Office equipment 5 years

 

Repairs and maintenance costs are normally charged to the statement of operations in the year in which they are incurred. In situations where it can be clearly demonstrated that the expenditure has resulted in an increase in the future economic benefits expected to be obtained from the use of the asset, the expenditure is capitalized as an additional cost of the asset.

 

The Company accounts for impairment of property, plant and equipment and amortizable intangible assets in accordance with ASC 360, which requires the Company to evaluate a long-lived asset for recoverability when there is an event or circumstance that indicates the carrying value of the asset may not be recoverable. We determine such impairment by measuring the estimated undiscounted future cash flows generated by these assets, comparing the result to the assets’ carrying values and, if necessary, adjusting the assets to the lower of its carrying value or fair value and charging current operations for the measured impairment. The determination of the undiscounted future cash flows and fair value of these assets are subject to significant judgment. As of June 30, 2012, the Company’s market capitalization was significantly lower than its total stockholders’ equity. Management considered this to be an indicator of impairment, and accordingly, performed an impairment test, using a normal and a worse-case scenario, and assessed fair value based on average tons sold, selling price per ton, gross margin, and other cash inflows and outflows for the next ten years where our mills are expected to remain in operation. We estimated volume sold and the sales revenues based upon prices at which Management reasonably estimates them to be sold in the next ten years. In performing the impairment test, Management also made assumptions that the Company would be able to restructure its defaulted bank loans with favorable and less favorable terms, respectively. No impairment charges were recognized for the current year. Assumptions and estimates used in our impairment test provide the general direction of major factors expected to affect our business and cash flows, and are subject to risks and uncertainties such as changes in interest rates, industry cyclicality, and factors surrounding the general Chinese and global economies. Those estimates will be reassessed for their reasonableness at each impairment test.

 

Other Policies

 

Other accounting policies used by the Company are set forth in the notes accompanying our financial statements.

 

Seasonality

 

Our operating results and operating cash flows historically have been subject to seasonal variations. Our revenues are usually higher in the second half of the calendar year than in the first half of the calendar year and the first quarter of the calendar year is usually the slowest quarter because fewer projects are undertaken during and around the Chinese New Year holidays.

 

Off-Balance Sheet Arrangements

 

For the year ended June 30, 2012, we did not have any off-balance sheet arrangements.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

Not Applicable.

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

 

The full text of our audited consolidated financial statements as of June 30, 2012 and 2011 begins on page F-1 of this report.

 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

 

None.

 

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ITEM 9A. CONTROLS AND PROCEDURES.

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) that are designed to ensure that information that would be required to be disclosed in Exchange Act reports is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including to our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

As required by Rule 13a-15 under the Exchange Act, our management, including our Chief Executive Officer, Mr. Hai Sheng Chen, and Chief Financial Officer, Ms. Leada Tak Tai Li, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2012. Based upon, and as of the date of this evaluation, Mr. Chen and Ms. Li, determined that because of the material weaknesses described below, as of June 30, 2012 our disclosure controls and procedures were not effective.

 

Management’s Annual Report on Internal Control over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting refers to the process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP, and includes those policies and procedures that:

 

  · pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;

 

  · provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that our receipts and expenditures are being made only in accordance with the authorization of our management and directors; and

 

  · provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

 

Our management assessed the effectiveness of our internal control over financial reporting as of June 30, 2012. In making this assessment, management used the framework set forth in the report entitled Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our management concluded that our internal control over financial reporting was not effective, as of June 30, 2012, as our accounting staff lacked sufficient accounting skills and experience necessary to fulfill our public reporting obligations according to U.S. GAAP and the SEC’s rules and regulations.

 

Management is currently seeking and plans to appoint qualified personnel as soon as practicable to remediate this material weakness. Our management does not believe that this material weakness had a material effect on our financial condition or results of operations or caused our financial statements as of and for the fiscal year ended June 30, 2012, such as to contain a material misstatement.

 

Because the Company is a smaller reporting company, this annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm.

 

Changes in Internal Controls over Financial Reporting

 

There were no changes in our internal controls over financial reporting during the fourth quarter of our fiscal year ended June 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

ITEM 9B. OTHER INFORMATION.

 

We have no information to disclose that was required to be disclosed in a report on Form 8-K during fourth quarter of fiscal year 2012, but was not reported.

 

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PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

 

Directors and Executive Officers

 

The following sets forth the name and position of each of our current executive officers and directors.

 

NAME   AGE   POSITION
Leada Tak Tai Li   32   Director (Chairperson), Chief Financial Officer
Hai Sheng Chen   49   Chief Executive Officer and Director
Zu De Jiang   66   Chief Operating Officer
Tung Kuen Tsui   67   Director
David Peter Wong   56   Director

 

Leada Tak Tai Li.  Leada Tak Tai Li has been the Chair of our Board of Directors since August 1, 2011 and Chief Financial Officer since December 28, 2006. From October 2005 until December 28, 2006, Ms. Li was the Chief Financial Officer of PSHL. Ms. Li has been a Non-Executive Director of STAR Pharmaceutical Limited since August 2009, and was an assistant to the Chairman for the same company between June 2004 and October 2005, where she was assisting with group activities and financial reporting. From November 2003 until May 2004, Ms. Li was an accountant with KPMG Hong Kong, a company engaged in audit, assurances and consulting services, conducting commercial due diligence on businesses in China. From January 2002 until September 2002, Ms. Li was an investment advisor conducting research and analysis with the private equity firm Suez Asia Holdings (Hong Kong) Ltd. In 2003, Ms. Li received her Master’s Degree in Accounting and Finance from Napier University in the U.K., and a Bachelors Degree in Commerce from the University of Melbourne in 2001.

 

Hai Sheng Chen. Mr. Hai Sheng Chen is a co-founder of the Company and has been our Chief Executive Officer since May 1, 2010.  He also served as an Executive Director and General Manager of the Company and its operating subsidiary, Chengtong, since July 2002.  Prior to joining us, Mr. Chen served from July 2001 to July 2002, as the Managing Director of Shanghai Krupp Stainless Steel Co. Limited, a steel processing company, and from August 1999 to May 2001, as the Deputy General Manager of Pudong Steel Co. Limited, a subsidiary of the Baosteel Group, a steel processing company.  Mr. Chen has an Executive MBA Degree from China Europe International Business School and a Bachelors Degree in Metallic Pressure Processing from the Beijing University of Science and Technologies.    

 

Zu De Jiang.   Zu De Jiang has been our Chief Operating Officer since May 1, 2010, and has been with us since our founding in 2002.  He served as our Assistant General Manager from February 2002 to February 2007, and has served as Assistant CEO since March 2007.  Prior to joining us, Mr. Jiang served from September 1996 to June 2001, as the Deputy General Manager of Shanghai Pudong Stainless Steel Thin Plate Co., Ltd.  and from April 1984 to September 1996, as the Deputy Head of Operations of the Cold Rolling Plant at Shanghai Pudong Steel (Group) Co., Ltd.  Prior to that, Mr. Jiang held various positions between September 1967 and April 1984 at Shanghai No. 3 Steel Factory, including Division Chief of the Cold Rolling Division. Mr. Jiang graduated from Shanghai Metallurgical Academy in September 1967 and holds a diploma in Steel Rolling.

 

Tung Kuen Tsui.  Tung Kuen Tsui has been a member of our Board of Directors since December 28, 2006.  Mr. Tsui has been retired since 1998. From 1995 to 1998, Mr. Tsui served as a Senior Credit Controller for PricewaterhouseCoopers. Prior to working as the Senior Credit Controller, Mr. Tsui held a variety of positions with PricewaterhouseCoopers since 1971, including Senior Manager, Information Systems. Mr. Tsui has a Master in Business Administration from the University of Macau. Mr. Tsui graduated as an Associate Member of Chartered Institute of Secretaries and Administrators in the United Kingdom.

 

David Peter Wong.  David Peter Wong has been a member of our Board of Directors since December 28, 2006. Mr. Wong is the Chief Financial Officer of Private Wealth Partners, LLC, an SEC-registered investment adviser based in California, and has been since November 2005. Mr. Wong served as the Corporate Controller for H&Q Asia Pacific, an Asian private equity firm from November 2002 to October 2005. Mr. Wong was the Corporate Controller of Hellman & Friedman, a private equity firm from January 2002 to September 2002. Mr. Wong is a U.K. Chartered Accountant with six years of public accounting experience with Ernst & Young in London and PriceWaterhouseCoopers in Hong Kong. Mr. Wong has a Bachelor of Arts degree in Economics and Geography from the University of Leeds in the United Kingdom. 

 

There are no agreements or understandings for any of our executive officers or director to resign at the request of another person and no officer or director is acting on behalf of nor will any of them act at the direction of any other person.

 

Directors are elected until their successors are duly elected and qualified.

 

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Qualifications, Attributes, Skills and Experience Represented on the Board

 

The Board has identified particular qualifications, attributes, skills and experience that are important to be represented on the Board as a whole, in light of the Company’s current needs and business priorities.  The Company is a NASDAQ listed company that offers products in the steel industry in China.  Therefore, the Board believes that a diversity of professional experiences in the steel industry, specific knowledge of key geographic growth areas, and knowledge of U.S. capital markets and  of U.S. accounting and financial reporting standards should be represented on the Board.  Set forth below is a tabular disclosure summarizing some of the specific qualifications, attributes, skills and experiences of our directors.

 

Director   Titles   Material Qualifications
Leada Tak Tai Li   Director and Chairperson  

●  Master in accounting and finance

●  Knowledge of U.S. accounting and financial reporting standards

●  Contributes invaluable long-term knowledge of our business and operations and of the steel industry and the cold rolling niche markets in China

         
Hai Sheng Chen   Director and Chief Executive Officer  

●  Co-founder of the Company and its oldest subsidiary

●  EMBA in Business Administration

●  Expertise in cold rolling and general knowledge of the steel industry with over 20 years of experience

        ●  Contributes invaluable long-term knowledge of our business and operations and of the steel industry and the cold rolling niche markets in China
         
Tung Kuen Tsui   Director  

●  Master in Business Administration

●  Served with PricewaterhouseCoopers for 27 years prior to his retirement in 1998

●  Knowledge of U.S. accounting and financial reporting standards.

         
David Peter Wong   Director  

●  Chief Financial Officer of a registered California-based investment adviser

●  U.K. Chartered Accountant with six years of public accounting experience with Ernst & Young in London and PriceWaterhouseCoopers in Hong Kong

        ● Up-to-date knowledge of U.S. accounting and financial reporting standards and knowledge of SEC rules and regulation

 

Family Relationships

 

There are no family relationships among any of our officers and directors.

 

Involvement in Certain Legal Proceedings

 

To the best of our knowledge, none of our directors or executive officers has, during the past ten years:

 

  · been convicted in a criminal proceeding or been subject to a pending criminal proceeding (excluding traffic violations and other minor offences);

 

  · had any bankruptcy petition filed by or against the business or property of the person, or of any partnership, corporation or business association of which he was a general partner or executive officer, either at the time of the bankruptcy filing or within two years prior to that time;

 

  · been subject to any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction or federal or state authority, permanently or temporarily enjoining, barring, suspending or otherwise limiting, his involvement in any type of business, securities, futures, commodities, investment, banking, savings and loan, or insurance activities, or to be associated with persons engaged in any such activity;

 

  · been found by a court of competent jurisdiction in a civil action or by the Securities and Exchange Commission or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended, or vacated;

 

  · been the subject of, or a party to, any federal or state judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated (not including any settlement of a civil proceeding among private litigants), relating to an alleged violation of any federal or state securities or commodities law or regulation, any law or regulation respecting financial institutions or insurance companies including, but not limited to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist order, or removal or prohibition order, or any law or regulation prohibiting mail or wire fraud or fraud in connection with any business entity; or

 

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  · been the subject of, or a party to, any sanction or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the Exchange Act (15 U.S.C. 78c(a)(26))), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act (7 U.S.C. 1(a)(29))), or any equivalent exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member.

 

Except as set forth in our discussion below in Item 13, “Certain Relationships and Related Transactions, and Director Independence – Transactions with Related Persons,” none of our directors, director nominees or executive officers has been involved in any transactions with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed pursuant to the rules and regulations of the SEC.

 

Board Composition and Committees

 

Our Board of Directors currently consists of four members: Leada Tak Tai Li, Hai Sheng Chen, Tung Kuen Tsui and David Peter Wong. Each of Che Kin Lui and Daniel Carlson, former members of our Board of Directors, resigned from their positions on the Company’s Board of Directors on August 13, 2012 and October 9, 2012, respectively. Each of Tung Kuen Tsui and David Peter Wong serves on our Board of Directors as an “independent director” as defined by as defined by Rule 5605(a)(2) of the NASDAQ Listing Rules and we are in the process of vetting candidates to serve as a third independent director to fill the vacancy left by Mr. Lui’s departure. Our Board of Directors has determined that David Peter Wong possesses the accounting or related financial management experience that qualifies him as financially sophisticated within the meaning of Rule 5605(c)(2)(A) of the NASDAQ Listing Rules and that he is an “audit committee financial expert” as defined by the rules and regulations of the SEC.

 

Our Board of Directors has established three committees: an audit committee, a compensation committee, and a corporate governance and nominating committee. Each committee is comprised entirely of independent directors. From time to time, our Board of Directors may establish other committees. Our Board of Directors has adopted a written charter for each of the committees, which is available on our website www.chinaprecisionsteelinc.com. Printed copies of these charters may be obtained, without charge, by contacting the Corporate Secretary, China Precision Steel, Inc., 18th Floor, Teda Building, 87 Wing Lok Street, Sheung Wan, Hong Kong, People’s Republic of China.

 

Audit Committee

 

Our independent directors, Tung Kuen Tsui, and David Peter Wong, serve as members of our audit committee.  Mr. Wong serves as chair of the audit committee.

 

The purpose of the audit committee is to oversee our accounting and financial reporting processes and the audits of our financial statements. The primary function of the audit committee is to oversee the Board by reviewing the financial information that will be provided to the stockholders and others, the preparation of our internal financial statements, and our audit and financial reporting process, including internal control over financial reporting. In addition, our audit committee is responsible for maintaining free and open lines of communication among the committee, the independent auditors and management. Our audit committee consults with our management and independent auditors before the presentation of financial statements to stockholders and, as appropriate, initiates inquiries into various aspects of our financial affairs. The committee is also responsible for considering, appointing, and establishing fee arrangements with our independent auditors and, if necessary, dismissing them. It is not responsible for preparing our financial statements or for planning or conducting the audits.

 

Compensation Committee

 

Our independent directors, Tung Kuen Tsui, and David Peter Wong, serve as members of our compensation committee.  Mr. Tung Kuen Tsui serves as Chair of the compensation committee.

 

Our compensation committee assists the Board in reviewing and approving the compensation structure of our directors and executive officers, including all forms of compensation to be provided to our directors and executive officers. Our chief executive officer may not be present at any committee meeting during which his compensation is deliberated.   The compensation committee is responsible for, among other things:

 

  · approving and overseeing the compensation package for our executive officers;

 

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  · reviewing and making recommendations to the Board with respect to the compensation of our directors;

 

  · reviewing and approving corporate goals and objectives relevant to the compensation of our chief executive officer, evaluating the performance of our chief executive officer in light of those goals and objectives, and setting the compensation level of our chief executive officer based on this evaluation; and

 

  · reviewing periodically and making recommendations to the Board regarding any long-term incentive compensation or equity plans, programs or similar arrangements, annual bonuses, employee pension and welfare benefit plans.

 

Corporate Governance and Nominating Committee

 

Our independent directors, Tung Kuen Tsui, and David Peter Wong, serve as members of our corporate governance and nominating committee.  Mr. Tung Kuen Tsui serves as Chair of the corporate governance and nominating committee.

 

The corporate governance and nominating committee assists the Board of Directors in identifying individuals qualified to become our directors and in determining the composition of the Board and its committees. It is responsible for, among other things:

 

  · identifying and recommending to the Board nominees for election or re-election to the board, or for appointment to fill any vacancy;

 

  · reviewing annually with the Board the current composition of the Board in light of the characteristics of independence, age, skills, experience and availability of service to us;

 

  · identifying and recommending to the Board the directors to serve as members of the Board’s committees; and

 

  · monitoring compliance with our code of business conduct and ethics.

 

In identifying and recommending nominees for election or re-election to the board, or for appointment to fill any vacancy, the corporate governance and nominating committee is also committed to engendering Board strength and effectiveness by seeking candidates with a diverse set of business, academic and life experiences and backgrounds who also possess knowledge and skills in areas of importance to the Company. The Committee does not use quotas but considers diversity when evaluating potential new directors.

 

The Committee identifies director candidates primarily through recommendations made by the non-employee directors. These recommendations are developed based on the directors’ own knowledge and experience in a variety of fields. Additionally the Committee considers recommendations made by the employee directors, stockholders, and others. All recommendations, regardless of the source, are evaluated on the same basis.

 

Stockholders may send recommendations for director candidates to the Corporate Secretary, China Precision Steel, Inc., 18th Floor, Teda Building, 87 Wing Lok Street, Sheung Wan, Hong Kong, People’s Republic of China.  A submission recommending a candidate should include sufficient biographical information to allow the Committee to evaluate the candidate, information concerning any relationship between the candidate and the stockholder recommending the candidate and material indicating the willingness of the candidate to serve if nominated and elected.

 

Section 16(A) Beneficial Ownership Reporting Compliance

 

Under U.S. securities laws, directors, certain executive officers and persons holding more than 10% of our common stock must report their initial ownership of the common stock, and any changes in that ownership, to the SEC.  The SEC has designated specific due dates for these reports.

 

Code of Ethics

 

Our Board of Directors has adopted a Code of Business Conduct and Ethics applies to all of our directors, officers and employees, including our principal executive officer, principal financial officer and principal accounting officer.  During the fiscal year ended June 30, 2012, there were no waivers of our Code of Business Conduct and Ethics.

 

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ITEM 11. EXECUTIVE COMPENSATION.

 

Summary Compensation Table – Fiscal Years Ended June 30, 2012 and 2011

 

The following table sets forth information concerning all cash and non-cash compensation awarded to, earned by or paid to the named persons for services rendered in all capacities during the noted periods. No other executive officer received total annual salary and bonus compensation in excess of $100,000.

 

Name and Principal Position    Year   Salary
($)
   Bonus
($)
   Stock
Awards
($)
   All Other
Compensation
($)
   Total
($)
Hai Sheng Chen, Chief   2012    28,391    -    -    -   28,391
Executive Officer   2011    27,072    -    -    -   27,072
Leada Tak Tai Li, Chairperson   2012    84,000    -    -    -   84,000
and Chief Financial Officer   2011    84,000    -    -    -   84,000

 

Employment Agreements

 

We have entered into executive employment agreements with each of Hai Sheng Chen, our Chief Executive Officer, Leada Tak Tai Li, our Board Chair and Chief Financial Officer and Zu De Jiang, our Chief Operating Officer. All executive employment agreements were entered into as of January 1, 2007, except Mr. Jiang’s employment agreement which was entered into on May 1, 2010, and will continue indefinitely until terminated in accordance with the terms of agreement. The base salary shown in the Summary Compensation Table above is described in each of the executive officer’s respective employment agreement, and each of them has the right to participate in our employee benefit plans. The executives are also entitled to reimbursement, to the fullest extent authorized by Delaware law, of all expenses incurred or suffered by them in connection with any claim brought against them because of or in connection with their positions with us or any of our affiliates, except to the extent that, such expenses arise as a result of the bad faith, willful misconduct or gross negligence of the executive, or as a result of his or her conviction for a felony.

 

Each of the executive employment agreements permits us to terminate the executive’s employment at any time by giving a written notice to the executive officer, provided that, if we terminate the executive’s employment without cause, the executive will be entitled to a termination payment equal to six months of his or her then current base salary, payable in six equal installments over the six-month period immediate following the date of termination. We may also terminate for cause, at any time, without notice or remuneration, for certain acts of the executive, including but not limited to a conviction or plea of guilty to a felony, negligence or dishonesty to our detriment and failure to perform agreed duties after a reasonable opportunity to cure the failure. An executive may terminate his or her employment upon thirty days’ written notice if there is a material reduction in his authority, duties and responsibilities or if there is a material breach by the us of the terms or conditions of the agreement after a reasonable opportunity to cure the breach. The agreements also provide that, if within 12 months following a change of control, any of the executives are terminated without cause or any of them terminate for good reason, then the vesting and exercisability of 50% of his or her stock options that are unvested at the time of the termination (if any) will accelerate and immediately become vested and exercisable as of the termination date, and will remain exercisable for 12 months following the termination date.

 

Each of the executive employment agreements contains customary non-competition, confidentiality, and non-disclosure covenants. Specifically, each executive officer has agreed, both during and after he or she is no longer employed by us, to hold in strict confidence and not to use, except as required in the performance of his duties in connection with the employment, any confidential information, technical data, trade secrets and know-how of our company or the confidential information of any third party, including our affiliated entities and our subsidiaries, received by us. The executive officers have also agreed to disclose in confidence to us all inventions, designs and trade secrets which they conceive, develop or reduce to practice and to assign all right, title and interest in them to us. In addition, each of the executive officers has agreed not to, while employed by us and for a period of 3 years following the termination or expiration of the agreement: approach our clients, customers or contacts or other persons or entities, and not to interfere with the business relationship between us and such persons and/or entities; assume employment with or provide services as a director for any of our competitors, or engage in any business which is in direct or indirect competition with our business; or solicit the services of any of our employees.

 

Outstanding Equity Awards at Fiscal Year End

 

No unexercised options or warrants were held by any of the named executive officers at year end. No equity awards were made during the year ended June 30, 2012.

 

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Compensation of Directors

 

The table below sets forth the compensation of our directors for serving as our directors for the fiscal year ended June 30, 2012:

 

Name   Fees Earned
or Paid in Cash
($)
   Stock
Awards
($)
   Option
Awards
($)
   Non-Equity
Incentive Plan
Compensation
($)
   All Other
Compensation
($)
   Total
($)
 
Che Kin Lui*   36,000    -    -    -    -    36,000 
David Peter Wong   42,000    -    -    -    -    42,000 
Tung Kuen Tsui   36,000    -    -    -    -    36,000 
Daniel Carlson*   36,000    -    -    -    -    36,000 

 

* Che Kin Lui and Daniel Carlson resigned from their positions on the Company’s Board of Directors on August 13, 2012 and October 9, 2012, respectively.

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

 

Security Ownership of Certain Beneficial Owners and Management

 

The following table sets forth information regarding beneficial ownership of our common stock as of September 28, 2012 (i) by each person who is known by us to beneficially own more than 5% of our common stock; (ii) by each of our officers and directors; and (iii) by all of our officers and directors as a group.  Unless otherwise specified, the address of each of the persons set forth below is in care of China Precision Steel, Inc., 18th Floor, Teda Building, 87 Wing Lok Street, Sheung Wan, Hong Kong, People’s Republic of China.

 

Name & Address of
Beneficial Owner
  Office, If Any  Title of Class   Amount &
Nature of
Beneficial
Ownership(1)
   Percent
of
Class(2)
 
Officers and Directors
 
Hai Sheng Chen
  Chief Executive Officer and Director   Common Stock, $0.001 par value    -    * 
 
Leada Tak Tai Li
  Chief Financial Officer and Board Chair   Common Stock, $0.001 par value    16,667    * 
Zu De Jiang  Chief Operating Officer   Common Stock, $0.001 par value    -    * 
Tung Kuen Tsui  Director   Common Stock, $0.001 par value    -    * 
David Peter Wong  Director   Common Stock, $0.001 par value    -    * 
All Officers and Directors as a group (5 persons named above)           16,667    * 
5% Security Holders
Wo Hing Li      Common Stock, $0.001 par value    1,279,103    33.0%

 

* Less than 1%

 

 

(1) Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities.

(2) A total of 3,880,866 shares of our common stock are considered to be outstanding pursuant to SEC Rule 13d-3(d)(1) as of September 28, 2012. For each beneficial owner above, any options exercisable within 60 days have been included in the denominator.

 

Changes in Control

 

There are no arrangements known to us, including any pledge by any person of our securities, the operation of which may at a subsequent date result in a change in control of the Company.

 

- 47 -
 

 

Securities Authorized for Issuance under Equity Compensation Plans

 

The following table includes the information as of the end of fiscal year 2012 for each category of our equity compensation plan:

 

Plan category 

Number of securities

to be issued upon

exercise of

outstanding options,

restricted stock,

warrants and rights 

(a)

  

Weighted-average

exercise price of

outstanding

options, restricted

stock, warrants

and rights 

(b)

  

Number of securities

remaining available for

future issuance under

equity compensation

plans (excluding securities

reflected in column (a)) 

(c)

 
Equity compensation plans approved by security holders(1)   -    -    180,435 
Equity compensation plans not approved by security holders   -    -    - 
Total   -    -    180,435 

 

(1) The China Precision Steel, Inc. 2006 Omnibus Long-Term Incentive Plan was approved by our stockholders on December 27, 2006. The plan is administered by our compensation committee and allows us to grant awards of stock options (including incentive stock options), stock appreciation rights, restricted stock, restricted stock units, unrestricted stock and cash awards to: (i) any employee, officer or director of the Company or our affiliates, or a consultant or adviser currently providing services to the Company or an affiliate; (ii) any outside director; and (iii) any other individual whose participation in the plan is determined to be in the best interests of the Company by the compensation committee.  We have reserved a maximum of 180,435 shares of our common stock to be issued under the plan.  No shares have been awarded under the 2006 Omnibus Long-Term Incentive Plan.

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

 

Transactions with Related Persons

 

None of our directors, director nominees or executive officers has been involved in any transactions with us or any of our directors, executive officers, affiliates or associates (other than compensation described under Item 11, “Executive Compensation”) since the beginning of our 2009 fiscal year which are required to be disclosed pursuant to the rules and regulations of the SEC.

 

Promoters and Certain Control Persons

 

We did not have any promoters at any time during the past five fiscal years.

 

Director Independence

 

Messrs. Tung Kuen Tsui, and David Peter Wong each serves on our Board of Directors as an “independent director” as defined by Rule 5605(a)(2) of the NASDAQ Listing Rules.

 

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.

 

Independent Registered Public Accounting Firm’s Fees

 

The following is a summary of the fees billed to the Company by Moore Stephens for professional services rendered for the fiscal years ended June 30, 2012 and 2011:

 

   June 30, 2012   June 30, 2011 
Audit Fees  $164,000   $164,000 
Audit Related Fees   -    - 
Tax Fees   -    - 
All Other Fees   -    - 
TOTAL  $164,000   $164,000 

 

“Audit Fees” consisted of the fees billed for professional services rendered for the audit of our annual financial statements and the reviews of the financial statements included in our Forms 10-Q and for any other services that were normally provided by Moore Stephens in connection with our statutory and regulatory filings or engagements.

 

“Audit Related Fees” consisted of the fees billed for professional services rendered for assurance and related services that were reasonably related to the performance of the audit or review of our financial statements and were not otherwise included in Audit Fees.

 

- 48 -
 

 

“Tax Fees” consisted of the fees billed for professional services rendered for tax compliance, tax advice and tax planning. Included in such Tax Fees were fees for preparation of our tax returns and consultancy and advice on other tax planning matters.

 

“All Other Fees” consisted of the fees billed for products and services provided by Moore Stephens and not otherwise included in Audit Fees, Audit Related Fees or Tax Fees. Included in such Other Fees were fees for services rendered by Moore Stephens in connection with our S-3 registration statements and private and public offerings conducted during such years.

 

Our audit committee has considered whether the provision of the non-audit services described above is compatible with maintaining auditor independence and determined that such services are appropriate. Before auditors are engaged to provide us audit or non-audit services, such engagement is (without exception, required to be) approved by the audit committee of our Board of Directors.

 

Pre-Approval Policies and Procedures

 

Under the Sarbanes-Oxley Act of 2002, all audit and non-audit services performed by our auditors must be approved in advance by our Board of Directors to assure that such services do not impair the auditors’ independence from us. In accordance with its policies and procedures, our Board of Directors pre-approved the audit service performed by Moore Stephens for our financial statements as of and for the year ended June 30, 2012.

 

PART IV

 

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.

 

Financial Statements and Schedules

 

The financial statements are set forth under Item 8 of this annual report on Form 10-K. Financial statement schedules have been omitted since they are either not required, not applicable, or the information is otherwise included.

 

Exhibit List

 

The following exhibits are filed as part of this report or incorporated by reference:

 

Exhibit No.   Description
3.1   Certificate of Incorporation (incorporated herein by reference to Annex 2 to the Company’s Definitive Proxy Statement filed on October 16, 2007)
     
3.2   Bylaws (incorporated herein by reference to Annex 3 to the Company’s Definitive Proxy Statement filed on October 16, 2007)
     
4.1   Form of Warrant, dated November 6, 2007 (incorporated herein by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on November 1, 2007)
     
4.2   Warrant, dated November 6, 2007, issued to Roth Capital Partners LLC (incorporated herein by reference Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on November 1, 2007)
     
4.3   Form of Warrant, dated February 2007 (incorporated herein by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on February 22, 2007)
     
4.4   Warrant, dated February 22, 2007, issued to Belmont Capital Group Limited (incorporated herein by reference Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on February 22, 2007)
     
4.5   Warrant, dated February 22, 2007, issued to CCG Elite Investor Relations (incorporated herein by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K filed on February 22, 2007)
     
10.1   Form of Subscription Agreement, dated November 1, 2007 (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on November 1, 2007)
     
10.2   Form of Placement Agency Agreement, dated October 31, 2007 (incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on November 1, 2007)
     
10.3   Form of Stock Purchase Agreement, dated February 16, 2007 (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on February 22, 2007)

 

- 49 -
 

 

10.4   Form of Limited Standstill Agreement (incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on February 22, 2007)
     
10.5   Redemption Agreement, dated December 28, 2006 (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on January 4, 2007)
     
10.6   Senior Loan Agreement, dated January 29, 2010, between Shanghai Blessford Alloy Co., Ltd. and DEG – Deutsche Investitions und Entwicklungsgessellschaft MBH (incorporated herein by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on February 16, 2010)
     
10.7   China Precision Steel, Inc. 2006 Omnibus Long Term Incentive Plan (incorporated herein by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed on January 4, 2007)
     
10.8   2006 Director Stock Plan, dated March 1, 2006 (incorporated herein by reference to Annex 3 to the Company’s Definitive Proxy Statement filed on November 22, 2006)
     
10.9   Executive Employment Agreement, dated as of January 1, 2007, between the Company and Wo Hing Li (incorporated herein by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on May 11, 2009)
     
10.10   Executive Employment Agreement, dated as of January 1, 2007, between the Company and Leada Tak Tai Li (incorporated herein by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q filed on May 11, 2009)
     
10.11   Executive Employment Agreement, dated as of January 1, 2007, between the Company and Hai Sheng Chen (incorporated herein by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q filed on May 11, 2009)
     
14   Code of Business Conduct and Ethics (incorporated herein by reference to Exhibit 14 to the Company’s Annual Report on Form 10-K filed on September 15, 2010)
     
21   Subsidiaries of the Company (incorporated herein by reference to Exhibit 21 to the Company’s Annual Report on Form 10-K filed on September 15, 2008)

 

31.1*   Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2*   Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1*   Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2*   Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

*Filed herewith.

 

- 50 -
 

 

SIGNATURES

 

In accordance with section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereto duly authorized individual.

 

Date: October 15, 2012

  CHINA PRECISION STEEL, INC.
     
  By: /s/ Hai Sheng Chen  
    Hai Sheng Chen
    Chief Executive Officer
     
  By: /s/ Leada Tak Tai Li  
    Leada Tak Tai Li
    Chief Financial Officer

 

In accordance with the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

 

Signature   Title   Date
         
/s/ Hai Sheng Chen   Chief Executive Officer and Director   October 15, 2012
Hai Sheng Chen (Principal Executive Officer)    
       
/s/ Leada Tak Tai Li  

Chair of the Board of Directors and

Chief Financial Officer

  October 15, 2012
Leada Tak Tai Li (Principal Financial and Accounting Officer)    
       
/s/ Tung Kuen Tsui   Director   October 15, 2012
Tung Kuen Tsui      
       
/s/ David Peter Wong   Director   October 15, 2012
David Peter Wong      

 

 
 

 

CHINA PRECISION STEEL, INC.
INDEX TO FINANCIAL STATEMENTS FOR THE YEARS
ENDED JUNE 30, 2012 AND 2011

 

Contents   Page(s)
     
Report of Independent Registered Public Accounting Firm   F-2
     
Consolidated Balance Sheets as of June 30, 2012 and 2011   F-3
     
Consolidated Statements of Operations for the Years Ended June 30, 2012 and 2011   F-4
     
Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended June 30, 2012 and 2011   F-5
     
Consolidated Statements of Cash Flows for the Years June 30, 2012 and 2011   F-6
     
Notes to Consolidated Financial Statements   F-7

 

 
 

 

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Stockholders of

 

China Precision Steel, Inc.

 

We have audited the accompanying consolidated balance sheets of China Precision Steel, Inc. and subsidiaries (collectively, the “Company”) (see Note 1 to the consolidated financial statements) as of June 30, 2012 and 2011, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each of the two years in the period ended June 30, 2012. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purposes of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of June 30, 2012 and 2011, and the results of its operations and cash flows for each of the two years in the period ended June 30, 2012, in conformity with accounting principles generally accepted in the United States of America.

 

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Notes 2, 13 and 14 to the consolidated financial statements, the Company has suffered a very significant loss in the year ended June 30, 2012 and defaulted on interest and principal repayments of bank borrowings that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regards to these matters are also described in Notes 13 and 14. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

 

Moore Stephens

 

Certified Public Accountants

 

Hong Kong

 

October 15, 2012

 

F-2
 

 

China Precision Steel, Inc. and Subsidiaries

Consolidated Balance Sheets

 

       June 30,   June 30, 
   Notes   2012   2011 
             
Assets               
                
Current assets               
Cash and cash equivalents       $1,602,805   $2,707,754 
Accounts receivable               
Trade, net of allowances of $3,231,613 and $1,063,620  at June 30, 2012 and 2011, respectively        59,116,931    41,335,759 
Bills receivable        173,089    201,133 
Other        1,117,243    1,420,192 
Inventories   8    15,516,220    25,077,449 
Prepaid expenses        668,867    633,416 
Advances to suppliers, net of allowance of $4,623,323 and $1,724,275 at June 30, 2012 and 2011, respectively   9    37,384,684    50,034,590 
                
Total current assets        115,579,839    121,410,293 
                
Property, plant and equipment               
Property, plant and equipment, net   10    67,752,991    75,311,221 
Construction-in-progress   11    233,512    64,762 
                
         67,986,503    75,375,983 
                
Intangible assets, net   12    1,880,129    1,892,249 
                
Goodwill        99,999    99,999 
                
Total assets       $185,546,470   $198,778,524 
                
Liabilities and Stockholders' Equity               
                
Current liabilities               
Short-term loans   13   $27,246,477   $27,370,648 
Long-term loan - current portion   14    16,200,000    3,600,000 
Accounts payable and accrued liabilities        6,772,892    5,599,323 
Advances from customers        2,253,956    2,275,241 
Other taxes payables        8,446,373    6,297,227 
Current income taxes payable        5,756,178    5,691,456 
                
Total current liabilities        66,675,876    50,833,895 
                
Long-term loans   14    -    14,400,000 
                
Stockholders' equity:               
Preferred stock: $0.001 per value, 8,000,000 shares authorized, no shares outstanding at June 30, 2012 and  2011, respectively   15    -    - 
Common stock: $0.001 par value, 62,000,000 shares authorized, 3,880,866 issued and outstanding at June 30, 2012 and 2011, respectively   15    3,880    3,880 
Additional paid-in capital   15    75,685,066    75,685,066 
Accumulated other comprehensive income        19,097,295    16,822,185 
Retained earnings        24,084,353    41,033,498 
                
Total stockholders' equity        118,870,594    133,544,629 
                
                
Total liabilities and stockholders' equity       $185,546,470   $198,778,524 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F-3
 

 

China Precision Steel, Inc. and Subsidiaries

Consolidated Statements of Operations

For the Years Ended June 30, 2012 and 2011

 

   Notes   2012   2011 
             
             
Sales revenues       $142,973,631   $151,199,711 
Cost of goods sold        148,780,427    145,234,370 
Gross (loss)/profit        (5,806,796)   5,965,341 
                
Operating expenses               
Selling expenses        209,793    263,537 
Administrative expenses        2,684,432    2,039,072 
Allowance for bad and doubtful debts        5,022,138    19,992 
Depreciation and amortization expense        216,444    224,350 
                
Total operating expenses        8,132,807    2,546,951 
                
(Loss)/income from operations        (13,939,603)   3,418,390 
                
Other income/(expense)               
Other revenues        89,604    3,454 
Interest and finance costs        (3,104,207)   (2,628,567)
                
Total other (expense)        (3,014,603)   (2,625,113)
                
(Loss)/income from operations before income tax        (16,954,206)   793,277 
                
Provision for income tax   16           
Current        (5,061)   536,327 
                
Total income tax (benefit)/expense        (5,061)   536,327 
                
Net (loss)/income       $(16,949,145)  $256,950 
                
Basic (loss)/earnings per share   17   $(4.37)  $0.07 
                
Basic weighted average shares outstanding        3,880,866    3,880,866 
                
Diluted (loss)/earnings per share   17   $(4.37)  $0.07 
                
Diluted weighted average shares outstanding        3,880,866    3,880,866 
                
Components of comprehensive (loss)/income:               
Net (loss)/income       $(16,949,145)  $256,950 
Foreign currency translation adjustment        2,275,110    6,191,210 
                
Comprehensive (loss)/income       $(14,674,035)  $6,448,160 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F-4
 

 

China Precision Steel, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders' Equity

For the Years Ended June 30, 2012 and 2011

 

               Accumulated         
           Additional   Other       Total 
   Common Stock   Paid-in   Comprehensive   Retained   Stockholders' 
   Share   Amount   Capital   Income   Earnings   Equity 
Balance at June 30, 2010   3,880,866   $3,880   $75,685,066   $10,630,975   $40,776,548   $127,096,469 
                               
Foreign currency translation adjustment   -    -    -    6,191,210    -    6,191,210 
Net income   -    -    -    -    256,950    256,950 
                               
Balance at June 30, 2011   3,880,866    3,880    75,685,066    16,822,185    41,033,498    133,544,629 
                               
Foreign currency translation adjustment   -    -    -    2,275,110    -    2,275,110 
Net loss   -    -    -    -    (16,949,145)   (16,949,145)
                               
Balance at June 30, 2012   3,880,866   $3,880   $75,685,066   $19,097,295   $24,084,353   $118,870,594 

 

The accompanying notes are an integral part of these consolidated financial statements.

F-5
 

 

China Precision Steel, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

For the Years Ended June 30, 2012 and 2011

 

 

   2012   2011 
Cash flows from operating activities          
Net (loss)/income  $(16,949,145)  $256,950 
Adjustments to reconcile net income to net cash provided by operating activities          
Depreciation and amortization   9,043,993    8,141,320 
Allowance for bad and doubtful debts   5,022,138    19,992 
Inventory provision   350,817    - 
(Gain)/loss on disposal of property, plant and equipment   (36,993)   632 
Net changes in assets and liabilities:          
Accounts receivable, net   (19,407,494)   5,531,665 
Inventories   9,637,950    4,848,044 
Prepaid expenses   (31,828)   (90,302)
Advances to suppliers   10,632,903    (35,388,589)
Accounts payable and accrued expenses   1,620,381    (5,366,268)
Advances from customers   (60,058)   (1,151,842)
Other taxes payable   2,041,833    2,238,690 
Current income taxes   (32,269)   33,120 
           
Net cash provided by/(used in) operating activities   1,832,228    (20,926,588)
           
Cash flows from investing activities          
Purchase of property, plant and equipment, including construction in progress   (340,155)   (5,998,122)
Proceeds from disposal of property, plant and equipment   56,006    - 
           
Net cash (used in) investing activities   (284,149)   (5,998,122)
           
Cash flows from financing activities          
Repayments of short-term loans   (2,697,352)   (837,525)
           
Net cash (used in) financing activities   (2,697,352)   (837,525)
           
Effect of exchange rate   44,324    1,433,283 
           
Net (decrease) in cash   (1,104,949)   (26,328,952)
           
Cash and cash equivalents, beginning of year   2,707,754    29,036,706 
           
Cash and cash equivalents, end of year  $1,602,805   $2,707,754 
           
Supplemental disclosures of cash flow information:          
           
Cash paid during the year for:          
Interest  $2,000,125   $2,638,853 
Taxes  $27,225   $503,957 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F-6
 

  

China Precision Steel, Inc.

Notes to the Consolidated Financial Statements

 

1. Description of Business

 

China Precision Steel, Inc. (the “Company,” “CPSL” or “we”) is a niche steel processing company principally engaged in the manufacture and sale of cold-rolled precision steel products for downstream applications including automobile components and spare parts, kitchen tools, electrical appliances, roofing and food packaging materials. Raw materials, hot-rolled steel coils, will go through certain reduction, heating and cutting processing procedures to give steel coils or plates different thickness and specifications for deliveries in accordance with customers’ requirements. Specialty precision steel offers specific control of thickness, shape, width, surface finish and other special quality features that compliment the emerging need for highly engineered end use applications. Precision steel pertains to the precision of measurements and tolerances of the above factors, especially thickness tolerance.

 

We have five wholly-owned subsidiaries, Partner Success Holdings Limited (“PSHL”), Blessford International Limited (“Blessford International”), Shanghai Chengtong Precision Strip Company Limited (“Chengtong”), Shanghai Blessford Alloy Company Limited (“Shanghai Blessford”) and Shanghai Tuorong Precision Strip Company Limited (“Tuorong”). The Company’s principal activities are conducted through our two operating subsidiaries, Chengtong and Shanghai Blessford with manufacturing facilities located in Shanghai, the People’s Republic of China (the “PRC”). The sole activity of Tuorong is the ownership of land use rights with respect to facilities utilized by Chengtong and Shanghai Blessford. PSHL and Blessford International are both British Virgin Islands companies with the sole purpose of investment holding.

 

2. Basis of Preparation of Financial Statements

 

The financial statements have been prepared in order to present the consolidated financial position and consolidated results of operations in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) and are expressed in terms of US dollars (see Note 3 “Functional Currency and Translating Financial Statements” below).

 

In June and July 2012, the Company defaulted on the repayment obligations of its short-term and long-term bank loans totaling $43,446,477. The Company is currently in discussions with its banks regarding the restructuring of these loans for repayment but has not yet agreed on specific terms. There can be no assurance that the Company will be able to successfully work out a repayment plan or otherwise fulfill its obligations under the loans. The uncertainty surrounding the successful restructuring of our bank loans and our current lack of readily available liquidity provided by other third party sources raise substantial doubt about our ability to continue as a going concern. Our consolidated financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern.

 

The consolidated balance sheets as of June 30, 2012 and 2011 include CPSL, PSHL, Blessford International, Chengtong, Shanghai Blessford, and Tuorong, collectively referred to as “the Group”. The consolidated statements of operations for the year ended June 30, 2012 and 2011 include CPSL, PSHL, Blessford International, Chengtong, Shanghai Blessford and Tuorong. Intercompany items have been eliminated.

 

3. Summary of Significant Accounting Policies

 

The following is a summary of significant accounting policies:

 

Cash and Cash Equivalents – The Company considers all highly liquid debt instruments purchased with maturity period of three months or less to be cash equivalents. The carrying amounts reported in the accompanying consolidated balance sheets for cash and cash equivalents approximate their fair value.

 

Accounts Receivable – Credit periods vary substantially across industries, segments, types and size of companies in the PRC where we operate our business. Because of the niche products that we process, our customers are usually also niche players in their own respective segment, who then sell their products to end product manufacturers. The business cycle is relatively long, as well as the credit periods. The Company offers credit to its customers for periods of 60 days, 90 days, 120 days and 180 days. We generally offer longer credit terms to long-standing recurring customers with good payment histories and sizable operations. Accounts receivable are recorded at the time revenue is recognized and are stated net of allowance for doubtful accounts.

 

F-7
 

 

Allowance for Doubtful Accounts – The Company maintains an allowance for doubtful accounts based on its assessment of the collectability of the accounts receivable. Management determines the collectability of outstanding accounts by maintaining regular communication with such customers and obtaining confirmation of their intent to fulfill their obligations to the Company. Management also considers past collection experience, our relationship with customers and the impact of current economic conditions on our industry and market. However, we note that the continuation or intensification of the current global economic crisis may have negative consequences on the business operations of our customers and adversely impact their ability to meet their financial obligations. 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. From time to time, we will review these credit periods, 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. If our actual collection experience or other conditions change, revisions to our allowances may be required, including a further provision which could adversely affect our operating income, or write back of provision when estimated uncollectible accounts are actually collected. At June 30, 2012 and 2011, the Company had $3,231,613 and $1,063,620 of allowances for doubtful accounts, respectively.

 

Bad debts are written off for past due balances over two years or when it becomes known to management that such amount is uncollectible. There was a provision for accounts receivable bad debts of $2,150,984 and $19,992 recognized for the years ended June 30, 2012 and 2011, respectively.

 

Inventories – Inventories are stated at the lower of cost or market. Cost is determined using the weighted average method.

 

Cost of inventories comprises all costs of purchases, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. Costs of conversion of inventories include fixed and variable production overheads, taking into account the stage of completion.

 

There was an inventory provision of $396,322 and $44,922 for the years ended June 30, 2012 and 2011, respectively.

 

Intangible Assets and Amortization – Intangible assets represent land use rights in China acquired by the Company and are stated at cost less amortization and impairment, if any. Amortization of land-use rights is calculated on the straight-line method, based on the period over which the right is granted by the relevant authorities in China.

 

Advances to Suppliers – In order to ensure 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 when the advance purchase contracts are entered into. Advances to suppliers are shown net of an allowance which represents potentially unrecoverable cash advances at each balance sheet date. 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. In general, we do not provide allowances against advances paid to those PRC state-owned companies as there is minimal risk of default. 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 reflect changes from our historic raw materials receipt experience and to ensure the appropriateness of the allowance in light of the circumstances present at the time of the review. 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. As of June 30, 2012 and 2011, the Company had made allowances of advances to suppliers of $4,623,323 and $1,724,275, respectively. There was a provision for advances to suppliers bad debts of $2,871,154 and $nil recognized for the years ended June 30, 2012 and 2011, respectively.

 

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 by the suppliers to deliver the contracted raw materials or refund the cash advances. To date, we have not written off any advances to suppliers.

 

Property, Plant and Equipment – Property, plant and equipment are stated at cost less accumulated depreciation. The cost of an asset comprises its purchase price and any directly attributable costs of bringing the asset to its present working condition and location for its intended use.

 

Depreciation is computed on a straight-line basis over the estimated useful lives of the related assets for financial reporting purposes. The estimated useful lives for significant property and equipment are as follows:

 

Buildings   10 years
Plant and machinery   10 years
Motor vehicles   5 years
Office equipment   5 years

 

Repairs and maintenance costs are normally charged to the statement of operations in the year in which they are incurred. In situations where it can be clearly demonstrated that the expenditure has resulted in an increase in the future economic benefits expected to be obtained from the use of the asset, the expenditure is capitalized as an additional cost of the asset.

 

F-8
 

 

Impairment of Long-Lived Assets – The Company accounts for impairment of property, plant and equipment and amortizable intangible assets in accordance with ASC Topic No. 360 “Property, Plant and Equipment” (“ASC 360”), which requires the Company to evaluate a long-lived asset for recoverability when there is an event or circumstance that indicates the carrying value of the asset may not be recoverable. An impairment loss is recognized when the carrying amount of a long-lived asset or asset group is not recoverable (when carrying amount exceeds the gross, undiscounted cash flows from use and disposition) and is measured as the excess of the carrying amount over the asset’s (or asset group’s) fair value. We primarily use the income valuation approach to determine the fair value of our long-lived assets, with fair value being the price that would be received from selling an asset in an orderly transaction between market participants at the measurement date.

 

Capitalized Interest – The Company capitalizes interest cost on borrowings incurred during the new construction or upgrade of qualified assets. Capitalized interest is added to the cost of the underlying assets and is amortized over the useful lives of the assets. During the years ended June 30, 2012 and 2011, the Company capitalized $nil interest to construction-in-progress.

 

Construction-in-Progress – Plant and production lines currently under development are accounted for as construction-in-progress. Construction-in-progress is recorded at acquisition cost, including land rights cost, development expenditure, professional fees and the interest expenses capitalized during the course of construction for the purpose of financing the project. Upon completion and readiness for use of the project, the cost of construction-in-progress is to be transferred to property, plant and equipment.

 

Contingent Liabilities and Contingent Assets  A contingent liability is a possible obligation that arises from past events and whose existence will only be confirmed by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the Company. It can also be a present obligation arising from past events that is not recognized because it is not probable that outflow of economic resources will be required or the amount of obligation cannot be measured reliably.

 

A contingent liability is not recognized but is disclosed in the notes to the financial statements. When a change in the probability of an outflow occurs so that outflow is probable, the contingency is then recognized as a provision.

 

A contingent asset is a possible asset that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain events not wholly within the control of the Company.

 

Contingent assets are not recognized but are disclosed in the notes to the financial statements when an inflow of economic benefits is probable. When inflow is virtually certain, an asset is recognized.

 

Advances from Customers  Advances from customers represent advance cash receipts from customers and for which goods have not been delivered or services have not been rendered at each balance sheet date. Advances from customers for goods to be delivered or services to be rendered in the subsequent period are carried forward as deferred revenue.

 

Revenue Recognition – Revenue from the sale of goods and services is recognized on the transfer of risks and rewards of ownership, which generally coincides with the time when the goods are delivered to customers and the title has passed and services have been rendered. Revenue is reported net of all VAT taxes. Other income is recognized when it is earned.

 

Functional Currency and Translating Financial Statements – The Company’s principal country of operations is the PRC. Our functional currency is Chinese Renminbi; however, the accompanying consolidated financial statements have been expressed in United States Dollars (“USD”). The consolidated balance sheets have been translated into USD at the exchange rates prevailing at each balance sheet date. The consolidated statements of operations and cash flows have been translated using the weighted-average exchange rates prevailing during the periods of each statement. The registered equity capital denominated in the functional currency is translated at the historical rate of exchange at the time of capital contribution. All translation adjustments resulting from the translation of the financial statements into the reporting currency are dealt with as other comprehensive income in stockholders’ equity.

 

Accumulated Other Comprehensive Income – Accumulated other comprehensive income represents the change in equity of the Company during the periods presented from foreign currency translation adjustments.

 

Taxation – Taxation on overseas profits has been calculated on the estimated assessable profits for the year at the rates of taxation prevailing in the country in which the Company operates.

 

United States

 

China Precision Steel, Inc. is subject to United States federal income tax at a tax rate of 34%. No provision for income taxes in the United States has been made as China Precision Steel, Inc. had no taxable income in fiscal years 2012 and 2011.

 

F-9
 

 

BVI

 

PSHL and Blessford International were incorporated in the British Virgin Islands and, under the current laws of the British Virgin Islands, are not subject to income taxes.

 

PRC

 

Provision for the PRC enterprise income tax is calculated at the prevailing rate based on the estimated assessable profits less available tax relief for losses brought forwardThe Company does not accrue taxes on unremitted earnings from foreign operations as it is the Company’s intention to invest these earnings in the foreign operations indefinitely.

 

Enterprise income tax

 

On March 16, 2007, the National People’s Congress of China passed The Enterprise Income Tax Law (the “New EIT Law”), and on December 6, 2007, the State Council of China passed the Implementing Rules for the EIT Law (“Implementing Rules”) which took effect on January 1, 2008. The New EIT Law and Implementing Rules impose a unified enterprise income tax (“EIT”) of 25% on all domestic-invested enterprises and foreign invested entities (“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.

 

Despite these changes, the EIT Law gives the FIEs established before March 16, 2007 (“Old FIEs”) a five-year grandfather period during which they can continue to enjoy their existing preferential tax treatments, commonly referred to as “tax holidays”, until these holidays expire. As an Old FIE, Chengtong’s tax holiday of a 50% reduction in the 25% statutory rates expired on December 31, 2008 and it is currently subject to the 25% statutory rates since January 1, 2009; Shanghai Blessford’s full tax exemption from the enterprise income tax expired on December 31, 2009, and it is subject to a 50% reduction for the three subsequent years expiring on December 31, 2012. Subsequent to the expiry of their tax holidays, Chengtong and Shanghai Blessford will be subject to enterprise income taxes at 25% or the prevailing statutory rates. The discontinuation of any such special or preferential tax treatment or other incentives would have an adverse effect on any organization’s business, fiscal condition and current operations in China.

 

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statements carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets, including tax loss and credit carry forwards, and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred income tax expense represents the change during the period in the deferred tax assets and deferred tax liabilities. The components of the deferred tax assets and liabilities are individually classified as current and non-current based on their characteristics. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

 

The Company follows the provisions of the ASC Topic No. 740 “Accounting for Income Taxes” and “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (“ASC 740”). ASC 740 requires the recognition of tax benefits or expenses based on the estimated future tax effects of temporary differences between the financial statements and tax bases of its assets and liabilities. Deferred tax assets and liabilities primarily relate to tax basis differences on unrealized gains on corporate equities, stock-based compensation, amortization periods of certain intangible assets and differences between the financial statements and tax bases of assets acquired.

 

The Company recognizes that virtually all tax positions in the PRC are not free of some degree of uncertainty due to tax law and policy changes in the PRC. However, the Company cannot reasonably quantify political risk factors and thus must depend on guidance issued by current officials in the PRC.

 

Based on all known facts and circumstances and current tax law, the Company believes that the total amount of unrecognized tax benefits as of June 30, 2012 is not material to its results of operations, financial condition or cash flows. The Company also believes that the total amount of unrecognized tax benefits as of June 30, 2012, if recognized, would not have a material effect on its effective tax rate. The Company further believes that there are no tax positions for which it is reasonably possible, based on current Chinese tax law and policy, that the unrecognized tax benefits will significantly increase or decrease over the next 12 months producing, individually or in the aggregate, a material effect on the Company’s results of operations, financial condition or cash flows.

 

Value added tax

 

The Provisional Regulations of the People’s Republic of China Concerning Value Added Tax promulgated by the State Council came into effect on January 1, 1994. Under these regulations and the Implementing Rules of the Provisional Regulations of the People’s Republic of China Concerning Value Added Tax, value added tax is imposed on goods sold in or imported into the PRC and on processing, repair and replacement services provided within the PRC.

 

F-10
 

 

Value added tax payable in the PRC is charged on an aggregated basis at a rate of 13% or 17% (depending on the type of goods involved) on the full price collected for the goods sold or, in the case of taxable services provided, at a rate of 17% on the charges for the taxable services provided, but excluding, in respect of both goods and services, any amount paid in respect of value added tax included in the price or charges, and less any deductible value added tax already paid by the taxpayer on purchases of goods and services in the same financial year.

 

The revised People’s Republic of China Tentative Regulations on Value Added Tax became effective on January 1, 2009 with the issuance of Order of the State Council No. 538. With the implementation of this VAT reform, input VAT associated with the purchase of fixed assets is now deductible against output VAT.

 

Retirement Benefit Costs – According to the PRC regulations on pension, Chengtong and Shanghai Blessford contribute to a defined contribution retirement scheme organized by municipal government in the province in which Chengtong and Shanghai Blessford were registered and all qualified employees are eligible to participate in the scheme. Contributions to the scheme are calculated at 37% of the employees’ salaries above a fixed threshold amount and the employees contribute 11%, while Chengtong and Shanghai Blessford contribute the balance contribution of 26%. The Group has no other material obligation for the payment of retirement benefits beyond the annual contributions under this scheme.

 

For the years ended June 30, 2012 and 2011, the Company’s pension cost charged to the statements of operations under the plan amounted to $264,258 and $233,432, respectively, all of which have been paid to the National Social Security Fund.

 

Fair Value of Financial Instruments – The carrying amounts of certain financial instruments, including cash, accounts receivable, other receivables, short-term loans, accounts payable, accrued expenses, and other payables approximate their fair values as at June 30, 2012 and 2011 because of the relatively short-term maturity of these instruments. The Company considers the carrying amount of long-term loans to approximate their fair values based on the interest rates of the instruments and the current market rate of interest.

 

Use of Estimates  The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

4. Concentrations of Business and Credit Risk

 

The Company’s list of customers whose purchases from us were 10% or more of total sales during the years ended June 30, 2012 and 2011 is as follows:

  

    2012     2011  
a. Customers   $     % to sales     $     % to sales  
Shanghai Shengdejia Metal Co. Ltd     17,829,967       12       32,261,653       21  
Shanghai Changshuo Steel Company, Ltd     14,842,069       11       23,410,550       16  

 

The Company’s list of suppliers whose sales to us exceeded 10% of our total purchases during the years ended June 30, 2012 and 2011 is as follows:

 

    2012     2011  
b. Suppliers   $     % to
Purchases
    $     % to
purchases
 
Dachang Huizu Baosheng Steel Products Co., Ltd.     31,035,606       26       28,878,126       24  
Hebei Nuojin Trading Co., Ltd.     28,581,403       24       -*       -*  
Wuxi Hangda Trading Co., Ltd.     14,389,057       12       18,700,715       16  
Zhejiang Wuchan Metal Group Co., Ltd.     -*       -*       15,962,338       13  

 

* Not 10% suppliers for the relevant years

 

Our management continues to take appropriate actions to perform ongoing business and credit reviews of our customers to reduce our exposure to new and recurring customers who have been deemed to pose a high credit risk to our business based on their commercial credit reports, our collection history, and our perception of the risk posed by their geographic location. We have halted all our direct sales to customers located in the Philippines since the year ended June 30, 2009 as we consider the associated credit risk to be relatively high. Based on publicly available reports, such as that issued by A.M. Best, there is a high risk that financial volatility may erupt in that country due to inadequate reporting standards, a weak banking system or asset markets and/or poor regulatory structure. We expect to resume such exports when conditions improve.

 

F-11
 

 

5. Accounts Receivable

 

The Company provides credit in the normal course of business. The Company performs ongoing credit evaluations of its domestic and international customers and clients and maintains allowances for bad and doubtful accounts based on factors surrounding the credit risk of specific customers and clients, historical trends, and other information. Trade accounts receivable, net totaled $59,116,931 and $41,335,759 as of June 30, 2012 and 2011, respectively.

 

From time to time, accounts receivable are reviewed for changes from the historic collection experience to ensure the appropriateness of the allowances. These estimates have been relatively accurate in the past and currently there is no need to revise such estimates. However, we will review such estimates more frequently when needed, and make revisions if necessary. The continuation or intensification of the current global economic crisis and turmoil in the global financial markets may have negative consequences for the business operations of our customers and adversely impact their ability to meet their obligations to us. A significant change in our collection experience, deterioration in the aging of receivables and collection difficulties could require that we increase our estimate of the allowance for doubtful accounts. Any such additional bad debt charges could materially and adversely affect our future operating results.

 

6. Valuation and Qualifying Accounts

 

       Additions   Deductions/         
   Balance at   Charged to   Write-offs       Balance at 
   Beginning   Costs and   Charged to   Exchange   End of 
Description  of Year   Expenses   Allowance   Difference   Year 
Allowance for Doubtful Accounts (Trade):                         
Year ended June 30, 2011   1,013,744    19,992    -    29,884    1,063,620 
Year ended June 30, 2012   1,063,620    2,150,984    -    17,009    3,231,613 
                          
Allowance for Doubtful Accounts (Suppliers):                         
Year ended June 30, 2011   1,643,419    -    -    80,856    1,724,275 
Year ended June 30, 2012   1,724,275    2,871,154    -    27,894    4,623,323 
                          
Valuation Allowance for Deferred Tax Assets:                         
Year ended June 30, 2011   3,845,263    417,749    -    107,389    4,370,401 
Year ended June 30, 2012   4,370,401    4,311,949    -    37,589    8,719,939 

 

7. Condensed Financial Information of Parent Company

 

Payments of dividends may be subject to some restrictions due to the fact that the operating activities are conducted in subsidiaries residing in the PRC. The laws and regulations of the PRC currently permit the payment of dividends only out of accumulated profits as determined in accordance with Chinese accounting standards and regulations. Our subsidiaries in the PRC 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, we will be unable to pay any dividends. We currently intend to retain any future earnings for use in the operation and expansion of our business. No cash dividends have been paid to the parent company for the last three fiscal years. In accordance with Rule 504/4.08 (e) (3) of Regulation S-X, the following are condensed parent company only financial statements as of and for the two years ended June 30, 2012 and 2011.

 

F-12
 

 

China Precision Steel, Inc.

Condensed Parent Company Only Balance Sheets

June 30, 2012 and 2011

 

   2012   2011 
Cash and cash equivalents  $29,235   $180,789 
Prepayments   339,433    420,854 
Total current assets   368,668    601,643 
           
Property, plant and equipment   2,938    2,370 
Investment in subsidiary, reported on equity method   55,471,427    69,315,760 
Advances to subsidiaries   63,266,786    63,785,345 
           
Total assets  $119,109,819   $133,705,118 
           
Current liabilities:          
Accounts payable  $234,659   $155,923 
Accrued expenses   4,566    4,566 
Total current liabilities  $239,225   $160,489 
           
Stockholders' equity:          
Ordinary stock, $.001 par value; 62,000,000 shares authorized; 3,880,866 shares issued and outstanding at June 30, 2012 and 2011, respectively   3,880    3,880 
Additional paid-in capital   75,685,066    75,685,066 
Other comprehensive income   19,097,295    16,822,185 
Retained earnings   24,084,353    41,033,498 
           
Total stockholders' equity  $118,870,594   $133,544,629 
           
Total liabilities and stockholders' equity  $119,109,819   $133,705,118 

 

China Precision Steel, Inc.

Condensed Parent Company Only Income Statements

For the Years Ended June 30, 2012 and 2011

 

   2012   2011 
         
Sales  $-   $- 
           
Operating and administrative expenses:          
General and administrative expenses   882,273    1,289,014 
Loss from operations   (882,273)   (1,289,014)
           
Other income:          
Interest income   418    3,454 
Other income   52,153    - 
Equity in earnings of unconsolidated subsidiaries   (16,119,443)   1,542,510 
(Loss)/income before income taxes   (16,949,145)   256,950 
           
Provision for income taxes   -    - 
           
Net (loss)/income  $(16,949,145)  $256,950 
           
The components of comprehensive (loss)/income:          
Net (loss)/income  $(16,949,145)  $256,950 
Foreign currency translation adjustment   2,275,110    6,191,210 
           
Comprehensive (loss)/income  $(14,674,035)  $6,448,160 

 

F-13
 

 

China Precision Steel, Inc.

Condensed Parent Company Only Statements of Cash Flows

For the Years Ended June 30, 2012 and 2011

 

   2012   2011 
Cash flows from operating activities:          
Net (loss)/income  $(16,949,145)  $256,950 
Adjustments to reconcile net income to operating activities -          
Add: depreciation   681    567 
Add: loss on fixed asset disposal   -    632 
Less: Equity in earnings of unconsolidated subsidiaries   16,119,443    (1,542,510)
Net changes in assets and liabilities          
Prepayments   81,421    (205,292)
Accounts payable   78,736    25,923 
Net cash (used in) operating activities   (668,864)   (1,463,730)
           
Cash flows from investing activities:          
Repayment of advances by subsidiaries   518,559    - 
Purchase of fixed assets   (1,249)   (2,167)
Net cash provided by/(used in) investing activities   517,310    (2,167)
           
Effect of exchange rate change on cash and cash equivalents   -    - 
           
Net (decrease) in cash and cash equivalents   (151,554)   (1,465,897)
           
Cash and cash equivalents, beginning of year   180,789    1,646,686 
           
Cash and cash equivalents, end of year  $29,235   $180,789 
           
Supplemental disclosures of cash flow information:          
Interest paid, net of capitalized amounts  $-   $- 
Income taxes paid  $-   $- 

 

8. Inventories

 

ASC 330-10-35, “Adjustments to Lower of Cost or Market”, requires us to reduce the carrying value of inventory when there is evidence that the utility of goods will be less than cost, whether due to physical deterioration, obsolescence, changes in price levels or other causes. The Company recorded inventory write-downs in the amounts of $396,322 and $44,922 for the years ended June 30, 2012 and 2011, respectively. These amounts were recognized as a loss of the current period.

 

As of June 30, 2012 and 2011, inventories consisted of the following:

 

   June 30,   June 30, 
At cost:  2012   2011 
Raw materials  $1,711,735   $5,360,128 
Work in progress   1,064,229    7,097,117 
Finished goods   6,409,395    8,744,037 
Consumable items   6,727,183    3,921,089 
    15,912,542    25,122,371 
Less: provision   (396,322)   (44,922)
   $15,516,220   $25,077,449 

 

Costs of finished goods include direct labor, direct materials, and production overhead before the goods are ready for sale.

 

Consumable items represent parts used in our cold rolling mills and other equipment that need to be replaced from time to time when necessary to ensure optimal operating results, such as bearings and rollers.

 

Inventories amounting to $6,299,566 (June 30, 2011: $7,096,698) were pledged for short-term loans totaling $19,354,534 at June 30, 2012 (June 30, 2011: $19,030,232).

 

F-14
 

 

9. Advances to Suppliers

 

Cash advances are shown net of allowances of $4,623,323 and $1,724,275 at June 30, 2012 and 2011, respectively.

 

Some of our suppliers are state-owned companies in the PRC or their subsidiaries. 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 generally do not provide allowances against such advances.

 

10. Property, Plant and Equipment

 

Property, plant and equipment, stated at cost less accumulated depreciation, consisted of the following:

 

   June 30,   June 30, 
   2012   2011 
Plant and machinery  $77,064,727   $75,670,080 
Buildings   23,438,143    23,045,416 
Motor vehicles   651,595    699,229 
Office equipment   539,416    519,421 
    101,693,881    99,934,146 
Less: Accumulated depreciation   (33,940,890)   (24,622,925)
   $67,752,991   $75,311,221 

 

Depreciation expense related to manufacturing is included as a component of cost of goods sold. During the years ended June 30, 2012 and 2011, depreciation totaling $6,351,180 and $5,453,419, respectively, was included as a component of cost of goods sold.

 

Plant and machinery amounting to $34,533,411 (June 30, 2011: $38,109,339) and $19,514,340 (June 30, 2011: $21,744,337) were pledged for short-term loans totaling $27,246,477 and long-term loans including current portion totaling $16,200,000, respectively, at June 30, 2012 (June 30, 2011: $27,189,629 and $18,000,000, respectively).

 

11. Construction-In-Progress

 

As of June 30, 2012 and 2011, construction-in-progress consisted of the following:

 

  

June 30,

2012

   June 30,
2011
 
Construction costs  $233,512   $64,762 

 

Construction-in-progress represents construction and installations of annealing furnaces.

   

12. Intangible Assets

   

Land use rights amounting to $1,877,363 (June 30, 2011: $1,886,717) were pledged for short-term loans totaling $27,246,477 at June 30, 2012 (June 30, 2011: $27,189,629).

 

The Company acquired land use rights in August 2004 and December 2006 for 50 years that expire in August 2054 and December 2056, respectively. The land use rights are amortized over a fifty-year term. An amortization amount of approximately $37,000 is to be recorded each year starting from the financial year ended June 30, 2009 for the remaining lease period.

 

Amortizable intangible assets of the Company are reviewed when there are triggering events to determine whether their carrying value has become impaired, in conformity with ASC 360. The Company also re-evaluates the periods of amortization to determine whether subsequent events and circumstances warrant revised estimates of useful lives.

 

13. Short-Term Loans

 

Short-term loans consisted of the following:

 

   June 30,   June 30, 
   2012   2011 
Bank loan dated June 29, 2011, due July 31, 2012, with an interest rate at 115% of the standard market rate set by the People’s Bank of China (“PBOC”) (7.2565% at June 30, 2012) per annum (Notes 10 and 12)   7,891,943    8,159,397 
           
Bank loan dated June 29, 2011, due July 31, 2012 with an interest rate at 115% of the standard market rate set by PBOC (7.2565% at June 30, 2012) per annum (Notes 8, 10 and 12)   19,354,534    19,030,232 
           
Bank loan dated January 19, 2011, due July 18, 2011 with an interest rate of 6.42% per annum   -    181,019 
   $27,246,477   $27,370,648 

 

F-15
 

 

The above bank loans outstanding at June 30, 2012 are Renminbi (“RMB”) loans. Other than the bank loan dated January 19, 2011 that was secured by bills receivable, all other short-term loans carry an interest rate of 1.15 times of the standard market rate set by the PBOC, and are secured by inventories, land use rights, buildings and plant and machinery, and guaranteed by PSHL and our former Chairman, Mr. Wo Hing Li. In addition, pursuant to a bank loan agreement entered into between the Company and Raiffeisen Zentralbank Osterreich AG ("RZB"), Mr. Li undertakes to maintain a shareholding percentage in the Company of not less than 33.4% unless otherwise agreed to with RZB.

 

The weighted-average interest rate on short-term loans at June 30, 2012 and 2011 was 7.26% and 7.25%, respectively.

 

Principal and interest under the short-term loans totaling $27,246,477 with RZB were to be repaid in full on July 31, 2012, but the Company has defaulted on this repayment obligation. The Company is currently in discussions with RZB regarding the restructuring of the loans for repayment but has not yet agreed on specific terms. Any restructuring will be subject to approval by RZB's governing bodies, and to the Company's ability to meet certain conditions and requirements that may be imposed by the Bank. RZB also has the right to take possession of the collateral granted in connection with their respective loan agreements, which action would have a material adverse impact on the Company.

 

As part of the ongoing discussions with RZB to potentially restructure our short-term loans, we are putting in place a series of measures to cut costs and improve overall profitability including expanding customer base to increase total demand, strategizing our product mix to re-focus on our competitive advantage and niche capabilities including the ultra-thin low-carbon and high strength high-carbon products, streamlining production and reducing number of workers in response to lower demand, hiring professionals and technicians to improve our production management and increase quality control, and continue to carry out research and development (“R&D”) to improve profitability of existing products and launch new high value-add products.

 

14. Long-Term Loan – Current Portion

 

   June 30,
2012
   June 30,
2011
 
Bank loan dated June 29, 2010, due June 15, 2016 with an interest rate of the London Interbank Offered Rate (“LIBOR”) plus 4.5% (5.2379% at June 30, 2012) per annum (Note 10)  $16,200,000   $18,000,000 

 

On January 29, 2010, Shanghai Blessford entered into a Senior Loan Agreement with DEG -Deutsche Investitions-Und Entwicklungsgesellschaft Mbh (“DEG”) for a loan amount up to $18,000,000 at an annual interest rate of 4.5% above the six-month USD LIBOR rate. The loan is to be repaid semi-annually over five years starting on December 15, 2011 and is secured by a mortgage on the new cold rolling line and annealing furnaces at Shanghai Blessford’s facilities and guaranteed by the Company.

 

In June 2012, the Company has defaulted on its semi-annual principal and interest repayment obligation in the amount of $2,234,025.68. The Company is currently in discussions with DEG regarding the restructuring of the loans for repayment but has not yet agreed on specific terms. Until such agreement is reached, DEG has the right to cancel the total outstanding commitment of the loan, demand immediate repayment of all or part of the loan with accrued interest, and/or terminate the loan agreement. DEG also has the right to take possession of the collateral granted in connection with its respective loan agreements, which action would have a material adverse impact on the Company.

 

15. Stockholders’ Equity

 

Reverse Stock Split

 

In June 2012, the stockholders of the Company approved the authority of the Company’s Board of Directors to effect a one-for-twelve reverse stock split of the Company’s outstanding common stock. The reverse stock split became effective on August 27, 2012 and as a result of the reverse stock split, the issued and outstanding shares of the Company’s common stock decreased to 3,880,866 shares, without any change in the par value of such shares. These consolidated financial statements and accompanying notes to the consolidated financial statements give retroactive effect to the reverse stock split for all periods presented.

 

Stock Warrants

 

On November 6, 2007, in connection with the Subscription Agreement, the Company issued to certain institutional accredited investors warrants to purchase 118,333 shares of Common Stock valued at $5,374,748, and Roth Capital Partners, LLC, as placement agent, received warrants to purchase 18,800 shares of Common Stock valued at $887,504. These amounts were recorded as syndication fees offsetting additional paid-in capital. Warrants issued to Roth Capital were not exercised and expired on November 5, 2010.

 

F-16
 

 

Information with respect to stock warrants outstanding is as follows:

 

Exercise
Price
   Outstanding
June 30, 2011
   Granted   Expired or
Exercised
   Outstanding
June 30, 2012
   Expiration Date
$101.40    118,333    -0-    -0-    118,333   May 5, 2013

 

16. Income Taxes

 

For PRC enterprise income tax reporting purposes, the Company is required to compute a 10% salvage value when computing depreciation expense and add back the allowance for doubtful debts. For financial reporting purposes, the Company does not take into account a 10% salvage value when computing depreciation expenses.

 

The tax holiday resulted in tax savings as follows:

 

   Years ended June 30, 
   2012   2011 
Tax savings  $0.00   $122,281 
           
Benefit per share          
Basic  $0.00   $0.00 
Diluted  $0.00   $0.00 

 

Significant components of the Group’s deferred tax assets and liabilities as of June 30, 2012 and 2011 are as follows:

 

   June 30,   June 30, 
Deferred tax assets and liabilities:  2012   2011 
Net operating loss carried forward  $6,668,613   $2,356,664 
Temporary differences resulting from allowances   2,051,326    2,013,737 
Net deferred income tax asset  $8,719,939   $4,370,401 
Valuation allowance   (8,719,939)   (4,370,401)
   $-   $- 

 

The Company has not recognized a deferred tax liability in respect of the undistributed earnings of its foreign subsidiaries of approximately $2,820,358 as of June 30, 2012 because the Company currently plans to reinvest those unremitted earnings such that the remittance of the undistributed earnings of those foreign subsidiaries to the Company will be postponed indefinitely. A deferred tax liability will be recognized when the Company no longer plans to permanently reinvest undistributed earnings.

 

A reconciliation of the provision for income taxes with amounts determined by the PRC income tax rate to income tax expense per books is as follows:

 

   Year ended June 30, 
   2012   2011 
Computed tax at the PRC statutory rate of 25%  $(4,311,962)  $(1,096)
Valuation allowance   4,349,538    525,138 
Income not subject to tax   (37,589)   (107,389)
Expenses not deductible for tax   13    14 
Additional income taxes (1)   -    241,941 
Overprovision   (5,061)   - 
Benefit of tax holiday   -    (122,281)
Income tax (benefit)/expense per books  $(5,061)  $536,327 

 

(1) The additional income taxes were taxes on the transfer of retained earnings to the registered capital of Shanghai Blessford during the year ended June 30, 2012.

 

F-17
 

 

Income tax (benefit)/expense consists of:

 

   Year ended June 30, 
   2012   2011 
Income tax (benefit)/expense for the year – PRC  $(5,061)  $536,327 
Deferred income tax benefit – PRC   -    - 
Income tax (benefit)/expense per books  $(5,061)  $536,327 

 

17. (Loss)/earnings Per Share

 

ASC 260-10 requires a reconciliation of the numerator and denominator of the basic and diluted (loss)/earnings per share (EPS) computations.

 

For the year ended June 30, 2012, warrants to purchase 118,333 shares at an exercise price of $101.40 were not included as their effect would have been anti-dilutive, however, securities represented by the 118,333 warrants still outstanding could potentially dilute basic earnings per share in the future.

 

For the year ended June 30, 2011, warrants to purchase 29,866 shares of common stock at an exercise price of $36.00, 188,333 shares at an exercise price of $101.40 and 18,800 shares at an exercise price of $88.56 were not included as their effect would have been anti-dilutive.

 

The following reconciles the components of the EPS computation:

 

   Income   Shares   Per Share 
   (Numerator)   (Denominator)   Amount 
For the year ended June 30, 2012:               
Net (loss)  $(16,949,145)          
Basic EPS (loss) available to common shareholders  $(16,949,145)   3,880,866   $(4.37)
Effect of dilutive securities:               
Warrants        -      
Diluted EPS (loss) available to common shareholders  $(16,949,145)   3,880,866   $(4.37)
For the year ended June 30, 2011:               
Net income  $256,950           
Basic EPS income available to common shareholders  $256,950    3,880,866   $0.07 
Effect of dilutive securities:               
Warrants        -      
Diluted EPS income available to common shareholders  $256,950    3,880,866   $0.07 

 

18. Contingencies and Commitments

 

Legal Proceedings

 

The Company is subject to various legal proceedings and claims that have arisen in the ordinary course of business.

 

On March 15, 2012, the Company received notice of a complaint filed by a Mr. Haining Zhang and China Venture Partners, Inc. in the U.S. Southern District Court of New York on March 9, 2012, against several defendants, including the Company, as successor to OraLabs Holding Corp.  In the complaint Mr. Zhang is alleging, among other things, breach of contract by the Company and certain of our former officers, directors and control persons, in connection with our December 2006 acquisition of Partner Success Holdings Limited. Among other things, Mr. Zhang alleges that the defendants breached an agreement to compensate him for services he allegedly performed in connection with seeking out a merger candidate for the Company. The Company believes that the suit is without merit and intends to vigorously defend its interests in the case. The Company was granted court permission to file a motion to dismiss the action as against it. Prior to filing the motion to dismiss, plaintiffs amended their complaint. Accordingly, the Company filed a motion to dismiss the amended complaint. That motion has now been fully briefed by the parties. The court has not yet advised whether it will permit oral argument on the motion prior to issuing a decision.

 

Although an estimate of any potential loss cannot be made at this time, the Company does not believe that its business or financial condition is materially adversely affected.

 

Capital Commitments

 

As of June 30, 2012, the Company did not have any capital commitments (June 30, 2011: $nil).

 

F-18
 

 

19. Impairment

 

We determine impairment of long-lived assets, including property, plant and equipment and amortizable intangible assets, by measuring the estimated undiscounted future cash flows generated by these assets, comparing the result to the assets’ carrying values and, if necessary, adjusting the assets to the lower of its carrying value or fair value and charging current operations for the measured impairment. The determination of the undiscounted future cash flows and fair value of these assets are subject to significant judgment.

 

The assets are subject to impairment consideration under ASC 360-10-35-17 if events or circumstances indicate that their carrying amounts might not be recoverable. In accordance with ASC360, as of June 30, 2012, as the Company’s market capitalization was lower than the carrying value of its assets, management performed an impairment test pursuant to the guidance outlined in ASC 360-10-35-21 and no impairment charges were recognized for the relevant year. As of June 30, 2012, the Company expects these assets to be fully recoverable based on the result of the impairment test. Goodwill amounting to $99,999 as at June 30, 2012 was considered immaterial and not tested for impairment in accordance with ASC 350.

 

20. Business Segment Information

 

Operations for the Company are summarized below by geographic area:

 

   Year Ended June 30, 2012 
   PRC   Foreign   Total 
Revenue  $135,460,918   $7,512,713   $142,973,631 
% of sales   95    5    100 

 

   Year Ended June 30, 2011 
   PRC   Foreign   Total 
Revenue  $146,829,732   $4,369,979   $151,199,711 
% of sales   97    3    100 

 

21. Quarterly Data - Unaudited

 

The following table sets forth certain information regarding the Company’s results of operations for each full quarter within the fiscal years ended June 30, 2012 and 2011:

 

   Quarter Ended 
   June 30,   March 31,   December 31,   September 30, 
Fiscal 2012:                    
Revenues  $37,649,588   $29,494,865   $33,662,335   $42,166,843 
Gross (loss)/profit   (2,952,641)   (1,117,208)   (1,798,717)   61,770 
Loss from operations before income tax   (9,051,355)   (3,312,915)   (3,565,153)   (1,024,783)
Net loss   (9,019,105)   (3,313,023)   (3,537,922)   (1,079,095)
Basic (loss) per share  $(2.32)  $(0.85)  $(0.91)  $(0.28)
Diluted (loss) per share  $(2.32)  $(0.85)  $(0.91)  $(0.28)
                     
Fiscal 2011:                    
Revenues  $46,045,610   $31,489,118   $39,768,528   $33,896,455 
Gross profit/(loss)   1,717,009    (41,616)   1,908,863    2,384,085 
Income/(loss) from operations before income tax   521,124    (886,646)   264,144    894,655 
Net income/(loss)   283,155    (872,497)   201,781    644,511 
Basic earnings/(loss) per share  $0.07   $(0.22)  $0.05   $0.17 
Diluted earnings/(loss) per share  $0.07   $(0.22)  $0.05   $0.17 

 

Earnings per share amounts for each quarter are required to be computed independently. As a result their sum may not equal the total year basic and diluted earnings per share.

 

F-19
 

 

22. Recent Accounting Pronouncements

 

In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income, ("ASU 2011-05"). ASU 2011-05 requires that all non-owner changes in shareholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. In December 2011, the FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No 2011-05, ("ASU 2011-12"). The amendments in ASU 2011-12 defer certain changes in ASU 2011-05 that relate to the presentation of reclassification adjustments out of accumulated other comprehensive income. The adoption of ASU 2011-05 and ASU 2011-12 is effective for the Company in fiscal year 2013 beginning July 1, 2012 but is eligible for early adoption. The Company is currently evaluating the effect of the presentation options of ASU 2011-05 and ASU 2011-12 on its financial statement presentation of comprehensive income.

 

In September 2011, the FASB issued ASU No. 2011-08, Intangibles-Goodwill and Other (Topic 350)-Testing Goodwill for Impairment, ("ASU 2011-08"), to simplify how entities test goodwill for impairment. ASU 2011-08 allows entities to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If a greater than 50 percent likelihood exists that the fair value is less than the carrying amount then a two-step goodwill impairment test as described in Topic 350 must be performed. ASU 2011-08 is effective for the Company in fiscal year 2013 beginning July 1, 2012 but is eligible for early adoption. The Company does not believe adoption of this new guidance will have a significant impact on its consolidated financial statements. 

 

In December 2011, the FASB issued ASU No. 2011-11, Disclosures About Offsetting Assets and Liabilities, ("ASU 2011-11"). The amendments in ASU 2011-11 require entities to disclose information about offsetting and related arrangements to enable users of financial statements to understand the effect of those arrangements on an entity's financial position. The amendments require enhanced disclosures by requiring improved information about financial instruments and derivative instruments that are either (i) offset in accordance with current literature or (ii) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with current literature. ASU 2011-11 is effective for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. This standard will become effective for the Company beginning July 1, 2013. The Company does not believe adoption of this new guidance will have a significant impact on its consolidated financial statements.

 

In July 2012, the FASB issued ASU No. 2012-02, Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment ("ASU 2012-02"). ASU 2012-02 amends Topic 350 by establishing an optional two-step analysis for impairment testing of indefinite-lived intangibles other than goodwill. This update allows an entity the option to first assess qualitative factors to determine whether it is necessary to perform the quantitative impairment test. Under that option, an entity no longer would be required to calculate the fair value of the intangible asset unless the entity determines, based on that qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. ASU 2012-02 is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012 and early adoption is permitted. This standard will become effective for the Company beginning July 1, 2013. The Company does not believe adoption of this new guidance will have a significant impact on its consolidated financial statements.

 

F-20
 

 

EXHIBIT INDEX

 

Exhibit No.   Description
3.1   Certificate of Incorporation (incorporated herein by reference to Annex 2 to the Company’s Definitive Proxy Statement filed on October 16, 2007)
     
3.2   Bylaws (incorporated herein by reference to Annex 3 to the Company’s Definitive Proxy Statement filed on October 16, 2007)
     
4.1   Form of Warrant, dated November 6, 2007 (incorporated herein by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on November 1, 2007)
     
4.2   Warrant, dated November 6, 2007, issued to Roth Capital Partners LLC (incorporated herein by reference Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on November 1, 2007)
     
4.3   Form of Warrant, dated February 2007 (incorporated herein by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on February 22, 2007)
     
4.4   Warrant, dated February 22, 2007, issued to Belmont Capital Group Limited (incorporated herein by reference Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on February 22, 2007)
     
4.5   Warrant, dated February 22, 2007, issued to CCG Elite Investor Relations (incorporated herein by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K filed on February 22, 2007)
     
10.1   Form of Subscription Agreement, dated November 1, 2007 (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on November 1, 2007)
     
10.2   Form of Placement Agency Agreement, dated October 31, 2007 (incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on November 1, 2007)
     
10.3   Form of Stock Purchase Agreement, dated February 16, 2007 (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on February 22, 2007)
     
10.4   Form of Limited Standstill Agreement (incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on February 22, 2007)
     
10.5   Redemption Agreement, dated December 28, 2006 (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on January 4, 2007)
     
10.6   Senior Loan Agreement, dated January 29, 2011, between Shanghai Blessford Alloy Co., Ltd. and DEG – Deutsche Investitions und Entwicklungsgessellschaft MBH (incorporated herein by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on February 16, 2011)
     
10.7   China Precision Steel, Inc. 2006 Omnibus Long Term Incentive Plan (incorporated herein by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed on January 4, 2007)
     
10.8   2006 Director Stock Plan, dated March 1, 2006 (incorporated herein by reference to Annex 3 to the Company’s Definitive Proxy Statement filed on November 22, 2006)
     
10.9   Executive Employment Agreement, dated as of January 1, 2007, between the Company and Wo Hing Li (incorporated herein by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on May 11, 2009)
     
10.10   Executive Employment Agreement, dated as of January 1, 2007, between the Company and Leada Tak Tai Li (incorporated herein by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q filed on May 11, 2009)
     
10.11   Executive Employment Agreement, dated as of January 1, 2007, between the Company and Hai Sheng Chen (incorporated herein by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q filed on May 11, 2009)
     
14   Code of Business Conduct and Ethics(incorporated herein by reference to Exhibit 14 to the Company’s Annual Report on Form 10-K filed on September 28, 2010)

 

 
 

 

21   Subsidiaries of the Company (incorporated herein by reference to Exhibit 21 to the Company’s Annual Report on Form 10-K filed on September 15, 2008)
     
31.1*   Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
     
31.2*   Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
     
32.1*   Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
     
32.2*   Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 
 

 

XFRA:3CP1 Annual Report 10-K Filling

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XFRA:3CP1 Annual Report 10-K Filing - 6/30/2012
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