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SUTR > SEC Filings for SUTR > Form 10-Q on 15-Nov-2012All Recent SEC Filings

Show all filings for SUTOR TECHNOLOGY GROUP LTD | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for SUTOR TECHNOLOGY GROUP LTD


15-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

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; 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, including those identified in Item 1A "Risk Factors" included in our Annual Report on Form 10-K for the year ended June 30, 2012, 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.

Readers are urged to carefully review and consider the various disclosures made by us in this report and our other filings with the SEC. These reports attempt to advise interested parties of the risks and factors that may affect our business, financial condition and results of operations and prospects. The forward-looking statements made in this report speak only as of the date hereof and we disclaim any obligation, except as required by law, to provide updates, revisions or amendments to any forward-looking statements to reflect changes in our expectations or future events.

Use of Terms

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

"Company," "we," "us" and "our" are to the combined business of Sutor Technology Group Limited, a Nevada corporation, and its subsidiaries: Sutor BVI, Sutor Technology, Changshu Huaye, Jiangsu Cold-Rolled and Ningbo Zhehua;

"Sutor BVI" are to our wholly-owned subsidiary Sutor Steel Technology Co., Ltd., a BVI company;

"Sutor Technology" are to our wholly-owned subsidiary Sutor Technology Co., Ltd., a PRC company;

"Changshu Huaye" are to our wholly-owned subsidiary Changshu Huaye Steel Strip Co., Ltd., a PRC company;

"Jiangsu Cold-Rolled" are to our wholly-owned subsidiary Jiangsu Cold-Rolled Technology Co., Ltd., a PRC company;

"Ningbo Zhehua" are to our wholly-owned subsidiary Ningbo Zhehua Heavy Steel Pipe Manufacturing Co., Ltd., a PRC company;

"Shanghai Huaye" are to Shanghai Huaye Iron & Steel Group Co., Ltd., a PRC company of which Lifang Chen, our major shareholder and chief executive officer, and her husband FengGao, are 100% owners, and its subsidiaries;

"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.

"China" and "PRC" are to the People's Republic of China;

"RMB" are to Renminbi, the legal currency of China; and

"U.S. dollar," "$" and "US$" are to the legal currency of the United States.

Overview of our Business

We are one of the leading China-based, non-state-owned manufacturers of fine finished steel products. We utilize a variety of processes and technological methodologies to convert steel manufactured by third parties into fine finished steel products. Our product offerings are focused on higher margin, value-added finished steel products, specifically hot-dip galvanized steel, or HDG steel, and pre-painted galvanized steel, or PPGI. In addition, we produce acid pickled steel, or AP steel, and cold-rolled steel, which represent the least processed of our finished products. Since November 2009, our product offerings have included welded steel pipe products. We use a large portion of our AP steel and cold-rolled steel to produce our HDG steel and PPGI products. Our vertical integration has allowed us to maintain more stable margins for our HDG steel and PPGI products.

We sell most of our products to customers who operate primarily in the solar energy, appliances, automobile, construction, infrastructure, medical equipment and water resource industries. Most of our customers are located in China. Our primary export markets are Europe, the Middle East, Asia, and South America.

Our manufacturing facilities, located in Changshu, China, have three HDG steel production lines, one PPGI production line, one AP steel production line and one cold-rolled steel line. Our current annual production capacity is approximately 700,000 metric tons, or MT, for HDG steel, 200,000 MT for PPGI, 500,000 MT for AP steel and 250,000 MT for cold-rolled steel. Ningbo Zhehua, our subsidiary located in Ningbo, currently has an annual capacity of 400,000 MT for welded steel pipe products.

Executive Overview of Quarterly Results

In the first quarter of fiscal 2013, our revenue declined approximately 10% as compared to the same period last year. Although total sales volume increased about 3.1%, the average selling price, or ASP, declined 12.7% during the first quarter of fiscal 2013 as compared with the same period last year. In the last quarter, we experienced a large price reduction of hot-rolled steel sheets, the principal raw materials for our products. In an effort to restructure the Chinese economy and promote sustainable economic growth, the Chinese government continued to control housing prices and the paces for infrastructure investments, which reduced demands for various products, including ours.

During the last quarter, we continued to make progresses in the construction of the new high precision cold-roll steel production line with a designed annual capacity of 500,000 MT. We expect that this facility will start commercial operations in the first half of calendar year 2013.

The following summarizes the major financial information for the first fiscal quarter of 2013:

Revenue: Revenue was $117.2 million for the three months ended September 30, 2012, a decrease of $13.0 million, or 10.0%, from $130.2 million for the same period last year.

Gross profit and margin: Gross profit was $8.5 million for the three months ended September 30, 2012, as compared to $11.0 million for the same period last year. Gross margin was 7.3% for the three months ended September 30, 2012, as compared to 8.4% for the same period last year.

Net income: Net income was $1.8 million for the three months ended September 30, 2012, a decrease of $3.2 million, or 63.2%, from $5.0 million for the same period of last year.

Fully diluted earnings per share: Fully diluted earnings per share were approximately $0.05 for the three months ended September 30, 2012, as compared to approximately $0.12 for the same period last year.

Reportable Operating Segments

We have four reportable operating segments - Changshu Huaye, Jiangsu Cold-Rolled, Ningbo Zhehua and Sutor Technology. Changshu Huaye manufactures and sells HDG steel and PPGI products. Jiangsu Cold-Rolled manufactures and sells AP steel, cold-rolled steel and HDG steel. Ningbo Zhehua manufactures and sells steel pipe products. Changshu Huaye and Jiangsu Cold-Rolled are adjacent to each other in Changshu, Jiangsu, and use largely the same management resources. Ningbo Zhehua is located in Ningbo, Zhejiang. Sutor Technology was recently established and has had limited operations so far. See Note 17, "Segment Information" to the condensed consolidated financial statements included elsewhere in this report.

Revenue

Our revenue is primarily generated from sales of our HDG steel, PPGI, AP steel, cold-rolled steel products, as well as our steel pipe products, such as longitudinally welded steel pipes and spiral welded steel pipes. Our revenue has historically been affected by sales volume, sales price of our products and our product mix.

In the three months ended September 30, 2012 and 2011, Changshu Huaye generated revenue of $35.4 million and $49.9 million, which represented 30.2% and 38.3% of our total revenue, respectively. Jiangsu Cold-Rolled generated revenue of $76.6 million and $65.0 million in the three months ended September 30, 2012 and 2011, which represented 65.4% and 49.8% of our total revenue, respectively. In the three months ended September 30, 2012 and 2011, Ningbo Zhehua generated revenue of $3.4 million and $14.5 million, which represented 2.9% and 11.1% of our total revenue, respectively. In addition, in the first quarter of fiscal year 2013, Sutor Technology generated revenue of $1.7 million.

A portion of our products are sold through our affiliate Shanghai Huaye, which also supplies to us a significant portion of our raw materials. Approximately 24.0% of our revenue was derived from Shanghai Huaye and its affiliates in the three months ended September 30, 2012, as compared to 24.4% last year. We continued to expand our own sales channel this quarter in effort to gain more market share. At the same time, we also take advantage of Shanghai Huaye's extensive sales network and to build brand value.

Cost of Revenue

Cost of revenue includes direct costs to manufacture our products, including the cost of raw materials, labor, overhead, energy cost, handling charges, and other expenses associated with the manufacture and delivery of product. Direct costs of manufacturing are generally highest when we first introduce a new product due to higher start-up costs and higher raw material costs. As production volume increases, we typically improve manufacturing efficiencies and are able to strengthen our purchasing power by buying raw materials in greater quantities.

In the three months ended September 30, 2012, approximately $64.1 million of raw material procurement was conducted through Shanghai Huaye and its affiliates. Due to the size of Shanghai Huaye and the economy of scale, it has stronger bargaining power than we do and our arrangement with Shanghai Huaye allows us to purchase raw materials at relatively lower prices than we could obtain from suppliers ourselves.

Gross Profit and Gross Margin

Gross profit is equal to the difference between our revenue and the cost of revenue. Gross margin is equal to gross profit divided by revenue. For the three months ended September 30, 2012, gross margin for domestic and international sales were approximately 7.0% and 10.2%, respectively. On a segment basis and after inter-company transfer, Changshu Huaye, Jiangsu Cold-Rolled and Ningbo Zhehua's gross margins were approximately 13.2%, 5.3% and -6.0%, respectively. For Sutor Technology, its gross margin was approximately -0.03% for the first quarter of fiscal 2013. It was a new business and had a limited amount of business during the period.

To gain market penetration, we price our products at levels that we believe are competitive. We continually strive to improve manufacturing efficiencies and reduce our production costs in order to offer superior products and services at competitive prices. General economic conditions, the cost of raw materials, and supply and demand of fine finished steel products within our markets influence sales prices. Our high-end, value-added products, such as the PPGI products, generally tend to have higher profit margins.

We implemented a vertical integration strategy where we use our own AP steel and cold-rolled steel products as raw materials for HDG steel and PPGI products. We believe our vertically integrated operations will allow us to provide customers with one-stop services, build customer loyalty, and maintain stable operating margins.

Operating Expenses

Our operating expenses primarily consist of general and administrative expenses and selling expenses.

General and Administrative Expenses

General and administrative expenses consist primarily of compensation and benefits for our general management, finance and administrative staff, professional and advisory fees, bad debts reserves, and other expenses incurred in connection with general corporate purposes. We expect most components of our general and administrative expenses will increase as our business grows and as we incur increased costs as a public company.

Selling Expenses

Selling expenses consist primarily of compensation and benefits for our sales and marketing staff, sales commissions, the cost of advertising, promotional and travel activities, transportation expenses, after-sales support services and other sales related costs.

Our selling expenses are generally affected by the amount of international sales and our sales to unrelated parties. The transportation costs for our international sales are generally higher than domestic sales. In addition, when we sell products to Shanghai Huaye and its affiliates, Shanghai Huaye generally arranges and bears the cost of transportation. In contrast, when we sell products to unrelated customers, we generally bear the transportation costs, but we are able to charge a higher price.

Provision for Income Taxes

Sutor Technology Group Limited is subject to United States federal income tax at a tax rate of 34%. Sutor BVI was incorporated in the British Virgin Islands and, under the current laws of the British Virgin Islands, is not subject to income taxes.

On March 16, 2007, the National People's Congress of China passed a new Enterprise Income Tax Law (EIT Law), and on December 6, 2007, the State Council of China passed its implementing rules, which took effect on January 1, 2008. The EIT Law and its implementing rules impose a unified enterprise income tax (EIT) of 25.0% on all domestic-invested enterprises and foreign invested enterprises (FIEs) established in the PRC, 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 existing FIEs a five-year grandfather period during which they can continue to enjoy their existing preferential tax treatments. Changshu Huaye is subject to an EIT of 15% from calendar years 2010 to 2012 because it qualifies as a high-tech enterprise. Changshu Huaye paid EIT at the 25% tax rate for the period between July and December 2010 and we have received a refund on the over-paid portion of the EIT. Jiangsu Cold-Rolled was subject to an EIT of 12.5% for the calendar years 2009, 2010 and 2011 and is subject to an EIT of 25% for the calendar year 2012 and beyond. Ningbo Zhehua and Sutor Technology are subject to an EIT of 25% and have no preferential tax treatments.

Results of Operations

Comparison of Three Months Ended September 30, 2012 and September 30, 2011

The following table sets forth key components of our results of operations for the periods indicated, both in dollars and as a percentage of our revenue.

(All amounts, other than percentages, in thousands of U.S. dollars)

                                            Three Months Ended               Three Months Ended
                                            September 30, 2012               September 30, 2011
                                                           % of                             % of
                                          Amount          Revenue          Amount          Revenue
Revenue
Revenue from unrelated parties          $    89,115            76.0 %    $    98,397            75.6 %
Revenue from related parties                 28,072            24.0 %         31,799            24.4 %
Total                                       117,187           100.0 %        130,196           100.0 %
Cost of Revenue
Cost of revenue from unrelated
parties                                     (82,028 )         (70.0 )%       (91,022 )         (69.9 )%
Cost of revenue from related parties        (26,612 )         (22.7 )%       (28,185 )         (21.7 )%
Total                                      (108,640 )         (92.7 )%      (119,207 )         (91.6 )%
Gross Profit                                  8,547             7.3 %         10,989             8.4 %
Operating Expenses
Selling expense                              (2,313 )          (2.0 )%        (2,336 )          (1.8 )%
General and administrative expense           (2,130 )          (1.8 )%        (2,925 )          (2.2 )%
Total Operating Expenses                     (4,443 )          (3.8 )%        (5,261 )          (4.0 )%
Income from Operations                        4,104             3.5 %          5,728             4.4 %
Other Income (Expense)
Interest income                                 962             0.8 %            290             0.2 %
Other income                                     25               -                5               -
Interest expense                             (3,534 )          (3.0 )%        (1,729 )          (1.3 )%
Other expense                                  (104 )             -             (381 )          (0.3 )%
Changes in fair value of warrant
liabilities                                      16               -              210             0.2 %
Total Other Income (Expense)                 (2,635 )          (2.2 )%        (1,604 )          (1.2 )%
Income Before Taxes                           1,470             1.3 %          4,123             3.2 %
Income tax (expense)/benefit                    366             0.3 %            861             0.6 %
Net Income                              $     1,835             1.6 %    $     4,984             3.8 %

Revenue. For the three months ended September 30, 2012, revenue was $117.2 million, compared to $130.2 million for the same period last year, a decrease of $13.0 million, or approximately 10.0%. The decrease was mainly attributable to the lower ASP. During the quarter, the ASP declined approximately 12.7% as compared with the same period last year due to lower prices of raw materials. In addition, revenue from our steel pipe products decreased by $11.1 million, or 76.5% primarily due to the timing of completion of projects to which our products are supplied as well as reduced demand. Although the production of our hot-dipped galvanized steel sheets increased approximately 9.5%, the impact was offset by the lower ASP.

The following table sets forth revenue by geography and by business segments for the three months ended September 30, 2012 and 2011.

(All amounts, other than percentages, in thousands of U.S. dollars)

                          Three Months Ended             Three Months Ended
                          September 30, 2012             September 30, 2011
                                         % of                           % of
                         Amount         Revenue         Amount         Revenue
Geographic Data
China                 $    106,692          91.0 %   $    105,361          80.9 %
Other Countries             10,495           9.0 %         24,834          19.1 %

Segment Data                                                                  ?
Changshu Huaye        $     35,424          30.2 %   $     49,883          38.3 %
Jiangsu Cold-Rolled         76,628          65.4 %         64,956          49.9 %
Ningbo Zhehua                3,386           2.9 %         14,454          11.1 %
Sutor Technology             1,749           1.5 %            902           0.7 %

On a geographic basis, revenue generated from outside of China was $10.5 million, or 9.0% of the total revenue, for the three months ended September 30, 2012, as compared to $24.8 million, or 19.1% of the total revenue, for the same period in 2011. We believe the decrease was mainly resulted from overall sluggish global economy and appreciating RMB.

On a segment basis, after eliminating intercompany sales and adjusting reconciliation items, revenue contributed by Changshu Huaye was $35.4 million for the three months ended September 30, 2012, a decrease of $14.5 million, or 29.1%, from $49.9 million for the same period last year. The decrease mainly resulted from lower PPGI sales of approximately $8.0 million and lower HDG sales of approximately $5.0 million. For the latter, part of the production was shifted to Jiangsu Cold-Rolled to take advantage of its newer production lines.

After eliminating the inter-company sales and adjusting reconciliation items, revenue contributed by Jiangsu Cold-Rolled increased $11.6 million to $76.6 million for the three months ended September 30, 2012, as compared to $65.0 million for the same period last year primarily due to higher revenue of approximately $9.8 million from cold-rolled steel products and higher revenue of about $2.7 million from HDG steel products. Although sales volume of HDG products from Jiangsu Cold-Rolled increased 21.4%, its impact was largely offset by the lower ASP of approximately 12.9%.

Revenue contributed by Ningbo Zhehua was $3.4 million for the three months ended September 30, 2012, a decrease of $11.1 million, or 76.6%, from $14.5 million for the same period in 2011, primarily resulting from the timing of product delivery and lower production.

In terms of related party sales as compared with sales to unrelated parties, our direct sales to unrelated parties in the three months ended September 30, 2012 decreased by $9.3 million, or 9.5%, to $89.1 million, from $98.4 million in the same period in 2011.

Cost of revenue. Cost of revenue decreased by $10.6 million, or 8.9%, to $108.6 million in the three months ended September 30, 2012, from $119.2 million in the same period in 2011. As a percentage of revenue, cost of revenue increased to 92.7% in the three months ended September 30, 2012, as compared to 91.6% in the same period last year. The reduced amount of the cost of revenue was generally in line with the decrease in sales revenue.

Gross profit and gross margin. Gross profit decreased by $2.4 million to $8.5 million in the three months ended September 30, 2012, from $11.0 million in the same period in 2011. Gross profit as a percentage of revenue (gross margin) was 7.3% for the three months ended September 30, 2012, as compared to 8.4% for the same period last year. The reduced gross margin was primarily due to lower internationals sales which had higher gross margin than domestic sales. During the first quarter of fiscal 2013, we generated approximately 9.0% of the revenue from international sales whereas the percentage was 19.1% for the same period last year. Our international sales usually account for between 10% and 15% of our total sales.

On a segment basis and after considering inter-company transfer, gross margin for Changshu Huaye increased to 13.2% in the three months ended September 30, 2012, from 10.9% in the same period last year, mainly because of reduced procurement costs. Gross margin for Jiangsu Cold-Rolled decreased to 5.3% in the three months ended September 30, 2012, from 5.8% in the same period last year, mainly due to higher revenue from cold-rolled steel products which had a lower gross margin than that of HDG steel products. Gross margin for Ningbo Zhehua decreased to -6.0% in the three months ended September 30, 2012, as compared to 9.2% in the same period in 2011, mainly because of the timing of the product delivery as well as reduced demand for our pipe products. Our pipe products are mainly used in construction projects which have various completion dates.

Total operating expenses. Our total operating expenses decreased by $0.9 million to $4.4 million in the three months ended September 30, 2012, from $5.3 million in the same period in 2011. As a percentage of revenue, our total operating expenses decreased to 3.8% in the three months ended September 30, 2012, from 4.1% in the same period in 2011.

Selling expenses. Our selling expenses decreased $0.02 million to $2.3 million in the three months ended September 30, 2012, from $2.3 million in the same period last year. As a percentage of revenue, our selling expenses increased to 2.0% for the three months ended September 30, 2012, from 1.8% for the same period last year. The amount of selling expenses was practically unchanged even though we sold more tonnage of products. Selling expenses as percentage of revenue was increased because of lower revenue due to lower ASP.

General and administrative expenses. General and administrative expenses decreased $0.8 million to $2.1 million, or 1.8% of the total revenue, in the three months ended September 30, 2012, from $2.9 million, or 2.2% of the revenue, in the same period in 2011. The decreased general and administrative expenses were primarily due to lower allowance for bad account receivables, lower insurance expenses and lower professional consulting expenses of $0.43 million, $0.22 million and $0.11 million, respectively.

Interest expense. Our interest expense increased $1.8 million to $3.5 million in the three months ended September 30, 2012, from $1.7 million in the same period in 2011. As a percentage of revenue, our interest expense was3.0% of total revenue in the three months ended September 30, 2012, compared to 1.3% in the same period in 2011. The increase in interest expense was mainly attributable to higher discounted interest expenses on bank notes while interest expenses on bank loans remained stable.

Provision for income taxes. Our income tax benefit decreased to $0.4 million in the three months ended September 30, 2012, from $0.9 million of income tax benefit in the same period last year, due to lower utilization of income tax benefits for purchasing certain capital equipment.

Net income. Net income, without including the foreign currency translation adjustment, decreased by $3.2 million, or 63.2%, to $1.8 million in the three months ended September 30, 2012, from $5.0 million in the same period in 2011, as a cumulative result of the above factors.

Liquidity and Capital Resources

Our major sources of liquidity for the periods covered by this quarterly report were mainly borrowings through short-term bank loans. Our operating activities provided approximately $7.3 million of cash in the three months ended September 30, 2012. As of September 30, 2012, our total indebtedness to non-related parties under existing short-term loans was approximately $107.9 million. Another $27.8 million was the current portion of long-term loans. We also had approximately $7.4 million under long-term loans to non-related parties. As of September 30, 2012, we had an unused line of credit with banks of approximately $32.1 million (RMB 200.0 million) which entitled us to draw bank loans for general corporate purposes.

Short-term and long-term banks loans are likely to continue to be our key sources of financing for the foreseeable future, although in the future we may raise additional capital by issuing shares of our capital stock in an equity financing. We expect to renew our short term bank loans when they become due.

Our liquidity and working capital may be affected by a material decrease in cash flow due to factors such as the continued use of cash in operating activities resulting from a decrease in sales due to the current global economic crisis, increased competition, decreases in the availability, or increases in the cost of raw materials, unexpected equipment failures, or regulatory changes.

As stated above, a portion of our operations is funded through short-term bank loans and we expect to renew our short term loans when they become due. We are exposed to a variety of risks associated with short-term borrowings including adverse fluctuations in fixed interest rates for short-term borrowings and unfavorable increases in variable interest rates, potential inability to service . . .

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