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CPSL > SEC Filings for CPSL > Form 10-Q on 16-Nov-2012All Recent SEC Filings

Show all filings for CHINA PRECISION STEEL, INC.

Form 10-Q for CHINA PRECISION STEEL, INC.


16-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; 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. You should carefully review the risk factors described in other documents we file from time to time with the U.S. Securities and Exchange Commission, including our Annual Report on Form 10-K for our fiscal year ended June 30, 2012.

The following discussion should be read in conjunction with our unaudited consolidated financial statements and the related notes that appear in Part I, Item 1, "Financial Statements," of this quarterly report. Our unaudited consolidated financial statements are stated in United States Dollars and are prepared in accordance with United States Generally Accepted Accounting Principles. The following discussion and analysis covers the Company's unaudited consolidated financial condition at September 30, 2012 and June 30, 2012, the end of its prior fiscal year, and its unaudited consolidated results of operation for the three months ended September 30, 2012 and 2011.

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;

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

? "BVI" are to the British Virgin Islands;

- 4 -

? "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; and

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

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.

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, Ethiopia and Turkey. 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 our 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) continuing to carry out R&D to improve profitability of existing products and launch new high value-add products; and (6) improving 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.

First Quarter Financial Performance Highlights

During the three months ended September 30, 2012, we largely reduced the production and sales of our loss-making low-carbon cold-rolled steel products as part of our strategies to streamline production, and gross loss for the three months ended September 30, 2012 decreased to $1,466,949 from $2,952,641 for the immediate prior quarter ended June 30, 2012. However, tightened credit and slowing growth in China continued to cause a slow turnover of our accounts receivable for the three months ended September 30, 2012, a trend that is strongly correlated to the experience of other companies in the coal and steel sectors in China during the past year.

During the three months ended September 30, 2012, we sold a total of 7,753 tons of products, a decrease of 37,795 tons from 45,548 tons a year ago, largely due to the decrease in sales of low-carbon cold-rolled steel products mentioned above. Despite a downward trend in steel prices during the quarter, our average cost per unit sold increased 3.6% while average selling prices decreased 17.1% period-on-period, mainly due to increases in factory overhead and direct labor per unit sold as a result of the substantially reduced units sold. Decreased sales volume coupled with high costs led to a gross loss of $1,466,949 and a net loss of $4,222,283 for the three months ended September 30, 2012. Total company backlog as of September 30, 2012 was $6,558,731.

- 5 -

In June and July 2012, we defaulted on the repayment obligations of our short-term and long-term bank loans totaling $43,751,689. 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 first fiscal quarter:

? Revenues: Our revenues were approximately $6.0 million for the quarter, a decrease of 85.9% from last year.

? Gross Margin: Gross margin was (24.6%) for the quarter, compared to 0.1% last year.

? Loss from operations before tax: Loss from operations before tax was approximately $4.2 million for the quarter, compared to a loss of approximately $1.0 million last year.

? Net loss: Net loss was approximately $4.2 million for the quarter, compared to a net loss of approximately $1.1 million last year.

? Fully diluted loss per share: Fully diluted loss per share was $1.09 for the quarter, compared to a loss per share of $0.28 last year.

Results of Operations

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

(All amounts in U.S. dollars)

                                                2012                             2011
                                                        % of                             % of
                                       Amount         Revenues          Amount         Revenues
Sales Revenues                        5,956,760           100.0       42,166,843           100.0
Cost of goods sold (including
depreciation and amortization)        7,423,709           124.6       42,105,073            99.9
Gross (loss)/profit                  (1,466,949 )         (24.6 )         61,770             0.1
Selling expenses                         29,273             0.5           68,304             0.2
Administrative expenses                 442,615             7.4          294,076             0.7
Allowance for bad and doubtful
debts                                 1,373,000            23.0                -               -
Depreciation and amortization
expense                                  51,961             0.9           54,444             0.1
(Loss) from operations               (3,363,798 )         (56.5 )       (355,054 )          (1.0 )
Total other expense                    (858,485 )         (14.4 )       (669,729 )          (1.6 )
(Loss) from operations before
income tax                           (4,222,283 )         (70.9 )     (1,024,783 )          (2.4 )
Income tax expense                           -               -            54,312             0.1
Net (loss)                           (4,222,283 )         (70.9 )     (1,079,095 )          (2.6 )
Basic (loss) per share                    (1.09 )                          (0.02 )
Diluted (loss) per share                  (1.09 )                          (0.02 )

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Sales Revenues

Sales volume decreased by 39,795 tons, or 83.0%, period-on-period, to 7,753 tons for the three months ended September 30, 2012, from 45,548 tons for the three months ended September 30, 2011 and as a result, sales revenues decreased by $36,210,083, or 85.9%, period-on-period, to $5,956,760 for the three months ended September 30, 2012, from $42,166,843 for the three months ended September 30, 2011. The decrease in sales revenues period-on-period is mainly attributable to the decrease in production and sales of our low-carbon cold-rolled products in an effort to reduce the sales of these loss-making products.

Sales by Product Line



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



                                   2012                                           2011
                                                                                                               Period-on-
Product           Quantity                         % of         Quantity                          % of         Period Qty.
Category           (tons)        $ Amount         Sales          (tons)         $ Amount         Sales          Variance
Low carbon
hard-rolled           1,470       1,133,619             19            261          239,887              1             1,209
Low carbon
cold-rolled           3,513       2,047,911             34         37,060       33,275,228             79           (33,547 )
High-carbon
hot-rolled               37          13,197            <1%          2,242        2,482,929              6            (2,205 )
High-carbon
cold-rolled           2,838       2,545,164             43          4,339        4,316,010             10            (1,501 )
Subcontracting
income                 (105 )         9,024            <1%          1,646        1,032,321              2            (1,751 )
Sales of scrap
metal                     -         207,845              4              -          820,468              2                 -
Total                 7,753       5,956,760            100         45,548       42,166,843            100           (37,795 )

During the three months ended September 30, 2012, domestic sales decreased across all product categories although there was a small increase in the sales of the exported low carbon hard-rolled steel products. Low-carbon cold-rolled steel products accounted for 34% of the current sales mix at an average selling price of $583 per ton for the three months ended September 30, 2012, compared to 79% of the sales mix at an average selling price per ton of $898 for the three months ended September 30, 2011. The decrease in sales in this category during the quarter was mainly due to streamlined production to reduce the sales of these loss-making products. Low-carbon hard-rolled steel products accounted for 19% of the current sales mix at an average selling price of $771 per ton for the three months ended September 30, 2012, compared to 1% of the sales mix at an average selling price per ton of $919 for the three months ended September 30, 2011, due to an increase in demand in the export market as a result of our more competitive selling prices in the global market during the period. High-carbon cold-rolled steel products accounted for 43% of the current sales mix at an average selling price of $897 per ton for the three months ended September 30, 2012, compared to 10% of the sales mix at an average selling price of $995 for the three months ended September 30, 2011. The products in this category are mainly used in the automobile industry and the decrease in sales volume period-on-period was a result of the slowing demand for automobiles in the PRC market. Subcontracting income revenues accounted for $9,024, or less than 1%, of the sales mix for the three months ended September 30, 2012, decreased from $1,032,321, or 2%, of the sales mix for the three months ended September 30, 2011, due to reduced demand. The negative quantity was due to the return of one batch of sample products with a small sales revenue.

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                           2012       2011            Variance
Average Selling Prices      ($)        ($)        ($)         (%)
Low-carbon hard-rolled      771         919       (148 )      (16.1 )
Low-carbon cold-rolled      583         898       (315 )      (35.1 )
High-carbon hot-rolled      353       1,107       (754 )      (68.1 )
High-carbon cold-rolled     897         995        (98 )       (9.8 )
Subcontracting income       (86 )       627       (713 )     (113.7 )

The average selling price per ton decreased to $768 for the three months ended September 30, 2012, compared to $926 in 2011, representing a decrease of $158, or 17.1%, period-on-period. This decrease was mainly due to decreases in general steel prices and therefore our selling prices during the quarter. Average selling prices decreased across all product categories during the three months ended September 30, 2012.

Sales Breakdown by Major Customer



                                                    2012                           2011
                                                            % of                            % of
Customers                                      $           Sales              $            Sales
Changshu Jiacheng Steel Plating Co.,
Ltd.                                         699,359             12        1,702,702              4
Unimax & Far Corporation                     637,147             11                *              *
Shanghai Wozi Jintian Blade Co., Ltd         607,652             10                *              *
Zhejiang Zhongwei Construction
Materials Co., Ltd                           489,025              8                *              *
Steelforce NV                                328,591              5
Shanghai Shengdejia Metal Co., Ltd.                *              *        7,505,117             18
Hangzhou Cogeneration Co., Ltd.                    *              *        7,504,827             18
Shanghai Changshuo Steel Co., Ltd.                 *              *        5,644,432             13
Zhejiang Yongfeng Steel Co., Ltd.                  *              *        5,271,256             13
                                           2,761,774             46       27,628,334             66
Others                                     3,194,986             54       14,538,509             34
Total                                      5,956,760            100       42,166,843            100

* Not major customers for the relevant periods

Sales revenue generated from our top five major customers as a percentage of total sales was 46% for the three months ended September 30, 2012, as compared to 66% in 2011. The change in customer mix reflects management's continuous efforts in expanding our customer base and geographical coverage during the course of the quarter.

Cost of Goods Sold

Cost of sales decreased by $34,681,364, or 82.4%, period-on-period, to $7,423,709 for the three months ended September 30, 2012, from $42,105,073 for the three months ended September 30, 2011. Cost of sales represented 124.6% of sales revenues for the three months ended September 30, 2012, compared to 99.9% for the three months ended September 30, 2011. Average cost per unit sold increased to $957 for the three months ended September 30, 2012, compared to $924 for the three months ended September 30, 2011, representing an increase of $33 per ton, or 3.6%, period-on-period.

                                         2012             2011                   Variance
                                          ($)             ($)               ($)             (%)
Cost of goods sold
- Raw materials                         4,435,761       38,457,731       (34,021,970 )       (88.5)
- Direct labor                            139,068          150,802           (11,734 )        (7.8)
- Manufacturing overhead                2,848,880        3,496,540          (647,660 )       (18.5)
                                        7,423,709       42,105,073       (34,681,364 )       (82.4)

Cost per unit sold
Total units sold (tons)                     7,753           45,548          (37,795)         (83.0)
Average cost per unit sold ($/ton)            957              924               33            3.6

- 8 -

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

? an increase in factory overhead per unit sold of $290, or 376.6%, from $77 for the three months ended September 30, 2011, to $367 for the three months ended September 30, 2012;

? an increase in direct labor per unit sold of $15, or 500.0%, from $3 for the three months ended September 30, 2011, to $18 for the three months ended September 30, 2012, offset by;

? a decrease in cost of raw materials per unit sold of $272, or 32.2%, from $844 for the three months ended September 30, 2011, to $572 for the three months ended September 30, 2012.

The cost of raw materials consumed decreased by $34,021,970, or 88.5%, period-on-period, to $4,435,761 for the three months ended September 30, 2012, from $38,457,731 for the three months ended September 30, 2011. This decrease was mainly due to a substantial decrease in total units sold during the three months ended September 30, 2012.

Direct labor costs decreased by $11,734, or 7.8%, period-on-period, to $139,068 for the three months ended September 30, 2012, from $150,802 for the three months ended September 30, 2011. Manufacturing overhead costs decreased by $647,660, or 18.5%, period-on-period, to $2,848,880 for the three months ended September 30, 2012, from $3,496,540 for the three months ended September 30, 2011. The decrease was mainly attributable to the combined effect of a decrease in utilities of $384,399, or 40.4%, period-on-period, to $566,724 for the three months ended September 30, 2011, from $951,123 for the three months ended September 30, 2011, and a decrease in consumables of $149,033, or 31.7%, period-on-period, to $320,617 for the three months ended September 30, 2012, from $469,650 for the three months ended September 30, 2011.

Gross Profit

Gross profit in absolute terms decreased by $1,528,719 or 2,474.9%, period-on-period, to a gross loss of $1,466,949 for the three months ended September 30, 2012, from a gross profit of $61,770 for the three months ended September 30, 2011. Gross profit margin decreased to (24.6%) for the three months ended September 30, 2012, from 0.1% for the three months ended September 30, 2011. The decrease in gross profit margin is mainly attributable to a 17.1% period-on-period decrease in average selling prices and a 3.6% period-on-period increase in average cost per unit sold.

Selling Expenses

Selling expenses decreased by $39,031, or 57.1%, period-on-period, to $29,273 for the three months ended September 30, 2012, from $68,304 for the three months ended September 30, 2011. The decrease was mainly attributable to lower transportation costs and traveling expenses period-on-period.

Administrative Expenses

Administrative expenses increased by $148,539 or 50.5%, period-on-period, to $442,615 for the three months ended September 30, 2012, compared to $294,076 for the three months ended September 30, 2011. This was mainly due to an increase in legal and professional fees period-on-period.

Allowance for Bad and Doubtful Debts

Allowance for bad and doubtful debts increased by $1,373,000, or 100.0%, period-on-period. Allowance recognized for the three months ended September 30, 2012 was in the amount of $1,373,000 in accordance with our policy for allowance for doubtful accounts.

- 9 -

Loss from Operations

Loss from operations increased by $3,008,744, or 847.4%, period-on-period, to a loss of $3,363,798 for the three months ended September 30, 2012, from$355,054 for the three months ended September 30, 2011, as a result of the factors discussed above.

Other Income

Other income decreased by $96, or 48.2%, to $103 for the three months ended September 30, 2012, from $199 for the three months ended September 30, 2011, due to lower interest income period-on-period.

Interest Expense

Total interest expense increased by $188,660, or 28.2%, to $858,588 for the three months ended September 30, 2012, from $669,928 for the three months ended September 30, 2011, due to the accrued late payment penalty interest as a result of the loan default.

Income Tax

For the three months ended September 30, 2012, we recognized no income tax expense, compared to an income tax expense of $54,312 for the three months ended September 30, 2011. The decrease of $54,312, or 100.0%, in income tax expense was a result of the net loss for the three months ended September 30, 2012.

Net Loss

Net loss increased by $3,143,188, or 291.3%, period-on-period, to $4,222,283 for the three months ended September 30, 2012, from $1,024,783 for the three months ended September 30, 2011. The increase in net loss is attributable to a combination of all the factors discussed above, principally the negative gross margin and the increase in allowance for bad and doubtful debts.

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 met these liquidity requirements with cash provided by operations, equity financing, and bank debt. As of September 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



                                               Three Months Ended September 30,
                                                 2012                   2011
Net cash provided by operating activities   $       171,468       $         303,740
Net cash (used in) investing activities              (7,424 )               (84,886 )
Net cash (used in) financing activities                   -                (810,921 )
Net cash flow                                        (7,238 )              (554,701 )

Operating Activities

Net cash flows provided by operating activities for the three months ended . . .

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