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CPSL > SEC Filings for CPSL > Form 10-K on 11-Oct-2013All Recent SEC Filings

Show all filings for CHINA PRECISION STEEL, INC.

Form 10-K for CHINA PRECISION STEEL, INC.


11-Oct-2013

Annual Report


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, 2013 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, 2013. 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, 2013. 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 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 micro electronics.

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 have implemented and will continue to implement a series of measures to remain viable and improve profitability and cash flows. 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) improve production management and increase quality control; (4) continuing to carry out R&D to improve profitability of existing products and launch new high value-add products; and (5) strengthening efforts of accounts receivables collection and limiting further credit sales. We will also continue to take appropriate actions to perform business and credit reviews of customers and suppliers with the downward pressure in the Chinese economy and a credit crunch which have caused many difficulties faced by businesses.

- 28 -

Recent Developments

On August 13, 2012, October 9, 2012, and on May 9, 2013 respectively, each of Che Kin Lui, Daniel Carlson and David Peter Wong 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 and Mr. Wong each 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. On May 9, 2013, the Board approved the appointment of Mr. Li Jian Lin as a member of the Board and as Chairman of the Audit Committee of the Company, effective July 1, 2013. As a result, the Company's Board currently consists of two independent members of the Board and Audit Committee. The Company is currently in the process of vetting suitable candidates to fulfill the composition requirements set forth in the NASDAQ's Listing Rule 5605 of at least three independent members on the Audit Committee. Such appointment will be announced as soon as it is completed.

Fiscal 2013 Financial Performance Highlights

During the year ended June 30, 2013, we saw a substantial reduction in demand for our cold rolled steel products coupled with lower selling prices, which have substantially and adversely impacted our gross margin. Tightened credit, slowing growth in China and overcapacity in the steel sector have caused large losses across the industry during Calendar year 2012. We have also made substantial provisions for our accounts receivable and advances to suppliers for the year ended June 30, 2013 due to slow turnover and risks of recoverability, a trend that is strongly correlated to those of the companies in the coal and steel sectors in China during the past two years.

During the year ended June 30, 2013, we sold a total of 56,232 tons of products, a decrease of 115,333 tons from 171,565 tons a year ago, largely due to the decrease in sales of low-carbon cold-rolled steel products. Our average cost per unit sold decreased 0.9% while average selling prices decreased 22.0% year-on-year, mainly due to increases in factory overhead and direct labor cost per unit sold as a result of the substantially reduced total units sold. Decreased sales volume coupled with a substantial allowance for bad and doubtful debts of $41,466,990 led to a net loss of $68,939,386 for the year ended June 30, 2013. Total company backlog as of June 30, 2013 was $7,576,418.

In June and July 2012, we defaulted on the repayment obligations of our short-term and long-term bank loans totaling $43,873,871. We are currently in discussions with our banks regarding the possibility to restructure 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. Each of the banks 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 have implemented and will continue to implement 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.

The Company has suffered a very significant loss in the year ended June 30, 2013. Operating cash flows have also been significantly adversely impacted by the slow turnover of our accounts receivable. We also expect the ongoing credit tightening in China and the slowdown of the Chinese economy to continue to have negative consequences on the business operations of our customers and suppliers and adversely impact their ability to meet their financial obligations to us. 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.

The following are some financial highlights for the year ended June 30, 2013:

? Revenues: Our revenues were approximately $36.5 million for the year, a decrease of 74.5% from last year.

? Gross Margin: Gross margin was (32.2%) for the year, compared to (4.1%) last year.

? Loss from operations before tax: Loss from operations before tax was approximately $68.9 million for the year, compared to a loss of approximately $17.0 million last year.

? Net loss: Net loss was approximately $68.9 million for the year, compared to a net loss of approximately $17.0 million last year.

? Fully diluted loss per share: Fully diluted loss per share was $17.76 for the year, compared to a loss per share of $4.37 last year.

- 29 -

Results of Operations

The following table sets forth key components of our results of operations for the fiscal years ended June 30, 2013 and 2012 and as a percentage of revenues.

(All amounts in U.S. dollars)

                                                  2013                              2012
                                                           % of                              % of
                                         Amount          Revenues          Amount          Revenues
Revenues                                 36,527,550           100.0       142,973,631           100.0
Cost of sales (including
depreciation and amortization)           48,301,295           132.2       148,780,427           104.1
Gross loss                              (11,773,745 )         (32.2 )      (5,806,796 )          (4.1 )
Selling expenses                            112,991             0.3           209,793             0.1
Administrative expenses                   2,465,576             6.7         2,684,432             1.9
Bad debts written off                    14,147,604            38.7                 -               -
Allowance for bad and doubtful
debts                                    41,466,990           113.5         5,022,138             3.5
Depreciation and amortization               199,885             0.5           216,444             0.2
Loss from operations                    (70,166,791 )        (192.1 )     (13,939,603 )          (9.7 )
Other income                              4,784,116            13.1            89,604             0.1
Interest and finance costs               (3,556,711 )          (9.7 )      (3,104,207 )          (2.2 )
Loss from operations before income
tax                                     (68,939,386 )        (188.7 )     (16,954,206 )         (11.9 )
Income tax (benefit)                              -            (0.0 )          (5,061 )          (0.0 )
Net loss                                (68,939,386 )        (188.7 )     (16,949,145 )         (11.9 )
Basic (loss) per share                       (17.76 )                           (4.37 )
Diluted (loss) per share                     (17.76 )                           (4.37 )

Sales Revenues

Sales volume decreased by 115,333 tons, or 67.2%, year-on-year, to 56,232 tons for the year ended June 30, 2013, from 171,565 tons for the year ended June 30, 2012 and as a result, sales revenues decreased by $106,446,081, or 74.5%, year-on-year, to $36,527,550 for the year ended June 30, 2013, from $142,973,631 for the year ended June 30, 2012. The decrease in sales revenues year-on-year is attributable to the substantial decrease in demand for low-carbon products as well as decrease in average selling prices.

Sales by Product Line



A break-down of our sales by product line for the years ended June 30, 2013 and
2012 is as follows:



                                                         2013                                       2012                        Year-on-
                                        Quantity                        % of       Quantity                         % of       Year Qty.
Product Category                         (tons)         $ Amount        Sales       (tons)         $ Amount         Sales       Variance
Low carbon hard rolled                      4,818        3,558,582          10        10,126         7,512,713           5         (5,308 )
Low carbon cold-rolled                     29,813       18,302,075          50       133,055       105,893,793          74       (103,242 )
High-carbon hot-rolled                      2,560        1,117,042           3         5,064         6,138,916           4         (2,504 )
High-carbon cold-rolled                    16,702       12,825,599          35        19,796        20,043,175          14         (3,094 )
Subcontracting income                       2,339          155,846          <1         3,524         1,144,270           1         (1,185 )
Sales of scrap                                  -          568,406           2             -         2,240,764           2              -
Total                                      56,232       36,527,550         100       171,565       142,973,631         100       (115,333 )

There were different trends of demand across various product categories during the year ended June 30, 2013. Low-carbon cold-rolled steel products accounted for 50% of the current sales mix at an average selling price of $614 per ton for the year ended June 30, 2013, compared to 74% of the sales mix at an average selling price per ton of $796 for the year ended June 30, 2012. The decrease in demand in this category was a result of largely decreased orders of steel used in the production of home appliances and steel roofing materials as a result of slowing in domestic consumer spending in these segments during the year. Low-carbon hard-rolled steel products accounted for 10% of the current sales mix at an average selling price of $739 per ton for the year ended June 30, 2013, compared to 5% of the sales mix at an average selling price per ton of $742 for the year ended June 30, 2012, the sales revenue of this category decreased due to RMB appreciation year-on-year which has made our pricing less attractive in the export market. High-carbon cold-rolled steel products accounted for 35% of the current sales mix at an average selling price of $768 per ton for the year ended June 30, 2013, compared to 14% of the sales mix at an average selling price of $1,012 for the year ended June 30, 2012. 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 $155,846, or less than 1%, of the sales mix for the year ended June 30, 2013, a decrease from $1,144,270, or 1%, of the sales mix for the year ended June 30, 2012. 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, 2013.

- 30 -

                                        2013       2012            Variance
              Average Selling Prices     ($)        ($)        ($)         (%)
              Low-carbon hard rolled      739         742         (3 )      (0.4 )
              Low-carbon cold-rolled      614         796       (182 )     (22.9 )
              High-carbon hot-rolled      436       1,212       (776 )     (64.0 )
              High-carbon cold-rolled     768       1,012       (244 )     (24.1 )
              Subcontracting income        67         325       (258 )     (79.4 )

The average selling price per ton decreased to $650 for the year ended June 30, 2013, compared to $833 in 2012, representing a decrease of $183, or 22.0%, year-on-year. This decrease was mainly due to decreases in steel prices and therefore our selling prices due to a slowdown of the Chinese economy and oversupply of steel products in the market during the year. There were decreases in average selling prices across all product categories during the year ended June 30, 2013.

Sales Breakdown by Major Customer



                                                  2013                         2012
                                                           % of                         % of
Customers                                     $           Sales            $           Sales
Shanghai Hongyu Metal Co., Ltd.             6,290,377         17                 - *        - *
Changshu Jiacheng Steel Plate Co., Ltd      5,278,035         15        11,169,785          8
Shanghai Wozi Jintian Blade Co., Ltd.       2,482,139          7                 - *        - *
Ludi Energy Group Co., Ltd.                 1,993,226          5                 - *        - *
Unimax & Far Corporation                    1,913,491          5                 - *        - *
Shanghai Shengdejia Metal Co., Ltd                  - *        - *      17,829,967         12
Shanghai Changshuo Steel Co., Ltd.                  - *        - *      14,842,069         11
Hangzhou Cogeneration Co., Ltd.                     - *        - *      13,101,996          9
Zhejiang Yongfeng Steel Co., Ltd.                   - *        - *      10,408,914          7
                                           17,957,268         49        67,352,731         47
Others                                     18,570,282         51        75,620,900         53
Total                                      36,527,550        100       142,973,631        100

* Not major customers for the relevant years

Sales revenue generated from our top five major customers as a percentage of total sales was 49% and 47% for the years ended June 30, 2013 and 2012, respectively. Sales to Shanghai Hongyu Metal Co., Ltd., Shanghai Wozi Jintian Blade Co., Ltd.,Ludi Energy Group Co., Ltd. And Unimax & Far Corporation, new major customers for the year ended June 30, 2013, accounted for 34% of our sales revenues. The change in customer mix reflects management's efforts in expanding our customer base and repositioning our products mix during the course of the year.

Cost of Goods Sold

Cost of sales decreased by $100,479,132, or 67.5%, year-on-year, to $48,301,295 for the year ended June 30, 2013, from $148,780,427 for the year ended June 30, 2012. Cost of sales represented 132.2% of sales revenues for the year ended June 30, 2013, compared to 104.1% for the year ended June 30, 2012. Average cost per unit sold slightly decreased to $859 for the year ended June 30, 2013, compared to $867 for the year ended June 30, 2012, representing a decrease of $8 per ton, or 0.9%, year-on-year.

                                            2013             2012                    Variance
                                            ($)               ($)               ($)              (%)
Cost of goods sold
- Raw materials                           38,254,765       135,715,619        (97,460,854 )        (71.8 )
- Direct labor                               547,839           585,332            (37,493 )         (6.4 )
- Manufacturing overhead                   9,498,691        12,479,476         (2,980,785 )        (23.9 )
                                          48,301,295       148,780,427       (100,479,132 )        (67.5 )
Cost per unit sold
Total units sold (tons)                       56,232           171,565           (115,333 )        (67.0 )
Average cost per unit sold ($/ton)               859               867                 (8 )         (0.9 )

- 31 -

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

? a decrease in cost of raw materials per unit sold of $111, or 14.0%, from $791 for the year ended June 30, 2012, to $680 for the year ended June 30, 2013;

? an increase in factory overhead per unit sold of $96, or 131.5%, from $73 for the year ended June 30, 2012, to $169 for the year ended June 30, 2013; and

? an increase in direct labor per unit sold of $7, or 233.3%, from $3 for the year ended June 30, 2012, to $10 for the year ended June 30, 2013.

Because of the downward trend in steel prices and the substantial decrease in sales volume during the year, the cost of raw materials consumed decreased by $97,460,854, or 71.8%, year-on-year, to $38,254,765 for the year ended June 30, 2013, from $135,715,619 for the year ended June 30, 2012.

Direct labor costs decreased by $37,493, or 6.4%, year-on-year, to $547,839 for the year ended June 30, 2013, from $585,332 for the year ended June 30, 2012.

Manufacturing overhead costs decreased by $2,980,785, or 23.9%, year-on-year, to $9,498,691 for the year ended June 30, 2013, from $12,479,476 for the year ended June 30, 2012. The decrease was mainly attributable to the combined effect of a decrease in utilities of $1,575,449, or 48.1%, year-on-year, to $1,702,507 for the year ended June 30, 2013, from $3,277,956 for the year ended June 30, 2012 and a decrease in low consumables of $679,972, or 36.6%, year-on-year, to $1,179,409 for the year ended June 30, 2013, from $1,859,381 for the year ended June 30, 2012. The substantially decreased units sold, year-on-year, have led to an increase in average manufacturing overhead cost per unit sold of 131.5% due to decreased economies of scale.

Gross Loss

Gross loss increased by $5,966,949, or 102.8%, year-on-year, to $11,773,745 for the year ended June 30, 2013, from a gross loss of $5,806,796 for the year ended June 30, 2012. Gross profit margin decreased to (32.2)% for the year ended June 30, 2013, from (4.1)% for the year ended June 30, 2012. The decrease in gross profit margin is mainly attributable to the effect of a 22.0% decrease in average selling prices, year-on-year, due to slowing demand and falling steel prices during the year ended June 30, 2013.

Selling Expenses

Selling expenses decreased by $96,802, or 46.1%, year-on-year, to $112,991 for the year ended June 30, 2013, from $209,793 in 2012. The decrease was mainly attributable to less selling expenses associated with lower sales revenues year-on-year.

Administrative Expenses

Administrative expenses decreased by $218,856, or 8.2%, year-on-year, to $2,465,576 for the year ended June 30, 2013, compared to $2,684,432 for the year ended June 30, 2012. This was chiefly due to lower wages paid out on lower average headcount during the year ended June 30, 2013.

Bad debts written off

Bad debts written off for the year ended June 30, 2013 was in the amount of $14,147,604, compared to $nil for the year ended June 30, 2012, mainly due to write off of long-outstanding receivables and advances according to management's assessment.

Allowance for Bad and Doubtful Debts

Allowance for bad and doubtful debts increased by $36,444,852 year-on-year. Allowance recognized for the year ended June 30, 2013 was in the amount of $41,466,990 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. Included in this amount is $28,089,004 for provision for accounts receivable bad debts, $19,348,204 for provision for advances to suppliers bad debts, $1,266,064 for reversal of provision for accounts receivable bad debts, and $4,704,154 for reversal of provision for advances to suppliers bad debts.

- 32 -

Loss from Operations

Loss from operations increased by $56,227,188, or 403.4%, year-on-year, to $70,166,791 for the year ended June 30, 2013 from a loss of $13,939,603 for the year ended June 30, 2012, as a result of the factors discussed above.

Other Income

Other income increased $4,694,512 or 5,239.2%, to $4,784,116 for the year ended June 30, 2013 from $89,604 for the year ended June 30, 2012. As a percentage of revenues, other income increased to 13.1% for the year ended June 30, 2013 from less than 0.1% for the year ended June 30, 2012. The increase in other income was primarily due to reversal of certain other payables during the year ended June 30, 2013 as these payables are no longer required from us.

Interest Expense

Total interest expense increased $452,504, or 14.6%, to $3,556,711 for the year ended June 30, 2013, from $3,104,207 for the year ended June 30, 2012 due to the accrual of overdue and penalty interest resulting from our loan default during the year ended June 30, 2013.

Income Tax

For the year ended June 30, 2013, we recognized no income tax benefit or expense, compared to an income tax benefit of $5,061 for the year ended June 30, 2012. The decrease of $5,061, or 100.0%, was due to a net loss for the year ended June 30, 2013 and tax refund received as a result of the net loss in 2012.

Net Loss

Net loss increased by $51,990,241, or 306.7%, year-on-year, to $68,939,386 for the year ended June 30, 2013, compared to $16,949,145 for the year ended June 30, 2012. The increase in net loss is attributable to a combination of all the factors discussed above, the major factors being a substantial decrease in sales revenues, a negative gross profit margin, and a substantial 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 historically met these liquidity requirements with cash provided by operations, equity financing, and bank debt. As of June 30, 2013, we had cash and cash equivalents of approximately $0.1 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,
                                                          2013             2012
Net cash (used in)/provided by operating activities   $   (178,047 )   $  1,832,228
Net cash (used in) investing activities                   (492,263 )       (284,149 )
Net cash (used in) financing activities                   (757,381 )     (2,697,352 )
Net cash flows                                          (1,527,562 )     (1,104,949 )

Net cash flows used in operating activities for the year ended June 30, 2013 were $178,047 as compared to net cash flows provided by operating activities of $1,832,228 for the year ended June 30, 2012, for a net decrease of $2,010,275. This decrease was mainly due to an increase in cash outflows from other taxes payable of $2,492,303, a decrease in cash inflows from advances to suppliers of $9,168,513, offset by an increase in cash inflows from accounts payable and accrued expenses of $1,590,725 during the year ended June 30, 2013.

- 33 -

For the year ended June 30, 2013, sales revenues generated from the top five major customers as a percentage of total sales were 49%, compared with 47% for . . .

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