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CPSL > SEC Filings for CPSL > Form 10-Q on 19-Nov-2013All Recent SEC Filings

Show all filings for CHINA PRECISION STEEL, INC.

Form 10-Q for CHINA PRECISION STEEL, INC.


19-Nov-2013

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, 2013.

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, 2013 and June 30, 2013, the end of its prior fiscal year, and its unaudited consolidated results of operation for the three months ended September 30, 2013 and 2012.

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;

? "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 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. 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) 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 Chinese economy and credit crunch which have caused many difficulties faced by businesses.

First Quarter Financial Performance Highlights

During the three months ended September 30, 2013, we saw a substantial increase in our sales volume, period-on-period. This is a direct result of the measures we have been taking during the past year including expanding customer base and improving production management, as mentioned above. However, as we further work to improve our operating results to achieve profitability, tightened credit and slowing growth in China continued to cause a negative impact on our business and a slow turnover of our accounts receivable for the three months ended September 30, 2013, 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, 2013, we sold a total of 20,449 tons of products, an increase of 12,696 tons from 7,753 tons a year ago, due to increase in domestic sales across all product categories. Our average cost per unit sold decreased 24.5% while average selling prices decreased 25.1% period-on-period. Low average selling price coupled with a large allowance for bad and doubtful debts of $5,121,777led to a gross loss of $2,994,259 and a net loss of $9,577,140 for the three months ended September 30, 2013. Total company backlog as of September 30, 2013 was $8,165,118.

In June and July 2012, we defaulted on the repayment obligations of our short-term and long-term bank loans totaling $44,311,165. We are currently in discussions with our banks regarding the possibility tore structure 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 constitutes 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 continued to suffer a significant loss in the period ended September 30, 2013. Operating cash flows have also been 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 third fiscal quarter:

? Revenues: Our revenues were approximately $11.8 million for the quarter, an increase of 97.5% from last year.

? Gross Margin: Gross margin was (25.4%) for the quarter, compared to (24.6%) last year.

? Loss from operations before tax: Loss from operations before tax was approximately $9.6 million for the quarter, compared to a loss of approximately $4.2 million last year.

? Net loss: Net loss was approximately $9.6 million for the quarter, compared to a net loss of approximately $4.2 million last year.

? Fully diluted loss per share: Fully diluted loss per share was $2.47 for the quarter, compared to a loss per share of $1.09 last year.

Results of Operations

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

(All amounts in U.S. dollars)

                                                  2013                             2012
                                                          % of                             % of
                                         Amount         Revenues          Amount         Revenues
Sales Revenues                          11,765,387           100.0        5,956,760           100.0
Cost of goods sold (including
depreciation and amortization)          14,759,646           125.4        7,423,709           124.6
Gross (loss)                            (2,994,259 )         (25.4 )     (1,466,949 )         (24.6 )
Selling expenses                            31,168             0.3           29,273             0.5
Administrative expenses                    447,431             3.8          442,615             7.4
Allowance for bad and doubtful
debts                                    5,121,777            43.5        1,373,000            23.0
Depreciation and amortization
expense                                     48,142             0.4           51,961             0.9
(Loss) from operations                  (8,642,777 )         (73.5 )     (3,363,798 )         (56.5 )
Total other expense                       (934,363 )          (7.9 )       (858,485 )         (14.4 )
(Loss) from operations before
income tax                              (9,577,140 )         (81.4 )     (4,222,283 )         (70.9 )
Income tax expense                               -               -                -               -
Net (loss)                              (9,577,140 )         (81.4 )     (4,222,283 )         (70.9 )
Basic (loss) per share                       (2.47 )                          (1.09 )
Diluted (loss) per share                     (2.47 )                          (1.09 )

Sales Revenues

Sales volume increased by 12,696 tons, or 163.7%, period-on-period, to 20,449 tons for the three months ended September 30, 2013, from 7,753 tons for the three months ended September 30, 2012 and as a result, sales revenues increased by $5,808,627, or 97.5%, period-on-period, to $11,765,387 for the three months ended September 30, 2013, from $5,956,760 for the three months ended September 30, 2012. The increase in sales revenues period-on-period is mainly attributable to the increase in production and sales as a result of management's sales and marketing efforts in the domestic market, as detailed more fully below.

Sales by Product Line



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



                                           2013                                        2012
                                                                                                                   Period-on-
                          Quantity                         % of        Quantity                        % of        Period Qty.
Product Category           (tons)         $ Amount        Sales         (tons)        $ Amount        Sales         Variance
Low carbon hard-rolled          442          407,106            4          1,470       1,133,619           19            (1,028 )
Low carbon cold-rolled       11,047        5,818,783           49          3,513       2,047,911           34             7,534
High-carbon hot-rolled        3,695          982,361            8             37          13,197          <1%             3,658
High-carbon cold-rolled       4,850        4,118,910           35          2,838       2,545,164           43             2,012
Subcontracting income           415           66,385            1           (105 )         9,024          <1%               520
Sales of scrap metal              -          371,842            3              -         207,845            4                 -

Total 20,449 11,765,387 100 7,753 5,956,760 100 12,696

During the three months ended September 30, 2013, sales increased across all product categories for domestic sales, but due to a strong RMB against USD, export sales were negatively impacted. Low-carbon cold-rolled steel products accounted for 49% of the current sales mix at an average selling price of $527 per ton for the three months ended September 30, 2013, compared to 34% of the sales mix at an average selling price per ton of $583 for the three months ended September 30, 2012. Low-carbon hard-rolled steel products accounted for 4% of the current sales mix at an average selling price of $921 per ton for the three months ended September 30, 2013, compared to 19% of the sales mix at an average selling price per ton of $771 for the three months ended September 30, 2012. Although average selling price increased period-on-period, there was less demand for this export category due to a strong RMB against USD. High-carbon cold-rolled steel products accounted for 35% of the current sales mix at an average selling price of $849 per ton for the three months ended September 30, 2013, compared to 43% of the sales mix at an average selling price of $897 for the three months ended September 30, 2012. The products in this category are mainly used in the automobile industry and the increase in sales volume period-on-period was a result of our sales and marketing efforts targeted at the automobiles components manufactures in the PRC market. We believe there is growth opportunity in this market segment and will continue to expand our customer base. Subcontracting income revenues accounted for $66,385, or 1%, of the sales mix for the three months ended September 30, 2013, increased from $9,024, or less than 1%, of the sales mix for the three months ended September 30, 2012, due to increased demand. The negative quantity in 2012 was due to the return of one batch of sample products with a small sales revenue.

                           2013      2012           Variance
Average Selling Prices      ($)       ($)       ($)        (%)
Low-carbon hard-rolled      921       771       150         19.5
Low-carbon cold-rolled      527       583       (56 )       (9.6 )
High-carbon hot-rolled      266       353       (87 )      (24.6 )
High-carbon cold-rolled     849       897       (48 )       (5.4 )
Subcontracting income       160       (86 )     246       (286.0 )

The average selling price per ton decreased to $575 for the three months ended September 30, 2013, compared to $768 in 2012, representing a decrease of $193, or 25.1%, 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, 2013 except for low-carbon hard-rolled products.

Sales Breakdown by Major Customer



                                                        2013                          2012
                                                                % of                          % of
Customers                                          $            Sales             $           Sales
ChangshuJiacheng Steel Plating Co., Ltd.        1,939,400            16         699,359            12
Hangzhou Pugang Steel Materials Co., Ltd.       1,290,449            11               *             *
ZhangjiagangGangxin New Construction
Materials Co., Ltd                              1,056,134             9               *             *
SUMEC International Technology Co., Ltd.          786,920             7               *             *
Shanghai WoziJintian Blade Co., Ltd               741,357             6         607,652            10
Unimax& Far Corporation                                 *             *         637,147            11
Zhejiang Zhongwei Construction Materials
Co., Ltd                                                *             *         489,025             8

Steelforce NV                                           *             *         328,591             5
                                                5,814,260            49       2,761,774            46
Others                                          5,951,127            51       3,194,986            54

Total 11,765,387 100 5,956,760 100

* Not major customers for the relevant periods

Sales revenue generated from our top five major customers as a percentage of total sales was 49% for the three months ended September 30, 2013, as compared to 46% in 2012. 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 increased by $7,335,937, or 98.8%, period-on-period, to $14,759,646 for the three months ended September 30, 2013, from $7,423,709 for the three months ended September 30, 2012. Cost of sales represented 125.4% of sales revenues for the three months ended September 30, 2013, compared to 124.6% for the three months ended September 30, 2012. Average cost per unit sold decreased to $722 for the three months ended September 30, 2013, compared to $957 for the three months ended September 30, 2012, representing a decrease of $235 per ton, or 24.5%, period-on-period.

                                            2013            2012                  Variance
                                            ($)              ($)             ($)            (%)
Cost of goods sold
- Raw materials                           12,020,483       4,435,761       7,584,722          171.0
- Direct labor                               139,908         139,068             840            0.6
- Manufacturing overhead                   2,599,255       2,848,880        (249,625 )        (8.8)
                                          14,759,646       7,423,709       7,335,937           98.8

Cost per unit sold
Total units sold (tons)                       20,449           7,753          12,696          163.8
Average cost per unit sold ($/ton)               722             957           (235)         (24.5)

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

? a decrease in factory overhead per unit sold of $240, or 65.4%, from $367 for the three months ended September 30, 2012, to $127 for the three months ended September 30, 2013;

? a decrease in direct labor per unit sold of $11, or 61.1%, from $18 for the three months ended September 30, 2012, to $7 for the three months ended September 30, 2013, offset by;

? an increase in cost of raw materials per unit sold of $16, or 2.8%, from $572 for the three months ended September 30, 2012, to $588 for the three months ended September 30, 2013.

The cost of raw materials consumed increased by $7,584,722, or 171.0%, period-on-period, to $12,020,483 for the three months ended September 30, 2013, from $4,435,761 for the three months ended September 30, 2012. This increase was mainly due to a substantial increase in total units sold during the three months ended September 30, 2013.

Direct labor costs decreased by $840, or 0.6%, period-on-period, to $139,908 for the three months ended September 30, 2013, from $139,068 for the three months ended September 30, 2012. Manufacturing overhead costs decreased by $249,625, or 8.8%, period-on-period, to $2,599,255 for the three months ended September 30, 2013, from $2,848,880 for the three months ended September 30, 2012. The decrease was mainly attributable to the combined effect of a decrease in depreciation of $328,041, or 18.4%, period-on-period, to $1,454,038 for the three months ended September 30, 2013, from $1,782,079 for the three months ended September 30, 2012, and partially offset by an increase in consumables of $106,755, or 33.3%, period-on-period, to $427,372 for the three months ended September 30, 2013, from $320,617 for the three months ended September 30, 2012.

Gross Loss

Gross loss in absolute terms increased by $1,527,310 or 104.1%, period-on-period, to $2,994,259 for the three months ended September 30, 2013, from a gross loss of $1,466,949 for the three months ended September 30, 2012. Gross profit margin decreased to (25.4%) for the three months ended September 30, 2013, from (24.6%) for the three months ended September 30, 2012. The decrease in gross profit margin is mainly attributable to a 25.1% period-on-period decrease in average selling price.

Selling Expenses

Selling expenses increased by $1,895, or 6.5%, period-on-period, to $31,168 for the three months ended September 30, 2013, from $29,273 for the three months ended September 30, 2011. The increase was mainly attributable to higher transportation costs and traveling expenses period-on-period.

Administrative Expenses

Administrative expenses slightly increased by $4,816 or 1.1%, period-on-period, to $447,431 for the three months ended September 30, 2013, compared to $442,615 for the three months ended September 30, 2011.

Allowance for Bad and Doubtful Debts

Allowance for bad and doubtful debts increased by $3,748,777, or 273.0%, period-on-period. Allowance recognized for the three months ended September 30, 2013 was in the amount of $5,121,777 in accordance with our policy for allowance for doubtful accounts.

Loss from Operations

Loss from operations increased by $5,278,979, or 156.9%, period-on-period, to $8,642,777 for the three months ended September 30, 2013, from$3,363,798 for the three months ended September 30, 2012, as a result of the factors discussed above.

Other Income

Other income increased by $2,425, or 2,354.4%, to $2,528 for the three months ended September 30, 2013, from $103 for the three months ended September 30, 2012, due to higher interest income period-on-period.

Interest Expense

Total interest expense increased by $78,303, or 9.1%, to $936,891 for the three months ended September 30, 2013, from $858,588 for the three months ended September 30, 2012, due to the accrual of overdue and penalty interest as resulting from our loan default.

Income Tax

For the three months ended September 30, 2013 and 2012, we recognized no income tax expense due to a net loss position.

Net Loss

Net loss increased by $5,354,857, or 126.8%, period-on-period, to $9,577,140 for the three months ended September 30, 2013, from $4,222,283 for the three months ended September 30, 2012. 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, 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



                                               Three Months Ended September 30,
                                                  2013                   2012
Net cash provided by operating activities   $         55,331       $        171,468
Net cash (used in) investing activities              (14,633 )               (7,424 )
Net cash (used in) financing activities              (47,650 )                    -
Net cash flow                                         (8,747 )               (7,238 )

Operating Activities

Net cash flows provided by operating activities for the three months ended September 30, 2013 were $55,331, as compared to $171,468 provided by operating activities for the three months ended September 30, 2012, resulting in a net decrease of $116,137. This decrease was mainly due to an increase in cash outflows for advances to suppliers of $3,174,279, offset by an increase in cash inflow from advances from customers of $2,498,417, during the three months ended September 30, 2013.

For the three months ended September 30, 2013, sales revenues generated from the top five major customers as a percentage of total sales was 49%, as compared to . . .

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