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CPSL > SEC Filings for CPSL > Form 10-Q on 19-Feb-2014All Recent SEC Filings

Show all filings for CHINA PRECISION STEEL, INC.

Form 10-Q for CHINA PRECISION STEEL, INC.


19-Feb-2014

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 December 31, 2013 and June 30, 2013, the end of its prior fiscal year, and its unaudited consolidated results of operation for the three and six months ended December 31, 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;

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? "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) continuing to carry out R&D to improve profitability of existing products and launch new high value-add products; and (3) 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.

Second Quarter Financial Performance Highlights

During the three months ended December 31, 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 December 31, 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.

- 5 -

During the three months ended December 31, 2013, we sold a total of 15,036 tons of products, an increase of 4,331 tons from 10,705 tons a year ago, due to an increase in domestic sales in our high-carbon product categories. However, average cost per unit sold increased 27.8% while average selling prices increased only 3.4% period-on-period. As a bid to combat air pollution in the northern part of China including Beijing, North China's Hebei Province has plans on cutting steel production by 86 million tons by 2020. Hebei is China's largest steel production base and expected lower output is going to have negative impact on our raw material cost in the short run. Low average selling price coupled with a large allowance for bad and doubtful debts of $6,546,832 led to a gross loss of $5,131,331 and a net loss of $12,958,983 for the three months ended December 31, 2013. Total company backlog as of December 31, 2013 was $3,577,492.

In June and July 2012, we defaulted on the repayment obligations of our short-term and long-term bank loans totaling $44,615,772. 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 has the right to take possession of the collateral (which collectively constitutes substantial assets of the Company) granted in connection with its 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 December 31, 2013. Operating cash flows have also been adversely impacted by the slow turnover of our accounts receivable. We 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 second fiscal quarter:

? Revenues: Our revenues were approximately $11.9 million for the quarter, an increase of 45.3% from last year.

? Gross Margin: Gross margin was (43.2%) for the quarter, compared to (15.9%) last year.

? Loss from operations before tax: Loss from operations before tax was approximately $13.0 million for the quarter, compared to a loss of approximately $10.9 million last year.

? Net loss: Net loss was approximately $13.0 million for the quarter, compared to a net loss of approximately $10.9 million last year.

? Fully diluted loss per share: Fully diluted loss per share was $3.34 for the quarter, compared to a loss per share of $2.80 last year.

Results of Operations

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

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Comparison of Three and Six Months Ended December 31, 2013 and 2012



                                                  Three Months Ended December 31,                                         Six Months Ended December 31,
                                               2013                              2012                                 2013                                 2012
                                                        % of                              % of                                                                      % of
                                      Amount          Revenues          Amount          Revenues          Amount           % of Revenues          Amount          Revenues
Revenues                           $  11,866,008          100.0      $   8,164,267          100.0      $  23,631,395                100.0      $  14,121,027          100.0
Cost of sales (including
depreciation and amortization)        16,997,339          143.2          9,466,225          115.9         31,756,985                134.4         16,889,934          119.6
Gross (loss)                          (5,131,331 )        (43.2 )       (1,301,958 )        (15.9 )       (8,125,590 )              (34.4 )       (2,768,907 )        (19.6 )
Selling expenses                          49,583            0.4             25,063            0.3             80,751                  0.3             54,336            0.4
Administrative expenses                  303,617            2.6            401,797            4.9            751,048                  3.2            844,412            6.0
Allowance for bad and doubtful
debts                                  6,546,832           55.2          8,786,214          107.6         11,668,609                 49.4         10,159,214           71.9
Depreciation and amortization
expense                                   40,500            0.3             52,050            0.6             88,642                  0.4            104,011            0.7
Total operating expenses               6,940,532           58.5          9,265,124          113.5         12,589,050                 53.3         11,161,973           79.0
(Loss) from operations               (12,071,863 )       (101.7 )      (10,567,082 )       (129.4 )      (20,714,640 )              (87.7 )      (13,930,880 )        (98.7 )
Other revenues                            57,536            0.5            607,654            7.4             60,064                  0.3            607,757            4.3
Interest and finance costs              (944,656 )         (8.0 )         (925,077 )        (11.3 )       (1,881,547 )               (8.0 )       (1,783,665 )        (12.6 )
Total other (expense)                   (887,120 )         (7.5 )         (317,423 )         (3.9 )       (1,821,483 )               (7.7 )       (1,175,908 )         (8.3 )
(Loss) before income taxes           (12,958,983 )       (109.2 )      (10,884,505 )       (133.3 )      (22,536,123 )              (95.4 )      (15,106,788 )       (107.0 )
Income tax expense                             -              -                  -              -                  -                    -                  -              -
Net (loss)                         $ (12,958,983 )       (109.2 )    $ (10,884,505 )       (133.3 )    $ (22,536,123 )              (95.4 )    $ (15,106,788 )       (107.0 )
Basic (loss) per share             $       (3.34 )                   $       (2.80 )                   $       (5.81 )                         $       (3.89 )
Diluted (loss) per share           $       (3.34 )                   $       (2.80 )                   $       (5.81 )                         $       (3.89 )

Sales Revenues

Sales volume increased by 4,331 tons, or 40.5%, period-on-period, to 15,036 tons for the three months ended December 31, 2013, from 10,705 tons for the three months ended December 31, 2012 and as a result, sales revenues increased by $3,701,741, or 45.3%, period-on-period, to $11,866,008 for the three months ended December 31, 2013, from $8,164,267 for the three months ended December 31, 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 three months ended December
31, 2013 and 2012 is as follows:



                                                          Three Months ended December 31,                               Period-on-
                                                   2013                                      2012                         Period
                                  Quantity                        % of       Quantity                       % of           Qty.
Product Category                   (tons)         $ Amount        Sales       (tons)        $ Amount        Sales        Variance
Low-carbon hard-rolled                  256          203,122           2         1,202         842,901          10             (946 )
Low-carbon cold-rolled                4,580        2,980,938          25         5,840       4,513,375          55           (1,260 )
High-carbon hot-rolled                5,448        4,283,070          36           142         104,472           1            5,306
High-carbon cold-rolled               4,253        3,649,753          31         2,909       2,544,079          31            1,344
Subcontracting income                   499           50,124          <1           612          31,768           1             (113 )
Sales of scrap metal                      -          699,001           6             -         127,672           2                -
Total                                15,036       11,866,008         100        10,705       8,164,267         100            4,331

During the three months ended December 31, 2013, domestic sales increased in our high-carbon product categories while sales decreased for our low-carbon product categories. Low-carbon cold-rolled steel products accounted for 25% of the current sales mix at an average selling price of $651 per ton for the three months ended December 31, 2013, compared to 55% of the sales mix at an average selling price per ton of $773 for the three months ended December 31, 2012. 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 2% of the current sales mix at an average selling price of $793 per ton for the three months ended December 31, 2013, compared to 10% of the sales mix at an average selling price per ton of $701 for the three months ended December 31, 2012, due to a strong RMB against USD which negatively impacted export sales. High-carbon cold-rolled steel products accounted for 31% of the current sales mix at an average selling price of $858 per ton for the three months ended December 31, 2013, compared to 31% of the sales mix at an average selling price of $875 for the three months ended December 31, 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 the increase in demand for automobiles in the PRC market and as a result of our continued sales and marketing efforts in this market segment. Subcontracting income revenues accounted for $50,124 or less than 1% of the sales mix for the three months ended December 31, 2013, a slight increase from $31,768 for the three months ended December 31, 2012.

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                                        Three Months ended
                                           December 31,
                                       2013            2012            Variance
           Average Selling Prices       ($)             ($)         ($)        (%)
           Low-carbon hard-rolled          793             701         92        13
           Low-carbon cold-rolled          651             773       (122 )     (16 )
           High-carbon hot-rolled          786             736         50         7
           High-carbon cold-rolled         858             875        (17 )      (2 )
           Subcontracting income           100              52         48        92

The average selling price per ton increased to $789 for the three months ended December 31, 2013 compared to $763 last year, representing an increase of $26, or 3.4%, period-on-period. This increase was mainly due to increases in general steel prices and therefore our selling prices during the quarter.

Sales Breakdown by Major Customer



                                                2013                              2012
                                                          % of                            % of
Customers                                  $              Sales             $             Sales
Shanghai Hongyu Metal Co., Ltd.          5,752,574              48               - *             - *
Maoxun Trading Co., Ltd.                 1,605,363              14               - *             - *
Shanghai Haiheng Co., Ltd.               1,296,646              11               - *             - *
Wozi Jintian Saw Blade Co., Ltd.           990,145               8               - *             - *
Zhangjiagang Gangxin New
Construction Materials Co., Ltd            844,816               7               - *             - *
Shanghai Bayou Co., Ltd.                         - *             - *       963,918              12
Shanghai Shengdejia Metal Products
Co., Ltd.                                        - *             - *       875,380              11
Changshu Jiacheng Steel Plating
Co., Ltd.                                        - *             - *       843,656              10
Shanghai Changshuo Steel Co., Ltd.               - *             - *       763,178               9
Shanghai Wozi Jintian Blade Co.,
Ltd.                                             - *             - *       529,399               6
                                        10,489,545              88       3,957,531              48
Others                                   1,376,463              12       4,206,736              52
Total                                   11,866,008             100       8,164,267             100

* Not major customers for the relevant periods

Sales revenue generated from our top five major customers as a percentage of total sales was 88% for the three months ended December 31, 2013, as compared to 49% 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 $7,531,114, or 79.6%, period-on-period, to $16,997,339 for the three months ended December 31, 2013, from $9,466,225 for the three months ended December 31, 2012. Cost of sales represented 143.2% of sales revenues for the three months ended December 31, 2013, compared to 115.9% for the three months ended December 31, 2012. Average cost per unit sold increased to $1,130 for the three months ended December 31, 2013, compared to $884 for the three months ended December 31, 2012, representing an increase of $246 per ton, or 27.8%, period-on-period, as detailed more fully below.

                                         2013            2012                Variance
                                         ($)              ($)             ($)          (%)
Cost of goods sold
- Raw materials                        13,412,519       7,438,121       5,974,398       80.3
- Direct labor                            201,922         107,895          94,027       87.1
- Manufacturing overhead                3,382,898       1,920,209       1,462,689       76.2
                                       16,997,339       9,466,225       7,531,114       79.6

Cost per unit sold
Total units sold (tons)                    15,036          10,705           4,331       40.5
Average cost per unit sold ($/ton)          1,130             884             246       27.8

- 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 $46, or 25.4%, from $179 for the three months ended December 31, 2012, to $225 for the three months ended December 31, 2013;

? an increase in direct labor per unit sold of $3, or 29.0%, from $10 for the three months ended December 31, 2012, to $13 for the three months ended December 31, 2013, and;

? an increase in cost of raw materials per unit sold of $197, or 28.4%, from $695 for the three months ended December 31, 2012, to $892 for the three months ended December 31, 2013.

The cost of raw materials consumed increased by $5,974,398, or 80.3%, period-on-period, to $13,412,519 for the three months ended December 31, 2013, from $7,438,121 for the three months ended December 31, 2012. This increase was due to a large increase in total units sold during the three months ended December 31, 2013 and an increase in the cost of raw materials.

Direct labor costs increased by $94,027, or 87.1%, period-on-period, from $107,895 for the three months ended December 31, 2012, to $201,922 for the three months ended December 31, 2013. Manufacturing overhead costs increased by $1,462,689, or 76.2%, period-on-period, from $1,920,209 for the three months ended December 31, 2012, to $3,382,898 for the three months ended December 31, 2013. The increase was mainly attributable to the combined effect of an increase in utilities of $389,499, or 133.7%, period-on-period, from $291,260 for the three months ended December 31, 2012, to $680,759 for the three months ended December 31, 2013, an increase in depreciation of $536,049, or 40.2%, period-on-period, from $1,331,827 for the three months ended December 31, 2012, to $1,867,876, and an increase in consumables of $236,347, or 103.3%, period-on-period, from $228,772 for the three months ended December 31, 2012, to $465,119 for the three months ended December 31, 2013.

Gross Profit

Gross profit in absolute terms decreased by $3,829,373 or 294.1%, period-on-period, from a gross loss of $1,301,958 for the three months ended December 31, 2012, to a gross loss of $5,131,331 for the three months ended December 31, 2013. Gross profit margin decreased to (43.2%) for the three months ended December 31, 2013, from (15.9%) for the three months ended December 31, 2012. The decrease in gross profit margin is mainly attributable to a 27.8% period-on-period increase in average cost per unit sold.

Selling Expenses

Selling expenses increased by $24,520, or 97.8%, period-on-period, from $25,063 for the three months ended December 31, 2012, to $49,583 for the three months ended December 31, 2013. The increase was mainly attributable to higher transportation costs and traveling expenses period-on-period.

Administrative Expenses

Administrative expenses decreased by $98,180 or 24.4%, period-on-period, from $401,797 for the three months ended December 31, 2012, compared to $303,617 for the three months ended December 31, 2013. This was mainly due to a decrease in traveling expenses associated with attendance at investment conferences and legal and professional fees period-on-period.

- 9 -

Allowance for Bad and Doubtful Debts

Allowance for bad and doubtful debts decreased by $2,239,382, or 25.5%, period-on-period. Allowance recognized for the three months ended December 31, 2012 was in the amount of $6,546,832 in accordance with our policy for allowance for doubtful accounts.

Loss from Operations

Loss from operations increased by $1,504,781, or 14.2%, period-on-period, to a loss of $12,071,863 for the three months ended December 31, 2013, from $10,567,082 for the three months ended December 31, 2012, as a result of the factors discussed above.

Other Income

Other income decreased by $550,118, or 90.5%, to $57,536 for the three months ended December 31, 2013, from $607,654 for the three months ended December 31, 2012.

Interest Expense

Total interest expense increased by $19,579, or 2.1%, to $944,656 for the three months ended December 31, 2013, from $925,077 for the three months ended December 31, 2012, due to the accrued late payment penalty interest as a result of the loan default.

Income Tax

. . .

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