Longhai Steel Inc. - FORM 10-Q

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EXCEL - IDEA: XBRL DOCUMENT - Longhai Steel Inc.	Financial_Report.xls
EX-10.1 - EXHIBIT 10.1 - Longhai Steel Inc.	exhibit10-1.htm
EX-31.2 - EXHIBIT 31.2 - Longhai Steel Inc.	exhibit31-2.htm
EX-32.2 - EXHIBIT 32.2 - Longhai Steel Inc.	exhibit32-2.htm
EX-31.1 - EXHIBIT 31.1 - Longhai Steel Inc.	exhibit31-1.htm
EX-32.1 - EXHIBIT 32.1 - Longhai Steel Inc.	exhibit32-1.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10−Q

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: September 30, 2011

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________to _____________

Commission File Number: 001-35017

LONGHAI STEEL INC.
(Exact Name of Registrant as Specified in Its Charter)

Nevada	11-3699388
(State or other jurisdiction of	(I.R.S. Employer Identification No.)
incorporation or organization)

No. 1 Jingguang Road, Neiqiu County
Xingtai City, Hebei Province 054000
People’s Republic of China
(Address of principal executive offices, Zip Code)

(+86) 319-686-1111
(Registrant’s telephone number, including area code)

_____________________________________________________
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X] No [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes [X] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [ ]	Accelerated filer [ ]
Non-accelerated filer [ ]	Smaller reporting company [X]
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [ ] No [X]

The number of shares outstanding of each of the issuer’s classes of common stock, as of November [10], 2011 is as follows:

Class of Securities	Shares Outstanding
Common Stock, $0.001 par value	10,000,418

Quarterly Report on Form 10-Q
Three and Nine Months Ended September 30, 2011

TABLE OF CONTENTS

PART I
FINANCIAL INFORMATION

Item 1.	Financial Statements	1
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	23
Item 4.	Controls and Procedures	23

PART II
OTHER INFORMATION

Item 1.	Legal Proceedings	24
Item 1A.	Risk Factors	24
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	24
Item 3.	Defaults Upon Senior Securities	24
Item 4.	(Removed and Reserved)	24
Item 5.	Other Information	24
Item 6.	Exhibits	25

PART I
FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

LONGHAI STEEL INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2011 AND 2010

	Page(s)
Contents
Consolidated Balance Sheets	2
Consolidated Statements of Operations and Comprehensive Income	3
Consolidated Statements of Cash Flows	4
Notes to Consolidated Financial Statements	5-15

LONGHAI STEEL INC.
CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 2011 AND DECEMBER 31, 2010
(UNAUDITED)

		September 30, 2011		December 31, 2010

ASSETS
Current Assets
Cash and cash equivalents	$	1,393,274	$	293,445
Accounts receivable, net		-		908,327
Inventory, net		29,747,733		8,500,770
Advance to suppliers		39,682,063		36,690,325
Tax receivable		166,613		276,638
Prepaid expenses		27,020		10,465
Notes receivable		496,716		226,867
Other current assets		469		6,350,750
Current deferred tax assets		272,081		74,976
Total current assets		71,785,969		53,332,563

Property, plant and equipment, net		23,104,151		24,648,690
Intangible assets		39,539		-
TOTAL ASSETS	$	94,929,659	$	77,981,253

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
Accounts payable	$	8,758,803	$	8,355,457
Advance from customers		28,249,200		15,692,067
Income tax payable		4,531,350		5,701,872
Accrued liabilities		1,931,064		2,209,976
Due to related party		622,095		1,531,755
Total current liabilities		44,092,512		33,491,127
Non-current deferred tax liabilities		156,021		170,686
TOTAL LIABILITIES		44,248,533		33,661,813

STOCKHOLDERS’ EQUITY

Common Stock, .001 par value, 100,000,000 shares authorized, 10,000,000 shares and 9,850,000 shares issued and outstanding, respectively		10,000		10,000
Additional paid-in capital		3,319,219		3,173,897
Statutory reserve		1,475,198		1,475,198
Accumulated other comprehensive income		3,703,523		2,166,544
Retained earnings		42,173,186		37,493,801
TOTAL STOCKHOLDERS’ EQUITY		50,681,126		44,319,440

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	94,929,659	$	77,981,253

The accompanying notes are an integral part of these unaudited consolidated financial statements

LONGHAI STEEL INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
FOR THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010
(UNAUDITED)

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
		2011			2010			2011			2010

Revenue	$	118,760,655		$	96,104,842		$	410,775,293		$	330,483,572
Cost of revenue		(115,899,850	)		(91,826,504	)		(400,408,290	)		(319,232,116	)
Gross profit		2,860,805			4,278,338			10,367,003			11,251,456

Impairment on inventory valuation		(674,282	)		-			(674,282	)		-
General and administrative expenses		(133,552	)		(406,971	)		(1,249,541	)		(1,445,726	)
Income from operations		2,052,971			3,871,367			8,443,180			9,805,730

Interest income		2,078			1,403			5,332			3,747
Interest expense		(748,113	)		(399,911	)		(2,148,980	)		(723,274	)
Other expenses		(1,935	)		(2,002	)		(11,340	)		(6,786	)
Total other income and expenses		(747,970	)		(400,510	)		(2,154,988	)		(726,313	)

Income before income taxes		1,305,001			3,470,857			6,288,192			9,079,417
Income tax expense		(325,853	)		(883,304	)		(1,608,807	)		(2,384,515	)

Net income	$	979,148		$	2,587,553		$	4,679,385		$	6,694,902

Net Income per share – basic and diluted	$	0.10		$	0.26		$	0.47		$	0.67

Weighted average shares outstanding – basic and diluted		10,000,000			10,000,000			10,000,000			9,953,297

Comprehensive Income
Net income	$	979,148		$	2,587,553		$	4,679,385		$	6,694,902
Other comprehensive income		468,874			624,426			1,536,979			772,389
Comprehensive income	$	1,448,022		$	3,211,979		$	6,216,364		$	7,467,291

The accompanying notes are an integral part of these unaudited consolidated financial statements

LONGHAI STEEL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR NINE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010
(UNAUDITED)

		Nine Months Ended September 30,
		2011			2010
Cash flows from operating activities:
Net income	$	4,679,385		$	6,694,902
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization		2,380,390			2,263,004
Deferred tax assets / liabilities		(211,467	)		1,099,429
Stock option expenses		145,322			456,724
Reserve for inventory obsolescence		674,282			-
Changes in operating assets and liabilities:
Accounts receivable		923,072			(2,393	)
Inventory		(21,307,130	)		(15,917,067	)
Advance to suppliers		(1,761,003	)		(10,275,655	)
Prepaid expenses and other current assets		6,437,432			(4,141,217	)
Tax receivable		117,183			(1,354,105	)
Due to / from related parties		1,519,935			88,544
Accounts payable		127,520			(8,930,403	)
Accrued liabilities		272,685			906,851
Advance from customers		11,850,261			(10,327,624	)
Income tax payable		(1,335,609	)		(299,751	)
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES		4,512,258			(39,738,761	)

Cash flows from investing activities:
Cash lending to related parties		(3,842,500	)		-
Cash repaid by related parties		3,842,500			-
Cash paid for fixed assets purchased by related party		(615,092	)		-
Cash paid for software		(38,906	)		-
Purchase of notes receivable		(258,216	)		(895,776	)
Purchase of property and equipment		(65,928	)		(2,329,538	)
CASH USED IN INVESTING ACTIVITIES		(978,142	)		(3,225,314	)

Cash flows from financing activities:
Cash advance from related parties		16,766,878			42,902,618
Cash repayment to related parties		(19,232,898	)		-
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES		(2,466,020	)		42,902,618
Effect of exchange rate changes on cash		31,733			165,887
Net (decrease) increase in cash and cash equivalents		1,099,829			104,430

Cash and cash equivalents, beginning balance		293,445			116,540
Cash and cash equivalents, ending balance	$	1,393,274		$	220,970

SUPPLEMENTARY DISCLOSURE:
Interest paid	$	2,143,710		$	721,997
Income tax paid		3,155,819			1,598,724

The accompanying notes are an integral part of these unaudited consolidated financial statements

LONGHAI STEEL INC. (Formerly Action Industries, Inc.)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - ORGANIZATION AND BUSINESS OPERATIONS

Longhai Steel Inc., a Nevada corporation (formerly Action Industries, Inc.) (“we”, “our” or the “Company”) was originally incorporated under the laws of the State of Georgia on December 4, 1995. On March 14, 2008, the Georgia corporation was merged with and into a newly formed Nevada corporation also named Action Industries, Inc. and all of the outstanding shares of the Georgia corporation were exchanged for shares in the surviving Nevada corporation.

On March 26, 2010, the Company completed a reverse acquisition transaction through a share exchange with Kalington Limited (hereafter referred to as “Kalington”), a Hong Kong entity established on November 5, 2009, and its shareholders, whereby the Company acquired 100% of the issued and outstanding capital stock of Kalington in exchange for 10,000 shares of our Series A Preferred Stock which constituted 98.5% of the Company’s issued and outstanding capital stock on an as-converted basis as of and immediately after the consummation of the reverse acquisition. On July 16, 2010, the Company effected a 1-for-125 reverse stock split of our issued and outstanding common stock (the “Reverse Stock Split”). Upon the date of the Reverse Stock Split all of the issued and outstanding shares of Series A Preferred Stock automatically converted into 9,850,000 shares of common stock. Following the effectiveness of the Reverse Stock Split and conversion of Series A Preferred Stock into common stock, there were 10,000,000 shares of our common stock issued and outstanding and no shares of preferred stock issued and outstanding. As a result of the reverse acquisition, Kalington became the Company’s wholly-owned subsidiary and the former stockholders of Kalington became our controlling stockholders. The share exchange transaction with Kalington and the Shareholders, was treated as a reverse acquisition for accounting and financial reporting purposes, with Kalington as the acquirer and the Company as the acquired party. After the reverse acquisition, the Company changed its name to Longhai Steel Inc.

As a result of the reverse acquisition transaction, the Company now owns all of the issued and outstanding capital stock of Kalington.

By virtue of its ownership in Kalington, the Company also owns Kalington Consulting, which is a wholly owned foreign subsidiary of Kalington and effectively and substantially controls Longhai, a leading producer of steel wire products in northeastern China, through a series of captive agreements known as variable interest agreements (the “VIE Agreements”) with Kalington Consulting.

Immediately prior to the reverse acquisition, the common stock of Kalington was owned by the following persons in the indicated percentages: William Hugh Luckman (3.51%); Wealth Index Capital Group LLC (a US company) (7.3%); K International Consulting Ltd. (a BVI company) (2.08%); Merrill King International Investment Consulting Ltd. (a BVI company) (0.31%); Shanchun Huang (3.12%); Xiucheng Yang (1.53%); Jianxin Wang (0.92%); Xingfang Zhang (29.45%); and Merry Success Limited (a BVI company) (51.78%) . Our Chief Financial Officer and Director, Dr. Eberhard Kornotzki, directly controls the shares held by K International Consulting Ltd. and has a beneficial interest in Wealth Index Capital Group LLC, and Chaojun Wang, our Chief Executive Officer, serves as a director of Merry Success Limited, our principal stockholder after the reverse acquisition, along with Jinhai Guo, its sole shareholder.

Kalington was established on November 5, 2009 in Hong Kong to serve as an intermediate holding company. Chaojun Wangcurrently serves as the directors of Kalington. Kalington Consulting was established in the PRC on March 18, 2010, and is 100% owned by Kalington. On March 5, 2010, the local government of the PRC issued a certificate of approval regarding the foreign ownership of Kalington Consulting. Chaojun Wang serves as the executive director of Kalington Consulting. Longhai, our operating VIE, was established in the PRC on August 26, 2008, as a result of the carve-out of the division of the Longhai Steel Group, for the purpose of engaging in the production of steel wire. Chaojun Wang serves as the Chairman of the Board of Directors and General Manager of Longhai and owns 80% of the capital stock in Longhai. Longhai’s additional shareholders are Wealth Index International (Beijing) Investment Co., Ltd. (15% owner), an entity owned and controlled by Dr. Eberhard Kornotzki, our Chief Financial Officer, and Wenyi Chen (5% owner). Chaojun Wang also owns 80% of the capital stock of and is the chief executive officer of the Longhai Steel Group.

All of the Company’s business operations are now conducted through its Hong Kong and Chinese subsidiaries, Kalington and Kalington Consulting, respectively, and controlled affiliate, Longhai. The Company’s principal business is the production of steel wire ranging from 6mm to 10mm in diameter. The Company operates two wire production lines which have a combined annual capacity of approximately nine hundred thousand tons per year. The Company’s products are sold to a number of distributors who transport the wire to nearby wire processing facilities. The Company’s wire is then further processed by third party wire refiners into a variety of products such as nails, screws, and wire mesh for use in reinforced concrete and fencing. The Company’s facilities and head offices are located in the town of Xingtai in southern Hebei Province.

Longhai leases a five-story office space and the building which houses our production facilities from the Longhai Steel Group. Until 2008, Longhai purchased 100% of its steel billet from the Longhai Steel Group. Since 2009, Longhai has purchased steel billet from third party vendors. Steel Billet is the principal raw material used in our production of steel wire. Longhai also purchases production utilities from the Longhai Steel Group.

Since there is common control between the Company and Longhai PRC, for accounting purposes, the acquisition of Longhai PRC has been treated as a recapitalization with no adjustment to the historical basis of the assets and liabilities of the consolidated company. The restructuring has been accounted for using the “as if” pooling method of accounting and the operations were consolidated as if the restructuring had occurred as of the beginning of the earliest period presented in our consolidated financial statements and the current corporate structure had been in existence throughout the periods covered by our consolidated financial statements.

NOTE 2 - BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements as of September 30, 2011 and December 31, 2010 have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") and pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations. Therefore, please read these financial statements and notes to the financial statements together with the audited financial statements and notes thereto in our Annual Report on Form 10-K of the year ended December 31, 2010. The income statement for the nine months ended September 30, 2011 cannot necessarily be used to project results for the full year.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Longhai Steel Inc. and its 100%-owned subsidiary Kalington and variable interest entity (“VIE”) Longhai for the nine months ended September 30, 2011. All significant inter-company accounts and transactions were eliminated in consolidation. Certain prior period numbers are reclassified to conform to current period presentation.

Use of Estimates

The preparation of consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the amount of revenues and expenses during the reporting periods. Management makes these estimates using the best information available at the time the estimates are made. However, actual results could differ materially from those results.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents and trade and bills receivables. As of September 30, 2011 and December 31, 2010, substantially all of the Company’s cash and cash equivalents were held by major financial institutions located in the PRC, which management believes are of high credit quality. With respect to trade receivables, the Company extends credit based on an evaluation of the customer’s financial condition. The Company generally does not require collateral for trade receivables and maintains an allowance for doubtful accounts of trade receivables. The Company operates principally in the PRC and grants credit to its customers in this geographic region. Although the PRC is economically stable, it is always possible that unanticipated events in foreign countries could disrupt the Company’s operations.

Comprehensive Income

Comprehensive income consists of two components, net income and other comprehensive income/ (loss). Other comprehensive income refers to revenue, expenses, gains and losses that under generally accepted accounting principles are recorded as an element of stockholders’ equity but are excluded from net income. During the periods presented, other comprehensive income (loss) includes cumulative translation adjustment from foreign currency translation.

Foreign Currency Transactions

The reporting currency of the Company is the U.S. dollar. The functional currency of the Company’s PRC subsidiaries is the RMB. Assets and liabilities of non-U.S. subsidiaries that operate in a local currency environment, where that local currency is the functional currency, are translated into U.S. dollars at exchange rates in effect at the balance sheet date; with the resulting translation adjustments directly recorded to a separate component of accumulated other comprehensive income. Income and expense accounts are translated at average exchange rates during the year. Gains and losses from foreign currency transactions are recorded in other income (loss), net. The functional currency is the local currency for all non-U.S. subsidiaries.

The balance sheet amounts at September 30, 2011, with the exception of shareholders’ equity, were translated at the exchange rate of 1 RMB to the U.S. $0.1565 compared to the exchange rate of 1 RMB to the U.S. $0.1517 at December 31, 2010. The equity accounts were stated at their historical exchange rates. The average translation rates applied to the income and cash flow statement amounts for the nine months ended September 30, 2011 and 2010 was1 RMB to the U.S. $0.1541 and U.S. $0.1471, respectively.

Translation adjustments resulting from this process are included in "accumulated other comprehensive income" in the consolidated statement of stockholders’ equity and were $3,703,523 and $2,166,544 as of September 30, 2011 and December 31, 2010, respectively.

Cash and Cash Equivalents

For Statement of Cash Flows purposes, the Company considers all cash on hand and in banks, including accounts in book overdraft positions, certificates of deposit and other highly-liquid investments with original maturity of three months or less, when purchased, to be cash and cash equivalents. The Company maintains cash with various banks and trust companies located in China. Cash accounts are not insured or otherwise protected. Should any bank or trust company holding cash deposits become insolvent, or if the Company is otherwise unable to withdraw funds, the Company would lose the cash on deposit with that particular bank or trust company.

Accounts Receivable

The Company’s policy is to maintain reserves for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. Accounts are written off against the allowance when it becomes evident collection will not occur. As of September 30, 2011 and December 31, 2010, the accounts receivable was Nil and $908,327, respectively.

Inventory

Inventories are stated at the lower of cost or market. Cost is determined on a weighted average basis and includes all expenditures incurred in bringing the goods to the point of sale and putting them in a saleable condition. In assessing the ultimate realization of inventories, the management makes judgments as to future demand requirements compared to current or committed inventory levels. Our reserve requirements generally increase as our projected demand requires; or decrease due to market conditions and product life cycle changes. The Company estimates the demand requirements based on market conditions, forecasts prepared by its customers, sales contracts and orders in hand.

In addition, the Company estimates net realizable value based on intended use, current market value and inventory aging analyses. The Company writes down inventories for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventories and their estimated market value based upon assumptions about future demand and market conditions. Historically, the actual net realizable value has been close to management’s estimate. The company recorded inventory impairment expense of $674,282 for the nine months ended September 30, 2011. There was no allowance for inventory impairment as of December 31, 2010.

Property, Plant and Equipment

Property, plant and equipment are recorded at cost. Gains or losses on disposals are reflected as gain or loss in the year of disposal. All ordinary repair and maintenance costs are expensed as incurred. Expenditures for maintenance and repairs are expensed as incurred. Major renewals and betterments are charged to the property accounts while replacements, maintenance and repairs, which do not improve or extend the lives of the respective assets, are expensed in the current period.

Depreciation for financial reporting purposes is provided using the straight-line method over the estimated useful lives of assets as set outlined below.

	Estimated Useful Life
Plant and building	20 years
Machinery and equipment	10 years
Office furniture and equipment	10 years
Transportation equipment	5 years

Impairment of Long-Lived Assets

In accordance with ASC 360, “Property, Plant and Equipment”, previously SFAS No. 144, the Company reviews the carrying values of long-lived assets, including property, plant and equipment and other intangible assets, whenever facts and circumstances indicate that the assets may be impaired. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net undiscounted cash flows expected to be generated by the asset. If an asset is considered impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds the fair value. Assets to be disposed of are reported at the lower of the carrying amount or fair value, less costs of disposal. For the nine months ended September 30, 2011 and 2010, the Company performed an annual impairment review of long-lived assets and concluded that there was no impairment loss for long-term investments.

Revenue Recognition

The Company recognizes sales in accordance with the U.S. Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition in Financial Statements” and SAB No. 104, “Revenue Recognition.”

The Company recognizes revenue when the following criteria are met:

(i) persuasive evidence of an arrangement exists;

(ii) delivery has occurred or services were rendered;

(iii) the price to the customer is fixed or determinable; and

(iv) collection of the resulting receivable is reasonably assured. Revenue is not recognized until title and risk of loss is transferred to the customer, which occurs upon delivery of goods, and objective evidence exists that customer acceptance provisions were met.

The Company bases its estimates on historical experience taking into consideration the type of products sold, the type of customer, and the type of specific transaction in each arrangement. Revenues represent the invoiced value of goods, net of value added tax (“VAT”).

The Company does not offer promotional payments, customer coupons, rebates or other cash redemption offers to its customers. Deposits or advance payments from customers prior to delivery of goods and passage of title of goods are recorded as advanced from customers.

Income Taxes

The Company accounts for income taxes in accordance with ASC 740 “Income Taxes”, previously SFAS No. 109. Under this method, deferred income taxes are recognized for the estimated tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts and each year-end based on enacted tax laws and statutory rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established to reduce deferred tax assets to the amount expected to be realized when, in management’s opinion; it is more likely than not that some portion of the deferred tax assets will not be realized. The provision for income taxes represents current taxes payable net of the change during the period in deferred tax assets and liabilities.

Earnings Per Share

The Company reports earnings per share in accordance with the provisions of ASC 260 “Earnings Per Share”. ASC 260 requires presentation of basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock using the treasury method.

Common stock equivalents represent the dilutive effect of the assumed exercise of the outstanding stock options and warrants, using the treasury stock method, at either the beginning of the respective period presented or the date of issuance, whichever is later, and only if the common stock equivalents are considered dilutive based upon the Company’s net income (loss) position at the calculation dates. As of September 30, 2011, the stock options issued to the Company’s executive were anti-dilutive and excluded from the calculation of diluted earnings per share. As of September 30, 2011 and December 31, 2010, the Company does not have any dilutive securities.

Fair Value of Financial Instruments

ASC 820 “Fair Value Measurements and Disclosures”, previously FAS 157, adopted January 1, 2008, defines fair value, establishes a three-level valuation hierarchy for disclosures of fair value measurement and enhances disclosure requirements for fair value measures. The carrying amounts reported in the balance sheets for current receivables and payables qualify as financial instruments. Management concluded the carrying values are a reasonable estimate of fair value because of the short period of time between the origination of such instruments and their expected realization and if applicable, their stated interest rate approximates current rates available. The three levels are defined as follows:

Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.
Level 3 inputs to the valuation methodology are unobservable and significant to the fair value.

The assets measured at fair value on a recurring basis subject to the disclosure requirements of ASC 820 as of September 30, 2011 are as follows:

Active markets

Significant other

Significant

For identical

Observable

Unobservable

Carrying value

Assets

Inputs

2011

(Level 1)

(Level 2)

(Level 3)

Cash and cash equivalents

1,393,274

The Company’s financial instruments include cash and cash equivalents, restricted cash, accounts receivable, notes receivables, other receivables, accounts payable, notes payable. Cash and cash equivalents consist primarily of high rated money market funds at a variety of well-known institutions with original maturities of three months or less. Management estimates that the carrying amounts of the non related party financial instruments approximate their fair values due to their short-term nature.

Recent Accounting Pronouncements

On February 25, 2010, the FASB issued ASU 2010-09 Subsequent Events Topic 855 “Amendments to Certain Recognition and Disclosure Requirements,” effective immediately. The amendments in the ASU remove the requirement for an SEC filer to disclose a date through which subsequent events have been evaluated in both issued and revised financial statements. Revised financial statements include financial statements revised as a result of either correction of an error or retrospective application of US GAAP. The FASB believes these amendments remove potential conflicts with the SEC’s literature. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

On March 5, 2010, the FASB issued ASU No. 2010-11 Derivatives and Hedging Topic 815 “Scope Exception Related to Embedded Credit Derivatives.” This ASU clarifies the guidance within the derivative literature that exempts certain credit related features from analysis as potential embedded derivatives requiring separate accounting. The ASU specifies that an embedded credit derivative feature related to the transfer of credit risk that is only in the form of subordination of one financial instrument to another is not subject to bifurcation from a host contract under ASC 815-15-25, Derivatives and Hedging — Embedded Derivatives — Recognition. All other embedded credit derivative features should be analyzed to determine whether their economic characteristics and risks are “clearly and closely related” to the economic characteristics and risks of the host contract and whether bifurcation is required. The ASU is effective for the Company on July 1, 2010. Early adoption is permitted. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

In April 2010, the FASB (Financial Accounting Standards Board) issued Accounting Standards Update 2010-17 (ASU 2010-17), Revenue Recognition-Milestone Method (Topic 605): Milestone Method of Revenue Recognition. The amendments in this Update are effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. Early adoption is permitted. If a vendor elects early adoption and the period of adoption is not the beginning of the entity’s fiscal year, the entity should apply the amendments retrospectively from the beginning of the year of adoption. The Company did not expect the provisions of ASU 2010-17 to have a material effect on the financial position, results of operations or cash flows of the Company.

NOTE 3 - INVENTORY

Inventory as of September 30, 2011 and December 31, 2010 were as follows:

		September 30, 2011			December 31, 2010
Raw material	$	1,036,234		$	235,152
Finished goods		27,445,832			6,423,029
Auxiliary inventory (spare parts)		1,950,916			1,842,589

Less: Allowance for obsolete inventories		(685,249	)		-

Total inventory	$	29,747,733		$	8,500,770

NOTE 4 - ADVANCE TO SUPPLIERS

		September 30, 2011		December 31, 2010
Advance to suppliers	$	39,682,063	$	36,690,325
Notes receivable		496,716		226,867

Advance to suppliers represents amounts prepaid for raw materials. The advances are applied against amounts due to the supplier as the materials are received.

Notes receivable represents bank acceptance bills that were not redeemed at the bank as of September 30, 2011. The Company uses bank acceptance bills regularly as method of payment between the Company and its customers. The Company has an internal policy requiring most bank acceptance bills to be redeemed by the end of each calendar year. However, there is no such requirement regarding the end of a quarter.

NOTE 5 – OTHER CURRENT ASSETS

As of September 30, 2011 and December 31, 2010, there was Nil and $6,350,750 unverified input VAT that represents input VAT amount that were pending verification through local tax bureau. The balance at December 31, 2010 was fully verified and offset against output VAT in January 2011.

NOTE 6 - PROPERTY, PLANT AND EQUIPMENT

As of September 30, 2011and December 31, 2010, property, plant and equipment consisted of the following:

		September 30, 2011			December 31, 2010
Plant and building	$	7,974,652		$	7,721,664
Machinery and equipment		20,669,849			20,014,123
Office furniture and equipment		8,996,459			8,686,807
Transportation equipment		142,120			96,988

Total property, plant and equipment		37,783,080			36,519,582
Less: accumulated depreciation		(14,678,929	)		(11,870,892	)

Total property, plant and equipment, net	$	23,104,151		$	24,648,690

Depreciation for the nine months ended September 30, 2011 and 2010 was $2,380,390 and $2,240,292, respectively. Depreciation for the three months ended September 30, 2011 and 2010 was $804,588 and $736,951, respectively.

NOTE 7 - RELATED PARTY BALANCE AND TRANSACTIONS

Due to related parties

As of September 30, 2011 and December 31, 2010, due to related parties was summarized as follows:

		September 30, 2011			December 31, 2010
Xingtai Longhai Steel Group Co., Ltd.	$	622,095		$	1,531,755

The Company purchases gas and other utilities used in the production of steel wire, from Xingtai Longhai Steel Group Co., Ltd., a related party under the control of Mr. Wang Chaojun, the Company’s Chief Executive Officer. As of September 30, 2011 and December 31, 2010, accounts payable related to the purchase of such utilities were $622,095 and $1,531,755, respectively.

The Company offered customers sales discounts in return for cash deposits. These cash deposits were subsequently loaned to Xingtai Longhai Steel Group Co., Ltd. In consideration for the foregoing loans, the Company received reimbursements from Xingtai Longhai Steel Group Co., Ltd. on sales discounts to third party customers in the amount of Nil and $1,527,203 in the nine months ended September 30, 2011 and 2010, respectively and reimbursements of Nil and Nil in the three months ended September 30, 2011 and 2010 respectively. The Company recorded these reimbursements as earned finance income which is included in revenue.

Related party transactions

Revenue

During the nine months ended September 30, 2011 and 2010, the Company sold scrap metal to members of the Longhai Group of companies in the amount of $6,358,114 and $3,371,799, respectively. During the three months ended September 30, 2011 and 2010, the Company sold scrap metal to members of the Longhai Group of companies in the amount of $2,267,410 and $1,002,167, respectively. These amounts are included in the Company’s income statement as revenue.

Revenue from the sale of steel wire to Xingtai Shenrui in the nine months ended September 30, 2011 and 2010, was Nil and $15,450,433, respectively.

Expenses

During the nine months ended September 30, 2011 and 2010, the Company purchased gas and other utilities from the Longhai Group in the amount of $2,610,339 and $7,849,214, respectively. During the three months ended September 30, 2011 and 2010, the Company purchased gas and other utilities from the Longhai Group in the amount of $814,772 and $2,614,167, respectively.

In addition, the Longhai Group rents office and workshop space to the Company. Rent expense for the nine months ended September 30, 2011 and 2010 was $404,042 and $21,327, respectively. Rent expense for the three months ended September 30, 2011 and 2010 was $389,243 and $7,147, respectively.

Short-term loan to related party

In June 2011, we lent $3,817,500 or 25 million RMB to our related party, Xingtai Longhai Steel Group Co. Ltd. for operational purposes. The term of the loan is two months and bears interest at 0.999% monthly rate. We noted the loan to related party is in violation to Sarbanes-Oxley Act of 2002, including Section 402’s prohibition against personal loans to directors and executive officers, either directly or indirectly. The loan would subject us and our chief executive officer to possible criminal, civil or administrative sanctions, penalties, or investigations, in addition to potential private securities litigation. The loan has short term of two months and we intended to settle the outstanding loan balance within the time period noted here. As of September 30, 2011, the related party has fully repaid the loan to us.

NOTE 8 – ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER PAYABLES

As of September 30, 2011 and December 31, 2010, the accounts payable, unearned revenue and accrued liabilities of the Company were summarized as follows:

		September 30, 2011		December 31, 2010
Accounts payable	$	8,758,803	$	8,355,457

Advance from customers		28,249,200		15,692,067

Accrued liabilities and other payables:
– payroll payable		403,077		198,171
– Accrued utility		-		103,096
– customer deposits		823,174		801,790
– payable for equipment purchased		412,735		1,004,907
– others		292,078		102,012
Subtotal of accrued expenses and other payables	$	1,931,064	$	2,209,976

NOTE 9 - INCOME TAX

Longhai is governed by the Income Tax Law of the PRC concerning the private-run enterprises, which are generally subject to tax at a statutory rate of 25% on income reported in the statutory financial statements after appropriate tax adjustments.

The following table summarizes the temporary differences which result in deferred tax assets and liabilities as of September 30, 2011 and December 31, 2010:

		September 30, 2011		December 31, 2010
Current deferred tax assets:
Expenses deductible in next year		100,770		74,976
Inventory impairment reserve		171,312		-
Total current deferred tax assets		272,082		74,976
Total deferred tax assets	$	272,082	$	74,976

		September 30, 2011		December 31, 2010
Non-current deferred tax liabilities:
Depreciation of fixed assets	$	156,021	$	170,686
Total deferred tax liabilities	$	156,021	$	170,686

Net current deferred tax liabilities		-		-
Net current deferred tax assets		272,082		74,976
Net non-current deferred tax liabilities		156,021		170,686

The following table reconciles the U.S. statutory rates to the Company’s effective tax rate for the nine months ended September 30, 2011 and 2010:

	2011		2010
US statutory rates	34.0%		34.0%
Tax rate difference	(9.2%	)	(9.0%	)
Valuation allowance	0.8%		-

Tax per financial statements	25.6%		25.0%

The valuation allowance is related to the net loss of Kalington Consulting and Longhai Steel Inc. holding company. Because these entities do not have revenue, we recorded valuation allowance on these losses.

NOTE 10– SHAREHOLDERS’ EQUITY

Series A Convertible Preferred Stock

On March 25, 2010, the Company filed a Certificate of Designation establishing the Series A Preferred Stock and setting forth the rights, preferences and privileges of the Series A Preferred Stock. On or about March 25, 2010, the Company issued 10,000 shares of Series A Preferred Stock.

Pursuant to the Certificate of Designation, the shares of Series A Preferred Stock automatically convert into shares of common stock on the basis of one share of Series A Preferred Stock for every 985 shares of common stock immediately subsequent to the effectiveness of the Company’s 1-for-125 reverse split of its outstanding common stock (the "Reverse Stock Split").

The Reverse Stock Split was effective on July 16, 2010 and the 10,000 outstanding shares of Series A Preferred Stock automatically converted into 9,850,000 shares of common stock, which constitutes 98.5% of the Company’s outstanding common stock. For accounting purposes, we treated the Series A Preferred Stock as being converted fully to common stock on a post- reverse split basis for all periods presented.

Following the Reverse Stock Split and the conversion of Series A Preferred Stock into common stock, the Company has 10,000,000 shares of common stock issued and outstanding and no shares of preferred stock issued and outstanding.

Statutory Reserve

Our PRC subsidiary is required under PRC laws and regulations to allocate at least 10% of our annual after-tax profits determined in accordance with PRC GAAP to a statutory general reserve fund until the amounts in said fund reach 50% of our PRC subsidiary’s registered capital. Allocations to these statutory reserve funds can only be used for specific purposes and are not transferable to us in the form of loans, advances or cash dividends.

NOTE 11– STOCK OPTION PLAN

On April 1, 2010, the Company granted a newly appointed executive officer a 5-year option to purchase 200,000 shares of the Company’s common stock. According to the stock option agreement, the option has a per share exercise price equal to $6.00, the fair market value of the stock on the date of grant. Half of the options are immediately exercisable and one-fourth will vest on each anniversary date of the grant over the next two years.

The Company uses the Black-Scholes option-pricing model to estimate the fair value of its stock options. The fair value of options was estimated on the date of grant. Valuation assumptions used in the Black-Scholes option-pricing model for options issued include (1) discount rate of 1.63% based upon United States Treasury yields in effect at the time of the grant, (2) expected term of 2.875 years based upon simplified calculations due to the limited period of time the Company’s equity shares have been publicly traded, (3) expected volatility of 88%, and (4) zero expected dividends. The calculated fair value of the grant at grant date was $664,328. No stock options were exercised during the nine months ended September 30, 2011.

NOTE 12 – COMMITMENTS AND CONTINGECIES

Social insurance for employees

According to the prevailing laws and regulations of the PRC, the Company is required to cover its employees with medical, retirement and unemployment insurance programs. Management believes that due to the transient nature of its employees, the Company does not need to provide all employees with such social insurances, and has paid the social insurances for the Company’s employees who have completed three months’ continuous employment with the Company.

In the event that any current or former employee files a complaint with the PRC government, the Company may be subject to making up the social insurances as well as administrative fines. As the Company believes that these fines would not be material, no provision has been made in this regard.

Tax issues

The tax authority of the PRC Government conducts periodic and ad hoc tax filing reviews on business enterprises operating in the PRC after those enterprises had completed their relevant tax filings, hence the Company’s tax filings may not be finalized. It is therefore uncertain as to whether the PRC tax authority may take different views about the Company’s tax filings which may lead to additional tax liabilities.

NOTE 13 - OPERATING RISKS

(a) Country risk

Currently, the Company’s revenues are primarily derived from the sale of steel wire to customers in the People’s Republic of China (“PRC”). The Company hopes to expand its operations to other countries, however, such expansion has not commenced and there is no assurance that the Company will be able to achieve such expansion. Therefore, a downturn or stagnation in the economic environment of the PRC could have a material adverse effect on the Company’s financial condition.

(b) Products risk

In addition to competing with other manufacturers of steel wires, the Company competes with larger PRC companies which have greater funds available for expansion, marketing, research and development and the ability to attract more qualified personnel. These PRC companies may be able to offer products at a lower price. There can be no assurance the Company will remain competitive should this occur.

(c) Exchange risk

The Company cannot guarantee the Renminbi, US dollar exchange rate will remain steady, therefore the Company could post the same profit for two comparable periods and post higher or lower profit depending on exchange rate of Renminbi and US dollars. The exchange rate could fluctuate depending on changes in the political and economic environments without notice.

(d) Political risk

Currently, PRC is in a period of growth and is openly promoting business development in order to bring more business into PRC. Additionally PRC currently allows a Chinese corporation to be owned by a United States corporation. If the laws or regulations relating to ownership of a Chinese corporation are changed by the PRC government, the Company’s ability to operate the PRC subsidiaries could be affected.

(e) Interest risk

The Company is exposed to interest rate risk arising from short-term variable rate borrowings from time to time. The Company’s future interest expense will fluctuate in line with any change in borrowing rates. The Company does not have any derivative financial instruments as of September 30, 2011 and believes its exposure to interest rate risk is not material.

NOTE 14 - MAJOR CUSTOMERS AND MAJOR VENDORS

The Company generated 68.7 percent and 41.8 percent of its revenues from five customers during the nine months ended September 30, 2011 and 2010, respectively.

The Company made 70.8 percent of its total purchases from three vendors during the nine months ended September 30, 2011. The Company made 83.2 percent of its total purchases from three vendors during the nine months ended September 30, 2010.

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

Special Note Regarding Forward Looking Statements

In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We use words such as “believe,” “expect,” “anticipate,” “project,” “target,” “plan,” “optimistic,” “intend,” “aim,” “will” or similar expressions which are intended to identify forward-looking statements. Such statements include, among others, those concerning market and industry segment growth and demand and acceptance of new and existing products; any projections of sales, earnings, revenue, margins or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements regarding future economic conditions or performance; as well as all assumptions, expectations, predictions, intentions or beliefs about future events. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, including those identified in Item 1A “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2010, as well as assumptions, which, if they were to ever materialize or prove incorrect, could cause the results of the Company to differ materially from those expressed or implied by such forward-looking statements.

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

Use of Terms

Except where the context otherwise requires and for the purposes of this report only:

“Company,” “we,” “us,” and “our” refer to the combined business of Longhai Steel Inc., a Nevada corporation, its wholly-owned subsidiaries, Kalington and Kalington Consulting, and its variable interest entity, Longhai;
“Kalington” refers to our direct subsidiary Kalington Limited, a Hong Kong company;
“Kalington Consulting” refers to our indirect subsidiary Xingtai Kalington Consulting Service Co., Ltd., a PRC company;
“Longhai” refers to our variable interest entity Xingtai Longhai Wire Rod Co. Ltd., a PRC company;
“Hong Kong” refers to the Hong Kong Special Administrative Region of the People’s Republic of China;
“PRC” and “China” are to the People’s Republic of China, excluding Hong Kong, Macau and Taiwan;
“SEC” are to the 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;
“Renminbi” and “RMB” are to the legal currency of China; and
“U.S. dollars,” “dollars” and “$” are to the legal currency of the United States.

Overview of our Business

We are a manufacturer of steel wire products in eastern China. We produce steel wire ranging from 6.5 mm to 10 mm in diameter on two wire production lines which have a combined annual capacity of approximately 0.9 million metric tons, or MT, per year. Our products are sold to a number of distributors who transport the wire to nearby wire processing facilities. Our wire is then further processed by these third party wire refiners into a variety of products such as nails, screws, and wire mesh for use in reinforced concrete and fencing.

Demand for our steel wire is driven primarily by spending in the construction and infrastructure industries. We have benefited from strong fixed asset investment and construction growth as the PRC has rapidly grown increasingly urbanized and invested in modernizing its infrastructure.

We sell our products to a number of distribution companies that transport our wire to nearby wire processors. Our products are manufactured on an on-demand basis, and we usually collect payment in advance. Sales prices are set at the market price for wire on a daily basis. Our customers generally prepay for their orders, and the final price may be adjusted to the market price on the day of pick up. This allows us to maintain a low inventory of both wire and billet and protects us from exposure to commodity price volatility. In order to increase sales and be competitive in the market, we occasionally offer discounted wholesale prices to customers at our discretion. Our sales efforts are directed toward developing long-term relationships with customers who are able to purchase in large quantities. During the year ended December 31, 2010, our top five distributors accounted for approximately 35% of our revenues, and during the year ended December 31, 2009, our top five distributors accounted for approximately 39% of our revenues.

Our production facilities are located at a 107,000 square meter property in Xingtai, Hebei Province. Our production facilities include a steel rolling mill, the unique feature of which is that two rolling lines are arranged in a “Y”-layout, i.e. two wire drawing lines share one furnace, one coarse and intermediate rolling mill, and other supporting equipment. This particular design facilitates cost savings and higher output at a higher quality.

Our corporate headquarters is located at No. 1 Jingguang Road, Neiqiu County, Xingtai City, Hebei Province, 054000, People’s Republic of China, and our telephone number is (86) 319 686-1111.

Recent Development

On August 1, 2011, Longhai entered into a lease agreement with Xingtai Longhai Steel Group Co. Ltd. (the “Landlord”), a related party, pursuant to which Longhai leased approximately 90,500 square meters of manufacturing space and all wire making equipment contained in the space (the “Lease”). Longhai commenced the Lease on August 1, 2011 and started operating the new production line (the “New Line”) on August 22, 2011. The New Line has the capacity to produce alloy steel, cold forging steel and welding rod. It is expected to increase Xingtai Longhai’s annual capacity and profit by approximately 60%.

Third Quarter Financial Performance Highlights

The following summarizes certain key financial information for the third quarter of 2011:

Revenue: Revenue increased $22.7 million, or 23.6%, to $118.8 million for the three months ended September 30, 2011, from $96.1 million for the same period in 2010.
Gross Profit: Gross profit decreased $1.4 million to $2.9 million in the period ended September 30, 2011, from $4.3 million in the same period in 2010.
Net Income: Net income decreased $1.6 million, or 61.5%, to $1.0 million for the three months ended September 30, 2011, from $2.6 million for the same period in 2010.
Fully diluted earnings per share: Fully diluted earnings per share were $0.10 and $0.26 for the three months ended September 30, 2011 and 2010, respectively.

Results of Operations

Comparison of Three Months Ended September 30, 2011 and September 30, 2010

The following table shows key components of our results of operations during the three month periods ended September 30, 2011 and 2010, both in dollars and as a percentage of our total revenue.

		Three Months Ended			Three Months Ended
		30-Sep-11			30-Sep-10
				% of			% of
		Amount		Revenues	Amount		Revenues
Net revenues	$	118,760,655			96,104,842
Cost of sales		(115,899,850	)	97.6%	(91,826,504	)	95.5%
Gross profit		2,860,805		2.4%	4,278,338		4.5%
Operating expenses:		(807,834	)	0.7%	(406,971	)	0.4%
Income from operations		2,052,971		1.7%	3,871,367		4.0%
Income before income tax		1,305,001		1.1%	3,470,857		3.6%
Income tax expense		(325,853	)	0.3%	(883,304	)	0.9%
Net income		979,148		0.8%	2,587,553		2.7%
Other comprehensive income		468,874		0.4%	624,426		0.6%
Comprehensive income	$	1,448,022		1.2%	3,211,979		3.3%

Net Revenues. Net revenues consist of revenue from the sale of steel wire and scrap metal. Roughly 99% of revenues are derived from wire. Our net revenues increased to $118.8 million in the three months ended September 30, 2011, from $96.1 million in the same period in 2010, representing a 23.6% increase. This increase was due to a 17% increase in our revenue per ton of wire sold. The increase was primarily attributable to an increase in average wire prices. Sales volume decreased from 183,517 MT to 181,220 MT, representing period over period decrease of 1.3% . The New Line generated 23,117.58 MT of sales and contributed approximately $15.2 million to the total revenue.

Cost of Sales. Our cost of sales increased $24.1 million, or 26.3%, to $115.9 million in the three months ended September 30, 2011, from $91.8 million in the same period in 2010. The cost of sales as a percentage of revenues increased from 95.5% to 97.6% between the periods. Our cost of sales is largely dictated by fluctuations in steel billet prices as billet typically represents more than 95% of our cost of goods sold. Cost of goods sold per ton of wire sold increased 20.5% period over period.

Gross Profit and Gross Margin. Our gross profit decreased $1.4 million to $2.9 million in the three months ended September 30, 2011 from $4.3 million in the same period in 2010. Gross margin declined from 4.5% for the three months ended September 30, 2010 to 2.4% for the three months ended September 30, 2011. The decrease in gross margin was primarily due to the narrowing of the spread between billet purchase prices and wire sales prices discussed above, as billet prices increased more than wire prices. While growth in infrastructure and construction remained robust, the steel wire market was softer in comparison to billet market due to stronger than expected local supply of wire during the summer of 2011. We expect increased wire and billet spreads in the remaining months of 2011 as the wire sales prices may increase as a result of restricted productions in some steel companies.

Operating expenses. Our operating expenses increased $0.4 million to $0.8 million in the three months ended September 30, 2011, from $0.4 million in the same period in 2010. The increase was due to impairment loss of assets which occurred in the three months ended September 30, 2011.

Income Before Income Taxes. Our income before income taxes decreased to $1.3 million in the three months ended September 30, 2011 from $3.5 million in the same period in 2010. This decrease was due to a decrease in our gross profit and an increase in our operating expenses as discussed above. In addition, we experienced higher interest expenses in association with the increased use of bank acceptance bills.

Bank acceptance bills are common instruments used by companies in China to secure credit terms from their suppliers. These instruments feature a local bank guarantee of the payment risk, which is provided for a fee. In these arrangements, a company and a bank enter into a bank acceptance agreement pursuant to which the bank agrees to accept and pay when due the company’s bills payable to the supplier. Cashing in such bank acceptance bills before they mature enables us to purchase more steel billet, our main production input, at a discount. The discounts are greater than the cost of cashing in said bank acceptance bills early.

Income Tax. Income tax decreased to $0.3 million in the three months ended September 30, 2011 from $0.9 million in the same period in 2010 as we had lower taxable income.

Net Income. In the quarter ended September 30, 2011, we generated net income of $1 million, compared to $2.6 million in the same period in 2010. This increase was primarily attributable to the factors discussed above.

Comparison of Nine Months Ended September 30, 2011 and September 30, 2010 (Unaudited)

		Nine Months Ended			Nine Months Ended
		30-Sep-11			30-Sep-10
				% of			% of
		Amount		Revenues	Amount		Revenues
Net revenues	$	410,775,293			330,483,572
Cost of sales		(400,408,290	)	97.5%	(319,232,116	)	96.6%
Gross profit		10,367,003		2.5%	11,251,456		3.4%
Operating expenses:		(1,923,823	)	0.5%	(1,445,726	)	0.4%
Income from operations		8,443,180		2.1%	9,805,730		3.0%
Income before income tax		6,288,192		1.5%	9,079,417		2.7%
Income tax expense		(1,608,807	)	0.4%	(2,384,515	)	0.7%
Net income		4,679,385		1.1%	6,694,902		2.0%
Other comprehensive income		1,536,979		0.4%	772,389		0.2%
Comprehensive income	$	6,216,364		1.5%	7,467,291		2.3%

Net Revenues. Our net revenues increased to $410.8 million in the nine months ended September 30, 2011 from $330.5 million in the same period in 2010, representing a 24.6% increase. This increase was due to a 16.91% increase in our revenue per ton of wire sold. The increase was primarily due to an increase in average wire prices. The sales volume increased from 649,985MT to 660,047MT, representing a period over period increase of 1.5% .

Cost of Sales. Our cost of sales increased $81.2 million, or 25.75%, to $400.4 million in the nine months ended September 30, 2011, from $319.2 million in the same period in 2010. The cost of sales as a percentage of revenues increased from 96.6% to 97.5% between the periods. Our cost of sales is largely dictated by fluctuations in steel billet prices as billet typically represents more than 95% of our cost of goods sold. Cost of goods sold per ton of wire sold increased 17.89% period over period.

Gross Profit and Gross Margin. Our gross profit decreased $0.9 million to $10.4 million in the nine months ended September 30, 2011 from $11.3 million in the same period in 2010. Gross margin declined from 3.4% for the nine months ended September 30, 2010 to 2.5% for the nine months ended September 30, 2011. The decrease in gross margin was primarily due to the narrowing of the spread between billet purchase prices and wire sales prices discussed above, as billet prices increased more than wire prices. While growth in infrastructure and construction remained robust, the steel wire market was softer in comparison to billet due to a stronger than expected local supply of wire during the summer of 2010. We expect increased wire and billet spreads in the remaining months of 2011 as the wire sales prices may increase as a result of restricted productions in some steel companies.

Operating expenses. Our operating expenses increased $0.5 million to $1.9 million in the nine months ended September 30, 2011, from $1.4 million in the same period in 2010. The increase was due to impairment loss of assets and expenses related to audit, legal, consulting and travel expenses associated with becoming a public company.

Income Before Income Taxes. Our income before income taxes decreased to $6.3 million in the nine months ended September 30, 2011 from $9.1 million in the same period in 2010. This decrease was due to a decrease in our gross profit and an increase in our operating expenses as discussed above. In addition, we experienced higher interest expenses in association with the increased use of bank acceptance bills.

Income Tax. Income tax decreased to $1.6 million in the nine months ended September 30, 2011 from $2.4 million in the same period in 2010 as we had lower taxable income.

Net Income. In the nine months ended September 30, 2011, we generated net income of $4.7 million, compared to $6.7 million in the same period in 2010. This decrease was primarily attributable to the factors discussed above.

Liquidity and Capital Resources

At September 30, 2011, we had cash and cash equivalents of $1,393,274, consisting primarily of cash on hand and demand deposits. The following table provides detailed information about our net cash flows for the period ended September 30, 2011. To date, we have financed our operations organically and through cash flows from equity contributions by our shareholders.

The following table sets forth a summary of our cash flows for the periods indicated:

Cash Flows

		Nine Months Ended
		September 30,
		2011		2010
Net cash provided by (used in) operating activities	$	4,512,258		(39,738,761	)
Net cash used in investing activities		(978,412	)	(3,225,314	)
Net cash provided by (used in) financing activities		(2,466,020	)	42,902,618
Effect of exchange rate changes on cash		31,733		165,887

Net increase (decrease) in cash and cash equivalents		1,099,829		104,430
Cash and cash equivalents at beginning of the year		293,445		116,540
Cash and cash equivalents at end of the year		1,393,274		220,970

Operating activities

Net cash provided by operating activities was $4.5 million for the period ended September 30, 2011, as compared to net cash used in operating activities of $39.7 million for the same period in 2010.

Our cash flows from operating activities changed significantly due to a decrease in accounts receivable and inventory balances and increase in accounts payable and advances from customers.

Investing activities

Net cash used in investing activities for the period ended September 30, 2011 was $1 million, compared to net cash used in investing activities of $3.2 million during the same period of 2010. This decrease in cash used in investing activities was mainly due to lower payments to a related party for the Company’s fixed assets purchased from such related party in prior years.

Financing activities

Net cash used in financing activities for the period ended September 30, 2011 was $2.5 million, as compared to net cash provided by financing activities of $42.9 million during the same period of 2010. The cash outflow in financing activities for the quarter ended September 30, 2011 mainly consisted of a cash repayment of short-term loan from a related party.

We believe that our cash on hand and cash flows from operations will meet our present cash needs, but we may require additional cash resources to implement our expansion through the acquisition of additional facilities. If our own financial resources are insufficient to satisfy our capital requirements, we may seek to sell additional equity or debt securities or obtain additional credit facilities. The sale of additional equity securities could result in dilution to our stockholders. The incurrence of indebtedness would result in increased debt service obligations and could require us to agree to operating and financial covenants that would restrict our operations. Financing may not be available in amounts or on terms acceptable to us, if at all. Any failure by us to raise additional funds on terms favorable to us, or at all, could limit our ability to expand our business operations and could harm our overall business prospects.

Inflation

Inflation and changing prices have not had a material effect on our business and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future. However, our management will closely monitor price changes in the steel industry and continually maintain effective cost control in operations.

Off Balance Sheet Arrangements

We do not have any off balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity or capital expenditures or capital resources that is material to an investor in our securities.

Seasonality

Our operating results and operating cash flows have not historically been subject to seasonal variations, however, the first quarter is usually the slowest quarter because fewer projects are undertaken during and around the Chinese spring festival.

Significant Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) requires our management to make assumptions, estimates and judgments that affect the amounts reported, including the notes thereto, and related disclosures of commitments and contingencies, if any. We have identified certain accounting policies that are significant to the preparation of our financial statements. These accounting policies are important for an understanding of our financial condition and results of operations. Critical accounting policies are those that are most important to the portrayal of our financial conditions and results of operations and require management’s difficult, subjective, or complex judgment, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. Certain accounting estimates are particularly sensitive because of their significance to financial statements and because of the possibility that future events affecting the estimate may differ significantly from management’s current judgments. We believe the following critical accounting policies involve the most significant estimates and judgments used in the preparation of our financial statements:

Revenue Recognition

Retail sales are recognized at the point of sale to customers, are recorded net of estimated returns, and exclude VAT. Wholesales to contracted customers are recognized as revenue at the time the product is shipped and title passes to the customer FOB shipping point.

Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the amount of revenues and expenses during the reporting periods. Management makes these estimates using the best information available at the time the estimates are made. However, actual results could differ materially from those results

Accounts Receivable

Accounts receivable consists of unpaid balances due from wholesale customers. Such balances generally are cleared in the subsequent month when the wholesale customers place another order. We do not provide an allowance for doubtful accounts because we have not experienced any credit losses in collecting these amounts from wholesale customers.

Impairment of Long-Lived Assets

We account for impairment of property and equipment and amortizable intangible assets in accordance with ASC 360, “Accounting for Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of”, which requires us to evaluate a long-lived asset for recoverability when there is event or circumstance that indicate the carrying value of the asset may not be recoverable. An impairment loss is recognized when the carrying amount of a long-lived asset or asset group is not recoverable (when carrying amount exceeds the gross, undiscounted cash flows from use and disposition) and is measured as the excess of the carrying amount over the asset’s (or asset group’s) fair value. There was no impairment of long-lived assets for the period ended September 30, 2011 or the period ended September 30, 2010.

Inventories

Merchandise inventories are stated at the lower of cost or market. Cost is determined on a weighted average basis and includes all expenditures incurred in bringing the goods to the point of sale and putting them in a salable condition. In assessing the ultimate realization of inventories, the management makes judgments as to future demand requirements compared to current or committed inventory levels. Our reserve requirements generally increase as our projected demand requirements or decrease due to market conditions and product life cycle changes. We estimate the demand requirements based on market conditions, forecasts prepared by customers, sales contracts and orders in hand.

In addition, we estimate net realizable value based on intended use, current market value and inventory ageing analyses. We write down inventories for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventories and their estimated market value based upon assumptions about future demand and market conditions.

Comprehensive Income

We have adopted the provisions of ASC 220 “Reporting Comprehensive Income,” which establishes standards for the reporting and display of comprehensive income, its components and accumulated balances in a full set of general purpose financial statements.

ASC 220 defines comprehensive income as comprised of net income and all changes to the statements of stockholders’ equity, except those due to investments by stockholders, changes in paid-in capital and distributions to stockholders, including adjustments to minimum pension liabilities, accumulated foreign currency translation, and unrealized gains or losses on marketable securities. Our other comprehensive income arose from the effect of foreign currency translation adjustments.

Foreign Currency Translation/Transactions

The balance sheet amounts at September 30, 2011, with the exception of shareholders’ equity, were translated at the exchange rate of 6.4018 RMB to the 1.00 U.S. dollar compared to the exchange rate of 6.6981 RMB to the 1.00 U.S. dollar at September 30, 2010. The equity accounts were stated at their historical exchange rates. The average translation rates applied to the income and cash flow statement amounts for the nine months ended September 30, 2011 and 2010 was 6.5064 RMB and 6.81648 RMB to the 1.00 U.S. dollar, respectively.

Translation adjustments resulting from this process are included in "accumulated other comprehensive income" in the consolidated statement of stockholders’ equity and were $1,536,979 and $772,389 as of September 30, 2011 and September 30, 2010, respectively.

Recent Accounting Pronouncements

Early adoption is permitted. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

In April 2010, the FASB (Financial Accounting Standards Board) issued Accounting Standards Update 2010-17 (ASU 2010-17), Revenue Recognition-Milestone Method (Topic 605): Milestone Method of Revenue Recognition. The amendments in this update are effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. Early adoption is permitted. If a vendor elects early adoption and the period of adoption is not the beginning of the entity’s fiscal year, the entity should apply the amendments retrospectively from the beginning of the year of adoption. The Company did not expect the provisions of ASU 2010-17 to have a material effect on the financial position, results of operations or cash flows of the Company.

Foreign Currency Exchange Rates

All of our revenues are collected in and substantially all of our expenses are paid in Chinese RMB. We face foreign currency rate translation risks when our results are translated to U.S. dollars. The registered equity capital denominated in the functional currency is translated at the historical rate of exchange at the time of capital contribution.

The Chinese RMB was relatively stable against the U.S. dollar at approximately 8.28 RMB to the $1.00 U.S. dollar until July 21, 2005 when the Chinese currency regime was altered resulting in a 2.1% revaluation versus the U.S. dollar. This move initially had the effect of pegging the exchange rate of the RMB at 8.11 RMB per U.S. dollar. Now the RMB exchange rate is no longer linked to the U.S. dollar but rather to a basket of currencies with a 0.3% margin of fluctuation resulting in further appreciation of the RMB against the U.S. dollar. Since June 30, 2009, the exchange rate had remained stable at 6.8307 RMB to 1.00 U.S. dollar until June 30, 2010 when the Chinese Central Bank allowed a further appreciation of the RMB by 0.43% to 6.8086 RMB to 1.00 U.S. dollar. On July 10, 2011, the RMB traded at 6.4630 to the U.S. dollar.

There remains international pressure on the Chinese government to adopt an even more flexible currency policy and the exchange rate of RMB is subject to changes in China’s government policies which are, to a large extent, dependent on the economic and political development both internationally and locally and the demand and supply of RMB in the domestic market. There can be no assurance that such exchange rate will continue to remain stable in the future amongst the volatility of currencies, globalization and the unstable economies in recent years. Since (i) our income and profit are denominated in RMB, and (ii) the payment of dividends, if any, will be in U.S. dollars, any decrease in the value of the RMB against other foreign currencies would adversely affect the value of the shares and dividends payable to shareholders, in foreign currency terms.

Commodity Prices

We are generally exposed to commodity price swings. Although there is no guaranteed correlation, steel wire prices generally fluctuate with steel prices, but the differential between market prices of steel billet and steel wire also fluctuates. Although we generally hold inventory for the duration of our 24-hour production cycle, sudden changes in the market price of steel and wire may directly impact the valuation of inventory and goods in progress, which influences earnings. So long as the market price differential between billets and wire does not shrink disproportionally, rising steel prices generally work in our favor as inventory purchased at lower prices would appreciate in such a scenario, resulting in additional profits when the wire is sold.

Recent Accounting Pronouncements

See Note 2 to our unaudited consolidated financial statements included elsewhere in this report.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not Applicable.

ITEM 4. CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Disclosure controls and procedures refer to controls and other procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

As required by Rule 13a-15(e), our management has carried out an evaluation, with the participation and under the supervision of our Chief Executive Officer, Mr. Chaojun Wang, and Chief Financial Officer, Heyin Lv, of the effectiveness of the design and operation of our disclosure controls and procedures, as of September 30, 2011. Based upon, and as of the date of this evaluation, Messrs. Wang and Lv, determined that our disclosure controls and procedures were effective.

Changes in Internal Control over Financial Reporting

We regularly review our system of internal control over financial reporting and make changes to our processes and systems to improve controls and increase efficiency, while ensuring that we maintain an effective internal control environment. Changes may include such activities as implementing new, more efficient systems, consolidating activities, and migrating processes.

There were no changes in our internal controls over financial reporting during the third quarter of fiscal 2011 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.

PART II
OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

From time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these, or other matters, may arise from time to time that may harm our business. We are currently not aware of any such legal proceedings or claims that we believe will have a material adverse affect on our business, financial condition or operating results.

ITEM 1A. RISK FACTORS.

Not Applicable.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4. (REMOVED AND RESERVED).

ITEM 5. OTHER INFORMATION.

On August 1, 2011, Longhai entered into a lease agreement with Xingtai Longhai Steel Group Co. Ltd. (the “Landlord”), a related party, pursuant to which Longhai leased approximately 90,500 square meters of manufacturing space and all wire making equipment contained in the space (the “Lease”). Longhai commenced the Lease on August 1, 2011 and started operating the new production line (the “New Line”) on August 22, 2011. The New Line has the capacity to produce alloy steel, cold forging steel and welding rod. It is expected to increase Longhai’s annual capacity and profit by approximately 60%.

The Lease has a term of five years, subject to Longhai’s option to renew the Lease after the initial expiration date. Longhai also has the option to terminate the Lease with at least 30 days notice to the Landlord.

The annual rent is RMB 14 million (approximately $2.2 million). Longhai is obligated to pay RMB 7 million (approximately $ 1.1 million) bi-annually to the Landlord on or before the 15^th day of the payment month. The initial payment shall be made on or before August 15, 2011.

The Lease also provides that Longhai shall give at least 30 days notice if it plans to upgrade any leased equipment. The Landlord will be responsible for the upgrade expenses and Longhai will be responsible for the maintenance expenses.

The foregoing description of the Lease is not intended to be complete and is qualified in its entirety by reference to the full text of the Lease, a copy of which is filed as Exhibit 10.1 hereto and incorporated by reference herein.

ITEM 6. EXHIBITS.

The following exhibits are filed as part of this report or incorporated by reference:

Exhibit No.	Description
10.1	Lease between Longhai and Xingtai Longhai Steel Group Co., Ltd., dated August 1, 2011
31.1	Certifications of Principal Executive Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certifications of Principal Financial Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certifications of Principal Executive Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certifications of Principal Financial Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	Interactive data files pursuant to Rule 405 of Regulation S-T (furnished herewith).

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: November 14, 2011	LONGHAI STEEL INC.

	By:	/s/ Chaojun Wang
		Chaojun Wang, Chief Executive Officer
		(Principal Executive Officer)

	By:	/s/ Heyin Lv
		Heyin Lv, Chief Financial Officer
		(Principal Financial Officer and Principal
		Accounting Officer)

EXHIBIT INDEX

Exhibit No.	Description
10.1	Lease between Longhai and Xingtai Longhai Steel Group Co., Ltd., dated August 1, 2011
31.1	Certifications of Principal Executive Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certifications of Principal Financial Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certifications of Principal Executive Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certifications of Principal Financial Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	Interactive data files pursuant to Rule 405 of Regulation S-T (furnished herewith).

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