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EX-32.1 - EXHIBIT 32.1 - Sutor Technology Group LTDv302481_ex32-1.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: December 31, 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: 001-33959

 

SUTOR TECHNOLOGY GROUP LIMITED

(Exact Name of Registrant as Specified in Its Charter)

 

  Nevada   87-0578370
       
 

(State or other jurisdiction of incorporation

or organization)

  (I.R.S. Employer Identification No.)

  

No 8, Huaye Road

Dongbang Industrial Park

Changshu, 215534
People’s Republic of China

(Address of principal executive offices, Zip Code)

 

(+86) 512-52680988

(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 S 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 S 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 ¨(Do not check if a smaller reporting company)   Smaller reporting company S

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ¨ No S

 

The number of shares outstanding of each of the issuer’s classes of common stock, as of February 10, 2012 is as follows:

 

Class of Securities   Shares Outstanding

 

Common Stock, $0.001 par value   40,285,780

 

 
 

 

 SUTOR TECHNOLOGY GROUP LIMITED

 

Quarterly Report on Form 10-Q

 Period Ended December 31, 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 20
Item 3. Quantitative and Qualitative Disclosures About Market Risk 32
Item 4. Controls and Procedures 32

 

PART II

OTHER INFORMATION

 

Item 1. Legal Proceedings 33
Item 1A. Risk Factors 33
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 33
Item 3.  Defaults Upon Senior Securities 33
Item 4. Mine Safety Disclosures 33
Item 5. Other Information 33
Item 6. Exhibits 34

 

i
 

 

 

PART I

FINANCIAL INFORMATION

 

ITEM 1.FINANCIAL STATEMENTS.

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

    Page
     
Unaudited Condensed Consolidated Balance Sheets as of December 31, 2011 and Condensed Consolidated Balance Sheets as of June 30, 2011   2
     
Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income for the Three and Six Months Ended December 31, 2011 and 2010   3
     
Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended December 31, 2011 and 2010   4
     
Notes to Unaudited Condensed Consolidated Financial Statements   5

 

 

1
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

   December 31,   June 30, 
   2011   2011 
ASSETS          
Current Assets:          
Cash and cash equivalents  $7,001,770   $21,324,931 
Restricted cash   124,390,722    72,326,482 
Trade accounts receivable, net of allowance for doubtful accounts of $1,030,942  and $856,554, respectively   11,679,042    3,969,090 
Other receivables and prepayments, net of allowance for doubtful accounts of $549,427 and $529,068, respectively   1,766,763    2,004,044 
Advances to suppliers, related parties, net of allowance of $130,015 and $127,903, respectively   116,782,481    116,772,842 
Advances to suppliers, third parties, net of allowance of $564,375 and $493,761, respectively   36,645,254    42,067,716 
Inventory, net   93,675,674    46,197,179 
Notes receivable   699,851    168,029 
Deferred tax assets   417,159    363,497 
Total Current Assets   393,058,716    305,193,810 
           
Advances for Purchase of Long Term Assets   82,531    81,191 
Property, Plant and Equipment, net   86,080,564    79,103,131 
Intangible Assets, net   3,097,967    3,083,569 
TOTAL ASSETS  $482,319,778   $387,461,701 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY          
Current Liabilities:          
Accounts payable  $117,820,851   $55,674,454 
Advances from customers   6,371,107    11,737,085 
Other payables and accrued expenses   4,998,772    4,840,135 
Other payables - related parties   -    594,105 
Short-term loans   108,565,063    95,494,490 
Total Current Liabilities   237,755,793    168,340,269 
           
Long-Term Loans   38,125,743    23,626,900 
Total Liabilities   275,881,536    191,967,169 
           
Stockholders' Equity          
Undesignated preferred stock - $0.001 par value; 1,000,000 shares authorized; no shares outstanding   -    - 
Common stock - $0.001 par value;
authorized: 500,000,000 shares as of December 31, 2011 and June 30, 2011;
issued: 40,745,602 shares as of December 31, 2011 and June 30, 2011;
outstanding: 40,285,780 and 40,745,602 as of December 31, 2011 and June 30, 2011, respectively
   40,745    40,745 
Additional paid-in capital   42,646,231    42,584,974 
Statutory reserves   15,662,039    15,662,039 
Retained earnings   114,691,488    107,137,213 
Accumulated other comprehensive income   33,932,008    30,069,561 
Less: Treasury stock, at cost   (534,269)   - 
Total Stockholders' Equity   206,438,242    195,494,532 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY  $482,319,778   $387,461,701 

 

The accompanying notes are an integral part of the condensed consolidated financial statements

 

2
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME

(Unaudited)

 

   For The Three Months Ended   For The Six Months Ended 
   December 31,   December 31, 
   2011   2010   2011   2010 
                 
Revenue:                    
Revenue  $83,070,982   $55,720,704   $181,467,497   $95,280,863 
Revenue from related parties   24,823,816    43,702,411    56,622,918    106,089,348 
    107,894,798    99,423,115    238,090,415    201,370,211 
                     
Cost of Revenue                    
Cost of revenue   74,930,923    50,290,654    165,952,519    86,037,699 
Cost of revenue from related party sales   22,552,581    39,677,905    50,737,745    97,442,396 
    97,483,504    89,968,559    216,690,264    183,480,095 
                     
Gross Profit   10,411,294    9,454,556    21,400,151    17,890,116 
                     
Operating Expenses:                    
                     
Selling expenses   2,078,492    1,982,635    4,414,272    3,363,113 
General and administrative expenses   2,578,617    1,720,113    5,504,115    3,363,258 
Total Operating Expenses   4,657,109    3,702,748    9,918,387    6,726,371 
Income from Operations   5,754,185    5,751,808    11,481,764    11,163,745 
                     
Other Incomes/(Expenses):                    
Interest income   388,207    248,402    678,415    437,715 
Other income   14,592    99,255    19,950    121,292 
Interest expense   (2,438,976)   (2,335,293)   (4,167,516)   (3,870,103)
Other expense   (477,176)   (209,349)   (858,667)   (275,063)
Total Other Expenses, net   (2,513,353)   (2,196,985)   (4,327,818)   (3,586,159)
                     
Income Before Taxes   3,240,832    3,554,823    7,153,946    7,577,586 
Income tax (expense)/benefit   (460,504)   (621,742)   400,329    (1,231,937)
Net Income  $2,780,328   $2,933,081   $7,554,275   $6,345,649 
                     
Basic Earnings per Share  $0.07   $0.07   $0.19   $0.16 
Diluted Earnings per Share  $0.07   $0.07   $0.19   $0.16 
                     
Basic Weighted Average Shares Outstanding   40,487,224    40,715,602    40,602,179    40,715,602 
Diluted Weighted Average Shares Outstanding   40,487,224    40,715,602    40,602,179    40,715,602 
                     
Net Income  $2,780,328   $2,933,081   $7,554,275   $6,345,649 
Foreign currency translation adjustment   1,375,046    2,523,968    3,862,447    5,600,766 
Comprehensive Income  $4,155,374   $5,457,049   $11,416,722   $11,946,415 

 

The accompanying notes are an integral part of the condensed consolidated financial statements

 

3
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

   For The Six Months Ended 
   December 31, 
   2011   2010 
Cash Flows from Operating Activities:          
Net income  $7,554,275   $6,345,649 
Adjustments to reconcile net income to net cash provided by/(used in) operating activities          
Depreciation and amortization   4,179,300    3,784,283 
Deferred tax assets   (47,431)   2,037 
Foreign currency exchange (gain)/loss   (686,395)   23,198 
Stock based compensation   61,257    62,737 
Gain on disposal of assets   -    (4,710)
Changes in current assets and liabilities:          
Trade accounts receivable, net   (7,624,315)   6,424,518 
Other receivable and prepayment   269,075    (359,606)
Advances to suppliers   6,087,748    (3,224,708)
Advances to suppliers - related parties   1,984,400    (16,321,928)
Inventory   (46,491,155)   896,374 
Accounts payable   60,932,832    (11,839,274)
Advances from customers   (5,520,486)   4,222,928 
Other payables and accrued expenses   222,530    (800,652)
Other payables - related parties   (601,014)   107,084 
Net Cash Provided by/(Used In) Operating Activities   20,320,621    (10,682,070)
           
Cash Flows from Investing Activities:          
Changes in notes receivable   (526,505)   (798,557)
Purchase of property, plant and equipment, net of value added tax refunds received   (9,786,882)   (831,690)
Proceeds from disposal of assets   -    5,949 
Net changes in restricted cash   (50,625,460)   4,724,215 
Net Cash Provided by/(Used In) Investing Activities   (60,938,847)   3,099,917 
           
Cash Flows from Financing Activities:          
Proceeds from loans   128,876,501    71,169,376 
Repayment of loans   (102,275,514)   (68,146,301)
Payments on repurchase of common stock   (534,269)   - 
Net Cash Provided by Financing Activities   26,066,718    3,023,075 
           
Effect of Exchange Rate Changes on Cash and Cash Equivalents   228,347    339,142 
           
Net Change in Cash and Cash Equivalents   (14,323,161)   (4,219,936)
Cash and Cash Equivalents at Beginning of Period   21,324,931    13,336,736 
Cash and Cash Equivalents at End of Period  $7,001,770   $9,116,800 
           
Supplemental Non-Cash Information:          
Offset of notes payable to related parties against receivable from related parties (Note 7)  $10,263,357   $9,870,221 
Supplemental Cash Flow Information:          
Cash paid during the period for interest  $(3,915,785)  $(3,583,122)
Cash received/(paid) during the period for income tax  $6,019   $(1,404,237)

 

The accompanying notes are an integral part of the condensed consolidated financial statements

 

4
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 1 - ORGANIZATION AND NATURE OF OPERATIONS

 

Sutor Technology Group Limited and subsidiaries (the “Company”) includes its wholly owned subsidiaries Sutor Steel Technology Co., Ltd. (“Sutor Steel”),  Changshu Huaye Steel Strip Co., Ltd. (“Changshu Huaye”),  Jiangsu Cold-Rolled Technology Co., Ltd. (“Jiangsu Cold-Rolled”), Ningbo Zhehua Heavy Steel Pipe Manufacturing Co., Ltd. (“Ningbo Zhehua”) and Sutor Technology Co., Ltd (“Sutor Technology”) as of December 31, 2011.

 

Ningbo Zhehua was organized under the laws of the People’s Republic of China (the “PRC”) on April 5, 2004. On November 10, 2009, pursuant to the Equity Transfer Agreement (the “Agreement”), Changshu Huaye acquired 100% of the equity interests of Ningbo Zhehua from Shanghai Huaye Iron & Steel Co., Ltd., (an entity under common control with the Company) (“Shanghai Huaye”) for approximately $6,615,825 in cash. The acquisition was a transfer of equity interests between entities under common control and was recognized as a recapitalization of Ningbo Zhehua into the Company in a manner similar to the pooling-of-interests method of accounting, with the assets and liabilities of Ningbo Zhehua recognized at their historical carrying amounts.

 

Nature of Operations - The Company’s operations are located in the PRC. For the three months ended December 31, 2011 and 2010, approximately 86.7% and 92.4%, respectively, of the Company’s revenue was derived from sales within the PRC of steel products. For the six months ended December 31, 2011 and 2010, approximately 83.5% and 92.8%, respectively, of the Company’s revenue was derived from sales within the PRC of steel products. A significant portion of the Company’s purchases and revenues consist of transactions with Shanghai Huaye and its subsidiaries. For the three months ended December 31, 2011 and 2010, approximately 23.0% and 44.0%, respectively, of the Company’s revenues was derived from Shanghai Huaye and its subsidiaries, and approximately 45.9% and 53.0%, respectively, of the Company’s purchases was from Shanghai Huaye and its subsidiaries. For the six months ended December 31, 2011 and 2010, approximately 23.8% and 52.7%, respectively, of the Company’s revenues was derived from Shanghai Huaye and its subsidiaries, and approximately 38.9% and 60.4%, respectively, of the Company’s purchases was from Shanghai Huaye and its subsidiaries. Changshu Huaye manufactures hot-dip galvanized steel and pre-painted galvanized steel. Jiangsu Cold-Rolled operates several production lines that refine products such as cold-rolled steel, acid pickled steel and hot-dip galvanized steel. Ningbo Zhehua primarily manufactures heavy steel pipe. Sutor Technology engages in trading of steel products.

 

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES

 

Interim Unaudited Financial Statements – The accompanying unaudited condensed consolidated financial statements of the Company and its subsidiaries as of December 31, 2011 and for the three and six months ended December 31, 2011 and 2010 reflect all adjustments (consisting only of normal recurring adjustments) that, in the opinion of management, are necessary to present fairly the consolidated financial position and results of operations of the Company for the periods presented. Operating results for the three and six months ended December 31, 2011 are not necessarily indicative of the results that may be expected for the year ending June 30, 2012. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2011. The Company follows the same accounting policies in the preparation of interim reports.

 

Principles of Consolidation – The accompanying unaudited condensed consolidated financial statements include the accounts and transactions of Sutor Technology Group Limited and its subsidiaries for all periods presented. All significant intercompany accounts and transactions have been eliminated in consolidation.

 

Restricted Cash – The Company's total restricted cash balance was approximately $124.4 million and $72.3 million as of December 31, 2011 and June 30, 2011, respectively. The restricted cash primarily consists of certificates of deposit and cash deposits for serving the note payables with the banks.

 

5
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES – continued

 

Functional Currency and Translating Financial Statements - In accordance with guidance now incorporated in ASC Topic 830 (formerly FAS 52), foreign currency transactions in RMB are reflected using the temporal method. Under this method, all monetary items are translated into the functional currency at the rate of exchange prevailing at the balance sheet date. Non-monetary items, including shareholder equity, are translated at historical rates. Income and expenses are translated at the rate in effect on the transaction dates. Transaction gains and losses, if any, are included in the determination of net income for the period. Sutor Technology Group Limited (incorporated in US) and Sutor Steel Technology Co., Ltd. (incorporated in BVI), maintain their books and records in U.S. dollars, “USD,” the currency of U.S.A., their functional currency. The Company’s subsidiaries based in PRC maintain their books and records in Renminbi (“RMB”), their functional currency. In translating the financial statements of the Company’s China subsidiaries from their functional currency into the Company's reporting currency of United States dollars, balance sheet accounts are translated using the closing exchange rate in effect at the balance sheet date and income and expense accounts are translated using an average exchange rate prevailing during the reporting period. Adjustments resulting from the translation, if any, are included in cumulative other comprehensive income (loss) in stockholders’ equity.

 

   December 31,
2011
   December 31,
2010
   June 30,
2011
 
Closing RMB : USD exchange rate at the period end   6.3585    6.6118    6.4635 
Average 6 months RMB : USD exchange rate   6.3892    6.7237      

 

Accounting Estimates - The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could materially differ from those estimates. The estimates and assumptions that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities are provision for doubtful accounts on trade receivables, notes receivables, other receivables, advances to suppliers, reserves for inventory, estimated useful lives of property and equipment, valuation allowance for deferred tax assets and share-based compensation.

 

Trade Accounts Receivable and Other Receivables - Trade accounts receivables and other receivables are carried at original invoiced amounts less an allowance for doubtful accounts. Other receivables consist of amounts advanced to suppliers, but subsequently not used, resulting in a receivable.

 

Allowance for doubtful accounts – Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The Company provides a general provision for doubtful accounts for the outstanding trade receivable balances based on historical experience and information available. Additionally, the Company makes specific bad debt provisions based on (i) specific assessment of the collectability of all significant accounts; and (ii) any specific knowledge the Company has acquired that might indicate that an account is uncollectible. The facts and circumstances of each account may require the Company to use substantial judgment in assessing its collectability.

 

Revenue Recognition - The Company recognizes revenues from the sale of products when they are realized and earned. The Company considers revenue realized and earned when (1) it has persuasive evidence of an arrangement, (2) delivery has occurred, (3) the sales price is fixed or determinable, and (4) collectability is reasonably assured. Revenues are not recognized until products have been shipped to the client, risk of loss has transferred to the client and client acceptance has been obtained, client acceptance provisions have lapsed, or the Company has objective evidence that the criteria specified in client acceptance provisions have been satisfied.

 

The Company sells some products to affiliates, who in turn sell the product to various other third party customers. The price, terms and conditions on the sales to affiliates are the same as those to third parties. Revenue is considered realized or realizable and earned when the affiliates ship the product to third party customers. A fee of 0.5% of the sale is paid to the affiliate for handling the product. Handling fees were $109,090 and $124,033 for the three months ended December 31, 2011 and 2010 respectively and have been classified as selling expenses in the statement of operations. Handling fees were $117,985 and $283,422 for the six months ended December 31, 2011 and 2010 respectively and have been classified as selling expenses in the statement of operations.

 

6
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES – continued

 

Recent Accounting Pronouncements – In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-04, “Fair Value Measurement (Topic 820)”: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The new guidance results in a consistent definition of fair value and common requirements for measurement of and disclosure about fair value between US GAAP and IFRS. The new guidance changes some fair value measurement principles and disclosure requirements. The disclosure requirements have been enhanced. The most significant change will require entities, for their recurring Level 3 fair value measurements, to disclose quantitative information about unobservable inputs used, a description of the valuation processes used by the entity, and a qualitative discussion about the sensitivity of the measurements. New disclosures are required about the use of a nonfinancial asset measured or disclosed at fair value if its use differs from its highest and best use. In addition, entities must report the level in the fair value hierarchy of assets and liabilities not recorded at fair value but where fair value is disclosed. The amendments in this update are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. The adoption of ASU 2011-04 will not have a material effect on the financial position, results of operations or cash flows of the Company.

 

In September 2011, the FASB issued ASU 2011-08, “Intangibles—Goodwill and Other (Topic 350)”. The amendments in this Update will allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under these amendments, an entity would not be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The amendments include a number of events and circumstances for an entity to consider in conducting the qualitative assessment. It will not have a material effect on the financial position, results of operations or cash flows when the Company adopts this standard in future.

 

In December 2011, the FASB issued ASU 2011-11, “Balance Sheet (Topic 210)”. The objective of this Update is to provide enhanced disclosures that will enable users of its financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position. This includes the effect or potential effect of rights of setoff associated with an entity’s recognized assets and recognized liabilities within the scope of this Update. The amendments require enhanced disclosures by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either Section 210-20-45 or Section 815-10-45. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The Company is currently assessing the impact, if any, that the adoption of this update will have on its consolidated financial statements and disclosures.

 

In December 2011, the FASB issued ASU 2011-12, “Comprehensive Income (Topic 220)”. The amendments in this Update supersede certain pending paragraphs in Accounting Standards Update No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, to effectively defer only those changes in Update 2011-05 that relate to the presentation of reclassification adjustments out of accumulated other comprehensive income. The amendments will be temporary to allow the Board time to redeliberate the presentation requirements for reclassifications out of accumulated other comprehensive income for annual and interim financial statements for public, private, and non-profit entities. The amendments in this Update are effective at the same time as the amendments in Update 2011-05 so that entities will not be required to comply with the presentation requirements in Update 2011-05 that this Update is deferring. For this reason, the transition guidance in paragraph 220-10-65-2 is consistent with that for Update 2011-05. The amendments in this Update are effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2011. For nonpublic entities, the amendments are effective for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. The adoption of this standard is not expected to have a material effect on the financial position, results of operations or cash flows of the Company.

 

7
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 3 – INVENTORY

 

Inventory consisted of the following:

 

   December 31,   June 30, 
   2011   2011 
Raw materials  $56,053,582   $18,991,085 
Finished goods   37,711,897    27,294,440 
           
    93,765,479    46,285,525 
Less: allowance for obsolescence   (89,805)   (88,346)
           
Total Inventory, net  $93,675,674   $46,197,179 

 

NOTE 4 – PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment includes the costs necessarily incurred to bring it to the condition and location necessary for its intended use. Foreign invested enterprises and foreign enterprises doing business in the PRC are generally able to receive a refund of the value-added tax paid on property and equipment purchased and manufactured within the PRC. The Company recognizes refunds of value-added tax as a reduction of property and equipment when the refunds are collected. The refunds are a long-term asset as it can take up to three years to collect them from the PRC government. Investment tax credits are realized upon collection from the government.

 

As of December 31, 2011, certain of the Company’s property, plant and equipment of approximately $40 million was pledged to the bank to secure the loan granted to the Company.

 

Property and equipment consisted of the following:

 

   December 31,   June 30, 
   2011   2011 
Buildings and plant  $42,727,565   $40,388,929 
Machinery   71,212,197    69,744,627 
Office and other equipment   1,306,342    1,252,653 
Vehicles   476,970    434,288 
    115,723,074    111,820,497 
Less: accumulated depreciation   (39,823,792)   (35,081,522)
    75,899,282    76,738,975 
Construction in progress   10,181,282    2,364,156 
Total Property, Plant and Equipment, net  $86,080,564   $79,103,131 

 

No interest has been capitalized in construction in progress as of December 31, 2011 as the amount is insignificant.

 

Depreciation is computed on a straight-line basis over the estimated useful lives of the assets, as follows:

 

Estimated useful lives
Buildings and Plant 20 years
Machinery 10 years
Office and other equipment 10 years
Vehicles 5 years

 

Depreciation expense for the three months ended December 31, 2011 and 2010 was $2,039,718 and $1,890,772, respectively. Depreciation expense for the six months ended December 31, 2011 and 2010 was $ 4,142,954 and $3,749,746, respectively.

 

8
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 5 - INTANGIBLE ASSETS

 

The Company’s intangible assets consist of several land use rights, which are amortized using the straight-line method over the lease term of 50 years. Amortization expense for the three months ended December 31, 2011 and 2010 was $18,241 and $17,413, respectively. Amortization expense for the six months ended December 31, 2011 and 2010 was $36,346 and $34,537, respectively.

 

Information of intangible assets by segment is presented below:

 

As of December 31, 2011  Changshu Huaye   Jiangsu Cold-Rolled   Total 
Cost  $2,323,803   $1,328,294   $3,652,097 
Accumulated Amortization   (373,941)   (180,189)   (554,130)
   $1,949,862   $1,148,105   $3,097,967 

 

As of June 30, 2011  Changshu Huaye   Jiangsu Cold-Rolled   Total 
Cost  $2,286,053   $1,306,716   $3,592,769 
Accumulated Amortization   (345,006)   (164,194)   (509,200)
   $1,941,047   $1,142,522   $3,083,569 

 

The following schedule sets forth the estimated amortization expense for the periods presented:

 

ESTIMATED AMORTIZATION EXPENSE    
Remainder of the year ending June 30, 2012  $36,521 
For the year ending June 30, 2013   73,042 
For the year ending June 30, 2014   73,042 
For the year ending June 30, 2015   73,042 
For the year ending June 30, 2016   73,042 
For the year ending June 30, 2017 and thereafter   2,769,278 

 

9
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 6 - LOANS

 

The Company’s loans consist of short and long-term loans from bank, and loans from an individual. The following schedules sets forth the Company’s loans as of the dates presented:

 

 Short-term and long-term loans comprised of the following:

  

        December 31,   June 30,  
    Maturity Date   2011   2011  
Bank loan at 4.78% interest, guaranteed by related party   7/8/2011     -     3,867,873  
Bank loan at 4.78% interest, guaranteed by related party   7/28/2011     -     7,271,602  
Bank loan at 2.85% interest, guaranteed by related party   8/17/2011     -     2,155,000  
Bank loan at 2.85% interest, guaranteed by related party   8/18/2011     -     2,130,000  
Bank loan at 4.78% interest, guaranteed by related party   8/20/2011     -     1,547,149  
Bank loan at 4.78% interest, guaranteed by related party   8/22/2011     -     6,188,598  
Bank loan at 5.85% interest, guaranteed by related party   8/30/2011     -     541,502  
Bank loan at 4.78% interest, guaranteed by related party   9/6/2011     -     6,188,598  
Bank loan at 4.78% interest, secured by property   9/30/2011     -     7,735,747  
Bank loan at 4.92% interest, guaranteed by related party   10/13/2011     -     302,197  
Bank loan at 5.81% interest, guaranteed by related party   10/18/2011     -     3,094,299  
Bank loan at 0.43% interest, guaranteed by related party   10/21/2011     -     556,000  
Bank loan at 5.00% interest, secured by property   10/24/2011     -     2,475,439  
Bank loan at 5.27% interest, guaranteed by related party   10/26/2011     -     3,094,299  
Bank loan at 5.00% interest, guaranteed by related party   11/10/2011     -     10,830,045  
Bank loan at 6.31% interest, guaranteed by related party   11/15/2011     -     3,094,299  
Bank loan at 5.00% interest, guaranteed by related party   11/17/2011     -     6,188,598  
Loan at 6.00% interest, unsecured (1)   11/20/2011           2,859,995  
Bank loan at 5.27% interest, guaranteed by related party   11/24/2011     -     5,260,308  
Bank loan at 5.27% interest, guaranteed by related party   12/15/2011     -     10,056,471  
Bank loan at 5.91% interest, guaranteed by related party   12/26/2011     -     1,547,149  
Bank loan at 6.10% interest, guaranteed by related party   1/17/2012     2,094,834     -  
Bank loan at 5.23% interest, guaranteed by related party   1/20/2012     2,359,047     2,320,724  
Bank loan at 3.94% interest, unsecured   1/20/2012     215,000     -  
Bank loan at 4.03% interest, unsecured   2/16/2012     735,000     -  
Bank loan at 4.03% interest, unsecured   2/23/2012     780,000     -  
Bank loan at 6.06% interest, guaranteed by related party   2/29/2012     3,145,396     3,094,299  
Bank loan at 6.41% interest, secured by property   4/26/2012     3,145,396     -  
Bank loan at 6.10% interest, unsecured   4/27/2012     3,145,396     -  
Bank loan at 6.31% interest, secured by property   5/19/2012     3,145,396     3,094,299  
Bank loan at 5.90% interest, guaranteed by related party   7/21/2012     7,391,680     -  
Bank loan at 2.55% interest, secured by cash deposit   7/29/2012     10,000,000     -  
Bank loan at 6.89% interest, guaranteed by related party   8/16/2012     6,290,792     -  
Bank loan at 7.22% interest, guaranteed by related party   8/23/2012     1,572,698     -  
Bank loan at 6.89% interest, guaranteed by related party   9/5/2012     4,718,094     -  
Bank loan at 5.97% interest, secured by property   9/27/2012     6,290,792     -  
Bank loan at 5.97% interest, secured by property   10/24/2012     2,516,317     -  
Bank loan at 5.97% interest, secured by property   11/9/2012     7,863,490     -  
Bank loan at 7.87% interest, guaranteed by related party   11/14/2012     3,145,396     -  
Bank loan at 6.56% interest, secured by property   11/16/2012     6,290,792     -  
Bank loan at 5.97% interest, secured by property   11/20/2012     5,347,173     -  
Bank loan at 5.97% interest, secured by property   11/27/2012     3,145,396     -  
Bank loan at 5.97% interest, secured by property   12/11/2012     10,222,535     -  
Bank loan at 4.38% interest, unsecured   12/13/2012     9,500,000     -  
Bank loan at 6.56% interest, secured by property   12/21/2012     3,931,745     -  
Bank loan at 6.56% interest, unsecured   12/26/2012     1,572,698     -  
Total Short-term loan       $ 108,565,063   $ 95,494,490  

 

10
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 6 - LOANS - continued

 

Long-term bank loan at 3.99% interest, unsecured   2/21/2013    17,124,500    17,124,500 
Long-term bank loan at 3.97% interest, unsecured   2/21/2013    6,502,400    6,502,400 
Long-term loan at 6.00% interest, unsecured (1)   12/31/2013    2,859,995    - 
Long-term bank loan at 6.65% interest, unsecured   9/11/2014    11,638,848    - 
Total Long-term loan     $38,125,743   $23,626,900 

 

(1) On November 20, 2008, the Company entered into a loan agreement with Lin, Guihua, a third party individual. Pursuant to the agreement, the Company financed from Lin, Guihua amounted to $2,859,995 for working capital, with interest rate 6% per annum and matured on November 20, 2011. On November 20, 2011, the Company and Lin, Guihua entered into a supplementary agreement to extend the loan to December 31, 2013 with the same terms.

 

The weighted average interest rate for the short-term and long term loans outstanding as of December 31, 2011 is 5.52%.

 

NOTE 7 - RELATED PARTIES

 

Purchases from Related Parties

The Company sells its products to and buys raw materials from a number of companies which are owned or controlled by the principal stockholders. Revenues related to these transactions are shown separately in the accompanying unaudited condensed consolidated statements of operations. For the three months ended December 31, 2011 and 2010, purchases from these related parties totaled of $57,889,169 and $46,331,792, respectively. For the six months ended December 31, 2011 and 2010, purchases from these related parties totaled of $97,755,525 and $104,163,993, respectively.

 

Due from Related Parties

The amounts due to related parties are non-interest bearing and were incurred in the normal course of business. Receivables from, advanced purchase deposits to, payables to and advanced sales deposits from related parties have been netted due to the right of offset. As of December 31, 2011 and June 30, 2011, the net amounts due from related parties were $116,782,481 and $116,772,842, respectively. The amounts charged for products to the Company by the related parties are under the same pricing, terms and conditions as those charged to third parties, and are due upon receipt. It is not uncommon for the Company with its related parties to accommodate an extension of 90 to 180 days. Amounts receivable from related parties are also due upon delivery. Advances to suppliers which are related parties, are relieved once the goods are received.

 

Letters of Credit Held by Related Parties

As of December 31, 2011, the Company had letters of credit totaling $4,089,015 in the form of banker’s acceptance notes that are held by related parties in connection with purchases from related parties. The banker’s acceptance notes carry a 0% interest rate, can be presented to the respective banks in 90 to 180 days from the dates they were written, are secured by cash on deposit with the respective banks and are guaranteed by related parties. These letters of credit were included in accounts payable – related parties and have been netted off with the advances to suppliers – related parties due to the right of offset.

 

Loans from Principal Shareholder

On December 20, 2007, Ms. Chen loaned the Company $7,099,998. The loan was for an initial period of 24 months through December 20, 2009, carried an interest rate of 5%.

 

On March 11, 2009, Ms. Chen loaned the Company $99,998.  The loan was for a period of 36 months, carried an interest rate of 3.60%.

 

On April 29, 2009, Ms. Chen loaned the Company $149,998.  The loan was for a period of 36 months, carried an interest rate of 5.00%.

 

On July 25, 2009, Ms. Chen loaned the Company $199,930. The loan was for a period of 12 months, and carried an interest rate of 2%.

 

The maturity of the loans described above with total principal of $7,549,924 was extended to December 31, 2013 through an agreement between the Company and Ms. Chen dated as of December 1, 2009.

 

11
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 7 - RELATED PARTIES - continued

 

On various dates from February 25, 2007 to June 30, 2009, Ms. Chen loaned the Company a total of $5.3 million.  The Company during that same period repaid Ms. Chen $2.5 million. The Company further paid off $1 million during the period ended March 31, 2010. The balance of the loan as of December 31, 2011 was $1,861,174 with no interest bearing and due on demand.

 

On May 10, 2011, the Company paid off $600,000 for the loan dated December 20, 2007 described above.

 

As of December 31, 2011, the accrued interest for the loans described above was $1,452,259. Since the Company has a right to offset the payables with amounts due from related parties, the aggregate amount of these notes and accrued interest of $10,263,357 has been recorded as a reduction of advances to related parties in the accompanying balance sheet as of December 31, 2011.

 

Rental Agreement with Principal Shareholder

 

On November 8, 2008, the Company entered into an agreement with the Principal Shareholder for the lease of 1,200 square meters of property in Changhsu, China.  Pursuant to the agreement, the Company will lease the property for three years, and pay the principal shareholder approximately $17,500 per month. The Company has accrued expense for this lease of $603,916 (RMB3,840,000) and $594,105 (RMB3,840,000) as of December 31, 2011 and June 30, 2011, respectively. This rental agreement has been terminated on June 1, 2011 through an agreement between the Principal Shareholder and the Company for its relocation since then.

 

On August 6, 2004, the Company entered into a 10 year lease agreement with its related company, Ningbo Huaye Steel Processing Co., Ltd. to use a factory building in the Ningbo Camel Luo Ji Dian Industrial Park. Lease payments are made quarterly at a monthly rate of approximately $12,582.

 

NOTE 8 - INCOME TAXES

 

The Company is registered in United States and subject to the enterprise income tax within the United States at the applicable rate of 34% on the taxable income.

 

The Company’s subsidiaries registered in the PRC are subject to income taxes within the PRC at the applicable tax rate of 25% on the taxable income as reported in their PRC statutory financial statements in accordance with the relevant income tax laws applicable to foreign invested enterprise.

 

In 2007, Jiangsu Cold-Rolled was granted an enterprise income tax holiday of a 100% enterprise income tax exemption for two years commencing from calendar year 2007, and a 50% enterprise income tax deduction for the next three years thereafter, from 2009 to 2011.

 

In September 2010, Changshu Huaye was awarded the title of High-Tech Enterprises by Jiangsu provincial government. According to the PRC income tax laws, it is subject to enterprise income tax at a rate of 15% for calendar years 2010, 2011 and 2012. Changshu Huaye paid EIT at the 25% tax rate for the period between January and June 2010 and the Company received a refund on the over-paid portion of the EIT in July 2011.

 

Taxes payable are a component of other payables and accrued expenses in the accompanying unaudited condensed consolidated balance sheets and consisted of:

 

   December 31,   June 30, 
   2011   2011 
Value added tax  $(533,609)  $(1,473,990)
Income tax   2,319,802    2,645,198 
Surtax, insurance, other   198,346    194,120 
Total taxes payable  $1,984,539   $1,365,328 

 

12
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 8 - INCOME TAXES - continued

 

Following is a reconciliation of income taxes at the calculated statutory rate:

   For The Three Months Ended   For The Six Months Ended 
   December 31,   December 31, 
   2011   2010   2011   2010 
Income before tax  $3,240,832   $3,554,823   $7,153,946   $7,577,586 
Income tax computed at PRC statutory rate of 25%   810,208    888,706    1,788,487    1,894,396 
True up differences   -    18,628    -    (30,586)
Benefit of favorable rates   (434,674)   (276,549)   (800,408)   (574,151)
Tax refund due to High-Tech Enterprise Qualification   (1,254)   -    (335,063)   - 
Tax refund due to purchase of Domestic Equipments   (4,232)   -    (1,130,815)   - 
Changes in valuation allowance   49,694    -    93,952    16 
Tax effect of parent   (19,129)   (9,043)   (93,249)   (57,738)
Permanent difference   59,891    -    76,767    - 
Total Income tax expense/(benefit)  $460,504   $621,742   $(400,329)  $1,231,937 

 

Deferred tax assets comprised of the following:

 

   December 31,   June 30, 
   2011   2011 
Taxable loss carry forward  $194,224   $72,752 
Stock based compensation   73,897    53,069 
Allowance for doubtful trade accounts receivable   252,696    211,945 
Allowance for doubtful other receivables   65,965    111,158 
Allowance for doubtful advances to suppliers   76,047    66,656 
Allowance for inventory obsolescence   22,451    22,086 
Less: Valuation allowance   (268,121)   (174,169)
Total Deferred tax assets  $417,159   $363,497 

 

The income tax expense comprised of the following:

 

   For The Three Months Ended   For The Six Months Ended 
   December 31,   December 31, 
   2011   2010   2011   2010 
Current  $472,997   $684,932   $(352,898)  $1,261,320 
Deferred   (12,493)   (63,190)   (47,431)   (29,383)
Total Income tax expense/(benefit)  $460,504   $621,742   $(400,329)  $1,231,937 

 

NOTE 9 – ISSUANCE OF COMMON STOCK AND WARRANTS

 

On March 10, 2010, the Company issued 2,740,000 shares of common stock and warrants to purchase up to 685,000 shares of common stock for an aggregate price of $7,398,000. Issuance costs of $583,804 were netted against the gross proceeds. The proceeds from the transaction were allocated to the common stock and warrants based on the relative fair value of the securities which was $5,838,910 and $975,286, respectively. 

 

The warrants have a five year term, expiring March 9, 2015, with an exercise price of $3.76 per share, adjustable for stock dividends, stock splits and upon occurrence of a fundamental transaction as defined in the warrant agreement. The fair value of the warrants was $1,368,428, valued using a Black-Scholes model.  The following assumptions were used to calculate the fair value of the warrants: dividend yield of 0%, expected volatility of 90%, risk-free interest rate of 2.39%, expected life of 5 years, and stock price of $2.99 per share. The Company evaluated the warrants and determined there is no derivative associated with the warrants.

 

13
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 9 – ISSUANCE OF COMMON STOCK AND WARRANTS - continued

 

The following table summarizes warrant activity for the three months ended December 31, 2011:

 

   Warrants   Weighted-
average
exercise price
 
Outstanding as of June 30, 2011   685,000    3.76 
Issued   -    - 
Exercised   -    - 
Expired   -    - 
Outstanding as of December 31, 2011   685,000   $3.76 

 

The aggregate intrinsic value as of December 31, 2011 and June 30, 2011 are $0.

 

NOTE 10 – STOCK-BASED COMPENSATION

 

Non-Vested Stock Grants

 

On February 1, 2010, the Company granted an executive 20,000 shares of restricted common stock with a grant date fair value of $3.04 per share as part of his remuneration for his service commencing February 1, 2010 for a one year period and vesting over that period.

 

On February 23, 2011, the Company granted an executive 30,000 shares of restricted common stock with a grant date fair value of $1.82 per share as part of his remuneration for his service commencing February 23, 2011 for a one year period. The restricted common stock will vest over a 12-month period. The amended agreement calls for a stock grant on each anniversary date through the end of the agreement.

 

Stock-based compensation expense for the three months ended December 31, 2011 and 2010 was $13,800 and $15,325, respectively. Stock-based compensation expense for the six months ended December 31, 2011 and 2010 was $27,600 and $30,650, respectively. The remaining $7,950 stock-based compensation will be expensed over the remainder of the one year service period. The value of the non-vested stock as of December 31, 2011 was $33,000.

 

Options

 

Stock Options granted to Key Employees

 

On April 27, 2010, the Board of Directors approved the grant of stock options to purchase 100,000 shares of the Company’s common stock under the “2009 Equity Incentive Plan” to certain key employees as reward for past services and to promote future performance. These options have an exercise price of $2.71 per share, expiring on the fifth anniversary of the grant date, and vest in three equal installments on each of the first, second and third anniversary of the vesting commencement date, which is April 27, 2010. The fair value of the options, determined using the Black-Scholes Option Pricing Model, was calculated using the following assumptions: risk free interest rate of 2%, expected dividend yield of 0%, expected volatility of 90% and an expected life of 5 years.

 

Stock Options granted to a Director

 

On February 23, 2011, the Board of Directors approved the grant of stock options to purchase 5,000 shares of the Company’s common stock under the “2009 Equity Incentive Plan” to a director as compensation for his service. These options have an exercise price of $2.71 per share, expiring on the fifth anniversary of the grant date, and vest in the first anniversary of the vesting commencement date, which is February 23, 2011. The fair value of the options, determined using the Black-Scholes Option Pricing Model, was calculated using the following assumptions: risk free interest rate of 2%, expected dividend yield of 0%, expected volatility of 50% and an expected life of 5 years.

 

14
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 10 – STOCK-BASED COMPENSATION - continued

 

Options - continued

 

Stock-based compensation expense for the three months ended December 31, 2011 and 2010 on the stock options were $16,829 and $16,044, respectively. Stock-based compensation expense for the six months ended December 31, 2011 and 2010 on the stock options were $33,657 and $32,087, respectively. The remaining $84,514 stock based compensation will be expensed over a weighted average service period of 1.3 years.

 

The following table summarizes the options activity as of December 31, 2011, and changes during the six months ended December 31, 2011:

 

   Options   Weighted-average
exercise price
   Weighted average remaining
contractual life (years)
   Aggregate Intrinsic
Value
 
Outstanding as of June 30, 2011   105,000   $2.71    3.87   $- 
Issued   -    -    -    - 
Exercised   -    -    -    - 
Expired   -    -    -    - 
Outstanding as of December 31, 2011   105,000   $2.71    3.36   $- 

 

Total intrinsic value of stock options outstanding as of December 31, 2011 and June 30, 2011 was $0.

 

NOTE 11 – TREASURY STOCK

 

On August 29, 2011, the Board of Directors authorized the Company to repurchase up to $5 million of the Company’s outstanding common stock over the next year in the open market, in privately negotiated transactions or as otherwise may be determined by the Chief Executive Offer and the Chief Financial Officer (“Authorized Officers”) and will be funded from available working capital. The timing and extent of any purchases depend upon the trading price of the Company’s common stock, general business and market conditions and other investment opportunities. Any common stock repurchased by the Company became part of its treasury stock which was shown as a separate item on the unaudited condensed consolidated balance sheets. The treasury stock may be retired or used by the Company to finance or execute acquisitions or other arrangements. As of December 31, 2011, the Company had repurchased 459,822 shares of its common stock at a total cost of $534,269.

 

NOTE 12 – EARNINGS PER SHARE

 

Basic earnings per share are computed on the basis of the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per share is computed on the basis of the weighted-average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period. The following table sets forth the computation of basic and diluted earnings per share:

 

15
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 12 – EARNINGS PER SHARE - continued

 

   For The Three Months Ended   For The Six Months Ended 
   December 31,   December 31, 
   2011   2010   2011   2010 
                 
Net income attributable to the common stockholders  $2,780,328   $2,933,081   $7,554,275   $6,345,649 
                     
Basic weighted-average common shares outstanding   40,487,224    40,715,602    40,602,179    40,715,602 
Dilutive effect of options, warrants, and contingently issuable shares                    
Diluted weighted-average common shares outstanding   40,487,224    40,715,602    40,602,179    40,715,602 
                     
Earnings per share:                    
Basic  $0.07   $0.07   $0.19   $0.16 
Diluted  $0.07   $0.07   $0.19   $0.16 

 

Warrants and options to purchase 685,000, and 105,000 shares of common stock, respectively were outstanding during the three and six months ended December 31, 2011, but were excluded from the computation of diluted earnings per share as their effect would have been anti-dilutive because the exercise prices of the options are larger than the average share price during the period.

 

NOTE 13 - COMMITMENTS AND CONTINGENCIES

 

Operating lease commitments - As of December 31, 2011, the Company has future minimum lease payments under non-cancelable operating leases with initial terms in excess of one year in relation to office premises consisting of the following:

 

   Lease Payment 
Remainder of the year ending June 30, 2012  $133,516 
For the year ending June 30, 2013   189,663 
For the year ending June 30, 2014   150,979 
For the year ending June 30, 2015 and thereafter   12,582 
Total  $486,740 

 

Commitment for design project - On September 13, 2010, the Company signed an agreement with Suzhou Institute of Architectural Design Co., Ltd. for the design of an office building and the cost of the design is $412,656 (RMB2,623,874).  The design project is still in process and the final drawing of the plan has yet to be submitted to the Company’s management for approval.  As of December 31, 2011, 20% of the cost, or $82,531 (RMB524,775) has been paid as the prepayment for the design project. The remaining balance is due upon the approval of the construction design and the completion of the construction of the office building.

 

16
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

  

NOTE 14 - SEGMENT INFORMATION

 

The Company has four operating segments represented by its four subsidiaries Changshu Huaye, Jiangsu Cold-Rolled, Ningbo Zhehua and Sutor Technology Co., Ltd. as described in Note 1.

 

Factors Management Used to Identify the Enterprise’s Operating Segments - The Company’s operating segments are business units that offer different products and are managed separately and require reporting to the various regulatory jurisdictions. Changshu Huaye mainly produces HDG products and PPGI products.  Jiangsu Cold-Rolled offers cold-rolled steel strips, acid pickled steel and hot-dip galvanized steel products. Ningbo Zhehua trades steel and manufactures heavy steel pipe products and Sutor Technology engages in trading of steel products.

 

Certain segment information is presented below:

 

As of December 31, 2011 and for the three months then ended  Changshu
Huaye
   Jiangsu
Cold-
Rolled
   Ningbo
Zhehua
   Sutor
Technology
   Inter-Segment
and Reconciling
Items
   Total 
                         
Revenue  $34,394,636   $29,296,190   $15,312,363   $2,229,834   $1,837,959   $83,070,982 
Revenue from related parties   1,923,874    22,884,493    15,449    -    -    24,823,816 
Revenue from other operating segments   13,947,927    34,035,529    -    -    (47,983,456)   - 
Total operating expenses   2,899,088    635,189    758,070    109,337    255,425    4,657,109 
Interest income   102,364    252,206    32,603    211    823    388,207 
Interest expense   366,304    1,726,891    76,505    -    269,276    2,438,976 
Depreciation and amortization expense   568,098    993,785    233,163    262,913    -    2,057,959 
Income tax expense/(benefit)   14,433    425,966    20,108    -    (3)   460,504 
Net segment profit/(loss)   100,984    2,933,458    118,885    (99,701)   (273,298)   2,780,328 
Capital expenditures, net of VAT refunds   38,123    8,639,509    340    -    -    8,677,972 
Segment assets  $263,835,074   $318,454,628   $38,623,867   $34,130,881   $(172,724,672)  $482,319,778 

 

As of December 31, 2010 and for the three months then ended  Changshu
Huaye
   Jiangsu
Cold-
Rolled
   Ningbo
Zhehua
   Sutor
Technology
   Inter-Segment
and Reconciling
Items
   Total 
                         
Revenue  $13,484,340   $30,165,261   $8,405,773   $-   $3,665,330   $55,720,704 
Revenue from related parties   21,615,970    22,051,358    35,083    -    -    43,702,411 
Revenue from other operating segments   4,746,490    30,613,305    -    -    (35,359,795)   - 
Total operating expenses   1,408,311    615,947    1,481,635    -    196,855    3,702,748 
Interest income   50,888    177,787    19,727    -    -    248,402 
Interest expense   208,422    1,967,451    25,025    -    134,395    2,335,293 
Depreciation and amortization expense   548,186    1,138,041    221,958    -    -    1,908,185 
Income tax expense/(benefit)   423,537    246,602    (48,397)   -    -    621,742 
Net segment profit/(loss)   1,236,317    1,668,412    (19,061)   -    47,413    2,933,081 
Capital expenditures, net of VAT refunds   11,515    345,579    24,886    78,049    -    460,029 
Segment assets  $192,351,988   $212,715,863   $29,546,125   $6,691,730   $(138,999,700)  $302,306,006 

 

17
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 14 - SEGMENT INFORMATION - continued

 

As of December 31, 2011 and for the six months then ended  Changshu
Huaye
   Jiangsu
Cold-
Rolled
   Ningbo
Zhehua
   Sutor
Technology
   Inter-Segment
and
Reconciling
Items
   Total 
                         
Revenue  $68,661,782   $64,370,885   $29,636,336   $3,132,073   $15,666,421   $181,467,497 
Revenue from related parties   3,711,726    52,765,496    145,696    -    -    56,622,918 
Revenue from other operating segments   27,645,948    61,678,380    -    -    (89,324,328)   - 
Total operating expenses   6,286,922    1,221,535    1,633,961    290,180    485,789    9,918,387 
Interest income   303,256    300,141    73,813    382    823    678,415 
Interest expense   725,325    2,854,211    159,728    -    428,252    4,167,516 
Depreciation and amortization expense   1,131,215    2,324,389    460,783    262,913    -    4,179,300 
Income tax expense/(benefit)   (248,967)   (367,572)   104,658    -    111,552    (400,329)
Net segment profit/(loss)   728,558    6,387,163    370,259    (276,731)   345,026    7,554,275 
Capital expenditures, net of VAT refunds   63,312    9,451,116    90,792    -    -    9,605,220 
Segment assets  $263,835,074   $318,454,628   $38,623,867   $34,130,881   $(172,724,672)  $482,319,778 

 

As of December 31, 2010 and for the six months then ended  Changshu
Huaye
   Jiangsu
Cold-
Rolled
   Ningbo
Zhehua
   Sutor
Technology
   Inter-Segment
and Reconciling
Items
   Total 
                         
Revenue  $22,910,388   $49,177,749   $14,509,804   $-   $8,682,922   $95,280,863 
Revenue from related parties   49,146,109    56,776,506    166,733    -    -    106,089,348 
Revenue from other operating segments   9,340,871    54,337,638    -    -    (63,678,509)   - 
Total operating expenses   3,462,904    869,969    2,017,126    63    376,309    6,726,371 
Interest income   233,882    181,364    22,469    -    -    437,715 
Interest expense   434,110    3,124,089    43,114    -    268,790    3,870,103 
Depreciation and amortization expense   1,087,184    2,257,345    439,754    -    -    3,784,283 
Income tax expense/(benefit)   701,103    560,102    (29,268)   -    -    1,231,937 
Net segment profit/(loss)   2,091,376    4,063,397    45,273    (63)   145,666    6,345,649 
Capital expenditures, net of VAT refunds   13,668    713,450    26,523    78,049    -    831,690 
Segment assets  $192,351,988   $212,715,863   $29,546,125   $6,691,730   $(138,999,700)  $302,306,006 

 

NOTE 15 - GEOGRAPHIC INFORMATION

 

The following schedule summarizes the sources of the Company’s revenue by geographic regions for the three and six months ended December 31, 2011 and 2010:

 

   For the Three Months Ended   For the Six Months Ended 
   December 31,   December 31, 
Geographic Area  2011   2010   2011   2010 
People's Republic of China  $93,544,542   $91,855,416   $198,905,773   $186,772,519 
Other Countries   14,350,256    7,567,699    39,184,642    14,597,692 
Total  $107,894,798   $99,423,115   $238,090,415   $201,370,211 

 

18
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 16 – SUBSEQUENT EVENTS

 

The Company evaluated all events or transactions that occurred after December 31, 2011 through the date of these financial statements were issued and has determined that there are no material recognizable subsequent events or transactions which would require recognition or disclosure in the financial statements.

  

19
 

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 June 30, 2011, 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 as otherwise indicated by the context, all references in this report to:

 

·“Company,” “we,” “us” and “our” are to the combined business of Sutor Technology Group Limited, a Nevada corporation, and its subsidiaries: Sutor BVI, Sutor Technology, Changshu Huaye, Jiangsu Cold-Rolled and Ningbo Zhehua;

 

·“Sutor BVI” are to our wholly-owned subsidiary Sutor Steel Technology Co., Ltd., a BVI company;

 

·“Sutor Technology” are to our wholly-owned subsidiary Sutor Technology Co., Ltd., a PRC company;

 

·“Changshu Huaye” are to our wholly-owned subsidiary Changshu Huaye Steel Strip Co., Ltd., a PRC company;

 

·“Jiangsu Cold-Rolled” are to our wholly-owned subsidiary Jiangsu Cold-Rolled Technology Co., Ltd., a PRC company;

 

·“Ningbo Zhehua” are to our wholly-owned subsidiary Ningbo Zhehua Heavy Steel Pipe Manufacturing Co., Ltd., a PRC company;

 

·“Shanghai Huaye” are to Shanghai Huaye Iron & Steel Group Co., Ltd., a PRC company of which Lifang Chen, our major shareholder and chief executive officer, and her husband Feng Gao, are 100% owners, and its subsidiaries;

 

·“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;

 

·“China” and “PRC” are to the People’s Republic of China;

 

·“RMB” are to Renminbi, the legal currency of China; and

 

·“U.S. dollar,” “$” and “US$” are to the legal currency of the United States.

 

20
 

  

Overview of our Business

 

We are one of the leading China-based non-state-owned manufacturers of fine finished steel products. We utilize a variety of processes and technological methodologies to convert steel manufactured by third parties into fine finished steel products. Our product offerings are focused on higher margin and value-added finished steel products including hot-dip galvanized steel (HDG steel) and prepainted galvanized steel (PPGI). In addition, we produce acid pickled steel (AP steel) and cold-rolled steel, which represent the least processed of our finished products. Our product offerings also include welded steel pipe products. We use a large portion of our AP steel and cold-rolled steel to produce our HDG steel and PPGI products. We believe our vertical integration allows us to maintain more stable margins for our HDG steel and PPGI products.

 

We sell most of our products to customers who operate primarily in the solar energy, household appliances, automobile, construction, infrastructure, medical equipment and water resource industries. Most of our customers are located in China. Our primary export markets are Europe, the Middle East, Asia, and South America.

 

Our manufacturing facilities, located in Changshu, China, have three HDG steel production lines, one PPGI production line, one AP steel production line and one cold-rolled steel line. Our current annual production capacity is approximately 700,000 metric tons, or MT, for HDG steel, 200,000 MT for PPGI, 500,000 MT for AP steel and 250,000 MT for cold-rolled steel. Ningbo Zhehua, our subsidiary located in Ningbo, currently has an annual capacity of 400,000 MT for welded steel pipe products.

 

Executive Overview of Quarterly Results

 

In the fiscal second quarter of fiscal 2012, we generated higher revenue and gross profit primarily due to higher average selling prices as compared to the same period last year. During this period, our net income declined slightly as a result of increased general and administrative expenses primarily due to business expansion and a recent inflationary environment in China. The strong demand for our hot-dip galvanized steel products and increased average selling prices were the major drivers for our higher sales. Further, our reliance on related parties’ distribution network continued to decline as we expanded our own sales channels. Approximately 77% of our total revenue was derived from direct sales in the three months ended December 31, 2011 as compared to approximately 56% in the same period last year. During the quarter, we continued to make progresses on the construction of the high precision cold-roll steel production line with a designed annual capacity of 500,000-metric tons. We expect that this facility will start commercial operations in the second half of calendar year 2012.

 

The following summarizes the major financial information for the second fiscal quarter:

 

·Revenue: Revenue was $107.9 million for the three months ended December 31, 2011, an increase of $8.5 million, or 8.6%, from $99.4 million for the same period last year.

 

·Gross Profit and Margin: Gross profit was $10.4 million for the three months ended December 31, 2011, as compared to $9.5 million for the same period last year. Gross margin was approximately 9.6% for the three months ended December 31, 2011, as compared to approximately 9.6% for the same period last year.

 

·Net Income: Net income was $2.8 million for the three months ended December 31, 2011, a decrease of $0.1 million, or approximately 3.4%, from $2.9 million for the same period of last year.

 

·Fully diluted earnings per share: Fully diluted earnings per share were approximately $0.07 for the three months ended December 31, 2011, as compared to approximately $0.07 for the same period last year.

 

Reportable Operating Segments

 

We have four reportable operating segments – Changshu Huaye, Jiangsu Cold-Rolled, Ningbo Zhehua and Sutor Technology. Changshu Huaye manufactures and sells HDG steel and PPGI products. Jiangsu Cold-Rolled manufactures and sells AP steel, cold-rolled steel and HDG steel. Ningbo Zhehua manufactures and sells steel pipe products. Changshu Huaye and Jiangsu Cold-Rolled are adjacent to each other in Changshu, Jiangsu, and use largely the same management resources. Ningbo Zhehua is located in Ningbo, Zhejiang. We have set up a new reportable segment Sutor Technology effective July 1, 2011 as our subsidiary. Sutor Technology is primarily engaged in R&D, marketing and sales of our products. See Note 14, “Segment Information” to the condensed consolidated financial statements included elsewhere in this report.

 

21
 

 

Revenue

 

Our revenue is primarily generated from sales of our HDG steel, PPGI, AP steel, cold-rolled steel products, as well as our steel pipe products, such as longitudinally welded steel pipes and spiral welded steel pipes. Our revenue has historically been affected by sales volume, sales price of our products and our product mix.

 

In the three months ended December 31, 2011 and 2010, Changshu Huaye generated revenue of approximately $38.2 million and $38.8 million, which represented approximately 35.4% and 39.0% of our total revenue, respectively. Jiangsu Cold-Rolled generated revenue of approximately $52.2 million and $52.2 million in the three months ended December 31, 2011 and 2010, which represented approximately 48.4% and 52.5% of our total revenue, respectively. In the three months ended December 31, 2011 and 2010, Ningbo Zhehua generated revenue of approximately $15.3 million and $8.4 million, which represented approximately 14.2% and 8.5% of our total revenue, respectively. In addition, in the second quarter of fiscal year 2012, Sutor Technology generated revenue of approximately $2.2 million.

 

A portion of our products are sold through our affiliate Shanghai Huaye, which also supplies to us a significant portion of our raw materials. Approximately 23.0% of our revenue was derived from Shanghai Huaye and its affiliates in the three months ended December 31, 2011, as compared to approximately 44.0% last year. We continued to expand our own sales channels in this quarter. At the same time, we also took advantage of Shanghai Huaye’s extensive logistics network and the economy of scale when purchasing raw materials.

 

Cost of Revenue

 

Cost of revenue includes direct costs to manufacture our products, including the cost of raw materials, labor, overhead, energy cost, handling charges, and other expenses associated with the manufacture and delivery of product. Direct costs of manufacturing are generally highest when we first introduce a new product due to higher start-up costs and higher raw material costs. As production volume increases, we typically improve manufacturing efficiencies and are able to strengthen our purchasing power by buying raw materials in greater quantities.

 

In the three months ended December 31, 2011, approximately $57.9 million of raw material procurement was conducted through Shanghai Huaye and its affiliates. Due to the size of Shanghai Huaye and the economy of scale, it has stronger bargaining power than we do and our arrangement with Shanghai Huaye allows us to purchase raw materials at relatively lower prices than we could obtain from suppliers ourselves.

 

Gross Profit and Gross Margin

 

Gross profit is equal to the difference between revenue and the cost of revenue. Gross margin is equal to gross profit divided by revenue. For the three months ended December 31, 2011, gross margin for domestic and international sales was approximately 9.1% and 13.1%, respectively. On a segment basis, Changshu Huaye, Jiangsu Cold-Rolled and Ningbo Zhehua’s gross margins were approximately 14.9%, 7.0% and 6.7%, respectively. As Sutor Technology just commenced operations, its gross margin was 0.42% in this quarter.

 

To gain market penetration, we price our products at levels that we believe are competitive. We continually strive to improve manufacturing efficiencies and reduce our production costs in order to offer superior products and services at competitive prices. General economic conditions, the cost of raw materials, and supply of and demand for fine finished steel products within our markets influence sales prices. Our high-end, value-added products, such as the PPGI products, generally tend to have higher profit margins.

 

We implemented a vertical integration strategy where we use our own AP steel and cold-rolled steel products as raw materials for HDG steel and PPGI products. We believe our vertically integrated operations will allow us to provide customers with one-stop services, build customer loyalty, and maintain stable operating margins.

 

Operating Expenses

 

Our operating expenses primarily consist of general and administrative expenses and selling expenses.

 

22
 

  

General and Administrative Expenses

 

General and administrative expenses consist primarily of compensation and benefits for our general management, finance and administrative staff, professional and advisory fees, bad debts reserves, and other expenses incurred in connection with general corporate purposes. We expect most components of our general and administrative expenses will increase as our business grows and as we incur increased costs as a public company.

 

Selling Expenses

 

Selling expenses consist primarily of compensation and benefits for our sales and marketing staff, sales commissions, the cost of advertising, promotional and travel activities, transportation expenses, after-sales support services and other sales related costs.

 

Our selling expenses are generally affected by the amount of international sales, unit shipping cost, use of free-on-board (FOB) or cost-insurance-freight (CIF), as well as the choice our customers make regarding who arrange the transportation services. The transportation costs for our international sales are generally higher than domestic sales. CIF usually results in higher selling expenses than FOB. Finally, some customers may come to our factories to pick up their orders whereas others may ask us to arrange transportation for them. In the latter, we usually charge a higher price.

 

Provision for Income Taxes

 

Sutor Technology Group Limited is subject to United States federal income tax at a tax rate of 34%. Sutor BVI was incorporated in the British Virgin Islands and, under the current laws of the British Virgin Islands, is not subject to income taxes.

 

On March 16, 2007, the National People’s Congress of China passed a new Enterprise Income Tax Law, or the EIT Law, and on December 6, 2007, the State Council of China passed its implementing rules, which took effect on January 1, 2008. The EIT Law and its implementing rules impose a unified enterprise income tax, or EIT, of 25.0% on all domestic-invested enterprises and foreign invested enterprises, or FIEs, established in the PRC, unless they qualify under certain limited exceptions. Therefore, nearly all FIEs are subject to the new tax rate alongside other domestic businesses rather than benefiting from the old FIE tax laws, and its associated preferential tax treatments, beginning January 1, 2008.

 

Despite these changes, the EIT Law gives existing FIEs a five-year grandfather period during which they can continue to enjoy their existing preferential tax treatments. Changshu Huaye is subject to an EIT of 15% from calendar years 2010 to 2012 because it qualifies as a high-tech enterprise for the calendar years 2010, 2011 and 2012. Changshu Huaye paid EIT at the 25% tax rate for the period between July and December 2010 and we have received a refund on the over-paid portion of the EIT. Jiangsu Cold-Rolled was subject to an EIT of 12.5% for the calendar years 2009, 2010 and 2011. Jiangsu Cold-Rolled will be subject to an EIT of 25% for the calendar year 2012 and beyond. Ningbo Zhehua and Sutor Technology are subject to an EIT of 25% and have no preferential tax treatments.

 

Results of Operations

 

Comparison of Three Months Ended December 31, 2011 and December 31, 2010

 

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

 

(All amounts, other than percentages, in thousands of U.S. dollars)

 

   Three Months Ended
December 31, 2011
   Three Months Ended
December 31, 2010
 
   Amount   % of Revenue   Amount   % of
Revenue
 
Revenue                    
Revenue from unrelated parties  $83,071    77.0%  $55,721    56.0%
Revenue from related parties   24,824    23.0%   43,702    44.0%
Total   107,895    100.0%   99,423    100.0%
Cost of Revenue                    
Cost of revenue from unrelated parties   74,931    69.5%   50,291    50.6%
Cost of revenue from related parties   22,553    20.9%   39,678    39.9%
Total   97,484    90.4%   89,969    90.5%
Gross Profit   10,411    9.6%   9,455    9.5%
Operating Expenses                    
Selling expense   2,078    1.9%   1,983    2.0%
General and administrative expense   2,579    2.4%   1,720    1.7%
Total Operating Expenses   4,657    4.3%   3,703    3.7%
Income from Operations   5,754    5.3%   5,752    5.8%
Other Income (Expense)                    
Interest income   388    0.4%   248    0.2%
Other income   15    0.0%   99    0.1%
Interest expense   (2,439)   (2.3)%   (2,335)   (2.3)%
Other expense   (477)   (0.4)%   (209)   (0.2)%
Total Other Income (Expense)   (2,513)   (2.3)%   (2,197)   (2.2)%
Income Before Taxes   3,241    3.0%   3,555    3.6%
Income tax (expense)/benefit   (461)   (0.4)%   (622)   (0.6)%
Net Income  $2,780    2.6%  $2,933    3.0%

 

Revenue. For the three months ended December 31, 2011, revenue was approximately $107.9 million, compared to $99.4 million for the same period last year, an increase of approximately $8.5 million, or 8.6%. The increase was mainly attributable to both increased sales volume due to improved capacity utilization and higher average selling prices, or ASP, for our HDG products. During the fiscal second quarter of 2012, sales volume and ASP of our HDG products increased approximately 10.5% and 10.4%, respectively, as compared to the same period of fiscal 2011. In addition, we benefited from the significant improvement in our steel pipe manufacturing business at Ningbo Zhehua, whose sales rose by approximately 82.1% as compared to the same period last year as we completed a large customer order in December 2011. However, we experienced lower sales of cold rolled steel products as we used more of them internally for the production of our other products during the second fiscal quarter and from PPGI products due to changes in product mix.

 

The following table sets forth revenue by geography and by business segments for the three months ended December 31, 2011 and 2010.

 

(All amounts, other than percentages, in thousands of U.S. dollars)

 

   Three Months Ended
December 31, 2011
   Three Months Ended
December 31, 2010
 
   Amount   % of
Revenue
   Amount   % of
Revenue
 
Geographic Data                    
China  $93,545    86.7%  $91,855    92.4%
Other Countries   14,350    13.3%   7,568    7.6%
                     
Segment Data                   
Changshu Huaye  $38,156    35.4%  $38,765    39.0%
Jiangsu Cold-Rolled   52,181    48.4%   52,217    52.5%
Ningbo Zhehua   15,,328    14.2%   8,441    8.5%
Sutor Technology   2,230    2.0%          

 

On a geographic basis, revenue generated from outside of China was approximately $14.4 million, or 13.3% of the total revenue, for the three months ended December 31, 2011, as compared to $7.6 million, or 7.6% of the total revenue, for the same period in 2010. The increase was mainly resulted from our efforts to expand product penetration into new markets, increase brand recognition, and foster acceptance of our products in the international markets.

 

On a segment basis, after eliminating intercompany sales and adjusting reconciliation items, revenue contributed by Changshu Huaye was approximately $38.2 million for the three months ended December 31, 2011, a decrease of approximately $0.6 million, or 1.6%, from approximately $38.8 million in the same period last year. The decrease mainly resulted from a reduction in production of low-end PPGI products as we shifted our focus to produce high-end and more profitable PPGI products, partially offset by higher HDG volumes and the ASP.

 

23
 

  

After eliminating the inter-company sales and adjusting reconciliation items, revenue contributed by Jiangsu Cold-Rolled remained stable at approximately $52.2 million for the three months ended December 31, 2011, as compared at approximately $52.2 million for the same period last year. The impact of lower sales of cold-rolled steel of approximately $4.8 million due to more in-house produced cold-rolled steel used to feed the HDG and PPGI production lines as well as lower revenue of approximately $2.0 million from acid pickled steel was offset by higher sales volume and the ASP of our HDG Steel products utilizing our 400,000 MT HDG production lines. We generated approximately $43.3 million from these HDG production lines in the three months ended December 31, 2011 as compared to approximately $37.4 million in the same period last year.

 

Revenue contributed by Ningbo Zhehua was approximately $15.3 million for the three months ended December 31, 2011, an increase of $6.9 million, or approximately 82.1% from $8.4 million in the same period in 2010, primarily resulting from a significant increase in the sales of spiral steel pipes and other products as we completed a large customer order in December 2011.

 

In terms of sales involving related parties as compared with sales to unrelated parties, our direct sales to unrelated parties in the three months ended December 31, 2011 increased $27.4 million, or 49.2%, to $83.1 million from $55.7 million in the same period in 2010 as we continued to expand our own sales channels.

 

Cost of revenue. Cost of revenue increased approximately $7.5 million, or 8.3%, to $97.5 million in the three months ended December 31, 2011, from approximately $90.0 million in the same period in 2010. As a percentage of revenue, cost of revenue remained stable at approximately 90.4% in the three months ended December 31, 2011, as compared to the same period last year. The increased amount of the cost of revenue was generally in line with the increased sales revenue.

 

Gross profit and gross margin. Gross profit increased approximately $0.9 million to $10.4 million in the three months ended December 31, 2011 from $9.5 million in the same period in 2010. Gross profit as a percentage of revenue (gross margin) remained stable as 9.6% in the three months ended December 31, 2011 and 2010.

 

On a segment basis, gross margin for Changshu Huaye increased to 14.9% in the three months ended December 31, 2011 from 11.5% in the same period last year, mainly because of increased ASP and international sales. Gross margin for Jiangsu Cold-Rolled increased to 7.0% in the three months ended December 31, 2011 from 6.3% in the same period last year, mainly due to the higher capacity utilization of our new HDG production lines, which reduced the average unit production cost. Gross margin for Ningbo Zhehua decreased to 6.7% in the three months ended December 31, 2011, as compared to 18.1% in the same period in 2010, mainly because we sold more low-margin spiral steel pipes.

 

Total operating expenses. Our total operating expenses increased approximately $1.0 million to $4.7 million in the three months ended December 31, 2011, from $3.7 million in the same period in 2010. As a percentage of revenue, our total operating expenses increased to approximately 4.3% in the three months ended December 31, 2011 from 3.7% in the same period in 2010.

 

Selling expenses. Our selling expenses increased approximately $0.1 million to $2.1 million in the three months ended December 31, 2011, from $2.0 million in the same period in 2010. As a percentage of revenue, our selling expenses decreased to 1.9% for the three months ended December 31, 2011, from 2.0% for the same period last year.

 

General and administrative expenses. General and administrative expenses increased $0.9 million to $2.6 million, or 2.4% of the total revenue, in the three months ended December 31, 2011, from $1.7 million, or 1.7% of the revenue, in the same period in 2010. The increased general and administrative expenses were primarily due to business expansion, increased labor costs and insurance premiums, and higher management expenses as a result of the recent overall inflationary environment in China. Compared with the same period of last year, our wages and salaries increased by approximately $0.4 million, insurance premiums by $0.2 million, and office expenses by $0.1 million as we moved into a new office building in May 2011. 

 

Interest expense. Our interest expense increased $0.1 million to $2.4 million in the three months ended December 31, 2011, from $2.3 million in the same period in 2010. As a percentage of revenue, our interest expenses was 2.3% of the total revenue in the three months ended December 31, 2011, compared to 2.3% in the same period in 2010.

 

Provision for income taxes. Our income tax expense decreased to approximately $0.5 million due to lower taxable income in the three months ended December 31, 2011, from $0.6 million in the same period last year.

 

24
 

 

Net income. Net income, without including the foreign currency translation adjustment, decreased approximately $0.1 million, or 3.4%, to $2.8 million in the three months ended December 31, 2011, from $2.9 million in the same period in 2010, as a cumulative result of the above factors.

 

Comparison of Six Months Ended December 31, 2011 and December 31, 2010

 

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

 

(All amounts, other than percentages, in thousands of U.S. dollars)

 

   Six Months Ended
December 31, 2011
   Six Months Ended
December 31, 2010
 
   Amount   % of
Revenue
   Amount   % of
Revenue
 
Revenue                    
Revenue from unrelated parties  $181,467    76.2%  $95,281    47.3%
Revenue from related parties   56,623    23.8%   106,089    52.7%
Total   238,090    100%   201,370    100.0%
Cost of Revenue                    
Cost of revenue from unrelated parties   165,952    69.7%   86,038    42.7%
Cost of revenue from related parties   50,738    21.3%   97,442    48.4%
Total   216,690    91.0%   183,480    91.1%
Gross Profit   21,400    9.0%   17,890    8.9%
Operating Expenses                    
Selling expense   4,414    1.9%   3,363    1.7%
General and administrative expense   5,504    2.3%   3,363    1.7%
Total Operating Expenses   9,918    4.2%   6,726    3.3%
Income from Operations   11,482    4.8%   11,164    5.5%
Other Income (Expense)                    
Interest income   678    0.3%   438    0.2%
Other income   20    0.0%   121    0.1%
Interest expense   (4,167)   (1.8)%   (3,870)   (1.9)%
Other expense   (859)   (0.3)%   (275)   (0.1)%
Total Other Income (Expense)   (4,328)   (1.8)%   (3,586)   (1.7)%
Income Before Taxes   7,154    3.0%   7,578    3.8%
Income tax (expense)/benefit   400    0.2%   (1,232)   (0.6)%
Net Income  $7,554    3.2%  $6,346    3.2%

  

Revenue. For the six months ended December 31, 2011, revenue was $238.1 million, compared to $201.4 million for the same period last year, an increase of approximately $36.7 million, or 18.2%. The increase was mainly attributable to both ASP increases and sales volume increases for our major products including HDG and PPGI products as compared to the same period last year. The sales revenue from our PPGI products, HDG products and steel pipes business, increased approximately 27.8%, 25.0%, and 103.0%, respectively, partially offset by lower revenue from our cold-rolled products as more cold-rolled products were used internally as intermediate products to produce HDG steel and PPGI.

 

The following table sets forth revenue by geography and by business segments for the six months ended December 31, 2011 and 2010.

 

(All amounts, other than percentages, in thousands of U.S. dollars)

 

   Six Months Ended
December 31, 2011
   Six Months Ended
December 31, 2010
 
   Amount   % of
Revenue
   Amount   % of
Revenue
 
Geographic Data                    
China  $198,906    83.5%  $186,772    92.8%
Other Countries   39,185    16.5%   14,598    7.2%
                     
Segment Data                   
Changshu Huaye  $88,040    37.0%  $80,739    40.1%
Jiangsu Cold-Rolled   117,137    49.2%   105,954    52.6%
Ningbo Zhehua   29,782    12.5%   14,677    7.3%
Sutor Technology   3,132    1.3%          

  

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On a geographic basis, revenue generated from outside of China was $39.2 million, or 16.5% of the total revenue, for the six months ended December 31, 2011, as compared to $14.6 million, or 7.2% of the total revenue, for the same period in 2010. The increase was mainly resulted from our efforts to expand product penetration into new and existing markets, increase brand recognition, and foster acceptance of our products in the international markets.

 

On a segment basis, after eliminating intercompany sales and adjusting reconciliation items, revenue contributed by Changshu Huaye was approximately $88.0 million for the six months ended December 31, 2011, an increase of $7.3 million, or 9.0%, from $80.7 million in the same period last year. The increase was primarily due to both higher sale volume and ASP for our PPGI products in the six months ended December 31, 2011 than in the same period last year.

 

After eliminating the inter-company sales and adjusting reconciliation items, revenue contributed by Jiangsu Cold-Rolled was approximately $117.1 million for the six months ended December 31, 2011, an increase of $11.1 million, or 10.5%, from approximately $106.0 million for the same period last year, mainly as a result of higher sales volume and the ASP of our HDG steel products utilizing our 400,000 MT HDG production lines, partially offset by lower revenue of approximately $16.3 million from our cold-rolled products as more cold-rolled products were used internally as intermediate products for HDG steel PPGI products. We generated approximately $90.8 million from these HDG production lines in the six months ended December 31, 2011 as compared to approximately $64.5 million in the same period last year, or up $26.4 million.

 

Revenue contributed by Ningbo Zhehua was $29.8 million for the six months ended December 31, 2011, an increase of $15.1 million from $14.7 million in the same period in 2010, primarily resulting from a significant increase in the sales of spiral steel pipes.

 

In terms of related party sales as compared with sales to unrelated parties, our direct sales to unrelated parties in the six months ended December 31, 2011 increased $86.2 million, or 90.5%, to $181.5 million from $95.3 million in the same period in 2010.

 

Cost of revenue. Cost of revenue increased $33.2 million, or 18.1%, to $216.7 million in the six months ended December 31, 2011 from $183.5 million in the same period in 2010. As a percentage of revenue, cost of revenue decreased slightly to 91.0% in the six months ended December 31, 2011 from 91.1% in the same period last year. We believe the increase in cost of revenue was generally in line with the increase in sales revenue.

 

Gross profit and gross margin. Gross profit increased $3.5 million to $21.4 million in the six months ended December 31, 2011 from $17.9 million in the same period in 2010. Gross profit as a percentage of revenue (gross margin) was 9.0% in the six months ended December 31, 2011, as compared to 8.9% in the same period in 2010.

 

On a segment basis, gross margin for Changshu Huaye increased to 12.9% in the six months ended December 31, 2011 from 10.7% in the same period last year, mainly because it exported more products in the six months ended December 31, 2011 than the same period in 2010 and our international sales generally have a higher gross margin than domestic sales. Gross margin for Jiangsu Cold-Rolled increased to 6.3% in the six months ended December 31, 2011 from 5.8% in the same period last year, mainly due to the higher capacity utilization of our new HDG production lines, which reduced the average unit production costs. Gross margin for Ningbo Zhehua decreased to 7.9% in the six months ended December 31, 2011, as compared to approximately 15.0% in the same period in 2010, mainly because we offered discounted prices to certain customers in new markets to establish long-term relationships and gain market shares. We also sold more low-margin spiral steel pipes during this period of time.

 

Total operating expenses. Our total operating expenses increased approximately $3.2 million to $9.9 million in the six months ended December 31, 2011 from $6.7 million in the same period in 2010. As a percentage of revenue, our total operating expenses increased to 4.2% in the six months ended December 31, 2011 from 3.3% in the same period in 2010.

 

26
 

 

Selling expenses. Our selling expenses increased approximately $1.0 million to $4.4 million in the six months ended December 31, 2011, from $3.4 million in the same period in 2010. As a percentage of revenue, our selling expenses increased to 1.9% for the six months ended December 31, 2011, from 1.7% for the same period last year. The dollar and percentage increase of selling expenses was primarily due to the increased international sales which generally had relatively higher shipping costs than domestic sales.

 

General and administrative expenses. General and administrative expenses increased $2.1 million to $5.5 million, or 2.3% of the total revenue, in the six months ended December 31, 2011, from $3.4 million, or 1.7% of revenue, in the same period in 2010. The increased general and administrative expenses were mainly because the increased labor costs, insurance premiums, administrative and startup expenses associated with Sutor Technology and management expenses caused by overall inflationary environment in China.

 

Interest expense. Our interest expense increased $0.3 million to $4.2 million in the six months ended December 31, 2011, from $3.9 million in the same period in 2010 mainly due to higher interest rate for bank loans. As a percentage of revenue, our interest expenses decreased to 1.8% in the six months ended December 31, 2011, from 1.9% in the same period in 2010.

 

Provision for income taxes. Our income tax benefit was $0.4 million in the six months ended December 31, 2011 as compared to the income expense of $1.2 million in the same period last year, primarily due to tax refunds. In the six months ended December 31, 2011, Changshu Huaye and Jiangsu Cold-Rolled received tax refunds of $0.3 million and $1.1 million, respectively.

 

Net income. Net income, without including the foreign currency translation adjustment, increased $1.3 million, or 20.6%, to $7.6 million in the six months ended December 31, 2011, from $6.3 million in the same period in 2010, as a cumulative result of the above factors.

 

Liquidity and Capital Resources

 

Our major sources of liquidity for the periods covered by this report were borrowings through short-term bank and private loans and long-term notes payable. Our operating activities provided approximately $20.3 million of cash in the six months ended December 31, 2011. As of December 31, 2011, our total indebtedness to non-related parties under existing short-term loans was approximately $108.6 million. We also had approximately $38.1 million under long-term notes payable to non-related parties. We had no notes payable to related parties, however, approximately $30.7 million of our short-term notes payable were guaranteed by Shanghai Huaye and its affiliates. As of December 31, 2011, we also had an unused line of credit with banks of approximately $31.4 million (RMB 200 million) which entitled us to draw bank loans for general corporate purposes.

 

Short-term bank and private loans and notes payable are likely to continue to be our key sources of financing for the foreseeable future, although in the future we may raise additional capital by issuing shares of our capital stock in an equity financing. We expect to renew our short term loans when they become due.

 

Our liquidity and working capital may be affected by a material decrease in cash flow due to factors such as the continued use of cash in operating activities resulting from a decrease in sales due to the current or future domestic and global economic recessions, increased competition, decreases in the availability, or increases in the cost of raw materials, unexpected equipment failures, or regulatory changes.

 

As stated above, a portion of our operations is funded through short-term bank loans and we expect to renew our short term loans when they become due. We are exposed to a variety of risks associated with short-term borrowings including adverse fluctuations in fixed interest rates for short-term borrowings and unfavorable increases in variable interest rates, potential inability to service our short term indebtedness through cash flow from operations and the overall reduction of credit in the current economic environment.

 

27
 

  

Our liquidity and working capital may also be affected by the substantial amount of our outstanding short-term loans, which represent our primary source of financing in China. Depending on the level of cash used in our operating activities and the level of our indebtedness, (i) it may become more difficult for us to satisfy our existing or future liabilities or obligations, which could in turn result in an event of default on such obligations, (ii) we may have to dedicate a substantial portion of our cash flows from borrowings to our operating activities and to debt service payments, thereby reducing the availability of cash for working capital and capital expenditures, acquisitions, general corporate purposes or other purposes, (iii) our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, general corporate purposes or other purposes may become impaired, (iv) our ability to withstand a downturn in our business, the industry in which we operate or the economy generally may be diminished, (v) we may experience limited flexibility in planning for, or reacting to, changes in our business and the industry in which we operate and (vi) we may find ourselves at a competitive disadvantage compared to competitors that have proportionately less debt. If we are unable to meet our debt service obligations, we could be forced to restructure or refinance our indebtedness, seek additional equity capital or sell assets. We may be unable to obtain financing or sell assets on satisfactory terms, or at all, which could cause us to default on our debt service obligations and be subject to foreclosure on such loans. Additionally, we could incur additional indebtedness in the future and, if new debt is added to our current debt levels, the risks above could intensify.

 

As some of our loans become due, we may elect to refinance, rather than repay, the indebtedness. However, there is no assurance that additional financing will become available on terms acceptable to us. We believe that we will have the ability to refinance our indebtedness when and if we elect to do so. While we currently are not in a position to know the terms of such refinancing, we expect to refinance our indebtedness at prevailing market rates and on prevailing market terms.

 

As of December 31, 2011, we had cash and cash equivalents (excluding restricted cash) of $7.0 million and restricted cash of $124.4 million. The following table provides detailed information about our net cash flow for the financial statement period presented in this report.

 

Cash Flow

(All amounts in thousands of U.S. dollars)

 

   Six Months Ended December 31, 
   2011   2010 
Net cash (used in) provided by operating activities  $20,321   $(10,682)
Net cash (used in) provided by investing activities   (60,939)   3,100 
Net cash provided by financing activities   26,067    3,023 
Effect of foreign currency translation on cash and cash equivalents   228    339 
Net cash flows   (14,323)   (4,220)

 

Operating Activities

 

Net cash provided by operating activities was approximately $20.3 million for the six months ended December 31, 2011, an increase of approximately $31.0 million from approximately $10.7 million of cash used in operating activities for the same period last year. The increase in net cash provided by operating activities was primarily due to increases in accounts payable, partially offset by the increased cash outflow for accounts receivable and inventory for the six months ended on December 31, 2011 as compared with the same period last year. At the year end of 2011, because we acquired more raw materials, our payment process slowed down. In addition, we increased inventories in anticipation of increased business needs. 

 

Investing Activities

 

Our main uses of cash for investing activities are payments relating to the acquisition of property, plant and equipment and restricted cash pledged as deposits for bankers’ acceptance bills.

 

Net cash used in investing activities during the six months ended December 31, 2011 was approximately $60.9 million, as compared to $3.1 million of cash provided by investing activities for the same period in 2010. The significant increase in net cash used for investing activities was primarily due to an increase in changes in restricted cash of approximately $55.3 million for the six months ended December 31, 2011 as compared to the six months ended December 31, 2010. We increased the amount of restricted cash in an effort to secure more bank loans and maintain liquidity as the money supply was tight in China.  

 

Financing Activities

 

Net cash provided by financing activities for the six months ended December 31, 2011 totaled $26.1 million, as compared to $3.0 million for the same period in 2010. The increase in net cash provided by financing activities was mainly due to an increase in proceeds from bank loans, partially offset by the cash used to pay back the debts that matured during the period.

 

28
 

  

As of December 31, 2011, the amount, maturity date and term of each of our loans were as follows: 

 

(All amounts in million of U.S. dollars)

 

        Starting    Maturity     
Lender   Amount*   Date   Date   Guarantor**
Industrial and Commercial Bank of China, Changshu Branch   $ 3.15   2011-05-20   2012-05-19   Changshu Huaye
The Agricultural Bank of China, Singapore Branch     10.00   2011-07-29   2012-07-29   Jiangsu Cold-Rolled
The Agricultural Bank of China, Changshu Branch     3.15   2011-10-28   2012-04-26   Jiangsu Cold-Rolled, Shanghai Huaye
Communications Bank of China, Changshu Branch     3.15   2011-11-14   2012-11-14   Shanghai Huaye
The Agricultural Bank of China, Changshu Branch     3.15   2011-11-28   2012-11-27   Jiangsu Cold-Rolled, Shanghai Huaye
Construction Bank of China, Changshu Branch     6.29   2011-11-17   2012-11-16   None
The Agricultural Bank of China, Changshu Branch     3.93   2011-12-22   2012-12-21   Jiangsu Cold-Rolled, Shanghai Huaye
Construction Bank of China, Changshu Branch     0.22   2011-11-07   2012-01-20   Jiangsu Cold-Rolled
Construction Bank of China, Changshu Branch     0.78   2011-12-05   2012-02-23   Jiangsu Cold-Rolled
Construction Bank of China, Changshu Branch     0.74   2011-12-05   2012-02-16   Jiangsu Cold-Rolled
The Agricultural Bank of China, Changshu Branch     2.36   2011-01-21   2012-01-20   Changshu Huaye, Shanghai Huaye
Industrial and Commercial Bank of China, Changshu Branch     3.15   2011-03-02   2012-02-29   Changshu Huaye, Shanghai Huaye
The Agricultural Bank of China, Changshu Branch     7.39   2011-07-25   2012-07-21   Changshu Huaye, Shanghai Huaye
The Agricultural Bank of China, Changshu Branch     6.29   2011-08-19   2012-08-16   Changshu Huaye, Shanghai Huaye
The Agricultural Bank of China, Changshu Branch     4.72   2011-09-05   2012-09-05   Changshu Huaye, Shanghai Huaye
The Agricultural Bank of China, Changshu Branch     6.29   2011-09-28   2012-09-27   None
Communications Bank of China, Changshu Branch     11.64   2011-09-27   2014-09-11   Changshu Huaye
The Agricultural Bank of China, Changshu  Branch     2.52   2011-10-25   2012-10-24   Changshu Huaye, Shanghai Huaye
Industrial and Commercial Bank of China, Changshu Branch     2.36   2011-10-31   2012-04-27   Changshu Huaye
The Agricultural Bank of China, Changshu Branch     7.86   2011-11-10   2012-11-09   Changshu Huaye, Shanghai Huaye
Industrial and Commercial Bank of China, Changshu Branch     0.79   2011-11-02   2012-04-27   Changshu Huaye
The Agricultural Bank of China, Changshu Branch     5.35   2011-11-21   2012-11-20   Changshu Huaye, Shanghai Huaye
The Agricultural Bank of China, Changshu Branch     10.22   2011-12-12   2012-12-11   Changshu Huaye, Shanghai Huaye
Industrial and Commercial Bank of China, Changshu Branch     1.57   2011-12-28   2012-12-26   Changshu Huaye
Chinatrust Commercial Bank, Hong Kong Branch     9.50   2011-12-29   2012-12-13   Jiangsu Cold-Rolled
Shenzhen Development Bank     1.57   2011-08-23   2012-08-23   Shanghai Huaye
The Agricultural Bank of China, Ningbo Branch     2.09   2011-10-21   2012-01-17   Shanghai Huaye
Lin, GuiHua     2.86   2008-11-20   2013-12-31   None
Macao International Bank Co., LTD     6.99   2011-02-23   2013-02-21   None
Macao International Bank Co., LTD     5.06   2011-03-11   2013-02-21   None
Macao International Bank Co., LTD     4.78   2011-03-23   2013-02-21   None
Macao International Bank Co., LTD     5.08   2011-04-01   2013-02-21   None
Macao International Bank Co., LTD     1.72   2011-04-11   2013-02-21   None
Total   $ 146.69            

 

29
 

 

 

 

* Calculated on the basis that $1 = RMB 6.36

** We do not pay any consideration to Shanghai Huaye or its affiliated companies, which are controlled by our CEO and her spouse, for the guarantees of our loans.

 

The loan agreements with banks generally contain debt covenants that require us to maintain certain financial and operating condition, among other things. We believe that we were in material compliance with these debt covenants as of December 31, 2011.

 

In the coming 12 months, we will have approximately $108.6 million in bank loans that will mature. We plan to replace these loans with new bank loans in approximately the same aggregate amounts.

 

We believe that our currently available working capital, credit facilities referred to above and the expected additional credit facility should be adequate to sustain our operations at the current level for at least the next twelve months. However, depending on our future needs and changes and trends in the capital markets affecting our shares and the Company, we may determine to seek additional equity or debt financing in the private or public markets.

 

Critical Accounting Policies

 

Interim Unaudited Financial Statements – The accompanying unaudited condensed consolidated financial statements of the Company and its subsidiaries as of December 31, 2011 and for the three and six months ended December 31, 2011 and 2010 reflect all adjustments (consisting only of normal recurring adjustments) that, in the opinion of management, are necessary to present fairly the consolidated financial position and results of operations of the Company for the periods presented. Operating results for the three and six months ended December 31, 2011 are not necessarily indicative of the results that may be expected for the year ending June 30, 2012. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2011. The Company follows the same accounting policies in the preparation of interim reports.

 

Principles of Consolidation – The accompanying unaudited condensed consolidated financial statements include the accounts and transactions of Sutor Technology Group Limited and its subsidiaries for all periods presented. All significant intercompany accounts and transactions have been eliminated in consolidation.

 

Functional Currency and Translating Financial Statements - In accordance with guidance now incorporated in ASC Topic 830 (formerly FAS 52), foreign currency transactions in RMB are reflected using the temporal method. Under this method, all monetary items are translated into the functional currency at the rate of exchange prevailing at the balance sheet date. Non-monetary items, including shareholder equity, are translated at historical rates. Income and expenses are translated at the rate in effect on the transaction dates. Transaction gains and losses, if any, are included in the determination of net income for the period. Sutor Technology Group Limited (incorporated in US) and Sutor Steel Technology Co., Ltd. (incorporated in BVI), maintain their books and records in U.S. dollars, “USD,” the currency of U.S.A., their functional currency. The Company’s subsidiaries based in PRC maintain their books and records in Renminbi (“RMB”), their functional currency. In translating the financial statements of the Company’s China subsidiaries from their functional currency into the Company's reporting currency of United States dollars, balance sheet accounts are translated using the closing exchange rate in effect at the balance sheet date and income and expense accounts are translated using an average exchange rate prevailing during the reporting period. Adjustments resulting from the translation, if any, are included in cumulative other comprehensive income (loss) in stockholders’ equity.

 

   December 31,
2011
   December 31, 
2010
   June 30,
2011
 
Closing RMB : USD exchange rate at the period end   6.3585    6.6118    6.4635 
Average 6 months RMB : USD exchange rate   6.3892    6.7237      

 

Accounting Estimates - The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could materially differ from those estimates. The estimates and assumptions that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities are provision for doubtful accounts on trade receivables, notes receivables, other receivables, advances to suppliers, reserves for inventory, estimated useful lives of property and equipment, valuation allowance for deferred tax assets and share-based compensation.

 

30
 

  

Trade Accounts Receivable and Other Receivables - Trade accounts receivables and other receivables are carried at original invoiced amounts less an allowance for doubtful accounts. Other receivables consist of amounts advanced to suppliers, but subsequently not used, resulting in a receivable.

 

Allowance for doubtful accounts – Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The Company provides a general provision for doubtful accounts for the outstanding trade receivable balances based on historical experience and information available. Additionally, the Company makes specific bad debt provisions based on (i) specific assessment of the collectability of all significant accounts; and (ii) any specific knowledge the Company has acquired that might indicate that an account is uncollectible. The facts and circumstances of each account may require the Company to use substantial judgment in assessing its collectability.

 

Revenue Recognition - The Company recognizes revenues from the sale of products when they are realized and earned. The Company considers revenue realized and earned when (1) it has persuasive evidence of an arrangement, (2) delivery has occurred, (3) the sales price is fixed or determinable, and (4) collectability is reasonably assured. Revenues are not recognized until products have been shipped to the client, risk of loss has transferred to the client and client acceptance has been obtained, client acceptance provisions have lapsed, or the Company has objective evidence that the criteria specified in client acceptance provisions have been satisfied.

 

The Company sells some products to affiliates, who in turn sell the product to various other third party customers. The price, terms and conditions on the sales to affiliates are the same as those to third parties. Revenue is considered realized or realizable and earned when the affiliates ship the product to third party customers. A fee of 0.5% of the sale is paid to the affiliate for handling the product. Handling fees were $109,090 and $124,033for the three months ended December 31, 2011 and 2010 respectively and have been classified as selling expenses in the statement of operations. Handling fees were $117,985and $283,422for the six months ended December 31, 2011 and 2010 respectively and have been classified as selling expenses in the statement of operations.

 

Recent Accounting Pronouncements

 

In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-04, “Fair Value Measurement (Topic 820)”: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The new guidance results in a consistent definition of fair value and common requirements for measurement of and disclosure about fair value between US GAAP and IFRS. The new guidance changes some fair value measurement principles and disclosure requirements. The disclosure requirements have been enhanced. The most significant change will require entities, for their recurring Level 3 fair value measurements, to disclose quantitative information about unobservable inputs used, a description of the valuation processes used by the entity, and a qualitative discussion about the sensitivity of the measurements. New disclosures are required about the use of a nonfinancial asset measured or disclosed at fair value if its use differs from its highest and best use. In addition, entities must report the level in the fair value hierarchy of assets and liabilities not recorded at fair value but where fair value is disclosed. The amendments in this update are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. The adoption of ASU 2011-04will not have a material effect on the financial position, results of operations or cash flows of the Company.

 

In September 2011, the FASB issued ASU 2011-08, “Intangibles—Goodwill and Other (Topic 350)”.The amendments in this Update will allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under these amendments, an entity would not be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The amendments include a number of events and circumstances for an entity to consider in conducting the qualitative assessment. It will not have a material effect on the financial position, results of operations or cash flows when the Company adopts this standard in future.

 

In December 2011, the FASB issued ASU 2011-11, “Balance Sheet (Topic 210)”. The objective of this Update is to provide enhanced disclosures that will enable users of its financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position. This includes the effect or potential effect of rights of setoff associated with an entity’s recognized assets and recognized liabilities within the scope of this Update. The amendments require enhanced disclosures by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either Section 210-20-45 or Section 815-10-45.An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The Company is currently assessing the impact, if any, that the adoption of this update will have on its consolidated financial statements and disclosures.

 

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In December 2011, the FASB issued ASU 2011-12, “Comprehensive Income (Topic 220)”. The amendments in this Update supersede certain pending paragraphs in Accounting Standards Update No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, to effectively defer only those changes in Update 2011-05 that relate to the presentation of reclassification adjustments out of accumulated other comprehensive income. The amendments will be temporary to allow the Board time to redeliberate the presentation requirements for reclassifications out of accumulated other comprehensive income for annual and interim financial statements for public, private, and non-profit entities. The amendments in this Update are effective at the same time as the amendments in Update 2011-05 so that entities will not be required to comply with the presentation requirements in Update 2011-05 that this Update is deferring. For this reason, the transition guidance in paragraph 220-10-65-2 is consistent with that for Update 2011-05. The amendments in this Update are effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2011. For nonpublic entities, the amendments are effective for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. The adoption of this standard is not expected to have a material effect on the financial position, results of operations or cash flows of the Company.

 

Seasonality

 

Our operating results and operating cash flows historically have not been subject to significant seasonal variations. This pattern may change, however, as a result of new market opportunities or new product introductions.

 

Off Balance Sheet Arrangements

 

We do not have any off-balance arrangements.

 

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) that are designed to ensure that information that would be required to be disclosed in Exchange Act reports is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including to our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

As required by Rule 13a-15 under the Exchange Act, our management, including our Chief Executive Officer, Ms. Lifang Chen, and Chief Financial Officer, Mr. Yongfei Jiang, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2011. Based on our assessment, Ms. Chen and Mr. Jiang determined that, as of December 31, 2011, our disclosure controls and procedures were effective.

 

Changes in Internal Control Over Financial Reporting

 

There were no changes in our internal control over financial reporting identified in connection with the evaluation performed during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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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.

 

During the second quarter of fiscal year 2012, we repurchased 402,887 shares of our common stock for $474,024 using available cash resources. The repurchases occurred in the open market. As of December 31, 2011, approximately $4.5 million remained of our $5 million repurchase program that we announced on August 30, 2011. The program expires August 31, 2012 but may be suspended or discontinued at any time without notice.

 

 

Period  Total
Number of
Shares 
Repurchased
   Average
Price Paid
per Share
   Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
   Approximate Dollar
Value of Shares that
May Yet be
Repurchased under
the Program
(in millions)
 
October 1, 2011 – October 31, 2011   180,600   $1.08    180,600    4.75 
November 1, 2011 – November 30, 2011   193,687   $1.26    193,687    4.50 
December 1, 2011 – December 31, 2011   28,600   $1.13    28,600    4.47 
Total   402,887         402,887      

 

No repurchase plans expired or were terminated during the second quarter of fiscal year 2012, nor do any plans exist under which we do not intend to make further purchases.

 

ITEM 3.DEFAULTS UPON SENIOR SECURITIES.

 

None.

 

ITEM 4.MINE SAFETY DISCLOSURES.

 

Not applicable.

 

ITEM 5.OTHER INFORMATION.

 

We have no information to disclose that was required to be in a report on Form 8-K during the period covered by this report, but was not reported. There have been no material changes to the procedures by which security holders may recommend nominees to our board of directors.

 

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ITEM 6.EXHIBITS.

 

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

  

Exhibit No.   Description
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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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: February 14, 2012 SUTOR TECHNOLOGY GROUP LIMITED
     
     
  By:  /s/ Lifang Chen
  Lifang Chen, Chief Executive Officer
  (Principal Executive Officer)

 

  By:  /s/ Yongfei Jiang
  Yongfei Jiang, Chief Financial Officer
 

(Principal Financial Officer and Principal

Accounting Officer)

 

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EXHIBIT INDEX

 

Exhibit No.

  Description
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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