Attached files

file filename
EXCEL - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDFinancial_Report.xls
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR8.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR2.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR5.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR6.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR4.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR9.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR3.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR7.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR16.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR22.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR10.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR15.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR21.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR23.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR19.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR20.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR11.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR14.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR18.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR13.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR12.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR17.htm
EX-32.2 - EXHIBIT 32.2 - Sutor Technology Group LTDv312825_ex32-2.htm
EX-31.1 - EXHIBIT 31.1 - Sutor Technology Group LTDv312825_ex31-1.htm
EX-32.1 - EXHIBIT 32.1 - Sutor Technology Group LTDv312825_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - Sutor Technology Group LTDv312825_ex31-2.htm
XML - IDEA: XBRL DOCUMENT - Sutor Technology Group LTDR1.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: March 31, 2012

 

¨ 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 x No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

 

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

 

Large accelerated filer £ Accelerated filer £
Non-accelerated filer ¨ (Do not check if a smaller reporting company) Smaller reporting company x

 

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

 

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

 

Class of Securities   Shares Outstanding
Common Stock, $0.001 par value   40,345,780

 

 
 

 

SUTOR TECHNOLOGY GROUP LIMITED

 

Quarterly Report on Form 10-Q

 Period Ended March 31, 2012

 

 

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 2
Item 3. Quantitative and Qualitative Disclosures About Market Risk 14
Item 4. Controls and Procedures 14
     
  PART II  
  OTHER INFORMATION  
     
Item 1. Legal Proceedings 16
Item 1A. Risk Factors 16
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 16
Item 3.  Defaults Upon Senior Securities 16
Item 4. Mine Safety Disclosures 17
Item 5. Other Information 17
Item 6. Exhibits 17

 

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 March 31, 2012 and Condensed Consolidated Balance Sheets as of June 30, 2011   F-1
     
Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income for the Three and Nine Months Ended March 31, 2012 and 2011   F-2
     
Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended March 31, 2012 and 2011   F-3
     
Notes to Unaudited Condensed Consolidated Financial Statements   F-4 - F-19

 

 
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

   March 31,   June 30, 
   2012   2011 
ASSETS          
Current Assets:          
Cash and cash equivalents  $5,543,404   $21,324,931 
Restricted cash   139,981,506    72,326,482 
Short-term investments   4,747,962    - 
Trade accounts receivable, net of allowance for doubtful accounts of $ 979,760 and $856,554, respectively   12,308,986    3,969,090 
Other receivables and prepayments, net of allowance for doubtful accounts of $ 337,434 and $529,068, respectively   1,785,800    2,004,044 
Advances to suppliers, related parties, net of allowance of $130,838 and $127,903, respectively   106,009,017    116,772,842 
Advances to suppliers, third parties, net of allowance of $223,794 and $493,761, respectively   38,322,228    42,067,716 
Inventory, net   84,052,192    46,197,179 
Notes receivable   522,276    168,029 
Deferred tax assets   361,117    363,497 
Total Current Assets   393,634,488    305,193,810 
           
Advances for Purchase of Long Term Assets   83,054    81,191 
Property, Plant and Equipment, net   87,930,444    79,103,131 
Intangible Assets, net   3,099,203    3,083,569 
TOTAL ASSETS  $484,747,189   $387,461,701 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY          
Current Liabilities:          
Accounts payable  $111,271,085   $55,674,454 
Advances from customers   10,364,964    11,737,085 
Other payables and accrued expenses   3,665,614    4,840,135 
Other payables - related parties   -    594,105 
Short-term loans   136,706,341    95,494,490 
Total Current Liabilities   262,008,004    168,340,269 
           
Long-Term Loans   13,605,682    23,626,900 
Total Liabilities   275,613,686    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 March 31, 2012 and June 30, 2011;          
issued: 40,805,602 shares and 40,745,602 shares as of March 31, 2012 and June 30, 2011, respectively;          
outstanding: 40,345,780 and 40,745,602 as of March 31, 2012 and June 30, 2011, respectively   40,805    40,745 
Additional paid-in capital   42,678,516    42,584,974 
Statutory reserves   15,662,039    15,662,039 
Retained earnings   115,910,157    107,137,213 
Accumulated other comprehensive income   35,376,255    30,069,561 
Less: Treasury stock, at cost   (534,269)   - 
Total Stockholders' Equity   209,133,503    195,494,532 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY  $484,747,189   $387,461,701 

 

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

 

F-1
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME

(Unaudited)

 

   For The Three Months Ended   For The Nine Months Ended 
   March 31,   March 31, 
   2012   2011   2012   2011 
                 
Revenue:                    
Revenue  $77,293,342   $62,521,577   $258,760,839   $157,802,440 
Revenue from related parties   32,641,713    38,853,040    89,264,631    144,942,388 
    109,935,055    101,374,617    348,025,470    302,744,828 
                     
Cost of Revenue                    
Cost of revenue   71,781,784    57,017,557    237,734,303    143,055,256 
Cost of revenue from related party sales   30,282,224    35,742,344    81,019,969    133,184,740 
    102,064,008    92,759,901    318,754,272    276,239,996 
                     
Gross Profit   7,871,047    8,614,716    29,271,198    26,504,832 
                     
Operating Expenses:                    
                     
Selling expenses   874,867    1,345,635    5,289,139    4,708,748 
General and administrative expenses   2,272,424    1,718,186    7,776,539    5,081,444 
Total Operating Expenses   3,147,291    3,063,821    13,065,678    9,790,192 
Income from Operations   4,723,756    5,550,895    16,205,520    16,714,640 
                     
Other Incomes/(Expenses):                    
Interest income   368,561    188,697    1,046,976    626,412 
Other income   85,323    2,594    105,273    123,886 
Interest expense   (3,484,944)   (1,986,540)   (7,652,460)   (5,856,643)
Other expense   79,488    (210,479)   (779,179)   (485,542)
Total Other Expenses, net   (2,951,572)   (2,005,728)   (7,279,390)   (5,591,887)
                     
Income Before Taxes   1,772,184    3,545,167    8,926,130    11,122,753 
Income tax expense   (553,515)   (76,958)   (153,186)   (1,308,895)
Net Income  $1,218,669   $3,468,209   $8,772,944   $9,813,858 
                     
Basic Earnings per Share  $0.03   $0.09   $0.22   $0.24 
Diluted Earnings per Share  $0.03   $0.09   $0.22   $0.24 
                     
Basic Weighted Average Shares Outstanding   40,345,780    40,727,935    40,531,461    40,719,653 
Diluted Weighted Average Shares Outstanding   40,345,780    40,727,935    40,531,461    40,719,653 
                     
Net Income  $1,218,669   $3,468,209   $8,772,944   $9,813,858 
Foreign currency translation adjustment   1,444,247    1,231,987    5,306,694    6,832,753 
Comprehensive Income  $2,662,916   $4,700,196   $14,079,638   $16,646,611 
                     

 

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

 

F-2
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

   For The Nine Months Ended 
   March 31, 
   2012   2011 
Cash Flows from Operating Activities:          
Net income  $8,772,944   $9,813,858 
Adjustments to reconcile net income to net cash provided by/(used in) operating activities          
Depreciation and amortization   6,492,260    5,715,855 
Deferred tax assets   10,738    54,587 
Foreign currency exchange (gain)/loss   (392,608)   191 
Stock based compensation   93,602    89,446 
Loss/(gain) on disposal of property, plant and equipment   72,892    (4,447)
Changes in current assets and liabilities:          
Trade accounts receivable, net   (8,291,096)   (5,228,146)
Other receivable and prepayment   264,671    (1,017,248)
Advances to suppliers   4,718,122    (15,922,866)
Advances to suppliers - related parties   13,630,723    (13,346,284)
Inventory   (36,851,431)   3,277,984 
Accounts payable   54,402,504    6,268,337 
Advances from customers   (1,619,409)   486,821 
Other payables and accrued expenses   (1,133,980)   (163,136)
Other payables - related parties   (608,674)   161,686 
Net Cash Provided by/(Used In) Operating Activities   39,561,258    (9,813,362)
           
Cash Flows from Investing Activities:          
Changes in notes receivable   (350,930)   59,884 
Purchase of property, plant and equipment, net of value added tax refunds received   (13,558,760)   (1,335,063)
Proceeds from disposal of property, plant and equipment   26,025    6,138 
Purchase of short-term investments   (4,755,262)   - 
Net changes in restricted cash   (66,096,711)   (12,595,955)
Net Cash Used In Investing Activities   (84,735,638)   (13,864,996)
           
Cash Flows from Financing Activities:          
Proceeds from loans   143,934,932    96,696,227 
Repayment of loans   (114,432,824)   (74,409,132)
Payments on repurchase of common stock   (534,269)   - 
Net Cash Provided by Financing Activities   28,967,839    22,287,095 
           
Effect of Exchange Rate Changes on Cash and Cash Equivalents   425,014    217,302 
           
Net Change in Cash and Cash Equivalents   (15,781,527)   (1,173,961)
Cash and Cash Equivalents at Beginning of Period   21,324,931    13,336,736 
Cash and Cash Equivalents at End of Period  $5,543,404   $12,162,775 
           
Supplemental Non-Cash Information:          
Offset of notes payable to related parties against receivable from related parties (Note 7)  $10,352,131   $9,959,383 
Supplemental Cash Flow Information:          
Cash paid during the period for interest expense  $(7,230,874)  $(5,426,740)
Cash paid during the period for income tax  $(476,495)  $(2,095,060)

 

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

 

F-3
 

 

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 March 31, 2012.

 

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 March 31, 2012 and 2011, approximately 94.2% and 87.4%, respectively, of the Company’s revenue was derived from sales of steel products within PRC. For the nine months ended March 31, 2012 and 2011, approximately 86.9% and 91.0%, respectively, of the Company’s revenue was derived from sales of steel products within PRC. 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 March 31, 2012 and for the three and nine months ended March 31, 2012 and 2011 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 nine months ended March 31, 2012 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 in ASC Topic 830, foreign currency transactions in Renminbi (“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 the PRC maintain their books and records in 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 USD, 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 in stockholders’ equity.

 

   March 31, 
2012
   March 31, 
2011
   June 30,
2011
 
Closing RMB : USD exchange rate at the period end   6.3185    6.5701    6.4635 
Average 9 months RMB : USD exchange rate   6.3088    6.6796      

 

F-4
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES - continued

 

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.

 

Short-term investments - Investments with stated maturities of greater than 90 days but less than 365 days are mainly time deposits that are classified as short-term investments. Short-term investments are classified as held-to-maturity and recorded at amortized cost when the Company has both the positive intent and ability to hold investments to maturity. As of March 31, 2012, all the short-term investments of the Company were classified as held-to-maturity.

 

Restricted Cash - The Company regularly pays some of its suppliers by bank acceptance notes. The Company has to deposit a cash deposit as a guarantee in the banks in order to obtain the bank acceptance notes. These pledged cash balances are presented in the consolidated balance sheets as restricted cash.

 

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 products 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 $47,905 and $82,866 for the three months ended March 31, 2012 and 2011 respectively and have been classified as selling expenses in the statement of operations. Handling fees were $66,371 and $366,288 for the nine months ended March 31, 2012 and 2011, 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 2011-04 will not have a material effect on the financial position, results of operations or cash flows of the Company.

 

F-5
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES - continued

 

Recent Accounting Pronouncements - continued

 

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.

 

NOTE 3 – SHORT-TERM INVESTMENTS

 

Short-term investments consisted of the following:

 

   Carrying   Unrealized   Estimated 
   Value   Gains/(Losses)   Fair Value 
                
 Held-to-maturity securities  $4,747,962   $-   $4,747,962 

 

No investment income was recognized related to the Company’s short-term investments for the three and nine months ended March 31, 2012 due to it is insignificant.

 

F-6
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 4 – INVENTORY

 

Inventory consisted of the following:

 

   March 31,   June 30, 
   2012   2011 
Raw materials  $47,174,684   $18,991,085 
Finished goods   36,967,881    27,294,440 
           
    84,142,565    46,285,525 
Less: allowance for obsolescence   (90,373)   (88,346)
           
Total Inventory, net  $84,052,192   $46,197,179 
           

 

NOTE 5 – 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 March 31, 2012 and June 30, 2011, certain of the Company’s property, plant and equipment amounting to approximately $40 million and $39 million, respectively, was pledged to banks to secure the loan granted to the Company.

 

Property and equipment consisted of the following:

 

   March 31,   June 30, 
   2012   2011 
Buildings and plant  $43,373,401   $40,388,929 
Machinery   71,775,356    69,744,627 
Office and other equipment   1,321,510    1,252,653 
Vehicles   479,989    434,288 
    116,950,256    111,820,497 
Less: accumulated depreciation   (42,239,075)   (35,081,522)
    74,711,181    76,738,975 
Construction in progress   13,219,263    2,364,156 
Total Property, Plant and Equipment, net  $87,930,444   $79,103,131 
           

 

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 March 31, 2012 and 2011 was $2,294,093 and $1,913,961, respectively.

Depreciation expense for the nine months ended March 31, 2012 and 2011 was $6,437,047 and $5,663,707, respectively.

 

F-7
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 6 - INTANGIBLE ASSETS

 

The Company’s intangible assets consisted 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 March 31, 2012 and 2011 was $18,867 and $17,611, respectively. Amortization expense for the nine months ended March 31, 2012 and 2011 was $55,213 and $52,148, respectively.

 

Information of intangible assets by segment is presented below:

 

As of March 31, 2012  Changshu Huaye   Jiangsu Cold-Rolled   Total 
Cost  $2,338,514   $1,336,703   $3,675,217 
Accumulated Amortization   (388,001)   (188,013)   (576,014)
   $1,950,513   $1,148,690   $3,099,203 
                

 

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  $18,376 
For the year ending June 30, 2013   73,504 
For the year ending June 30, 2014   73,504 
For the year ending June 30, 2015   73,504 
For the year ending June 30, 2016   73,504 
For the year ending June 30, 2017 and thereafter   2,786,810 

 

F-8
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 7 – 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 loans as of March 31, 2012 comprised of the following:

 

       March 31, 
   Maturity Date   2012 
Bank loan at 6.41% interest, secured by property, plant and equipment   4/26/2012    3,165,308 
Bank loan at 6.10% interest, unsecured   4/27/2012    3,165,308 
Bank loan at 6.31% interest, secured by property, plant and equipment   5/19/2012    3,165,308 
Bank loan at 5.90% interest, guaranteed by related party   7/21/2012    7,438,474 
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    6,330,616 
Bank loan at 7.22% interest, guaranteed by related party   8/23/2012    1,582,654 
Bank loan at 6.89% interest, guaranteed by related party   9/5/2012    4,747,962 
Bank loan at 5.97% interest, secured by property, plant and equipment   9/27/2012    6,330,616 
Bank loan at 5.97% interest, secured by property, plant and equipment   10/24/2012    2,532,247 
Bank loan at 5.97% interest, secured by property, plant and equipment   11/9/2012    7,913,271 
Bank loan at 7.87% interest, guaranteed by related party   11/14/2012    3,165,308 
Bank loan at 6.56% interest, secured by property, plant and equipment   11/16/2012    6,330,616 
Bank loan at 5.97% interest, secured by property, plant and equipment   11/20/2012    5,381,024 
Bank loan at 5.97% interest, secured by property, plant and equipment   11/27/2012    3,165,308 
Bank loan at 5.97% interest, secured by property, plant and equipment   12/11/2012    10,287,250 
Bank loan at 4.38% interest, unsecured   12/13/2012    9,500,000 
Bank loan at 6.56% interest, secured by property, plant and equipment   12/21/2012    3,956,635 
Bank loan at 6.56% interest, unsecured   12/26/2012    1,582,654 
Bank loan at 4.04% interest, secured by trade accounts receivable   4/30/2012    43,000 
Bank loan at 6.10% interest, secured by property, plant and equipment   6/28/2012    1,740,920 
Bank loan at 6.10% interest, secured by property, plant and equipment   7/30/2012    887,869 
Bank loan at 6.10% interest, unsecured   8/9/2012    3,165,308 
Bank loan at 6.10% interest, secured by property, plant and equipment   8/14/2012    5,127,804 
Bank loan at 6.04% interest, secured by property, plant and equipment   1/5/2013    2,373,981 
Bank loan at 3.99% interest, unsecured   2/21/2013    17,124,500 
Bank loan at 3.97% interest, unsecured   2/21/2013    6,502,400 
Total Short-term loan       $136,706,341 

 

F-9
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 7 - LOANS – continued

 

Short-term loans as of June 30, 2011 comprised of the following:

 

       June 30, 
   Maturity Date   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, plant and equipment   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, plant and equipment   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 5.23% interest, guaranteed by related party   1/20/2012    2,320,724 
Bank loan at 6.06% interest, guaranteed by related party   2/29/2012    3,094,299 
Bank loan at 6.31% interest, secured by property, plant and equipment   5/19/2012    3,094,299 
Total Short-term loan       $95,494,490 

 

Long-term loans as of March 31, 2012 and June 30, 2011 comprised of the following:

 

       March 31,   June 30, 
   Maturity Date   2012   2011 
Long-term bank loan at 3.99% interest, unsecured   2/21/2013    -    17,124,500 
Long-term bank loan at 3.97% interest, unsecured   2/21/2013    -    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    10,745,687    - 
Total Long-term loan       $13,605,682   $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 March 31, 2012 is 5.57%.

 

F-10
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 8 - RELATED PARTIES

 

Purchases from Related Parties

The Company sells its products to and buys raw materials from a number of companies which are ultimately owned or controlled by the same party (“Principal Stockholder”) as the Company. Revenues related to these transactions are shown separately in the accompanying unaudited condensed consolidated statements of operations. For the three months ended March 31, 2012 and 2011, purchases from these related parties totaled of $14,065,131 and $57,404,442, respectively. For the nine months ended March 31, 2012 and 2011, purchases from these related parties totaled of $111,820,655 and $160,697,670, 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 March 31, 2012 and June 30, 2011, the net amounts due from related parties were $106,009,017 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 March 31, 2012, the Company had letters of credit totaling $44,899,897 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 Related Parties

On December 20, 2007, Chen, Lifang (“Ms. Chen”), the Chairwoman and CEO of the Company, 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.

 

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 March 31, 2012 was $1,865,157 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 March 31, 2012, the accrued interest for the loans described above was $1,537,050. 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 $10,352,131 has been recorded as a reduction of advances to related parties in the accompanying balance sheet as of March 31, 2012.

 

F-11
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 8 - RELATED PARTIES – continued

 

Rental Agreement with Related Parties

On November 8, 2008, the Company entered into an agreement with the Ms. Chen 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 Ms. Chen approximately $17,500 per month. The Company has accrued expense for this lease of $607,739 (RMB3,840,000) and $594,105 (RMB3,840,000) as of March 31, 2012 and June 30, 2011, respectively. This rental agreement has been terminated on June 1, 2011 through an agreement between Ms. Chen and the Company for its relocation since then. The accrued lease expense has been recorded as a reduction of advances to related parties in the accompanying balance sheet as of March 31, 2012 due to the right of offset.

 

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 $12,661 (RMB 80,000).

 

NOTE 9 - 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 calendar year 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:

 

   March 31,   June 30, 
   2012   2011 
Value added tax  $(2,166,389)  $(1,473,990)
Income tax   2,344,765    2,645,198 
Surtax, insurance, other   186,126    194,120 
Total taxes payable  $364,502   $1,365,328 

 

F-12
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 9 - INCOME TAXES – continued

 

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

   For The Three Months Ended   For The Nine Months Ended 
   March 31,   March 31, 
   2012   2011   2012   2011 
Income before tax  $1,772,184   $3,545,167   $8,926,130   $11,122,753 
Income tax computed at PRC statutory rate of 25%   443,046    886,292    2,231,533    2,780,688 
Benefit of favorable rates   (67,182)   (269,806)   (867,590)   (843,957)
Tax refund due to High-Tech Enterprise Qualification   (4,270)   -    (339,333)   - 
Tax refund due to purchase of Domestic Equipments   (14,411)   -    (1,145,226)   - 
Changes in valuation allowance   60,193    103,985    154,145    104,001 
Tax effect of parent   38,987    (217,427)   (54,262)   (275,165)
Permanent difference   97,152    (426,086)   173,919    (456,672)
Total Income tax expense  $553,515   $76,958   $153,186   $1,308,895 

 

Deferred tax assets comprised of the following:

 

   March 31,   June 30, 
   2012   2011 
Taxable loss carryforward  $243,372   $72,752 
Stock based compensation   84,894    53,069 
Allowance for doubtful trade accounts receivable   241,986    211,945 
Allowance for doubtful other receivables   64,696    111,158 
Allowance for doubtful advances to suppliers   31,842    66,656 
Allowance for inventory obsolescence   22,593    22,086 
Less: Valuation allowance   (328,266)   (174,169)
Total Deferred tax assets  $361,117   $363,497 

 

The income tax expense comprised of the following:

 

   For The Three Months Ended   For The Nine Months Ended 
   March 31,   March 31, 
   2012   2011   2012   2011 
Current  $495,346   $(7,012)  $142,448   $1,254,308 
Deferred   58,169    83,970    10,738    54,587 
Total Income tax expense  $553,515   $76,958   $153,186   $1,308,895 

 

NOTE 10 – 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 and classified as equity. 

 

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.

 

F-13
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 10 – ISSUANCE OF COMMON STOCK AND WARRANTS – continued

 

The following table summarizes warrant activity for the three months ended March 31, 2012:

 

   Warrants   Weighted-average
exercise price
 
Outstanding as of June 30, 2011   685,000   $3.76 
Issued   -    - 
Exercised   -    - 
Expired   -    - 
Outstanding as of March 31, 2012   685,000   $3.76 

 

The aggregate intrinsic value as of March 31, 2012 and June 30, 2011 was $0.

 

NOTE 11 – 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.

 

On February 21, 2012, the Company granted an executive and a director 60,000 shares of restricted common stock with a grant date fair value of $1.23 per share as part of their remuneration for their service commencing February 21, 2012 for a one year period. The restricted common stock will vest on the one-year anniversary date of the grant date.

 

Stock-based compensation expense for the three months ended March 31, 2012 and 2011 was $16,016 and $10,698, respectively. Stock-based compensation expense for the nine months ended March 31, 2012 and 2011 was $43,616 and $41,348, respectively. The remaining $65,734 stock-based compensation will be expensed over the remainder of the one year service period. The value of the non-vested stock as of March 31, 2012 was $63,600.

 

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.

 

F-14
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 11 – STOCK-BASED COMPENSATION – continued

 

Options - continued

 

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.

 

Stock-based compensation expense for the three months ended March 31, 2012 and 2011 on the stock options were $16,330 and $15,695, respectively. Stock-based compensation expense for the nine months ended March 31, 2012 and 2011 on the stock options were $49,986 and $47,782, respectively. The remaining $68,185 stock based compensation will be expensed over a weighted average service period of 1.1 years.

 

The following table summarizes the options activity as of March 31, 2012, and changes during the nine months ended March 31, 2012:

 

   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 March 31, 2012   105,000   $2.71    3.11   $- 

 

Total intrinsic value of stock options outstanding as of March 31, 2012 and June 30, 2011 was $0.

 

NOTE 12 – 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 March 31, 2012, the Company had repurchased 459,822 shares of its common stock at a total cost of $534,269.

 

F-15
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 13 – 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:

 

   For The Three Months Ended   For The Nine Months Ended 
   March 31,   March 31, 
   2012   2011   2012   2011 
                 
Net income attributable to the common stockholders  $1,218,669   $3,468,209   $8,772,944   $9,813,858 
                     
Basic weighted-average common shares outstanding   40,345,780    40,727,935    40,531,461    40,719,653 
Dilutive effect of options, warrants, and contingently issuable shares                    
Diluted weighted-average common shares outstanding   40,345,780    40,727,935    40,531,461    40,719,653 
                     
Earnings per share:                    
Basic  $0.03   $0.09   $0.22   $0.24 
Diluted  $0.03   $0.09   $0.22   $0.24 

 

Warrants and options to purchase 685,000, and 105,000 shares of common stock, respectively were outstanding during the three and nine months ended March 31, 2012, 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 14 - COMMITMENTS AND CONTINGENCIES

 

Operating lease commitments - As of March 31, 2012, 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 $ 67,181
For the year ending June 30, 2013   190,864
For the year ending June 30, 2014   151,935
For the year ending June 30, 2015 and thereafter   12,661
Total $ 422,641

 

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 $415,268 (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 March 31, 2012, 20% of the cost, or $ 83,054 (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.

 

F-16
 

 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 15 – SIGNIFICANT CONCENTRATIONS

 

A significant portion of the Company’s purchases and revenues consist of transactions with Shanghai Huaye and its subsidiaries. For the three months ended March 31, 2012 and 2011, approximately 29.7% and 38.3%, respectively, of the Company’s revenues was derived from Shanghai Huaye and its subsidiaries, and approximately 17.4% and 70.0%, respectively, of the Company’s purchases was from Shanghai Huaye and its subsidiaries. For the nine months ended March 31, 2012 and 2011, approximately 25.6% and 47.9%, respectively, of the Company’s revenues was derived from Shanghai Huaye and its subsidiaries, and approximately 33.7% and 63.5%, respectively, of the Company’s purchases was from Shanghai Huaye and its subsidiaries.

 

Financial instruments that potentially subject the Company to a significant concentration of credit risk consist primarily of cash and cash equivalents and restricted cash. As of March 31, 2012 and June 30, 2011, substantially all of the Company’s cash and cash equivalents and restricted cash were held by major financial institutions located in the PRC, which management believes are of high credit quality.

 

The Company made advance payments to suppliers for purchase of raw materials. As of March 31, 2012 and June 30, 2011, approximately 73.4% and 73.5%, respectively, of the Company’s advances to suppliers was made to Shanghai Huaye and its subsidiaries.

 

NOTE 16 - SEGMENT INFORMATION

 

The Company has four reportable 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 Reportable Segments - The Company’s reportable 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 March 31, 2012 and
for the three months then
ended
  Changshu
Huaye
   Jiangsu
Cold-Rolled
   Ningbo
Zhehua
   Sutor
Technology
   Inter-Segment and
Reconciling Items
   Total 
                         
Revenue  $22,682,523   $47,121,236   $5,103,041   $2,363,043   $23,499   $77,293,342 
Revenue from related parties   9,628,855    23,011,001    1,857    -    -    32,641,713 
Revenue from other operating segments   2,939,039    8,520,488    -    -    (11,459,527)   - 
Total operating expenses   1,715,753    470,342    678,402    207,220    75,574    3,147,291 
Interest income   201,577    92,345    75,315    116    (792)   368,561 
Interest expense   511,787    2,791,671    53,912    -    127,574    3,484,944 
Depreciation and amortization expense   588,398    1,481,765    239,447    3,350    -    2,312,960 
Income tax expense   86,546    455,156    11,810    -    3    553,515 
Net segment profit/(loss)   489,380    1,716,454    (539,059)   (196,797)   (251,309)   1,218,669 
Capital expenditures   (20,484)   3,521,894    30,895    -    -    3,532,305 
Segment assets  $258,288,503   $369,967,663   $46,153,969   $33,949,134   $(223,612,080)  $484,747,189 
                               

 

F-17
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 16 - SEGMENT INFORMATION – continued

 

As of March 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  $24,212,157   $21,426,727   $6,775,413   $-   $10,107,280   $62,521,577 
Revenue from related parties   7,576,183    31,244,129    32,728    -    -    38,853,040 
Revenue from other operating segments   9,261,134    24,045,241    -    -    (33,306,375)   - 
Total operating expenses   1,953,224    263,334    682,270    14,481    150,512    3,063,821 
Interest income   136,956    25,285    26,456    -    -    188,697 
Interest expense   250,122    1,515,642    89,301    -    131,475    1,986,540 
Depreciation and amortization expense   555,048    1,151,399    225,125    -    -    1,931,572 
Income tax (benefit)/expense   (200,100)   225,011    52,047    -    -    76,958 
Net segment profit/(loss)   1,234,034    1,576,022    (40,941)   (14,481)   713,575    3,468,209 
Capital expenditures   23,566    477,390    1,902    515    -    503,373 
Segment assets  $222,780,712   $296,264,832   $28,353,809   $23,461,222   $(228,445,667)  $342,414,908 

 

As of March 31, 2012 and
for the nine months then
ended
  Changshu
Huaye
   Jiangsu
Cold-Rolled
   Ningbo
Zhehua
   Sutor
Technology
   Inter-Segment and
Reconciling Items
   Total 
                         
Revenue  $91,344,305   $111,492,121   $34,739,377   $5,495,116   $15,689,920   $258,760,839 
Revenue from related parties   13,340,581    75,776,497    147,553    -         89,264,631 
Revenue from other operating segments   30,584,987    70,198,868    -    -    (100,783,855)   - 
Total operating expenses   8,002,675    1,691,877    2,312,363    497,400    561,363    13,065,678 
Interest income   504,833    392,486    149,128    498    31    1,046,976 
Interest expense   1,237,112    5,645,882    213,640    -    555,826    7,652,460 
Depreciation and amortization expense   1,719,613    3,806,154    700,230    266,263         6,492,260 
Income tax expense/(benefit)   (162,421)   87,584    116,468    -    111,555    153,186 
Net segment profit/(loss)   1,217,938    8,103,617    (168,800)   (473,528)   93,717    8,772,944 
Capital expenditures   42,828    12,973,010    121,687    -         13,137,525 
Segment assets  $258,288,503   $369,967,663   $46,153,969   $33,949,134   $(223,612,080)  $484,747,189 
                               

 

As of March 31, 2011 and
for the nine months then
ended
  Changshu
Huaye
   Jiangsu Cold-
Rolled
   Ningbo
Zhehua
   Sutor
Technology
   Inter-Segment and
Reconciling Items
   Total 
                         
Revenue  $47,122,545   $70,604,476   $21,285,217   $-   $18,790,202   $157,802,440 
Revenue from related parties   56,722,292    88,020,635    199,461    -         144,942,388 
Revenue from other operating segments   18,602,005    78,382,879    -    -    (96,984,884)   - 
Total operating expenses   5,416,128    1,133,303    2,699,396    14,544    526,821    9,790,192 
Interest income   370,838    206,649    48,925    -    -    626,412 
Interest expense   684,232    4,639,731    132,415    -    400,265    5,856,643 
Depreciation and amortization expense   1,642,232    3,408,744    664,879    -    -    5,715,855 
Income tax expense   501,003    785,113    22,779    -    -    1,308,895 
Net segment profit/(loss)   3,325,410    5,639,419    4,332    (14,544)   859,241    9,813,858 
Capital expenditures   37,234    1,190,840    28,425    78,564    -    1,335,063 
Segment assets  $222,780,712   $296,264,832   $28,353,809   $23,461,222   $(228,445,667)  $342,414,908 

 

F-18
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 17 - GEOGRAPHIC INFORMATION

 

The following schedule summarizes the sources of the Company’s revenue by geographic regions for the three and nine months ended March 31, 2012 and 2011:

 

   For the Three Months Ended   For the Nine Months Ended 
   March 31,   March 31, 
  2012   2011   2012   2011 
Geographic Area                 
The PRC  $103,596,954   $88,602,341   $302,502,727   $275,374,860 
Other Countries   6,338,101    12,772,276    45,522,743    27,369,968 
Total  $109,935,055   $101,374,617   $348,025,470   $302,744,828 

 

NOTE 18 – SUBSEQUENT EVENTS

 

The Company evaluated all events or transactions that occurred after March 31, 2012 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.

 

F-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.

 

2
 

 

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 (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 third quarter of fiscal 2012, we generated higher revenue primarily due to higher sales volume of our HDG products as compared to the same period last year. However, sales volume of products with higher gross margin including steel pipes and PPGI products was lower than the same period last year which resulted in lower gross profits in the third quarter of 2012. During this period, our net income declined as a result of increased general and administrative expenses primarily due to business expansion, a recent inflationary environment in China and higher financing expenses due to the combination of higher interest rates, increased loan amount and discounted interest expenses on bank notes. The strong demand for our hot-dip galvanized steel products and increased average selling prices were the major drivers for our higher sales. During the quarter, we continued to make progresses towards the construction of the new high precision cold-roll steel production line with a designed annual capacity of 500,000 MT. 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 third fiscal quarter:

 

·Revenue: Revenue was $109.9 million for the three months ended March 31, 2012, an increase of $8.5 million, or 8.4%, from $101.4 million for the same period last year.

 

·Gross profit and margin: Gross profit was approximately $7.9 million for the three months ended March 31, 2012, as compared to $8.6 million for the same period last year. Gross margin was 7.2% for the three months ended March 31, 2012, as compared to 8.5% for the same period last year.

 

·Net income: Net income was $1.2 million for the three months ended March 31, 2012, a decrease of $2.3 million, or 65.7%, from $3.5 million for the same period of last year.
   
·Fully diluted earnings per share: Fully diluted earnings per share were $0.03 for the three months ended March 31, 2012, as compared to $0.09 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 16, “Segment Information” to the condensed consolidated financial statements included elsewhere in this report.

 

3
 

 

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 March 31, 2012 and 2011, Changshu Huaye generated revenue of $32.3 million and $41.9 million, which represented 29.4% and 41.3% of our total revenue, respectively. Jiangsu Cold-Rolled generated revenue of $70.1 million and $52.7 million in the three months ended March 31, 2012 and 2011, which represented 63.8% and 52.0% of our total revenue, respectively. In the three months ended March 31, 2012 and 2011, Ningbo Zhehua generated revenue of $5.1 million and $6.8 million, which represented 4.6% and 6.7% of our total revenue, respectively. In addition, in the third quarter of fiscal year 2012, Sutor Technology generated revenue of $2.4 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 29.7% of our revenue was derived from Shanghai Huaye and its affiliates in the three months ended March 31, 2012, as compared to 38.3% 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 March 31, 2012, approximately $14.1 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 March 31, 2012, gross margin for domestic and international sales was 7.1% and 8.9%, respectively. On a segment basis, Changshu Huaye, Jiangsu Cold-Rolled and Ningbo Zhehua’s gross margins were 8.7%, 7.2% and 2.2%, respectively. As Sutor Technology commenced operations recently, its gross margin was 0.44% 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.

 

4
 

 

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 miscellaneous 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 arranges 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 price composed of product price and transportation cost.

 

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 (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 (EIT) of 25.0% on all domestic-invested enterprises and foreign invested enterprises (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. 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 March 31, 2012 and March 31, 2011

 

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
March 31, 2012
   Three Months Ended
March 31, 2011
 
   Amount   % of
Revenue
   Amount   % of
Revenue
 
Revenue                    
Revenue from unrelated parties  $77,293    70.3%  $62,522    61.7%
Revenue from related parties   32,642    29.7%   38,853    38.3%
Total   109,935    100%   101,375    100.0%
Cost of Revenue                    
Cost of revenue from unrelated parties   71,782    65.3%   57,018    56.2%
Cost of revenue from related parties   30,282    27.5%   35,742    35.3%
Total   102,064    92.8%   92,760    91.5%
Gross Profit   7,871    7.2%   8,615    8.5%
Operating Expenses                    
Selling expense   875    0.8%   1,346    1.3%
General and administrative expense   2,272    2.1%   1,718    1.7%
Total Operating Expenses   3,147    2.9%   3,064    3.0%
Income from Operations   4,724    4.3%   5,551    5.5%
Other Income (Expense)                    
Interest income   369    0.3%   189    0.2%
Other income   85    0.1%   3    - 
Interest expense   (3,485)   (3.2)%   (1,987)   (2.0)%
Other expense   79    0.1%   (211)   (0.2)%
Total Other Income (Expense)   (2,952)   (2.7)%   (2,006)   (2.0)%
Income Before Taxes   1,772    1.6%   3,545    3.5%
Income tax (expense)/benefit   (554)   (0.5)%   (77)   (0.1)%
Net Income  $1,218    1.1%  $3,468    3.4%

 

5
 

 

Revenue. For the three months ended March 31, 2012, revenue was $109.9 million, compared to $101.4 million for the same period last year, an increase of $8.5 million, or 8.4%. The increase was mainly attributable to higher revenue from our HDG and acid-pickled steel products. During the three months ended March 31, 2012, revenue from our HDG and acid-pickled steel products increased by 36.1% and 39.3%, respectively, as compared to the same period last year. The higher revenue from HDG products was primarily due to the higher sales volume, which increased by approximately 37.1%. The higher revenue of acid-pickled steel was primarily due to higher sales volume and higher average selling price, which increased by 30.3% and 6.9%, respectively. The increased demands for HDG and acid picked products mainly resulted from our successful efforts to expand the group of end-customers. We recently established a special division to target and service large and end-user customers. During the quarter, we added more than one hundred end-customers. Further, demand for thick-spec HDG products exceeded supplies during the most recent quarter.

 

However, we experienced a decrease in sales of cold rolled steel products by approximately 86.0% mainly because we used more of them internally for the production of our other products. Furthermore, sales of PPGI and steel pipe products also decreased during the third fiscal quarter of 2012 due to the timing of the Chinese New Year, which limited the number of working days during the month of January and longer-than-normal facilities renovation, which caused a reduction of production of these products during this quarter. Revenues from PPGI and steel pipe products decreased 65.6% and 39.2%, respectively. We renovated the furnace of the PPGI production line in order to achieve long-term energy savings. The declined pipe product revenue was mainly due to the timing of projects. The average selling price was down 1.4% for the PPGI products and up 14.7% for the pipe products during the third-quarter ended March 31, 2012 as compared with the same period last year.

 

The following table sets forth revenue by geography and by business segments for the three months ended March 31, 2012 and 2011.

 

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

 

   Three Months Ended
March 31, 2012
   Three Months Ended
March 31, 2011
 
   Amount   % of
Revenue
   Amount   % of
Revenue
 
Geographic Data                    
China  $103,597    94.2%  $88,603    87.4%
Other Countries   6,338    5.8%   12,772    12.6%
                     
Segment Data                    
Changshu Huaye  $32,335    29.4%  $41,895    41.3%
Jiangsu Cold-Rolled   70,132    63.8%   52,672    52.0%
Ningbo Zhehua   5,105    4.6%   6,808    6.7%
Sutor Technology   2,363    2.2%   -    - 

 

6
 

 

On a geographic basis, revenue generated from outside of China was $6.4 million, or 5.8% of the total revenue, for the three months ended March 31, 2012, as compared to $12.8 million, or 12.6% of the total revenue, for the same period in 2011. The decrease was mainly attributable to the continued appreciation of RMB against U.S dollar and the uncertain economic recovery in the European markets that may have affected some customers’ purchase patterns.

 

On a segment basis, after eliminating intercompany sales and adjusting reconciliation items, revenue contributed by Changshu Huaye was $32.3 million for the three months ended March 31, 2012, representing a decrease of $9.6 million, or 22.9%, from $41.9 million for the same period last year. The decrease mainly resulted from lower PPGI and HDG revenue of approximately $7.0 million and $2.8 million, respectively. Changshu Huaye’s production facilities were under annual maintenance in the first month of the fiscal quarter, which reduced production capacity and sales volume. In addition to the regular maintenance, our PPGI production line furnace was renovated to save energy in the long run, which is a non-recurring event.

 

After eliminating the inter-company sales and adjusting reconciliation items, revenue contributed by Jiangsu Cold-Rolled increased to $70.1 million for the three months ended March 31, 2012, as compared at $52.7 million for the same period last year. During the quarter, the revenue from cold-rolled steel decreased by approximately $11.7 million due to the fact that more of these products were used in our HDG and PPGI production lines. At the same time, we had higher revenue of approximately $4.0 million from acid pickled steel and higher revenue from HDG Steel products utilizing our 400,000 MT HDG production lines. We generated approximately $50.0 million from HDG production lines in the three months ended March 31, 2012 as compared to approximately $27.4 million in the same period last year.

 

Revenue contributed by Ningbo Zhehua was $5.1 million for the three months ended March 31, 2012, a decrease of $1.7 million, or 25%, from $6.8 million for the same period in 2011, primarily resulting from the timing of the unfinished projects that the company’s products will be used for. A majority of the customers to whom the company’s products are sold are project contractors.

 

In terms of related party sales as compared with sales to unrelated parties, our direct sales to unrelated parties in the three months ended March 31, 2012 increased by $14.8 million, or 23.7%, to $77.3 million, from $62.5 million in the same period in 2011 as we continued to expand our own sales channels.

 

Cost of revenue. Cost of revenue increased by $9.3 million, or 10%, to $102.1 million in the three months ended March 31, 2012, from $92.8 million in the same period in 2011. As a percentage of revenue, cost of revenue increased to 92.8% in the three months ended March 31, 2012, as compared to 91.5% in 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 decreased by $0.7 million to $7.9 million in the three months ended March 31, 2012, from $8.6 million in the same period in 2011. Gross profit as a percentage of revenue (gross margin) was approximately 7.2% for the three months ended March 31, 2012 as compared with approximately 8.5% for the same period last year. The lower gross margin was due to the fact that we sold more lower gross margin products for the quarter ended March 31, 2012 than the same quarter last year. For instance, we sold more HDG products than PPGI products whereas HDG’s gross margin is usually lower than that of PPGI. As a result, the overall gross margin was reduced. In addition, our adoption of sales promotion policies to some extent negatively affected our profit margin.

 

On a segment basis, gross margin for Changshu Huaye decreased to 8.7% in the three months ended March 31, 2012, from 11.1% in the same period last year, mainly because of lower PPGI sales. Gross margin for Jiangsu Cold-Rolled increased to 7.2% in the three months ended March 31, 2012, from 4.5% in the same period last year, mainly due to the significant improved capacity utilization of the HDG production line, which reduced the average unit product costs. Gross margin for Ningbo Zhehua decreased to 2.2% in the three months ended March 31, 2012, as compared to 12.1% in the same period in 2011, mainly because of lower sales volume.

 

Total operating expenses. Our total operating expenses increased approximately $0.1 million to $3.2 million in the three months ended March 31, 2012, from $3.1 million in the same period in 2011. As a percentage of revenue, our total operating expenses decreased to 2.9% in the three months ended March 31, 2012, from 3.0% in the same period in 2011.

 

Selling expenses. Our selling expenses decreased by $0.4 million to $0.9 million in the three months ended March 31, 2012, from $1.3 million in the same period in 2011. As a percentage of revenue, our selling expenses decreased to 0.8% for the three months ended March 31, 2012, from 1.3% for the same period last year. The lower selling expenses were mainly due to lower international sales for the quarter ended March 31, 2012 than the same period last year.

 

7
 

 

General and administrative expenses. General and administrative expenses increased by $0.6 million to $2.3 million, or 2.1% of the total revenue, in the three months ended March 31, 2012, from $1.7 million, or 1.7% of the revenue, in the same period in 2011. The increased general and administrative expenses were primarily due to increased employee compensation and benefits, new office building maintenance expenses, depreciation for office supplies, and expenses for renovating employee dormitories in the amount of approximately $0.13 million, $0.1 million, $0.13 million and $0.14 million, respectively. 

 

Interest expense. Our interest expense increased by $1.5 million to $3.5 million in the three months ended March 31, 2012, from $2.0 million in the same period in 2011. As a percentage of revenue, our interest expense was approximately 3.2% of total revenue in the three months ended March 31, 2012, compared to 2.0% in the same period in 2011. Among the total increase, approximately $1 million of the increased amount was due to discounted interest expenses for bank notes and the remaining $0.5 million was due to higher interest rates and the increased loan amount.

 

Provision for income taxes. Our income tax expense increased to approximately $0.6 million in the three months ended March 31, 2012, from $0.08 million in the same period last year, primarily due to the expiration of the preferential income tax rate of 12.5% for Jiangsu Cold-rolled. Starting 2012, its statutory income tax rate increased to 25%.

 

Net income. Net income, without including the foreign currency translation adjustment, decreased by approximately $2.3 million, or 65.7%, to $1.2 million in the three months ended March 31, 2012, from $3.5 million in the same period in 2011, as a cumulative result of the above factors.

 

Comparison of Nine Months Ended March 31, 2012 and March 31, 2011

 

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)

 

   Nine Months Ended
March 31, 2012
   Nine Months Ended
March 31, 2011
 
   Amount   % of
Revenue
   Amount   % of
Revenue
 
Revenue                    
Revenue from unrelated parties  $258,761    74.4%  $157,803    52.1%
Revenue from related parties   89,264    25.6%   144,942    47.9%
Total   348,025    100.0%   302,745    100.0%
Cost of Revenue                    
Cost of revenue from unrelated parties   237,734    68.3%   143,055    47.3%
Cost of revenue from related parties   81,020    23.3%   133,185    44.0%
Total   318,754    91.6%   276,240    91.2%
Gross Profit   29,271    8.4%   26,505    8.8%
Operating Expenses                    
Selling expense   5,289    1.5%   4,709    1.6%
General and administrative expense   7,777    2.2%   5,081    1.7%
Total Operating Expenses   13,066    3.7%   9,790    3.2%
Income from Operations   16,205    4.7%   16,715    5.5%
Other Income (Expense)                    
Interest income   1,047    0.3%   626    0.2%
Other income   105    0%   124    0%
Interest expense   (7,652)   (2.2)%   (5,857)   (1.9)%
Other expense   (779)   (0.2)%   (486)   (0.2)%
Total Other Income (Expense)   (7,279)   (2.1)%   (5,592)   (1.8)%
Income Before Taxes   8,926    2.6%   11,123    3.7%
Income tax (expense)/benefit   (153)   0%   (1,309)   (0.4)%
Net Income  $8,773    2.5%  $9,814    3.3%

 

8
 

 

Revenue. For the nine months ended March 31, 2012, revenue was $348.0 million, compared to $302.7 million for the same period last year, an increase of approximately $45.3 million, or 15.0%. The increase was primarily due to increased international sales, which grew 66% as compared to the same time last year, and higher sales volume for both HDG and steel pipe products driven by the adoption of a series of sales promotion policies targeted at a wide range of end customers and completed contracts with SINOPEC.

 

The following table sets forth revenue by geography and by business segments for the nine months ended March 31, 2012 and 2011.

 

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

 

   Nine Months Ended
March 31, 2012
   Nine Months Ended
March 31, 2011
 
   Amount   % of
Revenue
   Amount   % of
Revenue
 
Geographic Data                    
China  $302,503    86.9%  $275,375    91.0%
Other Countries   45,522    13.1%   27,370    9.0%
                     
Segment Data                    
Changshu Huaye  $120,375    34.6%  $122,635    40.5%
Jiangsu Cold-Rolled   187,268    53.8%   158,625    52.4%
Ningbo Zhehua   34,887    10.0%   21,485    7.1%
Sutor Technology   5,495    1.6%   -    - 

 

On a geographic basis, revenue generated from outside of China was $45.5 million, or approximately 13.1% of the total revenue, for the nine months ended March 31, 2012, as compared to $27.4 million, or 9.0% of the total revenue, for the same period in 2011. The increase mainly resulted from our marketing efforts to increase global brand recognition and participation in international trade shows.

 

On a segment basis, after eliminating intercompany sales and adjusting reconciliation items, revenue contributed by Changshu Huaye was $120.4 million for the nine months ended March 31, 2012, representing a decrease of $2.1 million, or 1.7%, from $122.5 million in the same period last year. The decrease was primarily due to the annual facilities maintenance in the third fiscal quarter and the decreased sales in PPGI products. The timing and scale of the annual maintenance taking place in January were longer and larger than that in prior year. The revenue generated by PPGI products decreased by approximately 4.4% as compared to the same period last year.

 

After eliminating the inter-company sales and adjusting reconciliation items, revenue contributed by Jiangsu Cold-Rolled was $187.3 million for the nine months ended March 31, 2012, an increase of $28.7 million, or 18.1%, from $158.6 million for the same period last year, mainly as a result of higher sales volume and average selling prices of our HDG steel products utilizing our 400,000 MT HDG production lines, partially offset by lower revenue of $28.0 million from our cold-rolled products as more cold-rolled products were used internally as intermediate products for HDG steel PPGI products. We generated $140.8 million from these HDG production lines in the nine months ended March 31, 2012 as compared to approximately $91.9 million in the same period last year, an increase of $48.9 million.

 

Revenue contributed by Ningbo Zhehua was $34.9 million for the nine months ended March 31, 2012, an increase of $13.4 million from $21.5 million in the same period in 2011, primarily due to an increased export of large diameter welded steel pipes and completion of contracts with SINOPEC.

 

In terms of related party sales as compared with sales to unrelated parties, our direct sales to unrelated parties in the nine months ended March 31, 2012 increased by $101.0 million, or 64.0%, to $258.8 million, from $157.8 million in the same period in 2011 as we continued to expand our own sales channels.

 

Cost of revenue. Cost of revenue increased by $42.6 million, or 15.4%, to $318.8 million in the nine months ended March 31, 2012, from $276.2 million in the same period in 2011. As a percentage of revenue, cost of revenue increased slightly to 91.6% in the nine months ended March 31, 2012, from 91.2% in the same period last year. We believe the increased amount of the cost of revenue was generally in line with the increase in sales revenue.

 

9
 

 

Gross profit and gross margin. Gross profit increased by $2.8 million to $29.3 million in the nine months ended March 31, 2012, from $26.5 million in the same period in 2011. Gross profit as a percentage of revenue (gross margin) was 8.4% in the nine months ended March 31, 2012, as compared to 8.8% in the same period in 2011. The decrease in the gross margin was primarily due to the change in the mix of the products sold.

 

On a segment basis, gross margin for Changshu Huaye increased to 11.6% in the nine months ended March 31, 2012, from 10.9% in the same period last year, mainly due to an increase in average selling prices of both hot dipped galvanized and PPGI products. Gross margin for Jiangsu Cold-Rolled increased to 6.6% in the nine months ended March 31, 2012, from 5.3% 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 costs. Gross margin for Ningbo Zhehua decreased to 7.2% in the nine months ended March 31, 2012, as compared to 14.1% in the same period in 2011, mainly because we offered discounted prices to certain customers in new markets to establish long-term relationships and gain market shares. Ningbo Zhehua also sold more low-margin spiral steel pipes during this period of time.

 

Total operating expenses. Our total operating expenses increased by $3.3 million to $13.1 million in the nine months ended March 31, 2012 from $9.8 million in the same period in 2011. As a percentage of revenue, our total operating expenses increased to 3.7% in the nine months ended March 31, 2012, from 3.2% in the same period in 2011.

 

Selling expenses. Our selling expenses increased by $0.6 million to $5.3 million in the nine months ended March 31, 2012, from $4.7 million in the same period in 2011. As a percentage of revenue, our selling expenses decreased slightly to 1.5% for the nine months ended March 31, 2012, from 1.6% for the same period last year. The dollar amount of the increase in selling expenses was mainly attributable to increased domestic sales.

 

General and administrative expenses. General and administrative expenses increased by $2.7 million to $7.8 million, or 2.2% of the total revenue, in the nine months ended March 31, 2012, from $5.1 million, or 1.7% of revenue, in the same period in 2011. The increased general and administrative expenses were due to a number of factors including higher employee compensation and benefits of approximately $0.5 million, higher employee social security expenses of $0.11 million, and higher expenses for renovating employee dormitories of approximately $0.2 million in this period than same period a year ago.

 

Interest expense. Our interest expense increased by approximately $1.8 million to $7.7 million in the nine months ended March 31, 2012, from $5.9 million in the same period in 2011, mainly due to an increase of approximately $1.47 million in discounted interest expenses on bank notes and increased interest rates and bank loan amount. As a percentage of revenue, our interest expenses increased to 2.2% in the nine months ended March 31, 2012, from 1.9% in the same period in 2011.

 

Provision for income taxes. Our income tax expense was approximately $0.2 million in the nine months ended March 31, 2012 as compared to the income tax expense of $1.3 million in the same period last year. The decrease was due to lower taxable income and tax refunds. In the nine months ended March 31, 2012, Changshu Huaye and Jiangsu Cold-Rolled received tax refunds of $0.3 million and $1.1 million, respectively, for purchase of equipment, partially offset by higher income tax rate of 25% for the first calendar quarter of 2012 as compared to 12.5% in the same period last year for Jiangsu Cold-Rolled.

 

Net income. Net income, without including the foreign currency translation adjustment, decreased by $1.0 million, or 10.2%, to $8.8 million in the nine months ended March 31, 2012, from $9.8 million in the same period in 2011, 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 $39.6 million of cash in the nine months ended March 31, 2012. As of March 31, 2012, our total indebtedness to non-related parties under existing short-term loans was approximately $136.7 million. We also had approximately $13.6 million under long-term notes payable to non-related parties. We had no notes payable to related parties; however, approximately $25.0 million of our short-term notes payable were guaranteed by Shanghai Huaye and its affiliates. As of March 31, 2012, we also had an unused line of credit with banks of approximately $31.7 million (RMB 200.0 million) which entitled us to draw bank loans for general corporate purposes.

 

10
 

 

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.

 

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 March 31, 2012, we had cash and cash equivalents (excluding restricted cash) of $5.5 million, short-term investment of $4.7 million and restricted cash of approximately $140.0 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)

 

   Nine Months Ended March 31, 
   2012   2011 
Net cash provided by (used in) operating activities  $39,561   $(9,813)
Net cash (used in) investing activities   (84,736)   (13,865)
Net cash provided by financing activities   28,968    22,287 
Effect of foreign currency translation on cash and cash equivalents   425    217 
Net cash flows   (15,782)   (1,174)

 

Operating Activities

 

Net cash provided by operating activities was $39.6 million for the nine months ended March 31, 2012, an increase of $49.4 million from $9.8 million net cash used in operating activities for the same period last year. The increase in net cash provided by operating activities was primarily due to a $48.1 million increase in account payable and a $47.5 million decrease in advances to suppliers, partially offset by an increase in inventories of $40.1 million.   The increased account payable and inventories were mainly attributable to the fact that when demand for our HDG products exceeded supplies, we engaged in some spot transactions. As a result, the company’s increased both raw materials and product inventories.

 

11
 

 

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. Restricted cash will not be available for use until the related notes payable are paid to the bank.

 

Net cash used in investing activities was $84.7 million for the nine months ended March 31, 2012, as compared to $13.9 million for the same period in 2011. The increase in net cash used in investing activities was primarily due to increased amount of restricted cash of $53.5 million, increased purchase of equipment of $12.3 million and purchase of short-term investment of $4.7 million for the nine months ended March 31, 2012 as compared to the nine months ended March 31, 2011. 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. In addition, to pursue a reasonable yield, we bought some yield-enhanced products (Structured Deposits) as short-term investments.

 

Financing Activities

 

Net cash provided by financing activities was $29.0 million for the nine months ended March 31, 2012, as compared to $22.3 million for the same period in 2011. The increase in net cash provided by financing activities was mainly due to an additional borrowing of $47.2 million, partially offset by repayment of loans in an amount of $40.0 million.

 

As of March 31, 2012, the amount, maturity date and term of each of our loans were as follows: 

 

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

 

Lender  Amount*   Starting
Date
  Maturity
Date
  Guarantor**
Industrial and Commercial Bank of China, Changshu Branch  $3.17   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   3.17   2011-10-28  2012-04-26  Jiangsu Cold-Rolled, Shanghai Huaye
Communications Bank of China, Changshu Branch   3.17   2011-11-14  2012-11-14  Shanghai Huaye
The Agricultural Bank of China, Changshu Branch   3.17   2011-11-28  2012-11-27  Jiangsu Cold-Rolled, Shanghai Huaye
Construction Bank of China, Changshu Branch   6.33   2011-11-17  2012-11-16  None
The Agricultural Bank of China, Changshu Branch   3.96   2011-12-22  2012-12-21  Jiangsu Cold-Rolled, Shanghai Huaye
Construction Bank of China, Changshu Branch   0.43   2012-02-02  2012-04-30  None
The Agricultural Bank of China, Changshu Branch   7.44   2011-07-25  2012-07-21  Changshu Huaye, Shanghai Huaye
The Agricultural Bank of China, Changshu Branch   6.33   2011-08-19  2012-08-16  Changshu Huaye, Shanghai Huaye
The Agricultural Bank of China, Changshu Branch   4.75   2011-09-05  2012-09-05  Changshu Huaye, Shanghai Huaye
The Agricultural Bank of China, Changshu Branch   6.33   2011-09-28  2012-09-27  None
Communications Bank of China, Changshu Branch   10.75   2011-09-27  2014-09-11  Changshu Huaye
The Agricultural Bank of China, Changshu Branch   2.53   2011-10-25  2012-10-24  Changshu Huaye, Shanghai Huaye
Industrial and Commercial Bank of China, Changshu Branch   2.37   2011-10-31  2012-04-27  Changshu Huaye
The Agricultural Bank of China, Changshu Branch   7.91   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   5.38   2011-11-21  2012-11-20  Changshu Huaye, Shanghai Huaye
The Agricultural Bank of China, Changshu  Branch   10.29   2011-12-12  2012-12-11  Changshu Huaye, Shanghai Huaye
Industrial and Commercial Bank of China, Changshu Branch   1.58   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
The Agricultural Bank of China, Changshu Branch   2.37   2012-01-06  2013-01-05  Changshu Huaye, Shanghai Huaye
The Agricultural Bank of China, Changshu Branch   5.13   2012-02-15  2012-08-14  Changshu Huaye, Shanghai Huaye
Industrial and Commercial Bank of China, Changshu Branch   3.17   2012-02-16  2012-08-09  Changshu Huaye
Shenzhen Development Bank   1.58   2011-08-23  2012-08-23  Shanghai Huaye
The Agricultural Bank of China, Ningbo Branch   0.89   2012-02-22  2012-07-30  Changshu Huaye
The Agricultural Bank of China, Ningbo Branch   1.74   2012-03-28  2012-06-28  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  $150.31          

________________________

 

* Calculated on the basis that $1 = RMB 6.32

** 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.

 

12
 

 

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 compliance with these debt covenants as of March 31, 2012.

 

In the coming 12 months, we will have approximately $136.7 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

 

Critical accounting policies are those we believe are most important to portraying our financial conditions and results of operations and also require the greatest amount of subjective or complex judgments by management.  Judgments and uncertainties regarding the application of these policies may result in materially different amounts being reported under various conditions or using different assumptions.  There have been no material changes to the critical accounting policies previously disclosed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2011.

 

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.

 

13
 

 

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.

 

See Note 2, Significant Accounting Policies, to our unaudited condensed consolidated financial statements included elsewhere in this report.

 

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.

 

14
 

 

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 March 31, 2012. Based on this evaluation, Ms. Chen and Mr. Jiang determined that our disclosure controls and procedures were effective as of March 31, 2012.

 

Changes in Internal Control Over Financial Reporting

 

There were no changes in our internal controls over financial reporting during the third quarter of fiscal year 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

15
 

 

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.

 

Our Annual Report on Form 10-K for the fiscal year ended June 30, 2011 contains a detailed discussion of risk factors that could materially adversely affect our business, our operating results, or our financial condition. The following risk factor should be read in conjunction with that discussion. Except for the addition of this risk factor, there are no material changes from the risk factors previously disclosed in Item 1A “Risk Factors” of our Annual Report on Form 10-K for the year ended June 30, 2011.

 

Our auditor, like other independent registered public accounting firms operating in China, is not inspected by the U.S. Public Company Accounting Oversight Board, or the PCAOB, and as such, our investors currently do not have the benefits of PCAOB oversight.

 

Auditors of companies that are registered with the SEC and traded publicly in the United States, including our independent registered public accounting firm, must be registered with the PCAOB and are required by U.S. law to undergo regular inspections by the PCAOB to assess their compliance with U.S. law and professional standards in connection with their audits of public company financial statements filed with the SEC. Because our auditor is located in China, a jurisdiction where the PCAOB is currently unable to conduct inspections without the approval of the Chinese authorities, the audit work and practices of our auditor, like other registered audit firms operating in China, is currently not inspected by the PCAOB.

 

This lack of PCAOB inspections in China prevents the PCAOB from regularly evaluating audits and quality control procedures of any auditors operating in China, including our auditor. As a result, investors may be deprived of the benefits of PCAOB inspections.

 

The inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of our auditor’s audit procedures or quality control procedures as compared to auditors outside of China that are subject to PCAOB inspections. Investors may lose confidence in our reported financial information and procedures and the quality of our financial statements.

 

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

 

We have not sold any equity securities during the third quarter of fiscal year 2012 that were not previously disclosed in a quarterly report on Form 10-Q or a current report on Form 8-K that was filed during the quarter.

 

During the three-month period ended March 31, 2012, we did not repurchase any shares of our common stock.

 

No repurchase plans expired or were terminated during the third 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.

 

16
 

 

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 third quarter of fiscal year 2012, 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.

 

ITEM 6.   EXHIBITS.

 

The list of exhibits in the Exhibit Index to this report is incorporated herein by reference.

 

17
 

 

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: May 11, 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)

 

 
 

 

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).