Attached files
| file | filename |
|---|---|
| EX-31.2 - EXHIBIT 31.2 - Sutor Technology Group LTD | v389428_ex31-2.htm |
| EX-10.10 - EXHIBIT 10.10 - Sutor Technology Group LTD | v389428_ex10-10.htm |
| EX-31.1 - EXHIBIT 31.1 - Sutor Technology Group LTD | v389428_ex31-1.htm |
| EX-32.1 - EXHIBIT 32.1 - Sutor Technology Group LTD | v389428_ex32-1.htm |
| EX-23.1 - EXHIBIT 23.1 - Sutor Technology Group LTD | v389428_ex23-1.htm |
| EXCEL - IDEA: XBRL DOCUMENT - Sutor Technology Group LTD | Financial_Report.xls |
| EX-32.2 - EXHIBIT 32.2 - Sutor Technology Group LTD | v389428_ex32-2.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: June 30, 2014
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to _____________
Commission File No. 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) |
| (86) 512-52680988 |
| (Registrant’s telephone number, including area code) |
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Name of each exchange on which registered | |
| Common Stock, par value $0.001 per share | NASDAQ Capital Market |
Securities registered pursuant to Section 12(g) of the Exchange Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes ¨ No x
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 Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
¨
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 registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes ¨ No x
As of December 31, 2013 (the last business day of the registrant’s most recently completed second fiscal quarter), the aggregate market value of the shares of the registrant’s common stock held by non-affiliates (based upon the closing sale price of such shares as reported on the NASDAQ Capital Market) was approximately $20.4 million. Shares of the registrant’s common stock held by each executive officer and director and by each person who owns 10% or more of the outstanding common stock have been excluded from the calculation in that such persons may be deemed to be affiliates of the registrant. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
There were a total of 41,661,429 shares of the registrant’s common stock outstanding as of December 12, 2014.
DOCUMENTS INCORPORATED BY REFERENCE
None.
SUTOR TECHNOLOGY GROUP LIMITED
Annual Report on FORM 10-K
| For the Fiscal Year Ended June 30, 2014 |
TABLE OF CONTENTS
Special Note Regarding Forward Looking Statements
In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We use words such as “believe,” “expect,” “anticipate,” “project,” “target,” “plan,” “optimistic,” “intend,” “aim,” “will” or similar expressions which are intended to identify forward-looking statements. Such statements include, among others, those concerning market and industry segment growth and demand and acceptance of new and existing products; any projections of sales, earnings, revenue, margins or other financial items; any statements of the plans, strategies and objectives of management for future operations; and any statements regarding future economic conditions or performance, as well as all assumptions, expectations, predictions, intentions or beliefs about future events. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, as well as assumptions, which, if they were to ever materialize or prove incorrect, could cause the results of the Company to differ materially from those expressed or implied by such forward-looking statements. Potential risks and uncertainties include, among other things, factors such as:
| · | Downturns in the steel industry; |
| · | Competition and competitive factors in the markets in which we compete; |
| · | Our heavy reliance on Shanghai Huaye; |
| · | Market perception of U.S. listed Chinese companies; |
| · | Fluctuations in our raw material costs; |
| · | General economic and business conditions in China and in the local economies in which we regularly conduct business, which can affect demand for our products and services; and |
| · | Changes in laws, rules and regulations governing the business community in China in general and the steel industry in particular. |
Additional disclosures regarding factors that could cause our results and performance to differ from results or anticipated performance are discussed in Item 1A, “Risk Factors” included herein. All statements other than statements of historical fact are statements that could be deemed forward-looking statements. We assume no obligation and do not intend to update these forward-looking statements, except as required by law.
Use of Terms
Except as otherwise indicated by the context, 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: Changshu Huaye, Jiangsu Cold-Rolled, Ningbo Zhehua, Sutor BVI, and Sutor Technology PRC; |
| · | “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 Chairperson, and her husband Feng Gao, are 100% owners, and its subsidiaries; |
| 1 |
| · | “Sutor BVI” are to our wholly-owned subsidiary Sutor Steel Technology Co., Ltd., a BVI company; |
| · | “Sutor Technology PRC” are to our wholly-owned subsidiary Sutor Technology Co., Ltd., a PRC company; |
| · | “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 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. |
| ITEM 1. | BUSINESS. |
Overview
We are one of the leading China-based, non-state-owned manufacturers and services providers 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, value-added finished steel products, specifically hot-dip galvanized steel, or HDG steel, and pre-painted galvanized steel, or PPGI. In addition, we produce acid pickled steel, or AP steel, and cold-rolled steel, which represent the least processed of our finished products. Since November 2009, our product offerings have included 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. Our vertical integration has allowed us to maintain more stable margins for our HDG steel and PPGI products under normal circumstances. In addition, we offer fee-based steel processing services and market and sell our products through electronic commerce platforms.
We sell most of our products to customers who operate primarily in the green energy, appliances, automobile, construction, infrastructure, medical equipment and water resource industries. Most of our customers are located in China. Our primary export markets are Europe, the Middle East, Asia, and South America.
Our manufacturing facilities, located in Changshu, China, have three HDG steel production lines, one PPGI production line, one AP steel production line and one cold-rolled steel line. Our current annual production capacity is approximately 700,000 metric tons, or MT, for HDG steel, 200,000 MT for PPGI, 500,000 MT for AP steel and 250,000 MT for cold-rolled steel. Ningbo Zhehua, our subsidiary located in Ningbo, currently has an annual capacity of 400,000 MT for welded steel pipe products. We recently completed the construction of a new 500,000 MT cold-rolled production line in Changshu. We started producing products in small quantities and anticipate gradual ramp-up of capacity utilization in the coming quarters.
History and Corporate Structure
We were incorporated on May 1, 1997 in the State of Nevada under the name Bronze Marketing, Inc. and changed our name to Sutor Technology Group Limited effective March 6, 2007. Sutor BVI was incorporated in the BVI on August 15, 2006. Sutor BVI presently has two direct, wholly owned operating subsidiaries: Changshu Huaye and Jiangsu Cold-Rolled. Changshu Huaye was incorporated in China as a foreign investment enterprise on January 17, 2003 with registered capital of $81 million. Jiangsu Cold-Rolled was incorporated in China on August 28, 2003 as a foreign investment enterprise with registered capital of $40 million.
In November 2009, Changshu Huaye acquired 100% equity interest in Ningbo Zhehua for the total purchase price of RMB 45.2 million (approximately $6.6 million).
On February 24, 2010, we established Sutor Technology PRC as a wholly-owned subsidiary incorporated in China. We plan to consolidate all R&D activities into this subsidiary in the future.
| 2 |
The following chart reflects our organizational structure as of the date of this annual report:
Segment Information
Our four operating segments are categorized according to our four operating subsidiaries:
| · | Changshu Huaye, which manufactures and sells HDG steel and PPGI products; |
| · | Jiangsu Cold-Rolled, which manufactures and sells HDG steel, AP steel and cold-rolled steel; |
| · | Ningbo Zhehua, which manufactures and sells welded steel pipe products; and |
| · | Sutor Technology PRC, which primarily sells products of our other subsidiaries. |
Changshu Huaye and Jiangsu Cold-Rolled are located adjacent to each other in Changshu, China and use largely the same management resources. Ningbo Zhehua is located in Ningbo, China. For additional information about each segment, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Result of Operations” and Note 16, “Segment Information” to the consolidated financial statements included elsewhere in this annual report.
Our Products
Our current products include HDG steel, PPGI, AP steel, cold-rolled steel and welded steel pipe products. Our HDG steel and PPGI products are primarily manufactured by Changshu Huaye and our AP steel and cold-rolled steel products are primarily manufactured by Jiangsu Cold-Rolled. Jiangsu Cold-Rolled added two new HDG steel production lines and has manufactured HDG of both cold-rolled steel and hot-rolled steel since September 2008. Ningbo Zhehua manufactures our welded steel pipe products.
In 2008, we were certified ISO 9001:2008 for our quality management system, ISO 14001:2004 for our environmental management system, and GB/T28001-2001 for our occupational health and safety management system.
| 3 |
The following table set forth sales information about our product mix in last two fiscal years.
(All amounts, other than percentages, in millions of U.S. dollars)
| Fiscal Year Ended June 30, 2014 | Fiscal Year Ended June 30, 2013 | |||||||||||||||
| Product | Revenue | % of Total Revenue | Revenue | % of Total Revenue | ||||||||||||
| HDG Steel | $ | 266.0 | 65.6 | % | $ | 335.3 | 54.8 | % | ||||||||
| PPGI | 28.1 | 6.9 | % | 50.0 | 8.2 | % | ||||||||||
| AP Steel | 5.4 | 1.3 | % | 127.3 | 20.8 | % | ||||||||||
| Cold-Rolled Steel | 26.8 | 6.6 | % | 52.4 | 8.6 | % | ||||||||||
| Welded Steel Pipe Products | 29.0 | 7.1 | % | 27.0 | 4.4 | % | ||||||||||
| Other | 50.1 | 12.5 | % | 20.1 | 3.2 | % | ||||||||||
| Total | $ | 405.4 | 100.0 | % | $ | 612.1 | 100.0 | % | ||||||||
HDG Steel
Using a technology called hot-dip galvanizing, we manufacture corrosion-resistant and zinc-coated HDG steel in different dimensions and using different materials and specifications requested by our customers. HDG steel products are manufactured from steel substrate of cold-rolled or hot-rolled pickled coils by applying zinc to the surface of the material to enhance its corrosion protection. HDG steel products are principally used in the electrical household appliances and construction markets.
We produce not only common industrial specifications, but also extreme specifications that we believe only a few other large PRC state-owned steel manufacturers can produce. The following table compares our technical manufacturing capabilities for most of our products:
| Width (mm) | Thickness (mm) | Galvanized Layer Weight (g/m2 ) | ||||
| Our Specification Scope | 700-1250 | 0.18-4.5 | 70-280 | |||
| Common Industrial Specification Scope | 700-1250 | 0.3-1.2 | 100-180 |
We also are technologically capable of manufacturing more extreme specifications of up to 1300mm wide and 0.16mm thick HDG of cold-rolled steel. As a result, we maintain a competitive advantage in extreme specification technology in terms of thickness and the weight of the galvanized layer of our products. We have the flexibility to adjust production specifications to meet changes in market demand.
Sales of HDG steel products amounted to approximately 418,396 MT in fiscal year 2014, representing approximately 65.6% of our total revenue. Currently, our HDG steel products are manufactured by Changshu Huaye and Jiangsu Cold-Rolled. Changshu Huaye produces only HDG of cold-rolled steel. Jiangsu Cold-Rolled has two HDG steel production lines which are capable of galvanizing both hot-rolled and cold-rolled steel with both zinc and aluminum. Our production capacity of HDG steel is 700,000 MT per year.
With the production lines of Jiangsu Cold-Rolled, we offer HDG of hot-rolled steel, which we believe is more cost-efficient than production of HDG of cold-rolled steel because production of HDG steel products occurs directly on hot-rolled steel and, therefore, avoids the procedure of cold rolling hot-rolled steel. HDG of hot-rolled steel is generally thicker than HDG of cold-rolled steel with a specification range of 1.5mm to 4.5mm in terms of thickness.
PPGI Products
PPGI products are typically made to order based on customer specifications. Our PPGI products’ specification generally ranges from 700mm to 1250mm in width and from 0.2mm to 1.2mm in thickness. Our PPGI products are used mostly in solar energy, appliances and construction materials. We produce our PPGI by color-coating on HDG of cold-rolled steel and then coating them in various colors according to customer requirements. Our PPGI production line is equipped with the latest twice baking and coating technology, which together with indirect heating, enhances the color coated layers adhesion to the galvanized zinc layer.
Sales of PPGI products amounted to approximately 34,971 MT in fiscal year 2014, representing approximately 6.9% of our total revenue. Through our vertical integration strategy, we currently self-supply approximately 100% of HDG of cold-rolled steel to our PPGI production.
| 4 |
AP Steel
Our AP steel production line is located at Jiangsu Cold-Rolled, which became operative in September 2006. Acid pickling is a process that removes scales and oxides from the steel surface by pickling, cold rolling and annealing. AP steel products are used mostly as a raw material for cold-rolled steel strip, HDG steel, as well as components of automobile and manufacturing equipment. AP steel products come in several different dimensions and using different materials and different specifications.
Most of our AP steel products are used for our own production of HDG steel and full-hard cold-rolled steel. We also sell a portion of our AP steel products to the market. In fiscal year 2014, our sales of AP steel products were approximately 9,901 MT, representing approximately 1.3% of our total revenue.
Full-Hard, Cold-rolled Steel Products
We commenced manufacturing of full-hard cold-rolled steel products in January 2007. Full-hard cold-rolled steel strips are treated in an annealing process and are used to produce HDG of cold-rolled steel. We produce full-hard cold-rolled steel strips through a reverse cold rolling mill.
We use most of the full-hard cold-rolled steel strips for our production of HDG of cold-rolled steel. Our sales of cold-rolled steel products amounted to approximately 47,550 MT in fiscal year 2014, representing approximately 6.6% of our total revenue. In addition, approximately 85.8% of cold-rolled steel products were used for our own production.
Welded Steel Pipe Products
Our subsidiary Ningbo Zhehua has one advanced JCOE(which represents the first letters of the production processes) production line with characteristics of high forming accuracy and efficiency as well as balanced distribution of forming stress, for large-diameter, double-side, submerged-arc welded steel pipes, three US Lincoln production lines for spiral seam, double-side, submerged-arc welded steel pipes, and two REF production lines for roll-bending, double-side, submerged-arc welded steel pipes. Ningbo Zhehua is specialized in manufacturing large-diameter, double-side, submerged-arc welded steel pipes and spiral seam steel pipes. The finished products are extensively used for oil and gas transmission, municipal water supply projects, sewage treatment projects, and piling. Sales of welded steel pipe products amounted to approximately 42,067 MT in fiscal year 2014, representing approximately 7.1% of our total sales revenue.
Manufacturing
Our manufacturing facilities are located in Changshu and Ningbo, China. Our facilities in Changshu currently have three HDG steel production lines, one PPGI production line, one AP steel production line and one cold-rolled steel line. Our facilities in Ningbo have six welded steel pipe production lines. Our current annual production capacity is approximately 700,000 MT for HDG steel, 200,000 MT for PPGI, 500,000 MT for AP steels, 250,000 MT for cold-rolled steel and 400,000 MT for welded steel pipe products. In addition, we recently completed the construction of a new 500,000 MT cold-rolled production line. We started producing products in small quantities of limited products and anticipate gradual ramp-up of capacity utilization in the coming quarters. The facility has different production characteristics from our existing cold-rolled production line and is expected to expand our product offerings.
We utilize modern automated production technology which is strictly maintained. There are generally only 15 workers on a continuous cold-rolled galvanizing line and 11 workers on the PPGI production line per shift. The chart below demonstrates our production process.
| 5 |
Note: Dashed lines represent manufacturing processes.
Processing Services
We also provide fee-based steel processing service to our customers. For steel processing service, we charge our customers a fee to cover production expenses plus gross profits. The customers are responsible for purchasing raw materials steel sheets. For the traditional product sales, the sale price typically covers the cost of raw materials, production expenses and gross profits. Consequently, revenue from steel processing service is only a fraction of the traditional product sales. We believe the processing service is more scalable , which allows us to reduce the risks of declining commodity prices.
Raw Materials and Suppliers
The principal raw materials used in producing our products are steel coil, zinc, oil paint and acid. We source our raw materials from various suppliers, including our affiliate Shanghai Huaye which supplied approximately 45.9% of our raw materials in fiscal year 2014. We believe that our suppliers are sufficient to meet our present needs.
Steel coil accounted for approximately 95% of total production costs in fiscal year 2014. We generally purchase steel coil after receiving orders from customers and are generally able to pass on increased costs to customers. We purchase steel strips primarily from Chinese companies, both state-owned enterprises and private companies. State-owned enterprises can ensure a consistent large supply, but do not react quickly to the fluctuations in prevailing market prices. Private companies normally react quickly to price changes, but are not as reliable as state-owned enterprises in terms of consistent supply. By sourcing raw materials from a combination of state-owned enterprises and private companies, we enjoy both a reliable source of raw materials and competitive prices.
Zinc is an important raw material for HDG of cold-rolled steel and accounted for approximately 4% of our total production costs of HDG steel in fiscal year 2014. We have established long-term relationships with several Chinese suppliers. We compare the prevailing domestic prices and choose the lower price and can generally pass price fluctuations onto customers. Zinc prices are closely guided by the London Metal Exchange quotation and are the most volatile among those of all of our raw materials.
| 6 |
Our global sourcing network is designed to ensure the highest quality-to-price ratio of the raw materials we purchase. Our internal specialists collect Chinese domestic and global market information everyday and track domestic and global market price fluctuations closely, which allows us to react rapidly to any price changes.
Because we produce a portfolio of products of various specifications, amounts and delivery horizon, we use Shanghai Huaye extensively for our raw material supplies as we often cannot buy a variety of products in small quantities from large steel companies on contract terms favorable to us. When we buy from these steel companies we are usually required to sign long term contracts and pay cash advances up to a year in advance of the receipt of goods. The up-front cash payment may include collateral money, cash deposit and prepayment. Further, if we cannot take required amount of the delivery as specified in the contracts, the cash deposit for the collateral money would be forfeited. However, when we buy raw materials from Shanghai Huaye, we pay cash advances and the amount of up-front cash requirements would be similar to the amount if conducted with similar non-related party vendors in the industry. However, with cash advances to Shanghai Huaye we will not lose the advance payments if later we do not take enough of the delivery. In addition, as our customers are primarily small and medium size companies with small orders and various products specifications, it would not be in our best interest to sign many annual contracts with steel-making companies risking the loss of deposits on large orders.
Customers
Approximately 27.3% of our revenue was derived from Shanghai Huaye and its affiliates in fiscal year 2014. We currently do not have a long-term written contract with Shanghai Huaye and negotiate the terms of each transaction based on then current market condition. We believe such arrangement will afford us more flexibility and allow us to obtain more favorable prices based on the changing market. We believe we have a good relationship with Shanghai Huaye and expect Shanghai Huaye to remain as our major customer in the foreseeable future. We plan to further expand our sales channel and increase our direct sales to end customers in the future. Other than Shanghai Huaye, none of our customers individually accounted for more than 10% of our total revenue in fiscal year 2014.
Sales and Marketing
China is our most important market. Domestic sales represented approximately 92.5% of our total revenue in fiscal year 2014. Within China, the biggest market for our products is eastern China, which includes Shanghai, Zhejiang and Jiangsu provinces. Since September 2004, we have exported our products to Europe, the Middle East, Asia, and South America. Our foreign sales accounted for approximately 9.6% and 7.5% of our total revenue in fiscal years 2013 and 2014, respectively.
Our sales network covers most provinces and regions in China. We are developing a diversified sales network which allows us to effectively market products and services to our customers. We sold most of our products through our own sales and marketing department in fiscal year 2014. Our sales and marketing department consists of approximately 46 employees as of the date of this annual report.
Competition
Competition within the steel industry, both in China and worldwide, is intense. We compete with both large state-owned enterprises and smaller private companies. In addition, we also face competition from international steel manufacturers.
Even though the demand for fine finished steel products has increased in recent years, due to the over expansion of the total production capacity of HDG steel and PPGI products, supply for low-end HDG steel and PPGI products has outpaced demand. Due to the high requirements for production technology and equipment, we believe that demand for high-end HDG steel and PPGI market remains strong. Currently, only Sutor and a few large state-owned enterprises are capable of producing high-end HDG steel and PPGI products in China.
Private steel product manufacturers in China generally focus on low-end products. Many of our competitors are much smaller than us and use older equipment and production techniques. In contrast, our products are aimed at the high-end markets so we attempt to manufacture them with superior quality and broader range of specifications. We use advanced manufacturing equipment that we have purchased from developed countries, such as France and Italy, and employ engineers and researchers who are experienced with different production techniques. This allows us to provide a broad array of products in terms of thickness, zinc layer weight and width of steel coil, which helps us target high-end customers whose manufacturing specifications are extreme. In addition, through cooperation with our strategic partners, we have also established a vertically integrated business model that provides processing, distribution and customized logistic solutions. We believe this business model is difficult to duplicate and very few private companies have this capability.
| 7 |
There are several state-owned steel manufacturers that produce comparable products to our products. As compared with those competitors, we believe we differentiate ourselves by the following:
| · | We satisfy customers’ orders with shorter lead times and guarantee lead times for urgent orders, even very small orders, in as short as one or two days; |
| · | We have flexibility in sales arrangements and can take orders in a variety of sizes; |
| · | We operate more efficiently than our state-owned competitors and have lower total labor costs, therefore, lower product prices; and |
| · | We provide more customer-oriented services. |
We also compete with international steel product manufacturers in the global market, such as Mitel Corporation and Posco Steel. As compared to our competitors in Europe, Korea and the United States, we believe we have lower production costs and can offer more competitive pricing. In addition, competitors in developing countries lag behind due to low product quality and limited product specification ranges. We began exporting our products in September 2004 and our products are now sold to Europe, the Middle East, Asia, and South America. Our export sales accounted for approximately 7.5% of our total sales for fiscal year 2014.
Our operating subsidiaries, Changshu Huaye Jiangsu Cold-Rolled and Sutor Technology PRC, are located in Changshu, which provides us a transportation cost advantage. Changshu is situated in the eastern coastal part of China, the largest market hub for coated steel products in eastern China. In addition, our affiliate Shanghai Huaye has a logistic center in Changshu port, which provides us with convenient and low cost transportation for both raw materials and finished products. Further, our subsidiary Ningbo Zhehua is located in Ningbo which is one of the largest and most important sea port cities in China with easy access to both domestic and international markets.
Research and Development
We believe that the development of new products and production methods is important to our success. We established our high-performance steel sheet research center in 2007, which was recognized as the “Jiangsu Province Foreign Invested Research Center” by the Jiangsu Science and Technology Bureau. As of June 30, 2014, we had 27 research and development personnel and staff.
We set up Sutor Technology PRC in 2010 and we intend consolidate all R&D activities into this subsidiary in the future. We plan to build a facility in Sutor Technology PRC to be used solely for research and development of new products and technologies. We expect Sutor Technology PRC will help attract talent and enhance our leading position in the fine processed steel industry in China. Sutor Technology PRC is anticipated to enjoy preferential tax treatment when in full operation.
Intellectual Property
Our success depends, in part, on our ability to maintain and protect our proprietary technology and to conduct our business without infringing on the proprietary rights of others. We rely primarily on a combination of patents, trademarks and trade secrets, as well as employee and third-party confidentiality agreements, to safeguard our intellectual property. As of June 30, 2014, we held 67 patents and had 19 patent applications pending.
All of our products are sold with the trademark of “
,”
which is known by Chinese and international clients. In August 2005, Shanghai Huaye agreed to transfer the trademark of “
”
to us without consideration. Such transfer was approved by the Trademark office of the State Administration for Industry and Commerce
of China in August 2006. As a result, we have all the legal rights for the trademark, the term of which expires in July 2015.
All our key employees, especially engineers, have signed confidentiality and non-competition agreements with us. In addition, all our employees are obligated to protect our confidential information. Where appropriate for our business strategy, we will continue to take steps to protect our intellectual property rights.
| 8 |
Employees
As of June 30, 2014, we had approximately 537 full-time employees. Approximately 236 employees are from Changshu Huaye, approximately 141 employees from Jiangsu Cold-Rolled and approximately 160 from Ningbo Zhehua.
The following table sets forth the number of our full-time employees by function.
| Function | Number of Employees | |
| Manufacturing | 362 | |
| General and administration | 102 | |
| Marketing and sales | 46 | |
| Research and development | 27 |
We believe that we maintain a good working relationship with our employees and we have not experienced any significant labor disputes or any difficulty in recruiting staff for our operations. Our employees are not covered by a collective bargaining agreement. We have not experienced any work stoppages.
We are required under PRC law to make contributions to the employee benefit plans at specified percentages of the after-tax profit. In addition, we are required by the PRC law to cover employees in China with various type of social insurance. We believe that we are in material compliance with the relevant PRC laws.
Regulation
General Regulation of Business
As a producer of steel products in China, we are regulated by the national and local laws of the PRC.
We are subject to various governmental regulations related to environmental protection. The major environmental regulations applicable to us include: the Environmental Protection Law of the PRC, the Law of PRC on the Prevention and Control of Water Pollution, Implementation Rules of the Law of PRC on the Prevention and Control of Water Pollution, the Law of PRC on the Prevention and Control of Air Pollution, Implementation Rules of the Law of PRC on the Prevention and Control of Air Pollution, the Law of PRC on the Prevention and Control of Solid Waste Pollution, and the Law of PRC on the Prevention and Control of Noise Pollution.
We believe that we are in material compliance with all registrations and requirements for the issuance and maintenance of all licenses required by the governing bodies, and that all license fees and filings are current.
Taxation
On March 16, 2007, the National People’s Congress of China passed the Enterprise Income Tax Law, or the EIT Law, and on November 28, 2007, the State Council of China passed its implementing rules, both of which took effect on January 1, 2008. The EIT Law and its implementing rules impose a unified earned income tax, or EIT, rate of 25.0% on all domestic-invested enterprises and foreign invested enterprises, or FIEs, unless they qualify under certain limited exceptions. In 2013, Changshu Huaye applied to renew its certificate as a high-tech enterprise and the application has been approved. As a result, Changshu Huaye continues to have an EIT of 15% from calendar years 2013 to 2015. Jiangsu Cold-Rolled’s tax holiday expired at the end of 2011, and therefore, it was subject to an EIT rate of 12.5% in calendar year 2011 and is subject to an EIT rate of 25% starting in calendar year 2012. Ningbo Zhehua and Sutor Technology PRC are subject to an EIT of 25% and have no preferential tax treatments.
In addition to the changes to the current tax structure, under the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a resident enterprise and will normally be subject to an EIT of 25% on its global income. The implementing rules define the term “de facto management bodies” as “an establishment that exercises, in substance, overall management and control over the production, business, personnel, accounting, etc., of a Chinese enterprise.” If the PRC tax authorities subsequently determine that we should be classified as a resident enterprise, then our organization’s global income will be subject to PRC income tax of 25%. For detailed discussion of PRC tax issues related to resident enterprise status, see Item 1A, “Risk Factors – Risks Related to Doing Business in China – Under the New Enterprise Income Tax Law, we may be classified as a “resident enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders.”
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Foreign Currency Exchange
All of our sales revenue and expenses are denominated in RMB. Under the PRC foreign currency exchange regulations applicable to us, RMB is convertible for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions. Currently, our PRC operating subsidiaries may purchase foreign currencies for settlement of current account transactions, including payments of dividends to us, without the approval of the PRC State Administration of Foreign Exchange, or SAFE, by complying with certain procedural requirements. Conversion of RMB for capital account items, such as direct investment, loan, security investment and repatriation of investment, however, is still subject to the approval of SAFE. In particular, if our PRC operating subsidiaries borrow foreign currency through loans from us or other foreign lenders, these loans must be registered with SAFE, and if we finance the subsidiaries by means of additional capital contributions, these capital contributions must be approved by certain government authorities, including the PRC Ministry of Commerce, or MOFCOM, or their respective local branches. These limitations could affect our PRC operating subsidiaries’ ability to obtain foreign exchange through debt or equity financing.
Dividend Distributions
Our revenues are earned by our PRC subsidiaries. However, PRC regulations restrict the ability of our PRC subsidiaries to make dividends and other payments to their offshore parent company. PRC legal restrictions permit payments of dividend by our PRC subsidiaries only out of their accumulated after-tax profits, if any, determined in accordance with PRC accounting standards and regulations. Each of our PRC subsidiaries is also required under PRC laws and regulations to allocate at least 10% of our annual after-tax profits determined in accordance with PRCGAAP to a statutory general reserve fund until the amounts in such fund reaches 50% of its registered capital. These reserves are not distributable as cash dividends. Our PRC subsidiaries have the discretion to allocate a portion of their after-tax profits to staff welfare and bonus funds, which may not be distributed to equity owners except in the event of liquidation.
In addition, under the EIT Law, the Notice of the State Administration of Taxation on Negotiated Reduction of Dividends and Interest Rates, which was issued on January 29, 2008, and the Notice of the State Administration of Taxation Regarding Interpretation and Recognition of Beneficial Owners under Tax Treaties, which became effective on October 27, 2009, dividends from our PRC operating subsidiaries paid to us through our subsidiaries may be subject to a withholding tax at a rate of 10%. Furthermore, the ultimate tax rate will be determined by treaty between the PRC and the tax residence of the holder of the PRC subsidiary. Dividends declared and paid from before January 1, 2008 on distributable profits are grandfathered under the EIT Law and are not subject to withholding tax.
The Company intends on reinvesting profits, if any, and does not intend on making cash distributions of dividends in the near future.
Environmental Matters
Our manufacturing facilities are subject to various pollution control regulations with respect to noise, water and air pollution and the disposal of waste and hazardous materials. We are also subject to periodic inspections by local environmental protection authorities. Our operating subsidiaries have received certifications from the relevant PRC government agencies in charge of environmental protection indicating that their business operations are in material compliance with the relevant PRC environmental laws and regulations. We are not currently subject to any pending actions alleging any violations of applicable PRC environmental laws.
Seasonality
Our operating results and operating cash flows historically have not been subject to any significant seasonal variations. However, extended holidays in China such as the Lunar Chinese New Year and October holidays will impact the Company’s operations due to holiday shut downs. This pattern may change, however, as a result of new market opportunities or new product introductions.
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Available Information
Our Internet website is at www.sutorcn.com. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, including exhibits, and amendments to those reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Exchange Act, are available free of charge on our website as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the SEC. Copies of these reports may also be obtained free of charge by sending written requests to our Secretary, Sutor Technology Group Limited, No. 8 Huaye Road, Dongbang Industrial Park, Changshu, China, 215534. The information posted on our website is not part of this or any other report we file with or furnish with the SEC. Investors can also read and copy any materials filed by us with the SEC at the SEC’s Public Reference Room which is located at 100 F Street, NE, Washington, DC 20549. Information about the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. Our filings can also be accessed at the SEC’s website: www.sec.gov.
RISKS RELATED TO OUR BUSINESS
We maintain a close business relationship with Shanghai Huaye and any disruption of this relationship or the financial stability of Shanghai Huaye could damage our business.
Our company and Shanghai Huaye, which is 100% owned by our majority shareholder and Chairperson, Lifang Chen and her husband Feng Gao, have a close business relationship. Approximately 27.3% of our revenue was derived from Shanghai Huaye and its affiliates in fiscal year 2014, which distribute our products. In addition, a large portion of our raw materials were supplied by Shanghai Huaye in fiscal year 2014. We believe that the larger size of Shanghai Huaye gives it greater bargaining power than us and our arrangement with Shanghai Huaye allows us to leverage its bargaining power and purchase raw materials at relatively lower purchase prices from suppliers. We do not have long-term written contracts with Shanghai Huaye. In the past, Shanghai Huaye also has provided credit support on our behalf and guaranties for our benefit in connection with loans to us from third party lenders.
If our business relationship with Shanghai Huaye changes negatively or Shanghai Huaye’s financial condition deteriorates, this would harm our business in many ways. We would be forced to rely on other third parties for raw materials and product distribution if Shanghai Huaye ceases to be a supplier of our raw materials and/or a distributor of our products at current levels. We may not be able to negotiate terms with these third parties that are as favorable as our arrangements with Shanghai Huaye. For instance, we may be requested to sign long-term agreements with other suppliers and pay a significant amount of cash deposit. If we fail to accept enough of the contracted products from these suppliers, our deposit could be forfeited. If this happens, our revenues could decrease, our production costs could increase and our profit margin could be strained. In addition, a material adverse change in the financial condition and creditworthiness of Shanghai Huaye could impair our existing credit facilities and ability to obtain loans in the future.
Our level of indebtedness may make it more difficult for us to fulfill all of our debt obligations and may reduce the amount of cash available for maintaining and growing our operations, which could have an adverse effect on our revenues.
Our major source of liquidity is borrowing through short-term bank and private loans. Our total debt under existing loans as of June 30, 2014 was approximately $150.3 million, of which approximately $139.2 million are short-term loans to non-related third parties. We expect to renew our short-term loans when they become due. Our inability to renew these loans upon maturity may cause us working capital constraints. This substantial indebtedness could also impair our financial condition and our ability to fulfill all of our debt obligations, especially during a downturn in our business, in the industry in which we operate or in the general economy. Our indebtedness and the incurrence of any new indebtedness could (i) make it more difficult for us to satisfy our existing obligations, which could in turn result in an event of default on such obligations, (ii) require us to seek other sources of capital to finance cash used in operating activities, thereby reducing the availability of cash for working capital, capital expenditures, acquisitions, general corporate purposes or other purposes, (iii) impair our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, general corporate purposes or other purposes; (iv) diminish our ability to withstand a downturn in our business, the industry in which we operate or the economy generally, (v) limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate, or (vi) place us 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.
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Any decrease in the availability, or increase in the cost, of raw materials could materially affect our earnings.
Our operations depend heavily on the availability of various raw materials and energy resources, including steel coil, zinc, oil paint, electricity and natural gas. Steel coil has historically made up approximately 95% of our total cost of sales. The availability of raw materials and energy resources may decrease and their prices may fluctuate greatly. We purchase a large portion of our raw materials from our affiliate Shanghai Huaye and we have long-term relationships with several other suppliers. However, if Shanghai Huaye or any other important suppliers are unable or unwilling to provide us with raw materials on terms favorable to us, we may be unable to produce certain products. This could result in a decrease in profit and damage to our reputation in our industry. In the event our raw material and energy costs increase, we may not be able to pass these higher costs on to our customers in full or at all. Any increase in the prices for raw materials or energy resources could materially increase our costs and therefore lower our earnings.
Our industry is highly fragmented and competitive, and increased competition could reduce our operating income.
The steel manufacturing and processing business is highly fragmented and competitive. We compete with a number of other steel manufacturers and processors in China, on a region-by-region basis, and with foreign steel manufacturers on a worldwide basis. Our goal is to market our products to customers who demand the highest quality products and precision in the end product so we compete primarily on the precision and range of achievable tolerances, the quality of our products and the raw materials used in our products. We compete with companies of various sizes, some of which have more established brand names and relationships in certain markets we serve than we do. Increased competition could force us to lower our prices or offer services at a higher cost to us, which could reduce our margins and operating income.
A downturn or negative changes in the highly volatile steel industry will harm our business and profitability.
The steel industry as a whole is cyclical and pricing can be volatile as a result of general economic conditions, energy costs, labor costs, competition, import duties, tariffs and currency exchange rates. These macroeconomic factors have historically resulted in wide fluctuations in the steel industry both in China and globally. In our case, future economic downturns, stagnant economies or currency fluctuations in China or globally could decrease the demand for products or increase the amount of imports of steel into China, which could negatively impact our sales, margins and profitability.
We may be exposed to potential risks relating to our internal controls over financial reporting and our ability to have the operating effectiveness of our internal controls attested to by our independent auditors.
As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the SEC adopted rules requiring public companies to include a report of management on the Company’s internal controls over financial reporting in their annual reports and, for companies that are not small reporting companies, the independent registered public accounting firm auditing a company’s financial statements to attest to and report on the operating effectiveness of such company’s internal controls. Our management had previously identified material weaknesses in our internal control over financial reporting in fiscal years 2008 and 2009. Although our management believes that our internal control over financial reporting was effective as of June 30, 2014, we can provide no assurance that we will comply with all of the requirements imposed thereby and we will receive a positive attestation from our independent auditors in the future, when required. In the event we identify significant deficiencies or material weaknesses in our internal controls that we cannot remediate in a timely manner or we are unable to receive a positive attestation from our independent auditors with respect to our internal controls when such attestation is required, investors and others may lose confidence in the reliability of our financial statements.
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.
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The inability of the PCAOB to conduct inspections of auditors in China also 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. As a result, investors may be deprived of the benefits of PCAOB inspections and may lose confidence in our reported financial information and procedures and the quality of our financial statements.
If we become directly subject to the recent scrutiny, criticism and negative publicity involving U.S.-listed Chinese companies, we may have to expend significant resources to investigate and resolve the matter which could harm our business operations, stock price and reputation and could result in a loss of your investment in our stock, especially if such matter cannot be addressed and resolved favorably.
Recently, U.S. public companies that have substantially all of their operations in China, particularly companies like us which have completed so-called reverse merger transactions, have been the subject of intense scrutiny, criticism and negative publicity by investors, financial commentators and regulatory agencies, such as the SEC. Much of the scrutiny, criticism and negative publicity has centered around financial and accounting irregularities and mistakes, a lack of effective internal controls over financial accounting, inadequate corporate governance policies or a lack of adherence thereto and, in many cases, allegations of fraud. As a result of the scrutiny, criticism and negative publicity, the publicly traded stock of many U.S. listed Chinese companies has sharply decreased in value and, in some cases, has become virtually worthless. Many of these companies are now subject to shareholder lawsuits, SEC enforcement actions and are conducting internal and external investigations into the allegations. It is not clear what effect this sector-wide scrutiny, criticism and negative publicity will have on our Company, our business and our stock price. If we become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, we will have to expend significant resources to investigate such allegations and/or defend our Company. This situation will be costly and time consuming and distract our management from growing our company. If such allegations are not proven to be groundless, our Company and business operations may be severely and adversely affected and your investment in our stock could be rendered worthless.
We may be unable to fund the substantial ongoing capital and maintenance expenditures that our operations require.
Our operations are capital intensive and our business strategy may require additional substantial capital investment. We require capital for building new production lines, acquiring new equipment, maintaining the condition of our existing equipment and complying with environmental laws and regulations. We plan to fund our capital expenditures from operating cash flow and our credit facilities and may require additional debt or equity financing. We cannot assure you, however, that financing will be available or, if financing is available, it may result in increased interest and amortization expense, increased leverage, dilution and decreased income available to fund further expansion. In addition, future debt financings may limit our ability to withstand competitive pressures and render us more vulnerable to economic downturns. If we are unable to fund our capital requirements, we may be unable to implement our business plan, and our financial performance may suffer.
Unexpected equipment failures may damage our business due to production curtailments or shutdowns.
Our manufacturing processes are extremely specialized and depend on critical pieces of equipment, such as air knife machines, welding tools and apparatus, color-coating machines, roll mills, ABB roll and tension knives. This machinery is highly specialized and cannot be repaired or replaced without significant expense and time delay. On occasion, our equipment may be out of service as a result of unanticipated failures which may result in material plant shutdowns or periods of reduced production. Interruptions in production capabilities will inevitably increase production costs and reduce our sales and earnings. In addition to equipment failures, our facilities are also subject to the risk of catastrophic loss due to unanticipated events such as fires, explosions or adverse weather conditions. Furthermore, any interruption in production capability may require us to make large capital expenditures to remedy the situation, which could have a negative effect on our profitability and cash flows. Although we have business interruption insurance, we cannot provide any assurance that the insurance will cover all losses that we experience as a result of the equipment failures. In addition, longer-term business disruption could result in a loss of customers. If this were to occur, our future sales levels, and therefore our profitability, could be adversely affected.
Our revenue will decrease if there is less demand for construction materials or electrical household appliances.
Our products often serve as important components in construction materials and electrical household appliances. Therefore, we are subject to the general changes in economic conditions affecting the construction and household appliance segments of the economy. Demand for our products is typically affected by a number of economic factors, including, but not limited to, consumer interest rates, consumer confidence, retail trends, sales of existing homes, and the level of mortgage financing. If there is a decline in economic activity in China and the other markets in which we operate or a decrease of sales of construction materials and electrical household appliances, demand for our products and our revenue will likewise decrease.
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Environmental regulations impose substantial costs and limitations on our operations.
We are subject to various national and local environmental laws and regulations in China concerning issues such as air emissions, wastewater discharges, and solid waste management and disposal. These laws and regulations can restrict or limit our operations and expose us to liability and penalties for non-compliance. While we believe that our facilities are in material compliance with all applicable environmental laws and regulations, the risks of substantial unanticipated costs and liabilities related to compliance with these laws and regulations are an inherent part of our business. It is possible that future conditions may develop, arise or be discovered that create new environmental compliance or remediation liabilities and costs. While we believe that we can comply with existing environmental legislation and regulatory requirements and that the costs of compliance have been included within budgeted cost estimates, compliance may prove to be more limiting and costly than anticipated.
If our customers and/or the ultimate consumers of products that use our products successfully assert product liability claims against us due to defects in our products, our operating results may suffer and our reputation may be harmed.
Our products are widely applied in the manufacturing of many products, including electrical household appliances, medical instruments and large industrial equipment. Significant property damage, personal injuries and even death can result from malfunctioning products. If our products are not properly manufactured or installed and/or if people are injured as a result of our products, we could be subject to claims for damages based on theories of product liability and other legal theories in some jurisdictions in which our products are sold. The costs and resources to defend such claims could be substantial and, if such claims are successful, we could be responsible for paying some or all of the damages. We do not have product liability insurance. The publicity surrounding these sorts of claims is also likely to damage our reputation, regardless of whether such claims are successful. Any of these consequences resulting from defects in our products would hurt our operating results and stockholder value.
We might fail to adequately protect our intellectual property and third parties may claim that our products infringe upon their intellectual property.
As part of our business strategy, we intend to accelerate our investment in new technologies in an effort to strengthen and differentiate our product portfolio and make our manufacturing processes more efficient. As a result, we believe that the protection of our intellectual property will become increasingly important to our business. Currently, we have 67 patents and 19 patent applications pending. We expect to rely on a combination of patents, trade secrets, trademarks and copyrights to provide protection in this regard, but this protection might be inadequate. For example, our pending or future patent applications might not be approved or, if allowed, they might not be of sufficient strength or scope. Conversely, third parties might assert that our technologies infringe their proprietary rights. In either case, litigation could result in substantial costs and diversion of our resources, and whether or not we are ultimately successful, the litigation could hurt our business and financial condition.
Expansion of our business may strain our management and operational infrastructure and impede our ability to meet any increased demand for our fine finished steel products.
Our growth strategy includes growing our operations by meeting the anticipated growth in demand for existing products, introducing new product offerings, and identifying and acquiring or investing in suitable candidates on acceptable terms. In 2009, we acquired a 100% ownership interest in Ningbo Zhehua. In addition, our subsidiary, Jiangsu Cold-Rolled, has recently completed construction of several new production lines and has been put into operation, but lacks a proven operational history. Over time, we may acquire or make investments in other providers of products that complement our business and other companies in our industry. Growth in our business may place a significant strain on our personnel, management, financial systems and other resources. Our business growth also presents numerous risks and challenges, including:
| · | our ability to successfully and rapidly expand sales to potential customers in response to potentially increasing demand; |
| · | our ability to integrate and retain key management, sales, research and development, production and other personnel; |
| · | our ability to incorporate the acquired products or capabilities into our offerings from an engineering, sales and marketing perspective; |
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| · | integration and support pre-existing supplier, distribution and customer relationships; |
| · | adverse effects on our reported operating results due to possible write-down of goodwill associated with acquisitions; |
| · | potential disputes with sellers of acquired businesses, technologies, services, products and potential liabilities; |
| · | the costs associated with such growth, which are difficult to quantify, but could be significant; and |
| · | rapid technological change. |
To accommodate this growth and compete effectively, we may need to obtain additional funding to improve information systems, procedures and controls and expand, train, motivate and manage existing and additional employees. Funding may not be available in a sufficient amount or on favorable terms, if at all. If we are not able to manage these activities and implement these strategies successfully to expand to meet any increased demand, our operating results could suffer.
We depend heavily on key personnel, and turnover of key employees and senior management could harm our business.
Our future business and results of operations depend in significant part upon the continued contributions of our key technical and senior management personnel, including Lifang Chen, our Chairperson, Chief Executive Officer and President, and Naijiang Zhou, our Chief Financial Officer. They also depend in significant part upon our ability to attract and retain additional qualified management, technical, marketing and sales and support personnel for our operations. If we lose a key employee, if a key employee fails to perform in his or her current position, or if we are not able to attract and retain skilled employees as needed, our business could suffer. Significant turnover in our senior management could significantly deplete our institutional knowledge held by our existing senior management team. We depend on the skills and abilities of these key employees in managing the manufacturing, technical, marketing and sales aspects of our business, any part of which could be harmed by turnover in the future.
Changes in our effective tax rate or tax liability may have an adverse effect on our results of operations.
Because we are a U.S. company with operating subsidiaries in China and we engage in international sales, we are subject to federal and state tax in the U.S., state and local tax in China and other foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of our business, there are some transactions where the ultimate tax determination is uncertain. Additionally our calculations of income taxes are based on our interpretations of applicable tax laws in the jurisdictions in which we file. Although we believe our tax estimates are appropriate, there is no assurance that the final determination of our income tax liability will not be materially different than what is reflected in our income tax provisions and accruals. We are also subject to the periodic examination of our income tax returns by tax authorities. The outcomes from these examinations may have an adverse effect on our operating results and financial condition. Furthermore, our provision for income tax could increase as we expand our international operations, adopt new products, implement changes to our operating structure or undertake intercompany transactions in light of acquisitions, changing tax laws, and our current and anticipated business and operational requirements. Should additional taxes be assessed as a result of new legislation, an audit or litigation; or if our effective tax rate should change as a result of changes in federal, international or state and local tax laws, there could be a material adverse effect on our income tax provision and results of operations.
Ms. Lifang Chen’s association with Shanghai Huaye could pose a conflict of interest.
Ms. Lifang Chen, our chairperson and beneficial owner of 72.9% of our common stock, also beneficially owns 100% of Shanghai Huaye, which is a major distributor of our products and provider of our raw materials. As a result, conflicts of interest may arise from time to time. We will attempt to resolve any such conflicts of interest in our favor. Our officers and directors are accountable to us and our shareholders as fiduciaries, which requires that such officers and directors exercise good faith and integrity in handling our affairs.
We may be exposed to liabilities under the Foreign Corrupt Practices Act, and any determination that we violated the Foreign Corrupt Practices Act could have a material adverse effect on our business.
We are subject to the Foreign Corrupt Practice Act, or FCPA, and other laws that prohibit improper payments or offers of payments to foreign governments and their officials and political parties by U.S. persons and issuers as defined by the statute for the purpose of obtaining or retaining business. We have operations, agreements with third parties and make sales in China, which may experience corruption. Our activities in China create the risk of unauthorized payments or offers of payments by one of the employees, consultants, sales agents or distributors of our company, because these parties are not always subject to our control. It is our policy to implement safeguards to discourage these practices by our employees. Also, our existing safeguards and any future improvements may prove to be less than effective, and the employees, consultants, sales agents or distributors of our Company may engage in conduct for which we might be held responsible. Violations of the FCPA may result in severe criminal or civil sanctions, and we may be subject to other liabilities, which could negatively affect our business, operating results and financial condition. In addition, the government may seek to hold our Company liable for successor liability FCPA violations committed by companies in which we invest or that we acquire.
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RISKS RELATED TO DOING BUSINESS IN CHINA
Adverse changes in political and economic policies of the PRC government could impede the overall economic growth of China, which could reduce the demand for our products and damage our business.
We conduct substantially all of our operations and generate most of our revenue in China. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. The PRC economy differs from the economies of most developed countries in many respects, including:
| · | a higher level of government involvement; |
| · | a early stage of development of the market-oriented sector of the economy; |
| · | a rapid growth rate; |
| · | a higher level of control over foreign exchange; and |
| · | the allocation of resources. |
As the PRC economy has been transitioning from a planned economy to a more market-oriented economy, the PRC government has implemented various measures to encourage economic growth and guide the allocation of resources. While these measures may benefit the overall PRC economy, they may also have a negative effect on us.
Although the PRC government has in recent years implemented measures emphasizing the utilization of market forces for economic reform, the PRC government continues to exercise significant control over economic growth in China through the allocation of resources, controlling the payment of foreign currency-denominated obligations, setting monetary policy and imposing policies that impact particular industries or companies in different ways.
Any adverse change in economic conditions or government policies in China could have a material adverse effect on the overall economic growth in China, which in turn could lead to a reduction in demand for our services and consequently have a material adverse effect on our business and prospects.
Uncertainties with respect to the PRC legal system could limit the legal protections available to you and us.
We conduct substantially all of our business through our operating subsidiaries in the PRC. Our operating subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to foreign-invested enterprises. The PRC legal system is based on written statutes, and prior court decisions may be cited for reference but have limited precedential value. Since 1979, a series of new PRC laws and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since the PRC legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involve uncertainties, which may limit legal protections available to you and us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. In addition, most of our executive officers and directors are residents of China and not of the United States, and substantially all the assets of these persons are located outside the United States. As a result, it could be difficult for investors to affect service of process in the United States or to enforce a judgment obtained in the United States against our Chinese operations and subsidiaries.
If we are found to have failed to comply with applicable laws, we may incur additional expenditures or be subject to significant fines and penalties.
Our operations are subject to PRC laws and regulations applicable to us. However, many PRC laws and regulations are uncertain in their scope, and the implementation of such laws and regulations in different localities could have significant differences. In certain instances, local implementation rules and/or the actual implementation are not necessarily consistent with the regulations at the national level. Although we strive to comply with all the applicable PRC laws and regulations, we cannot assure you that the relevant PRC government authorities will not later determine that we have not been in compliance with certain laws or regulations.
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In addition, our facilities and products are subject to many laws and regulations. Our failure to comply with these and other applicable laws and regulations in China could subject us to administrative penalties and injunctive relief, as well as civil remedies, including fines, injunctions and recalls of our products. It is possible that changes to such laws or more rigorous enforcement of such laws or with respect to our current or past practices could have a material adverse effect on our business, operating results and financial condition. Further, additional environmental, health or safety issues relating to matters that are not currently known to management may result in unanticipated liabilities and expenditures.
The PRC government exerts substantial influence over the manner in which we must conduct our business activities.
The PRC government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property and other matters. We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of the jurisdictions in which we operate may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations.
Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof and could require us to divest ourselves of any interest we then hold in Chinese properties or joint ventures.
Restrictions on currency exchange may limit our ability to receive and use our sales effectively.
The majority of our revenues will be settled in RMB and U.S. dollars, and any future restrictions on currency exchanges may limit our ability to use revenue generated in RMB to fund any future business activities outside China or to make dividend or other payments in U.S. dollars. Although the Chinese government introduced regulations in 1996 to allow greater convertibility of the RMB for current account transactions, significant restrictions still remain, including primarily the restriction that foreign-invested enterprises may only buy, sell or remit foreign currencies after providing valid commercial documents, at those banks in China authorized to conduct foreign exchange business. In addition, conversion of RMB for capital account items, including direct investment and loans, is subject to governmental approval in China, and companies are required to open and maintain separate foreign exchange accounts for capital account items. We cannot be certain that the Chinese regulatory authorities will not impose more stringent restrictions on the convertibility of the RMB.
Fluctuations in exchange rates could adversely affect our business and the value of our securities.
The value of our common stock will be indirectly affected by the foreign exchange rate between the U.S. dollar and RMB and between those currencies and other currencies in which our revenues may be denominated. Appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue that will be exchanged into U.S. dollars, as well as earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.
Since July 2005, the RMB has no longer been pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future PRC authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.
Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies.
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Sometimes we may need to import some of our raw materials and major equipment. In the event that the U.S. dollars appreciate against RMB, our costs will increase. If we cannot pass the resulting cost increases onto our customers, our profitability and operating results may suffer. In addition, since our sales to international customers are growing rapidly, we are increasingly subject to the risk of foreign currency depreciation.
Restrictions under PRC law on our PRC subsidiaries’ ability to make dividends and other distributions could materially and adversely affect our ability to grow, make investments or acquisitions that could benefit our business, pay dividends to you, and otherwise fund and conduct our business.
Substantially all of our revenues are earned by our PRC subsidiaries. However, PRC regulations restrict the ability of our PRC subsidiaries to make dividends and other payments to its offshore parent company. PRC legal restrictions permit payments of dividends by our PRC subsidiaries only out of their accumulated after-tax profits, if any, determined in accordance with PRC accounting standards and regulations. Our PRC subsidiaries are also required under PRC laws and regulations to allocate at least 10% of their annual after-tax profits determined in accordance with PRC generally accepted accounting principles to a statutory general reserve fund until the amounts in said fund reaches 50% of our registered capital. Allocations to these statutory reserve funds can only be used for specific purposes and are not transferable to us in the form of loans, advances, or cash dividends. Any limitations on the ability of our PRC subsidiary to transfer funds to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends and otherwise fund and conduct our business.
You may have difficulty enforcing judgments against us.
We are a Nevada holding company and most of our assets are located outside of the United States. Almost all of our operations are conducted in the PRC. In addition, most of our directors and officers are nationals and residents of countries other than the United States. A substantial portion of the assets of these persons is located outside the United States. As a result, it may be difficult for you to effect service of process within the United States upon these persons. It may also be difficult for you to enforce in U.S. courts judgments on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors, most of whom are not residents in the United States and the substantial majority of whose assets are located outside of the United States. In addition, there is uncertainty as to whether the courts of the PRC would recognize or enforce judgments of U.S. courts. Although the recognition and enforcement of foreign judgments are generally provided for under the PRC Civil Procedures Law, courts in China may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based on treaties between China and the country where the judgment is made or on reciprocity between jurisdictions. China does not have any treaties or other arrangements that provide for the reciprocal recognition and enforcement of foreign judgments with the United States. In addition, according to the PRC Civil Procedures Law, courts in the PRC will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates basic principles of PRC law or national sovereignty, security or the public interest. So it is uncertain whether a PRC court would enforce a judgment rendered by a court in the United States.
PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident beneficial owners or our company to liabilities or penalties, limit our ability to contribute capital to our PRC subsidiaries, limit the ability of our PRC subsidiaries to increase their registered capital or distribute profits to us, or otherwise materially and adversely affect us.
On July 14, 2014, the SAFE issued the Circular Relating to Foreign Exchange Administration of Offshore Investment, Financing and Roundtrip Investment by Domestic Residents Through Special Purpose Vehicles, or Circular 37. Circular 37 repeals and replaces the Notice Concerning Foreign Exchange Controls on Domestic Residents’ Financing and Roundtrip Investment Through Offshore Special Purpose Vehicles, or Circular 75. Under Circular 37, PRC residents are required to register with the SAFE or its local branches prior to establishing, or acquiring control of, an offshore company for the purpose of investment or financing that offshore company with equity interests in, or assets of, a PRC enterprise or with offshore equity interest or assets legally held by such PRC resident. In addition, PRC residents are required to amend their registrations with the SAFE and its local branches to reflect any material changes with respect to such PRC resident’s investment in such offshore company, including changes to basic information of such PRC resident, increase or decrease in capital, share transfer or share swap, merger or division. In the event that a PRC shareholder fails to make the required registration or update the previously filed registration, the PRC subsidiaries of that offshore special purpose vehicle may be prohibited from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to their offshore parent company, and the offshore parent company may also be prohibited from contributing additional capital into its PRC subsidiaries. Furthermore, failure to comply with the various foreign exchange registration requirements described above could result in liability under the PRC laws for evasion of applicable foreign exchange restrictions.
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We have requested our relevant shareholders who are subject to the SAFE regulations to make the necessary registrations under the SAFE regulations. However, we may not be fully informed of the identities of the beneficial owners of our company. We do not have control over our beneficial owners and cannot assure you that all of our PRC resident beneficial owners will comply with SAFE regulations. The failure of our beneficial owners who are PRC residents to comply with these SAFE registrations may subject such beneficial owners or our PRC subsidiaries to fines and legal sanctions. Furthermore, since Circular 37 was recently promulgated and it is unclear how this regulation, and any future regulation concerning offshore or cross-border transactions, will be interpreted, amended and implemented by the relevant PRC government authorities, we cannot predict how these regulations will affect our business operations or future strategy. Failure to register or comply with relevant requirements may also limit our ability to contribute additional capital to our PRC subsidiaries and limit our PRC subsidiaries’ ability to distribute dividends to our company. These risks may have a material adverse effect on our business, financial condition and results of operations.
Under the New Enterprise Income Tax Law, we may be classified as a “resident enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders.
Under the PRCEIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. The implementing rules of the EIT Law define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise.
On April 22, 2009, the State Administration of Taxation issued the Notice Concerning Relevant Issues Regarding Cognizance of Chinese Investment Controlled Enterprises Incorporated Offshore as Resident Enterprises pursuant to Criteria of de facto Management Bodies, or the Notice, further interpreting the application of the EIT Law and its implementation against non-Chinese enterprise or group controlled offshore entities. Pursuant to the Notice, an enterprise incorporated in an offshore jurisdiction and controlled by a Chinese enterprise or group will be classified as a “domestically incorporated resident enterprise” if (i) its senior management in charge of daily operations reside or perform their duties mainly in China; (ii) its financial or personnel decisions are made or approved by bodies or persons in China; (iii) its substantial assets and properties, accounting books, corporate chops, board and shareholder minutes are kept in China; and (iv) at least half of its directors with voting rights or senior management often resident in China. A resident enterprise would be subject to an enterprise income tax rate of 25% on its worldwide income and its non-PRC stockholders would be subject to a withholding tax at a rate of 10% when dividends are paid to such non-PRC stockholders. However, it remains unclear as to whether the Notice is applicable to an offshore enterprise incorporated by a Chinese natural person. Nor are detailed measures on enforcement of PRC tax against non-domestically incorporated resident enterprises are available. Therefore, it is unclear how tax authorities will determine tax residency based on the facts of each case.
We may be deemed to be a resident enterprise by Chinese tax authorities. If the PRC tax authorities determine that we are a “resident enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations. In our case, this would mean that income such as interest on financing proceeds and non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Second, although under the EIT Law and its implementing rules dividends paid to us from our PRC subsidiary would qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes. Finally, it is possible that future guidance issued with respect to the new “resident enterprise” classification could result in a situation in which a 10% withholding tax is imposed on dividends we pay to our non-PRC stockholders and with respect to gains derived by our non-PRC stockholders from transferring our shares.
If we were treated as a “resident enterprise” by PRC tax authorities, we would be subject to taxation in both the U.S. and China, and our PRC tax may not be creditable against our U.S. tax.
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We face uncertainty from China’s Circular on Strengthening the Administration of Enterprise Income Tax on Non-Resident Enterprises' Share Transfer, or Circular 698, that was released in December 2009 with retroactive effect from January 1, 2008.
The Chinese State Administration of Taxation released a circular on December 15, 2009 that addresses the transfer of shares by nonresident companies, generally referred to as Circular 698. Circular 698, which is effective retroactively to January 1, 2008, may have a significant impact on many companies that use offshore holding companies to invest in China. Circular 698, which provides parties with a short period of time to comply with its requirements, indirectly taxes foreign companies on gains derived from the indirect sale of a Chinese company. Where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise by selling the shares in an offshore holding company, and the latter is located in a country or jurisdiction where the effective tax burden is less than 12.5% or where the offshore income of his, her, or its residents is not taxable, the foreign investor is required to provide the tax authority in charge of that Chinese resident enterprise with the relevant information within 30 days of the transfers. Moreover, where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise through an abuse of form of organization and there are no reasonable commercial purposes such that the corporate income tax liability is avoided, the PRC tax authority will have the power to re-assess the nature of the equity transfer in accordance with PRC’s “substance-over-form” principle and deny the existence of the offshore holding company that is used for tax planning purposes.
There is uncertainty as to the application of Circular 698. For example, while the term "indirectly transfer" is not defined, it is understood that the relevant PRC tax authorities have jurisdiction regarding requests for information over a wide range of foreign entities having no direct contact with China. It is also unclear, in the event that an offshore holding company is treated as a domestically incorporated resident enterprise, whether Circular 698 would still be applicable to transfer of shares in such offshore holding company. Moreover, the relevant authority has not yet promulgated any formal provisions or formally declared or stated how to calculate the effective tax in the country or jurisdiction and to what extent and the process of the disclosure to the tax authority in charge of that Chinese resident enterprise. In addition, there are not any formal declarations with regard to how to decide “abuse of form of organization” and “reasonable commercial purpose,” which can be utilized by us to balance if our Company complies with the Circular 698. If Circular 698 is determined to be applicable to us based on the facts and circumstances around such share transfers, we may become at risk of being taxed under Circular 698 and we may be required to expend valuable resources to comply with Circular 698 or to establish that we should not be taxed under Circular 698, which could have a material adverse effect on our financial condition and results of operations.
The disclosures in our reports and other filings with the SEC and our other public pronouncements are not subject to the scrutiny of any regulatory bodies in the PRC. Accordingly, our public disclosure should be reviewed in light of the fact that no governmental agency that is located in China where all of our operations and business are located have conducted any due diligence on our operations or reviewed or cleared any of our disclosure.
We are regulated by the SEC and our reports and other filings with the SEC are subject to SEC review in accordance with the rules and regulations promulgated by the SEC under the Securities Act and the Exchange Act. Unlike public reporting companies whose operations are located primarily in the United States, however, all of our operations are located in China. Since all of our operations and business takes place in China, it may be more difficult for the Staff of the SEC to overcome the geographic and cultural obstacles that are present when reviewing our disclosure. These same obstacles are not present for similar companies whose operations or business take place entirely or primarily in the United States. Furthermore, our SEC reports and other disclosure and public pronouncements are not subject to the review or scrutiny of any PRC regulatory authority. For example, the disclosure in our SEC reports and other filings are not subject to the review of the CSRC, a PRC regulator that is tasked with oversight of the capital markets in China. Accordingly, you should review our SEC reports, filings and our other public pronouncements with the understanding that no local regulator has done any due diligence on our company and with the understanding that none of our SEC reports, other filings or any of our other public pronouncements has been reviewed or otherwise been scrutinized by any local regulator.
RISKS RELATED TO THE MARKET FOR OUR STOCK
Certain of our stockholders hold a significant percentage of our outstanding voting securities.
Ms. Lifang Chen, our Chairperson, is the beneficial owner of approximately 72.9% of our outstanding voting securities. As a result, she possesses significant influence and can elect a majority of our board of directors and authorize or prevent proposed significant corporate transactions. Her ownership and control may also have the effect of delaying or preventing a future change in control, impeding a merger, consolidation, takeover or other business combination or discourage a potential acquirer from making a tender offer.
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Although publicly traded, the trading market in our common stock has been substantially less liquid than the average trading market for a stock quoted on the Nasdaq Stock Market and this low trading volume may adversely affect the price of our common stock.
Our common stock started trading on the Nasdaq Capital Market under the symbol “SUTR” in February 2008. The trading volume of our common stock has been comparatively low to other companies listed on Nasdaq. Limited trading volume will subject our shares of common stock to greater price volatility and may make it difficult for you to sell your shares of common stock at a price that is attractive to you.
Certain provisions of our Articles of Incorporation may make it more difficult for a third party to effect a change- in-control.
Our articles of incorporation authorize the board of directors to issue up to 1,000,000 shares of preferred stock. The preferred stock may be issued in one or more series, the terms of which may be determined at the time of issuance by the board of directors without further action by the stockholders. These terms may include voting rights including the right to vote as a series on particular matters, preferences as to dividends and liquidation, conversion rights and redemption rights provisions. The issuance of any preferred stock could diminish the rights of holders of our common stock, and therefore could reduce the value of such common stock. In addition, specific rights granted to future holders of preferred stock could be used to restrict our ability to merge with, or sell assets to, a third party. The ability of the board of directors to issue preferred stock could make it more difficult, delay, discourage, prevent or make it more costly to acquire or effect a change-in-control, which in turn could prevent the stockholders from recognizing a gain in the event that a favorable offer is extended and could materially and negatively affect the market price of our common stock.
The market price of our common stock is volatile, leading to the possibility of its value being depressed at a time when you want to sell your holdings.
The market price of our common stock is volatile, and this volatility may continue. Numerous factors, many of which are beyond our control, may cause the market price of our common stock to fluctuate significantly. These factors include:
| · | our earnings releases, actual or anticipated changes in our earnings, fluctuations in our operating results or our failure to meet the expectations of financial market analysts and investors; |
| · | changes in financial estimates by us or by any securities analysts who might cover our stock; |
| · | speculation about our business in the press or the investment community; |
| · | significant developments relating to our relationships with our customers or suppliers; |
| · | stock market price and volume fluctuations of other publicly traded companies and, in particular, those that are in the steel industries; |
| · | customer demand for our products; |
| · | investor perceptions of the steel industries in general and our company in particular; |
| · | the operating and stock performance of comparable companies; |
| · | general economic conditions and trends; |
| · | major catastrophic events; |
| · | announcements by us or our competitors of new products, significant acquisitions, strategic partnerships or divestitures; |
| · | changes in accounting standards, policies, guidance, interpretation or principles; |
| · | loss of external funding sources; |
| · | sales of our common stock, including sales by our directors, officers or significant stockholders; and |
| · | additions or departures of key personnel. |
Securities class action litigation is often instituted against companies following periods of volatility in their stock price. This type of litigation could result in substantial costs to us and divert our management’s attention and resources. Moreover, securities markets may from time to time experience significant price and volume fluctuations for reasons unrelated to operating performance of particular companies. For example, in July 2008, the securities markets in the United States, China and other jurisdictions experienced the largest decline in share prices since September 2001. These market fluctuations may adversely affect the price of our common stock and other interests in our company at a time when you want to sell your interest in us.
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If we fail to meet all applicable continued listing requirements of the Nasdaq Capital Market and Nasdaq determines to delist our common stock, the delisting could adversely affect the market liquidity of our common stock, impair the value of your investment, adversely affect our ability to raise needed funds and subject us to additional trading restrictions and regulations.
Companies listed on The NASDAQ Stock Market, or NASDAQ, are subject to delisting for, among other things, failure to maintain a minimum closing bid price per share of $1.00 for 30 consecutive business days or failure to timely file all required periodic financial reports with the SEC. On August 8, 2014, we received a deficiency letter from NASDAQ, indicating that for the last 30 consecutive business days our common stock had a closing bid price below the $1.00 minimum closing bid as required for continued listing set forth in Nasdaq Listing Rule 5550(a)(2). In accordance with Nasdaq Listing Rule 5810(c)(3)(A), we were provided a grace period of 180 calendar days, or until February 4, 2015, to regain compliance with this requirement. Although we are actively monitoring the bid price for our common stock and will consider all available options to resolve the deficiency, we cannot be sure that our share price will regain compliance timely. As of December 12, 2014, the closing price of our common stock was $0.64 per share.
On October 16, 2014, we received notice from NASDAQ indicating that, due to our failure to timely file our annual report on Form 10-K for the fiscal year ended June 30, 2014 (the “Form 10-K”), we no longer comply with the NASDAQ Listing Rule 5250(c)(1). The notification letter states that the Company has 60 calendar days, or until December 15, 2014, to submit a plan to regain compliance and if NASDAQ accept the plan, NASDAQ may grant the Company up to 180 calendar days from the filing due date of the Annual Report, or until April 13, 2015, to regain compliance. On October 20, 2014, we received an additional notice from NASDAQ indicating that, due to our failure to timely file our quarterly report on Form 10-Q for the period ended September 30, 2014 (the “Form 10-Q”), and because we remain delinquent in filing the Form 10-K, we do not comply with the NASDAQ Listing Rule 5250(c)(1). Again we have until December 15, 2014 to submit a plan to regain compliance.
NASDAQ's notices have no immediate effect on the listing of our common stock on the NASDAQ Capital Market. With the filing of this annual report and the Form 10-Q, which is expected to be filed at the same time of this annual report, we believe that we will regain compliance before the deadline set up by the staff of NASDAQ. However, we cannot assure you that we will continue to be able to meet this or other continued listing requirements of NASDAQ.
If our common stock loses its status on The NASDAQ Capital Market, our common stock would likely trade in the over-the-counter market. If our shares were to trade on the over-the-counter market, selling our common stock could be more difficult because smaller quantities of shares would likely be bought and sold, transactions could be delayed, and security analysts’ coverage of us may be reduced. In addition, in the event our common stock is delisted, broker-dealers have certain regulatory burdens imposed upon them, which may discourage broker-dealers from effecting transactions in our common stock, further limiting the liquidity of our common stock. These factors could result in lower prices and larger spreads in the bid and ask prices for our common stock. Such delisting from The NASDAQ Capital Market and continued or further declines in our share price could also greatly impair our ability to raise additional necessary capital through equity or debt financing, and could significantly increase the ownership dilution to shareholders caused by our issuing equity in financing or other transactions.
We do not intend to pay dividends for the foreseeable future.
For the foreseeable future, we intend to retain any earnings to finance the development and expansion of our business, and we do not anticipate paying any cash dividends on our common stock. Accordingly, investors must be prepared to rely on sales of their common stock after price appreciation to earn an investment return, which may never occur. Investors seeking cash dividends should not purchase our common stock. Any determination to pay dividends in the future will be made at the discretion of our board of directors and will depend on our results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law and other factors our board deems relevant.
| ITEM 1B. | UNRESOLVED STAFF COMMENTS. |
Not Applicable.
| ITEM 2. | PROPERTIES. |
There is no private land ownership in China. Individuals and companies are permitted to acquire land use right for special purposes. Changshu Huaye and Jiangsu Cold-rolled currently have land use rights to six parcels of land located in Dongbang Town, Changshu, China with approximately 360,000 square meters in aggregate, consisting of manufacturing facilities, office buildings and land reserved for future expansion. The land use rights for these properties will expire in 2054. This period may be renewed at the expiration of the initial and any subsequent terms. Granted land use rights are transferable and may be used as security for borrowings and other obligations. We have fully paid the land use fees. Some of our real property is subject to lien to secure certain bank loans.
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Ningbo Zhehua leased a factory building located in the Ningbo Camel Machinery & Electronics Industrial Park, Ningbo, China. The lease will expire on December31, 2014 and we expect to renew the lease annually after it expires.
We have three principal manufacturing facilities: Changshu Huaye, Jiangsu Cold-Rolled and Ningbo Zhehua. Changshu Huaye and Jiangsu Cold-Rolled are located in Dongbang Industrial park, Changshu, China and Ningbo Zhehua is located in Ningbo, China. Changshu Huaye was established in January 2003 and started operation in June 2004, with an annual production capacity of 300,000 MT of HDG of cold-rolled steel and 200,000 MT of PPGI. In fiscal year 2014, the capacity utilization rates for the HDG production line and PPGI production line were approximately 84.2% and 20.2%, respectively. Jiangsu Cold-Rolled was established in August 2003 and its AP steel production line started operation in September 2006 with an annual production capacity of 500,000 MT. The cold-rolled steel production line started operation in January 2007 and has an annual production capacity of 250,000 MT. In fiscal year 2014, the capacity utilization rates for the AP steel production line and cold-rolled steel production line were approximately 81.7% and 134.2%, respectively. Jiangsu Cold-Rolled constructed two new HDG steel production lines with annual manufacturing capacity of 400,000 MT which became operational at the end of September 2008. As of June 30, 2014, their capacity utilization rate was approximately 81.1%. The new HDG steel production lines are capable of galvanizing both hot-rolled and cold-rolled steel with both zinc and aluminum, allowing us to better meet the needs of our customers and minimizing any excess capacity strains on our current HDG steel production lines. Ningbo Zhehua was established in 2004. It has one JCOE production line for large-diameter, double-side, submerged-arc welded steel pipes, three US Lincoln production lines for spiral seam, double-side, submerged-arc welded steel pipes and two REF production lines for roll-bending, double-side, submerged-arc welded steel pipes. In fiscal year 2014, the average utilization rate of our weld steel pipe production lines were approximately 11.2%. The utilization ratio of the pipe production lines are affected by both the type of products manufactured and the demand for our products.
We recently completed the construction of a new 500,000 MT cold-rolled production line in Changshu. We started producing in small quantities of limited products and expect gradual ramp-of capacity utilization in the coming quarters.
We believe that all our properties have been adequately maintained, are generally in good condition, and are suitable and adequate for our business.
| ITEM 3. | 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 4. | MINE SAFETY DISCLOSURES. |
Not applicable.
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| ITEM 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES. |
Market Information
Our common stock is quoted on the Nasdaq Capital Market under the symbol “SUTR.”
The following table sets forth, for the periods indicated, the high and low closing prices of our common stock. These prices reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.
| Closing Bid Prices(1) | ||||||||
| High | Low | |||||||
| Year Ended June 30, 2014 | ||||||||
| 1st Quarter | $ | 2.28 | $ | 1.45 | ||||
| 2nd Quarter | 2.08 | 1.71 | ||||||
| 3rd Quarter | 2.10 | 1.72 | ||||||
| 4th Quarter | 1.84 | 0.92 | ||||||
| Year Ended June 30, 2013 | ||||||||
| 1st Quarter | $ | 0.98 | $ | 0.72 | ||||
| 2nd Quarter | 1.13 | 0.80 | ||||||
| 3rd Quarter | 2.43 | 0.95 | ||||||
| 4th Quarter | 2.05 | 1.40 | ||||||
(1) The above table sets forth the range of high and low closing prices per share of our common stock as reported by www.quotemedia.com for the periods indicated.
Approximate Number of Holders of Our Common Stock
As of December 12, 2014, there were approximately 17 holders of record of our common stock. This number excludes the shares of our common stock owned by stockholders holding stock under nominee security position listings.
Dividend Policy
We have never declared dividends or paid cash dividends. Our board of directors will make any future decisions regarding dividends. We currently intend to retain and use any future earnings for the development and expansion of our business and do not anticipate paying any cash dividends in the near future.
Securities Authorized for Issuance Under Equity Compensation Plans
See Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters — Securities Authorized for Issuance Under Equity Compensation Plans.”
Recent Sales of Unregistered Securities
We did not sell any equity securities during the fiscal year ended June 30, 2014 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 2014 fiscal year.
Purchases of Equity Securities
On August 29, 2011, the Board of Directors of the Company authorized a repurchase of up to $5 million of the Company’s common stock over 12 months pursuant to a stock repurchase program, or the Repurchase Program. Under the terms of the Repurchase Program, the Company may repurchase shares through open market, negotiated private or block transactions. The Repurchase Program does not obligate the Company to repurchase any dollar amount or number of shares of its common stock, and the program may be extended, modified, suspended or discontinued at any time. The Repurchase Program expired on August 31, 2012.
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During the fiscal year ended June 30, 2014, we did not repurchase any shares of our common stock. No repurchase plans expired or were terminated during the fiscal year ended June 30, 2014, nor do any plans exist under which we do not intend to make further purchases.
| ITEM 6. | SELECTED FINANCIAL DATA. |
Not Applicable.
| ITEM 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. |
The following management’s discussion and analysis should be read in conjunction with our financial statements and the notes thereto and the other financial information appearing elsewhere in this report. In addition to historical information, the following discussion contains certain forward-looking information. See “Special Note Regarding Forward Looking Statements” above for certain information concerning those forward looking statements. Our financial statements are prepared in U.S. dollars and in accordance with U.S. GAAP.
Overview
We are one of the leading Chinese non-state-owned manufacturers and service providers for 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, value-added finished steel products, specifically, HDG steel and PPGI products. In addition, we produce AP steel and cold-rolled steel, which represent the least processed of our finished products. As a result of our acquisition of Ningbo Zhehua in November 2009, our product offerings have included 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. Our vertical integration has allowed 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, 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 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. In addition, we recently completed the construction of a new 500,000 MT cold-rolled production line. The facility is located in Changshu, Jiangsu. We started producing products in small quantities of limited products and expect gradual ramp-up capacity utilization in the coming quarters.
Revenue
Our revenue is primarily generated from sales and processing of our HDG steel, PPGI, AP steel and cold-rolled steel products. As a result of our acquisition of Ningbo Zhehua, we also generate revenue from sales of 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.
We have four reportable business segments including our three principal manufacturing facilities, Changshu Huaye, Jiangsu Cold-Rolled and Ningbo Zhehua and one newly established subsidiary with limited operations, Sutor Technology PRC. Changshu Huaye manufactures HDG steel and PPGI products. In fiscal years 2014 and 2013, Changshu Huaye generated revenue of approximately $153.4 million and $175.8 million, which represented approximately 37.8% and 28.7% of our total revenue, respectively. Jiangsu Cold-Rolled manufactures AP steel, cold-rolled steel and HDG steel products. Jiangsu Cold-Rolled generated revenue of approximately $190.6 million and $391.8 million in fiscal years 2014 and 2013, which represented approximately 47.0% and 64.0% of our total revenue, respectively. Ningbo Zhehua manufactures steel pipe products. In fiscal years 2014 and 2013, Ningbo Zhehua generated revenue of approximately $52.9 million and $34.2 million, which represented approximately 13.0% and 5.6% of our total revenue, respectively. In fiscal years 2014 and 2013, Sutor Technology PRC generated revenue of approximately $8.6 million and $10.3 million, which represented approximately 2.1% and 1.7% of our total revenue, respectively. 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 27.3% of our revenue was derived from Shanghai Huaye and its affiliates in fiscal year 2014, as compared to approximately 35.4% last year. We expanded our own sales channel this year in an effort to gain more market share. At the same time, we continue to take advantage of Shanghai Huaye’s extensive sales network and to build brand value.
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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 fiscal year 2014, approximately $170.6 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 our revenue and the cost of revenue. Gross margin is equal to gross profit divided by revenue. In fiscal year 2014, gross margin for domestic and international sales were approximately 7.7% and 14.7%, respectively. On a segment basis, Changshu Huaye, Jiangsu Cold-Rolled and Ningbo Zhehua’s gross margins were approximately 11.0%, 6.4% and 2.1%, respectively. Sutor Technology PRC has a gross margin of 6.0% in fiscal year 2014.
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 and demand of 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.
General and Administrative Expenses
General and administrative expenses consist primarily of compensation and benefits for our general management, finance and administrative staff, professional and advisory fees, bad debts reserves, and other expenses incurred in connection with general corporate purposes. We expect most components of our general and administrative expenses will increase as our business grows and as we incur increased costs as a public company.
Selling Expenses
Selling expenses consist primarily of compensation and benefits for our sales and marketing staff, sales commissions, the cost of advertising, promotional and travel activities, transportation expenses, after-sales support services and other sales related costs.
Our selling expenses are generally affected by the amount of international sales and our sales to unrelated parties. The transportation costs for our international sales are generally higher than domestic sales. In addition, when we sell products to Shanghai Huaye and its affiliates, Shanghai Huaye generally arranges and bears the cost of transportation. In contrast, when we sell products to customers other than Shanghai Huaye, we generally bear the transportation costs, but we are able to charge a higher price.
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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.
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 was subject to an EIT of 15% from calendar years 2010 to 2012 because it qualified as a high-tech enterprise for the calendar years 2010, 2011 and 2012. In 2013, Changshu Huaye applied to renew its certificate as a high-tech enterprise and the application has been approved. As a result, it will continue to have an EIT of 15% from calendar years 2013 to 2015. Jiangsu Cold-Rolled was subject to an EIT of 12.5% for the calendar years 2010 and 2011 and is subject to an EIT of 25% for the calendar year 2012 and beyond. Ningbo Zhehua and Sutor Technology PRC are subject to an EIT of 25% and have no preferential tax treatments. See Item 1, “Business – Regulation – Taxation” for a detailed description of the EIT Law and tax regulations applicable to our Chinese subsidiaries.
Reportable Operating Segments
We have four reportable operating segments which are categorized based on manufacturing facilities and nature of operations – Changshu Huaye, Jiangsu Cold-Rolled, Ningbo Zhehua and Sutor Technology PRC. 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 and use largely the same management resources. Ningbo Zhehua is located in Ningbo, China. Sutor Technology PRC is intended to cover R&D operations of the Company and so far had limited trading operations. See Note 13, “Segment Information” to the consolidated financial statements included elsewhere in this report.
Results of Operations
Comparison of Fiscal Years Ended June 30, 2014 and June 30, 2013
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 net sales.
(All amounts, other than percentages, in thousands of U.S. dollars)
| Fiscal Year Ended June 30, 2014 | Fiscal Year Ended June 30, 2013 | |||||||||||||||
| Amount | Percentage of Revenue | Amount | Percentage of Revenue | |||||||||||||
| Revenue: | $ | $ | ||||||||||||||
| Revenue from unrelated parties | 262,635 | 64.8 | % | 395,434 | 64.6 | % | ||||||||||
| Revenue from related parties | 142,780 | 35.2 | % | 216,642 | 35.4 | % | ||||||||||
| Total | 405,415 | 100.0 | % | 612,076 | 100.0 | % | ||||||||||
| Cost of Revenue: | (371,768 | ) | (91.7 | )% | (567,140 | ) | (92.7 | )% | ||||||||
| Gross Profit | 33,647 | 8.3 | % | 44,936 | 7.3 | % | ||||||||||
| Operating Expenses | ||||||||||||||||
| Selling expense | (4,993 | ) | (1.3 | )% | (8,267 | ) | (1.3 | )% | ||||||||
| General and administrative expense | (11,492 | ) | (2.8 | )% | (10,516 | ) | (1.7 | )% | ||||||||
| Total Operating Expenses | (16,485 | ) | (4.1 | )% | (18,783 | ) | (3.0 | )% | ||||||||
| Income from Operations | 17,162 | 4.2 | % | 26,153 | 4.3 | % | ||||||||||
| Other Income (Expense) | ||||||||||||||||
| Interest income | 3,264 | 0.8 | % | 3,414 | 0.6 | % | ||||||||||
| Other income | 140 | - | 458 | 0.1 | % | |||||||||||
| Interest expense | (10,114 | ) | (2.5 | )% | (10,210 | ) | (1.7 | )% | ||||||||
| Other expense | (785 | ) | (0.2 | )% | (460 | ) | (0.1 | )% | ||||||||
| Changes in fair value of warrant liabilities | 144 | - | (97 | ) | - | |||||||||||
| Income from equity method investments | 274 | 0.1 | % | 371 | - | |||||||||||
| Total Other Expense | (7,077 | ) | (1.8 | )% | (6,524 | ) | (1.1 | )% | ||||||||
| Income Before Taxes | 10,085 | 2.4 | % | 19,629 | 3.2 | % | ||||||||||
| Provision for income taxes | (3,016 | ) | (0.7 | )% | (2,723 | ) | (0.4 | )% | ||||||||
| Net Income | $ | 7,069 | 1.7 | % | $ | 16,906 | 2.8 | % | ||||||||
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Revenue. For the fiscal year ended June 30, 2014, revenue was $405.4 million compared to $612.1 million last year, a decrease of approximately $206.7 million, or 33.8%. Total sales volume in tons decreased approximately 39.3% in fiscal year 2014 as compared to last year, which reflected the impact of stagnant Chinese real estate markets, steel industry overcapacity as well as the Company’s transition from a pure fine-finished steel manufacturer to a steel product and processing service provider. For a typical product sales transaction, our product price covers the cost of raw materials as well as gross profits; while for a fee-based steel processing service, the price for our service does not contain the cost of raw materials as the customers buy the raw materials and we charge them only for a processing fee to cover processing expenses and a profit. Therefore, revenue from steel processing services is significantly lower than that from product sales.
Our business was relatively stable during the first three quarters of fiscal 2014 while our sales declined significantly during the fourth quarter. We believe a number of factors contributed to this change: First, the prices of steel products declined to a multi-year low level during the fourth quarter and the market generally believed that the near-term outlook remained bearish. As a result, very few customers were willing to place large orders with us and fulfilling small orders reduced our production efficiency. Second, the real estate markets in most cities in China were stagnant. In some markets, housing prices and sales declined so dramatically that the local governments had to repeal its restrictive policies to control housing prices and excessive investment in the real estate. A stagnant real estate market affected demands for a variety of steel products including steel products for construction and infrastructure as well as for household appliances. Moreover, banks in general tightened their policy of granting of new lines of credit to non-state-owned enterprises. Due to the tight liquidity of many small and medium enterprises (SMEs), which are our core clients, they were unable to expand their operations and some even had to reduce their operating scale, which significantly adversely affected our operations.
The following table sets forth revenue by geography and the percentage of our total revenue and total revenue by business segments for fiscal years 2014 and 2013.
(All amounts, other than percentages, in thousands of U.S. dollars)
| Fiscal Year Ended June 30, 2014 | Fiscal Year Ended June 30, 2013 | |||||||||||||||
| Amount | Percentage of Revenue | Amount | Percentage of Revenue | |||||||||||||
| Geographic Data: | ||||||||||||||||
| China | $ | 375,170 | 92.5 | % | $ | 553,207 | 90.4 | % | ||||||||
| Other Countries | 30,245 | 7.5 | % | 58,869 | 9.6 | % | ||||||||||
| Segment Data: | ||||||||||||||||
| Changshu Huaye | $ | 153,351 | 37.8 | % | $ | 175,823 | 28.7 | % | ||||||||
| Jiangsu Cold-Rolled | 190,599 | 47.0 | % | 391,752 | 64.0 | % | ||||||||||
| Ningbo Zhehua | 52,889 | 13.1 | % | 34,183 | 5.6 | % | ||||||||||
| Sutor Technology PRC | 8,576 | 2.1 | % | 10,318 | 1.7 | % | ||||||||||
On a geographic basis, revenue generated from outside of China was $30.2 million, or 7.5% of total revenue, for fiscal year 2014, as compared to $58.9 million, or 9.6% of total revenue, for fiscal year 2013. The reduction of international sales occurred when prices of steel continued to decline and customers slowed down their purchases. In addition, in order to maintain our liquidity, we ceased selling products to some international customers who needed our financing, which also constrained our sales.
On a segment basis, after eliminating intercompany sales, revenue contributed by Changshu Huaye was $153.4 million for fiscal year 2014, reflecting a decrease of $22.4 million, or 12.7%, from $175.8 million in fiscal year 2013. The reduction was primarily due to a lower PPGI revenue of approximately $21.9 million. Both the sales volume and the average selling price (“ASP”) for our PPGI products were lower in fiscal 2014 than fiscal 2013, reflecting the overall weakness in the manufacturing sectors attributable to the compound impact of economic transition from an economy driven by investment and export to one driven by domestic consumption, depressed real estate market, overall excessive capacity in the steel industry as well as the tight liquidity in the private sectors.
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After eliminating the inter-company sales, revenues contributed by Jiangsu Cold-Rolled were $190.6 million for fiscal year 2014, a decrease of $201.2 million from $391.8 million last year, mainly as a result of reduced AP revenue of approximately $121.9 million, reduced cold-rolled revenue of approximately $25.6 million and reduced HDG revenue accounting for most of the remaining variance. In addition to the macro-economic reasons discussed above, we reduced sales of low margin AP steel and concentrated instead on high margin HDG steel. Moreover, part of HDG sales was replaced with HDG processing services. We intend to develop more processing services to reduce our reliance on capital and its related financial risks. This is a fee based service that results in lower revenue but generally higher gross margin than our traditional product sales.
Revenues contributed by Ningbo Zhehua were $52.9 million for fiscal year 2014, an increase of approximately $18.7 million from $34.2 million in fiscal year 2013, primarily due to trading operations. Further, during fiscal 2014 we expanded our pipe production offerings to counter the impact of reduced investment in the construction and infrastructure sectors.
Revenues contributed by Sutor Technology PRC were $8.6 million for fiscal year 2014, a decrease of approximately $1.7 million from $10.3 million in fiscal year 2013. This entity primarily sells products produced by our other subsidiaries.
In terms of sales to related parties as compared with sales to unrelated parties, our direct sales to unrelated parties in fiscal year 2014 decreased $132.8 million, or 33.6%, to $262.6 million from $395.4 million in fiscal year 2013.
Cost of revenue. Cost of revenue decreased $195.3 million, or 34.4%, to $371.8 million in fiscal year 2014 from $567.1 million in fiscal year 2013. As a percentage of revenue, cost of revenue was 91.7% in fiscal year 2014, compared with 92.7% in fiscal year 2013. The decrease in the cost of revenue as a percentage of revenue was mainly due to the fact that sale of low-margin AP steel was significantly reduced in fiscal 2014 as compared with fiscal 2013.
Gross profit and gross margin. Gross profit decreased $11.3 million to $33.6 million in fiscal year 2014 from $44.9 million in fiscal year 2013. Gross profit as a percentage of revenue (gross margin) was 8.3% in fiscal year 2014 as compared with 7.3% last year. The increased gross margin mainly resulted from the change in the composition of the products we sold. We sold much less low margin AP steel in fiscal 2014 than in fiscal 2013.
On a segment basis, gross margin for Changshu Huaye decreased to 11.0% in fiscal year 2014 from 12.0% last year, mainly because of lower sales of PPGI steel. Gross margin for Jiangsu Cold-Rolled increased to 6.4% in fiscal year 2014 from 5.5% last year, mainly due to increased sales of HDG sales. Gross margin for Ningbo Zhehua decreased to 2.1% in fiscal year 2014, as compared to 7.5% in fiscal year 2013, mainly because of higher contribution from low margin trading revenue. Gross margin for Sutor Technology PRC increased to 6.0% in fiscal year 2014, as compared to 3.8% in fiscal year 2013, mainly because of increased product sales of higher margin products.
Total operating expenses. Our total operating expenses decreased approximately $2.3 million to $16.5 million in fiscal year 2014 from $18.8 million in fiscal year 2013. As a percentage of revenue, our total operating expenses increased to 4.1% in fiscal year 2014 from 3.0% in fiscal year 2013.
Selling expenses. Our selling expenses decreased approximately $3.3 million to $5.0 million in fiscal year 2014, from $8.3 million in fiscal year 2013. As a percentage of revenue, our selling expense was 1.3% in fiscal year 2014 as compared to 1.3% in fiscal 2013. The dollar decrease of selling expenses was primarily due to reduced sales, particularly our internationals sales. In addition, a higher percentage of more shipment was made through the local harbor in Changshu, which further reduced shipping and handling expenses.
General and administrative expenses. General and administrative expenses increased $1.0 million, or 9.5%, to $11.5 million, or 2.8% of revenue, in fiscal year 2014, from $10.5 million, or 1.7% of revenue, in fiscal year 2013. The higher general and administrative expenses were primarily due to the provision for account receivables in the amount of approximately $0.5 million. Our research development expenses increased $0.1 million, or 25.0%, to $ 0.5 million, or 1.4 % of revenue in fiscal year 2014 as compared to $0.4 million, or 0.1% of revenue in fiscal year 2013.
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Interest expense. Our interest expense decreased $0.1 million to $10.1 million in fiscal year 2014, from $10.2 million in fiscal year 2013. As a percentage of revenue, our interest expenses increased to 2.5% in fiscal year 2014, from 1.7% in fiscal year 2013. The increase in interest expense as percentage of revenue was mainly attributable to the fact that the decrease in total revenue outpaced the decrease in interest expense. The Company’s total debt and average interest rate remained relatively stable.
Provision for income taxes. We incurred income tax expense of $3.0 million with an effective tax rate of 29.9% in fiscal year 2014 as compared to $2.7 million with an effective tax rate of 13.9% in fiscal year 2013. The primary reason of the significant change in effective tax rate is that we had a favorable one-time income tax credit and income tax refund in the amount of approximately $0.87 million last fiscal year.
Net income. Net income, without including the foreign currency translation adjustment, decreased $9.8 million, or approximately 58.2%, to $7.1 million in fiscal year 2014, from $16.9 million in fiscal year 2013, as a cumulative result of the above factors.
Liquidity and Capital Resources
Our major sources of liquidity for the periods covered by this annual report were borrowings through short-term bank and private loans and long-term notes payable. Our operating activities used approximately $10.1 million of cash in fiscal year 2014. As of June 30, 2014, our total indebtedness to non-related parties under existing short-term loans was approximately $139.2 million. We also had approximately $2.9 million under long-term loans to non-related parties and $8.2 million long-term loans to the related parties. We had short-term notes payable approximately $136.3 million. As of June 30, 2014, the Company also had an unused line of credit with banks of approximately $31.7 million (RMB195 million) which entitled us to draw bank loans for general corporate purposes.
Short-term bank and private loans and notes payable are likely to continue to be our key sources of financing for the foreseeable future, although in the future we may raise additional capital by issuing shares of our capital stock in an equity financing. We expect to renew our short term loans when they become due.
Our liquidity and working capital may be affected by a material decrease in cash flow due to factors such as the continued use of cash in operating activities resulting from a decrease in sales due to the current global economic crisis, 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.
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As of June 30, 2014, we had cash and cash equivalents (excluding restricted cash) of $12.2 million and restricted cash of $60.9 million. The following table provides detailed information about our net cash flow for all financial statement periods presented in this report.
Cash Flow
(all amounts in thousands of U.S. dollars)
| Fiscal Years Ended June 30, | ||||||||
| 2014 | 2013 | |||||||
| Net cash used in operating activities | (10,056 | ) | (20,469 | ) | ||||
| Net cash used in investing activities | (6,604 | ) | (9,318 | ) | ||||
| Net cash provided by financing activities | 25,299 | 23,756 | ||||||
| Effect of foreign currency translation on cash and cash equivalents | (62 | ) | 102 | |||||
| Net cash flows | 8,577 | (5,929 | ) | |||||
Operating Activities
Net cash used in operating activities was $10.1 million for fiscal year 2014, an improvement of $10.4 million from $20.5 million net cash used in operating activities for the last fiscal year. The outflows of the operating cash during the fiscal year ended June 30, 2014 were mainly attributable to reduced notes payable of $43.4 million, increased inventory of $25.1 million, and increased trade account receivable of $15.9 million.The major source of cash inflows from operations in fiscal 2014 included net income and depreciation and amortization of $7.1 million and $9.1 million respectively, reduction in notes receivable of $19.8 million, reduction in restricted cash of $27.0 million, and higher advances from customers of $12.0 million..
According to our arrangements with Shanghai Huaye, our cash advances will not be forfeited if we fail to take all of the deliveries. In addition, we do not have long-term contracts with Shanghai Huaye. We place orders from them based on our current needs and market prices. If we purchase products from other steel companies, we may not be able to negotiate terms with these companies that are as favorable as our arrangements with Shanghai Huaye. We expect that we will be required to enter into long-term supply agreements with them including paying cash deposit in an amount similar to our prepayment to Shanghai Huaye. Further, some of the deposit will be forfeited if we do not take required amount of the products as specified in the contracts. Because our customers are primarily small and medium size companies and their orders are relatively small with various product specifications, we believe it will be in our best interest not to enter into any large long-term arrangements with the suppliers.
In fiscal 2014, our advances to related parties increased by 13.6% as compared with the last year. During the fourth quarter of fiscal 2014, our orders from customers dropped precipitously and we did not achieve the sales growth we had planned for in fiscal 2014. In addition, we originally anticipated that we need additional raw materials for our newly finished cold-rolled production line of 500,000 tons annual capacity, but so far we have only produced limited amount of products from this new production line.
Investing Activities
Our main uses of cash for investing activities are payments relating to the acquisition of property, plant and equipment and restricted cash pledged as deposits for bankers’ acceptance bills.
Net cash used in investing activities during fiscal year 2014 was $6.6million as compared to $9.3 million net cash used in investing activities for fiscal year 2013. The decrease in net cash used in investing activities was primarily due to the purchase of plant and equipment of $7.8 million and short-term investment of $3.3 million, partially offset by proceeds of approximately $4.6 million from reducing our equity interest in a joint venture.
Financing Activities
Net cash provided by financing activities for fiscal year 2014 totaled $25.3 million, as compared to $23.8 million net cash provided by financing activities for fiscal year 2013. The net cash provided by financing activities was mainly due to additional bank loans.
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As of June 30, 2014, 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** | ||||||
| Construction Bank of China, Changshu Branch | $ | 6.5 | 2013-10-16 | 2014-10-15 | None | |||||
| Communications Bank of China, Changshu Branch | 3.2 | 2013-11-04 | 2014-11-01 | Shanghai Huaye | ||||||
| Construction Bank of China, Changshu Branch | 4.4 | 2014-04-30 | 2014-10-29 | Shanghai Huaye | ||||||
| The Agricultural Bank of China, Changshu Branch | 2.4 | 2014-05-16 | 2015-05-05 | Shanghai Huaye, Jiangsu Cold-Rolled, Ningbo Zhehua | ||||||
| The Agricultural Bank of China, Changshu Branch | 3.6 | 2014-05-17 | 2015-05-15 | Shanghai Huaye, Jiangsu Cold-Rolled, Ningbo Zhehua | ||||||
| The Agricultural Bank of China, Changshu Branch | 2.4 | 2014-05-19 | 2015-05-18 | Shanghai Huaye, Jiangsu Cold-Rolled, Ningbo Zhehua | ||||||
| Construction Bank of China, Changshu Branch | 2.0 | 2014-05-23 | 2014-11-22 | Shanghai Huaye | ||||||
| The Agricultural Bank of China, Changshu Branch | 2.6 | 2014-06-11 | 2015-06-10 | Shanghai Huaye, Jiangsu Cold-Rolled | ||||||
| Industrial and Commercial Bank of China, Changshu Branch | 1.3 | 2014-06-13 | 2015-06-09 | Shanghai Huaye, Ningbo Zhehua | ||||||
| Industrial and Commercial Bank of China, Changshu Branch | 3.2 | 2014-06-20 | 2015-06-19 | Shanghai Huaye, Ningbo Zhehua | ||||||
| The Agricultural Bank of China, Changshu Branch | 4.1 | 2014-06-20 | 2015-06-19 | Shanghai Huaye, Jiangsu Cold-Rolled, Ningbo Zhehua | ||||||
| The Agricultural Bank of China, Changshu Branch | 4.1 | 2014-06-24 | 2015-06-23 | Shanghai Huaye, Jiangsu Cold-Rolled, Ningbo Zhehua | ||||||
| The Agricultural Bank of China, Changshu Branch | 4.1 | 2014-06-25 | 2015-06-23 | Shanghai Huaye, Jiangsu Cold-Rolled, Ningbo Zhehua | ||||||
| Industrial and Commercial Bank of China, Changshu Branch | 3.3 | 2014-06-17 | 2015-06-13 | Shanghai Huaye, Ningbo Zhehua | ||||||
| Industrial and Commercial Bank of China, Changshu Branch | 1.5 | 2014-06-25 | 2015-06-22 | Shanghai Huaye, Ningbo Zhehua | ||||||
| Industrial and Commercial Bank of China, Changshu Branch | 1.3 | 2014-06-25 | 2015-06-23 | Sutor Technology PRC, Ningbo Zhehua | ||||||
| Industrial and Commercial Bank of China, Changshu Branch | 3.2 | 2013-08-13 | 2014-08-07 | Changshu Huaye | ||||||
| Industrial and Commercial Bank of China, Changshu Branch | 1.7 | 2013-12-19 | 2014-12-18 | Shanghai Huaye, Changshu Huaye | ||||||
| The Agricultural Bank of China, Changshu Branch | 7.5 | 2014-01-22 | 2014-07-21 | Shanghai Huaye, Changshu Huaye | ||||||
| The Agricultural Bank of China, Changshu Branch | 6.5 | 2014-02-11 | 2014-08-08 | Shanghai Huaye, Changshu Huaye | ||||||
| The Agricultural Bank of China, Changshu Branch | 4.2 | 2014-02-18 | 2014-08-15 | Shanghai Huaye, Changshu Huaye | ||||||
| The Agricultural Bank of China, Changshu Branch | 4.9 | 2014-03-26 | 2015-03-23 | Shanghai Huaye, Changshu Huaye | ||||||
| The Agricultural Bank of China, Changshu Branch | 4.2 | 2014-04-14 | 2015-04-13 | Shanghai Huaye, Changshu Huaye | ||||||
| The Agricultural Bank of China, Changshu Branch | 8.8 | 2014-04-17 | 2015-04-15 | Shanghai Huaye, Changshu Huaye | ||||||
| The Agricultural Bank of China, Changshu Branch | 3.2 | 2014-04-30 | 2015-04-17 | Shanghai Huaye, Changshu Huaye | ||||||
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| The Agricultural Bank of China, Changshu Branch | 2.8 | 2014-05-21 | 2015-05-20 | Shanghai Huaye, Changshu Huaye | ||||||
| Industrial and Commercial Bank of China, Changshu Branch | 3.1 | 2014-05-26 | 2015-05-25 | Shanghai Huaye, Changshu Huaye | ||||||
| Industrial and Commercial Bank of China, Changshu Branch | 2.6 | 2014-04-11 | 2015-04-10 | Shanghai Huaye, Changshu Huaye | ||||||
| Industrial and Commercial Bank of China, Changshu Branch | 0.6 | 2014-04-15 | 2015-04-14 | Shanghai Huaye, Changshu Huaye | ||||||
| Industrial and Commercial Bank of China, Changshu Branch | 1.4 | 2014-06-12 | 2015-06-10 | Shanghai Huaye, Changshu Huaye | ||||||
| The Agricultural Bank of China, Changshu Branch | 3.9 | 2014-06-20 | 2015-06-19 | Shanghai Huaye, Changshu Huaye | ||||||
| The Agricultural Bank of China, Changshu Branch | 3.2 | 2014-06-20 | 2015-06-19 | Shanghai Huaye, Changshu Huaye | ||||||
| The Agricultural Bank of China, Changshu Branch | 3.2 | 2014-06-23 | 2015-06-22 | Shanghai Huaye, Changshu Huaye | ||||||
| The Agricultural Bank of China, Changshu Branch | 2.4 | 2014-06-24 | 2015-06-22 | Shanghai Huaye, Changshu Huaye | ||||||
| The Agricultural Bank of China, Changshu Branch | 3.2 | 2014-06-23 | 2015-06-22 | Shanghai Huaye, Changshu Huaye | ||||||
| The Agricultural Bank of China, Changshu Branch | 4.2 | 2014-06-23 | 2015-06-22 | Shanghai Huaye, Changshu Huaye | ||||||
| Industrial and Commercial Bank of China, Changshu Branch | 1.1 | 2014-06-18 | 2015-06-15 | Shanghai Huaye, Changshu Huaye | ||||||
| Industrial and Commercial Bank of China, Changshu Branch | 3.6 | 2014-06-19 | 2015-06-18 | Shanghai Huaye, Changshu Huaye | ||||||
| Construction Bank of China, Changshu Branch | 1.8 | 2014-06-27 | 2015-06-26 | Shanghai Huaye, Changshu Huaye | ||||||
| The Agricultural Bank of China, Ningbo Branch | 3.2 | 2014-01-27 | 2014-07-25 | Shanghai Huaye, Changshu Huaye | ||||||
| Pingan Bank, Ningbo Branch | 3.2 | - | - | Shanghai Huaye, Changshu Huaye | ||||||
| The Agricultural Bank of China, Ningbo Branch | 1.5 | - | - | Shanghai Huaye, Changshu Huaye | ||||||
| Lin, Guihua | 2.9 | 2008-11-20 | 2016-12-31 | None | ||||||
Chen,Lifang | 8.2 | 2013-12-31 | 2016-12-31 | None | ||||||
| Total | $ | 150.3 |
* Calculated on the basis that $1 = RMB6.16
** We do not pay any consideration to Shanghai Huaye or its affiliated companies, which are controlled by our CEO and her spouse, for the guarantees of our loans.
The loan agreements with banks generally contain debt covenants that require us to maintain certain inventory levels, among other things. We were in material compliance with these debt covenants as of June 30, 2014.
In the coming 12 months, we have approximately $139.2 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.
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Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires our management to make assumptions, estimates and judgments that affect the amounts reported in the financial statements, including the notes thereto, and related disclosures of commitments and contingencies, if any. We consider our critical accounting policies to be those that require the more significant judgments and estimates in the preparation of financial statements, including the following:
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires our management to make assumptions, estimates and judgments that affect the amounts reported in the financial statements, including the notes thereto, and related disclosures of commitments and contingencies, if any.
We consider the policies discussed below to be critical to an understanding of our consolidated financial statements as their application places significant demands on the judgment of our management. We believe the following critical accounting policies are the most significant to the presentation of our financial statements and some of which may require the most difficult, subjective and complex judgments and should be read in conjunction with our consolidated financial statements, the risks and uncertainties described under “Risk Factors” and other disclosures included in this annual report.
Revenue Recognition - We recognize revenues from the sale of products when they are realized and earned. We consider 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 we have objective evidence that the criteria specified in client acceptance provisions have been satisfied.
We sell some products to related parties, who in turn sell the products to various other unrelated party customers. The price, terms and conditions on the sales to related parties are the same as those to unrelated parties. Revenue is considered realized or realizable and earned when the related parties ship the products to unrelated party customers. A fee of 0.5% of the sales is paid to the related parties for handling the products. Handling fees were approximately $241,624 and $109,167 for the year ended June 30, 2014 and 2013 respectively and have been recorded in selling expenses in the statement of operations.
Allowance for Doubtful Accounts- We provide a general provision for doubtful accounts for the outstanding trade receivable balances based on historical experience and information available. Additionally, we make 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 us to use substantial judgment in assessing its collectability.
Inventories - Inventories are stated at the lower of cost or market. The cost of inventories is determined using first-in-first-out method, and includes expenditure incurred in acquiring the inventories and bringing them to their existing location and condition. In case of finished goods and work in progress, cost includes an appropriate share of production overhead based on normal operating capacity. The Company regularly reviews the cost of inventories against their estimated fair market value and records a lower of cost or market write-down for inventories that have cost in excess of estimated market value.
Impairment of Long-lived Assets - We evaluates its long-lived assets or asset group, including intangible assets with finite lives, for impairment whenever events or changes in circumstances (such as a significant adverse change to market conditions that will impact the future use of the assets) indicate that the carrying amount of an asset or a group of long-lived assets may not be recoverable. When these events occur, we evaluates for impairment by comparing the carrying amount of the assets to future undiscounted net cash flows expected to result from the use of the assets and their eventual disposition. If the sum of the expected undiscounted cash flow is less than the carrying amount of the assets, we would recognize an impairment loss based on the excess of the carrying amount of the asset group over its fair value. Fair value is generally determined by discounting the cash flows expected to be generated by the assets, when the market prices are not readily available for the long-lived assets. No impairment charge was recognized for each of the year ended June 30, 2014 and 2013.
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Income Taxes–We accounts for income taxes using the liability method whereby deferred income taxes are recognized for the tax consequences of temporary differences by applying statutory tax rates applicable to future years to the differences between the financial statement carrying amounts and the tax bases of certain assets and liabilities, changes in deferred tax assets and liabilities, if any, include the impact of any tax rate changes enacted during the year. ASC Topic350, “Accounting for Income Taxes,” requires that deferred tax assets be reduced by a valuation allowance if, based on all available evidence, it is considered more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. Additionally, we account for uncertainty in income taxes using a two-step approach to recognize and measure uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. The Company classifies the liability for unrecognized tax benefits as current to the extent that we anticipate payment (or receipt) of cash within one year. Interest and penalties related to uncertain tax positions are recognized in the provision for income taxes. We did not have any uncertain tax positions for the year ended June 30, 2013 and 2012. If the amount of our taxable income or income tax liability is a determinant of the amount of a grant, the grant is treated as a reduction of the income tax provision in the year the grant is realized.
Stock-based Compensation – Share options granted to employees are accounted for under ASC 718, “Compensation – Stock Compensation”, which requires that share-based awards granted to employees be measured based on the grant date fair value and recognized as compensation expense over the requisite service period (which is generally the vesting period) in the consolidated statements of operations. We has elected to recognize compensation expense using the straight-line method for all share options granted with service conditions that have a graded vesting schedule. ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from initial estimates. Forfeiture rate is estimated based on historical and future expectation of employee turnover rate and are adjusted to reflect future change in circumstances and facts, if any. Share-based compensation expense is recorded net of estimated forfeitures such that expense is recorded only for those share-based awards that are expected to vest. To the extent we revise this estimate in the future, the share-based payments could be materially impacted in the period of revision, as well as in following periods.
Transactions in which goods or services are received in exchange for equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. The measurement date of the fair value of the equity instrument issued is the date on the earlier of: (1) the performance commitment date, or (2) the date the services required under the arrangement have been completed.
Recent Accounting Pronouncements
On July 18, 2013, the FASB issued ASU 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists” (Income Taxes - Topic 740). This update applies to all entities that have unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, unless otherwise provided in the update. To the extent that a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. For example, an entity should not evaluate whether the deferred tax asset has expired before the statute of limitations on the tax position or whether the deferred tax asset may be used prior to the unrecognized tax benefit being settled. The amendments in this update do not require new recurring disclosures. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The Company is currently evaluating the impact of adopting this update on its financial statements.
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2014-09 (“ASU 2014-09”), “Revenue from Contracts with Customers (Topic 606)”. ASU 2014-09 will eliminate transaction-specific and industry-specific revenue recognition guidance under current USGAAP and replace it with a principle-based approach for determining revenue recognition. ASU 2014-09 will require that companies recognize revenue based on the value of transferred goods or services as they occur in the contract. The ASU also will require additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 is effective for reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. Entities can transition to the standard either retrospectively or as a cumulative effect adjustment as of the date of adoption. The Company is currently assessing the impact the adoption of ASU 2014-09 and the effect of the standard on our ongoing financial reporting.
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In June 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2014-12 (“ASU 2014-12”), “Compensation—Stock Compensation (Topic 718) - Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period.” ASU 2014-12 requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in Topic 718 as it relates to awards with performance conditions that affect vesting to account for such awards. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. As indicated in the definition of vest, the stated vesting period (which includes the period in which the performance target could be achieved) may differ from the requisite service period. For all entities, the amendments in this Update are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. The effective date is the same for both public business entities and all other entities. Entities may apply the amendments in this Update either (a) prospectively to all awards granted or modified after the effective date or (b) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. If retrospective transition is adopted, the cumulative effect of applying this Update as of the beginning of the earliest annual period presented in the financial statements should be recognized as an adjustment to the opening retained earnings balance at that date. Additionally, if retrospective transition is adopted, an entity may use hindsight in measuring and recognizing the compensation cost. The Company is currently evaluating the impact of adopting this Update on its financial statements.
Off-Balance Sheet Arrangements
We do not have any off-balance arrangements.
| ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. |
Not Applicable.
| ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. |
The full text of our audited consolidated financial statements as of June 30, 2014 and 2013 begins on page F-1 of this report.
| ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. |
As previously disclosed in the Current Report on Form 8-K, dated October 23, 2014, the Audit Committee of the Board of Directors of the Company approved the dismissal of Grant Thornton, the China member firm of Grant Thornton International (“Grant Thornton”) as the Company's independent registered public accounting firm on October 17, 2014.
Other than described below, during the Company’s two most recent fiscal years (ended June 30, 2014 and 2013) and during the subsequent interim period through October 17, 2014, there were (1) no disagreements with Grant Thornton on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which disagreements, if not resolved to the satisfaction of Grant Thornton, would have caused Grant Thornton to make reference to the subject matter of the disagreements in connection with its reports, and (2) no events of the type listed in paragraphs (A) through (D) of Item 304(a)(1)(v) of Regulation S-K.
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In connection with the audit of the Company’s financial statements for the fiscal year ended June 30, 2014, Grant Thornton raised questions and planned to expand the scope of audit work on the revenue contributed from certain significant customers of the Company. As part of its audit scope, Grant Thornton selected the significant sales to these customers, which were reported as third-party sales, for testing. These transactions represented approximately two-thirds of unaudited fourth quarter revenue. Grant Thornton questioned whether the sales to these four customers in the fourth quarter satisfied revenue recognition criteria, due to certain facts related to the sales transactions, such as lack of fixed payment terms and the lack of cash receipts related to any of these transactions from the end of the fiscal year through the date we dismissed Grant Thornton.
In addition to questioning the sales for proper revenue recognition, Grant Thornton questioned the Company’s classification of the sales as third-party sales based on the fact that management of the majority of these customers were former employees of Shanghai Huaye Iron & Steel Group Co., Ltd., a PRC company of which the Company’s major shareholder and her husband are 100% owners, and three of the customers’ primary places of business resided at the related party facilities and location of one customer was not verified, as noted below. As the fourth quarter was a slow period for the steel industry with significant declines in steel prices and demand in China, Grant Thornton also questioned the substance of these significant sales in addition to the aspects of these sales mentioned previously.
As part of their procedures to complete their audit work related to these transactions, Grant Thornton would seek information that is not in the possession, custody or control of the Company. Grant Thornton indicated that the documentation we provided to substantiate the transactions did not satisfactorily achieve their audit objectives and they requested the following:
| · | Financial records and other business or credit rating information of the customers in question | |
| · | Information regarding the corporate structure of these customers and business agreements between those entities and our related party | |
| · | Permission to perform site visits at the customer locations, interview management, and observe the inventory and sales records between the Company and the customers. |
Initially the site visits were arranged by the customers with the consent of the Company, but after the customers requested to know Grant Thornton’s procedures in advance of the visit all four customers revoked their consent to allow Grant Thornton to perform site visitations.
In addition to revenue testing, Grant Thornton requested that the Company revise its analysis of inventory reserves and further evaluate the recoverability and classification of inventory advances paid to related parties due to downward trend in the steel prices and demand in the China market subsequent to the fiscal year-end period.
Grant Thornton also advised the Company and the Audit Committee that, depending upon what Grant Thornton learned from the procedures performed pursuant to its audit scope, it might request additional information. The Company has concluded that Grant Thornton’s proposed procedures may create risks for the Company with respect to the Company’s obligation to timely file its annual report on Form 10-K for the fiscal year 2014.
These issues and requests were not resolved to Grant Thornton’s satisfaction.
| ITEM 9A. | CONTROLS AND PROCEDURES. |
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, Ms. Lifang Chen and Mr. Naijiang Zhou, respectively, evaluated the effectiveness of our disclosure controls and procedures. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports, such as this report, that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Based on that evaluation, Ms. Chen and Mr. Zhou concluded that our disclosure controls and procedures were effective as of June 30, 2014.
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Management’s Annual Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting refers to the process designed by, or under the supervision of, our chief executive officer and chief financial officer, and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP, and includes those policies and procedures that:
| · | pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets; |
| · | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that our receipts and expenditures are being made only in accordance with the authorization of our management and directors; and |
| · | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements. |
Management conducted an evaluation of the effectiveness of our internal control over financial reporting as of June 30, 2014 based on the framework set forth in the report entitled Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the evaluation, management concluded that our internal control over financial reporting as of June 30, 2014 was effective.
Because we are a smaller reporting company, this annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm.
Changes in Internal Control over Financial Reporting
There were no changes in our internal controls over financial reporting during the fourth quarter of our fiscal year ended June 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
| ITEM 9B. | OTHER INFORMATION. |
We have no information to disclose that was required to be disclosed in a report on Form 8-K during the fourth quarter of fiscal year 2014, but was not reported.
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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
Directors and Executive Officers
The following sets forth the name and position of each of our current executive officers and directors.
| NAME | AGE | POSITION | ||||
| Lifang Chen | 43 | Chairman of the Board, Chief Executive Officer and President | ||||
| Naijiang Zhou | 51 | Director and Chief Financial Officer | ||||
| Shoubin Xiong | 48 | Chief Operating Officer | ||||
| Gerard Pascale | 44 | Director | ||||
| Guoyou Shao | 65 | Director | ||||
| Xinchuang Li | 51 | Director | ||||
Lifang Chen. Ms. Chen is the founder of the Company. She became our Chairwoman on February 1, 2007. Under her leadership, the Company became a leading finished steel manufacturer in China with a vertically integrated business model offering unique one-stop customer services that are difficult to replicate. At the Company, Ms. Chen has cultivated a seasoned management team of professionals that are focused on growing the Company’s business and that are well known in the industry. Prior to founding the Company in 2002, Ms. Chen directed the civil administration bureau of Xiaoshan municipal government in China from September 1993 to May 2001 where she helped design various policies to strengthen the operations of local companies, coordinated businesses between private enterprise and local banks, and reviewed and approved IPOs for large companies. Ms. Chen is an accomplished entrepreneur in the Chinese fine finished steel industry and excels in enterprise management and industry and government relations. She obtained an MA degree in Philosophy from Zhejiang University.
Naijiang Zhou. Mr. Zhou became our director on January 28, 2013 and has been our Chief Financial Officer since December 14, 2012. Prior to that, Mr. Zhou was the Vice President of Finance of the Company since February 1, 2010. Before that, Mr. Zhou served as Executive Vice President and Chief Financial Officer at Rich Fields Investment, Ltd., a private equity investment firm since 2008. From April 2007 to July 2008, Mr. Zhou worked as international research analyst at Roth Capital Partners, a full service U.S. banking firm. Before joining Roth Capital, Mr. Zhou worked for seven years as principal financial planner and principal financial analyst at American Electric Power, where he was responsible for strategic planning, financial planning and analysis, and corporate development. Prior to that, he worked for the Wing Group as financial analyst and U.S. Global Investors as senior research analyst and co-managed mutual fund investments. Mr. Zhou received both a Ph.D. in Energy and Mineral Resources and an MBA degree from the University of Texas at Austin, and a B.Sc. in Petroleum Engineering from China Petroleum University. He also holds the Chartered Financial Analyst (CFA) designation.
Shoubin Xiong. Mr. Xiong became our Chief Operating Officer on February 11, 2014. After Mr. Xiong joined the Company in February 2012, he served as general manager of technical management center of the Company. Mr. Xiong has extensive experience in production line operations management. During his tenure, Mr. Xiong is in charge of new product research and development, equipment and technical transformation and daily operations management. From December 2006 to January 2012, Mr. Xiong served as vice general manager of Wuhan Henghong Mechanical and Electrical Co., Ltd and was in charge of production line budgeting, installation, testing and operations management. As chief technical engineer with China First Metallurgical Group Co., Ltd. from July 1990 to December 2005, Mr. Xiong was responsible for production lines installation, budgeting and equipment maintenance at several large steel mills including Wu Steel and Guangzhou Iron & Steel Enterprises Group. Mr. Xiong is a senior engineer and holds the Bachelor’s degree in metallurgical engineering.
Gerard Pascale. Mr. Pascale has been a member of our Board since January 15, 2010. Mr. Pascale has extensive experience in financial accounting, financial analysis and planning, marketing research, corporate governance and securities. He is a Vice President with Chile Mining Technologies, Inc. (OTCBB: LVEN), a mineral extraction company based in the Republic of Chile, whom he advised in preparing for their public transaction and fund raise. For the past two and a half years he has served as President and CEO of SC Financial Group, LLC, where he specializes in advising both US and international clients on valuation, financial modeling and the responsibilities of publicly traded US companies. Previously, he was the Director of Finance at Heritage Management Consultants, Inc. where Mr. Pascale specialized in providing finance and SEC support throughout the entire process of listing on a US exchange. From 2003 to 2005, Mr. Pascale was a Director with the Corporate Executive Board, a consulting firm delivering data and tools, practice research and insight to clients. He has also held financial analyst positions with Intel Corporation and Emerson Electric. Mr. Pascale has a Bachelor of Science in Accounting from Virginia Tech and an MBA in finance from the University of Chicago.
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Guoyou Shao. Mr. Shao has been a member of our Board since February 2008. Since April 2003, Mr. Shao has served as Board Chairman of Fortis Haitong Investment Management Co., Ltd., one of the first sino-foreign joint ventures specializing in fund management to gain approval in China. Prior to this, Mr. Shao served as Manager of the Investor Relations Department of Haitong Securities Co. Ltd. since July 1998. Mr. Shao has extensive securities investment and asset management experience and holds a Master’s degree in Business Administration from Hong Kong Science Management Institute.
Xinchuang Li. Mr. Li has been a member of our Board since February 2008. Since 2009, Mr. Li has served as the Director of China Metallurgical Industry Planning & Research Institute (CMIPRI) in Beijing. From 2008 to 2009, Mr. Li served as the Executive Director of CMIPRI. From 2002 to 2008, Mr. Li served as the Vice Director and Chief Engineer of CMIPRI. From 1998 to 2002, Mr. Li served as the Vice-Chief Engineer of CMIPRI. Mr. Li has significant experience in the operations of companies engaged in steel production with a particular focus and specialization in the operations, planning and strategic focus of companies operating in the Chinese steel industry. Mr. Li holds a Master’s degree in Business Administration from Fordham University and Beijing University.
There are no agreements or understandings for any of our executive officers or director to resign at the request of another person and no officer or director is acting on behalf of nor will any of them act at the direction of any other person.
Directors are elected until their successors are duly elected and qualified.
Director Qualifications
Directors are responsible for overseeing the Company’s business consistent with their fiduciary duty to shareholders. This significant responsibility requires highly-skilled individuals with various qualities, attributes and professional experience. The Board believes that there are general requirements for service on the Company’s Board of Directors that are applicable to all directors and that there are other skills and experience that should be represented on the Board as a whole but not necessarily by each director. The Board and the Governance and Nominating Committee of the Board consider the qualifications of directors and director candidates individually and in the broader context of the Board’s overall composition and the Company’s current and future needs.
Qualifications for All Directors
In its assessment of each potential candidate, including those recommended by shareholders, the Governance and Nominating Committee considers the nominee’s judgment, integrity, experience, independence, understanding of the Company’s business or other related industries and such other factors the Governance and Nominating Committee determines are pertinent in light of the current needs of the Board. The Governance and Nominating Committee also takes into account the ability of a director to devote the time and effort necessary to fulfill his or her responsibilities to the Company.
The Board and the Governance and Nominating Committee require that each director be a recognized person of high integrity with a proven record of success in his or her field. Each director must demonstrate innovative thinking, familiarity with and respect for corporate governance requirements and practices, an appreciation of multiple cultures and a commitment to sustainability and to dealing responsibly with social issues. In addition to the qualifications required of all directors, the Board assesses intangible qualities including the individual’s ability to ask difficult questions and, simultaneously, to work collegially.
The Board does not have a specific diversity policy, but considers diversity of race, ethnicity, gender, age, cultural background and professional experiences in evaluating candidates for Board membership. Diversity is important because a variety of points of view contribute to a more effective decision-making process.
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Qualifications, Attributes, Skills and Experience to be Represented on the Board as a Whole
The Board has identified particular qualifications, attributes, skills and experience that are important to be represented on the Board as a whole, in light of the Company’s current needs and business priorities. The Company’s services are performed in areas of future growth located outside of the United States. Accordingly, the Board believes that international experience or specific knowledge of key geographic growth areas and diversity of professional experiences should be represented on the Board. In addition, the Company’s business is multifaceted and involves complex financial transactions. Therefore, the Board believes that the Board should include some directors with a high level of financial literacy and some directors who possess relevant business experience members of senior management teams. Our business involves complex technologies in a highly specialized industry, and therefore, the Board believes that extensive knowledge of the Company’s business and industry should be represented on the Board.
Summary of Qualifications of Directors
Set forth below is a narrative disclosure that summarizes some of the specific qualifications, attributes, skills and experiences of our directors. For more detailed information, please refer to the biographical information for each director set forth above.
Lifang Chen. Ms. Chen has extensive senior management experience in the industry in which we operate, having served as our Chairman since February 2007 and Chief Executive Officer from May 2008 to February 2014. In addition, Ms. Chen has worked extensively with various governmental agencies in connection with our industry.
Naijiang Zhou. Mr. Zhou is a financial expert with Chartered Financial Analyst (CFA) designation. He has extensive experience in our industry as well as on corporate accounting, finance and capital management matters.
Gerard Pascale. Mr. Pascale brings to the Board a high level of financial literacy and sophistication, and extensive financial and capital markets experience, including M&A, debt and equity financings, restructuring and business expansion. In addition, Mr. Pascale has extensive experience dealing with corporate governance matters and filings with the U.S. Securities and Exchange Commission.
Guoyou Shao. Mr. Shao has extensive securities investment, asset management and investor relations experience.
Xinchuang Li. Mr. Li has significant experience in the operations of companies engaged in steel production with a particular focus and specialization in the operations, planning and strategic focus of companies operating in the Chinese steel industry.
Family Relationships
There are no family relationships among our directors or officers.
Involvement in Certain Legal Proceedings
To the best of our knowledge, none of our directors or executive officers has, during the past ten years:
| · | been convicted in a criminal proceeding or been subject to a pending criminal proceeding (excluding traffic violations and other minor offences); |
| · | had any bankruptcy petition filed by or against the business or property of the person, or of any partnership, corporation or business association of which he was a general partner or executive officer, either at the time of the bankruptcy filing or within two years prior to that time; |
| · | been subject to any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction or federal or state authority, permanently or temporarily enjoining, barring, suspending or otherwise limiting, his involvement in any type of business, securities, futures, commodities, investment, banking, savings and loan, or insurance activities, or to be associated with persons engaged in any such activity; |
| · | been found by a court of competent jurisdiction in a civil action or by the Securities and Exchange Commission or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended, or vacated; |
| · | been the subject of, or a party to, any federal or state judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated (not including any settlement of a civil proceeding among private litigants), relating to an alleged violation of any federal or state securities or commodities law or regulation, any law or regulation respecting financial institutions or insurance companies including, but not limited to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist order, or removal or prohibition order, or any law or regulation prohibiting mail or wire fraud or fraud in connection with any business entity; or |
| · | been the subject of, or a party to, any sanction or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the Exchange Act (15 U.S.C. 78c(a)(26))), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act (7 U.S.C. 1(a)(29))), or any equivalent exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member. |
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Except as set forth in our discussion below in Item 13, “Certain Relationships and Related Transactions, and Director Independence – Transactions with Related Persons,” none of our directors, director nominees or executive officers has been involved in any transactions with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed pursuant to the rules and regulations of the SEC.
Board Composition and Committees
Our board of directors is comprised of Lifang Chen, Naijiang Zhou, Gerard Pascale, Guoyou Shao and Xinchuang Li.
Messrs. Gerard Pascale, Guoyou Shao, and Xinchuang Li each serves on our board of directors as an “independent director” as defined by as defined by Rule 5605(a)(2) of the NASDAQ Listing Rules. Our board of directors has determined that Gerard Pascale possesses the accounting or related financial management experience that qualifies him as financially sophisticated within the meaning of Rule 5605(c)(2)(A) of the NASDAQ Listing Rule and that he is an “audit committee financial expert” as defined by the rules and regulations of the SEC.
Our board of directors currently has three standing committees which perform various duties on behalf of and report to the board of directors: (i) audit committee, (ii) compensation committee and (iii) governance and nominating committee. Each of the three standing committees is comprised entirely of independent directors. From time to time, the board of directors may establish other committees.
Audit Committee
Our board of directors established an audit committee in February 2008. Our audit committee consists of three members: Gerard Pascale, Guoyou Shao, and Xinchuang Li. Our audit committee oversees our accounting and financial reporting processes and the audits of the financial statements of our company. Mr. Pascale serves as our audit committee chairman.
Our audit committee is responsible for, among other things:
| · | selecting our independent auditors and pre-approving all auditing and non-auditing services permitted to be performed by our independent auditors; |
| · | reviewing with our independent auditors any audit problems or difficulties and management’s response; |
| · | reviewing and approving all proposed related-party transactions, as defined in Item 404 of Regulation S-K under the Securities Act; |
| · | discussing the annual audited financial statements with management and our independent auditors; |
| · | reviewing major issues as to the adequacy of our internal controls and any special audit steps adopted in light of significant internal control deficiencies; |
| · | annually reviewing and reassessing the adequacy of our audit committee charter; |
| · | meeting separately and periodically with management and our internal and independent auditors; |
| · | reporting regularly to the full board of directors; and |
| · | such other matters that are specifically delegated to our audit committee by our board of directors from time to time. |
Compensation Committee
Our board of directors established a compensation committee in February 2008. Our compensation committee consists of three members: Gerard Pascale, Guoyou Shao, and Xinchuang Li. Mr. Shao serves as the chairman of our compensation committee. Our compensation committee assists the board of directors in reviewing and approving the compensation structure of our directors and executive officers, including all forms of compensation to be provided to our directors and executive officers. Our Chief Executive Officer may not be present at any meeting of our compensation committee during which her compensation is deliberated.
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Our compensation committee is responsible for, among other things:
| · | approving and overseeing the compensation package for our executive officers; |
| · | reviewing and approving corporate goals and objectives relevant to the compensation of our Chief Executive Officer; |
| · | evaluating the performance of our Chief Executive Officer in light of those goals and objectives, and setting the compensation level of our Chief Executive Officer based on this evaluation; and |
| · | reviewing periodically and making recommendations to the board of directors regarding any long-term incentive compensation or equity plans, programs or similar arrangements, annual bonuses, employee pension and welfare benefit plans. |
Governance and Nominating Committee
Our board of directors established a governance and nominating committee in February 2008. Our governance and nominating committee consists of three members: Gerard Pascale, Guoyou Shao, and Xinchuang Li. Mr. Li serves as the chairman to our governance and nominating committee. The governance and nominating committee assists the board of directors in identifying individuals qualified to become our directors and in determining the composition of the board of directors and its committees.
Our governance and nominating committee is responsible for, among other things:
| · | identifying and recommending to the board of directors nominees for election or re-election to the board of directors, or for appointment to fill any vacancy; |
| · | reviewing annually with the board of directors the current composition of the board of directors in light of the characteristics of independence, age, skills, experience and availability of service to us; and |
| · | identifying and recommending to the board of directors the directors to serve as members of the committees. |
Section 16(A) Beneficial Ownership Reporting Compliance
Under U.S. securities laws, directors, certain executive officers and persons holding more than 10% of our common stock must report their initial ownership of the common stock, and any changes in that ownership, to the SEC. The SEC has designated specific due dates for these reports. In fiscal year 2013, all such reports were timely filed. In making these statements, we have relied upon examination of the copies of all Section 16(a) forms provided to us and the written representations of our executive officers, directors and beneficial owner of more than 10% of a registered class of our equity securities.
Code of Ethics
On January 31, 2007, our board of directors adopted a new code of ethics that applies to all of our directors, officers and employees, including our principal executive officer, principal financial officer and principal accounting officer. The new code replaces our prior code of ethics that applied only to our principal executive officer, principal financial officer, principal accounting officer or controller and any person who performed similar functions, and addresses, among other things, honesty and ethical conduct, conflicts of interest, compliance with laws, regulations and policies, including disclosure requirements under the federal securities laws, confidentiality, trading on inside information, and reporting of violations of the code. A copy of the Code of Ethics has been filed as Exhibit 14 to our current report on Form 8-K, filed on February 2, 2007.
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| ITEM 11. | EXECUTIVE COMPENSATION. |
Summary Compensation Table – Fiscal Years Ended June 30, 2014 and 2013
The following table sets forth information concerning all cash and non-cash compensation awarded to, earned by or paid to the named persons for services rendered in all capacities during the noted periods. No other executive officer received total annual salary and bonus compensation in excess of $100,000.
| Name and Principal Position | Year | Salary ($) | Bonus ($) | Stock Awards ($)(1) | All Other Compensation ($) | Total ($) | ||||||||||||||||
| Lifang Chen, CEO (2) | 2014 | 106,169 | - | - | - | 106,169 | ||||||||||||||||
| 2013 | 150,000 | - | 20,926 | - | 170,926 | |||||||||||||||||
| Zhuo Wang, former CEO(3) | 2014 | 50,000 | - | 32,375 | - | 82,375 | ||||||||||||||||
| 2013 | - | - | - | - | - | |||||||||||||||||
| Naijiang Zhou, CFO(4) | 2014 | 113,285 | - | 71,250 | - | 184,535 | ||||||||||||||||
| 2013 | 110,880 | - | 55,750 | - | 166,630 | |||||||||||||||||
(1) This amount represents the compensation expense that the Company recognized for financial statement reporting purposes in the applicable fiscal year for the portion of the fair value of equity awards granted to the named executive officer in such fiscal year, in accordance with ASC 718-10, “Share-Based Payment,” and ASC 505-50, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services,” respectively. Such amount thus does not reflect the amount of compensation actually received by the named executive officer during the applicable fiscal year. For a description of the assumptions used in calculating the fair value of these equity awards, see Note 10 to the consolidated financial statements included elsewhere in this report.
(2) Ms. Chen resigned from her positions as the Company’s Chief Executive Officer and President on February 11, 2014. Pursuant to the Company’s 2009 Equity Incentive Plan, the Company granted options to purchase 40,000 shares of its common stock to Ms. Chen with an exercise price of $2.71 per share on April 27, 2010. One-third of the option vested on the first, second and third anniversary of the date of grant, respectively. On October 30, 2014, Ms. Chen was appointed as the Company’s Chief Executive and President.
(3) Mr. Wang became the Company’s Chief Executive Officer and President on February 11, 2014. Pursuant to the Company’s 2009 Equity Incentive Plan, on January 7, 2014, the Company granted Mr. Wang 35,000 shares of restricted stock, which vest on the one-year anniversary of the grant date. On April 27, 2010, Mr. Wang was granted an option to purchase 3,000 shares of common stock under the Company’s 2009 Equity Incentive Plan. The option vests and becomes exercisable in three equal installments on each of the first, second and third anniversary of the grant date of the option. The expiration date of the option is the fifth anniversary of the grant date of the option. Mr. Wang resigned from his position as the Company’s Chief Executive Officer and President on October 30, 2014.
(4) Pursuant to the Company’s 2009 Equity Incentive Plan, we granted options to purchase 20,000 shares of our common stock to Mr. Zhou with an exercise price of $2.71 per share on April 27, 2010. One-third of the option vested on the first, second and third anniversary of the date of grant, respectively. In addition, Mr. Zhou received 20,000 restricted shares of common stock as part of his compensation for services from February 1, 2010 to January 31, 2011. According to the amendment to the employment agreement entered into on February 23, 2011, Mr. Zhou received 30,000 additional restricted shares of common stock as part of his annual compensation to be vested over a twelve month period. On February 9, 2012, the parties amended Mr. Zhou’s employment agreement further, under which amendment Mr. Zhou’s monthly base salary was increased from RMB 50,000 to RMB 58,000 (approximately $9,200) and the Company granted 50,000 restricted shares to Mr. Zhou on February 21, 2012 under the 2009 Equity Incentive Plan, which shares vest on the 12-month anniversary date of the grant date. On December 14, 2012, the Company granted Mr. Zhou 50,000 shares of restricted stock under the 2009 Equity Incentive Plan, which will vest on the one-year anniversary date of the grant date. On January 7, 2014, Mr. Zhou was granted 50,000 shares of restricted stock under the Company's 2009 Equity Incentive Plan, which will vest on the one-year anniversary of the grant date.
Employment Agreements
On October 31, 2014, our subsidiary, Sutor BVI entered into an employment agreement with Ms. Chen, our Chief Executive Officer, under which Ms. Chen will receive an annual salary of $150,000. Ms. Chen’s employment with us is at-will and can be terminated by either party at any time with or without cause.
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On December 14, 2012, the Company and Sutor BVI entered into an employment agreement with Mr. Zhou, under which Mr. Zhou will receive an annual salary of RMB 696,000 (approximately $111,360). In addition, the Company granted Mr. Zhou 50,000 restricted shares of the Company’s common stock under the Company’s 2009 Equity Incentive Plan, which shares will vest on the first anniversary of the grant date. The term of the employment agreement is for one year, which will be renewed automatically when it expires unless the employment is terminated by the parties. Mr. Zhou’s employment with the Company is at-will and can be terminated by either party at any time with or without cause, and with or without notice.
We have not provided retirement benefits (other than a state pension scheme in which all of our employees in China participate) or severance or change of control benefits to our named executive officer.
Outstanding Equity Awards at Fiscal Year End
The following table sets forth the equity awards outstanding at June 30, 2014 for each of our named executive officers.
| OPTION AWARDS(1) | STOCK AWARDS | |||||||||||||||||||||||||||||||||
| Name | Number of Securities Underlying Unexercised Options (#) Exercisable | Number of Securities Underlying Unexercised Options (#) Unexercisable | Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options (#) | Option Exercise Price ($) | Option Expiration Date | Number of Shares or Units of Stock That Have Not Vested (#) | Market Value of Shares or Units of Stock That Have Not Vested ($)(2) | Equity Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights That Have Not Vested (#) | Equity Incentive Plan Awards: Market or Payout Value of Unearned Shares, Units or Other Rights That Have Not Vested (#) | |||||||||||||||||||||||||
| Lifang Chen | 40,000 | - | - | 2.71 | 4/27/2015 | 40,000 | 40,000 | - | - | |||||||||||||||||||||||||
| Zhuo Wang | 3,000 | - | - | 2.71 | 4/27/2015 | 3,000 | 3,000 | - | - | |||||||||||||||||||||||||
| Naijiang Zhou | 20,000 | - | - | 2.71 | 4/27/2015 | 50,000 | 50,000 | - | - | |||||||||||||||||||||||||
| (1) | On April 27, 2010, we issued options to our executive officers under the Sutor Technology Group Limited 2009 Equity Incentive Plan. One-third of the option will each vest on the first, second and third anniversaries of the date of grant. |
| (2) | Values are based on the closing stock price of $1.00 per share on June 30, 2014. |
Compensation of Directors
The table below sets forth the compensation of our directors for the fiscal year ended June 30, 2014:
| Name | Fees Earned or Paid in Cash ($) | Stock Awards ($) | Option Awards ($) | Non-Equity Incentive Plan Compensation ($) | All Other Compensation ($) | Total ($) | ||||||||||||||||||
| Gerard Pascale | 55,000 | 21,800 | - | - | - | 76,800 | ||||||||||||||||||
| Guoyou Shao | 20,433 | - | - | - | - | 20,433 | ||||||||||||||||||
| Xinchuang Li | 20,433 | - | - | - | - | 20,433 | ||||||||||||||||||
Under the terms of the independent director contract that we entered into with each above independent directors in 2014, Mr. Pascale is entitled to $55,000 in cash and 10,000 restricted shares of the Company, vesting on the 12-month anniversary date of the grant date, Mr. Shao is entitled to RMB 132,000 (approximately $20,433) and Mr. Li is entitled to RMB132,000 (approximately $20,433), as annual compensation for their service as independent directors, and as chairpersons of various board committees, as applicable. Mr. Pascale’s compensation is greater because he has greater responsibilities as the Audit Committee Chairman. Under the terms of the agreements, we will reimburse our directors for reasonable travel expenses related to attendance at board and committee meetings.
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Additionally, we entered into Indemnification Agreements with each of Messrs. Pascale, Shao and Li. Under the terms of these Indemnification Agreements, the Company agreed to indemnify the independent directors against expenses, judgments, fines, penalties or other amounts actually and reasonably incurred by the independent directors in connection with any proceeding (other than a proceeding by or in the right of the Company) if the independent director acted in good faith and in the best interests of the Company, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the independent director’s conduct was unlawful. The Company also agreed to pay any such expenses to an independent director in advance of the final disposition of any such proceeding if the director agrees to repay such amount to the extent it is ultimately determined they are not entitled to indemnification; provided, however, that the Company is not obligated to make any such advance payment if the board of directors determines, in its sole discretion, that it does not appear that such director has met the standards of conduct which make it permissible under applicable law to indemnify such director, and that the advancement of expenses would not be in the best interests of the Company and its stockholders.
| ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. |
Security Ownership of Certain Beneficial Owners and Management
The following table sets forth information regarding beneficial ownership of our common stock as of December 11, 2014 (i) by each person who is known by us to beneficially own more than 5% of our common stock; (ii) by each of our officers and directors; and (iii) by all of our officers and directors as a group. Unless otherwise specified, the address of each of the persons set forth below is in care of Sutor Technology Group Limited, No. 8, Huaye Road, Dongbang Industrial Park Changshu, China, 215534.
| Name & Address of Beneficial Owner | Office, If Any | Title of Class | Amount
& Nature of Beneficial Ownership(1) | Percent of Class(2) | ||||||||
| Officers and Directors | ||||||||||||
| Lifang Chen | Chairwoman, Chief Executive Officer and President | Common Stock | 30,378,050 | (3) (4) | 72.9 | % | ||||||
| Naijiang Zhou | Chief Financial Officer | Common Stock | 70,000 | (5) | * | |||||||
| ShoubinXiong | Chief Operating Officer | Common Stock | - | * | ||||||||
| Gerard Pascale | Director | Common Stock | 36,625 | (6) | * | |||||||
| Guoyou Shao | Director | Common Stock | - | * | ||||||||
| Xinchuang Li | Director | Common Stock | - | * | ||||||||
| All Officers and Directors as a group (7 persons named above) | 30,484,675 | 73.2 | % | |||||||||
| 5% Security Holders | ||||||||||||
| Total Raise Investments Ltd. | Common Stock | 30,338,050 | 72.8 | % | ||||||||
| Lifang Chen | Common Stock | 30,378,050 | (3) | 72.9 | % | |||||||
* Less than 1%.
| (1) | Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. |
| (2) | A total of 41,661,429 shares of our common stock are considered to be outstanding pursuant to SEC Rule 13d-3(d)(1) as of December 11, 2014. For each beneficial owner above, any options exercisable within 60 days have been included in the denominator. |
| (3) | Includes 30,338,050 shares of common stock owned by Total Raise Investments Ltd., a BVI company wholly owned by Ms. Chen. Ms. Chen disclaims beneficial ownership of such shares except to the extent of her pecuniary interest therein. |
| (4) | Pursuant to the Company’s 2009 Equity Incentive Plan, we granted Ms. Chen an option to purchase 40,000 shares of common stock with an exercise price of $2.71 per share on April 27, 2010. One-third of the option vested on the first, second and third anniversary of the date of grant, respectively. |
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| (5) | On February 1, 2010, Mr. Zhou received 20,000 shares of our common stock in accordance with the terms of the employment agreement, to vest in equal installments over a twelve month period. On February 23, 2011, Mr. Zhou was granted 30,000 shares of our common stock in accordance with the terms of the employment agreement, to vest in equal installments over a twelve month period. Pursuant to the Company’s 2009 Equity Incentive Plan, we also granted Mr. Zhou an option to purchase 20,000 shares of common stock with an exercise price of $2.71 per share on April 27, 2010. One-third of the option will each vest on the first, second and third anniversaries of the date of grant. On February 9, 2012, the parties amended Mr. Zhou’s employment agreement further, under which amendment the Company granted 50,000 restricted shares to Mr. Zhou on February 21, 2012, vesting on the 12-month anniversary date of the grant date. On December 14, 2012, the Company granted Mr. Zhou 50,000 shares of restricted stock under the 2009 Equity Incentive Plan, which will vest on the one-year anniversary date of the grant date. On January 7, 2014, the Company granted Mr. Zhou 50,000 shares of restricted stock under the 2009 Equity Incentive Plan, which will vest on the one-year anniversary date of the grant date. On September 23, 2013 and May 19, 2014, Mr. Zhou disposed of 20,000 and 130,000, respectively, of his shares that were vested. |
| (6) | Pursuant to the Company’s 2009 Equity Incentive Plan, we granted Mr. Pascale an option to purchase 5,000 shares of common stock with an exercise price of $2.71 per share which vested monthly in equal installments over a 12-month period starting February 23, 2011. On February 21, 2012, we granted 10,000 restricted shares to Mr. Pascale, which vested on the one-year anniversary date of the grant date. On March 7, 2013, Mr. Pascale was granted 10,000 shares of restricted stock under the Company's 2009 Equity Incentive Plan, which will vest on the one-year anniversary date of the grant date. On February 10, 2014, Mr. Pascale was granted 10,000 shares of restricted stock under the Company’s 2009 Equity Incentive Plan, which will vest on the one-year anniversary date of the grant date. |
Changes in Control
There are no arrangements known to us, including any pledge by any person of our securities, the operation of which may at a subsequent date result in a change in control of the Company.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table includes the information as of the end of fiscal year 2014 for each category of our equity compensation plan:
| Plan category | Number of securities to be issued upon exercise of outstanding options, restricted stock, warrants and rights (a) | Weighted-average exercise price of outstanding options, restricted stock, warrants and rights (b) | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (c) | |||||||||
| Equity compensation plans approved by security holders(1) | 105,000 | (2) | $ | 2.71 | 1,725,000 | |||||||
| Equity compensation plans not approved by security holders | - | - | - | |||||||||
| Total | 105,000 | $ | 2.71 | 1,725,000 | ||||||||
| (1) | On April 15, 2009, our board of directors authorized the establishment of the Sutor Technology Group Limited 2009 Equity Incentive Plan, whereby we are authorized to issue shares of our Common Stock to certain employees, directors and consultants. The maximum aggregate number of shares of our common stock that may be issued under the Plan is 2,000,000 shares. The Plan was approved by our stockholders on June 16, 2009. |
| (2) | On April 27, 2010, we granted options to purchase a total of 100,000 shares of our common stock to certain officers, directors and employees with an exercise price of $2.71 per share. One third of the option will vest and become exercisable on the first, second and third anniversaries of the date of grant. On February 1, 2010, Mr. Naijiang Zhou received 20,000 shares of our common stock in accordance with the terms of the employment agreement, to vest in equal installments over a twelve month period. On February 23, 2011, we issued 30,000 shares of our common stock to Mr. Naijiang Zhou under the 2009 Equity Incentive Plan, to vest in equal installments over a twelve month period. On February 21, 2012, the Company granted 50,000 restricted shares to Mr. Zhou, vesting on the 12-month anniversary date of the grant date. On December 14, 2012, the Company granted Mr. Zhou 50,000 shares of restricted stock under the 2009 Equity Incentive Plan, which will vest on the one-year anniversary date of the grant date. On February 23, 2011, we granted Mr. Pascale an option to purchase 5,000 shares of common stock with an exercise price of $2.71 per share which will vest monthly in equal installments over a 12-month period starting February 23, 2011. On February 21, 2012, we granted 10,000 restricted shares to Mr. Pascale, which will vest on the one-year anniversary date of the grant date. On March 7, 2013, Mr. Pascale was granted 10,000 shares of restricted stock under the Company's 2009 Equity Incentive Plan, which will vest on the one-year anniversary date of the grant date. On February 10, 2014, Mr. Pascale was granted 10,000 shares of restricted stock under the Company's 2009 Equity Incentive Plan, which will vest on the one-year anniversary date of the grant date. |
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| ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. |
Transactions with Related Persons
The following includes a summary of transactions since the beginning of our 2014 fiscal year, or any currently proposed transaction, in which we were or are to be a participant and the amount involved exceeded or exceeds the lesser of $120,000 or one percent of the average of our total assets at year-end for the last two completed fiscal years, and in which any related person had or will have a direct or indirect material interest (other than compensation described under Item 11, “Executive Compensation”). We believe the terms obtained or consideration that we paid or received, as applicable, in connection with the transactions described below were comparable to terms available or the amounts that would be paid or received, as applicable, in arm’s-length transactions.
| · | We sell our products to and buy raw materials from various companies which are beneficially owned or controlled by our CEO and President, Ms. Lifang Chen. The amounts charged for products to our Company by such related party are under the same pricing, terms and conditions as those charged to third parties. See Note 10 “Related Parties” to the consolidated financial statements included elsewhere in this report. The transactions relating to the sale of our products are set forth below: |
| Amount of Transaction | ||||||||||
| Related Party | Nature of Transaction | Fiscal 2014 | Fiscal 2013 | |||||||
| Ningbo Huaye Steel Processing Co., Ltd. | Sale of products by Company | $ | 32,514 | $ | 88,503 | |||||
| ChangshuBaojin Steel Processing Co., Ltd. | Sale of products by Company | 6,935,773 | 7,156,007 | |||||||
| Shanghai Huaye Steel Processing Co., Ltd. | Sale of products by Company | 168,975 | 26,592,113 | |||||||
| Shanghai Huaye Steel Group Co., Ltd. | Sale of products by Company | 94,497,315 | 138,518,128 | |||||||
| Wuxi Haide Steel Processing Co., Ltd. | Sale of products by Company | 5,576,973 | 10,202,517 | |||||||
| Zhejiang Nanye Metal Cutting & Delivery Co., Ltd. | Sale of products by Company | 17,734 | 285,757 | |||||||
| Guangzhou Qiyuan Steel Processing Co., Ltd. | Sale of products by Company | 3,329,105 | 7,591,233 | |||||||
| Tianjin Huaye Steel processing Co., Ltd. | Sale of products by Company | - | 5,836,853 | |||||||
| TanggangHuaye (Tianjin) Steel Marketing Co., Ltd. | Sale of products by Company | - | 20,370,377 | |||||||
| Tianjin Xinhao Trade Co., Ltd. | Sale of products by Company | 18,500,752 | - | |||||||
| Wuxi Suwu Industry Co., Ltd | Sale of products by Company | 7,952,450 | - | |||||||
| Guangzhou Xingbang Metal Industry Co., Ltd | Sale of products by Company | 5,768,806 | - | |||||||
For the years ended June 30, 2014 and 2013, purchases from related parties beneficially owned or controlled by Ms. Chen totaled $170,571,823 and $261,808,367, respectively.
| · | At June 30, 2014 and 2013, the Company had letters of credit totaling $50,760,185 and $83,081,204, respectively, 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. |
| · | During the years ended June 30, 2014 and 2013, the Company repaid $1,050,000 and nil loans from related parties. As of June 30, 2014 and 2013, the Company had loans from related parties totaling $8,182,019 and $8,182,019 respectively; and accrued interest totaling $1,252,039 and $1,961,940, respectively. The loans from related parties and accrued interest have been recorded as a reduction of advances to suppliers, related parties in the accompanying consolidated balance sheet as of June 30, 2014 and 2013. |
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| · | Some of our notes payables are guaranteed by Shanghai Huaye and its affiliates, as disclosed under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources.” We did not pay any stated or unstated consideration to Shanghai Huaye or its affiliates for their guarantees of our note payables. |
| · | On August 6, 2004, our subsidiary Ningbo Zhehua entered into a lease agreement with Ningbo Huaye Steel Processing Co., Ltd., a subsidiary of Shanghai Huaye, pursuant to which Ningbo Zhehua leased a factory building located at the Ningbo Camel Machinery & Electronics Industrial Park. The lease agreement has a term of 10 years and expires on December 31, 2014.We expect that the lease will be renewed annually after the initial term expires. |
Except as set forth in our discussion above, none of our directors, director nominees or executive officers has been involved in any transactions with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed pursuant to the rules and regulations of the SEC.
Promoters and Certain Control Persons
We did not have any promoters at any time during the past five fiscal years.
Parents of the Company
Total Raise Investments Ltd., an entity owned and controlled by Ms. Lifang Chen, our Chairperson, currently owns approximately 72.8% of our common stock.
Director Independence
Messrs. Gerard Pascale, Guoyou Shao, and Xinchuang Li each serves on our board of directors as an “independent director” as defined by Rule 5605(a) (2) of the NASDAQ Listing Rules.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
Independent Registered Public Accounting Firm’s Fees
The following is a summary of the fees billed to the Company by its independent registered public accounting firms for professional services rendered for the fiscal years ended June 30, 2014 and 2013:
(in thousands of U.S. dollars)
| June 30, 2014 | June 30, 2013 | |||||||
| Audit fees(1) | $ | 454.1 | $ | 425.6 | ||||
| Audit-related fees(2) | - | 8.4 | ||||||
| Tax fees | - | - | ||||||
| All other fees | - | - | ||||||
| Total | 454.1 | 434.0 | ||||||
| (1) | Consists of fees billed for the audit of our annual financial statements, review of financial statements included in our Quarterly Reports on Form 10-Q and services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements. |
| (2) | Consists of assurance and related services that are reasonably related to the performance of the audit and reviews of our financial statements and are not included in “audit fees” in this table. The services provided by our accountants within this category consisted of advice relating to SEC matters and employee benefit matters. |
Pre-Approval Policies and Procedures
Under the Sarbanes-Oxley Act of 2002, all audit and permissible non-audit services performed by our auditors must be approved in advance by our Board to assure that such services do not impair the auditors’ independence from us. In accordance with its policies and procedures, our Board pre-approved the audit and permissible non-audit services performed by our principal accountant for the consolidated financial statements as of and for the year ended June 30, 2014.
| 49 |
| ITEM 15. | EXHIBITS, FINANCIAL STATEMENT SCHEDULES. |
Financial Statements and Schedules
The financial statements are set forth under Item 8 of this annual report on Form 10-K. Financial statement schedules have been omitted since they are either not required, not applicable, or the information is otherwise included.
Exhibit List
The list of exhibits in the Exhibit Index to this Report is incorporated herein by reference.
| 50 |
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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: December 15, 2014
| SUTOR TECHNOLOGY GROUP LIMITED | ||
| By: | /s/Lifang Chen | |
| Lifang Chen | ||
| Chief Executive Officer | ||
| By: | /s/ Naijiang Zhou | |
| Naijiang Zhou | ||
| Chief Financial Officer | ||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| Signature | Title | Date | ||
| /s/ Lifang Chen | Chairperson, Chief Executive Officer | December 15, 2014 | ||
| Lifang Chen | (Principal Executive Officer) | |||
| /s/ Naijiang Zhou | Director, Chief Financial Officer | December 15, 2014 | ||
| Naijiang Zhou | (Principal Financial and Accounting Officer) | |||
| /s/ Gerard Pascale | Director | December 15, 2014 | ||
| Gerard Pascale | ||||
| /s/ Guoyou Shao | Director | December 15, 2014 | ||
| Guoyou Shao | ||||
| /s/ Xinchuang Li | Director | December 15, 2014 | ||
| Xinchuang Li |
| 51 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Sutor Technology Group Limited and subsidiaries
We have audited the accompanying consolidated balance sheets of Sutor Technology Group Limited and subsidiaries (the “Company”) as of June 30, 2014 and 2013, and the related consolidated statements of operations and comprehensive income, stockholders’ equity, and cash flows for each of the two years in the period ended June 30, 2014. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sutor Technology Group Limited and subsidiaries as of June 30, 2014 and 2013, and the results of their operations and their cash flows for each of the two years in the period ended June 30, 2014, in conformity with accounting principles generally accepted in the United States of America.
/s/ BDO China Shu Lun Pan Certified Public Accountants LLP
Beijing, China
December 15, 2014
| F-1 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
| June 30, | June 30, | |||||||
| 2014 | 2013 | |||||||
| ASSETS | ||||||||
| Current Assets: | ||||||||
| Cash and cash equivalents | $ | 12,178,225 | $ | 3,601,385 | ||||
| Restricted cash | 60,860,255 | 108,825,425 | ||||||
| Short-term investments | 3,248,652 | - | ||||||
| Trade accounts receivable, unrelated parties, net of allowance for doubtful accounts of $1,368,723 and $623,742, respectively | 6,331,702 | 7,331,291 | ||||||
| Trade accounts receivable, related parties | 16,149,269 | - | ||||||
| Notes receivables | 194,919 | 19,835,677 | ||||||
| Other receivables and prepayments, unrelated parties, net of allowance for doubtful accounts of $255,628 and $248,128, respectively | 1,875,785 | 3,446,187 | ||||||
| Other receivables and prepayments, related parties | 405,558 | - | ||||||
| Advances to suppliers, unrelated parties, net of allowance for doubtful accounts of $527,673 and $796,026, respectively | 8,645,751 | 43,175,047 | ||||||
| Advances to suppliers, related parties | 286,085,768 | 251,900,527 | ||||||
| Inventories, net | 78,277,682 | 52,377,135 | ||||||
| Current deferred tax assets | 1,507,840 | 952,417 | ||||||
| Total Current Assets | 475,761,406 | 491,445,091 | ||||||
| Non-current Assets: | ||||||||
| Advances for purchase of long term assets | 85,241 | 17,085,958 | ||||||
| Property, plant and equipment, net | 87,121,382 | 71,508,912 | ||||||
| Intangible assets, net | 3,568,855 | 3,074,372 | ||||||
| Long-term investments | 1,814,734 | 6,686,539 | ||||||
| Total Non-current Assets | 92,590,212 | 98,355,781 | ||||||
| TOTAL ASSETS | $ | 568,351,618 | $ | 589,800,872 | ||||
| F-2 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(CONTINUED)
| June 30, | June 30, | |||||||
| 2014 | 2013 | |||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
| Current Liabilities: | ||||||||
| Short-term loans | $ | 139,223,123 | $ | 138,968,845 | ||||
| Long-term loans, current portion | - | 7,418,003 | ||||||
| Accounts payable, unrelated parties | 5,843,599 | 9,645,713 | ||||||
| Notes payable | 136,274,446 | 178,917,942 | ||||||
| Other payables and accrued expenses, unrelated parties | 4,613,201 | 7,291,220 | ||||||
| Other payables and accrued expenses, related parties | 3,110,196 | - | ||||||
| Advances from customers, unrelated parties | 7,917,111 | 11,008,550 | ||||||
| Advances from customers, related parties | 15,114,353 | - | ||||||
| Warrant liabilities | 866 | 144,535 | ||||||
| Total Current Liabilities | 312,096,895 | 353,394,808 | ||||||
| Non-Current Liabilities | ||||||||
| Long-term loans, unrelated parties | 2,859,995 | 1,180,877 | ||||||
| Long-term loans, related parties | 8,182,018 | - | ||||||
| Total Non-current Liabilities | 11,042,013 | 1,180,877 | ||||||
| Total Liabilities | 323,138,908 | 354,575,685 | ||||||
| Commitments and Contingencies (Note 15) | ||||||||
| Stockholders' Equity | ||||||||
| Undesignated preferred stock - $0.001 par value; 1,000,000 shares authorized; nil shares outstanding | - | - | ||||||
| Common stock - $0.001 par value; authorized: 500,000,000 shares as of June 30, 2014 and 2013; issued: 42,252,267 shares and 40,965,602 shares as of June 30, 2014 and 2013, respectively | 42,252 | 40,965 | ||||||
| Additional paid-in capital | 43,652,089 | 41,793,142 | ||||||
| Statutory reserves | 22,725,841 | 20,426,971 | ||||||
| Retained earnings | 137,081,594 | 132,311,592 | ||||||
| Accumulated other comprehensive income | 42,362,443 | 41,304,026 | ||||||
| Less: Treasury stock, at cost, 590,838 as of June 30, 2014 and 2013 | (651,509 | ) | (651,509 | ) | ||||
| Total Stockholders' Equity | 245,212,710 | 235,225,187 | ||||||
| TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY | $ | 568,351,618 | $ | 589,800,872 | ||||
The accompanying notes are an integral part of the consolidated financial statements
| F-3 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
| For The Year Ended | ||||||||
| June 30 | ||||||||
| 2014 | 2013 | |||||||
| Revenue from unrelated parties | $ | 262,635,057 | $ | 395,433,973 | ||||
| Revenue from related parties | 142,780,398 | 216,641,488 | ||||||
| Total Revenue | 405,415,455 | 612,075,461 | ||||||
| Cost of Revenue | (371,768,467 | ) | (567,139,939 | ) | ||||
| Gross Profit | 33,646,988 | 44,935,522 | ||||||
| Operating Expenses: | ||||||||
| Selling expenses | (4,993,368 | ) | (8,266,533 | ) | ||||
| General and administrative expenses | (11,491,805 | ) | (10,516,116 | ) | ||||
| Total Operating Expenses | (16,485,173 | ) | (18,782,649 | ) | ||||
| Income from Operations | 17,161,815 | 26,152,873 | ||||||
| Other Incomes/(Expenses): | ||||||||
| Interest income | 3,263,566 | 3,414,416 | ||||||
| Interest expense | (10,113,479 | ) | (10,209,681 | ) | ||||
| Changes in fair value of warrant liabilities | 143,669 | (97,131 | ) | |||||
| Income from equity method investments | 274,225 | 370,814 | ||||||
| Other income | 139,624 | 457,735 | ||||||
| Other expense | (784,597 | ) | (460,412 | ) | ||||
| Total Other Expenses | (7,076,992 | ) | (6,524,259 | ) | ||||
| Income Before Taxes | 10,084,823 | 19,628,614 | ||||||
| Income tax expense | (3,015,951 | ) | (2,723,150 | ) | ||||
| Net Income | $ | 7,068,872 | $ | 16,905,464 | ||||
| Other Comprehensive Income: | ||||||||
| Foreign currency translation adjustment | 1,058,417 | 5,681,785 | ||||||
| Comprehensive Income | 8,127,289 | 22,587,249 | ||||||
| Basic Earnings per Share | $ | 0.17 | $ | 0.42 | ||||
| Diluted Earnings per Share | $ | 0.17 | $ | 0.42 | ||||
| Basic Weighted Shares Outstanding | 41,517,840 | 40,251,218 | ||||||
| Diluted Weighted Shares Outstanding | 41,517,840 | 40,251,218 | ||||||
The accompanying notes are an integral part of the consolidated financial statements
| F-4 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
| Accumulated | ||||||||||||||||||||||||||||||||
| Common Stock | Additional Paid-in | Statutory | Retained | Other Comprehensive | Treasury | |||||||||||||||||||||||||||
| Number | Amount | Capital | Reserves | Earnings | Income | Stock | Total | |||||||||||||||||||||||||
| Balance as of June 30, 2012 | 40,805,602 | $ | 40,805 | $ | 41,344,306 | $ | 18,100,361 | $ | 117,732,738 | $ | 35,622,241 | $ | (607,668 | ) | $ | 212,232,783 | ||||||||||||||||
| Deemed contribution from stockholders in connection with the disposal of Ningbo Taixiang Investment Co., Ltd. | - | - | 119,420 | - | - | - | - | 119,420 | ||||||||||||||||||||||||
| Stock-based compensation | 160,000 | 160 | 329,416 | - | - | - | 329,576 | |||||||||||||||||||||||||
| Provision of statutory reserves | - | - | - | 2,326,610 | (2,326,610 | ) | - | - | - | |||||||||||||||||||||||
| Net income for the year | - | - | - | - | 16,905,464 | - | - | 16,905,464 | ||||||||||||||||||||||||
| Foreign currency translation adjustment | - | - | - | - | - | 5,681,785 | - | 5,681,785 | ||||||||||||||||||||||||
| Repurchase of common stock | - | - | - | - | - | - | (43,841 | ) | (43,841 | ) | ||||||||||||||||||||||
| Balance as of June 30, 2013 | 40,965,602 | $ | 40,965 | $ | 41,793,142 | $ | 20,426,971 | $ | 132,311,592 | $ | 41,304,026 | $ | (651,509 | ) | $ | 235,225,187 | ||||||||||||||||
| Issuance of common stock | 1,041,665 | 1,042 | 1,498,958 | - | - | - | - | 1,500,000 | ||||||||||||||||||||||||
| Stock-based compensation | 245,000 | 245 | 359,989 | - | - | - | - | 360,234 | ||||||||||||||||||||||||
| Provision of statutory reserves | - | - | - | 2,298,870 | (2,298,870 | ) | - | - | - | |||||||||||||||||||||||
| Net income for the year | - | - | - | - | 7,068,872 | - | - | 7,068,872 | ||||||||||||||||||||||||
| Foreign currency translation adjustment | - | - | - | - | 1,058,417 | - | 1,058,417 | |||||||||||||||||||||||||
| Balance as of June 30, 2014 | 42,252,267 | $ | 42,252 | $ | 43,652,089 | $ | 22,725,841 | $ | 137,081,594 | $ | 42,362,443 | $ | (651,509 | ) | $ | 245,212,710 | ||||||||||||||||
The accompanying notes are an integral part of the consolidated financial statements
| F-5 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
| For The Year Ended | ||||||||
| June 30 | ||||||||
| 2014 | 2013 | |||||||
| Cash Flows from Operating Activities: | ||||||||
| Net income | $ | 7,068,872 | $ | 16,905,464 | ||||
| Adjustments to reconcile net income to net cash provided by/(used in) operating activities | ||||||||
| Depreciation and amortization | 9,068,355 | 8,868,707 | ||||||
| Provision/(reversal) for doubtful accounts | 478,682 | (392,969 | ) | |||||
| Write downs of inventories | - | 141,173 | ||||||
| Stock-based compensation | 496,292 | 193,518 | ||||||
| Foreign currency exchange gain | (47,909 | ) | (454,657 | ) | ||||
| (Gain)/loss on disposal of property, plant and equipment | (11,062 | ) | 16,240 | |||||
| Interest income from short-term investments carried at amortized cost | - | (31,059 | ) | |||||
| Income from equity method investments | (274,225 | ) | (370,814 | ) | ||||
| Deferred income taxes | (552,796 | ) | (223,911 | ) | ||||
| Changes in fair value of warrant liabilities | (143,669 | ) | 97,131 | |||||
| Changes in current assets and liabilities: | ||||||||
| Restricted cash | 27,002,074 | (20,674,295 | ) | |||||
| Trade accounts receivable, unrelated parties | 286,190 | 544,243 | ||||||
| Trade accounts receivable, related parties | (16,182,388 | ) | - | |||||
| Notes receivable | 19,759,493 | (2,514,588 | ) | |||||
| Other receivables and prepayments, unrelated parties | 1,443,844 | 1,150,326 | ||||||
| Other receivables and prepayments, related parties | (406,390 | ) | - | |||||
| Advances to suppliers, unrelated parties | 35,042,929 | (15,318,614 | ) | |||||
| Advances to suppliers, related parties | (33,197,638 | ) | (54,965,689 | ) | ||||
| Inventories | (25,116,596 | ) | (982,823 | ) | ||||
| Accounts payable, unrelated parties | (3,740,716 | ) | (4,385,361 | ) | ||||
| Notes payable | (43,438,610 | ) | 50,723,310 | |||||
| Other payables and accrued expenses, unrelated parties | (2,709,446 | ) | (1,668,531 | ) | ||||
| Other payables and accrued expenses, related parties | 3,113,187 | - | ||||||
| Advances from customers, unrelated parties | (3,140,092 | ) | 2,874,317 | |||||
| Advances from customers, related parties | 15,145,350 | - | ||||||
| Net Cash Used In Operating Activities | (10,056,269 | ) | (20,468,882 | ) | ||||
| Cash Flows from Investing Activities: | ||||||||
| Purchase of property, plant and equipment | (7,750,475 | ) | (5,310,774 | ) | ||||
| Proceeds from disposal of property, plant and equipment | 411,448 | 889,743 | ||||||
| Purchase of intangible assets | (567,444 | ) | (3,565,706 | ) | ||||
| Payment for long-term investments | - | (6,213,456 | ) | |||||
| Proceeds from disposal of long-term investments | 4,557,440 | - | ||||||
| Payments for short-term investments | (3,255,314 | ) | - | |||||
| Disposal of subsidiary, net of cash disposed of $27,401 and nil, respectively | - | (27,401 | ) | |||||
| Proceeds from sale of short-term investments | - | 4,909,220 | ||||||
| Net Cash Used In Investing Activities | (6,604,345 | ) | (9,318,374 | ) | ||||
| Cash Flows from Financing Activities: | ||||||||
| Proceeds from loans | 238,160,540 | 117,603,938 | ||||||
| Payments of loans | (235,852,667 | ) | (119,567,659 | ) | ||||
| Proceeds from issuance of common stock | 1,500,000 | |||||||
| Changes in restricted cash | 21,491,892 | 25,763,889 | ||||||
| Payments on repurchase of common stock | - | (43,841 | ) | |||||
| Net Cash Provided By Financing Activities | 25,299,765 | 23,756,327 | ||||||
| Effect of Exchange Rate Changes on Cash | (62,311 | ) | 101,783 | |||||
| F-6 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
| Net Change in Cash and Cash Equivalents | 8,576,840 | (5,929,146 | ) | |||||
| Cash and Cash Equivalents at Beginning of Year | 3,601,385 | 9,530,531 | ||||||
| Cash and Cash Equivalents at End of Year | $ | 12,178,225 | $ | 3,601,385 | ||||
| Supplemental Non-Cash Information: | ||||||||
| Offset of notes payable to related parties against receivable from related parties | $ | - | $ | 10,791,134 | ||||
| Accounts payable for purchase of long-term assets | (107,346 | ) | (1,244,579 | ) | ||||
| Advances for purchase of long-term assets | 17,103,162 | (1,733,684 | ) | |||||
| Supplemental Cash Flow Information: | ||||||||
| Cash paid during the year for interest expense | $ | (11,484,801 | ) | $ | (8,670,207 | ) | ||
| Cash paid during the year for income tax | $ | (5,113,782 | ) | $ | (2,595,402 | ) |
The accompanying notes are an integral part of the consolidated financial statements
| F-7 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND NATURE OF OPERATIONS
Sutor Technology Group Limited (“Sutor”) was incorporated on May 1, 1997 in the State of Nevada under the name of Bronze Marketing, Inc. and changed the name to Sutor Technology Group Limited effective March 6, 2007. Its principal activity is investment holding. The principal activities of its subsidiaries are described in the table below. Sutor together with its subsidiaries listed below are referred to as the “Company” hereinafter.
As of June 30, 2014, Sutor’s subsidiaries included the following entities:
| Name of subsidiary or affiliate | Date of incorporation/ acquisition | Place of incorporation | Percentage of shareholding | Principal activities | ||||||
| Sutor Steel Technology Co., Ltd. (“Sutor BVI”) | August 15, 2006 | British Virgin Islands | 100 | % | Investment holding | |||||
| Changshu Huaye Steel Strip Co., Ltd. (“Changshu Huaye”) | January 17, 2003 | PRC | 100 | % | Manufacture of hot-dip galvanized steel (“HDG”) and pre-painted galvanized steel (“PPGI”) | |||||
| Jiangsu Cold-Rolled Technology Co., Ltd. (“Jiangsu Cold-Rolled”) | August 28, 2003 | PRC | 100 | % | Manufacture of cold-rolled steel, acid pickled steel and hot-dip galvanized steel | |||||
| Ningbo Zhehua Heavy Steel Pipe Manufacturing Co., Ltd. (“Ningbo Zhehua”) | April 5, 2004 | PRC | 100 | % | Manufacture of heavy steel pipe | |||||
| Sutor Technology Co., Ltd. (“Sutor Technology”) | February 24, 2010 | PRC | 100 | % | Trading of steel products | |||||
In October 2012, Ningbo Zhehua established a wholly owned subsidiary, Ningbo Taixiang Investment Co., Ltd (“Ningbo Taixiang”). The principle activity of Ningbo Taixiang is investment. Ningbo Taixiang has not incurred any operations since its establishment. In June 2013, the Company disposed 100% equity interest in Ningbo Taixiang to its related party (Note 10). The disposal of Ningbo Taixiang was accounted for as a transaction between entities under common control. Therefore the transaction was recorded at carryover basis and any difference between the carrying value and the amount received are recorded in stockholder’s equity.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - The consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States (“US GAAP”).
Principles of Consolidation – The accompanying consolidated financial statements include the accounts and transactions of Sutor and its subsidiaries for all years presented. All significant intercompany balances and transactions have been eliminated in consolidation.
| F-8 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES - continued
Functional Currency and Translating Financial Statements - Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transaction. Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency using the applicable exchange rates at the balance sheet dates. The resulting exchange differences are recorded in the condensed consolidated statement of operations and comprehensive income.
The reporting currency of the Company is the United States Dollars (“USD”). Sutor and Sutor BVI maintain their books and records in USD, their functional currency. The PRC subsidiaries maintain their books and records in its local currency, the Renminbi Yuan (“RMB”), which is their functional currencies as being the primary currency of the economic environment in which these entities operate. In general, for consolidation purposes, assets and liabilities of its subsidiaries whose functional currency is not the USD are translated into USD, in accordance with ASC Topic 830-30, “Translation of Financial Statement”, using the exchange rate on the balance sheet date. Revenues and expenses are translated at average rates prevailing during the period. The gains and losses resulting from translation of financial statements of foreign subsidiaries are recorded as a separate component of accumulated other comprehensive income.
Translation of amounts from RMB into US$1 has been made at the following exchange rates for the respective years:
| June 30, 2014 | June 30, 2013 | |||||||
| Closing RMB : USD exchange rate at the year end | 6.1564 | 6.1807 | ||||||
| Average RMB : USD exchange rate for the year | 6.1438 | 6.2767 | ||||||
The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into US$ at the rates used in translation.
Accounting Estimates – The preparation of financial statements in conformity with US GAAP 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 accounts receivable, notes receivable, other receivables and prepayments, advances to suppliers, reserves for inventories, estimated useful lives of property, plant and equipment, valuation allowance for deferred tax assets and valuation of warrant liabilities.
Cash and Cash Equivalents - Cash and cash equivalents are stated at cost, which approximates fair value, and consist of cash on hand and bank deposits, which are unrestricted as to withdrawal and use and have original maturities of less than 90 days.
Restricted Cash - Restricted cash represents amounts held by banks in escrow as security for either notes payable that have yet to be drawn down or bank loans and therefore are not available for the Company’s use.
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. There was no short-term investment as of June 30, 2013. As of June 30, 2014, all the short-term investments of the Company were classified as held-to-maturity.
Trade Accounts Receivable - Trade accounts receivable are carried at original invoiced amounts less an allowance for doubtful accounts.
Allowance for doubtful accounts – 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.
| F-9 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES - continued
Inventories - Inventories are stated at the lower of cost or market. The cost of inventories is determined using first-in-first-out method, and includes expenditure incurred in acquiring the inventories and bringing them to their existing location and condition. In case of finished goods and work in progress, cost includes an appropriate share of production overhead based on normal operating capacity. The Company regularly reviews the cost of inventories against their estimated fair market value and records a lower of cost or market write-down for inventories that have cost in excess of estimated market value.
Property, Plant and Equipment – Property, plant and equipment are stated at cost and are depreciated using the straight-line method over the estimated useful lives of the assets as follows:
| Life | ||
| Buildings and plant | 20 years | |
| Machinery | 10 years | |
| Office and other equipment | 10 years | |
| Vehicles | 5 years |
Repair and maintenance costs are charged to expense as incurred, whereas the costs of betterments that extend the useful life of property, plant and equipment are capitalized as additions to the related assets. Retirements, sale and disposals of assets are recorded by removing the cost and accumulated depreciation with any resulting gain or loss reflected in the consolidated statements of operations.
Property, plant and equipment that are purchased or constructed which require a period of time before the assets are ready for their intended use are accounted for as construction-in-progress. Construction-in-progress is recorded at acquisition cost, including installation costs. Construction-in-progress is transferred to specific property, plant and equipment accounts and commences depreciation when these assets are ready for their intended use.
Interest costs are capitalized if they are incurred during the acquisition, construction or production of a qualifying asset and such costs could have been avoided if expenditures for these assets have not been made. Capitalization of interest costs commences when the activities to prepare the asset are in progress and expenditures and borrowing costs are incurred. Interest costs are capitalized until the assets are ready for their intended use.
Foreign invested enterprises and foreign enterprises running business in the PRC are generally able to receive a refund of the value-added tax paid on property, plant and equipment purchased and manufactured within the PRC. The Company recognizes refunds of value-added tax as a reduction of property, plant and equipment when the refunds are collected.
Intangible Assets – Intangible assets are land use rights. Acquisition costs of land use rights are capitalized and amortized using the straight-line method over the land lease term of 50 years.
Impairment of Long-lived Assets - The Company evaluates its long-lived assets or asset group, including intangible assets with finite lives, for impairment whenever events or changes in circumstances (such as a significant adverse change to market conditions that will impact the future use of the assets) indicate that the carrying amount of an asset or a group of long-lived assets may not be recoverable. When these events occur, the Company evaluates for impairment by comparing the carrying amount of the assets to future undiscounted net cash flows expected to result from the use of the assets and their eventual disposition. If the sum of the expected undiscounted cash flow is less than the carrying amount of the assets, the Company would recognize an impairment loss based on the excess of the carrying amount of the asset group over its fair value. Fair value is generally determined by discounting the cash flows expected to be generated by the assets, when the market prices are not readily available for the long-lived assets. No impairment charge was recognized for each of the year ended June 30, 2014 and 2013.
| F-10 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES - continued
Equity method investments – Affiliated company (partially owned affiliate) is an entity over which the Company has significant influence, but which it does not control. Investments in affiliated company (“Investee”) are accounted for as equity method investments. Under equity method, the Company’s share of the post-acquisition profits or losses of Investee is recognized in the consolidated statements of operations. Unrealized gains on transactions between the Company and its Investee are eliminated to the extent of the Company’s interest in Investee; unrealized losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. When the Company’s share of losses in Investee equals or exceeds its interest in the Investee, the Company does not recognize further losses, unless the Company has incurred obligations or made payments on behalf of the Investee.
The Company continually reviews its equity method investments to determine whether a decline in fair value below the carrying value is other than temporary. The primary factors the Company considers in its determination are the length of time that the fair value of the investment is below the Company’s carrying value and the financial condition, operating performance and near term prospects of Investee. In addition, the Company considers the reason for the decline in fair value, including general market conditions, industry specific or Investee specific reasons, changes in valuation subsequent to the balance sheet date and the Company’s intent and ability to hold the investments for a period of time sufficient to allow for a recovery in fair value. If the decline in fair value is deemed to be other than temporary, the carrying value of the investments is written down to fair value. There was no impairment for equity method investments as of June 30, 2014.
Fair Values of Financial Instruments - The Company adopted ASC 820 “Fair value measurements and disclosures”. This guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). The guidance outlines a valuation framework and creates a fair value hierarchy in order to increase the consistency and comparability of fair value measurements and the related disclosures. Under US GAAP, certain assets and liabilities must be measured at fair value, and the guidance details the disclosures that are required for items measured at fair value.
The three levels are defined as follows: Level 1 – Valuations based on quoted prices in active markets for identical assets or liabilities. Level 2 – Valuations based other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 – Valuations based on inputs that are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability.
Financial instruments of the Company primarily comprise of cash and cash equivalents, restricted cash, short-term investments, trade accounts receivable, other receivables, loans, accounts payable, other payables and warrant liabilities. As of June 30, 2014 and 2013, carrying values of cash and cash equivalents, restricted cash, short-term investments, trade accounts receivable, other receivables, short-term loans, current portion of long-term loans, accounts payable and other payables approximated their fair values because of their generally short maturities. The estimated fair value of long-term loan approximated the carrying amount as of June 30, 2014 and 2013 as they bear floating interest rate and the market rate approximate the floating interest rates at the respective balance sheet dates. Warrants are recorded as liabilities at their estimated fair value at the date of issuance, with subsequent changes in estimated fair value recorded in changes in fair value of warrant liabilities on the Company’s statement of operations in each subsequent period. The warrants were measured at estimated fair value using the Black Scholes valuation model, which was based, in part, upon inputs for which there is little or no observable market data, requiring the Company to develop its own assumptions. Inherent in this model were assumptions related to expected stock-price volatility, expected life, risk free interest rate and dividend yield. We estimated the volatility of our common stock at the date of issuance, and at each subsequent reporting period, based on historical volatility that matches the expected remaining life of the warrants. The risk-free interest rate was based on the U.S. Treasury zero-coupon yield curve on the grant date for a maturity similar to the expected remaining life of the warrants. The expected life of the warrants was assumed to be equivalent to their remaining contractual term. The dividend rate was based on our historical rate, which we anticipated to remain at zero. The assumptions used in calculating the estimated fair value of the warrants represent our best estimates. However these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and different assumptions were used, the warrant liability and the changes in estimated fair value could be materially different.
| F-11 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES - continued
Liabilities measured at fair value on a recurring basis are summarized below:
| Balance as of June 30, 2014 | ||||||||||||||||
| Fair Value Measurements | ||||||||||||||||
| Carrying Value | Level 1 | Level 2 | Level 3 | |||||||||||||
| Warrant liabilities | $ | 866 | $ | - | $ | - | $ | 866 | ||||||||
| Balance as of June 30, 2013 | ||||||||||||||||
| Fair Value Measurements | ||||||||||||||||
| Carrying Value | Level 1 | Level 2 | Level 3 | |||||||||||||
| Warrant liabilities | $ | 144,535 | $ | - | $ | - | $ | 144,535 | ||||||||
For a summary of changes in warrant liabilities for the year ended June 30, 2014 and 2013, please see Note 12.
Statutory Reserves - In accordance with the PRC Regulations on Enterprises with Foreign Investment, an enterprise established in the PRC with foreign investment is required to provide for certain statutory reserves, namely (i) General Reserve Fund, (ii) Enterprise Expansion Fund and (iii) Staff Welfare and Bonus Fund, which are appropriated from net profit as reported in the enterprise’s PRC statutory accounts. A wholly owned foreign enterprise (“WOFE”) is required to allocate at least 10% of its annual after-tax profit to the General Reserve Fund until the balance of such fund has reached 50% of its respective registered capital. A non-wholly owned foreign invested enterprise is permitted to provide for the above allocation at the discretion of its board of directors. Appropriations to the Enterprise Expansion Fund and Staff Welfare and Bonus Fund are at the discretion of the board of directors for all foreign invested enterprises. The aforementioned reserves can only be used for specific purposes and are not distributable as cash dividends.
Accumulated Other Comprehensive Income - Accumulated other comprehensive income presented in the accompanying consolidated financial statements consists of foreign currency translation adjustments.
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 related parties, who in turn sell the product to various other unrelated party customers. The price, terms and conditions on the sales to related parties are the same as those to unrelated parties. Revenue is considered realized or realizable and earned when the related parties ship the products to unrelated party customers. A fee of 0.5% of the sales is paid to the related parties for handling the product. Handling fees were $241,624 and $109,167 for the year ended June 30, 2014 and 2013 respectively and have been recorded in selling expenses in the statement of operations.
Cost of Revenue - Cost of products sold includes wages, materials, handling charges, and other expenses associated with the manufacture and delivery of product.
Shipping and Handling Costs - Shipping and handling costs are billed to customers and recorded as revenue, and the associated costs are included in cost of revenues.
| F-12 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES - continued
Employee Benefits - The full-time employees of the Company’s PRC subsidiaries are entitled to staff welfare benefits including medical care, housing fund, pension benefits and unemployment insurance, which are governmental mandated defined contribution plans. These entities are required to accrue for these benefits based on certain percentages of the employees’ respective salaries, subject to certain ceilings, in accordance with the relevant PRC regulations, and make cash contributions to the state-sponsored plans out of the amounts accrued.
Stock-based Compensation – Share options granted to employees are accounted for under ASC 718, “Compensation – Stock Compensation”, which requires that share-based awards granted to employees be measured based on the grant date fair value and recognized as compensation expense over the requisite service period (which is generally the vesting period) in the consolidated statements of operations. The Company has elected to recognize compensation expense using the straight-line method for all share options granted with service conditions that have a graded vesting schedule.
ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from initial estimates. Forfeiture rate is estimated based on historical and future expectation of employee turnover rate and are adjusted to reflect future change in circumstances and facts, if any. Share-based compensation expense is recorded net of estimated forfeitures such that expense was recorded only for those share-based awards that are expected to vest. To the extent the Company revises this estimate in the future, the share-based payments could be materially impacted in the period of revision, as well as in following periods.
Transactions in which goods or services are received in exchange for equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. The measurement date of the fair value of the equity instrument issued is the date on the earlier of: (1) the performance commitment date, or (2) the date the services required under the arrangement have been completed.
Income Taxes – The Company accounts for income taxes using the liability method whereby deferred income taxes are recognized for the tax consequences of temporary differences by applying statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of certain assets and liabilities, changes in deferred tax assets and liabilities, if any, include the impact of any tax rate changes enacted during the year. ASC Topic 350, “Accounting for Income Taxes,” requires that deferred tax assets be reduced by a valuation allowance if, based on all available evidence, it is considered more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. Additionally, the Company accounts for uncertainty in income taxes using a two-step approach to recognize and measure uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. The Company classifies the liability for unrecognized tax benefits as current to the extent that the Company anticipates payment (or receipt) of cash within one year. Interest and penalties related to uncertain tax positions are recognized in the provision for income taxes. The Company did not have any uncertain tax positions for the year ended June 30, 2014 and 2013.
If the amount of the Company’s taxable income or income tax liability is a determinant of the amount of a grant, the grant is treated as a reduction of the income tax provision in the year the grant is realized.
Earnings Per Share – Earnings per share are calculated in accordance with ASC subtopic 260-10 (“ASC 260-10”), Earnings Per Share: Overall. Basic earnings per share is computed by dividing net income attributable to holders of ordinary shares by the weighted average number of ordinary shares outstanding during the period. Diluted earnings per share are computed using the weighted average number of shares and dilutive equivalent shares outstanding during the period. Dilutive equivalent shares consist of ordinary shares issuable upon the exercise of stock options granted, with an exercise price less than the average fair market value for such period, using the treasury stock method. Dilutive equivalent shares are excluded from the computation of diluted earnings per share if their effects would be anti-dilutive.
| F-13 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES – continued
Share Repurchase Program – Pursuant to a Board of Directors’ resolution on August 29, 2011, the Company’s management is authorized 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. The Company accounted for those shares repurchase as Treasury Stock at cost in accordance to ASC Subtopic 505-30 (“ASC 505-30”), Treasury Stock and is shown separately in the stockholders’ equity as the Company has not yet decided on the ultimate disposition of those repurchased stocks. The treasury stock may be retired or used by the Company to finance or execute acquisitions or other arrangements. As of June 30, 2014 and 2013, the Company had repurchased 590,838 shares of its common stock at a total cost of $651,509.
Treasury stock reissuance – Shares of common stock repurchased by the Company that are not retired are recorded at cost as treasury stock and result in a reduction of stockholders' equity in the Company's consolidated balance sheets. From time to time, treasury shares may be reissued as part of the Company's stock-based compensation programs. When shares are reissued, the Company uses the weighted average cost method for determining cost. If the issuance price is higher than the cost, the excess of the issuance price over cost is credited to additional paid-in capital (“APIC”). If the issuance price is lower than the cost, the difference is first charged against any credit balance in APIC from treasury stock and the balance is charged to retained earnings. During the years ended June 30, 2014 and 2013, the Company did not reissue shares from treasury stock.
Recent Accounting Pronouncements – On July 18, 2013, the FASB issued ASU 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists” (Income Taxes - Topic 740). This update applies to all entities that have unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, unless otherwise provided in the update. To the extent that a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. For example, an entity should not evaluate whether the deferred tax asset has expired before the statute of limitations on the tax position or whether the deferred tax asset may be used prior to the unrecognized tax benefit being settled. The amendments in this update do not require new recurring disclosures. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The Company is currently evaluating the impact of adopting this update on its financial statements.
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2014-09 (“ASU 2014-09”), “Revenue from Contracts with Customers (Topic 606)”. ASU 2014-09 will eliminate transaction-specific and industry-specific revenue recognition guidance under current US GAAP and replace it with a principle-based approach for determining revenue recognition. ASU 2014-09 will require that companies recognize revenue based on the value of transferred goods or services as they occur in the contract. The ASU also will require additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 is effective for reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. Entities can transition to the standard either retrospectively or as a cumulative effect adjustment as of the date of adoption. The Company is currently assessing the impact the adoption of ASU 2014-09 and the effect of the standard on our ongoing financial reporting.
| F-14 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES – continued
In June 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2014-12 (“ASU 2014-12”), “Compensation—Stock Compensation (Topic 718) - Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period.” ASU 2014-12 requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in Topic 718 as it relates to awards with performance conditions that affect vesting to account for such awards. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. As indicated in the definition of vest, the stated vesting period (which includes the period in which the performance target could be achieved) may differ from the requisite service period. For all entities, the amendments in this Update are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. The effective date is the same for both public business entities and all other entities. Entities may apply the amendments in this Update either (a) prospectively to all awards granted or modified after the effective date or (b) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. If retrospective transition is adopted, the cumulative effect of applying this Update as of the beginning of the earliest annual period presented in the financial statements should be recognized as an adjustment to the opening retained earnings balance at that date. Additionally, if retrospective transition is adopted, an entity may use hindsight in measuring and recognizing the compensation cost. The Company is currently evaluating the impact of adopting this Update on its financial statements.
| F-15 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 – SHORT-TERM INVESTMENTS
Short-term investments as of June 30, 2014 consisted of the following:
| Carrying | Unrealized | Estimated | ||||||||||
| Value | Gains/(Losses) | Fair Value | ||||||||||
| Held-to-maturity securities | ||||||||||||
| - Fixed rate time deposits | $ | 3,248,652 | $ | - | $ | 3,248,652 | ||||||
The following table summarizes the movement of short-term investments for the years ended June 30, 2014 and 2013:
| For The Year Ended | ||||||||
| June 30, | ||||||||
| 2014 | 2013 | |||||||
| Balance at beginning of the year | $ | - | $ | 4,849,112 | ||||
| Payment for fixed rate time deposits | 3,255,314 | - | ||||||
| Interest income recognized during the year | - | 31,059 | ||||||
| Foreign currency translation difference | (6,662 | ) | 29,049 | |||||
| Disposal of short-term investments | - | (4,909,220 | ) | |||||
| Balance at end of the year | $ | 3,248,652 | $ | - | ||||
As of June 30, 2014, all of the Company’s short-term investments were pledged to banks to secure the loan granted to the Company (Note 9).
NOTE 4 – OTHER RECEIVABLES AND PREPAYMENTS
Other receivables and prepayments, unrelated parties as of June 30, 2014 and 2013 consisted of the following:
| June 30, | June 30, | |||||||
| 2014 | 2013 | |||||||
| Tax recoverable | $ | 10,266 | $ | - | ||||
| Prepaid expenses | - | 136,058 | ||||||
| Other receivables | 2,121,147 | 3,558,257 | ||||||
| 2,131,413 | 3,694,315 | |||||||
| Less: allowance for doubtful accounts | (255,628 | ) | (248,128 | ) | ||||
| Other receivables and prepayments, unrelated parties, net | $ | 1,875,785 | $ | 3,446,187 | ||||
NOTE 5 – INVENTORIES
Inventories consisted of the following:
| June 30, | June 30, | |||||||
| 2014 | 2013 | |||||||
| Raw materials | $ | 14,006,475 | $ | 28,844,850 | ||||
| Finished goods | 64,405,222 | 23,793,747 | ||||||
| 78,411,697 | 52,638,597 | |||||||
| Less: allowance for obsolescence | (134,015 | ) | (261,462 | ) | ||||
| Inventories, net | $ | 78,277,682 | $ | 52,377,135 | ||||
| F-16 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 – PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment as of June 30, 2014 and 2013 consisted of the following:
| June 30, | June 30, | |||||||
| 2014 | 2013 | |||||||
| Buildings and plant | $ | 47,013,051 | $ | 46,704,868 | ||||
| Machinery | 72,916,144 | 73,096,228 | ||||||
| Office and other equipment | 1,734,518 | 1,346,734 | ||||||
| Vehicles | 669,101 | 471,456 | ||||||
| 122,332,814 | 121,619,286 | |||||||
| Less: accumulated depreciation | (62,419,223 | ) | (53,682,239 | ) | ||||
| 59,913,591 | 67,937,047 | |||||||
| Construction in progress | 27,207,791 | 3,571,865 | ||||||
| Property, Plant and Equipment, net | $ | 87,121,382 | $ | 71,508,912 | ||||
As of June 30, 2014 and 2013, certain of the Company’s property, plant and equipment amounted to approximately $39 million was pledged to banks to secure the loan granted to the Company (Note 9).
Depreciation expense for the years ended June 30, 2014 and 2013 was $ 8,984,249 and $8,705,240, respectively.
NOTE 7 – INTANGIBLE ASSETS
Intangible assets as of June 30, 2014 and 2013 consisted of the following:
| June 30, | June 30, | |||||||
| 2014 | 2013 | |||||||
| Cost | $ | 4,338,269 | $ | 3,757,157 | ||||
| Less: Accumulated amortization | (769,414 | ) | (682,785 | ) | ||||
| Intangible Assets, net | $ | 3,568,855 | $ | 3,074,372 | ||||
The Company’s intangible assets represented several land use rights, which are amortized using the straight-line method over the lease term of 50 years. Amortization expense for the years ended June 30, 2014 and 2013 was $84,106 and $163,467, respectively.
As of June 30, 2014 and 2013, certain of the Company’s intangible assets amounted to approximately $2.8 million and $2.9 million, respectively, was pledged to banks to secure the loan granted to the Company (Note 9).
The following schedule sets forth the estimated amortization expense for the periods presented:
| ESTIMATED AMORTIZATION EXPENSE | ||||
| For the year ending June 30, 2015 | 86,765 | |||
| For the year ending June 30, 2016 | 86,765 | |||
| For the year ending June 30, 2017 | 86,765 | |||
| For the year ending June 30, 2018 | 86,765 | |||
| For the year ending June 30, 2019 | 86,765 | |||
| For the year ending June 30, 2020 and thereafter | 3,135,030 | |||
| Total | $ | 3,568,855 |
| F-17 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 – LONG-TERM INVESTMENTS
In August 2012, the Company together with other two unrelated companies jointly established CRM Suzhou. The Company holds 39% equity interest in CRM Suzhou with the consideration of $6.2 million in cash. The Company evaluated its interest in CRM Suzhou under relevant guidance in ASC 810 and ASC 323 pertaining to consolidation and equity method accounting, respectively. The Company determined that it does not have a controlling financial interest in the investee, but rather possesses significant influence. Accordingly, the Company has accounted for this investment under the equity method.
In 2014, the Company entered into a share transfer agreement with China Railway Materials Wuhan Company Limited (“CRM Wuhan”), CRM Suzhou’s holding company, and sold 28% of CRM Suzhou’s shares held by Jiangsu Coldrolled to CRM Wuhan for total consideration of $4.5 million in cash. The Company evaluated its interest in CRM Suzhou again after disposal under relevant guidance in ASC 810 and ASC 323 pertaining to consolidation and equity method accounting, respectively. The Company determined that it neither has a controlling financial interest in the investee nor possesses significant influence. Accordingly, the Company has accounted for this investment under the cost method after disposal. Immediately before the disposal, the carrying value of the investment in CRM Suzhou was $6.4 million as a result of the equity accounting; and immediately after the disposal, the carrying value of the investment CRM Suzhou was $1.8 million.
NOTE 9 – LOANS
Loans are as follows as of the respective balance sheet dates:
| June 30, | June 30, | |||||||
| 2014 | 2013 | |||||||
| Short-term loans | $ | 139,223,123 | $ | 138,968,845 | ||||
| Long-term loans, current portion | - | 7,418,003 | ||||||
| 139,223,123 | 146,386,848 | |||||||
| Long-term loans, non-current portion | 11,042,013 | 1,180,877 | ||||||
| Total loans | $ | 150,265,136 | $ | 147,567,725 | ||||
The short-term loans outstanding as of June 30, 2014 and June 30, 2013 bore a weighted average interest rate of 6.82% and 5.11% per annum, respectively. These loans were obtained from financial institutions and have contract terms of three months to one year.
The long-term loans outstanding as of June 30, 2014 and June 30, 2013 bore a weighted average interest rate of 4.63% and 7.10% per annum, respectively. These loans were obtained from financial institutions and one individual. Long-term loans have contract terms of one to three years.
Short-term loans as of June 30, 2014 were secured/guaranteed by the following:
| Secured/guaranteed by | ||||
| Jointly guaranteed by (i) a related party, and (ii) the Company's property, plant and equipment | $ | 75,476,159 | ||
| Guaranteed by a related party | 52,701,548 | |||
| Guaranteed by the Company's property, plant and equipment | 11,045,416 | |||
| Total short-term loans | $ | 139,223,123 | ||
Short-term loans as of June 30, 2013 were secured/guaranteed by the following:
| Secured/guaranteed by | ||||
| Jointly guaranteed by (i) a related party, and (ii) the Company's property, plant and equipment | $ | 45,464,106 | ||
| Guaranteed by a related party | 40,351,593 | |||
| Guaranteed by the Company's property, plant and equipment | 28,152,151 | |||
| Guaranteed by the Company's cash deposit | 10,000,000 | |||
| Jointly guaranteed by (i) the Company's cash deposit, (ii) the Company's notes receivable | 9,500,000 | |||
| Unsecured | 5,500,995 | |||
| Total short-term loans | $ | 138,968,845 | ||
| F-18 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 – LOANS - continued
Long-term loans, current portion as of June 30, 2013 were secured/guaranteed by the following:
| Secured/guaranteed by | ||||
| Guaranteed by the Company's property, plant and equipment | 4,558,008 | |||
| Unsecured | 2,859,995 | |||
| Total long-term loans, current portion | $ | 7,418,003 | ||
An amount of nil and $7,418,003 has been reclassified from long-term loans, non-current to long-term loans, current as of June 30, 2014 and June 30, 2013, respectively, to reflect amounts will be due and paid within 12 months.
Long-term loans, non-current portion as of June 30, 2014 were secured/guaranteed by the following:
| Secured/guaranteed by | ||||
| Unsecured | $ | 11,042,013 | ||
Long-term loans, non-current portion as of June 30, 2013 were secured/guaranteed by the following:
| Secured/guaranteed by | ||||
| Guaranteed by the Company's property, plant and equipment | $ | 1,180,877 | ||
The Company must use the loans for the purpose specified in borrowing agreements, pay interest at the interest rate described in borrowing agreements. The Company also has to repay the principal outstanding on the specified date as described in borrowing agreements. As of June 30, 2014, the asset-liability ratio of Jiangsu Coldrolled was 72% which exceeded the ratio of 65% as required by a loan agreement with a bank for the short-term bank borrowing of $1.8 million. Management believes the breach of financial covenant does not have significant impacts to this consolidated financial statements. Except this, management believes that the Company had complied with such financial covenants as of June 30, 2014, and will continue to comply with them.
NOTE 10 – RELATED PARTY TRANSACTIONS
The Company’s related parties mainly include Shanghai Huaye and its subsidiaries, which were ultimately controlled by the same party as the Company; CRM Suzhou, which is the Company’s equity investee; Tianjin Xinhao Commerce Co., Ltd, Hangzhou Xiaoshan Ruifan Industrial Co., Ltd, Guangzhou Xingbang Metal Industrial Co., Ltd. and Wuxi Suwu Industrial Co., Ltd. (collectively “Related Trading Companies”), over which the Company’s ultimate controlling party has significant influence.
Annual Related Party Activities
| For The Year Ended | ||||||||
| June 30, | ||||||||
| 2014 | 2013 | |||||||
| Sales to Shanghai Huaye and its subsidiaries | $ | 110,558,389 | $ | 216,641,488 | ||||
| Sales to Related Trading Companies | 32,222,009 | - | ||||||
| Purchases from Shanghai Huaye and its subsidiaries | 170,571,823 | 261,808,367 | ||||||
| Purchases from CRM Suzhou | 31,525,875 | 98,372,902 | ||||||
| Handling fees paid to Shanghai Huaye and its subsidiaries | 241,624 | 109,167 | ||||||
| Sales of property, plant and equipment to Shanghai Huaye and its subsidiaries | 390,760 | - | ||||||
| Disposal of Ningbo Taixiang to Shanghai Huaye and its subsidiaries | - | 4,062,751 | ||||||
| Rental fees to Shanghai Huaye and its subsidiaries | 253,395 | 152,947 | ||||||
| Interest expenses to Shanghai Huaye | 340,098 | 340,098 | ||||||
Year-End Related Party Balances
| June 30, | June 30, | |||||||
| 2014 | 2013 | |||||||
Trade accounts receivable | $ | 16,149,269 | $ | - | ||||
| Advances to suppliers | 286,085,768 | 251,900,527 | ||||||
| Other receivables | 405,558 | |||||||
| Other payables and accrued expenses | 3,110,196 | - | ||||||
| Long-term loans | 8,182,018 | - | ||||||
| F-19 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 – RELATED PARTY TRANSACTIONS - continued
The amounts charged for products to the Company by Shanghai Huaye and its subsidiaries under the same pricing, terms and conditions as those charged to third parties. Different to nonrelated party suppliers, the Company does not have to enter into a long-term contract with related party suppliers in which case is more flexible for the Company.
Receivables from, advanced purchase deposits to, loans, payables to and advanced sales deposits from Shanghai Huaye and its subsidiaries as of June 30, 2013 have been netted due to the right of offset through agreements with these related parties. Below is a summary of the gross balances before the offset. No such offset as of June 30, 2014.
| June 30, | ||||
| 2013 | ||||
| Trade accounts receivable | $ | 14,074,297 | ||
| Other receivables | 4,062,751 | |||
| Advances to suppliers | 246,016,845 | |||
| Accounts payable | (155,322 | ) | ||
| Other payables | (1,331,079 | ) | ||
| Advances from customers | (623,007 | ) | ||
| Short-term borrowings | (8,182,018 | ) | ||
| Accrued expenses | (1,961,940 | ) | ||
| Netted balance | 251,900,527 | |||
NOTE 11 – INCOME TAXES
Sutor 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.
Sutor BVI is a tax-exempt company incorporated in British Virgin Islands.
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 September 2013, Changshu Huaye was awarded the title of High-New-Tech Enterprises (“HNTE”) 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 2013, 2014 and 2015.
Income tax payable as of June 30, 2014 and 2013 were $536,219 and $3,391,728, respectively, which were presented as a component of other payables and accrued expenses in the accompanying consolidated balance sheets.
The reconciliation of tax computed by applying the statutory income tax rate applicable to PRC operations to income tax expense is as following:
| For The Year Ended | ||||||||
| June 30, | ||||||||
| 2014 | 2013 | |||||||
| Income before tax | $ | 10,084,823 | $ | 19,628,615 | ||||
| Income tax calculated at PRC statutory rate of 25% | 2,521,206 | 4,907,154 | ||||||
| Benefit of favorable rates | (625,568 | ) | (860,134 | ) | ||||
| Tax refund due to purchase of Domestic Equipment | - | (865,846 | ) | |||||
| Effect of differences in foreign tax rate | 442,495 | (2,459,965 | ) | |||||
| Changes in valuation allowance | 595,649 | 1,820,858 | ||||||
| Others | 82,169 | 181,083 | ||||||
| Total Income tax expense | $ | 3,015,951 | $ | 2,723,150 | ||||
| F-20 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 – INCOME TAXES - continued
Deferred tax assets as of June 30, 2014 and 2013 comprised of the following:
| June 30, | June 30, | |||||||
| 2014 | 2013 | |||||||
| Net tax loss carry forward | $ | 3,737,039 | $ | 2,836,510 | ||||
| Stock-based compensation | 331,064 | 162,324 | ||||||
| Allowance for doubtful trade accounts receivable | 303,627 | 137,611 | ||||||
| Allowance for doubtful other receivables | 63,253 | 54,555 | ||||||
| Allowance for doubtful advances to suppliers | 120,724 | 186,186 | ||||||
| Allowance for inventory obsolescence | 33,504 | 65,365 | ||||||
| Accrued expenses | 54,402 | - | ||||||
| Less: Valuation allowance | (3,135,773 | ) | (2,490,134 | ) | ||||
| Total Deferred tax assets | $ | 1,507,840 | $ | 952,417 | ||||
As of June 30, 2014, the Company has a tax loss for PRC enterprise income tax purposes of $4,897,735 which are available to offset future taxable income, if any, through 2019; the Company has a tax loss for United States federal income tax purposes of $6,807,890 which are available to carry back two years or offset future taxable income, if any, through 2034. The valuation allowance for 2013 and 2014 specifically relate to NOLs generated by WOFE and in foreign jurisdictions, primarily in the United States, where a tax benefit cannot be currently realized. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. The net realizable deferred tax assets relate to temporary differences from accrued expenses in a foreign jurisdiction where the Company believes it is more likely than not it has both sufficient recoverable taxes and projected future taxable income to realize the benefits of these deductible differences, net of the existing valuation allowance at June 30, 2014 and 2013. The amount of the deferred tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.
The income tax expense for the years ended June 30, 2014 and 2013 comprised of the following:
| For The Year Ended | ||||||||
| June 30, | ||||||||
| 2014 | 2013 | |||||||
| Current | $ | 3,568,747 | $ | 2,947,061 | ||||
| Deferred | (552,796 | ) | (223,911 | ) | ||||
| Total Income tax expense | $ | 3,015,951 | $ | 2,723,150 | ||||
NOTE 12 – WARRANTS
On March 10, 2010, The Company issued warrants to purchase up to 685,000 shares of common stock in connection with the Company’s registered direct offering. The warrants are exercisable for a five year period, 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 values of the warrants at the issuance date and the end of each reporting period were calculated using Black-Scholes pricing model and based on the following assumptions:
| June 30, 2014 | June 30, 2013 | |||||||
| Year end date | Year end date | |||||||
| Warrants indexed to common stock | 685,000 | 685,000 | ||||||
| Trading market price | $ | 1.00 | $ | 1.52 | ||||
| Exercise price | $ | 3.76 | $ | 3.76 | ||||
| Estimated Term (Year) | 0.67 | 1.67 | ||||||
| Expected volatility | 60.57 | % | 75.40 | % | ||||
| Risk-free rate | 0.11 | % | 0.36 | % | ||||
| Dividend yield rates | 0.00 | % | 0.00 | % | ||||
| Fair value of warrants | $ | 866 | $ | 144,535 | ||||
The Warrants were recorded as liabilities at their estimated fair value at the date of issuance, with subsequent changes in estimated fair value recorded in changes in fair value of warrant liabilities on the Company’s consolidated statement of operations in each subsequent period.
| F-21 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 – WARRANTS - continued
The following table summarizes the movement of warrant liabilities for the years ended June 30, 2014 and 2013:
| For The Year Ended | ||||||||
| June 30, | ||||||||
| 2014 | 2013 | |||||||
| Balance at beginning of the year | $ | 144,535 | $ | 47,404 | ||||
| Changes in fair value | (143,669 | ) | 97,131 | |||||
| Balance at end of the year | $ | 866 | $ | 144,535 | ||||
NOTE 13 – STOCK-BASED COMPENSATION
2009 Equity Incentive Plan
In April 2009, the Company authorized an equity incentive plan (“2009 Equity Incentive Plan”) that provides for issuance of up to 2,000,000 shares of the Company’s common stock. Under the 2009 Equity Incentive Plan, the management may, at their discretion, grant any employees and directors of the Company, and consultants (i) options to subscribe for common stocks, (ii) stock appreciation rights to receive payment, in cash and/or the Company’ common stocks, equals to the excess of the fair market value of the Company’ common stocks, (iii) Restricted stock awards and restricted stock units, or (iv) other types of compensation based on the performance of the Company’ common stocks. The exercise price of the options may not be less than the fair market value of the share on the grant date and the option term may not exceed ten years.
Non-Vested Stock Grants to employees and directors
On December 14, 2012, the Company granted an executive 50,000 shares of restricted common stock with a grant date fair value of $1.00 per share as part of his remuneration for his service commencing December 14, 2012 for a one year period. The restricted common stock will vest on the one-year anniversary date of the grant date.
On March 7, 2013, the Company granted a director 10,000 shares of restricted common stock with a grant date fair value of $2.43 per share as part of his remuneration for the service commencing March 7, 2013 for a one-year period. The restricted common stock will vest on the one-year anniversary date of the grant date.
On January 7, 2014, the Company granted seven employees 135,000 shares of restricted common stock with a grant date fair value of $1.85 per share as part of their remuneration for the service commencing January 7, 2014 for a one-year period. The restricted common stock will vest on the one-year anniversary date of the grant date.
On February 10, 2014, the Company granted a director 10,000 shares of restricted common stock with a grant date fair value of $1.93 per share as part of his remuneration for the service commencing February 10, 2014 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 years ended June 30, 2014 and 2013 was $166,234 and $82,260, respectively. The remaining $142,241 stock-based compensation will be expensed over the remainder of the one year service period. The value of the non-vested stock at June 30, 2014 is $145,000.
Non-Vested Stock Grants to non-employees
On April 29, 2013 (“Agreement Date”), the Company entered into a consultancy agreement with a Company’s external consultant. In accordance with the agreement, the consultant will provide financing consultancy service to the Company and the Company will grant 200,000 restricted common stocks as consideration, out of which, 100,000 restricted common stock will vest 30 days after the Agreement Date (e.g. May 20, 2013) and the other 100,000 restricted common stock will vest 180 days after the Agreement Date (e.g. October 26, 2013). The service period is one year from April 29, 2013 to April 29, 2014.
| F-22 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 – STOCK-BASED COMPENSATION - continued
The Company accounted for equity instruments granted to non-employees in accordance with ASC 505-50 “Equity-Based Payments to Non-Employees”. Restricted stocks granted to non-employees are measured at the fair value of the equity instrument as of the earlier of (a) the date at which a commitment for performance by the counterparty to earn the equity instruments is reached (a performance commitment) or (b) the date at which the counterparty's performance is complete. Because the restricted stocks will vest 30 and 180 days after the Agreement Date for the first and second half of the grant of 200,000 restricted stocks, respectively, a measurement date has been reached on May 20, 2013 and October 26, 2013 for the first 100,000 and second 100,000 grant of restricted stocks, respectively. Since the service will be performed during the year started from April 29, 2013, the Company recognized a prepayment at the date of grant based on the fair value of the measurement date.
Stock-based compensation expense for the years ended June 30, 2014 and 2013 was $330,058 and $58,942, respectively. As of June 30, 2014, the remaining unrecognized stock-based compensation was nil.
Options to employees
Stock Options granted to key employees
On April 27, 2010, the Board of Directors approved the grant of stock options to purchase 100,000 shares of the Company’s common stock under the “2009 Equity Incentive Plan” to certain key employees as reward for past services and to promote future performance. These options have an exercise price of $2.71 per share, expiring on the fifth anniversary of the grant date, and vest in three equal installments on each of the first, second and third anniversary of the vesting commencement date, which is April 27, 2010. The fair value of the options, determined using the Black-Scholes Option Pricing Model, was calculated using the following assumptions: risk free interest rate of 2%, expected dividend yield of 0%, expected volatility of 90% and an expected life of 5 years.
Stock-based compensation expense for the years ended June 30, 2014 and 2013 on the stock options were nil and $52,316, respectively. As of June 30, 2014, the remaining unrecognized stock-based compensation is nil.
The following table summarizes the options activity for the years ended June 30, 2014 and 2013:
| Options | Weighted-average exercise price | Weighted average remaining contractual life (years) | Aggregate Intrinsic Value | |||||||||||||
| Outstanding as of June 30, 2012 | 105,000 | $ | 2.71 | 2.86 | $ | - | ||||||||||
| Issued | - | - | - | - | ||||||||||||
| Exercised | - | - | - | - | ||||||||||||
| Expired | - | - | - | - | ||||||||||||
| Outstanding as of June 30, 2013 | 105,000 | 2.71 | 1.86 | - | ||||||||||||
| Issued | - | - | - | - | ||||||||||||
| Exercised | - | - | - | - | ||||||||||||
| Expired | - | - | - | - | ||||||||||||
| Outstanding as of June 30, 2014 | 105,000 | $ | 2.71 | 0.86 | $ | - | ||||||||||
Total intrinsic value of stock options outstanding as of June 30, 2014 and 2013 was nil.
| F-23 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14 – 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 years. 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 year. The following table sets forth the computation of basic and diluted earnings per share:
| For The Year Ended | ||||||||
| June 30, | ||||||||
| 2014 | 2013 | |||||||
| Net income attributable to the common stockholders | $ | 7,068,872 | $ | 16,905,464 | ||||
| Basic weighted-average common shares outstanding | 41,517,840 | 40,251,218 | ||||||
| Dilutive effect of warrants and options | - | - | ||||||
| Diluted weighted-average common shares outstanding | 41,517,840 | 40,251,218 | ||||||
| Earnings per share: | ||||||||
| Basic | $ | 0.17 | $ | 0.42 | ||||
| Diluted | $ | 0.17 | $ | 0.42 | ||||
Warrants and options to purchase 685,000, and 105,000 shares of common stock, respectively were outstanding during the year ended June 30, 2014 and 2013, 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 warrants and options were larger than the average share price during the year.
NOTE 15 - COMMITMENTS AND CONTINGENCIES
Operating lease commitments - As of June 30, 2014, the Company has future minimum lease payments under non-cancelable operating leases in relation to office premises consisting of the following:
| Lease Payment | ||||
| For the year ending June 30, 2015 | 350,854 | |||
| For the year ending June 30, 2016 | 350,854 | |||
| For the year ending June 30, 2017 | 350,854 | |||
| For the year ending June 30, 2018 | 350,854 | |||
| For the year ending June 30, 2019 and thereafter | 1,812,748 | |||
| Total | $ | 3,216,164 | ||
Capital commitments – The Company entered into agreements with suppliers to purchase property, plant and equipment. As of June 30, 2014 and 2013, the Company had purchase obligations totaled $2,464,606 and $5,627,858, respectively.
Indemnification Obligations – The Company entered into agreements whereby its directors are indemnified for certain events or occurrences while the director is, or was, serving at the Company's request in such capacity. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has a directors' liability insurance policy that reduces its exposure and enables the Company to recover a portion of future amounts paid. As a result of the Company's insurance policy coverage, the Company believes the estimated fair value of these indemnification agreements is minimal. Accordingly, no liabilities have been recorded for these agreements as of June 30, 2014.
| F-24 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 – SIGNIFICANT CONCENTRATIONS
Concentration of credit risk
Assets that potentially subject the Company to significant concentrations of credit risk consist primarily of cash and cash equivalents, restricted cash, trade accounts receivable and advances to suppliers. The Company performs ongoing credit evaluations with respect to the financial condition of its debtors, but does not require collateral. As of June 30, 2014 and 2013, substantially all of the Company’s cash and cash equivalents and restricted cash were held in major financial institutions located in the PRC, which management considers to be of high credit quality. However, the deposit accounts in PRC were not insured in any manner. Trade accounts receivable are generally unsecured and denominated in RMB, and derived from revenues earned from operations primarily in the PRC. Advances to suppliers are typically unsecured and arise from deposits paid in advance for future purchases of raw materials. In order to determine the value of the Company’s trade accounts receivable and advances to suppliers, the Company records a provision for doubtful accounts to cover probable credit losses. Management reviews and adjusts this allowance periodically based on historical experience and its evaluation of the collectability of outstanding trade accounts receivable and advances to suppliers.
Concentration of customers
The Company currently sold a substantial portion of its products to Shanghai Huaye and its subsidiaries. As a percentage of revenues, 27.3% and 35.4% of the Company’s revenue was derived from Shanghai Huaye and its subsidiaries for the years ended June 30, 2014 and 2013, respectively. The loss of sales from Shanghai Huaye and its subsidiaries would have a significant negative impact on the Company’s business. Sales to customers were mostly made through non-exclusive, short-term arrangements. Due to the Company’s dependence on Shanghai Huaye and its subsidiaries, any negative events with respect to Shanghai Huaye and its subsidiaries may cause material fluctuations or declines in the Company’s revenue and have a material adverse effect on the Company’s financial condition and results of operations.
Concentration of suppliers
A significant portion of the Company’s raw materials were sourced from Shanghai Huaye and its subsidiaries who collectively accounted for an aggregate of 45.9% and 48.8% of the Company’s total purchases for the years ended June 30, 2014 and 2013, respectively. Failure to develop or maintain relationships with these suppliers may cause the Company to be unable to source adequate raw materials needed to manufacture its products. Any disruption in the supply of raw materials to the Company may adversely affect the Company’s business, financial condition and results of operations.
| F-25 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 – SEGMENT INFORMATION
The Company has four reportable segments represented by its four subsidiaries Changshu Huaye, Jiangsu Cold-Rolled, Ningbo Zhehua and Sutor Technology 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 June 30, 2014 and for the year then ended | Changshu Huaye | Jiangsu Cold-Rolled | Ningbo Zhehua | Sutor Technology | Inter-Segment and Reconciling Items | Total | ||||||||||||||||||
| Revenue from unrelated parties | $ | 103,245,109 | $ | 115,164,377 | $ | 35,654,768 | $ | 8,570,803 | $ | - | $ | 262,635,057 | ||||||||||||
| Revenue from related parties | 50,105,743 | 75,434,703 | 17,234,374 | 5,578 | - | 142,780,398 | ||||||||||||||||||
| Revenue from other operating segments | 26,952,590 | 85,954,366 | 10,632,409 | 3,420 | (123,542,785 | ) | - | |||||||||||||||||
| Total operating expenses | 8,905,248 | 2,630,460 | 3,036,950 | 1,042,966 | 869,549 | 16,485,173 | ||||||||||||||||||
| Interest income | 1,350,500 | 1,683,636 | 228,694 | 377 | 359 | 3,263,566 | ||||||||||||||||||
| Interest expense | 3,351,251 | 5,113,508 | 275,251 | - | 1,373,469 | 10,113,479 | ||||||||||||||||||
| Depreciation and amortization expense | 2,413,034 | 5,085,392 | 1,023,074 | 546,855 | - | 9,068,355 | ||||||||||||||||||
| Income tax expense | 953,632 | 2,330,844 | (268,525 | ) | - | - | 3,015,951 | |||||||||||||||||
| Net segment profit/(loss) | 5,302,045 | 6,192,311 | (252,552 | ) | (525,774 | ) | (3,647,158 | ) | 7,068,872 | |||||||||||||||
| Capital expenditures | 2,533,376 | 5,947,668 | 105,003 | - | - | 8,586,047 | ||||||||||||||||||
| Segment assets | 275,466,919 | $ | 385,865,909 | $ | 52,065,838 | $ | 32,883,736 | $ | (177,930,784 | ) | $ | 568,351,618 | ||||||||||||
| As of June 30, 2013 and for the year then ended | Changshu Huaye | Jiangsu Cold-Rolled | Ningbo Zhehua | Sutor Technology | Inter-Segment
and Reconciling Items | Total | ||||||||||||||||||
| Revenue from unrelated parties | $ | 153,545,396 | $ | 204,229,745 | $ | 27,474,831 | $ | 10,177,247 | $ | 6,754 | $ | 395,433,973 | ||||||||||||
| Revenue from related parties | 22,270,356 | 187,521,768 | 6,708,359 | 141,005 | - | 216,641,488 | ||||||||||||||||||
| Revenue from other operating segments | 19,437,557 | 93,904,065 | - | - | (113,341,622 | ) | - | |||||||||||||||||
| Total operating expenses | 9,617,720 | 4,443,065 | 3,089,320 | 839,290 | 793,254 | 18,782,649 | ||||||||||||||||||
| Interest income | 1,938,031 | 1,249,928 | 225,924 | 481 | 52 | 3,414,416 | ||||||||||||||||||
| Interest expense | 1,853,979 | 6,671,915 | 151,582 | - | 1,532,205 | 10,209,681 | ||||||||||||||||||
| Depreciation and amortization expense | 2,320,712 | 5,053,639 | 959,080 | 535,276 | - | 8,868,707 | ||||||||||||||||||
| Income tax expense | 1,386,618 | 2,819,641 | (161,302 | ) | - | (1,321,807 | ) | 2,723,150 | ||||||||||||||||
| Net segment profit/(loss) | 7,214,717 | 11,633,050 | (490,628 | ) | (405,853 | ) | (1,045,822 | ) | 16,905,464 | |||||||||||||||
| Capital expenditures | 534,039 | 3,148,883 | 4,276,561 | - | 7,959,483 | |||||||||||||||||||
| Segment assets | 251,793,786 | $ | 343,704,650 | $ | 48,037,358 | $ | 33,699,875 | $ | (87,434,797 | ) | $ | 589,800,872 | ||||||||||||
| F-26 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18 – GEOGRAPHIC INFORMATION
The following schedule summarizes the sources of the Company’s revenue by geographic regions for the years ended June 30, 2014 and 2013:
| For the Year Ended June 30, | ||||||||||||
| Geographic Area | 2014 | 2013 | ||||||||||
| PRC | $ | 375,170,191 | $ | 553,207,007 | ||||||||
| Other Countries | 30,245,264 | 58,868,454 | ||||||||||
| Total | $ | 405,415,455 | $ | 612,075,461 | ||||||||
NOTE 19 – ADDITIONAL INFORMATION - CONDENSED FINANCIAL STATEMENTS
The following condensed financial statements have been prepared in accordance with SEC Regulation S-X Rule 5-04 and Rule 12-04. The financial information of the parent company, Sutor, has been prepared using the same accounting policies as set out in the preceding footnotes to the consolidated financial statements except that the Company records its investment in subsidiaries under the equity method of accounting. Such investment to subsidiaries is presented on the balance sheet as “Investment in subsidiaries” and the profit of the subsidiaries is presented as “Investment income” on the statement of operations.
These statements should be read in conjunction with the preceding notes to the consolidated financial statements of the Company. Certain information and footnote disclosures normally included in financial statements prepared in accordance with US GAAP have been condensed or omitted.
As of June 30, 2014 and 2013, there were no material contingencies, significant provisions for long-term obligations, or guarantees of Sutor, except for those which have been separately disclosed in the consolidated financial statements of the Company, if any.
Condensed Balance Sheets
| June 30, | June 30, | |||||||
| 2014 | 2013 | |||||||
| ASSETS | ||||||||
| Current Assets: | ||||||||
| Cash and cash equivalents | $ | 175,771 | $ | 44,880 | ||||
| Other receivables | 25 | 136,083 | ||||||
| Total Current Assets | 175,796 | 180,963 | ||||||
| Investments in Subsidiaries | 270,877,160 | 261,384,561 | ||||||
| TOTAL ASSETS | $ | 271,052,956 | $ | 261,565,524 | ||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
| Current Liabilities: | ||||||||
| Short-term loans | $ | - | $ | 24,333,990 | ||||
| Long-term loans, current portion | - | - | ||||||
| Other payables and accrued expenses | 8,736 | 8,736 | ||||||
| Other payables, related parties | 25,830,644 | 1,853,076 | ||||||
| Warrant liabilities | 866 | 144,535 | ||||||
| Total Current Liabilities | 25,840,246 | 26,340,337 | ||||||
| Stockholders' Equity | ||||||||
| Common stock | 42,252 | 40,965 | ||||||
| Additional paid-in capital | 86,014,532 | 83,097,168 | ||||||
| Retained earnings | 159,807,435 | 152,738,563 | ||||||
| Less: Treasury stock, at cost | (651,509 | ) | (651,509 | ) | ||||
| Total Stockholders' Equity | 245,212,710 | 235,225,187 | ||||||
| TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY | $ | 271,052,956 | $ | 261,565,524 | ||||
| F-27 |
SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 19 – ADDITIONAL INFORMATION - CONDENSED FINANCIAL STATEMENTS – continued
Condensed Statements of Operations
| For The Years Ended | ||||||||
| June 30 | ||||||||
| 2014 | 2013 | |||||||
| Operating Expenses: | ||||||||
| General and administrative expenses | $ | (647,216 | ) | $ | (379,725 | ) | ||
| Loss from Operations | (647,216 | ) | (379,725 | ) | ||||
| Other Incomes/(Expenses): | ||||||||
| Investment income | 8,434,182 | 17,090,123 | ||||||
| Interest income | 8 | 28 | ||||||
| Interest expense | (861,771 | ) | (1,020,507 | ) | ||||
| Changes in fair value of warrant liabilities | 143,669 | (97,131 | ) | |||||
| Other expenses | - | (9,131 | ) | |||||
Total Other Income | 7,716,088 | 15,963,382 | ||||||
| Income Before Taxes | 7,068,872 | 15,583,657 | ||||||
Income tax benefit | - | 1,321,807 | ||||||
| Net Income | $ | 7,068,872 | $ | 16,905,464 | ||||
Condensed Statements of Cash Flows
| For The Years Ended | ||||||||
| June 30 | ||||||||
| 2014 | 2013 | |||||||
| Net Cash Used In Operating Activities | $ | (1,950,397 | ) | $ | (379,725 | ) | ||
| Net Cash Used In Investing Activities | - | - | ||||||
| Net Cash Provided By Financing Activities | 2,081,288 | 366,509 | ||||||
| Net Change in Cash and Cash Equivalents | 130,891 | (13,216 | ) | |||||
| Cash and Cash Equivalents at Beginning of Year | 44,880 | 58,096 | ||||||
| Cash and Cash Equivalents at End of Year | $ | 175,771 | $ | 44,880 | ||||
| F-28 |
EXHIBIT INDEX
| Exhibit No. | Description | |
| 3.1 | Articles of Incorporation of the registrant as filed with the Secretary of State of Nevada, as amended to date. [incorporated by reference to Exhibit 3.1 to the registrant’s annual report on Form 10K-SB filed on March 30, 2007] | |
| 3.2 | Amended and Restated Bylaws of the registrant. [Incorporated by reference to Exhibit 3.1 to the registrant’s current report on Form 8-K filed on March 8, 2013] | |
| 4.1 | Sutor Technology Group Limited 2009 Equity Incentive Plan [Incorporated by reference to Exhibit B to the registrant’s proxy statement dated May 13, 2009 relating to the registrant’s 2009 Annual Meeting of Shareholders] | |
| 10.1 | Form of Subscription Agreement, dated as of March 4, 2010, by and between the registrant and each of the purchasers identified on the signature pages thereto. [Incorporated by reference to Exhibit 10.1 to the registrant’s current report Form 8-K filed on March 8, 2010] | |
| 10.2 | Employment Agreement, dated December 18, 2009, by and between the registrant and Naijiang Zhou [Incorporated by reference to Exhibit 10.1 to the registrant’s current report Form 8-K filed on January 4, 2010] | |
| 10.3 | Amendment to Employment Contract, dated February 23, 2011, by and between the registrant and Naijiang Zhou. [Incorporated by reference to Exhibit 10.2 to the registrant’s current report Form 8-K filed on February 24, 2011] | |
| 10.4 | Independent Director’s Contract, dated as of January 20, 2010, by and between the registrant and Gerard Pascale [Incorporated by reference to Exhibit 10.1 to the registrant’s current report Form 8-K filed on January 20, 2010] | |
| 10.5 | Amendment to Independent Director’s Contract, dated February 23, 2011, by and between the registrant and Gerard Pascale. [Incorporated by reference to Exhibit 10.1 to the registrant’s current report Form 8-K filed on February 24, 2011] | |
| 10.6 | Indemnification Agreement, dated as of January 20, 2010, by and between the registrant and Gerard Pascale [Incorporated by reference to Exhibit 10.2 to the registrant’s current report Form 8-K filed on January 20, 2010] | |
| 10.7 | Lease Agreement, dated August 6, 2004, by and between Ningbo Zhehua and Ningbo Huaye Steel Processing Co., Ltd. [Incorporated by reference to Exhibit 10.14 to the registrant’s annual report Form 10-K filed on September 28, 2010] | |
| 10.8 | Amendment No. 2 to Independent Director’s Contract, dated February 9, 2012, by and between the Company and Gerard Pascale [Incorporated by reference to Exhibit 10.1 to the registrant’s current report on Form 8-K filed on February 15, 2012] | |
| 10.9 | Employment Agreement, dated December 14, 2012, by and among the Company, Sutor Steel Technology Co., Ltd. and Naijiang Zhou. [Incorporated by reference to Exhibit 10.1 to the registrant’s current report on Form 8-K filed on December 19, 2012] | |
| 10.10* | Employment Agreement, dated October 31, 2014, by and between Sutor Steel Technology Co., Ltd. and Lifang Chen. | |
| 10.11 | Form of Securities Purchase Agreement [Incorporated by reference to Exhibit 10.1 to the registrant’s current report on Form 8-K filed on July 9, 2013] | |
| 14 | Amended and Restated Business Ethics Policy and Code of Conduct. [Incorporated by reference to Exhibit 14 to the registrant’s current report on Form 8-K filed on February 2, 2007] | |
| 21 | List of subsidiaries of the registrant. [Incorporated by reference to Exhibit 21 to the registrant’s annual report Form 10-K filed on September 28, 2010] | |
| 23.1* | Consent of BDO China Shu Lun Pan Certified Public Accountants LLP | |
| 31.1* | Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 31.2* | Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 32.1* | Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 32.2* | Certification of Chief Financial Officer 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). |
* Filed herewith