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EX-31.1 - EXHIBIT 31.1 - Sutor Technology Group LTDv400227_ex31-1.htm
EX-32.1 - EXHIBIT 32.1 - Sutor Technology Group LTDv400227_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - Sutor Technology Group LTDv400227_ex31-2.htm
EX-10.1 - EXHIBIT 10.1 - Sutor Technology Group LTDv400227_ex10-1.htm
EX-10.5 - EXHIBIT 10.5 - Sutor Technology Group LTDv400227_ex10-5.htm
EX-32.2 - EXHIBIT 32.2 - Sutor Technology Group LTDv400227_ex32-2.htm
EX-10.2 - EXHIBIT 10.2 - Sutor Technology Group LTDv400227_ex10-2.htm
EX-10.3 - EXHIBIT 10.3 - Sutor Technology Group LTDv400227_ex10-3.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.20549

 

FORM 10−Q

(Mark One)

 

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

 

For the quarterly period ended: December 31, 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 Number: 001-33959

 

SUTOR TECHNOLOGY GROUP LIMITED

(Exact Name of Registrant as Specified in Its Charter)

 

Nevada   87-0578370
(State or other jurisdiction of incorporation
or organization)
  (I.R.S. Employer Identification No.)

 

 

No 8, Huaye Road

DongbangIndustrial Park

Changshu, 215534
People’s Republic of China

(Address of principal executive offices, Zip Code)

 

(+86) 512-52680988

(Registrant’s telephone number, including area code)

 

 

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

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

 

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

 

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

 

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

 

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

 

The number of shares outstanding of each of the issuer’s classes of common stock, as of February 12, 2015 is as follows:

 

Class of Securities   Shares Outstanding
Common Stock, $0.001 par value   41,616,429

 

 
 

 

SUTOR TECHNOLOGY GROUP LIMITED

 

Quarterly Report on Form 10-Q

Period Ended December 31, 2014

 

 

TABLE OF CONTENTS

 

PART I
FINANCIAL INFORMATION
     
Item 1. Financial Statements 1
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 2
Item 3. Quantitative and Qualitative Disclosures About Market Risk 15
Item 4. Controls and Procedures 15
     
PART II
OTHER INFORMATION
     
Item 1. Legal Proceedings 16
Item 1A. Risk Factors 16
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 16
Item 3. Defaults Upon Senior Securities 16
Item 4. Mine Safety Disclosures 16
Item 5. Other Information 16
Item 6. Exhibits 16

 

i
 

 

PART I

FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS.

 

 

 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

    Page
     
Unaudited Condensed Consolidated Balance Sheets as of December 31, 2014 and Condensed Consolidated Balance Sheets as of June 30, 2014   F-1 – F-2
     
Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income for the Three and Six Months Ended December 31, 2014 and 2013   F-3
     
Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended December 31, 2014 and 2013   F-4 – F-5
     
Notes to Unaudited Condensed Consolidated Financial Statements   F-6 – F-21

  

1
 

  

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

   December 31,   June 30, 
   2014   2014 
         
ASSETS          
Current Assets:          
Cash and cash equivalents  $3,307,151   $12,178,225 
Restricted cash        60,860,255 
Short-term investments        3,248,652 
Trade accounts receivable, unrelated parties, net of allowance for doubtful accounts of $1,235,225 and $1,368,723, respectively   5,325,628    6,331,702 
Trade accounts receivable, related parties   40,105,863    16,149,269 
Notes receivables   10,030,830    194,919 
Other receivables and prepayments, unrelated parties, net of allowance for doubtful accounts of $282,473 and $255,628, respectively   2,215,777    1,875,785 
Other receivables and prepayments, related parties   406,245    405,558 
Advances to suppliers, unrelated parties, net of allowance for doubtful accounts of $555,985 and $527,673, respectively   8,704,548    8,645,751 
Advances to suppliers, related parties   307,892,313    286,085,768 
Inventories, net   29,141,842    78,277,682 
Current deferred tax assets   2,873,476    1,507,840 
Total Current Assets   410,003,673    475,761,406 
Non-current Assets:          
Advances for purchase of long term assets   85,385    85,241 
Property, plant and equipment, net   82,714,923    87,121,382 
Intangible assets, net   3,531,438    3,568,855 
Long-term investments   1,817,805    1,814,734 
Total Non-current Assets   88,149,551    92,590,212 
TOTAL ASSETS  $498,153,224   $568,351,618 
           

 

F-1
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(CONTINUED)

 

   December 31,   June 30, 
   2014   2014 
         
LIABILITIES AND STOCKHOLDERS’ EQUITY          
Current Liabilities:          
Short-term loans  $202,865,133   $139,223,123 
Accounts payable, unrelated parties   5,072,840    5,843,599 
Accounts payable, related parties   351,448    - 
Notes payable   1,663,104    136,274,446 
Other payables and accrued expenses, unrelated parties   15,812,163    4,613,201 
Other payables and accrued expenses, related parties   3,200,839    3,110,196 
Advances from customers, unrelated parties   8,999,245    7,917,111 
Advances from customers, related parties   8,382,043    15,114,353 
Warrant liabilities   138    866 
Total Current Liabilities   246,346,953    312,096,895 
Non-Current Liabilities          
Long-term loans, unrelated parties   2,859,995    2,859,995 
Long-term loans, related parties   8,182,018    8,182,018 
Total Non-current Liabilities   11,042,013    11,042,013 
Total Liabilities   257,388,966    323,138,908 
           
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 December 31 and June 30, 2014;
issued: 42,252,267 shares and 42,252,267 shares as of December 31 and June 30, 2014, respectively
   42,252    42,252 
Additional paid-in capital   43,788,093    43,652,089 
Statutory reserves   22,725,841    22,725,841 
Retained earnings   132,016,722    137,081,594 
Accumulated other comprehensive income   42,842,859    42,362,443 
Less: Treasury stock, at cost, 590,838 as of December 31 and June 30, 2014   (651,509)   (651,509)
Total Stockholders' Equity   240,764,258    245,212,710 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY  $498,153,224   $568,351,618 

 

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

 

F-2
 

  

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME

 

   For The Three Months Ended   For The Six Months Ended 
   December 31,   December 31, 
   2014   2013   2014   2013 
                 
Revenue from unrelated parties  $22,304,103   $102,230,215   $39,296,001   $204,412,337 
Revenue from related parties   62,998,146    26,086,595    83,994,078    63,012,798 
Total Revenue   85,302,249    128,316,810    123,290,079    267,425,135 
Cost of Revenue   (80,030,060)   (114,691,101)   (119,862,160)   (241,596,881)
Gross Profit   5,272,189    13,625,709    3,427,919    25,828,254 
                     
Operating Expenses:                    
                     
Selling expenses   (756,869)   (1,337,918)   (1,026,509)   (3,332,774)
General and administrative expenses   (1,887,366)   (2,624,720)   (4,136,617)   (5,528,990)
Total Operating Expenses   (2,644,235)   (3,962,638)   (5,163,126)   (8,861,764)
Income from Operations   2,627,954    9,663,071    (1,735,207)   16,966,490 
                     
Other Incomes/(Expenses):                    
Interest income   169,379    786,544    615,864    1,836,766 
Interest expense   (2,438,408)   (2,574,958)   (5,416,755)   (4,378,253)
Changes in fair value of warrant liabilities   (135)   (54,311)   728    (66,898)
Income from equity method investments   -    180,956    -    266,128 
Other income   19,736    174,752    293,098    219,026 
Other expense   (118,085)   (201,757)   (184,930)   (219,780)
Total Other Expenses, net   (2,367,513)   (1,688,774)   (4,691,995)   (2,343,011)
                     
Income/(Loss) Before Taxes   260,441    7,974,297    (6,427,202)   14,623,479 
Income tax (expense)/benefit   (233,029)   (1,579,161)   1,362,330    (3,040,096)
Net Income/(Loss)  $27,412   $6,395,136   $(5,064,872)  $11,583,383 
                     
Other Comprehensive Income:                    
Foreign currency translation adjustment   405,834    1,477,555    480,416    3,137,112 
Comprehensive Income/(Loss)  $433,246   $7,872,691   $(4,584,456)  $14,720,495 
                     
Basic Earnings/(Loss) per Share  $(0.00)  $0.15   $(0.12)  $0.28 
Diluted Earnings/(Loss) per Share  $(0.00)  $0.15   $(0.12)  $0.28 
                     
Basic Weighted Average Shares Outstanding   41,661,429    41,453,386    41,661,429    41,383,956 
Diluted Weighted Average Shares Outstanding   41,661,429    41,453,386    41,661,429    41,383,956 
                     

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

 

F-3
 

  

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

   For The Six Months Ended 
   December 31, 
   2014   2013 
Cash Flows from Operating Activities:          
Net (loss)/income  $(5,064,872)  $11,583,383 
Adjustments to reconcile net income to net cash provided by/(used in) operating activities          
Depreciation and amortization   4,038,490    4,510,854 
Provision/(reversal) for doubtful accounts   (81,765)   123,435 
Stock based compensation   136,004    238,320 
Foreign currency exchange gain   -    (194,913)
Gain on disposal of property, plant and equipment   -    (10,985)
Income from equity method investments   -    (266,128)
Deferred income taxes   (1,362,330)   (86,678)
Changes in fair value of warrant liabilities   (728)   66,898 
Changes in current assets and liabilities:          
Restricted cash   60,929,534    (20,188,832)
Trade accounts receivable, unrelated parties   1,151,793    (2,320,586)
Trade accounts receivable, related parties   (23,916,037)   - 
Notes receivable   (9,830,144)   213,696 
Other receivables and prepayments, unrelated parties   (363,029)   (5,775,579)
Advances to suppliers, unrelated parties   (71,547)   17,643,081 
Advances to suppliers, related parties   (21,311,121)   33,716,400 
Inventories   49,237,038    (61,110,422)
Accounts payable, unrelated parties   266,935    46,830,652 
Accounts payable, related parties   351,254    (20,276,893)
Notes payable   (126,789,039)   - 
Other payables and accrued expenses, unrelated parties   11,186,772    (293,095)
Other payables and accrued expenses, related parties   88,221    - 
Advances from customers, unrelated parties   1,068,671    10,458,615 
Advances from customers, related parties   (14,732,496)   - 
Net Cash (Used in)/Provided by Operating Activities   (75,068,396)   14,861,223 
           
Cash Flows from Investing Activities:          
Purchase of property, plant and equipment   (490,844)   (7,818,783)
Proceeds from disposal of property, plant and equipment   -    15,052 
Purchase of intangible assets   -    (567,268)
Payments for short-term investments   -    (3,254,308)
Proceeds from sale of short-term investments   3,252,350    - 
Net Cash Provided by/(Used In) Investing Activities   2,761,506    (11,625,307)
           
Cash Flows from Financing Activities:          
Proceeds from loans   111,384,323    93,079,729 
Repayment of loans   (48,012,958)   (110,464,374)
Proceeds from issuance of common stock   -    1,500,000 
Changes in restricted cash   -    21,485,248 
Net Cash Provided by Financing Activities   63,371,365    5,600,603 
           
Effect of Exchange Rate Changes on Cash and Cash Equivalents   64,451    87,351 
           
Net Change in Cash and Cash Equivalents   (8,871,074)   8,923,870 
Cash and Cash Equivalents at Beginning of Period   12,178,225    3,601,385 
Cash and Cash Equivalents at End of Period  $3,307,151   $12,525,255 
           
F-4
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(CONTINUED)

 

Supplemental Non-Cash Information:          
Offset of notes payable to related parties against receivable from related parties  $-   $11,126,897 
Accounts payable for purchase of long-term assets  $(1,047,151)  $(495,344)
Advances for purchase of long-term assets  $-   $17,097,874 
           
Supplemental Cash Flow Information:          
Cash paid during the period for interest expense  $(5,035,611)  $(4,430,640)
Cash paid during the period for income tax  $-   $(3,122,617)
           

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

 

F-5
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED 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 December 31, 2014, Sutor’s subsidiaries and affiliated company 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

 

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES

 

Interim Unaudited Financial Statements – The accompanying unaudited condensed consolidated financial statements of the Company reflect all adjustments (consisting only of normal recurring adjustments) that, in the opinion of management, are necessary to present fairly the consolidated financial position and results of operations of the Company for the periods presented. Operating results for the three and six months ended December 31, 2014 are not necessarily indicative of the results that may be expected for the year ending June 30, 2015. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2014. The Company follows the same accounting policies in the preparation of interim reports.

 

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

 

F-6
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED 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 periods:

 

   December 31, 
2014
   December 31, 
2013
   June 30,
2014
 
Closing RMB : USD exchange rate at the period end   6.1460    6.1122    6.1564 
Average six months RMB : USD exchange rate   6.1494    6.1457    n/a 

 

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 USD 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. 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-7
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED 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 the three months ended December 31, 2014 and 2013, respectively. The change of business model did not trigger impairment of long-term assets since all of the long-term assets continue to be utilized by the processing model.

 

F-8
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES - continued

 

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 December 31, 2014 and June 30, 2014, 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 were carried at cost on the condensed consolidated balance sheets, and carrying amounts approximated their fair values because of their generally short maturities. The estimated fair value of long-term loan approximated the carrying amount as of December 31, 2014 and June 30, 2014 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.

 

Liabilities measured at fair value on a recurring basis are summarized below:

 

   Balance as of December 31, 2014 
       Fair Value Measurements 
   Carrying Value   Level 1   Level 2   Level 3 
                     
Warrant liabilities  $138   $-   $-   $138 

 

   Balance as of June 30, 2014 
       Fair Value Measurements 
   Carrying Value   Level 1   Level 2   Level 3 
                     
Warrant liabilities  $866   $-   $-   $866 

 

For a summary of changes in warrant liabilities for the three and six months ended December 31, 2014, 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.

 

F-9
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES - continued

 

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.

 

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.

 

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 three months ended December 31, 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.

 

F-10
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES - continued

 

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.

 

Recent Accounting Pronouncements – 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.

 

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.

 

In August 2014, the FASB issued Accounting Standards Update No. 2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern”, which will explicitly require management to assess an entity’s ability to continue as a going concern and to provide related footnote disclosures in certain circumstances. Currently, there is no guidance in GAAP about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern or to provide related footnote disclosures. The amendments in this Update provide that guidance. In doing so, the amendments should reduce diversity in the timing and content of footnote disclosures. The amendments require management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. Specifically, the amendments (1) provide a definition of the term “substantial doubt”, (2) require an evaluation every reporting period including interim periods, (3) provide principles for considering the mitigating effect of management’s plans, (4) require certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans, (5) require an express statement and other disclosures when substantial doubt is not alleviated and (6) require an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). The amendments in this update are effective for the first annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted. The Company is currently evaluating the impact of adopting this update on its financial statements.

 

F-11
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES - continued

In January 2015, the FASB issued Accounting Standards Update No. 2015-01, “Income Statement-Extraordinary and Unusual Items (Subtopic 225-20)”, which simplifies income statement presentation by eliminating the concept of an extraordinary item. As a result, entities will no longer segregate an extraordinary item from the results of ordinary operations; separately present an extraordinary item on its income statement, net of tax, after income from continuing operations; and disclose income taxes and earnings per share data applicable to an extraordinary item. The guidance is effective for the Company beginning the first quarter of fiscal 2017 with early adoption permitted. The adoption of this guidance is not expected to have a significant impact on our consolidated financial position, results of operations, or cash flows.

 

NOTE 3 – SHORT-TERM INVESTMENTS

 

The following table summarizes the movement of short-term investments for the six month ended December 31, 2014:

 

   Amount 
As of June 30, 2014   3,248,652 
Foreign currency translation adjustment   3,698 
Disposal of short-term investments   (3,252,350)
As of December 31, 2014  $- 

 

NOTE 4 – OTHER RECEIVABLES AND PREPAYMENTS

 

Other receivables and prepayments as of December 31, 2014 and June 30, 2014 consisted of the following:

 

   December 31,   June 30, 
   2014   2014 
Tax recoverable  $22,276   $10,266 
Other receivables   2,475,974    2,121,147 
    2,498,250    2,131,413 
Less: allowance for doubtful accounts   (282,473)   (255,628)
Other receivables and prepayments, net  $2,215,777   $1,875,785 

 

NOTE 5 – INVENTORIES

 

Inventories as of December 31, 2014 and June 30, 2014 consisted of the following:

 

   December 31,   June 30, 
   2014   2014 
Raw materials  $18,292,803   $14,006,475 
Finished goods   10,983,280    64,405,222 
    29,276,083    78,411,697 
Less: allowance for obsolescence   (134,241)   (134,015)
Inventories, net  $29,141,842   $78,277,682 

 

F-12
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 6 – PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment as of December 31, 2014 and June 30, 2014 consisted of the following:

 

   December 31,   June 30, 
   2014   2014 
Buildings and plant  $47,092,604   $47,013,051 
Machinery   73,108,646    72,916,144 
Office and other equipment   1,746,147    1,734,518 
Vehicles   670,233    669,101 
    122,617,630    122,332,814 
Less: accumulated depreciation   (66,522,114)   (62,419,223)
    56,095,516    59,913,591 
Construction in progress   26,619,407    27,207,791 
Property, Plant and Equipment, net  $82,714,923   $87,121,382 

 

As of December 31, 2014 and June 30, 2014, certain of the Company’s property, plant and equipment amounted to approximately $38 million and $39 million, respectively, was pledged to banks to secure the loan granted to the Company (Note 9).

 

Depreciation expense for the three months ended December 31, 2014 and 2013 was $1,877,118 and $2,244,272, respectively.

Depreciation expense for the six months ended December 31, 2014 and 2013 was $3,995,058 and $4,470,232, respectively.

 

NOTE 7 – INTANGIBLE ASSETS

 

Intangible assets as of December 31, 2014 and June 30, 2014 consisted of the following:

 

   December 31,   June 30, 
   2014   2014 
Cost  $4,345,610   $4,338,269 
Less: Accumulated amortization   (814,172)   (769,414)
Intangible Assets, net  $3,531,438   $3,568,855 

 

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 three months ended December 31, 2014 and 2013 was $21,753 and $21,789, respectively. Amortization expense for the six months ended December 31, 2014 and 2013 was $43,432 and $40,622, respectively.

 

As of December 31, 2014 and June 30, 2014, certain of the Company’s intangible assets amounted to approximately $2.8 million 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     
Remainder of the year ending June 30, 2015  $43,456 
For the year ending June 30, 2016   86,912 
For the year ending June 30, 2017   86,912 
For the year ending June 30, 2018   86,912 
For the year ending June 30, 2019   86,912 
For the year ending June 30, 2020 and thereafter   3,140,334 
Total  $3,531,438 

 

F-13
 

 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED 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 March 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:

 

   December 31,   June 30, 
   2014   2014 
Short-term loans  $202,865,133   $139,223,123 
Long-term loans, current portion   -    - 
    202,865,133    139,223,123 
Long-term loans, non-current portion   11,042,013    11,042,013 
Total loans  $213,907,146   $150,265,136 

 

The short-term loans outstanding as of December 31, 2014 and June 30, 2014 bore a weighted average interest rate of 6.88% and 6.82% 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 December 31, 2014 and June 30, 2014 bore a weighted average interest rate of 4.63% per annum. These loans were obtained from financial institutions and one individual. Long-term loans have contract terms of more than one year to three years.

 

Short-term loans as of December 31, 2014 were secured/guaranteed by the following:

 

Secured/guaranteed by    
Guaranteed by related parties  $105,740,966 
Jointly guaranteed by (i) related parties, and (ii) the Company's property, plant and equipment   95,822,507 
Guaranteed by the Company's property, plant and equipment   1,301,660 
Total short-term loans  $202,865,133 

 

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 

 

F-14
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 9 – LOANS - continued

 

Long-term loans, non-current portion as of December 31, 2014 were secured/guaranteed by the following:

 

Secured/guaranteed by    
Unsecured  $11,042,013 

 

Long-term loans, non-current portion as of June 30, 2014 were secured/guaranteed by the following:

 

Secured/guaranteed by    
Unsecured  $11,042,013 

 

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 December 31, 2014, amount of $13,273,969 included in the short-term loans remained unpaid and was reclassified from the notes payable, which bear an interest rate of 5.6% per annum and have contract terms of one year, in accordance with the agreement entered between the Company and banks.

 

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 entity in which the Company owns shares; 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”) and Shanghai Legang Supply Chain Co., Ltd. (“Legang”), over which the Company’s ultimate controlling party has significant influence.

 

Related Party Activities

 

   For the Three Months Ended   For the Six month ended 
   December 31,   December 31, 
   2014   2013   2014   2013 
Sales to Shanghai Huaye and its subsidiaries  $35,221,975   $26,086,595   $35,221,975   $63,012,798 
Sales to Related Trading Companies   27,776,171    -    48,772,103    - 
Purchases from Shanghai Huaye and its subsidiaries   32,874,914    49,751,644    32,935,995    145,882,058 
Purchases from CRM Suzhou   -    3,579,917    603,938    26,916,087 
Rental fees to Shanghai Huaye and its subsidiaries   87,986    39,176    175,724    78,103 
Interest expenses to Shanghai Huaye   85,723    85,723    171,446    171,447 
Handling fee paid to Shanghai Huaye and its subsidiaries   90,345    -    90,345    88,782 

 

Related Party Balances

 

   December 31,   June 30, 
   2014   2014 
Trade accounts receivables due from Shanghai Huaye and its subsidiaries  $29,736,816   $3,974,558 
Trade accounts receivables due from Trading Entities   10,369,047    12,174,711 
Advances paid to Shanghai Huaye and its subsidiaries for purchase of raw materials   245,101,713    281,720,894 
Advances paid to Trading Entities for purchase of raw materials   1,478,924    3,231,826 
Advances paid to Legang for purchase of raw materials   60,675,490    - 
Advances paid to CRM Suzhou for purchase of raw materials   636,186    1,133,048 
Other receivables due from Shanghai Huaye and its subsidiaries   406,245    405,558 
Accounts payable due to Shanghai Huaye and its subsidiaries   351,448    - 
Other payables and accrued expenses due to Shanghai Huaye and its subsidiaries   3,200,839    3,110,196 
Long-term loans due to Shanghai Huaye and its subsidiaries   8,182,018    8,182,018 

 

 

 

F-15
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 10 – RELATED PARTY TRANSACTIONS - continued

 

(1) 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.

 

NOTE 11 – INCOME TAXES

 

The Company has total income tax of $233,029 and income tax benefit of $1,362,330 for the three months and six months ended December 31, 2014, respectively. The Company continues to conduct most of its business through its major PRC subsidiaries whose applicable income tax rates are 15% or 25% for the three and six months ended December 31, 2014.

 

The Company’s effective tax rates were 89% and 20% for the three months ended December 31, 2014 and 2013, respectively and 21% and 21% for the six months ended December 31, 2014 and 2013. The change in effective tax rate was mainly resulted from the non-deductible expenses incurred in the three months ended December 31, 2014 while the income before taxes was small.

 

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:

 

   December 31, 2014   June 30, 2014 
   Quarter end date   Year end date 
Warrants indexed to common stock   685,000    685,000 
Trading market price  $0.50   $1.00 
Exercise price  $3.76   $3.76 
Estimated Term (Year)   0.17    0.67 
Expected volatility   149.25%   60.57%
Risk-free rate   0.02%   0.11%
Dividend yield rates   0.00%   0.00%
Fair value of warrants  $138   $866 

 

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.

 

The following table summarizes the movement of warrant liabilities for the six months ended December 31, 2014 and 2013:

 

   For The Six Months Ended 
   December 31, 
   2014   2013 
Balance at beginning of the period  $866   $144,535 
Changes in fair value   (728)   66,898 
Balance at end of the period  $138   $211,433 

 

F-16
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

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 three months ended December 31, 2014 and 2013 was $68,001 and $16,307, respectively. Stock-based compensation expense for the six months ended December 31, 2014 and 2013 was $136,003 and $35,086, respectively. The remaining $6,238 stock-based compensation will be expensed over the remainder of the one-year service period. The value of the non-vested stock at December 31, 2014 is $72,500.

 

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.

 

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 three months ended December 31, 2014 and 2013 were nil and $108,598, respectively. Stock-based compensation expense for the six months ended December 31, 2014 and 2013 were nil and $203,234, respectively.

 

F-17
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 13 – STOCK-BASED COMPENSATION - continued

 

Options to 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 three months ended December 31, 2014 and 2013 on the stock options were nil and $16,043, respectively. Stock-based compensation expense for the six months ended December 31, 2014 and 2013 on the stock options were nil and $32,087, respectively. As of December 31, 2014, the remaining unrecognized stock-based compensation is nil.

 

The following table summarizes the options activity for the six months ended December 31, 2014:

 

   Options   Weighted-average
exercise price
   Weighted average remaining
contractual life (years)
   Aggregate Intrinsic
Value
 
Outstanding as of June 30, 2014   105,000   $2.71    0.86   $- 
Issued   -    -    -    - 
Exercised   -    -    -    - 
Expired   -    -    -    - 
Outstanding as of December 31, 2014   105,000   $2.71    0.36   $- 

 

Total intrinsic value of stock options outstanding as of December 31, 2014 and June 30, 2014 was nil.

 

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

 

   For The Three Months Ended   For The Six Months Ended 
   December 31,   December 31, 
   2014   2013   2014   2013 
                 
Net income attributable to the common stockholders  $27,412   $6,395,136   $(5,064,872)  $11,583,383 
                     
Basic weighted-average common shares outstanding   41,661,429    41,453,386    41,661,429    41,383,956 
Dilutive effect of warrants and options   -    -    -    - 
Diluted weighted-average common shares outstanding   41,661,429    41,453,386    41,661,429    41,383,956 
                     
Earnings per share:                    
Basic  $(0.00)  $0.15   $(0.12)  $0.28 
Diluted  $(0.00)  $0.15   $(0.12)  $0.28 

 

Warrants and options to purchase 685,000, and 105,000 shares of common stock, respectively were outstanding during as of December 31, 2014 and June 30, 2014, 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 period.

 

F-18
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 

 

NOTE 15 - COMMITMENTS AND CONTINGENCIES

 

Operating lease commitments - As of December 31, 2014, the Company has future minimum lease payments under non-cancelable operating leases in relation to office premises consisting of the following:

 

   Lease Payment 
Remainder of the year ending June 30, 2015   175,724 
For the year ending June 30, 2016   351,448 
For the year ending June 30, 2017   351,448 
For the year ending June 30, 2018   351,448 
For the year ending June 30, 2019   351,448 
For the year ending June 30, 2020 and thereafter   1,464,367 
Total  $3,045,883 

 

Capital commitments – The Company entered into agreements with suppliers to purchase property, plant and equipment. As of December 31, 2014 and June 30, 2014, the Company had purchase obligations totaled $2,504,792 and $2,464,606, 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 December 31, 2014.

 

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 December 31, 2014 and June 30, 2014, 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, 73.9% and 20.3% of the Company’s revenue was derived from Shanghai Huaye and its subsidiaries for the three months ended December 31, 2014 and 2013, respectively; 68.1% and 23.6% of the Company’s revenue was derived from Shanghai Huaye and its subsidiaries for the six months ended December 31, 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 70.7% and 43.1% of the Company’s total purchases for the three months ended December 31, 2014 and 2013, respectively; an aggregate of 57.3% and 50.5% of the Company’s total purchases for the six months ended December 31, 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-19
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED 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 HDG steel products. Ningbo Zhehua manufactures heavy steel pipe products and Sutor Technology engages in trading of steel products.

 

Certain segment information is presented below:

 

As of December 31, 2014 and for
the three months then ended
  Changshu
Huaye
   Jiangsu
Cold-Rolled
   Ningbo
Zhehua
   Sutor
Technology
   Inter-Segment and
Reconciling Items
   Total 
Revenue from unrelated parties  $1,475,239   $15,185,364   $4,808,603   $834,897   $-   $22,304,103 
Revenue from related parties   25,488,419    33,880,734    3,628,993    -    -    62,998,146 
Revenue from other operating segments   3,193,787    18,148,684    621,680    -    (21,964,151)   - 
Total operating expenses   1,788,253    452,360    202,638    184,819    16,165    2,644,235 
Interest income   55,599    68,021    43,759    1,996    4    169,379 
Interest expense   764,806    1,381,676    112,948    -    178,978    2,438,408 
Depreciation and amortization expense   272,798    1,225,117    245,814    136,825    18,317    1,898,871 
Income tax expense/(benefit)   (228,132)   622,238    (161,077)   -    -    233,029 
Net segment profit/(loss)   (1,081,201)   1,868,199    (354,722)   (59,868)   (344,996)   27,412 
Capital expenditures   38,769    20,095    1    -    -    58,865 
Segment assets   238,487,279   $338,865,601   $43,450,660   $34,677,832   $(157,328,148)  $498,153,224 

 

As of December 31, 2013 and for
the three months then ended
  Changshu
Huaye
   Jiangsu
Cold-Rolled
   Ningbo
Zhehua
   Sutor
Technology
   Inter-Segment and
Reconciling Items
   Total 
Revenue from unrelated parties  $43,288,250   $46,524,694   $10,353,468   $2,063,803   $-   $102,230,215 
Revenue from related parties   11,062,462    10,063,382    4,960,733    18    -    26,086,595 
Revenue from other operating segments   2,086,742    23,484,758    2,416,240    3,419    (27,991,159)   - 
Total operating expenses   2,260,244    776,214    538,550    217,288    170,342    3,962,638 
Interest income   310,259    466,569    9,464    91    161    786,544 
Interest expense   467,340    1,767,976    1,626    -    338,016    2,574,958 
Depreciation and amortization expense   598,493    1,274,540    255,920    137,108    -    2,266,061 
Income tax expense   701,908    843,741    33,512    -    -    1,579,161 
Net segment profit/(loss)   4,207,423    2,543,509    100,538    (88,724)   (367,610)   6,395,136 
Capital expenditures   616,281    887,128    93,094    -    -    1,596,503 
Segment assets   262,472,451   $392,899,382   $48,335,498   $33,451,372   $(195,203,803)  $541,954,900 

 

F-20
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 17 – SEGMENT INFORMATION - continued

 

As of December 31, 2014 and for
the six months then ended
  Changshu
Huaye
   Jiangsu
Cold-Rolled
   Ningbo
Zhehua
   Sutor
Technology
   Inter-Segment and
Reconciling Items
   Total 
Revenue from unrelated parties  $2,886,292   $28,275,778   $7,164,309   $969,622   $-   $39,296,001 
Revenue from related parties   31,767,823    48,597,262    3,628,993    -    -    83,994,078 
Revenue from other operating segments   6,755,623    19,684,494    1,881,268    -    (28,321,385)   - 
Total operating expenses   2,785,121    1,258,051    639,416    501,657    (21,119)   5,163,126 
Interest income   98,163    428,809    86,235    2,642    15    615,864 
Interest expense   1,803,505    3,131,362    123,935    -    357,953    5,416,755 
Depreciation and amortization expense   865,648    2,523,761    502,563    273,179    (126,661)   4,038,490 
Income tax benefit   (590,497)   (439,048)   (332,785)   -    -    (1,362,330)
Net segment loss   (3,052,898)   (452,937)   (846,173)   (258,718)   (454,146)   (5,064,872)
Capital expenditures   57,433    155,290    473    -    -    213,196 
Segment assets  $238,487,279   $338,865,601   $43,450,660   $34,677,832   $(157,328,148)  $498,153,224 

 

As of December 31, 2013 and for
the six months then ended
  Changshu
Huaye
   Jiangsu
Cold-Rolled
   Ningbo
Zhehua
   Sutor
Technology
   Inter-Segment and
Reconciling Items
   Total 
Revenue from unrelated parties  $100,642,524   $78,911,056   $18,274,937   $6,583,820   $-   $204,412,337 
Revenue from related parties   17,845,221    32,209,387    12,952,614    5,576    -    63,012,798 
Revenue from other operating segments   6,652,820    55,329,908    2,416,240    3,419    (64,402,387)   - 
Total operating expenses   5,154,889    1,575,263    1,195,526    481,235    454,851    8,861,764 
Interest income   819,637    910,920    105,626    256    327    1,836,766 
Interest expense   921,797    2,780,219    50,207    -    626,030    4,378,253 
Depreciation and amortization expense   1,192,991    2,540,349    504,171    273,343    -    4,510,854 
Income tax expense/(benefit)   1,338,008    1,709,881    (7,793)   -    -    3,040,096 
Net segment profit/(loss)   7,711,889    5,416,337    (23,377)   (208,418)   (1,313,048)   11,583,383 
Capital expenditures   2,392,029    4,785,530    93,094    -    -    7,270,653 
Segment assets  $262,472,451   $392,899,382   $48,335,498   $33,451,372   $(195,203,803)  $541,954,900 

 

NOTE 18 – GEOGRAPHIC INFORMATION

 

The following schedule summarizes the sources of the Company’s revenue by geographic regions for the three and six months ended December, 2014 and 2013:

 

   For the Three Months Ended   For the Six Months Ended 
   December 31,   December 31, 
Geographic Area  2014   2013   2014   2013 
People's Republic of China  $83,831,434   $123,212,281   $120,774,225   $244,227,432 
Other Countries   1,470,815    5,104,529    2,515,854    23,197,703 
Total  $85,302,249   $128,316,810   $123,290,079   $267,425,135 

  

F-21
 

 

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

 

Special Note Regarding Forward Looking Statements

 

In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We use words such as “believe,” “expect,” “anticipate,” “project,” “target,” “plan,” “optimistic,” “intend,” “aim,” “will” or similar expressions which are intended to identify forward-looking statements. Such statements include, among others, those concerning market and industry segment growth and demand and acceptance of new and existing products; any projections of sales, earnings, revenue, margins or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements regarding future economic conditions or performance; as well as all assumptions, expectations, predictions, intentions or beliefs about future events. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, including those identified in Item 1A “Risk Factors” included in our Annual Report on Form 10-K for the year ended June 30, 2014, as well as assumptions, which, if they were to ever materialize or prove incorrect, could cause the results of the Company to differ materially from those expressed or implied by such forward-looking statements.

 

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

 

Use of Terms

 

Except as otherwise indicated by the context, all references in this report to:

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

·“SEC” are to the United States Securities and Exchange Commission;

 

·“Securities Act” are to the Securities Act of 1933, as amended;

 

·“Exchange Act” are to the Securities Exchange Act of 1934, as amended.

 

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

 

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

 

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

 

2
 

 

Overview of our Business

 

We are one of the leading China-based, non-state-owned manufacturers and service 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. 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 two cold-rolled steel lines. 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.

 

Since early fiscal year 2015, we have been in the process of transforming our business from manufacturing and selling fine finished steel products to one that offers both manufactured products and fee-based customized processing services. Sutor Technology PRC dedicates itself to providing innovative services with a focus on brand promotion, sales channels expansion and integrated order processing. Changshu Huaye, Jiangsu Cold-Rolled and Ningbo Zhehua focus on product quality improvement and technological upgrading, as well as promoting fee-based processing services.

 

Executive Overview of Quarterly Results

 

Along with the structural adjustment in the Chinese steel industry, our focus on sales growth of fine finished steel products has been more on profit growth than revenue scale. Our revenue and net income during the second quarter of fiscal 2015 increased 124.5% and 100.6%, respectively, as compared with the first quarter of fiscal 2015, although they decreased significantly as compared with the same period last year.

 

The following summarizes the major financial information for the second fiscal quarter of fiscal 2015:

 

·Revenue: Revenue was $85.3 million for the three months ended December 31, 2014, a decrease of $43.0 million, or 33.5%, from $128.3 million for the same period last year.

 

·Gross profit and margin: Gross profit was $5.3 million for the three months ended December 31, 2014, as compared to $13.6 million for the same period last year. Gross margin was 6.2% for the three months ended December 31, 2014, as compared to 10.6% for the same period last year.

 

·Net income: Net income was $0.03 million for the three months ended December 31, 2014, a decrease of $6.37 million, or 99.5%, from $6.4 million for the same period of last year.

 

·Fully diluted earnings per share: Fully diluted earnings per share were approximately $0 for the three months ended December 31, 2014, as compared to approximately $0.15 for the same period last year.

 

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 dedicates itself to providing innovative services with a focus on brand promotion, sales channels expansion and integrated order processing. See Note 17, “Segment Information” to the consolidated financial statements included elsewhere in this report.

 

3
 

 

Revenue

 

Our revenue is mainly generated from sales 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. In addition, we also generate revenue from offering fee-based steel processing services.

 

In the three months ended December 31, 2014 and 2013, Changshu Huaye generated revenue of $27.0 million and $54.4 million, which represented 31.6% and 42.4% of our total revenue, respectively. Jiangsu Cold-Rolled generated revenue of $49.1 million and $56.6 million in the three months ended December 31, 2014 and 2013, which represented 57.5% and 44.1% of our total revenue, respectively. In the three months ended December 31, 2014 and 2013, Ningbo Zhehua generated revenue of $8.4 million and $15.3 million, which represented 9.9% and 11.9% of our total revenue, respectively. In addition, in the three months ended December 31, 2014 and 2013, Sutor Technology PRC generated revenue of $0.8 million and $2.1 million, which represented 1.0% and 1.6% of our total revenue, respectively.

 

Historically a portion of our products was sold through our affiliate Shanghai Huaye, which also supplied to us a significant portion of our raw materials. Approximately 41.3% of our revenue was derived from Shanghai Huaye and its affiliates in the three months ended December 31, 2014, as compared to 20.3% last year. We are considering integration of downstream and upstream industrial resources from related parties in order to leverage our own brand value and improve brand operational performance.

 

Cost of Revenue

 

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

 

In the three months ended December 31, 2014, approximately $32.9 million of raw material procurement was conducted through Shanghai Huaye and its affiliates. Due to the size of Shanghai Huaye and the economy of scale, it has stronger bargaining power than we do and our arrangement with Shanghai Huaye allows us to purchase raw materials at relatively lower prices than we could obtain from suppliers ourselves.

 

Gross Profit and Gross Margin

 

Gross profit is equal to the difference between revenue and the cost of revenue. Gross margin is equal to gross profit divided by revenue. For the three months ended December 31, 2014, gross margin for domestic and international sales was 5.8% and 25.2%, respectively, as compared with 10.0% and 20.6%, respectively, in the same period last year. On a segment basis, Changshu Huaye, Jiangsu Cold-Rolled and Ningbo Zhehua’s gross margins were approximately 4.2%, 7.2% and (2.8)%, respectively. Sutor Technology PRC has a gross margin of approximately 14.7% for the second quarter of fiscal 2015.

 

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. For the second quarter of fiscal 2015, we did not produce PPGI steel as the production line was shut down for scheduled technical upgrading, which reduced our revenue and lowered our overall gross margin. We expect that our revenue and overall gross margin will improve after February 2015 when the upgrading of PPGI production line is completed.

 

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 solution services, build customer loyalty, and maintain stable operating margins.

 

4
 

 

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, research and development expenses and other expenses incurred in connection with general corporate purposes. The change in general and administrative expenses is generally commensurate with the change in our revenue.

 

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.

 

Provision for Income Taxes

 

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

 

On March 16, 2007, the National People’s Congress of China passed a new Enterprise Income Tax Law, or the EIT Law, and on December 6, 2007, the State Council of China passed its implementing rules, which took effect on January 1, 2008. The EIT Law gives existing foreign invested enterprises 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, Jiangsu provincial government renewed the high-tech enterprise status of Changshu Huaye. As a result, Changshu Huaye is entitled to the preferred tax rate of 15% for the three years 2013 through 2016. 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.

 

Recent Development

 

On February 8, 2015, Changshu Huaye entered into a non-binding letter of intent (the “LOI”) with the shareholders of Shanghai Huaye. The LOI contemplates a transaction in which Changshu Huaye will acquire Shanghai Huaye, pursuant to which it is expected that Changshu Huaye will become a controlling shareholder of Shanghai Huaye when the transaction is completed. Consummation of the transaction is subject to entry into a definitive agreement between the parties containing specific singing and closing terms and conditions yet to be negotiated.

 

Results of Operations

 

Comparison of Three Months Ended December 31, 2014 and December 31, 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 revenue.

 

5
 

 

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

 

   Three Months Ended
December 31, 2014
   Three Months Ended
December 31, 2013
 
   Amount   % of
Revenue
   Amount   % of
Revenue
 
Revenue from unrelated parties  $22,304    26.1%  $102,230    79.7%
Revenue from related parties   62,998    73.9%   26,087    20.3%
Total Revenue   85,302    100.0%   128,317    100.0%
Cost of Revenue   80,030    93.8%   114,691    89.4%
Gross Profit   5,272    6.2%   13,626    10.6%
Operating Expenses                    
Selling expense   757    0.9%   1,338    1.0%
General and administrative expense   1,887    2.2%   2,625    2.1%
Total Operating Expenses   2,644    3.1%   3,963    3.1%
Income from Operations   2,628    3.1%   9,663    7.5%
Other Income (Expense)                    
Interest income   169    0.2%   786    0.6%
Other income   19    -    175    0.2%
Interest expense   (2,438)   (2.9)%   (2,575)   (2.0)%
Other expense   (118)   (0.1)%   (202)   (0.2)%
Changes in fair value of warrant liabilities   -    -    (54)   - 
Income from equity method investments   -    -    181    0.1%
Total Other Expenses, net   (2,368)   (2.8)%   (1,689)   (1.3)%
Income Before Taxes   260    0.3%   7,974    6.2%
Income tax (expense)/benefit   (233)   (0.3)%   (1,579)   (1.2)%
Net Income  $27    -   $6,395    5.0%

 

Revenue. For the three months ended December 31, 2014, revenue was $85.3 million, compared to $128.3 million for the same period last year, a decrease of $43.0 million, or 33.5%. The decrease was mainly attributable to the change in our business model. In the past, our revenue was primarily derived from selling manufactured products and the sales price included the cost of steel sheets plus a gross profit. With the fee-based processing services, the price of pure processing services does not include the cost of steel sheets as the customers are responsible for procurement of the raw materials. As a result, revenue from processing one ton of fine finished steel products is only a fraction of the revenue from the traditional business model. We believe that the fee-based model is more measurable and allows us to better adapt to the changes in the Chinese economy and improve company competitiveness. For the three months ended December 31, 2014, the volume of fee-based processing represents approximately 20% of the total production volume, while very minimum fee-based processing service revenue for the same period in last year.

 

The following table sets forth revenue by geography and by business segments for the three months ended December 31, 2014 and 2013.

 

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

 

   Three Months Ended
December 31, 2014
   Three Months Ended
December 31, 2013
 
   Amount   % of
Revenue
   Amount   % of
Revenue
 
Geographic Data                    
China  $83,831    98.3%  $123,212    96.0%
Other Countries   1,471    1.7%   5,105    4.0%
                     
Segment Data                    
Changshu Huaye  $26,964    31.6%  $54,351    42.4%
Jiangsu Cold-Rolled   49,066    57.5%   56,588    44.1%
Ningbo Zhehua   8,437    9.9%   15,314    11.9%
Sutor Technology PRC   835    1.0%   2,064    1.6%

 

On a geographic basis, revenue generated from outside of China was $1.5 million, or 1.7% of the total revenue, for the three months ended December 31, 2014, as compared to $5.1 million, or 4.0% of the total revenue, for the same period in 2013. The decrease was mainly because of the decline in demand for our products and the upgrading of PPGI production line. As a result, we did not produce the PPGI products which are our main exported products.

 

6
 

 

On a segment basis, after eliminating intercompany sales and adjusting reconciliation items, revenue contributed by Changshu Huaye was $27.0 million for the three months ended December 31, 2014, reflecting a decrease of $27.4 million, or 50.4%, from $54.4 million for the same period last year. The decrease mainly resulted from the transformation of our business model as well as the shutdown of the PPGI line for technical upgrading.

 

After eliminating inter-company sales and adjusting reconciliation items, revenue contributed by Jiangsu Cold-Rolled was $49.1 million for the three months ended December 31, 2014, as compared at $56.6 million for the same period last year. As explained above, the decrease in sales revenue was mainly because of changes in our business model.

 

Revenue contributed by Ningbo Zhehua was $8.4 million for the three months ended December 31, 2014, a decrease of $6.9 million, or 45.1%, from $15.3 million for the same period in 2013, primarily resulting from changes in our business model.

 

Revenues contributed by Sutor Technology PRC were $0.8 million for the three months ended December 31, 2014, a decrease of approximately $1.3 million from $2.1 million for the same period in 2013, primarily resulting from the reduced demand for our products.

 

In terms of sales to related party as compared with sales to unrelated parties, our direct sales to unrelated parties in the three months ended December 31, 2014 decreased by $79.9 million, or 78.2%, to $22.3 million, from $102.2 million in the same period in 2013.

 

Cost of revenue. Cost of revenue decreased by $34.7 million, or 30.3%, to $80.0 million in the three months ended December 31, 2014, from $114.7 million in the same period in 2013. As a percentage of revenue, cost of revenue increased to 93.8% in the three months ended December 31, 2014, as compared to 89.4% in the same period last year. The decrease in cost of revenue was mainly due to our new fee-based processing model that part of our business became pure processing service, which significantly reduced our cost of revenue. However, its percentage of revenue increased because those fixed costs including depreciation and amortization cost did not decrease at the early stage of our transformation period.

 

Gross profit and gross margin. Gross profit decreased by $8.3 million to $5.3 million in the three months ended December 31, 2014, from $13.6 million in the same period in 2013. Gross profit as a percentage of revenue (gross margin) was 6.2% for the three months ended December 31, 2014, as compared to 10.6% for the same period last year. The main reason for the declined gross margin was the scheduled technical upgrading of our PPGI production line and as a result, we did not produce high margin PPGI products. In addition, in order to speed up our transformation, we offered more competitive prices for processing services to attract more customers.

 

On a segment basis, gross margin for Changshu Huaye decreased to 4.2% in the three months ended December 31, 2014, from 13.4% in the same period last year. Gross margin for Jiangsu Cold-Rolled decreased to 7.2% in the three months ended December 31, 2014, from 9.0% in the same period last year. Gross margin for Ningbo Zhehua decreased to (2.8)% in the three months ended December 31, 2014, as compared to 5.3% in the same period in 2013. The main reason for above decreased gross margins was because of our ongoing business model transformation and PPGI production line upgrading. Gross margin for Sutor Technology PRC was 14.7% in the three months ended December 31, 2014, as compared to 6.3% in the same period last year, resulting from the functional change of Sutor Technology PRC to be a center of our brand building and order services offering higher value-added customized service.

 

Total operating expenses. Our total operating expenses decreased by $1.4 million to $2.6 million in the three months ended December 31, 2014, from $4.0 million in the same period in 2013. As a percentage of revenue, our total operating expenses remained 3.1% in the three months ended December 31, 2014, the same as in the same period last year.

 

Selling expenses. Our selling expenses decreased by $0.5 million to $0.8 million in the three months ended December 31, 2014, from $1.3 million in the same period in 2013. As a percentage of revenue, our selling expenses decreased to 0.9% for the three months ended December 31, 2014, from 1.0% for the same period last year. The decrease was mainly due to reduced shipping, handling and miscellaneous expenses of approximately $0.65 million as a result of our declined sales.

 

General and administrative expenses. General and administrative expenses was $1.9 million, or 2.2% of the total revenue, in the three months ended December 31, 2014, as compared with $2.62 million, or 2.1% of the revenue, in the same period in 2013. The decrease was primarily due to reduced office expenses and miscellaneous local fees resulted from the reduction of our sales.

 

7
 

 

Interest Income. Our interest income decreased by $0.6 million to $0.2 million in the three months ended December 31, 2014, from $0.8 million in the same period in 2013. As a percentage of revenue, our interest expense was 0.2% of total revenue in the three months ended December 31, 2014, compared to 0.6% in the same period in 2013. The decrease was mainly due to a change in financing structure. Our notes payable decreased during the three months ended December 31, 2014, which resulted in less restricted cash and accordingly lower interest income. The decrease of notes payable reduced our discounted cost and financial cost.

 

Interest expense. Our interest expense decreased by $0.2 million to $2.4 million in the three months ended December 31, 2014, from $2.6 million in the same period in 2013. As a percentage of revenue, our interest expense was 2.9% of total revenue in the three months ended December 31, 2014, compared to 2.0% in the same period in 2013. The decrease was mainly due to the fact that some of our bank acceptances were converted into short term loans, which reduced our interest expense.

 

Provision for income taxes. Our income tax expense decreased to $0.2 million in the three months ended December 31, 2014, from $1.6 million of income tax benefit in the same period last year, mainly due to the decreased taxable profit amount.

 

Net income. Net income, without including the foreign currency translation adjustment, decreased by $6.37 million, or 99.5%, to $0.03 million in the three months ended December 31, 2014, from $6.4 million in the same period in 2013, as a cumulative result of the above factors.

 

Comparison of Six Months Ended December 31, 2014 and December 31, 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 revenue.

 

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

 

   Six Months Ended
December 31, 2014
   Six Months Ended
December 31, 2013
 
   Amount   % of
Revenue
   Amount   % of
Revenue
 
Revenue from unrelated parties  $39,296    31.9%  $204,412    76.4%
Revenue from related parties   83,994    68.1%   63,013    23.6%
Total Revenue   123,290    100.0%   267,425    100.0%
Cost of Revenue   119,862    97.2%   241,597    90.3%
Gross Profit   3,428    2.8%   25,828    9.7%
Operating Expenses                    
Selling expense   1,026    0.8%   3,333    1.3%
General and administrative expense   4,137    3.4%   5,529    2.0%
Total Operating Expenses   5,163    4.2%   8,862    3.3%
Income from Operations   (1,735)   (1.4)%   16,966    6.4%
Other Income (Expense)                    
Interest income   616    0.5%   1,837    0.7%
Other income   293    0.2%   219    0.1%
Interest expense   (5,416)   (4.4)%   (4,378)   (1.7)%
Other expense   (185)   (0.1)%   (220)   (0.1)%
Changes in fair value of warrant liabilities   -    -    (67)   - 
Equity in gain of affiliated company   -    -    266    0.1%
Total Other Expenses, net   (4,692)   (3.8)%   (2,343)   (0.9)%
Income Before Taxes   (6,427)   (5.2)%   14,623    5.5%
Income tax (expense)/benefit   1,362    1.1%   (3,040)   (1.2)%
Net Income  $(5,065)   (4.1)%  $11,583    4.3%

 

8
 

 

Revenue. For the six months ended December 31, 2014, revenue was $123.3 million, compared to $267.4 million for the same period last year, a decrease of $144.1 million, or 53.9%. The decrease was mainly attributable to the change in our business model. As described above, under our new fee-based processing service model, the price of pure processing services does not include the cost of steel sheets as the customers are responsible for procurement of the raw materials. As a result, revenue from processing one ton of fine finished steel products is only a fraction of the revenue from the traditional business model. For the six months ended December 31, 2014, the volume of fee-based processing represents approximately 20% of the total production volume, while very minimum fee-based processing service revenue for the same period in last year. 

 

The following table sets forth revenue by geography and by business segments for the six months ended December 31, 2014 and 2013.

 

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

 

   Six Months Ended
December 31, 2014
   Six Months Ended
December 31, 2013
 
   Amount   % of
Revenue
   Amount   % of
Revenue
 
Geographic Data                    
China  $120,774    98.0%  $244,227    91.3%
Other Countries   2,516    2.0%   23,198    8.7%
                     
Segment Data                    
Changshu Huaye  $34,654    28.1%  $118,488    44.3%
Jiangsu Cold-Rolled   76,873    62.3%   111,120    41.5%
Ningbo Zhehua   10,793    8.8%   31,228    11.7%
Sutor Technology PRC   970    0.8%   6,589    2.5%

 

On a geographic basis, revenue generated from outside of China was $2.5 million, or 2.0% of the total revenue, for the six months ended December 31, 2014, as compared to $23.2 million, or 8.7% of the total revenue, for the same period in 2013. The decrease was mainly because of the upgrading of PPGI production line. As a result, we did not produce the PPGI products which are our main exported products.

 

On a segment basis, after eliminating intercompany sales and adjusting reconciliation items, revenue contributed by Changshu Huaye was $34.7 million for the six months ended December 31, 2014, reflecting a decrease of $83.8 million, or 70.7%, from $118.5 million for the same period last year. The decrease mainly resulted from the transformation of business model as well as the shutdown of the PPGI line for technical upgrading.

 

After eliminating inter-company sales and adjusting reconciliation items, revenue contributed by Jiangsu Cold-Rolled was $76.9 million for the six months ended December 31, 2014, as compared at $111.1 million for the same period last year. As explained above, the decrease in sales revenue was mainly because of the transformation of our business model.

 

Revenue contributed by Ningbo Zhehua was $10.8 million for the six months ended December 31, 2014, a decrease of $20.4 million, or 65.4%, from $31.2 million for the same period in 2013. The decrease in sales revenue was mainly because of the transformation of our business model to one based on processing fee charges and timing of contract delivery.

 

Revenues contributed by Sutor Technology PRC were $1.0 million for the six months ended December 31, 2014, a decrease of approximately $5.6 million from $6.6 million for the same period in 2013, primarily resulting from the decline in demand for our products.

 

In terms of sales to related party as compared with sales to unrelated parties, our direct sales to unrelated parties in the six months ended December 31, 2014 decreased by $165.1 million, or 80.8%, to $39.3 million, from $204.4 million in the same period in 2013.

 

Cost of revenue. Cost of revenue decreased by$121.7 million, or 50.4%, to $119.9 million in the six months ended December 31, 2014, from $241.6 million in the same period in 2013. As a percentage of revenue, cost of revenue increased to 97.2% in the six months ended December 31, 2014, as compared to 90.3% in the same period last year. The decrease in cost of revenue was mainly due to our new fee-based processing model that part of our business became pure processing service, which significantly reduced our cost of revenue However, its percentage of revenue increased because those fixed costs including depreciation and amortization cost did not decrease at the early stage of our transformation period.

 

9
 

 

Gross profit and gross margin. Gross profit decreased by $22.4 million to $3.4 million in the six months ended December 31, 2014, from $25.8 million in the same period in 2013. Gross profit as a percentage of revenue (gross margin) was 2.8% for the six months ended December 31, 2014, as compared to 9.7% for the same period last year. The main reason for the declined gross margin was our scheduled technical upgrading of the PPGI production line. As a result, we did not produce PPGI products, which generally have a higher margin than our other products. In addition, in order to speed up our transformation, we offered processing services with competitive prices to attract more customers, which also reduced our gross margin.

 

On a segment basis, gross margin for Changshu Huaye decreased to 3.8% in the six months ended December 31, 2014, from 12.2% in the same period last year. Gross margin for Jiangsu Cold-Rolled decreased to 3.0% in the six months ended December 31, 2014, from 8.9% in the same period last year. Gross margin for Ningbo Zhehua decreased to (4.6)% in the six months ended December 31, 2014, as compared to 4.1% in the same period in 2013. The main reason for above decreased gross margins was because of our ongoing business model transformation, PPGI production line upgrading and the delivery timing of various steel pipes. Gross margin for Sutor Technology PRC was 24.8% in the six months ended December 31, 2014, as compared to 4.2% in the same period last year, resulting from the functional change of Sutor Technology PRC to be a center of our brand building and order services offering higher value-added customized service.

 

Total operating expenses. Our total operating expenses decreased by $3.7 million to $5.2 million in the six months ended December 31, 2014, from $8.9 million in the same period in 2013. As a percentage of revenue, our total operating expenses decreased to 4.2% in the six months ended December 31, 2014, from 3.3% in the same period in 2013.

 

Selling expenses. Our selling expenses decreased by $2.3 million to $1.0 million in the six months ended December 31, 2014, from $3.3 million in the same period in 2013. As a percentage of revenue, our selling expenses decreased to 0.8% for the six months ended December 31, 2014, from 1.3% for the same period last year. The decrease was mainly due to reduced shipping, handling and miscellaneous expenses of approximately $1.9 million as our sales, especially international sales reduced significantly during the six months ended on December 31, 2014.

 

General and administrative expenses. General and administrative expenses was $4.1 million, or 3.4% of the total revenue, in the six months ended December 31, 2014, as compared with $5.5 million, or 2.1% of the revenue, in the same period in 2013. The decrease was primarily due to the decrease of office expenses, miscellaneous local fees, staff benefits and business entertainment expenses.

 

Interest Income. Our interest income decreased by $1.2 million to $0.6 million in the six months ended December 31, 2014, from $1.8 million in the same period in 2013. As a percentage of revenue, our interest expense was 0.5% of total revenue in the six months ended December 31, 2014, compared to 0.7% in the same period in 2013. The decrease was mainly due to a change in financing structure. Our notes payable decreased during the six months ended December 31, 2014, which resulted in less restricted cash and accordingly lower interest income. The decrease of notes payable reduced our discounted cost and financial cost.

 

Interest expense. Our interest expense increased by $1.0 million to $5.4 million in the six months ended December 31, 2014, from $4.4 million in the same period in 2013. As a percentage of revenue, our interest expense was 4.4% of total revenue in the six months ended December 31, 2014, compared to 1.6% in the same period in 2013. The increase in interest expense was mainly due to the adjustment of financing structure that we changed bank note payables to short term loans, which reduced the restricted cash and improved financial liquidity.

 

Provision for income taxes. Our income tax benefit is $1.4 million in the six months ended December 31, 2014, increased from $3.0 million of income tax expense in the same period last year, which was mainly due to the decreased taxable profit.

 

Net income. Net income, without including the foreign currency translation adjustment, decreased by $16.7 million, or 144.0%, to $(5.1) million in the six months ended December 31, 2014, from $11.6 million in the same period in 2013, as a cumulative result of the above factors.

 

Liquidity and Capital Resources

 

Our major sources of liquidity for the periods covered by this quarterly report were mainly borrowings through short-term bank loans. Our net cash used in operating activities was approximately $75.1 million for the six months ended December 31, 2014. As of December 31, 2014, our total indebtedness to non-related parties under existing short-term loans was approximately $202.9 million. There was no current portion of long-term loans as of December 31, 2014. We also had approximately $11.0 million under long-term loans. As of December 31, 2014, we had an unused line of credit with banks of approximately $30.9 million (RMB190 million) which entitled us to draw bank loans for general corporate purposes.

 

10
 

 

Short-term and long-term banks loans 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 bank 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 a challenging economic climate, increased competition, decreases in the availability, or increases in the cost of raw materials, unexpected equipment failures, or regulatory changes.

 

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

 

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

 

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

 

As of December 31, 2014, we had cash and cash equivalents of $3.3 million and no restricted cash. The following table provides detailed information about our net cash flow for the financial statement period presented in this report.

 

Cash Flow

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

 

   Six Months Ended December 31, 
   2014   2013 
Net cash (used in) provided by operating activities  $(75,068)  $14,861 
Net cash (used in) investing activities   2,762    (11,625)
Net cash provided by financing activities   63,371    5,601 
Effect of foreign currency translation on cash and cash equivalents   64    87 
Net cash flows   (8,871)   8,924 

 

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Operating Activities

 

Net cash used in operating activities was $75.1 million for the six months ended December 31, 2014, as compared to $14.9 million cash provided by operating activities for the same period last year. The increase in net cash used by operating activities was primarily due to increased prepayment of approximately $21.4 million to suppliers, increased accounts payable of $0.6 million, reduced notes payable of 126.8 million, net income of $(5.1) million, reduced advances from customers of $13.7 million, and depreciation and amortization of $4 million, partially offset by the reduced inventory of $49.2 million, reduced restricted cash of $60.9 million and increased trade and notes receivable of $33 million. We are taking measures to balance our accounts payable and receivable in an effort to maintain adequate liquidity. The recent inventory consisted of mostly raw steel materials. From the first quarter to the second quarter of fiscal 2015, our inventory of finished goods decreased by approximately $30.6 million. The decrease of inventories was mainly due to the upgrade of PPGI production line so purchase of raw materials was reduced.

 

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 provided in investing activities was $2.8 million for the six months ended December 31, 2014, as compared to $11.6 million used in investing activities for the same period last year. During the six months ended December 31, 2014, we received proceeds from sale of short-term investments of $3.3 million, which was partially offset by the purchase of plant and equipment for $0.5 million.

 

Financing Activities

 

Net cash provided by financing activities was $63.4 million for the six months ended December 31, 2014, as compared to $5.6 million provided by financial activities for the same period in 2013. The increase in cash flow provided by financing activities was mainly due to proceeds from loans of $111.4 million, among which approximately $48.0 million was used to repay matured loans.

 

As of December 31, 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**
Communications Bank of China, Changshu Branch  $3.3   2013-11-04  2015-11-03  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
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

 

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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
Construction Bank of China, Changshu   3.8   2014-07-28  2015-07-27  Shanghai Huaye
Industrial and Commercial Bank of China, Changshu Branch   3.7   2014-08-19  2015-08-18  Shanghai Huaye,  Ningbo Zhehua
Construction Bank of China, Changshu   5.4   2014-08-08  2015-08-07  Shanghai Huaye
Construction Bank of China, Changshu   2.7   2014-08-14  2015-08-13  Shanghai Huaye
Industrial and Commercial Bank of China, Changshu Branch   0.4   2014-08-27  2015-08-26  Shanghai Huaye,  Ningbo Zhehua
Construction Bank of China, Changshu   6.5   2014-10-15  2015-10-14  Shanghai Huaye
Construction Bank of China, Changshu   4.4   2014-10-21  2015-04-28  Shanghai Huaye
Construction Bank of China, Changshu   2.0   2014-11-22  2015-05-21  Shanghai Huaye
Communications Bank of China, Changshu Branch   4.8   2014-10-17  2015-10-17  Shanghai Huaye, Jiangsu Cold-Rolled, Ningbo Zhehua
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   3.3   2014-04-30  2015-04-17  Shanghai Huaye, Changshu Huaye
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   0.7   2014-04-15  2015-04-14  Shanghai Huaye, Changshu Huaye
Industrial and Commercial Bank of China, Changshu Branch   1.3   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   0.3   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   3.3   2014-06-23  2015-06-22  Shanghai Huaye, Changshu Huaye
The Agricultural Bank of China, Changshu Branch   4.1   2014-06-23  2015-06-22  Shanghai Huaye, Changshu Huaye

 

13
 

 

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   1.8   2014-06-27  2015-06-26  Shanghai Huaye, Changshu Huaye
Industrial and Commercial Bank of China, Changshu Branch   1.5   2014-07-16  2015-07-10  Shanghai Huaye, Changshu Huaye
Industrial and Commercial Bank of China, Changshu Branch   1.0   2014-07-16  2015-07-15  Shanghai Huaye, Changshu Huaye
Industrial and Commercial Bank of China, Changshu Branch   4.0   2014-07-18  2015-07-17  Shanghai Huaye, Changshu Huaye
Industrial and Commercial Bank of China, Changshu Branch   3.4   2014-07-25  2015-07-21  Shanghai Huaye, Changshu Huaye
Industrial and Commercial Bank of China, Changshu Branch   4.0   2014-07-18  2015-07-18  Shanghai Huaye, Changshu Huaye
The Agricultural Bank of China, Changshu Branch   3.2   2014-08-15  2015-08-14  Shanghai Huaye, Changshu Huaye
The Agricultural Bank of China, Changshu Branch   3.2   2014-08-15  2015-08-14  Shanghai Huaye, Changshu Huaye
The Agricultural Bank of China, Changshu Branch   3.2   2014-08-15  2015-08-14  Shanghai Huaye, Changshu Huaye
The Agricultural Bank of China, Changshu Branch   3.2   2014-08-15  2015-08-14  Shanghai Huaye, Changshu Huaye
The Agricultural Bank of China, Changshu Branch   3.3   2014-08-16  2015-08-15  Shanghai Huaye, Changshu Huaye
The Agricultural Bank of China, Changshu Branch   3.3   2014-08-16  2015-08-15  Shanghai Huaye, Changshu Huaye
The Agricultural Bank of China, Changshu Branch   3.3   2014-08-16  2015-08-15  Shanghai Huaye, Changshu Huaye
Industrial and Commercial Bank of China, Changshu Branch   3.3   2014-08-08  2015-08-06  Shanghai Huaye, Changshu Huaye
Industrial and Commercial Bank of China, Changshu Branch   3.8   2014-08-14  2015-08-11  Shanghai Huaye, Changshu Huaye
Industrial and Commercial Bank of China, Changshu Branch   1.0   2014-09-17  2015-09-11  Shanghai Huaye, Changshu Huaye
Industrial and Commercial Bank of China, Changshu Branch   4.0   2014-09-19  2015-03-17  Shanghai Huaye, Changshu Huaye
Industrial and Commercial Bank of China, Changshu Branch   4.0   2014-09-19  2015-03-18  Shanghai Huaye, Changshu Huaye
Industrial and Commercial Bank of China, Changshu Branch   1.8   2014-09-10  2015-09-09  Shanghai Huaye, Changshu Huaye
Construction Bank of China, Changshu   1.1   2014-09-22  2015-09-21  Shanghai Huaye, Changshu Huaye
Industrial and Commercial Bank of China, Changshu Branch   1.6   2014-10-14  2015-10-13  Shanghai Huaye, Changshu Huaye
Industrial and Commercial Bank of China, Changshu Branch   3.6   2014-10-10  2015-04-09  Shanghai Huaye, Changshu Huaye
Communications Bank of China, Changshu Branch   3.1   2014-10-08  2015-10-08  Shanghai Huaye, Changshu Huaye
Communications Bank of China, Changshu Branch   5.4   2014-12-25  2015-12-25  Shanghai Huaye, Changshu Huaye
The Agricultural Bank of China, Ningbo  Branch   3.3   2014-01-27  2014-07-25  Shanghai Huaye, Changshu Huaye
Pingan Bank, Ningbo Branch   2.3   2014-08-25  2015-08-25  Shanghai Huaye, Changshu Huaye
Pingan Bank, Ningbo Branch   1.6   2014-09-30  2015-09-30  Shanghai Huaye, Changshu Huaye

 

14
 

 

Lin, Guihua   2.9   2008-11-20  2016-12-31  None
Shanghai Huaye   8.2   2013-12-31  2016-12-31  None
Total   213.9          

 

 

* Calculated on the basis that $1 = RMB6.15

 

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

 

The loan agreements with banks generally contain debt covenants that require us to maintain certain financial and operating condition, among other things. We believe that we were in compliance with these debt covenants as of December 31, 2014.

 

In the coming twelve months, we will have approximately $202.9 million in bank loans that will mature. We plan to replace these loans with new bank loans in approximately the same aggregate amounts.

 

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

 

Critical Accounting Policies

 

Critical accounting policies are those we believe are most important to portraying our financial conditions and results of operations and also require the greatest amount of subjective or complex judgments by management. Judgments and uncertainties regarding the application of these policies may result in materially different amounts being reported under various conditions or using different assumptions. There have been no material changes to the critical accounting policies previously disclosed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2014.

 

Recent Accounting Pronouncements

 

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

 

Seasonality

 

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

 

Off Balance Sheet Arrangements

 

We do not have any off-balance arrangements.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

Not applicable.

 

ITEM 4. 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. Jun Xu, 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 management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on that evaluation, Ms. Chen and Mr. Xu concluded that as of December 31, 2014, our disclosure controls and procedures were effective.

 

15
 

 

Changes in Internal Control Over Financial Reporting

 

There were no changes in our internal controls over financial reporting during the second quarter of fiscal year 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II

OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS.

 

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

 

ITEM 1A. RISK FACTORS.

 

Not applicable.

 

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

 

We have not sold any equity securities during the second quarter of fiscal year 2015 that were not previously disclosed in a quarterly report on Form 10-Q or a current report on Form 8-K that was filed during the quarter.

 

During the three month period ended December 31, 2014, we did not repurchase any shares of our common stock.

 

No repurchase plans expired or were terminated during the second quarter of fiscal year 2015, nor do any plans exist under which we do not intend to make further purchases.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES.

 

Not applicable.

 

ITEM 5. OTHER INFORMATION.

 

None.

 

ITEM 6. EXHIBITS.

 

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

 

16
 

 

SIGNATURES

 

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

 

Date: February 17, 2015 SUTOR TECHNOLOGY GROUP LIMITED
     
  By:  /s/ Lifang Chen
    Lifang Chen, Chief Executive Officer
    (Principal Executive Officer)

 

  By:  /s/ Jun Xu
    Jun Xu, Chief Financial Officer
   

(Principal Financial Officer and Principal

Accounting Officer)

 

17
 

 

EXHIBIT INDEX

 

Exhibit No.   Description
10.1   Independent Director Contract, dated February 1, 2015, by and between the Company and Guoyou Shao.
10.2   Independent Director Contract, dated February 16, 2015, by and between the Company and Xinchuang Li
10.3   Annual Product Supply Contract, dated December 10, 2014, by and between Ningbo Zhehua and Shanghai Legang Supply Chain Co., Ltd.
10.4   Annual Product Supply Contract, dated December 10, 2014, by and between Jiangsu Cold-Rolled and Shanghai Legang Supply Chain Co., Ltd.
10.5   Annual Product Supply Contract, dated December 10, 2014, by and between Changshu Huaye and Shanghai Legang Supply Chain Co., Ltd.
31.1   Certifications of Principal Executive Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2   Certifications of Principal Financial Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1   Certifications of Principal Executive Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2   Certifications of Principal Financial Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101   Interactive data files pursuant to Rule 405 of Regulation S-T (furnished herewith).

  

18