Attached files
file | filename |
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8-K - Sutor Technology Group LTD | v168127_8k.htm |
EX-99.2 - Sutor Technology Group LTD | v168127_ex99-2.htm |
EX-99.3 - Sutor Technology Group LTD | v168127_ex99-3.htm |
EX-23.1 - Sutor Technology Group LTD | v168127_ex23-1.htm |
Exhibit
99.1
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND
RESULTS OF OPERATIONS.
In
November 2009, the Company completed the acquisition of Ningbo Zhehua. Because
the acquisition represents a transaction between entities under common control,
the Company’s historical financial information has been adjusted, similar to a
pooling of interests, to include the financial position, results of operations
and cash flows of Ningbo Zhehua for all periods presented. Accordingly, the
following Management’s Discussion and Analysis of Financial Condition and
Results of Operations has been adjusted from that presented in the Company’s
2009 Annual Report on Form 10-K.
The
Company’s adjusted financial statements are included as Exhibit 99.2 to
this Report that includes this adjusted Management’s Discussion and Analysis of
Financial Condition and Results of Operations. The following discussion and
analysis of the Company’s financial condition and results of operations should
be read in conjunction with the adjusted financial statements, including the
accompanying notes and the unaudited supplementary information included
therein.
Overview
We are
one of the leading Chinese private manufacturers of fine finished steel products
used by steel fabricators and other applications. 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 (“HDG Steel”) and prepainted galvanized steel (“PPGI”). In
addition, we produce acid pickled steel ("AP Steel") and cold-rolled steel,
which represent the less processed of our finished products. As a result of our
recent acquisition of Ningbo Zhehua, our product offerings are now expanded to
welded steel pipe products. A large portion of our AP Steel and cold-rolled
steel is used for our production of HDG Steel and PPGI products. Our vertical
integration has allowed us to maintain more stable margins for our HDG Steel and
PPGI products.
We
operate in the highly competitive steel industry and face strong competition
from numerous PRC and international companies. Our business is affected by a
number of factors, including, but not limited to, cost to manufacture products,
financial stability of our customers and suppliers, economic conditions, ability
to develop new products, political climate, local and national laws and
regulations and foreign currency exchange fluctuations. As part of our growing
strategy, we continually seek to broaden our market reach by
introducing new production lines and improve our profit margin by vertical
integration. In fiscal year 2009, our subsidiary Jiangsu Cold-Rolled added two
new HDG Steel production lines which are capable of galvanizing both hot-rolled
and cold-rolled steel with both zinc and aluminum. We expect the addition of the
new production lines will help our revenue growth in the future.
We have
several strategic priorities designed to create long-term sustainable growth for
our company and value for our shareholders, including vertical integration,
developing new products, increasing production capacity, and strengthening of
our research and development capabilities.
Recent
Event
On
November 6, 2009, our subsidiary Changshu Huaye entered into an equity transfer
agreement with Shanghai Huaye pursuant to which Changshu Huaye purchased a 100%
equity interest in Ningbo Zhehua for the total purchase price of RMB
45,172,855.34 (approximately $6.6 million). Ningbo Zhehua manufactures and sells
a variety of welded steel pipes The acquisition closed on November 10,
2009.
Our major
shareholder, chief executive officer and chairwoman, Lifang Chen and her husband
Feng Gao are 100% owners of Shanghai Huaye. As a result, the Agreement with
Shanghai Huaye was identified and acknowledged by the Company’s Board of
Directors from the outset as a related party transaction and an independent
appraiser was hired by the Audit Committee composed of all the independent
directors to assist in determining the value of Ningbo Zhehua. On November 5,
2009, the Audit Committee of the Board approved the related-party transaction
and recommended approval of the Agreement to the Board. The Board approved the
Agreement on November 5, 2009, with Ms. Chen abstaining. Please see
the Company’s current report on Form 8-K filed on November 10, 2009 for more
details.
Revenue
Our
revenue is generated from sales of our HDG Steel, PPGI, AP Steel, and
cold-rolled steel products. As a result of the recent acquisition of Ningbo
Zhehua, our revenue also is generated 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.
Our
operations consist of three business segments: Changshu Huaye, Jiangsu
Cold-Rolled and Ningbo Zhehua, which are our three principal manufacturing
facilities. Changshu Huaye currently manufactures HDG Steel and PPGI products.
In fiscal years 2009 and 2008, Changshu Huaye generated revenue of $237.8
million and $260.5 million which represented 55.3% and 55.4% of our total
revenue, Jiangsu Cold-rolled currently manufactures AP Steel, cold-rolled steel,
and HDG Steel. Jiangsu Cold-Rolled generated revenue of $103.7 million and
$157.5 million in fiscal years 2009 and 2008, representing 24.1% and 33.5% of
our total revenue, respectively. Ningbo Zhehua manufactures and sells steel pipe
products. In fiscal years 2009 and 2008, it generated revenue of
$88.3 million and $52.2 million which represented 20.5% and 11.1% of our total
revenue, respectively.
A
substantial portion of our products are sold through our affiliate Shanghai
Huaye. Approximately 44.6% of our revenue was derived from Shanghai Huaye and
its affiliates in fiscal year 2009. We plan to further diversify our customer
base to enhance profitability.
Cost
of Revenue
Cost of
revenue includes direct costs to manufacture products, including the cost of raw
materials, labor, overhead, energy cost, handling charges, and other expenses
associated with the manufacture and delivery of product.
Direct
costs of manufacturing are generally highest when we first introduce a new
product due to higher associated 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. Our new HDG production lines, which started operation at the
end of September 2008, had a relatively high cost of production in fiscal year
2009. As these two production lines start to operate at normal levels, we expect
our manufacturing efficiency will improve in the future.
Gross
Profit and Gross Margin
Gross
profit is equal to the difference between our revenue and the cost of revenue.
Gross margin is equal to gross profit divided by revenue. In fiscal year 2009,
the gross margins of Changshu Huaye and Jiangsu Cold-Rolled, Ningbo Zhehua were
12.1% ,4.0%, and 4.0%, respectively. Gross margins for domestic and
international sales were approximately 7.4% and 17.6%, respectively. Changes in
our gross margins are primarily driven by changes in our product mix, economies
of scale, and our vertical integration strategy.
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 products of comparable quality to
our Chinese state-owned competitors and international competitors at lower
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.
In
January 2007, we implemented a vertical integration strategy where we use our
own AP Steel and cold-rolled steel products as raw materials for HDG Steel
products and HDG Steel products as raw materials for PPGI products. We believe
this vertical integration of our operations will allow us to maintain more
stable margins for our HDG Steel and PPGI products.
Operating
Expenses
Our
operating expenses consist of selling expense and general and administrative
expenses.
General
and Administrative Expenses
General
and administrative expenses consist primarily of compensation and benefits for
our general management, finance and administrative staff, professional and
advisory fees, bad debts reserves, and other expenses incurred in connection
with general corporate purposes. We expect most components of our general and
administrative expenses will increase as our business grows and as we incur
increased costs as a public company.
Selling
Expenses
Selling
expenses consist primarily of compensation and benefits for our sales and
marketing staff, sales commissions, the cost of advertising, promotional and
travel activities, transportation expenses, after-sales support services and
other sales related costs.
Our
selling expenses are largely affected by the amount of international sales and
sales to unrelated parties. The transportation costs for international sales are
generally higher than domestic sales. Our export sales accounted for
10.6% of our revenue in fiscal year 2009 as compared to 5.5% in fiscal year
2008. In addition, when we sell products to Shanghai Huaye and its affiliates,
Shanghai Huaye generally arranges and bears the cost of the 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
United
States
Sutor
Technology Group Limited is subject to United States federal income tax at a tax
rate of 34%. No provision for income taxes in the United States has been made as
Sutor Technology Group Limited had no U.S. taxable income in fiscal year
2009.
BVI
Sutor BVI
was incorporated in the BVI and, under the current laws of the BVI, is not
subject to income taxes.
PRC
On March
16, 2007, the National People’s Congress of China passed the new enterprise
income tax law (the “New EIT Law”), and on December 6, 2007, the State Council
of China passed the Implementing Rules for the EIT Law (“Implementing Rules”)
which took effect on January 1, 2008. The New EIT Law and Implementing Rules
impose a unified EIT of 25.0% on all domestic-invested enterprises and FIEs,
unless they qualify under certain limited exceptions. Therefore, nearly all FIEs
are subject to the new tax rate alongside other domestic businesses rather
than benefiting from the old FIE tax laws, and its associated preferential tax
treatments, beginning January 1, 2008.
Despite
these changes, the EIT Law gives the FIEs established before March 16, 2007
(“Old FIEs”) a five-year grandfather period during which they can continue to
enjoy their existing preferential tax treatments. During this five-year
grandfather period, the Old FIEs which enjoyed tax rates lower than 25% under
the original EIT Law shall gradually increase their EIT rate by 2% per year
until the tax rate reaches 25%. In addition, the Old FIEs that are eligible for
the “two-year exemption and three-year half reduction” or “five-year exemption
and five-year half-reduction” under the original EIT Law, are allowed to
remain to enjoy their preference until these holidays expire. The
discontinuation of any such special or preferential tax treatment or other
incentives would have an adverse effect on any organization’s business, fiscal
condition and current operations in China.
In
addition to the changes to the current tax structure, under the EIT Law, an
enterprise established outside of China with “de facto management bodies” within
China is considered a resident enterprise and will normally be subject to an EIT
of 25.0% on its global income. The Implementing Rules define the term “de facto
management bodies” as “an establishment that exercises, in substance, overall
management and control over the production, business, personnel, accounting,
etc., of a Chinese enterprise.” If the PRC tax authorities subsequently
determine that the Company should be classified as a resident enterprise, then
the organization’s global income will be subject to PRC income tax of
25.0%.
Our
subsidiary Changshu Huaye was subject to an EIT rate of 12.5% for calendar year
2008 and is and will be subject to an EIT rate of 25% for calendar year 2009 and
beyond. Our subsidiary Jiangsu Cold-Rolled is subject to an EIT rate of 12.5%
for 2009, 2010 and 2011. Ningbo Zhehua is subject to an EIT rate of 25% for
calendar year 2009.
Reportable
Operating Segments
We have
three reportable operating segments which are categorized based on manufacturing
facility – Changshu Huaye, Jiangsu Cold-Rolled and Ningbo Zhehua. 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. See Note
11, “Segment Information” to the consolidated financial statements included
elsewhere in this annual report.
Results
of Operations
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 thousand of U.S. dollars)
2009
|
2008
|
|||||||||||||||
Amount
|
As a
Percentage
of Revenue
|
Amount
|
As a Percentage
of Revenue
|
|||||||||||||
Revenue:
|
|
|||||||||||||||
Revenue
from unrelated parties
|
$ | 238,043 | 55.4 | % | $ | 276,972 | 58.9% | % | ||||||||
Revenue
from related parties
|
191,710 | 44.6 | % | 193,300 | 41.1% | % | ||||||||||
Total
|
429,753 | 100.0 | % | 470,272 | 100.0 | % | ||||||||||
|
||||||||||||||||
Cost of
Revenue:
|
|
|||||||||||||||
Cost of revenue:
|
185,989 | 43.3 | % | 302,013 | 64.2 | % | ||||||||||
Purchases
from related parties
|
207,458 | 48.3 | % | 119,667 | 25.5 | % | ||||||||||
Total
|
393,447 | 91.6 | % | 421,680 | 89.7 | % | ||||||||||
|
||||||||||||||||
Gross
Profit
|
36,306 | 8.4 | % | 48,592 | 10.3 | % | ||||||||||
|
||||||||||||||||
Operating
Expenses
|
|
|||||||||||||||
Selling
expense
|
4,668 | 1.1 | % | 4,418 | 0.9 | % | ||||||||||
General
and administrative expense
|
5,485 | 1.3 | % | 4,777 | 1.0 | % | ||||||||||
Total
Operating Expenses
|
10,153 | 2.4 | % | 9,195 | 1.9 | % | ||||||||||
Income
from Operations
|
26,154 | 6.1 | % | 39,397 | 8.4 | % | ||||||||||
|
||||||||||||||||
Other Income
(Expense)
|
|
|||||||||||||||
Interest
income
|
1,502 | 0.3 | % | 1,099 | 0.2 | % | ||||||||||
Other
income
|
229 | 0.1 | % | 216 | 0.0 | % | ||||||||||
Interest
expense
|
(6,065 | ) | (1.4 | )% | (6,292 | ) | (1.3 | )% | ||||||||
Other
expense
|
(729 | ) | (0.2 | )% | (978 | ) | (0.2 | )% | ||||||||
Total
Other Expense
|
(5,062 | ) | (1.2 | )% | (5,955 | ) | (1.3 | )% | ||||||||
|
||||||||||||||||
Income
Before Taxes and Minority Interest
|
21,091 | 4.9 | % | 33,442 | 7.1 | % | ||||||||||
Provision
for income taxes
|
(2,412 | ) | (0.6 | )% | (2,133 | ) | (0.4 | )% | ||||||||
Net
Income
|
$ | 18,679 | 4.3 | % | $ | 31,309 | 6.7 | % |
The
following table sets forth revenue by geography and the percentage of our total
revenue and total revenue by business segments for fiscal years 2009 and
2008.
(All
amounts, other than percentages, in thousand of U.S. dollars)
2009
|
2008
|
|||||||||||||||
Revenue
|
As a Percentage
of Revenue
|
Revenue
|
As a Percentage
of Revenue
|
|||||||||||||
Geographic
Data:
|
||||||||||||||||
China
|
$ | 384,354 | 89.4 | % | $ | 444,220 | 94.5 | % | ||||||||
Hong
Kong
|
9,929 | 2.3 | % | 7,071 | 1.5 | % | ||||||||||
United
States
|
10,211 | 2.4 | % | 2,398 | 0.5 | % | ||||||||||
Other
Countries
|
25,260 | 5.9 | 16,583 | 3.5 | ||||||||||||
Total
revenue
|
$ | 429,753 | 100.0 | % | $ | 470,272 | 100.0 | % | ||||||||
Segment
Data:
|
||||||||||||||||
Changshu
Huaye
|
$ | 237,800 | 55.3 | % | 260,528 | 55.4 | % | |||||||||
Ningbo
Zhehua
|
88,268 | 20.5 | % | 52,242 | 11.1 | % | ||||||||||
Jiangsu
Cold-Rolled
|
103,685 | 24.1 | % | 157,502 | 33.5 | % | ||||||||||
Total
revenue
|
$ | 429,753 | 100 | % | $ | 470,272 | 100 | % |
Comparison
of Years ended June 30, 2009 and June 30, 2008.
Revenue.
Our revenue decreased $40.5 million, or 8.6%, to $429.8 million in fiscal year
2009 from $470.3 million in fiscal year
2008. The global economic crisis had a negative impact on the steel industry
generally, leading to a decline of the price of our main raw material steel
which caused the per unit sales price of our products and our revenue to
decrease. In response to the global economic crisis, we also made a strategic
decision to further reduce our per unit sales price in certain instances to both
maintain our market share and attract new customers.
On a
geographic basis, revenue generated from outside of China was $45.4 million, or
10.6% of total revenue for fiscal year 2009, as compared to $26.0 million, or
5.5% of total revenue for fiscal year 2008. The percentage increase was mainly
due to increased sales into the Middle East market and sales of our newly
developed anti-septic and fingerprint resistant steel products, which were well
received by the international market.
On a
segment basis, our subsidiary Jiangsu Cold-Rolled experienced a decline in
revenue for fiscal year 2009. After eliminating inter-company sales, Jiangsu
Cold-Rolled’s revenues were $103.7 million in fiscal year 2009. As part of our
vertical integration strategy, we used most of Jiangsu Cold-Rolled’s products as
raw materials in the operations of our subsidiary, Changshu Huaye. Changshu
Huaye’s revenues were $237.8 million in fiscal year 2009, a decrease of
$22.7 million, or 8.7%, from $260.5 million in fiscal year 2008. Changshu Huaye
sold less HDG Steel products to third parties in fiscal year 2009 as compared to
2008 as more of our own HDG Steel products were used in the production of PPGI
products in fiscal year 2009 to reduce production costs. Ningbo Zhehua’s
revenues were $88.3 million in fiscal year 2009, an increase of $36.1 million,
or 69.0%, from $52.2 million in fiscal year 2008. Ningbo Zhehua generated $27.9
million more revenue from steel trading activities in fiscal year 2009 as
compared to fiscal year 2008.
In terms
of sales to related parties as compared with sales to unrelated parties, our
direct sales to unrelated parties in fiscal year 2009 decreased $38.9 million,
or 14.1% to $238.0 million from $276.9 million in fiscal year 2008. Our sales to
Shanghai Huaye and its affiliates in fiscal year 2009 were $191.7 million, a
decrease of $1.6 million, or 0.8% as compared to $193.3 million in fiscal year
2008. Through our relationship with Shanghai Huaye, we gained access to Shanghai
Huaye’s sales network and expanded our market share and brand
value.
Cost of
Revenue. Our cost of revenue decreased $ 28.3 million, or 6.7%
to $393.4 million in fiscal year 2009 from $421.7 million in fiscal year 2008.
As a percentage of revenue, the cost of revenue increased to 91.6% in
fiscal year 2009 from 89.7% in fiscal year 2008. Even though our cost of revenue
decreased on a dollar basis, we implemented a strategic decision to reduce the
per unit sale price which led to the modest increase in cost as a percentage of
revenue. We believe the successful implementation of such strategy allowed us to
remain profitable in fiscal year 2009 despite the challenging economy. In
addition, we received a larger proportion of smaller orders in fiscal year 2009
as compared to fiscal year 2008 which impaired our ability to realize economies
of scale.
Gross
Profit . Our gross profit decreased $12.3 million to $36.3 million in
fiscal year 2009 from $48.6 million in fiscal year 2008. Gross profit as a
percentage of revenue (gross margin) was 8.4% in fiscal year 2009, as compared
to 10.3% in fiscal year 2008. Such decrease in our gross margin was mainly due
to lower per unit sales price and higher production costs for the reasons as
stated in the paragraph immediately above.
Gross
margins for Changshu Huaye decreased to 12.1% in fiscal year 2009 from 14.7% in
fiscal year 2008. Gross margins for Jiangsu Cold-Rolled decreased to 4.0% in
fiscal year 2009 from 4.3% in fiscal year 2008. Such decrease was mainly due to
the reasons stated above. Gross margins for Ningbo Zhehua decreased to 4.0% in
fiscal year 2009 from 7.0% in fiscal year 2008. As discussed above, Ningbo
Zhehua generated $27.9 million more revenue from steel trading activities in
fiscal year 2009 which generally had a lower margin than that for steel pipe
products.
Total Operating
Expenses. Our total operating expenses increased $1.0 million to $10.2
million in fiscal year 2009 from $9.2 million in fiscal year 2008. As a
percentage of revenue, our total operating expenses increased to 2.4 % in fiscal
year 2009 from 1.9 % in fiscal year 2008.
General and Administrative
Expenses. Our general and administrative expenses increased
$0.7 million to $5.5 million in fiscal year 2009 from $4.8 million in fiscal
year 2008. As a percentage of revenue, general and administrative expenses
increased to 1.3% in fiscal year 2009 from 1.0% in fiscal year 2008. We incurred
more general and administrative expenses in fiscal year 2009 in connection with
the two new HDG Steel production lines which became operative at the end of
September, 2008.
Selling Expenses. Our selling
expenses increased $0.3 million to $4.7 million in fiscal year 2009 from $4.4
million in fiscal year 2008. As a percentage of revenue, our selling expenses
increased to 1.1% in fiscal year 2009 from 0.9% in fiscal year 2008. As part of
our sales promotion efforts, we agreed to pay transportation costs for some of
our customers. In addition, our international sales increased in fiscal year
2009 as compared to last year which also contributed to higher transportation
expenses.
Interest
Expense. Our
interest expense decreased $0.2 million to $6.1 million in fiscal year 2009,
from $6.3 million in fiscal year 2008. As a percentage of revenue, our interest
expenses increased to 1.4% in fiscal year 2009, from 1.3% in fiscal year 2008.
The amount decrease was mainly due to the decreased interest rate. In December
2008, the People’s Bank of China reduced the benchmark interest rate, the
interest rate for one-year loan has been reduced by 0.27% to 5.31% from
5.58%.
Provision for
Income Taxes. We incurred income tax expense of $2.4 million and
$2.1million in fiscal years 2009 and 2008, respectively. Such
increase was primarily attributable to the increased tax rate applicable to
Changshu Huaye. Changshu Huaye’s tax holiday expired by the end of 2008, as a
result, it became subject to an EIT rate of 25% in 2009, as compared to 12.5% in
2008.
Net
Income. Net income, without including the foreign currency translation
adjustment, decreased $12.6 million, or 40.3%, to $18.7 million in fiscal year
2009 from $31.3 million in fiscal year 2008, as a result of the factors
described above.
Liquidity
and Capital Resources
Our major
sources of liquidity for the 2009 and 2008 financial years were borrowings
through short-term bank and private loans. Our operating activities provided
$43.5 million of cash in fiscal year 2009. External sources of cash flows have
been required and will likely continue to be required. At June 30, 2009, our
total indebtedness to non-related parties under existing short-term loans was
$104.3 million, our short-term notes payable to related parties was $9.9
million, and our long-term notes payable to non-related parties was $2.9
million, our long-term notes payable to related parties totaled $0.2
million.
Short-term
bank and private loans are likely to continue to be our key sources of liquidity
for the foreseeable future, although in the future we may decide to raise
additional capital by issuing shares of our capital stock in an equity
financing.
Our
liquidity and working capital may be affected by a material decrease in cash
flow due to factors such as the continued use of cash in operating activities
resulting from a decrease in sales due to the current global economic crisis,
increased competition, decreases in the availability, or increases in the cost,
of raw materials, unexpected equipment failures, or regulatory changes. Please
see section entitled “ Risk Factors ” for a more complete description of risks
affecting our business, liquidity, working capital and financial
results.
A portion
of our operations is funded through short-term bank loans. As these loans become
due, we may repay them in full at maturity or elect to refinance them. 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 (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
June 30, 2009, we had cash and cash equivalents (excluding restricted cash) of
$10.7 million and restricted cash of $64.8 million. The following table provides
detailed information about our net cash flow for all financial statement periods
presented in this report.
Cash
Flow
(all
amounts in thousands of U.S. dollars)
For
the Fiscal Year Ended June 30,
|
||||||||
2009
|
2008
|
|||||||
Net
cash provided by (used in) operating activities
|
$ | 43,531 | $ | (37,567 | ) | |||
Net
cash used in investing activities
|
(18,891 | ) | (39,427 | ) | ||||
Net
cash (used in) provided by financing activities
|
(26,522 | ) | 78,461 | |||||
Net
cash flow
|
$ | (1,841 | ) | $ | 2,691 |
Operating
Activities:
Net cash
provided by operating activities was $43.5 million in fiscal year 2009, an
increase of $81.1 million from the $37.6 million net cash used in operating
activities in fiscal year 2008. Such increase of net cash provided by operating
activities was primarily attributable to a $46.1 million lesser increase in
advances to related party suppliers for 2009 as compared to 2008 and a
decrease in inventory for 2009 compared to an increase in inventory for 2008 in
the amount of $49.9 million. These changes are off-set by a decline
in net income of $12.6 million for 2009 compared to 2008.
Investing
Activities:
Our main
uses of cash for investing activities are payments relating to the acquisition
of property, plant and equipment and restricted cash pledged as deposits for
bankers’ acceptance bills.
Net cash
used in investing activities in fiscal year 2009 was $18.9 million, which is a
decrease of $20.5 million from net cash used in investing activities of $39.4
million in fiscal year 2008. Such decrease of net cash used in investing
activities was mainly due to a $21.5 million decrease in the change of
restricted cash as compared to the prior year.
Financing
Activities:
Net cash
used in financing activities in fiscal year 2009 totaled $26.5 million as
compared to $78.5 million provided by financing activities in fiscal year 2008.
The decrease of cash provided by financing activities was mainly attributable to
the net change of proceeds from new loans and payments on those notes of $99.6
million.
We
believe we currently maintain a good business relationship with many banks. As
of June 30, 2009, the amount, maturity date and term of each of our bank loans
were as follows.
(All
amounts in million of U.S. dollars)
Banks
|
Amounts*
|
Starting
Date
|
Maturity Date
|
Guarantor**
|
||||||
Changshu
Rural Commercial Bank
|
$ | 1.75 |
February
11, 2009
|
August
6, 2009
|
none
|
|||||
Bank
of China, Changshu Branch
|
1.75 |
February
13, 2009
|
August
13, 2009
|
Shanghai
Huaye
|
||||||
Changshu
Rural Commercial Bank
|
3.36 |
March
25, 2009
|
September
23, 2009
|
None
|
||||||
China
Industry and Commerce Bank, Changshu Branch
|
1.46 |
April
15, 2009
|
April
13, 2010
|
None
|
||||||
Changshu
Rural Commercial Bank
|
3.21 |
May
7, 2009
|
November
6, 2009
|
None
|
||||||
China
Industry and Commerce Bank, Changshu Branch
|
1.46 |
May
18, 2009
|
May
18, 2010
|
None
|
||||||
China
Industry and Commerce Bank, Changshu Branch
|
1.46 |
May
27, 2009
|
May
24, 2010
|
None
|
||||||
The
Agricultural Bank of China, Changshu Branch
|
7.30 |
May
31, 2009
|
May
27, 2010
|
Shanghai
Huaye/Jiangsu
Cold
Rolled
|
||||||
Communication
Bank, changshu Branch
|
2.92 |
June
29, 2009
|
June
25, 2010
|
Shanghai
Huaye
|
||||||
China
Industry and Commerce Bank, Changshu Branch
|
1.46 |
December
29, 2008
|
December
28, 2009
|
Changshu
Huaye
|
||||||
The
Agricultural Bank of China, Changshu Branch
|
1.90 |
February
5, 2009
|
August
4, 2009
|
none
|
||||||
The
Agricultural Bank of China, Changshu Branch
|
7.30 |
February
23, 2009
|
August
22, 2009
|
Shanghai
Huaye/Changshu
Huaye
|
||||||
China
Industry and Commerce Bank, Changshu Branch
|
2.92 |
February
27, 2009
|
February
26, 2010
|
Changshu
Huaye
|
||||||
The
Agricultural Bank of China, Changshu Branch
|
4.53 |
March
3, 2009
|
July
16, 2009
|
Shanghai
Huaye/Changshu
Huaye
|
||||||
The
Agricultural Bank of China, Changshu Branch
|
5.84 |
March
27, 2009
|
September
26, 2009
|
Shanghai
Huaye/Changshu
Huaye
|
||||||
The
Agricultural Bank of China, Changshu Branch
|
5.84 |
March
28, 2009
|
September
27, 2009
|
Shanghai
Huaye/Changshu
Huaye
|
||||||
The
Agricultural Bank of China, Changshu Branch
|
5.84 |
April
2, 2009
|
September
30, 2009
|
Shanghai
Huaye/Changshu
Huaye
|
||||||
The
Agricultural Bank of China, Changshu Branch
|
9.64 |
May
15, 2009
|
November
14, 2009
|
None
|
||||||
The
Agricultural Bank of China, Changshu Branch
|
1.46 |
May
19, 2009
|
November
18, 2009
|
None
|
||||||
The
Agricultural Bank of China, Changshu Branch
|
1.46 |
May
21, 2009
|
November
20, 2009
|
None
|
||||||
The
Agricultural Bank of China, Changshu Branch
|
4.38 |
May
27, 2009
|
November
26, 2009
|
None
|
||||||
China
Industry and Commerce Bank, Changshu Branch
|
2.92 |
May
25, 2009
|
April
29, 2010
|
Changshu
Huaye
|
||||||
The
Agricultural Bank of China, Changshu Branch
|
2.63 |
May
27, 2009
|
August
27, 2009
|
None
|
||||||
The
Agricultural Bank of China, Changshu Branch
|
2.05 |
February
17, 2009
|
August
17, 2009
|
Shanghai
Huaye
|
||||||
Bank
of China, Changshu Branch
|
5.26 |
February
17, 2009
|
August
17, 2009
|
Shanghai
Huaye
|
||||||
The
Agricultural Bank of China, Changshu Branch
|
3.80 |
February
26, 2009
|
August
26, 2009
|
Shanghai
Huaye
|
||||||
Changshu
Rural Commercial Bank
|
2.34 |
March
3, 2009
|
September
3, 2009
|
None
|
||||||
The
Agricultural Bank of China, Changshu Branch
|
1.46 |
February
23, 2009
|
August
23, 2009
|
None
|
||||||
Bank
of China, Changshu Branch
|
2.19 |
February
24, 2009
|
August
24, 2009
|
None
|
||||||
The
Agricultural Bank of China, Changshu Branch
|
4.38 |
May
12, 2009
|
November
12, 2009
|
Shanghai
Huaye/Jiangsu
Cold
Rolled
|
||||||
Chen
Lifang
|
1.57 |
May
15, 2008
|
Non
fixed Date
|
None
|
||||||
Chen
Lifang
|
7.20 |
December
20, 2007
|
December
20, 2009
|
None
|
||||||
Lin
Guihua
|
2.86 |
November
20, 2008
|
November
20, 2011
|
None
|
||||||
Chen
Lifang
|
0.10 |
March
11, 2009
|
March
11, 2012
|
None
|
||||||
Chen
Lifang
|
0.15 |
April
29, 2009
|
April
29, 2012
|
None
|
||||||
Chen
Lifang
|
0.05 |
March
28, 2007
|
Non
fixed Date
|
None
|
||||||
Chen
Lifang
|
0.10 |
May
8, 2007
|
Non
fixed Date
|
None
|
||||||
Chen
Lifang
|
0.03 |
June
15, 2007
|
Non
fixed Date
|
None
|
||||||
Chen
Lifang
|
0.05 |
August
7, 2007
|
Non
fixed Date
|
None
|
||||||
Chen
Lifang
|
0.07 |
September
17, 2007
|
Non
fixed Date
|
None
|
||||||
Chen
Lifang
|
0.10 |
September
27, 2007
|
Non
fixed Date
|
None
|
||||||
Chen
Lifang
|
0.10 |
December
10, 2007
|
Non
fixed Date
|
None
|
||||||
Chen
Lifang
|
0.20 |
February
25, 2007
|
Non
fixed Date
|
None
|
||||||
Chen
Lifang
|
0.10 |
April
9, 2008
|
Non
fixed Date
|
None
|
||||||
Chen
Lifang
|
0.10 |
April
18, 2008
|
Non
fixed Date
|
None
|
||||||
Chen
Lifang
|
0.10 |
August
28, 2008
|
Non
fixed Date
|
None
|
||||||
Chen
Lifang
|
0.05 |
September
12, 2008
|
Non
fixed Date
|
None
|
||||||
Chen
Lifang
|
0.08 |
October
20, 2008
|
Non
fixed Date
|
None
|
||||||
Bank
of China, Ningbo Branch
|
0.03 |
April
14, 2009
|
July
28, 2009
|
None
|
||||||
Total
|
$ | 117.35 |
*
Calculated on the basis that $1 = RMB 6.8448
** 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 contain debt covenants that require the Company to
maintain certain inventory levels. The Company was in compliance with these debt
covenants at June 30, 2009.
Our
material capital expenditure requirements for fiscal year 2010 are expected to
be approximately $20.0 million, which will be used for updating and expansion of
our production lines, equipment and facilities. In addition, we expect that an
additional $20.0 million of working capital will be needed to maintain our
business operations in the next twelve months which will be raised through bank
loans. In the coming 12 months, we have approximately $104.3 million in bank
loans that will mature. Among $9.9 million related party loans, $7.1 million
will mature in the following 12 months. We plan to replace these loans with new
bank loans in approximately the same aggregate amounts.
We
believe that our currently available working capital after receiving the credit
facilities referred to above and the expected additional credit facility should
be adequate to sustain our operations at our current levels through 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
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires our management to make
assumptions, estimates and judgments that affect the amounts reported in the
financial statements, including the notes thereto, and related disclosures of
commitments and contingencies, if any. We consider our critical accounting
policies to be those that require the more significant judgments and estimates
in the preparation of financial statements, including the
following:
·
|
Functional Currency and
Translating Financial Statements - The consolidated financial
statements have been prepared in accordance with accounting principles
generally accepted in the United States of America. The functional
currency of the Company is the Chinese Yuan Renminbi (“RMB”); however, the
consolidated financial statements have been expressed in United States
Dollars (“USD”). The consolidated balance sheets have been translated
into USD at the exchange rates prevailing at each balance sheet date. The
consolidated statements of operations and cash flows have been translated
using the weighted-average exchange rates prevailing during the periods of
each statement. Transactions in the Company’s equity securities have been
recorded at the exchange rate existing at the time of the
transaction.
|
·
|
Principles of
Consolidation - The consolidated financial statements include the
accounts and transactions of Sutor Technology Group Limited and its
subsidiaries for all periods presented. All significant intercompany
accounts and transactions have been eliminated in
consolidation.
|
·
|
Restricted Cash - The
Company has entered into agreements to pay suppliers, which require the
Company to maintain cash balances as security for notes payable to the
suppliers. These secured cash balances are presented in the consolidated
balance sheets as restricted cash.
|
·
|
Advances to Suppliers and from
Customers - The Company, as is common practice in the PRC, will
often make advance payments to its suppliers for materials, or receive
advance payments from its customers. The Company had net advances to
suppliers of $25,039,763 and $41,093,633 at June 30, 2009 and 2008,
respectively. The Company also had advances from its customers in the
amount of $18,805,901 and $20,711,566 at June 30, 2009 and 2008,
respectively.
|
·
|
Revenue Recognition -
The Company recognizes revenues from the sale of products when they are
realized and earned. The Company considers revenue realized or realizable
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) collectibility is reasonably assured. Revenues are not recognized
until products have been shipped to the client, risk of loss has
transferred to the client and client acceptance has been obtained, client
acceptance provisions have lapsed, or the Company has objective evidence
that the criteria specified in client acceptance provisions have been
satisfied.
|
The
Company sells product to affiliates, who in turn sell the product to various
other third party customers. The price, terms and conditions on the sales to
affiliates are the same as those to third parties. Revenue is considered
realized or realizable and earned when the affiliates ship the product to third
party customers. A fee of 0.5% of the sale is paid to the affiliate for handling
the product. These handling fees have been classified as selling expenses
in the statement of operations.
·
|
Cost of Revenue - Cost
of products sold includes wages, materials, handling charges, and other
expenses associated with the manufacture and delivery of
product.
|
The
following table discloses the metrics by which we determine our allowance for
doubtful accounts in respect of our accounts receivable:
Term of Outstanding Accounts
Receivable
|
Percentage of Account Receivable Included in
Allowance
for Doubtful Accounts
|
|||
1-30
days
|
0.0 | |||
31-90
days
|
7.5 | |||
91-180
days
|
15.0 | |||
181-360
days
|
30.0 | |||
1-2
years
|
60.0 | |||
Over
2 years
|
100.0 |
·
|
Basic and Diluted Earnings per
Common Share - The computation of basic earnings per common
share is based on income divided by the weighted-average number of common
shares outstanding. Diluted earnings per common share are calculated by
dividing income assuming dilution by the weighted-average number of common
shares and potential dilutive. The Company does not have any potentially
dilutive securities. The calculations of basic and diluted income per
share were as follows:
|
For the Years Ended June
|
||||||||
2009
|
2008
|
|||||||
Net
income
|
$ | 18,679,110 | $ | 31,306,925 | ||||
Weighted-Average
Basic and Dilutive Common Shares Outstanding
|
37,955,602 | 37,955,602 | ||||||
Basic
and Diluted Earnings per Common Share
|
$ | 0.49 | $ | 0.82 |
Recently issued accounting
pronouncements
In
September 2006, the Financial Accounting Standards Board (FASB) issued
SFAS No. 157, Fair
Value Measurements, which defines fair value, establishes a framework for
measuring fair value in generally accepted accounting principles and expands
disclosures about fair value measurements. SFAS No. 157 was effective for
fiscal years beginning after November 15, 2007, and interim periods within
those fiscal years. In February 2008, the FASB issued FASB Staff Position (FSP
FIN) No. 157-2 which extended the effective date for certain nonfinancial assets
and nonfinancial liabilities to fiscal years beginning after November 15,
2008. The adoption of the portions of SFAS No. 157 that were not
postponed by (FSP FIN) No. 157-2 did not have an effect on our consolidated
financial statements. The Company does not expect the adoption of the postponed
portions of SFAS No. 157 to have a material impact on our consolidated
financial statements.
In
December 2007, the FASB issued SFAS No. 141(R), Business Combinations, and
SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements. SFAS No. 141(R) requires an
acquirer to measure the identifiable assets acquired, the liabilities assumed
and any non-controlling interest in the acquiree at their fair values on the
acquisition date, with goodwill being the excess value over the net identifiable
assets acquired. SFAS No. 160 clarifies that a non-controlling interest in
a subsidiary should be reported as equity in the consolidated financial
statements, consolidated net income shall be adjusted to include the net income
attributed to the non-controlling interest and consolidated comprehensive income
shall be adjusted to include the comprehensive income attributed to the
non-controlling interest. The calculation of earnings per share will continue to
be based on income amounts attributable to the parent. SFAS
No. 141(R) and SFAS No. 160 are effective for financial
statements issued for fiscal years beginning after December 15, 2008. Early
adoption is prohibited. SFAS No. 141(R) and SFAS No. 160 are not expected to
have a material impact on our results of operations or financial
position.
In
December 2007, the FASB ratified Emerging Issues Task Force (EITF)
Issue No. 07-1, Accounting for Collaborative
Arrangements (EITF 07-1). EITF 07-1 defines collaborative
arrangements and establishes reporting requirements for transactions between
participants in a collaborative arrangement and between participants in the
arrangement and third parties. EITF 07-1 also establishes the appropriate income
statement presentation and classification for joint operating activities and
payments between participants, as well as the sufficiency of the disclosures
related to these arrangements. EITF 07-1 is effective for fiscal years
beginning after December 15, 2008. The Company does not expect the adoption
of EITF 07-1 to have a material impact on our consolidated financial
statements.
In April
2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of
Intangible Assets (FSB FAS 142-3). FSP FAS 142-3 amends the
factors that should be considered in developing renewal or extension assumptions
used to determine the useful life of a recognized intangible asset under SFAS
No. 142, Goodwill and Other
Intangible Assets. The intent of this FSP is to improve the consistency
between the useful life of a recognized intangible asset under FAS 142 and the
period of expected cash flows used to measure the fair value of the asset under
SFAS No. 141(R) and other generally accepted accounting principles. FSP FAS
142-3 is effective for fiscal years, and interim periods within those fiscal
years, beginning after December 15, 2008. The Company does not expect the
adoption of FSP FAS 142-3 to have a material impact on our consolidated
financial statements.
In May
2008, the FASB issued SFAS 162, The Hierarchy of Generally Accepted
Accounting Principles. SFAS No. 162 identifies the sources of
accounting principles and provides entities with a framework for selecting the
principles used in preparation of financial statements that are presented in
conformity with GAAP. The current GAAP hierarchy has been criticized
because it is directed to the auditor rather than the entity, it is complex, and
it ranks FASB Statements of Financial Accounting Concepts, which are subject to
the same level of due process as FASB Statements of Financial Accounting
Standards, below industry practices that are widely recognized as generally
accepted but that are not subject to due process. The Board believes
the GAAP hierarchy should be directed to entities because it is the entity (not
its auditors) that is responsible for selecting accounting principles for
financial statements that are presented in conformity with GAAP. The
adoption of FASB 162 is not expected to have a material impact on the Company’s
financial statements.
In
September 2008, the FASB issued FSP FAS 133-1 and FIN 45-4, Disclosures about Credit Derivatives
and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB
Interpretation No. 45; and Clarification of the Effective Date of FASB Statement
No. 161 (FSP FAS 133-1 and FIN 45-4). FSP FAS 133-1 and FIN 45-4 amends
and enhances disclosure requirements for sellers of credit derivatives and
financial guarantees. It also clarifies that the disclosure requirements of SFAS
No. 161 are effective for quarterly periods beginning after November 15, 2008,
and fiscal years that include those periods. FSP FAS 133-1 and FIN 45-4 is
effective for fiscal years ending after November 15, 2008. The adoption of FSP
FAS 133-1 and FIN 45-4 has not had a material impact on the Company’s financial
statements.
In
December 2008, the FASB issued FASB Staff Position FAS 140-4 and FIN 46(R)-8,
Disclosures by Public Entities
(Enterprises) about Transfers of Financial Assets and Interests in Variable
Interest Entities ("FSP FAS 140-4 and FIN 46(R)-8"). FSP FAS 140-4 and
FIN 46(R)-8 amends SFAS 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities and FIN
46(R), FASB Interpretation No.
46 (R), Consolidation of Variable Interest Entities, an interpretation of
Accounting Research Bulletin No. 51, to require public entities to
provide additional disclosures about transfers of financial assets and their
involvement with variable interest entities. FSP FAS 140-4 and FIN 46(R)-8 is
effective for fiscal years ending after December 15, 2008. The adoption of FSP
FAS 140-4 and FIN 46(R)-8 has not had a material impact on the Company’s
financial statements.
In April
2009, the FASB issued FSP FAS 107-1 and APB 28-1 Interim Disclosures about Fair Value
of Financial Instruments. FSP FAS 107-1 and APB 28-1 relate to fair value
disclosures for any financial instruments that are not currently reflected on
the balance sheet of companies at fair value. Prior to issuing this FSP, fair
values for these assets and liabilities were only disclosed once a year. The FSP
now requires these disclosures on a quarterly basis, providing qualitative and
quantitative information about fair value estimates for all those financial
instruments not measured on the balance sheet at fair value. FSP FAS
107-1 and APB 28-1 is effective for interim reporting periods ending after June
15, 2009, with early adoption permitted for periods ending after March 15,
2009. The adoption of FSP FAS 107-1 and APB 28-1 is not expected to
have a material impact on the Company’s financial statements.
In May
2009, the FASB issued Statement of Financial Accounting Standards No. 165,
“Subsequent Events”
(SFAS 165). Under SFAS 165, requires companies to evaluate events and
transactions that occur after the balance sheet date but before the date the
financial statements are issued, or available to be issued in the case of
non-public entities. SFAS 165 requires entities to recognize in the
financial statements the effect of all events or transactions that provide
additional evidence of conditions that existed at the balance sheet date,
including the estimates inherent in the financial preparation process. Entities
shall not recognize the impact of events or transactions that provide evidence
about conditions that did not exist at the balance sheet date but arose after
that date. SFAS 165, also requires entities to disclose the date through
which subsequent events have been evaluated. SFAS 165 is effective for
interim and annual reporting periods ending after June 15, 2009. The
Company adopted the provisions of SFAS 165 for the year ended June 30,
2009, as required, the adoption did not have a material impact on the Company’s
financial statements. The Company evaluated events subsequent to the
balance sheet date through September 23, 2009.
On
January 1, 2009 the Company adopted EITF Issue No. 08-5, Issuer’s Accounting for Liabilities
Measured at Fair Value With a Third-Party Credit Enhancement (EITF 08-5).
EITF 08-5 provides guidance for measuring liabilities issued with an attached
third-party credit enhancement (such as a guarantee). It clarifies that the
issuer of a liability with a third-party credit enhancement (such as a
guarantee) should not include the effect of the credit enhancement in the fair
value measurement of the liability. There was no effect on the Company’s
consolidated financial statements upon adoption of EITF 08-5.
In June
2009, the FASB issued SFAS No. 168, The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting
Principles or SFAS No. 168. SFAS No. 168 will become the single
source of authoritative nongovernmental U.S. GAAP, superseding existing FASB,
American Institute of Certified Public Accountants (AICPA), Emerging Issues Task
Force (EITF), and related accounting literature. SFAS No. 168 reorganizes the
thousands of GAAP pronouncements into roughly 90 accounting topics and displays
them using a consistent structure. Also included is relevant SEC guidance
organized using the same topical structure in separate sections. SFAS No. 168
will be effective for financial statements issued for reporting periods ending
after September 15, 2009. This will have an impact on the Company’s financial
disclosures since all future references to authoritative accounting literature
will be references in accordance with SFAS No. 168.
Seasonality
Our
operating results and operating cash flows historically have not been subject to
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.