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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.20549

 

FORM 10-K

 

(Mark One)

 

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

For the fiscal year ended: June 30, 2012

 

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

For the transition period from ____________ to _____________

 

Commission File No. 001-33959

 

SUTOR TECHNOLOGY GROUP LIMITED

 

(Exact name of registrant as specified in its charter)

 

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

 

No 8, Huaye Road

DongbangIndustrialPark

Changshu, 215534

People’s Republic of China

 

(Address of principal executive offices)

 

(86) 512-52680988

 

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class   Name of each exchange on which registered
Common Stock, par value $0.001 per share   NASDAQ Capital Market

 

Securities registered pursuant to Section 12(g) of the Exchange Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

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 o Accelerated Filer o
Non-Accelerated Filer o (Do not check if a smaller reporting company) Smaller reporting company x

 

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

 

As of December 31, 2011 (the last business day of the registrant’s most recently completed second fiscal quarter), the aggregate market value of the shares of the registrant’s common stock held by non-affiliates (based upon the closing sale price of such shares as reported on the NASDAQ Capital Market) was approximately $10.9 million. Shares of the registrant’s common stock held by each executive officer and director and by each person who owns 10% or more of the outstanding common stock have been excluded from the calculation in that such persons may be deemed to be affiliates of the registrant. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

 

There were a total of 40,214,764 shares of the registrant’s common stock outstanding as of September 10, 2012.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

None.

 

 
 

 

 

SUTOR TECHNOLOGY GROUP LIMITED

 

Annual Report on FORM 10-K

 For the Fiscal Year Ended June 30, 2012

 

 

TABLE OF CONTENTS

 

PART I
     
Item 1. Business 2
Item 1A. Risk Factors 10
Item 1B. Unresolved Staff Comments 22
Item 2. Properties 22
Item 3. Legal Proceedings 22
Item 4. Mine Safety Disclosures 22
     
PART II
     
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 23
Item 6. Selected Financial Data 24
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 24
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 38
Item 8. Financial Statements and Supplementary Data 38
Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 38
Item 9A. Controls and Procedures 38
Item 9B. Other Information 39
     
PART III
     
Item 10. Directors, Executive Officers and Corporate Governance 40
Item 11. Executive Compensation 44
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 47
Item 13. Certain Relationships and Related Transactions, and Director Independence 48
Item 14. Principal Accounting Fees and Services 50
     
PART IV
     
Item 15. Exhibits, Financial Statement Schedules 50

 

 
 

 

Special Note Regarding Forward Looking Statements

 

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

 

·Downturns in the steel industry;
·Competition and competitive factors in the markets in which we compete;
·Our heavy reliance on Shanghai Huaye;
·Market perception of U.S. listed Chinese companies;
·Fluctuations in our raw material costs;
·General economic and business conditions in China and in the local economies in which we regularly conduct business, which can affect demand for our products and services; and
·Changes in laws, rules and regulations governing the business community in China in general and the steel industry in particular.

 

Additional disclosures regarding factors that could cause our results and performance to differ from results or anticipated performance are discussed in Item 1A, “Risk Factors” included herein. All statements other than statements of historical fact are statements that could be deemed forward-looking statements. We assume no obligation and do not intend to update these forward-looking statements, except as required by law.

 

Use of Terms

 

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

 

·“Company,” “we,” “us” and “our” are to the combined business of Sutor Technology Group Limited, a Nevada corporation, and its subsidiaries: Changshu Huaye, Jiangsu Cold-Rolled, Ningbo Zhehua, Sutor BVI, and Sutor Technology PRC; 
·“Changshu Huaye” are to our wholly-owned subsidiary Changshu Huaye Steel Strip Co., Ltd., a PRC company;
·“Jiangsu Cold-Rolled” are to our wholly-owned subsidiary Jiangsu Cold-Rolled Technology Co., Ltd., a PRC company;
·“Ningbo Zhehua” are to our wholly-owned subsidiary Ningbo Zhehua Heavy Steel Pipe Manufacturing Co., Ltd., a PRC company;
·“Shanghai Huaye” are to Shanghai Huaye Iron & Steel Group Co., Ltd., a PRC company of which Lifang Chen, our major shareholder and chief executive officer, and her husband Feng Gao, are 100% owners, and its subsidiaries;
·“Sutor BVI” are to our wholly-owned subsidiary Sutor Steel Technology Co., Ltd., a BVI company;
·“Sutor Technology PRC” are to our wholly-owned subsidiary Sutor Technology Co., Ltd., a PRC company;
·“SEC” are to the United States Securities and Exchange Commission;
·“Securities Act” are to the Securities Act of 1933, as amended;
·“Exchange Act” are to the Securities Exchange Act of 1934, as amended.
·“China” and “PRC” are to People’s Republic of China;
·“RMB” are to Renminbi, the legal currency of China; and
·“U.S. dollar,” “$” and “US$” are to the legal currency of the United States.

 

1
 

 

PART I

 

ITEM 1. BUSINESS.

 

Overview

 

We are one of the leading China-based, non-state-owned manufacturers of fine finished steel products. We utilize a variety of processes and technological methodologies to convert steel manufactured by third parties into fine finished steel products. Our product offerings are focused on higher margin, 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.

 

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

 

Our manufacturing facilities, located in Changshu, China, have three HDG steel production lines, one PPGI production line, one AP steel production line and one cold-rolled steel line. Our current annual production capacity is approximately 700,000 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.

 

History and Corporate Structure

 

We were incorporated on May 1, 1997 in the State of Nevada under the name Bronze Marketing, Inc. and changed our name to Sutor Technology Group Limited effective March 6, 2007 as a result of our reverse acquisition of Sutor BVI in February 2007.

 

On February 1, 2007, we acquired Sutor BVI through a share exchange transaction pursuant to which the shareholders of Sutor BVI transferred all capital stock of Sutor BVI to us in exchange for 85.2% ownership of our Company. Our acquisition of Sutor BVI was accounted for as a recapitalization effected by a share exchange, wherein Sutor BVI is considered the acquirer for accounting and financial reporting purposes. The assets and liabilities of the acquired entity have been brought forward at their book value and no goodwill has been recognized.

 

In November 2009, our subsidiary Changshu Huaye acquired 100% equity interest in Ningbo Zhehua for the total purchase price of RMB 45.2 million (approximately $6.6 million).

 

On February 24, 2010, we established Sutor Technology PRC as a wholly-owned subsidiary incorporated in China. We plan to consolidate all R&D activities into this subsidiary in the future.

 

2
 

 

The following chart reflects our organizational structure as of the date of this annual report:

 

 

Segment Information

 

Our three operating segments are categorized according to our three operating subsidiaries:

 

·Changshu Huaye, which manufactures and sells HDG steel and PPGI products;
·Jiangsu Cold-Rolled, which manufactures and sells HDG steel, AP steel and cold-rolled steel; and
·Ningbo Zhehua, which manufactures and sells welded steel pipe products.

 

Changshu Huaye and Jiangsu Cold-Rolled are located adjacent to each other in Changshu, China and use largely the same management resources. Ningbo Zhehua is located in Ningbo, China. For additional information about each segment, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Result of Operations” and Note 16, “Segment Information” to the consolidated financial statements included elsewhere in this annual report.

 

Our Products

 

Our current products include HDG steel, PPGI, AP steel, cold-rolled steel and welded steel pipe products. Our HDG steel and PPGI products are primarily manufactured by Changshu Huaye and our AP steel and cold-rolled steel products are primarily manufactured by Jiangsu Cold-Rolled. Jiangsu Cold-Rolled added two new HDG steel production lines and has manufactured HDG of both cold-rolled steel and hot-rolled steel since September 2008. Ningbo Zhehua manufactures our welded steel pipe products.

 

In 2008, we were certified ISO 9001:2008 for our quality management system, ISO 14001:2004 for our environmental management system, and GB/T28001-2001 for our occupational health and safety management system.

 

3
 

 

The following table sets forth sales information about our product mix in last two fiscal years. 

 

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

 

   Fiscal Year Ended June 30, 2012   Fiscal Year Ended June 30, 2011 
Product  Revenue   % of Total
Revenue
   Revenue   % of Total
Revenue
 
HDG Steel  $339.3    63.8%  $251.9    58.4%
PPGI   46.1    8.7%   61.8    14.3%
AP Steel   64.8    12.2%   34.3    8.0%
Cold-Rolled Steel   16.0    3.0%   40.3    9.3%
Welded Steel Pipe Products   36.4    6.8%   31.6    7.3%
Other   29.0    5.5%   11.8    2.7%
Total  $531.6    100.0%  $431.7    100.0%

 

HDG Steel

 

Using a technology called hot-dip galvanizing, we manufacture corrosion-resistant and zinc-coated HDG steel in different dimensions and using different materials and specifications requested by our customers. HDG steel products are manufactured from steel substrate of cold-rolled or hot-rolled pickled coils by applying zinc to the surface of the material to enhance its corrosion protection. HDG steel products are principally used in the electrical household appliances and construction markets.

 

We produce not only common industrial specifications, but also extreme specifications that we believe only a few other large PRC state-owned steel manufacturers can produce. The following table compares our technical manufacturing capabilities for most of our products:

 

    Width (mm)   Thickness (mm)   Galvanized Layer Weight (g/m2 )
Our Specification Scope   700-1250   0.18-4.5   70-280
Common Industrial Specification Scope   700-1250   0.3-1.2   100-180

 

We also are technologically capable of manufacturing more extreme specifications of up to 1300mm wide and 0.16mm thick HDG of cold-rolled steel. As a result, we maintain a competitive advantage in extreme specification technology in terms of thickness and the weight of the galvanized layer of our products. We have the flexibility to adjust production specifications to meet changes in market demand.

 

Sales of HDG steel products amounted to approximately 451,269 MT in fiscal year 2012, representing approximately 63.8% of our total revenue. Currently, our HDG steel products are manufactured by Changshu Huaye and Jiangsu Cold-Rolled. Changshu Huaye produces only HDG of cold-rolled steel. Jiangsu Cold-Rolled added two new HDG steel production lines which are capable of galvanizing both hot-rolled and cold-rolled steel with both zinc and aluminum. These two new production lines became operational at the end of September 2008. The addition of the new production lines significantly expanded our production capacity of HDG steel, which increased production capacity from 300,000 MT per year to 700,000 MT per year.

 

With the new production lines, we offer HDG of hot-rolled steel, which we believe is more cost-efficient than production of HDG of cold-rolled steel because production of HDG steel products occurs directly on hot-rolled steel and, therefore, avoids the procedure of cold rolling hot-rolled steel. HDG of hot-rolled steel is generally thicker than HDG of cold-rolled steel with a specification range of 1.5mm to 4.5mm in terms of thickness.

 

PPGI Products

 

PPGI products are typically made to order based on customer specifications. Our PPGI products’ specification generally ranges from 700mm to 1250mm in width and from 0.2mm to 1.2mm in thickness. Our PPGI products are used mostly in solar energy, appliances and construction materials. We produce our PPGI by color-coating on HDG of cold-rolled steel and then coating them in various colors according to customer requirements. Our PPGI production line is equipped with the latest twice baking and coating technology, which together with indirect heating, enhances the color coated layers adhesion to the galvanized zinc layer.

 

4
 

 

Sales of PPGI products amounted to approximately 44,612 MT in fiscal year 2012, representing approximately 8.7% of our total revenue. Through our vertical integration strategy, we currently self-supply almost100% of HDG of cold-rolled steel to our PPGI production.

 

AP Steel

 

Our AP steel production line became operative in September 2006. Acid pickling is a process that removes scales and oxides from the steel surface by pickling, cold rolling and annealing. AP steel products are used mostly as a raw material for cold-rolled steel strip, HDG steel, as well as components of automobile and manufacturing equipment. AP steel products come in several different dimensions and using different materials and different specifications.

 

Most of our AP steel products are used for our own production of HDG steel and full-hard cold-rolled steel. We also sell a small portion of our AP steel products to the market. In fiscal year 2012, our sales of AP steel products were approximately 127,568 MT, representing approximately12.2% of our total revenue.

 

Full-Hard, Cold-rolled Steel Products

 

We commenced manufacturing of full-hard cold-rolled steel products in January 2007. Full-hard cold-rolled steel strips are treated in an annealing process and are used to produce HDG of cold-rolled steel. We produce full-hard cold-rolled steel strips through a reverse cold rolling mill.

 

We use most of the full-hard cold-rolled steel strips for our production of HDG of cold-rolled steel. The remaining undergoes the annealing process and is sold to the market. Our sales of full-hard cold-rolled steel products amounted to approximately 23,963 MT in fiscal year 2012, representing approximately 3.0% of our total revenue. In addition, approximately 93.0% of cold-rolled steel products were used for our own production.

 

Welded Steel Pipe Products

 

Our subsidiary Ningbo Zhehua has one advanced JCOE (which represents the first letter of the production processes) production line with characteristics of high forming accuracy and efficiency as well as balanced distribution of forming stress, for large-diameter, double-side, submerged-arc welded steel pipes, three US Lincoln production lines for spiral seam, double-side, submerged-arc welded steel pipes, and two REF production lines for roll-bending, double-side, submerged-arc welded steel pipes.  Ningbo Zhehua is specialized in manufacturing large-diameter, double-side, submerged-arc welded steel pipes and spiral seam steel pipes. The finished products are extensively used for oil and gas transmission, municipal water supply projects, sewage treatment projects, and piling.  Sales of welded steel pipe products amounted to approximately 41,070 MT in fiscal year 2012, representing approximately 6.8% of our total sales revenue.

 

Manufacturing

 

Our manufacturing facilities are located in Changshu and Ningbo, China. Our facilities in Changshu currently have three HDG steel production lines, one PPGI production line, one AP steel production line and one cold-rolled steel line. Our facilities in Ningbo have six welded steel pipe production lines. Our current annual production capacity is approximately 700,000 MT for HDG steel, 200,000 MT for PPGI, 500,000 MT for AP steels, 250,000 MT for cold-rolled steel and 400,000 MT for welded steel pipe products.

 

We utilize modern automated production technology which is strictly maintained. There are generally only 15 workers on a continuous cold-rolled galvanizing line and 11 workers on the PPGI production line per shift. The chart below demonstrates our production process.

 

5
 

 

 

Raw Materials and Suppliers

 

The principal raw materials used in producing our products are steel coil, zinc, oil paint and acid. We source our raw materials from various suppliers, including our affiliate Shanghai Huaye which supplied approximately 36.3% of our raw materials in fiscal year 2012. We believe that our suppliers are sufficient to meet our present needs.

 

Steel coil accounted for approximately 94% of total production costs in fiscal year 2012. We generally purchase steel coil after receiving orders from customers and are generally able to pass on increased costs to customers. We purchase steel strips primarily from Chinese companies, both state-owned enterprises and private companies. State-owned enterprises can ensure a consistent large supply, but do not react quickly to the fluctuations in prevailing market prices. Private companies normally react quickly to price changes, but are not as reliable as state-owned enterprises in terms of consistent supply. By sourcing raw materials from a combination of state-owned enterprises and private companies, we enjoy both a reliable source of raw materials and competitive prices.

 

Zinc is an important raw material for HDG of cold-rolled steel and accounted for approximately 4% of our total production costs of HDG steel in fiscal year 2012. We have established long-term relationships with several Chinese suppliers. We compare the prevailing domestic prices and choose the lower price and can generally pass price fluctuations onto customers. Zinc prices are closely guided by the London Metal Exchange quotation and are the most volatile among those of all of our raw materials.

 

Our global sourcing network is designed to ensure the highest quality-to-price ratio of the raw materials we purchase. Our internal specialists collect Chinese domestic and global market information everyday and track domestic and global market price fluctuations closely, which allows us to react rapidly to any price changes.

 

Customers

 

We sell most of our steel products to customers who operate in the solar energy, appliances, automobile, construction, infrastructure, medical equipment and water resource industries.

 

6
 

 

Approximately 29.3% of our revenue was derived from Shanghai Huaye and its affiliates in fiscal year 2012. We currently do not have a long-term written contract with Shanghai Huaye and negotiate the terms of each transaction based on then current market condition. We believe such arrangement will afford us more flexibility and allow us to obtain more favorable prices based on the changing market. We believe we have a good relationship with Shanghai Huaye and expect Shanghai Huaye to remain as our major customer in the foreseeable future.  We plan to further expand our sales channel and increase our direct sales to end customers in the future. Other than Shanghai Huaye, none of our customers accounted for more than 10% of our total revenue in fiscal year 2012.

 

Sales and Marketing

 

China is our most important market. Domestic sales represented approximately 88.7% of our total revenue in fiscal year 2012. Within China, the biggest market for our products is eastern China, which includes Shanghai, Zhejiang and Jiangsu provinces. Since September 2004, we have exported our products to Europe, the Middle East, Asia, and South America. Our foreign sales accounted for approximately 14.4% and 11.3% of our total revenue in fiscal years 2011 and 2012, respectively.

 

Our sales network covers most provinces and regions in China. We are developing a diversified sales network which allows us to effectively market products and services to our customers. We sold approximately 70.7% of our products through our own sales and marketing department in fiscal year 2012. Our sales and marketing department consists of approximately78 employees as of the date of this annual report.

 

Competition

 

Competition within the steel industry, both in China and worldwide, is intense. We compete with both large state-owned enterprises and smaller private companies. In addition, we also face competition from international steel manufacturers.

 

Even though the demand for fine finished steel products has increased in recent years, due to the over expansion of the total production capacity of HDG steel and PPGI products, supply for low-end HDG steel and PPGI products has outpaced demand. Due to the high requirements for production technology and equipment, we believe that demand for high-end HDG steel and PPGI market remains strong. Currently, only we and a few large state-owned enterprises are capable of producing high-end HDG steel and PPGI products in China.

 

Private steel product manufacturers in China generally focus on low-end products. Many of our competitors are much smaller than us and use older equipment and production techniques. In contrast, our products are aimed at the high-end markets so we attempt to manufacture them with superior quality and broader range of specifications. We use advanced manufacturing equipment that we have purchased from developed countries, such as France and Italy, and employ engineers and researchers who are experienced with different production techniques. This allows us to provide a broad array of products in terms of thickness, zinc layer weight and width of steel coil, which helps us target high-end customers whose manufacturing specifications are extreme. In addition, through cooperation with our strategic partners, we have also established a vertically integrated business model that provides processing, distribution and customized logistic solutions. We believe this business model is difficult to duplicate and very few private companies have this capability.

 

There are several state-owned steel manufacturers that produce comparable products to our products. As compared with those competitors, we believe we differentiate ourselves by the following:

 

·We satisfy customers’ orders with shorter lead times and guarantee lead times for urgent orders, even very small orders, in as short as one or two days;

 

·We have flexibility in sales arrangements and can take orders in a variety of sizes;

 

·We operate more efficiently than our state-owned competitors and have lower total labor costs, therefore, lower product prices; and

 

·We provide more customer-oriented services.

 

We also compete with international steel product manufacturers in the global market, such as ArcelorMittal and Posco Steel. As compared to our competitors in Europe, Korea and the United States, we believe we have lower production costs and can offer more competitive pricing. In addition, competitors in developing countries lag behind due to low product quality and limited product specification ranges. We began exporting our products in September 2004 and our products are now sold to Europe, the Middle East, Asia, and South America. Our export sales accounted for approximately 11.3% of our total sales for fiscal year 2012.

 

7
 

 

Our operating subsidiaries, Changshu Huaye and Jiangsu Cold-Rolled, are both located in Changshu, which provides us with a transportation cost advantage. Changshu is situated in the eastern coastal part of China, the largest market for coated steel products in China. In addition, our affiliate Shanghai Huaye has a logistic center in Changshu port, which provides us with convenient and low cost transportation for both raw materials and finished products. Further, our subsidiary Ningbo Zhehua is located in Ningbo which is one of the largest and most important sea port cities in China with easy access to both domestic and international markets.

 

Research and Development

 

We believe that the development of new products and production methods is important to our success. We established our high-performance steel sheet research center in 2007 which was recognized as the “Jiangsu Province Foreign Invested Research Center” by the Jiangsu Science and Technology Bureau. As of June 30, 2012, we had 86 research and development personnel and staff.

 

We recently set up Sutor Technology PRC, a wholly-owned subsidiary incorporated in China, and plan to consolidate all R&D activities into this subsidiary in the future. We plan to build a facility in the new subsidiary to be used solely for research and development of new products and technologies. We expect the new subsidiary will help attract talent and enhance our leading position in the fine processed steel industry in China. The new subsidiary is anticipated to enjoy preferential tax treatment when in full operation.

 

Intellectual Property

 

Our success depends, in part, on our ability to maintain and protect our proprietary technology and to conduct our business without infringing on the proprietary rights of others. We rely primarily on a combination of patents, trademarks and trade secrets, as well as employee and third-party confidentiality agreements, to safeguard our intellectual property. As of June 30, 2012, we held 43 patents and had 33 patent applications pending.

 

All of our products are sold with the trademark of “,” which is known by Chinese and international clients. In August 2005, Shanghai Huaye agreed to transfer the trademark of “” to us without consideration. Such transfer was approved by the Trademark office of the State Administration for Industry and Commerce of China in August 2006. As a result, we have all the legal rights for the trademark, the term of which expires in July 2015.

 

All our key employees, especially engineers, have signed confidentiality and non-competition agreements with us. In addition, all our employees are obligated to protect our confidential information. Where appropriate for our business strategy, we will continue to take steps to protect our intellectual property rights.

 

Employees

 

As of June 30, 2012, we had approximately 731 full-time employees. Approximately 341 are employees of Changshu Huaye, approximately 199 are employees of Jiangsu Cold-Rolled, and approximately 191 are employees of Ningbo Zhehua.

 

The following table sets forth the number of our full-time employees by function.

 

Function   Number of Employees
Manufacturing   493
General and administration   74
Marketing and sales   78
Research and development   86

 

We believe that we maintain a good working relationship with our employees and we have not experienced any significant labor disputes or any difficulty in recruiting staff for our operations. Our employees are not covered by a collective bargaining agreement. We have not experienced any work stoppages.

 

We are required under PRC law to make contributions to the employee benefit plans at specified percentages of the after-tax profit. In addition, we are required by the PRC law to cover employees in China with various type of social insurance. We believe that we are in material compliance with the relevant PRC laws.

 

8
 

 

Regulation

 

General Regulation of Business

 

As a producer of steel products in China, we are regulated by the national and local laws of the PRC.

 

We are subject to various governmental regulations related to environmental protection. The major environmental regulations applicable to us include: the Environmental Protection Law of the PRC, the Law of PRC on the Prevention and Control of Water Pollution, Implementation Rules of the Law of PRC on the Prevention and Control of Water Pollution, the Law of PRC on the Prevention and Control of Air Pollution, Implementation Rules of the Law of PRC on the Prevention and Control of Air Pollution, the Law of PRC on the Prevention and Control of Solid Waste Pollution, and the Law of PRC on the Prevention and Control of Noise Pollution.

 

We believe that we are in material compliance with all registrations and requirements for the issuance and maintenance of all licenses required by the governing bodies, and that all license fees and filings are current.

 

Taxation

 

On March 16, 2007, the National People’s Congress of China passed the Enterprise Income Tax Law, or the EIT Law, and on November 28, 2007, the State Council of China passed its implementing rules, both of which took effect on January 1, 2008. The EIT Law and its implementing rules impose a unified earned income tax, or EIT, rate of 25.0% on all domestic-invested enterprises and foreign invested enterprises, or FIEs, unless they qualify under certain limited exceptions.  Changshu Huaye is subject to an EIT of 15% from calendar years 2010 to 2012 because it qualifies as a high-tech enterprise for the calendar years 2010, 2011, 2012. Jiangsu Cold-Rolled’s tax holiday expired at the end of 2011, and therefore, it was subject to an EIT rate of 12.5% in calendar year 2011 and is subject to an EIT rate of 25% starting in calendar year 2012. Ningbo Zhehua and Sutor Technology PRC are subject to an EIT of 25% and have no preferential tax treatments.

 

In addition to the changes to the current tax structure, under the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a resident enterprise and will normally be subject to an EIT of 25% on its global income. The implementing rules define the term “de facto management bodies” as “an establishment that exercises, in substance, overall management and control over the production, business, personnel, accounting, etc., of a Chinese enterprise.” If the PRC tax authorities subsequently determine that we should be classified as a resident enterprise, then our organization’s global income will be subject to PRC income tax of 25%.  For detailed discussion of PRC tax issues related to resident enterprise status, see Item 1A, “Risk Factors – Risks Related to Doing Business in China – Under the New Enterprise Income Tax Law, we may be classified as a “resident enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders.”

 

Foreign Currency Exchange

 

All of our sales revenue and expenses are denominated in RMB. Under the PRC foreign currency exchange regulations applicable to us, RMB is convertible for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions. Currently, our PRC operating subsidiaries may purchase foreign currencies for settlement of current account transactions, including payments of dividends to us, without the approval of the PRC State Administration of Foreign Exchange, or SAFE, by complying with certain procedural requirements.  Conversion of RMB for capital account items, such as direct investment, loan, security investment and repatriation of investment, however, is still subject to the approval of SAFE. In particular, if our PRC operating subsidiaries borrow foreign currency through loans from us or other foreign lenders, these loans must be registered with SAFE, and if we finance the subsidiaries by means of additional capital contributions, these capital contributions must be approved by certain government authorities, including the PRC Ministry of Commerce, or MOFCOM, or their respective local branches.  These limitations could affect our PRC operating subsidiaries’ ability to obtain foreign exchange through debt or equity financing.

 

Dividend Distributions

 

Our revenues are earned by our PRC subsidiaries.  However, PRC regulations restrict the ability of our PRC subsidiaries to make dividends and other payments to their offshore parent company.  PRC legal restrictions permit payments of dividend by our PRC subsidiaries only out of their accumulated after-tax profits, if any, determined in accordance with PRC accounting standards and regulations.  Each of our PRC subsidiaries is also required under PRC laws and regulations to allocate at least 10% of our annual after-tax profits determined in accordance with PRC GAAP to a statutory general reserve fund until the amounts in such fund reaches 50% of its registered capital.  These reserves are not distributable as cash dividends. Our PRC subsidiaries have the discretion to allocate a portion of their after-tax profits to staff welfare and bonus funds, which may not be distributed to equity owners except in the event of liquidation.

 

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In addition, under the EIT Law, the Notice of the State Administration of Taxation on Negotiated Reduction of Dividends and Interest Rates, which was issued on January 29, 2008, and the Notice of the State Administration of Taxation Regarding Interpretation and Recognition of Beneficial Owners under Tax Treaties, which became effective on October 27, 2009, dividends from our PRC operating subsidiaries paid to us through our subsidiaries may be subject to a withholding tax at a rate of 10%. Furthermore, the ultimate tax rate will be determined by treaty between the PRC and the tax residence of the holder of the PRC subsidiary.  Dividends declared and paid from before January 1, 2008 on distributable profits are grandfathered under the EIT Law and are not subject to withholding tax.

 

The Company intends to reinvest profits, if any, and does not intend to make cash distributions of dividends in the near future.

 

Environmental Matters

 

Our manufacturing facilities are subject to various pollution control regulations with respect to noise, water and air pollution and the disposal of waste and hazardous materials. We are also subject to periodic inspections by local environmental protection authorities. Our operating subsidiaries have received certifications from the relevant PRC government agencies in charge of environmental protection indicating that their business operations are in material compliance with the relevant PRC environmental laws and regulations. We are not currently subject to any pending actions alleging any violations of applicable PRC environmental laws.

 

Seasonality

 

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

 

Available Information

 

Our Internet website is at www.sutorcn.com. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, including exhibits, and amendments to those reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Exchange Act, are available free of charge on our website as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the SEC. Copies of these reports may also be obtained free of charge by sending written requests to our Secretary, Sutor Technology Group Limited, No. 8 Huaye Road, Dongbang Industrial Park, Changshu, China, 215534. The information posted on our website is not part of this or any other report we file with or furnish with the SEC. Investors can also read and copy any materials filed by us with the SEC at the SEC’s Public Reference Room which is located at 100 F Street, NE, Washington, DC20549. Information about the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. Our filings can also be accessed at the SEC’s website: www.sec.gov.

  

ITEM 1A.RISKFACTORS.

 

RISKS RELATED TO OUR BUSINESS

 

We maintain a close business relationship with Shanghai Huaye and any disruption of this relationship or the financial stability of Shanghai Huaye could damage our business.

 

Our company and Shanghai Huaye, which is 100% owned by our majority shareholder, Chairperson and CEO, Lifang Chen and her husband Feng Gao, have a close business relationship.  Approximately 29.3% of our revenue was derived from Shanghai Huaye and its affiliates in fiscal year 2012, which distribute our products. In addition, a large portion of our raw materials were supplied by Shanghai Huaye in fiscal year 2012.  We believe that the larger size of Shanghai Huaye gives it greater bargaining power than us and our arrangement with Shanghai Huaye allows us to leverage its bargaining power and purchase raw materials at relatively lower purchase prices from suppliers. We do not have long-term written contracts with Shanghai Huaye.  In the past, Shanghai Huaye also has provided credit support on our behalf and guaranties for our benefit in connection with loans to us from third party lenders.

 

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If our business relationship with Shanghai Huaye changes negatively or Shanghai Huaye’s financial condition deteriorates, this would harm our business in many ways.   We would be forced to rely on other third parties for raw materials and product distribution if Shanghai Huaye ceases to be a supplier of our raw materials and/or a distributor of our products at current levels.  We may not be able to negotiate terms with these third parties that are as favorable as our arrangements with Shanghai Huaye.  If this happens, our revenues could decrease, our production costs could increase and our profit margin could be strained.  In addition, a material adverse change in the financial condition and creditworthiness of Shanghai Huaye could impair our existing credit facilities and ability to obtain loans in the future.

 

Any decrease in the availability, or increase in the cost, of raw materials could materially affect our earnings.

 

Our operations depend heavily on the availability of various raw materials and energy resources, including steel coil, zinc, oil paint, electricity and natural gas. Steel coil has historically made up approximately 90.0% of our total cost of sales. The availability of raw materials and energy resources may decrease and their prices may fluctuate greatly. We purchase a large portion of our raw materials from our affiliate Shanghai Huaye and we have long-term relationships with several other suppliers. However, if Shanghai Huaye or any other important suppliers are unable or unwilling to provide us with raw materials on terms favorable to us, we may be unable to produce certain products. This could result in a decrease in profit and damage to our reputation in our industry. In the event our raw material and energy costs increase, we may not be able to pass these higher costs on to our customers in full or at all. Any increase in the prices for raw materials or energy resources could materially increase our costs and therefore lower our earnings.

 

Our industry is highly fragmented and competitive, and increased competition could reduce our operating income.

 

The steel manufacturing and processing business is highly fragmented and competitive. We compete with a number of other steel manufacturers and processors in China, on a region-by-region basis, and with foreign steel manufacturers on a worldwide basis. Our goal is to market our products to customers who demand the highest quality products and precision in the end product so we compete primarily on the precision and range of achievable tolerances, the quality of our products and the raw materials used in our products. We compete with companies of various sizes, some of which have more established brand names and relationships in certain markets we serve than we do. Increased competition could force us to lower our prices or offer services at a higher cost to us, which could reduce our margins and operating income.

 

A downturn or negative changes in the highly volatile steel industry will harm our business and profitability.

 

The steel industry as a whole is cyclical and pricing can be volatile as a result of general economic conditions, energy costs, labor costs, competition, import duties, tariffs and currency exchange rates. These macroeconomic factors have historically resulted in wide fluctuations in the steel industry both in China and globally. In our case, future economic downturns, stagnant economies or currency fluctuations in China or globally could decrease the demand for products or increase the amount of imports of steel into China, which could negatively impact our sales, margins and profitability.

 

We may be exposed to potential risks relating to our internal controls over financial reporting and our ability to have the operating effectiveness of our internal controls attested to by our independent auditors.

 

As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the SEC adopted rules requiring public companies to include a report of management on the Company’s internal controls over financial reporting in their annual reports and, for companies that are not small reporting companies, the independent registered public accounting firm auditing a company’s financial statements to attest to and report on the operating effectiveness of such company’s internal controls. Our management had previously identified material weaknesses in our internal control over financial reporting in fiscal years 2008 and 2009. Although our management believes that our internal control over financial reporting was effective as of June 30, 2012, we can provide no assurance that we will comply with all of the requirements imposed thereby and we will receive a positive attestation from our independent auditors in the future, when required. In the event we identify significant deficiencies or material weaknesses in our internal controls that we cannot remediate in a timely manner or we are unable to receive a positive attestation from our independent auditors with respect to our internal controls, investors and others may lose confidence in the reliability of our financial statements.

 

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

 

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

 

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

 

If we become directly subject to the recent scrutiny, criticism and negative publicity involving U.S.-listed Chinese companies, we may have to expend significant resources to investigate and resolve the matter which could harm our business operations, stock price and reputation and could result in a loss of your investment in our stock, especially if such matter cannot be addressed and resolved favorably.

 

Recently, U.S. public companies that have substantially all of their operations in China, particularly companies like us which have completed so-called reverse merger transactions, have been the subject of intense scrutiny, criticism and negative publicity by investors, financial commentators and regulatory agencies, such as the SEC. Much of the scrutiny, criticism and negative publicity has centered around financial and accounting irregularities and mistakes, a lack of effective internal controls over financial accounting, inadequate corporate governance policies or a lack of adherence thereto and, in many cases, allegations of fraud.  As a result of the scrutiny, criticism and negative publicity, the publicly traded stock of many U.S. listed Chinese companies has sharply decreased in value and, in some cases, has become virtually worthless.  Many of these companies are now subject to shareholder lawsuits, SEC enforcement actions and are conducting internal and external investigations into the allegations.  It is not clear what effect this sector-wide scrutiny, criticism and negative publicity will have on our Company, our business and our stock price.  If we become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, we will have to expend significant resources to investigate such allegations and/or defend our Company.  This situation will be costly and time consuming and distract our management from growing our company.  If such allegations are not proven to be groundless, our Company and business operations may be severely and adversely affected and your investment in our stock could be rendered worthless.

 

We may be unable to fund the substantial ongoing capital and maintenance expenditures that our operations require.

 

Our operations are capital intensive and our business strategy may require additional substantial capital investment. We require capital for building new production lines, acquiring new equipment, maintaining the condition of our existing equipment and complying with environmental laws and regulations. We plan to fund our capital expenditures from operating cash flow and our credit facilities and may require additional debt or equity financing. We cannot assure you, however, that financing will be available or, if financing is available, it may result in increased interest and amortization expense, increased leverage, dilution and decreased income available to fund further expansion. In addition, future debt financings may limit our ability to withstand competitive pressures and render us more vulnerable to economic downturns. If we are unable to fund our capital requirements, we may be unable to implement our business plan, and our financial performance may suffer.

 

Our level of indebtedness may make it more difficult for us to fulfill all of our debt obligations and may reduce the amount of cash available for maintaining and growing our operations, which could have an adverse effect on our revenues.

 

Our major source of liquidity is borrowing through short-term bank and private loans. Our total debt under existing loans as of June 30, 2012 was approximately $147.4 million, of which approximately $138.9 million are short-term loans to non-related third parties. We expect to renew our short-term loans when they become due. Our inability to renew these loans upon maturity may cause us working capital constraints. This substantial indebtedness could also impair our financial condition and our ability to fulfill all of our debt obligations, especially during a downturn in our business, in the industry in which we operate or in the general economy. Our indebtedness and the incurrence of any new indebtedness could (i) make it more difficult for us to satisfy our existing obligations, which could in turn result in an event of default on such obligations, (ii) require us to seek other sources of capital to finance cash used in operating activities, thereby reducing the availability of cash for working capital, capital expenditures, acquisitions, general corporate purposes or other purposes, (iii) impair our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, general corporate purposes or other purposes; (iv) diminish our ability to withstand a downturn in our business, the industry in which we operate or the economy generally, (v) limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate, or (vi) place us at a competitive disadvantage compared to competitors that have proportionately less debt. If we are unable to meet our debt service obligations, we could be forced to restructure or refinance our indebtedness, seek additional equity capital or sell assets.

 

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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.

 

Unexpected equipment failures may damage our business due to production curtailments or shutdowns.

 

Our manufacturing processes are extremely specialized and depend on critical pieces of equipment, such as air knife machines, welding tools and apparatus, color-coating machines, roll mills, ABB roll and tension knives. This machinery is highly specialized and cannot be repaired or replaced without significant expense and time delay. On occasion, our equipment may be out of service as a result of unanticipated failures which may result in material plant shutdowns or periods of reduced production. Interruptions in production capabilities will inevitably increase production costs and reduce our sales and earnings. In addition to equipment failures, our facilities are also subject to the risk of catastrophic loss due to unanticipated events such as fires, explosions or adverse weather conditions. Furthermore, any interruption in production capability may require us to make large capital expenditures to remedy the situation, which could have a negative effect on our profitability and cash flows. Although we have business interruption insurance, we cannot provide any assurance that the insurance will cover all losses that we experience as a result of the equipment failures. In addition, longer-term business disruption could result in a loss of customers. If this were to occur, our future sales levels, and therefore our profitability, could be adversely affected.

 

Our revenue will decrease if there is less demand for construction materials or electrical household appliances.

 

Our products often serve as important components in construction materials and electrical household appliances. Therefore, we are subject to the general changes in economic conditions affecting the construction and household appliance segments of the economy. Demand for our products is typically affected by a number of economic factors, including, but not limited to, consumer interest rates, consumer confidence, retail trends, sales of existing homes, and the level of mortgage financing. If there is a decline in economic activity in China and the other markets in which we operate or a decrease of sales of construction materials and electrical household appliances, demand for our products and our revenue will likewise decrease.

 

Environmental regulations impose substantial costs and limitations on our operations.

 

We are subject to various national and local environmental laws and regulations in China concerning issues such as air emissions, wastewater discharges, and solid waste management and disposal. These laws and regulations can restrict or limit our operations and expose us to liability and penalties for non-compliance. While we believe that our facilities are in material compliance with all applicable environmental laws and regulations, the risks of substantial unanticipated costs and liabilities related to compliance with these laws and regulations are an inherent part of our business. It is possible that future conditions may develop, arise or be discovered that create new environmental compliance or remediation liabilities and costs. While we believe that we can comply with existing environmental legislation and regulatory requirements and that the costs of compliance have been included within budgeted cost estimates, compliance may prove to be more limiting and costly than anticipated.

 

If our customers and/or the ultimate consumers of products that use our products successfully assert product liability claims against us due to defects in our products, our operating results may suffer and our reputation may be harmed.

 

Our products are widely applied in the manufacturing of many products, including electrical household appliances, medical instruments and large industrial equipment. Significant property damage, personal injuries and even death can result from malfunctioning products. If our products are not properly manufactured or installed and/or if people are injured as a result of our products, we could be subject to claims for damages based on theories of product liability and other legal theories in some jurisdictions in which our products are sold. The costs and resources to defend such claims could be substantial and, if such claims are successful, we could be responsible for paying some or all of the damages. We do not have product liability insurance. The publicity surrounding these sorts of claims is also likely to damage our reputation, regardless of whether such claims are successful. Any of these consequences resulting from defects in our products would hurt our operating results and stockholder value.

 

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We might fail to adequately protect our intellectual property and third parties may claim that our products infringe upon their intellectual property.

 

As part of our business strategy, we intend to accelerate our investment in new technologies in an effort to strengthen and differentiate our product portfolio and make our manufacturing processes more efficient. As a result, we believe that the protection of our intellectual property will become increasingly important to our business. Currently, we have 43 patents and 33 patent applications pending. We expect to rely on a combination of patents, trade secrets, trademarks and copyrights to provide protection in this regard, but this protection might be inadequate. For example, our pending or future patent applications might not be approved or, if allowed, they might not be of sufficient strength or scope. Conversely, third parties might assert that our technologies infringe their proprietary rights. In either case, litigation could result in substantial costs and diversion of our resources, and whether or not we are ultimately successful, the litigation could hurt our business and financial condition.

 

Expansion of our business may strain our management and operational infrastructure and impede our ability to meet any increased demand for our fine finished steel products.

 

Our growth strategy includes growing our operations by meeting the anticipated growth in demand for existing products, introducing new product offerings, and identifying and acquiring or investing in suitable candidates on acceptable terms. In 2009, we acquired a 100% ownership interest in Ningbo Zhehua. In addition, our subsidiary, Jiangsu Cold-Rolled, has recently completed construction of several new production lines and has been put into operation, but lacks a proven operational history. Over time, we may acquire or make investments in other providers of products that complement our business and other companies in our industry. Growth in our business may place a significant strain on our personnel, management, financial systems and other resources. Our business growth also presents numerous risks and challenges, including:

 

·our ability to successfully and rapidly expand sales to potential customers in response to potentially increasing demand;

 

·our ability to integrate and retain key management, sales, research and development, production and other personnel;

 

·our ability to incorporate the acquired products or capabilities into our offerings from an engineering, sales and marketing perspective;

 

·integration and support of pre-existing supplier, distribution and customer relationships;

 

·adverse effects on our reported operating results due to possible write-down of goodwill associated with acquisitions;

 

·potential disputes with sellers of acquired businesses, technologies, services, products and potential liabilities;

 

·the costs associated with such growth, which are difficult to quantify, but could be significant; and

 

·rapid technological change.

 

To accommodate this growth and compete effectively, we may need to obtain additional funding to improve information systems, procedures and controls and expand, train, motivate and manage existing and additional employees. Funding may not be available in a sufficient amount or on favorable terms, if at all. If we are not able to manage these activities and implement these strategies successfully to expand to meet any increased demand, our operating results could suffer.

 

We depend heavily on key personnel, and turnover of key employees and senior management could harm our business.

 

Our future business and results of operations depend in significant part upon the continued contributions of our key technical and senior management personnel, including Lifang Chen, our Chief Executive Officer, and Yongfei Jiang, our Chief Financial Officer. They also depend in significant part upon our ability to attract and retain additional qualified management, technical, marketing and sales and support personnel for our operations. If we lose a key employee, if a key employee fails to perform in his or her current position, or if we are not able to attract and retain skilled employees as needed, our business could suffer. Significant turnover in our senior management could significantly deplete our institutional knowledge held by our existing senior management team. We depend on the skills and abilities of these key employees in managing the manufacturing, technical, marketing and sales aspects of our business, any part of which could be harmed by turnover in the future.

 

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Changes in our effective tax rate or tax liability may have an adverse effect on our results of operations.

 

Because we are a U.S. company with operating subsidiaries in China and we engage in international sales, we are subject to federal and state tax in the U.S., state and local tax in China and other foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of our business, there are some transactions where the ultimate tax determination is uncertain. Additionally our calculations of income taxes are based on our interpretations of applicable tax laws in the jurisdictions in which we file. Although we believe our tax estimates are appropriate, there is no assurance that the final determination of our income tax liability will not be materially different than what is reflected in our income tax provisions and accruals. We are also subject to the periodic examination of our income tax returns by tax authorities. The outcomes from these examinations may have an adverse effect on our operating results and financial condition. Furthermore, our provision for income tax could increase as we expand our international operations, adopt new products, implement changes to our operating structure or undertake intercompany transactions in light of acquisitions, changing tax laws, and our current and anticipated business and operational requirements. Should additional taxes be assessed as a result of new legislation, an audit or litigation; or if our effective tax rate should change as a result of changes in federal, international or state and local tax laws, there could be a material adverse effect on our income tax provision and results of operations.

 

Ms. Lifang Chen’s association with Shanghai Huaye could pose a conflict of interest.

 

Ms. Lifang Chen, our Chairman and beneficial owner of 75.5% of our common stock, also beneficially owns 100% of Shanghai Huaye, which is a major distributor of our products and provider of our raw materials. As a result, conflicts of interest may arise from time to time. We will attempt to resolve any such conflicts of interest in our favor. Our officers and directors are accountable to us and our shareholders as fiduciaries, which requires that such officers and directors exercise good faith and integrity in handling our affairs.

 

We may be exposed to liabilities under the Foreign Corrupt Practices Act, and any determination that we violated the Foreign Corrupt Practices Act could have a material adverse effect on our business.

 

We are subject to the Foreign Corrupt Practice Act, or FCPA, and other laws that prohibit improper payments or offers of payments to foreign governments and their officials and political parties by U.S. persons and issuers as defined by the statute for the purpose of obtaining or retaining business. We have operations, agreements with third parties and make sales in China, which may experience corruption. Our activities in China create the risk of unauthorized payments or offers of payments by one of the employees, consultants, sales agents or distributors of our company, because these parties are not always subject to our control. It is our policy to implement safeguards to discourage these practices by our employees. Also, our existing safeguards and any future improvements may prove to be less than effective, and the employees, consultants, sales agents or distributors of our Company may engage in conduct for which we might be held responsible. Violations of the FCPA may result in severe criminal or civil sanctions, and we may be subject to other liabilities, which could negatively affect our business, operating results and financial condition. In addition, the government may seek to hold our Company liable for successor liability FCPA violations committed by companies in which we invest or that we acquire.

 

RISKS RELATED TO DOING BUSINESS IN CHINA

 

Adverse changes in political and economic policies of the PRC government could impede the overall economic growth of China, which could reduce the demand for our products and damage our business.

 

We conduct substantially all of our operations and generate most of our revenue in China. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. The PRC economy differs from the economies of most developed countries in many respects, including:

 

·a higher level of government involvement;
·an early stage of development of the market-oriented sector of the economy;
·a rapid growth rate;
·a higher level of control over foreign exchange; and
·the allocation of resources.

 

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As the PRC economy has been transitioning from a planned economy to a more market-oriented economy, the PRC government has implemented various measures to encourage economic growth and guide the allocation of resources. While these measures may benefit the overall PRC economy, they may also have a negative effect on us.

 

Although the PRC government has in recent years implemented measures emphasizing the utilization of market forces for economic reform, the PRC government continues to exercise significant control over economic growth in China through the allocation of resources, controlling the payment of foreign currency-denominated obligations, setting monetary policy and imposing policies that impact particular industries or companies in different ways.

 

Any adverse change in economic conditions or government policies in China could have a material adverse effect on the overall economic growth in China, which in turn could lead to a reduction in demand for our services and consequently have a material adverse effect on our business and prospects.

 

Uncertainties with respect to the PRC legal system could limit the legal protections available to you and us.

 

We conduct substantially all of our business through our operating subsidiaries in the PRC. Our operating subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to foreign-invested enterprises. The PRC legal system is based on written statutes, and prior court decisions may be cited for reference but have limited precedential value. Since 1979, a series of new PRC laws and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since the PRC legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involve uncertainties, which may limit legal protections available to you and us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. Also, most of our executive officers and directors are residents of China and not of the United States, and substantially all the assets of these persons are located outside the United States. As a result, it could be difficult for investors to affect service of process in the United States or to enforce a judgment obtained in the United States against our Chinese operations and subsidiaries.

 

If we are found to have failed to comply with applicable laws, we may incur additional expenditures or be subject to significant fines and penalties.

 

Our operations are subject to PRC laws and regulations applicable to us. However, many PRC laws and regulations are uncertain in their scope, and the implementation of such laws and regulations in different localities could have significant differences. In certain instances, local implementation rules and/or the actual implementation are not necessarily consistent with the regulations at the national level. Although we strive to comply with all the applicable PRC laws and regulations, we cannot assure you that the relevant PRC government authorities will not later determine that we have not been in compliance with certain laws or regulations.

 

In addition, our facilities and products are subject to many laws and regulations. Our failure to comply with these and other applicable laws and regulations in China could subject us to administrative penalties and injunctive relief, as well as civil remedies, including fines, injunctions and recalls of our products. It is possible that changes to such laws or more rigorous enforcement of such laws with respect to our current or past practices could have a material adverse effect on our business, operating results and financial condition. Further, additional environmental, health or safety issues relating to matters that are not currently known to management may result in unanticipated liabilities and expenditures.

 

The PRC government exerts substantial influence over the manner in which we must conduct our business activities.

 

The PRC government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property and other matters. We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of the jurisdictions in which we operate may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations.

 

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Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof and could require us to divest ourselves of any interest we then hold in Chinese properties or joint ventures.

 

Restrictions on currency exchange may limit our ability to receive and use our sales effectively.

 

The majority of our revenues will be settled in RMB and U.S. dollars, and any future restrictions on currency exchanges may limit our ability to use revenue generated in RMB to fund any future business activities outside China or to make dividend or other payments in U.S. dollars. Although the Chinese government introduced regulations in 1996 to allow greater convertibility of the RMB for current account transactions, significant restrictions still remain, including primarily the restriction that foreign-invested enterprises may only buy, sell or remit foreign currencies after providing valid commercial documents, at those banks in China authorized to conduct foreign exchange business. In addition, conversion of RMB for capital account items, including direct investment and loans, is subject to governmental approval in China, and companies are required to open and maintain separate foreign exchange accounts for capital account items. We cannot be certain that the Chinese regulatory authorities will not impose more stringent restrictions on the convertibility of the RMB.

 

Fluctuations in exchange rates could adversely affect our business and the value of our securities.

 

The value of our common stock will be indirectly affected by the foreign exchange rate between the U.S. dollar and RMB and between those currencies and other currencies in which our revenues may be denominated. Appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue that will be exchanged into U.S. dollars, as well as earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.

 

Since July 2005, the RMB has no longer been pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future PRC authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.

 

Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies.

 

Sometimes we may need to import some of our raw materials and major equipment. In the event that the U.S. dollars appreciate against RMB, our costs will increase. If we cannot pass the resulting cost increases onto our customers, our profitability and operating results may suffer. In addition, since our sales to international customers are growing rapidly, we are increasingly subject to the risk of foreign currency depreciation.

 

Restrictions under PRC law on our PRC subsidiaries’ ability to make dividends and other distributions could materially and adversely affect our ability to grow, make investments or acquisitions that could benefit our business, pay dividends to you, and otherwise fund and conduct our business.

 

Substantially all of our revenues are earned by our PRC subsidiaries. However, PRC regulations restrict the ability of our PRC subsidiaries to make dividends and other payments to their offshore parent company. PRC legal restrictions permit payments of dividends by our PRC subsidiaries only out of their accumulated after-tax profits, if any, determined in accordance with PRC accounting standards and regulations. Our PRC subsidiaries are also required under PRC laws and regulations to allocate at least 10% of their annual after-tax profits determined in accordance with PRC generally accepted accounting principles to a statutory general reserve fund until the amounts in said fund reaches 50% of our registered capital. Allocations to these statutory reserve funds can only be used for specific purposes and are not transferable to us in the form of loans, advances, or cash dividends. Any limitations on the ability of our PRC subsidiary to transfer funds to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends and otherwise fund and conduct our business.

 

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You may have difficulty enforcing judgments against us.

 

We are a Nevada holding company and most of our assets are located outside of the United States. Almost all of our operations are conducted in the PRC. In addition, most of our directors and officers are nationals and residents of countries other than the United States. A substantial portion of the assets of these persons is located outside the United States. As a result, it may be difficult for you to effect service of process within the United States upon these persons. It may also be difficult for you to enforce in U.S. courts judgments on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors, most of whom are not residents in the United States and the substantial majority of whose assets are located outside of the United States. In addition, there is uncertainty as to whether the courts of the PRC would recognize or enforce judgments of U.S. courts. Although the recognition and enforcement of foreign judgments are generally provided for under the PRC Civil Procedures Law, courts in China may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based on treaties between China and the country where the judgment is made or on reciprocity between jurisdictions. China does not have any treaties or other arrangements that provide for the reciprocal recognition and enforcement of foreign judgments with the United States. In addition, according to the PRC Civil Procedures Law, courts in the PRC will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates basic principles of PRC law or national sovereignty, security or the public interest. So it is uncertain whether a PRC court would enforce a judgment rendered by a court in the United States.

 

Failure to comply with PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident stockholders to personal liability, limit our ability to acquire PRC companies or to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute profits to us or otherwise materially adversely affect us.

 

Our ability to conduct foreign-exchange activities in the PRC is subject to uncertainties surrounding the interpretation of SAFE regulations, one of which is Circular 75. Under the Notice on Relevant Issues in the Foreign Exchange Control over Financing and Return Investment Through Special Purpose Companies by Residents Inside China (as amended and supplemented, “Circular 75”), PRC residents must register with a local branch of SAFE (1) before they establish or gain control of an overseas special purpose vehicle, or SPV, for the purpose of overseas equity financing (including convertible debt financing); (2) when they contribute their assets or equity interests in a domestic enterprise to an SPV or engage in overseas financing after contributing assets or equity interests to an SPV; and (3) when their SPV undergoes a material change outside of China, such as a change in share capital or merger or acquisition. If any PRC resident who holds stock in an SPV fails to make the required SAFE registration and make any amended registration, the onshore PRC subsidiaries of that offshore company may be prohibited from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to the offshore SPV. Failure to comply with the SAFE registration and amendment registration requirements described above could result in liability for evading PRC laws applicable to foreign exchange restrictions.

 

We have advised our shareholders who are PRC residents, as defined in Circular 75, to register with the relevant branch of SAFE, as currently required, in connection with their equity interests in us and our acquisitions of equity interests in our PRC subsidiaries. However, we cannot provide any assurances that their existing registrations have fully complied with, and they have made all necessary amendments to their registration to fully comply with, all applicable registrations or approvals required by Circular 75. Moreover, because of uncertainty over how Circular 75 will be interpreted and implemented, and how or whether SAFE will apply it to us, we cannot predict how it will affect our business operations or future strategies. For example, our present and prospective PRC subsidiaries’ ability to conduct foreign exchange activities, such as the remittance of dividends and foreign currency-denominated borrowings, may be subject to compliance with Circular 75 by our PRC resident beneficial holders. In addition, such PRC residents may not always be able to complete the necessary registration procedures required by Circular 75. We also have little control over either our present or prospective direct or indirect shareholders or the outcome of such registration procedures. A failure by our PRC resident beneficial holders or future PRC resident shareholders to comply with Circular 75, if SAFE requires it, could subject these PRC resident beneficial holders to fines or legal sanctions, restrict our overseas or cross-border investment activities, limit our subsidiaries’ ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.

 

Under the New Enterprise Income Tax Law, we may be classified as a “resident enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders.

 

On March 16, 2007, the National People’s Congress of China passed the EIT Law and on November 28, 2007, the State Council of China passed its implementing rules, both of which took effect on January 1, 2008. Under the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. The implementing rules of the EIT Law define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise.

 

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On April 22, 2009, the State Administration of Taxation issued the Notice Concerning Relevant Issues Regarding Cognizance of Chinese Investment Controlled Enterprises Incorporated Offshore as Resident Enterprises pursuant to Criteria of de facto Management Bodies, or the Notice, further interpreting the application of the EIT Law and its implementation against non-Chinese enterprise or group controlled offshore entities. Pursuant to the Notice, an enterprise incorporated in an offshore jurisdiction and controlled by a Chinese enterprise or group will be classified as a “domestically incorporated resident enterprise” if (i) its senior management in charge of daily operations reside or perform their duties mainly in China; (ii) its financial or personnel decisions are made or approved by bodies or persons in China; (iii) its substantial assets and properties, accounting books, corporate chops, board and shareholder minutes are kept in China; and (iv) at least half of its directors with voting rights or senior management often resident in China. A resident enterprise would be subject to an enterprise income tax rate of 25% on its worldwide income and its non-PRC stockholders would be subject to a withholding tax at a rate of 10% when dividends are paid to such non-PRC stockholders. However, it remains unclear as to whether the Notice is applicable to an offshore enterprise incorporated by a Chinese natural person. Nor are detailed measures on enforcement of PRC tax against non-domestically incorporated resident enterprises are available. Therefore, it is unclear how tax authorities will determine tax residency based on the facts of each case.

 

We may be deemed to be a resident enterprise by Chinese tax authorities. If the PRC tax authorities determine that we are a “resident enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations. In our case, this would mean that income such as interest on financing proceeds and non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Second, although under the EIT Law and its implementing rules dividends paid to us from our PRC subsidiary would qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes. Finally, it is possible that future guidance issued with respect to the new “resident enterprise” classification could result in a situation in which a 10% withholding tax is imposed on dividends we pay to our non-PRC stockholders and with respect to gains derived by our non-PRC stockholders from transferring our shares.

 

If we were treated as a “resident enterprise” by PRC tax authorities, we would be subject to taxation in both the U.S. and China, and our PRC tax may not be creditable against our U.S. tax.

 

We face uncertainty from China’s Circular on Strengthening the Administration of Enterprise Income Tax on Non-Resident Enterprises' Share Transfer, or Circular 698, that was released in December 2009 with retroactive effect from January 1, 2008.

 

The Chinese State Administration of Taxation released a circular on December 15, 2009 that addresses the transfer of shares by nonresident companies, generally referred to as Circular 698. Circular 698, which is effective retroactively to January 1, 2008, may have a significant impact on many companies that use offshore holding companies to invest in China. Circular 698, which provides parties with a short period of time to comply with its requirements, indirectly taxes foreign companies on gains derived from the indirect sale of a Chinese company. Where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise by selling the shares in an offshore holding company, and the latter is located in a country or jurisdiction where the effective tax burden is less than 12.5% or where the offshore income of his, her, or its residents is not taxable, the foreign investor is required to provide the tax authority in charge of that Chinese resident enterprise with the relevant information within 30 days of the transfers. Moreover, where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise through an abuse of form of organization and there are no reasonable commercial purposes such that the corporate income tax liability is avoided, the PRC tax authority will have the power to re-assess the nature of the equity transfer in accordance with PRC’s “substance-over-form” principle and deny the existence of the offshore holding company that is used for tax planning purposes. There is uncertainty as to the application of Circular 698. For example, while the term "indirectly transfer" is not defined, it is understood that the relevant PRC tax authorities have jurisdiction regarding requests for information over a wide range of foreign entities having no direct contact with China. It is also unclear, in the event that an offshore holding company is treated as a domestically incorporated resident enterprise, whether Circular 698 would still be applicable to transfer of shares in such offshore holding company. Moreover, the relevant authority has not yet promulgated any formal provisions or formally declared or stated how to calculate the effective tax in the country or jurisdiction and to what extent and the process of the disclosure to the tax authority in charge of that Chinese resident enterprise. In addition, there are not any formal declarations with regard to how to decide “abuse of form of organization” and “reasonable commercial purpose,” which can be utilized by us to balance if our Company complies with the Circular 698. If Circular 698 is determined to be applicable to us based on the facts and circumstances around such share transfers, we may become at risk of being taxed under Circular 698 and we may be required to expend valuable resources to comply with Circular 698 or to establish that we should not be taxed under Circular 698, which could have a material adverse effect on our financial condition and results of operations.

 

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The disclosures in our reports and other filings with the SEC and our other public pronouncements are not subject to the scrutiny of any regulatory bodies in the PRC.  Accordingly, our public disclosure should be reviewed in light of the fact that no governmental agency that is located in China where all of our operations and business are located have conducted any due diligence on our operations or reviewed or cleared any of our disclosure.

 

We are regulated by the SEC and our reports and other filings with the SEC are subject to SEC review in accordance with the rules and regulations promulgated by the SEC under the Securities Act and the Exchange Act. Unlike public reporting companies whose operations are located primarily in the United States, however, all of our operations are located in China. Since all of our operations and business takes place in China, it may be more difficult for the Staff of the SEC to overcome the geographic and cultural obstacles that are present when reviewing our disclosure.  These same obstacles are not present for similar companies whose operations or business take place entirely or primarily in the United States. Furthermore, our SEC reports and other disclosure and public pronouncements are not subject to the review or scrutiny of any PRC regulatory authority.  For example, the disclosure in our SEC reports and other filings are not subject to the review of the CSRC, a PRC regulator that is tasked with oversight of the capital markets in China. Accordingly, you should review our SEC reports, filings and our other public pronouncements with the understanding that no local regulator has done any due diligence on our company and with the understanding that none of our SEC reports, other filings or any of our other public pronouncements has been reviewed or otherwise been scrutinized by any local regulator.  

 

RISKS RELATED TO THE MARKET FOR OUR STOCK

 

Our common stock could be delisted from the NASDAQ Capital Market.

 

On June 25, 2012, we received a deficiency letter from The Nasdaq Stock Market, or Nasdaq, indicating that for the last 30 consecutive business days our common stock, had a closing bid price below the $1.00 minimum closing bid as required for continued listing set forth in Nasdaq Listing Rule 5550(a)(2). In accordance with Nasdaq Listing Rule 5810(c)(3)(A), we were provided a grace period of 180 calendar days, or until December 24, 2012, to regain compliance with this requirement. At this time, this notification has no immediate effect on the listing and trading of our common stock on The Nasdaq Capital Market.

 

We can regain compliance with the minimum closing bid price rule if the bid price of our common stock closes at $1.00 or higher for a minimum of 10 consecutive business days during the initial 180 calendar day grace period. If compliance is not achieved by December 24, 2012, we may be eligible for an additional 180 calendar day grace period if we meet The Nasdaq Capital Market continued listing requirements for market value of publicly held shares and all other initial listing criteria as set forth in Nasdaq Listing Rule 5505 other than the minimum closing bid price requirement. If we are not eligible for such additional grace period, or it appears to the staff of Nasdaq that we will not be able to regain compliance during the grace period, Nasdaq will provide written notice to the Company that its securities will be delisted from The Nasdaq Capital Market. At such time, we would be able to appeal the delisting determination to the Nasdaq Listing Qualifications Department which would incur additional expenditures.

 

Certain of our stockholders hold a significant percentage of our outstanding voting securities.

 

Ms. Lifang Chen, our Chairman and Chief Executive Officer, is the beneficial owner of approximately 75.5% of our outstanding voting securities. As a result, she possesses significant influence and can elect a majority of our board of directors and authorize or prevent proposed significant corporate transactions. Her ownership and control may also have the effect of delaying or preventing a future change in control, impeding a merger, consolidation, takeover or other business combination or discourage a potential acquirer from making a tender offer.

 

Although publicly traded, the trading market in our common stock has been substantially less liquid than the average trading market for a stock quoted on the Nasdaq Stock Market and this low trading volume may adversely affect the price of our common stock.

 

Our common stock started trading on the Nasdaq Capital Market under the symbol “SUTR” in February 2008. The trading volume of our common stock has been comparatively low to other companies listed on Nasdaq. Limited trading volume will subject our shares of common stock to greater price volatility and may make it difficult for you to sell your shares of common stock at a price that is attractive to you. 

 

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Given the volatility of our common stock and trends in the stock market in general, there can be no assurance that we will regain compliance with the Nasdaq continued listing requirement. A delisting from the Nasdaq Capital Market could result in our common stock being quoted on an over-the-counter market, which is generally considered to be a less efficient market than the Nasdaq Capital Market. Such delisting could have a materially adverse effect on the price and liquidity of our common stock as well as our ability to obtain financing for the continuation of our operations, which could result in the loss of confidence by investors, suppliers and employees.

 

Certain provisions of our Articles of Incorporation may make it more difficult for a third party to effect a change- in-control.

 

Our articles of incorporation authorize the board of directors to issue up to 1,000,000 shares of preferred stock. The preferred stock may be issued in one or more series, the terms of which may be determined at the time of issuance by the board of directors without further action by the stockholders. These terms may include voting rights including the right to vote as a series on particular matters, preferences as to dividends and liquidation, conversion rights and redemption rights provisions. The issuance of any preferred stock could diminish the rights of holders of our common stock, and therefore could reduce the value of such common stock. In addition, specific rights granted to future holders of preferred stock could be used to restrict our ability to merge with, or sell assets to, a third party. The ability of the board of directors to issue preferred stock could make it more difficult, delay, discourage, prevent or make it more costly to acquire or effect a change-in-control, which in turn could prevent the stockholders from recognizing a gain in the event that a favorable offer is extended and could materially and negatively affect the market price of our common stock.

 

The market price of our common stock is volatile, leading to the possibility of its value being depressed at a time when you want to sell your holdings.

 

The market price of our common stock is volatile, and this volatility may continue. Numerous factors, many of which are beyond our control, may cause the market price of our common stock to fluctuate significantly. These factors include:

 

·our earnings releases, actual or anticipated changes in our earnings, fluctuations in our operating results or our failure to meet the expectations of financial market analysts and investors;
·changes in financial estimates by us or by any securities analysts who might cover our stock;
·speculation about our business in the press or the investment community;
·significant developments relating to our relationships with our customers or suppliers;
·stock market price and volume fluctuations of other publicly traded companies and, in particular, those that are in the steel industries;
·customer demand for our products;
·investor perceptions of the steel industries in general and our company in particular;
·the operating and stock performance of comparable companies;
·general economic conditions and trends;
·major catastrophic events;
·announcements by us or our competitors of new products, significant acquisitions, strategic partnerships or divestitures;
·changes in accounting standards, policies, guidance, interpretation or principles;
·loss of external funding sources;
·sales of our common stock, including sales by our directors, officers or significant stockholders; and
·additions or departures of key personnel.

 

Securities class action litigation is often instituted against companies following periods of volatility in their stock price. This type of litigation could result in substantial costs to us and divert our management’s attention and resources. Moreover, securities markets may from time to time experience significant price and volume fluctuations for reasons unrelated to operating performance of particular companies. For example, in July 2008, the securities markets in the United States, China and other jurisdictions experienced the largest decline in share prices since September 2001. These market fluctuations may adversely affect the price of our common stock and other interests in our company at a time when you want to sell your interest in us.

 

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We do not intend to pay dividends for the foreseeable future.

 

For the foreseeable future, we intend to retain any earnings to finance the development and expansion of our business, and we do not anticipate paying any cash dividends on our common stock. Accordingly, investors must be prepared to rely on sales of their common stock after price appreciation to earn an investment return, which may never occur. Investors seeking cash dividends should not purchase our common stock. Any determination to pay dividends in the future will be made at the discretion of our board of directors and will depend on our results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law and other factors our board deems relevant.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS.

 

Not applicable.

 

ITEM 2. PROPERTIES.

 

There is no private land ownership in China. Individuals and companies are permitted to acquire land use right for special purposes. Changshu Huaye and Jiangsu Cold-rolled currently have land use rights to six parcels of land located in Dongbang Town, Changshu, China with approximately 360,000 square meters in aggregate, consisting of manufacturing facilities, office buildings and land reserved for future expansion. The land use rights for these properties will expire in 2054. This period may be renewed at the expiration of the initial and any subsequent terms. Granted land use rights are transferable and may be used as security for borrowings and other obligations. We have fully paid the land use fees. Some of our real property is subject to lien to secure certain bank loans.

 

Ningbo Zhehua leased a factory building located in the Ningbo Camel Machinery & Electronics Industrial Park, Ningbo, China. The lease has a term of 10 years which will expire on August 31, 2013.

 

We have three principal facilities: Changshu Huaye, Jiangsu Cold-Rolled and Ningbo Zhehua. Changshu Huaye and Jiangsu Cold-Rolled are located in Dongbang Industrial park, Changshu, China and Ningbo Zhehua is located in Ningbo, China. Changshu Huaye was established in January 2003 and started operation in June 2004, with an annual production capacity of 300,000 MT of HDG of cold-rolled steel and 200,000 MT of PPGI. In fiscal year 2012, the capacity utilization rates for the HDG production line and PPGI production line were approximately 65.2% and 20.2%, respectively. Jiangsu Cold-Rolled was established in August 2003 and its AP steel production line started operation in September 2006 with an annual production capacity of 500,000 MT. The cold-rolled steel production line started operation in January 2007 and has an annual production capacity of 250,000 MT. In fiscal year 2012, the capacity utilization rates for the AP steel production line and cold-rolled steel production line were approximately 107.6% and 136.1%, respectively. Jiangsu Cold-Rolled constructed two new HDG steel production lines with annual manufacturing capacity of 400,000 MT which became operational at the end of September 2008. As of June 30, 2012, their capacity utilization rate was approximately76.3%. The new HDG steel production lines are capable of galvanizing both hot-rolled and cold-rolled steel with both zinc and aluminum, allowing us to better meet the needs of our customers and minimizing any excess capacity strains on our current HDG steel production lines. Ningbo Zhehua was established in 2004. It has one JCOE production line for large-diameter, double-side, submerged-arc welded steel pipes, three US Lincoln production lines for spiral seam, double-side, submerged-arc welded steel pipes and two REF production lines for roll-bending, double-side, submerged-arc welded steel pipes. In fiscal year 2012, the average utilization rate of our weld steel pipe production lines were approximately 20.2%.

 

We believe that all our properties have been adequately maintained, are generally in good condition, and are suitable and adequate for our business.

 

ITEM 3. LEGAL PROCEEDINGS.

 

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

 

ITEM 4. MINE SAFETY DISCLOSURES.

 

Not applicable.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

 

Market Information

 

Our common stock is quoted on the Nasdaq Capital Market under the symbol “SUTR.” 

 

The following table sets forth, for the periods indicated, the high and low closing prices of our common stock.  These prices reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.

 

   Closing Bid Prices(1) 
   High   Low 
Year Ended June 30, 2012          
1st Quarter  $1.52   $0.86 
2nd Quarter   1.37    0.85 
3rd Quarter   1.30    1.02 
4th Quarter   1.14    0.85 
           
Year Ended June 30, 2011          
1st Quarter  $2.14   $1.64 
2nd Quarter   2.26    1.78 
3rd Quarter   2.36    1.61 
4th Quarter   1.73    1.10 

 

(1) The above table sets forth the range of high and low closing prices per share of our common stock as reported by www.quotemedia.com for the periods indicated.

 

Approximate Number of Holders of Our Common Stock

 

As of September 10, 2012, there were approximately 13 holders of record of our common stock.  This number excludes the shares of our common stock owned by stockholders holding stock under nominee security position listings.

 

Dividend Policy

 

We have never declared dividends or paid cash dividends. Our board of directors will make any future decisions regarding dividends. We currently intend to retain and use any future earnings for the development and expansion of our business and do not anticipate paying any cash dividends in the near future.

 

Securities Authorized for Issuance Under Equity Compensation Plans

 

See Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters — Securities Authorized for Issuance Under Equity Compensation Plans.”

 

Recent Sales of Unregistered Securities

 

We have not sold any equity securities during the fiscal year ended June 30, 2012 that were not previously disclosed in a quarterly report on Form 10-Q or a current report on Form 8-K that was filed during the 2012 fiscal year.

 

Purchases of Equity Securities

 

On August 29, 2011, the Board of Directors of the Company authorized a repurchase of up to $5 million of the Company’s common stock over 12 months pursuant to a stock repurchase program, or the Repurchase Program. Under the terms of the Repurchase Program, the Company may repurchase shares through open market, negotiated private or block transactions. The Repurchase Program does not obligate the Company to repurchase any dollar amount or number of shares of its common stock, and the program may be extended, modified, suspended or discontinued at any time. The following table provides information relating to the Company’s repurchases of common stock during the fourth quarter of the fiscal year ended June 30, 2012.

 

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               Approximate Dollar 
           Total Number of   Value of Shares that 
   Total       Shares Purchased   May Yet be 
   Number of   Average   as Part of Publicly   Repurchased under 
   Shares   Price Paid   Announced Plans   the Program 
Period  Repurchased   per Share   or Programs   (in millions) 
April 1, 2012 – April 30, 2012   -   $-    -   $4.47 
May 1, 2012 – May 31, 2012   -   $-    -   $4.47 
June 1, 2012 – June 30, 2012   105,455   $0.93    105,455   $4.37 
Total   105,455         105,455   $ 

 

ITEM 6. SELECTED FINANCIAL DATA.

 

Not Applicable.

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

The following management’s discussion and analysis should be read in conjunction with our financial statements and the notes thereto and the other financial information appearing elsewhere in this report. In addition to historical information, the following discussion contains certain forward-looking information. See “Special Note Regarding Forward Looking Statements” above for certain information concerning those forward looking statements. Our financial statements are prepared in U.S. dollars and in accordance with U.S. GAAP.

 

Overview

 

We are one of the leading Chinese non-state-owned manufacturers 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, HDG steel and PPGI products. In addition, we produce AP steel and cold-rolled steel, which represent the least processed of our finished products.  As a result of our acquisition of Ningbo Zhehua in November 2009, our product offerings have included welded steel pipe products. We use a large portion of our AP steel and cold-rolled steel to produce our HDG steel and PPGI products. Our vertical integration has allowed us to maintain more stable margins for our HDG steel and PPGI products.

 

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

 

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

 

Revenue

 

Our revenue is generated from sales of our HDG steel, PPGI, AP steel and cold-rolled steel products. Since 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.

 

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We have four reportable business segments: Changshu Huaye, Jiangsu Cold-Rolled, Ningbo Zhehua and Sutor Technology, and the first three segments are our principal manufacturing facilities.  Sutor Technology was recently established and has had limited operations so far. Changshu Huaye manufactures HDG steel and PPGI products.  In fiscal years 2012 and 2011, Changshu Huaye generated revenue of approximately $170.5 million and $186.2 million, which represented approximately 32.1% and 43.1% of our total revenue, respectively.  Jiangsu Cold-Rolled manufactures AP steel, cold-rolled steel and HDG steel products. Jiangsu Cold-Rolled generated revenue of approximately $311.3 million and $214.0million in fiscal years 2012 and 2011, which represented approximately 58.6% and 49.6% of our total revenue, respectively. Ningbo Zhehua manufactures steel pipe products. In fiscal years 2012 and 2011, Ningbo Zhehua generated revenue of approximately $42.4 million and $31.5 million, which represented approximately 7.9% and 7.3% of our total revenue, respectively. A portion of our products are sold through our affiliate Shanghai Huaye, which also supplies to us a large portion of our raw materials. Approximately 29.3% of our revenue was derived from Shanghai Huaye and its affiliates in fiscal year 2012, as compared to approximately 38.4% last year. We expanded our own sales channel this year in effort to gain more market share. At the same time, we continue to take advantage of Shanghai Huaye’s extensive sales network and to build brand value. In fiscal year 2012, Sutor Technology had approximately $7.4 million in revenue and accounted for approximately 1.4% of our total revenue.

 

Cost of Revenue

 

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

 

In fiscal year 2012, approximately $168.1 million of raw material procurement was conducted through Shanghai Huaye and its affiliates.  Due to the size of Shanghai Huaye and the economy of scale, it has stronger bargaining power than we do and our arrangement with Shanghai Huaye allows us to purchase raw materials at relatively lower prices than we could obtain from suppliers ourselves.

 

Gross Profit and Gross Margin

 

Gross profit is equal to the difference between our revenue and the cost of revenue.  Gross margin is equal to gross profit divided by revenue.  In fiscal year 2012, gross margin for domestic and international sales were approximately 7.3% and 13.3%, respectively. On a segment basis, Changshu Huaye, Jiangsu Cold-Rolled and Ningbo Zhehua’s gross margins were approximately 10.4%, 6.5% and 7.8%, respectively. For Sutor Technology, its gross margin was approximately 3.8% for fiscal 2012. It was a new business and had a limited amount of business during the period.

 

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

 

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

 

Operating Expenses

 

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

 

General and Administrative Expenses

 

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

  

Selling Expenses

 

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

 

25
 

 

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.

 

The EIT Law gives existing FIEs a five-year grandfather period during which they can continue to enjoy their existing preferential tax treatments. Changshu Huaye is subject to an EIT of 15% from calendar years 2010 to 2012 because it qualifies as a high-tech enterprise for the calendar years 2010, 2011 and 2012. Changshu Huaye paid EIT at the 25% tax rate for the period between July and December 2010 and the Company received a refund on the over-paid portion of the EIT in July 2011. Jiangsu Cold-Rolled was subject to EIT of 12.5% for the calendar years 2010 and 2011 and is subject to an EIT of 25% for the calendar year 2012 and beyond. Ningbo Zhehua and Sutor Technology PRC are subject to an EIT of 25% and have no preferential tax treatments. See Item 1, “Business – Regulation – Taxation” for a detailed description of the EIT Law and tax regulations applicable to our Chinese subsidiaries.

 

Reportable Operating Segments

 

We have four reportable operating segments which are categorized based on manufacturing facilities and nature of operations – Changshu Huaye, Jiangsu Cold-Rolled, Ningbo Zhehua and Sutor Technology. 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. Finally, we have Sutor Technology, which is intended to cover R&D operations and so far had limited trading operations. See Note 13, “Segment Information” to the consolidated financial statements included elsewhere in this report.

 

Results of Operations

 

Comparison of Fiscal Years Ended June 20, 2012 and June 30, 2011

 

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

 

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

 

   June 30, 2012   June 30, 2011 
   Amount   Percentage
of Revenue
   Amount   Percentage
of Revenue
 
Revenue:                  
Revenue from unrelated parties   375,948    70.7%   266,127    61.6%
Revenue from related parties   155,676    29.3%   165,570    38.4%
Total   531,624    100%   431,697    100%
Cost of Revenue:                    
Cost of revenue from unrelated parties   (347,052)   (65.3)%   (240,848)   (55.8)%
Cost of revenue from related parties   (142,848)   (26.9)%   (150,397)   (34.8)%
Total   (489,900)   (92.2)%   (391,245)   (90.6)%
Gross Profit   41,723    7.8%   40,452    9.4%
Operating Expenses                    
Selling expense   (7,236)   (1.3)%   (7,504)   (1.8)%
General and administrative expense   (10,781)   (2.0)%   (7,814)   (1.8)%
Total Operating Expenses   (18,017)   (3.3)%   (15,318)   (3.6)%
Income from Operations   23,706    4.5%   25,134    5.8%
Other Income (Expense)                    
Interest income   2,832    0.5%   902    0.2%
Other income   409    0.0%   164    0.0%
Interest expense   (13,317)   (2.5)%   (7,971)   (1.8)%
Other expense   (918)   (0.0)%   (794)   (0.1)%
Changes in fair value of warrant liabilities   352    0.0%   607    0.1%
Total Other Income (Expense)   (10,642)   (2.0)%   (7,092)   (1.6)%
Income Before Taxes   13,063    2.5%   18,042    4.2%
Income tax expense   (998)   (0.2)%   (3,429)   (0.8)%
Net Income  $12,065    2.3%  $14,613    3.4%

 

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Revenue. For the fiscal year ended June 30, 2012, revenue was $531.6 million compared to $431.7 million last year, an increase of approximately 23.1% primarily due to increased sales volume. Total sales volume in tons increased approximately 18.0% in fiscal year 2011 as compared to the same period last year, which reflected higher capacity utilization of our production facilities. Production of hop-dip galvanized steel was up 31.1% in 2012 than 2011 due to growing market demand for these products. Our diversified product lines are used in a variety of applications including construction, infrastructure, household appliances, solar water heaters, information technology and medical instruments. Although lately investments in construction and infrastructure in China have slowed down, consumer products and other sectors of the Chinese economy still grew from fiscal 2011 to 2012 due to significant replacement markets, demographic change and urbanization trend in China which, we believe, creates long-term and relatively stable demand for our fine finished steel products.

 

The following table sets forth revenue by geography and the percentage of our total revenue and total revenue by business segments for fiscal years 2012 and 2011.

 

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

 

   June 30, 2012   June 30, 2011 
   Amount   Percentage
of Revenue
   Amount   Percentage
of Revenue
 
Geographic Data:                    
China  $471,557    88.7%  $369,507    85.6%
Other Countries   60,067    11.3%   62,190    14.4%
                     
Segment Data:                    
Changshu Huaye  $170,549    32.1%  $186,162    43.1%
Jiangsu Cold-Rolled   311,307    58.6%   214,010    49.6%
Ningbo Zhehua   42,407    7.9%   31,525    7.3%
Sutor Technology   7,361    1.4%   n/a    n/a 

 

On a geographic basis, revenue generated from outside of China was $60.1 million, or 11.3% of total revenue, for fiscal year 2012, as compared to $62.2 million, or 14.4% of total revenue, for fiscal year 2011. The decrease was mainly attributable to overall weak global economies which reduced near-term demand for our steel products.

 

On a segment basis, after eliminating intercompany sales, revenue contributed by Changshu Huaye was $170.5 million for fiscal year 2012, reflecting a decrease of $15.7 million, or 8.4%, from $186.2 million in fiscal year 2011. The lower revenue was primarily due to lower production volume and export of our PPGI products. In fiscal 2012, our revenue from exported PPGI steel was approximately $20.1 million as compared to $34.0 million in fiscal 2011, or $13.9 million lower.

 

After eliminating the inter-company sales, revenues contributed by Jiangsu Cold-Rolled were $311.3 million for fiscal year 2012, an increase of $97.3 million from $214.0 million last year, or 45.5%, mainly as a result of higher sales of HDG products as demand for household appliances remained strong in China. Revenue from HDG products increased approximately $85.6 million to $217.8 million in fiscal year 2012 from $132.2 million last year. In addition, revenue from acid-pickled products was approximately $64.8 million in fiscal 2012 as compared with $34.3 million last year. However, revenue from cold-rolled products was approximately $16.0 million in fiscal 2012 as compared to approximately $40.3 million in 2011. Cold-rolled steel can either be an intermediate product to produce HDG steel or sold to end customers. In fiscal 2012, we used more internally produced cold-rolled steel to produce HDG products in our vertically integrated production process. As a result, less cold-rolled steel was available for sale to customers.

 

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Revenues contributed by Ningbo Zhehua were $42.4 million for fiscal year 2012, an increase of approximately $10.8 million from $31.6 million in fiscal year 2011, primarily resulting from completion of a number of projects that Ningbo Zhehua’s products are used for. A majority of the customers to whom Ningbo Zhehua’s products are sold are project contractors.

 

In terms of sales to related parties as compared with sales to unrelated parties, our direct sales to unrelated parties in fiscal year 2012 increased $109.8 million, or 41.3%, to $375.9 million from $266.1 million in fiscal year 2011. We began to benefit from our continuing marketing and efforts to enhance our brand recognition.

 

Cost of revenue.  Cost of revenue increased $98.7 million, or 25.2%, to $489.9 million in fiscal year 2012 from $391.2 million in fiscal year 2011. As a percentage of revenue, cost of revenue increased to 92.2% in fiscal year 2012 from 90.6% last year. The increase in cost of revenue was mainly due to overall and consistent with increased sales volume and revenue.

 

Gross profit and gross margin. Gross profit increased $1.2 million to $41.7 million in fiscal year 2012 from $40.5 million in fiscal year 2011. Gross profit as a percentage of revenue (gross margin) was 7.8% in fiscal year 2012, as compared to 9.4% in fiscal year 2011. The decreased gross margin mainly resulted from the changes in the mix of products sold in fiscal 2012. In fiscal year 2012, we sold more acid-pickled steel but less PPGI steel. Acid-pickled steel has lower gross margin than PPGI steel. In addition, lower exports sales also contributed to lower overall gross margin. The gross margin for our exported products was approximately 13.3% as compared with approximately 7.3% for our domestic sales. The overall weak global economies affected our exports.

 

On a segment basis, gross margin for Changshu Huaye decreased to 10.4% in fiscal year 2012 from 13.5% last year, mainly because lower PPGI production and exports. Gross margin for Jiangsu Cold-Rolled increased to 6.5% in fiscal year 2012 from 5.3% last year, mainly due to better capacity utilization, more sales of higher-gross margin HDG steel and less sales of lower gross margin cold-rolled steel. Gross margin for Ningbo Zhehua decreased to 7.8% in fiscal year 2012, as compared to 13.7% in fiscal year 2011, mainly because we reduced product prices to gain market shares as well as due to a one-time sale of some excess inventory of raw materials at cost.

 

Total operating expenses. Our total operating expenses increased approximately $2.7 million to $18.0 million in fiscal year 2012 from $15.3 million in fiscal year 2011. As a percentage of revenue, our total operating expenses decreased to 3.3% in fiscal year 2012 from 3.5% in fiscal year 2011 as the increase in revenue outpaced the increase in total operating expenses.  

 

Selling expenses. Our selling expenses decreased approximately $0.3 million to $7.2 million in fiscal year 2012, from $7.5 million in fiscal year 2011. As a percentage of revenue, our selling expense was 1.3% in fiscal 2012 as compared to 1.7% in fiscal 2011. The decrease in selling expenses was primarily due to lower international sales and effective cost control measures.

 

General and administrative expenses.  General and administrative expenses increased $3.0 million, or 38.5%, to $10.8 million, or 2.0% of revenue, in fiscal year 2012, from $7.8 million, or 1.8% of revenue, in fiscal year 2011. The higher general and administrative expenses were partially due to a number of factors including higher employee benefits of approximately $0.8 million, higher building maintenance and repair expense of $0.2 million, and higher allowance for bad account receivables of $0.2 million, than in the prior fiscal year.

 

Interest expense. Our interest expense increased $5.3 million to $13.3 million in fiscal 2012, from $8.0 million in fiscal 2011. As a percentage of revenue, our interest expenses increased to 2.5% in fiscal 2012, from 1.8% in fiscal 2011.  The increase in interest expense was mainly attributable to higher interest expense of approximately $1.7 million due to higher average principal amount of bank loans as well as higher discounted interest expenses on bank notes.

 

Provision for income taxes. We incurred income tax expense of $1.0 million in fiscal 2012 as compared to $3.4 million in fiscal 2011. The reduced income tax expense of $2.4 million was primarily due to an income tax refund of approximately $2.1 million for purchasing certain equipment.

 

Net income.Net income, without including the foreign currency translation adjustment, decreased $2.5 million, or approximately 17.1%, to $12.1million in fiscal year 2012, from $14.6 million in fiscal year 2011, as a cumulative result of the above factors.

 

28
 

 

Liquidity and Capital Resources

 

Our major sources of liquidity for the periods covered by this annual report were borrowings through short-term bank and private loans and long-term notes payable.  Our operating activities provided approximately $2.6 million of cash in fiscal year 2012. As of June 30, 2012, our total indebtedness to non-related parties under existing short-term loans was approximately $139.0 million. We also had approximately $8.5 million under long-term notes payable to non-related parties. We had no notes payable to related parties. As of June 30, 2012, the Company also had an unused line of credit with banks of approximately $31.7 million (RMB 200 million) which entitled us to draw bank loans for general corporate purposes.

 

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

 

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

 

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

 

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

 

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

 

As of June 30, 2012, we had cash and cash equivalents (excluding restricted cash) of $9.5 million and restricted cash of $111.6 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)

 

(Unaudited)  Fiscal Years Ended June 30, 
   2012   2011 
Net cash provided by(used in) operating activities   13,169    (8,177)
Net cash (used in)provided by investing activities   (30,528)   (12,902)
Net cash provided by (used in) financing activities   5,205    28,441 
Effect of foreign currency translation on cash and cash equivalents   360    627 
Net cash flows   (11,794)   7,988 

 

29
 

 

Operating Activities

 

Net cash provided by operating activities was $13.2 million in fiscal 2012 compared to $8.2 million cash used in fiscal 2011. Cash provided by operations in fiscal 2012 mainly consisted of our net income of $12.1 million, depreciation and amortization of $8.6 million, and changes in advances to suppliers and account payable of $13.6 million and $6.2 million, respectively. Advances to suppliers decreased from 2011 to 2012 mainly due to the timing of payment. Cash used for working capital requirements was primarily attributable to increased inventory of $3.1million, increased trade account receivables of $3.4 million, and lower advances from customers of $4.0 million in fiscal 2012 than 2011.

 

Investing Activities

 

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

 

Net cash used in investing activities during fiscal year 2012 was $30.5 million as compared to $12.9 million net cash used in investing activities for fiscal year 2011. The increase of $17.6 million in net cash used in investing activities was primarily due to the capital expenditures for the new 500,000 MT cold-rolled production line under construction.

 

For fiscal 2013, we estimate the capital expenditure will be approximately $15 million consisting of approximately $7 million to be used for the completion of the construction of the 500,000 MT cold-rolled production line and $8 million for facility upgrading and technical innovation. Under normal operating conditions, we believe we can fund the planned capital expenditure through internally generated cash flows.

 

Financing Activities

 

Net cash provided by financing activities for fiscal year 2012 totaled $5.2 million, as compared to $28.4 million net cash provided by financing activities for fiscal year 2011. As compared with last fiscal year, the decrease in net cash provided by financing activities was mainly due to higher cash outflows of $8.3 million for repayment of loans and increased restricted cash in the amount of approximately $20.5 million in fiscal 2012 than 2011, partially offset by increased proceeds from loans of approximately $6.2 million.

 

30
 

 

As of June 30, 2012, the amount, maturity date and term of each of our loans were as follows.

 

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

 

Lender   Amount*   Starting
Date
  Maturity
Date
  Guarantor**
The Agricultural Bank of China, Singapore Branch   $ 10.0   2011-07-29   2012-07-29   Jiangsu Cold-Rolled
Communications Bank of China, Changshu Branch     3.17   2011-11-14   2012-11-14   Shanghai Huaye
The Agricultural Bank of China, Changshu Branch     3.17   2011-11-28   2012-11-27   Jiangsu Cold-Rolled, Shanghai Huaye
Construction Bank of China, Changshu Branch     6.33   2011-11-17   2012-11-16   None
The Agricultural Bank of China, Changshu Branch     3.96   2011-12-22   2012-12-21   Jiangsu Cold-Rolled, Shanghai Huaye
The Agricultural Bank of China, Changshu Branch     3.17   2012-04-27   2013-04-26   Changshu Huaye
Industrial and Commercial Bank of China, Changshu Branch     3.17   2012-05-30   2013-05-28   Changshu Huaye
Construction Bank of China, Changshu Branch     0.13   2012-05-14   2012-08-03   None
The Agricultural Bank of China, Changshu Branch     7.44   2011-07-25   2012-07-21   Changshu Huaye, Shanghai Huaye
The Agricultural Bank of China, Changshu Branch     6.33   2011-08-19   2012-08-16   Changshu Huaye, Shanghai Huaye
The Agricultural Bank of China, Changshu Branch     4.75   2011-09-05   2012-09-05   Changshu Huaye, Shanghai Huaye
The Agricultural Bank of China, Changshu Branch     6.33   2011-09-28   2012-09-27   None
Communications Bank of China, Changshu Branch     9.77   2011-09-27   2014-09-11   Changshu Huaye
The Agricultural Bank of China, Changshu Branch     2.53   2011-10-25   2012-10-24   Changshu Huaye, Shanghai Huaye
The Agricultural Bank of China, Changshu Branch     7.92   2011-11-10   2012-11-09   Changshu Huaye, Shanghai Huaye
The Agricultural Bank of China, Changshu Branch     5.38   2011-11-21   2012-11-20   Changshu Huaye, Shanghai Huaye
The Agricultural Bank of China, Changshu Branch     10.29   2011-12-12   2012-12-11   Changshu Huaye, Shanghai Huaye
Industrial and Commercial Bank of China, Changshu Branch     1.58   2011-12-28   2012-12-26   Changshu Huaye
Chinatrust Commercial Bank, Hong Kong Branch     9.50   2011-12-29   2012-12-13   Jiangsu Cold-Rolled
The Agricultural Bank of China, Changshu Branch     2.38   2012-01-06   2013-01-05   Changshu Huaye, Shanghai Huaye
The Agricultural Bank of China, Changshu Branch     4.81   2012-02-15   2012-08-14   Changshu Huaye, Shanghai Huaye
Industrial and Commercial Bank of China, Changshu Branch     3.17   2012-2-16   2012-08-09   Changshu Huaye
Industrial and Commercial Bank of China, Changshu Branch     0.63   2012-04-27   2013-04-26   Changshu Huaye
Industrial and Commercial Bank of China, Changshu Branch     2.53   2012-04-27   2013-04-26   Changshu Huaye
Shenzhen Development Bank     1.58   2011-08-23   2012-08-23   Shanghai Huaye
The Agricultural Bank of China, Ningbo Branch     0.89   2012-02-02   2012-07-30   Changshu Huaye
Lin, Guihua     2.86   2008-11-20   2013-12-31   None
Macao International Bank Co., LTD     6.99   2011-02-23   2013-02-21   None
Macao International Bank Co., LTD     5.06   2011-03-11   2013-02-21   None
Macao International Bank Co., LTD     4.78   2011-03-23   2013-02-21   None
Macao International Bank Co., LTD     5.08   2011-04-01   2013-02-21   None
Macao International Bank Co., LTD     1.72   2011-04-01   2013-02-21   None
Total   $ 147.42            

 

* Calculated on the basis that $1 = RMB [6.31]

 

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

 

The loan agreements with banks generally contain debt covenants that require us to maintain certain inventory levels, among other things. We were in compliance with these debt covenants as of June 30, 2012.

 

In the coming 12 months, we have approximately $138.9 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

 

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: 

 

31
 

 

Principles of Consolidation – The accompanying consolidated financial statements include the accounts and transactions of the Company for all years presented. All significant intercompany accounts and transactions have been eliminated in consolidation.

 

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 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 Company's subsidiaries in the PRC maintain their books and records in its local currency, the Renminbi Yuan (“RMB”), which is functional currency 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 within the statement of changes in stockholders’ equity.

 

Translation of amounts from RMB into US$1 has been made at the following exchange rates for the respective years:

 

   June 30, 
2012
   June 30,
2011
 
Closing RMB : USD exchange rate at the year end   6.3143    6.4635 
Average RMB : USD exchange rate for the year   6.3519    6.6278 

 

The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into US$ at the rates used in translation.

 

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

 

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, 2012, 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.

 

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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.

 

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 - Acquisition costs of land use rights are capitalized and amortized using the straight-line method over their estimated useful lives.

 

Impairment of Long-lived Assets - The Company evaluates its long-lived assets or asset group, including intangible assets with finite lives, for impairment whenever events or changes in circumstances (such as a significant adverse change to market conditions that will impact the future use of the assets) indicate that the carrying amount of an asset or a group of long-lived assets may not be recoverable. When these events occur, the Company evaluates for impairment by comparing the carrying amount of the assets to future undiscounted net cash flows expected to result from the use of the assets and their eventual disposition. If the sum of the expected undiscounted cash flow is less than the carrying amount of the assets, the Company would recognize an impairment loss based on the excess of the carrying amount of the asset group over its fair value. Fair value is generally determined by discounting the cash flows expected to be generated by the assets, when the market prices are not readily available for the long-lived assets. No impairment charge was recognized for each of the two years ended June 30, 2012 and 2011.

 

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Fair Values of Financial Instruments - The Company adopted Accounting Standards Codification (“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 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.

 

ASC 820-10 describes three main approaches to measuring the fair value of assets and liabilities: (1) market approach; (2) income approach and (3) cost approach. The market approach uses prices and other relevant information generated from market transactions that involve identical or comparable assets or liabilities. The income approach uses valuation techniques to convert future amounts to a single present value amount. The measurement is based on the value indicated by current market expectations about the future amount. The cost approach is based on the amount that would currently be required to replace an asset.

 

Financial instruments of the Company primarily comprise of cash and cash equivalents, restricted cash, trade accounts receivable, other receivables, loans, accounts payable, other payables and warrant liabilities. As of June 30, 2012 and 2011, carrying values of these financial instruments except warrant liabilities approximated their fair values because of their generally short maturities. 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.

 

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

 

   Balance as of June 30, 2012 
       Fair Value Measurements 
   Carrying Value   Level 1   Level 2   Level 3 
Short-term investments                    
-Fixed rate time deposits  $4,849,112   $4,849,112   $-   $- 

 

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

 

   Balance as of June 30, 2012 
       Fair Value Measurements 
   Carrying Value   Level 1   Level 2   Level 3 
                 
Warrant liabilities  $47,404   $-   $-   $47,404 

 

   Balance as of June 30, 2011 
       Fair Value Measurements 
   Carrying Value   Level 1   Level 2   Level 3 
                 
Warrant liabilities  $399,572   $-   $-   $399,572 

 

For a summary of changes in short-term investments for the years ended June 30, 2012 and 2011, please see Note 4.

 

For a summary of changes in warrant liabilities for the years ended June 30, 2012 and 2011, please see Note 11.

 

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Statutory Reserves - In accordance with the PRC Regulations on Enterprises with Foreign Investment, an enterprise established in the PRC with foreign investment is required to provide for certain statutory reserves, namely (i) General Reserve Fund, (ii) Enterprise Expansion Fund and(iii) Staff Welfare and Bonus Fund, which are appropriated from net profit as reported in the enterprise’s PRC statutory accounts. A wholly owned foreign enterprise (“WOFE”) is required to allocate at least 10% of its annual after-tax profit to the General Reserve Fund until the balance of such fund has reached 50% of its respective registered capital. A non-wholly owned foreign invested enterprise is permitted to provide for the above allocation at the discretion of its board of directors. Appropriations to the Enterprise Expansion Fund and Staff Welfare and Bonus Fund are at the discretion of the board of directors for all foreign invested enterprises. The aforementioned reserves can only be used for specific purposes and are not distributable as cash dividends.

 

Accumulated Other Comprehensive Income - Accumulated other comprehensive income presented in the accompanying consolidated financial statements consists of foreign currency translation adjustments.

 

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

 

The Company sells some products to related parties, who in turn sell the product to various other unrelated party customers. The price, terms and conditions on the sales to related parties are the same as those to unrelated parties. Revenue is considered realized or realizable and earned when the related parties ship the products to unrelated party customers. A fee of 0.5% of the sales is paid to the related parties for handling the product. Handling fees were $83,739 and $422,119 for the years ended June 30, 2012 and 2011 respectively and 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.

 

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.

 

Share 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.

 

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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 Topic350, “Accounting for Income Taxes,” requires that deferred tax assets be reduced by a valuation allowance if, based on all available evidence, it is considered more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. Additionally, 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 years ended June 30, 2012 and 2011.

 

If the amount of the Company’s taxable income or income tax liability is a determinant of the amount of a grant, the grant is treated as a reduction of the income tax provision in the year the grant is realized.

 

Earnings Per Share–Earnings per share are calculated in accordance with ASC subtopic 260-10 (“ASC 260-10”), Earnings Per Share: Overall. Basic earnings per share is computed by dividing net income attributable to holders of ordinary shares by the weighted average number of ordinary shares outstanding during the period. Diluted earnings per share are computed using the weighted average number of shares and dilutive equivalent shares outstanding during the period. Dilutive equivalent shares consist of ordinary shares issuable upon the exercise of stock options granted, with an exercise price less than the average fair market value for such period, using the treasury stock method. Dilutive equivalent shares are excluded from the computation of diluted earnings per share if their effects would be anti-dilutive.

 

Share Repurchase Program–Pursuant to a Board of Directors’ resolution on August 29, 2011, the Company’s management is authorized to repurchase up to $5 million of the Company’s outstanding common stock over the next year in the open market, in privately negotiated transactions or as otherwise may be determined by the Chief Executive Offer and the Chief Financial Officer (“Authorized Officers”) and will be funded from available working capital. The timing and extent of any purchases depend upon the trading price of the Company’s common stock, general business and market conditions and other investment opportunities. The Company accounted for those shares repurchase as Treasury Stock at cost in accordance to ASC Subtopic 505-30 (“ASC 505-30”), Treasury Stock and is shown separately in the stockholders’ equity as the Company has not yet decided on the ultimate disposition of those repurchased stocks. The treasury stock may be retired or used by the Company to finance or execute acquisitions or other arrangements. As of June 30, 2012, the Company had repurchased 544,477 shares of its common stock at a total cost of $607,668.

 

Treasury stock reissuance–Shares of common stock repurchased by the Company that are not retired are recorded at cost as treasury stock and result in a reduction of stockholders' equity in the Company's consolidated balance sheets. From time to time, treasury shares may be reissued as part of the Company's stock-based compensation programs. When shares are reissued, the Company uses the weighted average cost method for determining cost. If the issuance price is higher than the cost, the excess of the issuance price over cost is credited to additional paid-in capital (“APIC”). If the issuance price is lower than the cost, the difference is first charged against any credit balance in APIC from treasury stock and the balance is charged to retained earnings. During the years ended June 30, 2012 and June 30, 2011, the Company did not reissue shares from treasury stock.

 

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

 

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In June 2011, the FASB issued Accounting Standards Update 2011-05 (ASU 2011-05), “Presentation of Comprehensive Income.” ASU 2011-05eliminates the option to report other comprehensive income and its components in the statement of changes in shareholders’ equity and requires an entity to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement or in two separate but consecutive statements. This pronouncement is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. In December 2011, the FASB issued ASU 2011- 12 (ASU 2011-12), Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. ASU 2011-12 defers the requirement in ASU 2011-05 that entities present reclassification adjustments for each component of accumulated other comprehensive income (“AOCI”) in both net income and other comprehensive income on the face of the financial statements. ASU 2011-12 requires entities to continue to present amounts reclassified out of AOCI on the face of the financial statements or disclose those amounts in the notes to the financial statements. The effective date of ASU 2011-12 is consistent with ASU 2011-05, which is effective for fiscal years and interim periods beginning after December 15, 2011 for public entities. The provisions of ASU 2011-05 and ASU 2011-12 are not expected to have a material impact on the presentation of the Company’s consolidated financial statements.

 

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

 

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.

 

Revision of Prior Year Financial Statements

 

During the year ended June 30, 2012, the Company identified an error related to the classification of the warrants to purchase up to 685,000 shares of common stock (with the fair value of $1.3 million at the issuance date of March 10, 2010). Previously, the Warrants were reflected as a component of equity as opposed to liabilities on the consolidated balance sheets and the consolidated statements of operations did not include the subsequent non-cash changes in estimated fair value of the Warrants. However, since the Company is obliged to deliver registered shares to the warrant holders upon exercise, the warrants should be classified as liabilities in accordance with Accounting Standards Codification 815 (“ASC 815”) because there are further registration and prospectus delivery requirements that are outside of the control of the Company. The Company assessed the materiality of this error on prior periods’ financial statements in accordance with the SEC’s Staff Accounting Bulletin No. 99 (“SAB 99”), and concluded that the error was not material to any of its prior annual or interim financial statements. As a result, the Company elected to revise its previously issued consolidated financial statements the next time they are filed as permitted in SEC’s Staff Accounting Bulletin No.108 (“SAB 108”) regarding immaterial revisions. As each subsequent filing is made in the future, the previous period consolidated financial statements affected by the errors will be revised. The Company has revised the consolidated balance sheet as of June 30, 2011 and the consolidated statements of operations for the year ended June 30, 2011 included herein to reflect the correct balances. The opening additional paid-in capital and retained earnings as of June 30, 2010 also have been corrected as shown in the consolidated statements of stockholders’ equity to reflect the adjustments made to the warrants and changes in estimated fair value. The impact of correcting this error on net income as reported for the year ended June 30, 2011 was an increase of $607,331.

 

Set out below are the line items within the consolidated balance sheet as of June 30, 2011 and consolidated statement of operations for the year then ended have been affected by the revisions. The revisions had no impact on the Company’s total cash flows from operating, investing or financing activities.

 

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   As of June 30, 2011 
   Previously
reported
   Adjustments   Revised 
Consolidated Balance Sheet               
                
Warrant liabilities  $-   $399,572   $399,572 
Total Current Liabilities   168,340,269    399,572    168,739,841 
Total Liabilities   191,967,169    399,572    192,366,741 
Additional paid-in capital   42,584,974    (1,368,428)   41,216,546 
Retained earnings   107,137,213    968,856    108,106,069 
Total Stockholders' Equity  $195,494,532   $(399,572)  $195,094,960 

 

   For the year ended June 30, 2011 
   Previously
reported
   Adjustments   Revised 
Consolidated Statement of Operations               
                
Changes in fair value of warrant liabilities  $-   $607,331   $607,331 
Total Other Incomes/(Expenses)   (7,699,181)   607,331    (7,091,850)
Income Before Taxes   17,434,680    607,331    18,042,011 
Net Income  $14,005,173   $607,331   $14,612,504 
                
Basic Earnings per Share  $0.34   $0.02   $0.36 
Diluted Earnings per Share  $0.34   $0.02   $0.36 
                
Comprehensive Income  $24,542,802   $607,331   $25,150,133 

 

ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

Not Applicable.

 

ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

 

The full text of our audited consolidated financial statements as of June 30, 2012 and 2011 begins on page F-1 of this report.

 

ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

 

None.

 

ITEM 9A.CONTROLS AND PROCEDURES.

 

Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of our chief executive officer and chief financial officer, Ms. Lifang Chen and Mr. Yongfei Jiang, respectively, evaluated the effectiveness of our disclosure controls and procedures. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports, such as this report, that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Based on that evaluation, Ms. Chen and Mr. Jiang concluded that our disclosure controls and procedures were effective as of June 30, 2012.

 

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Management’s Annual Report on Internal Control Over Financial Reporting

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting refers to the process designed by, or under the supervision of, our chief executive officer and chief financial officer, and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP, and includes those policies and procedures that:

 

·pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;

 

·provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that our receipts and expenditures are being made only in accordance with the authorization of our management and directors; and
·provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

 

Management conducted an evaluation of the effectiveness of our internal control over financial reporting as of June 30, 2012 based on the framework set forth in the report entitled Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the evaluation, management concluded that our internal control over financial reporting as of June 30, 2012 was effective.

 

During the fiscal year 2012, the management identified an error related to the classification of warrants in prior financial statements (Note 3 to the consolidated financial statements under Item 15 of this annual report). Although the management believes it had no material impact on the current or prior financial statements, the error, if not corrected, may have a significant misstatement on future financial reporting. This was a significant deficiency in our internal control procedures. Considering this was the only and an isolated incident as well as the fact that since this transaction has occurred the Company has increased the competency and experience of its accounting staff, management currently has the ability to deal with similar accounting issues.  As a result, the management believes this sole significant deficiency did not affect the overall effectiveness of our internal control processes. During the fiscal year 2012, the management did not identify any material weaknesses in the Company’s internal control procedures.

 

Because we are a smaller reporting company, this annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal controls over financial reporting during the fourth quarter of our fiscal year ended June 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

ITEM 9B. OTHER INFORMATION.

 

We have no information to disclose that was required to be disclosed in a report on Form 8-K during fourth quarter of fiscal year 2012, but was not reported.

 

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PART III

 

ITEM 10.DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

 

Directors and Executive Officers

 

The following sets forth the name and position of each of our current executive officers and directors.

 

NAME   AGE   POSITION
Lifang Chen   41   Chairman of the Board, Chief Executive Officer and President
Yongfei Jiang   35   Director, Chief Financial Officer, Treasurer and Secretary
Naijiang Zhou   49   Vice President of Finance
Gerard Pascale   42   Director
Guoyou Shao   63   Director
Xinchuang Li   49   Director

 

Lifang Chen. Ms. Chen is the founder of the Company. She became our Chairwoman on February 1, 2007 and our CEO in May 2008. Under her leadership, the Company became a leading finished steel manufacturer in China with a vertically integrated business model offering unique one-stop customer services that are difficult to replicate. At the Company, Ms. Chen has cultivated a seasoned management team of professionals that are focused on growing the Company’s business and that are well known in the industry. Prior to founding the Company in 2002, Ms. Chen directed the civil administration bureau of Xiaoshan municipal government in China from September 1993 to May 2001 where she helped design various policies to strengthen the operations of local companies, coordinated businesses between private enterprise and local banks, and reviewed and approved IPOs for large companies. Ms. Chen is an accomplished entrepreneur in the Chinese fine finished steel industry and excels in enterprise management and industry and government relations. She obtained an MA degree in Philosophy from Zhejiang University.

 

Yongfei Jiang. Mr. Jiang became our director in June 2009 and has been our Chief Financial Officer, Treasurer and Secretary since February 2007. Mr. Jiang oversees all financial management activities of the Company including financial operations, governance, P&L budgeting, forecasting and analysis. He has also been the Chief Financial Officer our subsidiary, Changshu Huaye since 2005. From 2002 to 2005, Mr. Jiang was the financial manager at Guangzhou Huaye Steel Processing Company Limited where he was primarily responsible for the company’s banking operations. Prior to that he was the director of finance at Zhejiang Guotai Insulation Materials Company and participated in corporate restructuring and developing the ERP systems for the company. Mr. Jiang graduated from Zhejiang Finance and Economic College.

 

Naijiang Zhou. Mr. Zhou became our Vice President of Finance on February 1, 2010. Mr. Zhou served as Executive Vice President and Chief Financial Officer at Rich Fields Investment, Ltd., a private equity investment firm since 2008.  From April 2007 to July 2008, Mr. Zhou worked as international research analyst at Roth Capital Partners, a full service U.S. banking firm.  Before joining Roth Capital, Mr. Zhou worked for seven years as principal financial planner and principal financial analyst at American Electric Power, where he was responsible for strategic planning, financial planning and analysis, and corporate development. Prior to that, he worked for the Wing Group as financial analyst and U.S. Global Investors as senior research analyst and co-managed mutual fund investments. Mr. Zhou received both a Ph.D. and an MBA degree from the University of Texas at Austin, and a B.S. in Petroleum Engineering from China Petroleum University. He also holds the Chartered Financial Analyst (CFA) designation.

 

Gerard Pascale. Mr. Pascale has been a member of our Board since January 15, 2010. Mr. Pascale has extensive experience in financial accounting, financial analysis and planning, marketing research, corporate governance and securities. He is the Chief Financial Officer with Chile Mining Technologies, Inc. (OTCBB: LVEN), a mineral extraction company based in the Republic of Chile, whom he advised in preparing for their public transaction and fund raise. For the past two and a half years he has served as President and CEO of SC Financial Group, LLC, where he specializes in advising both US and international clients on valuation, financial modeling and the responsibilities of publicly traded US companies.  Previously, he was the Director of Finance at Heritage Management Consultants, Inc. where Mr. Pascale specialized in providing finance and SEC support throughout the entire process of listing on a US exchange.  From 2003 to 2005, Mr. Pascale was a Director with the Corporate Executive Board, a consulting firm delivering data and tools, practice research and insight to clients. He has also held financial analyst positions with Intel Corporation and Emerson Electric.  Mr. Pascale has a Bachelor of Science in Accounting from Virginia Tech and an MBA in finance from the University of Chicago.

 

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Guoyou Shao. Mr. Shao has been a member of our Board since February 2008. Since April 2003, Mr. Shao has served as Board Chairman of Fortis Haitong Investment Management Co., Ltd., one of the first Sino-foreign joint ventures specializing in fund management to gain approval in China. Prior to this, Mr. Shao served as Manager of the Investor Relations Department of Haitong Securities Co. Ltd. since July 1998. Mr. Shao has extensive securities investment and asset management experience and holds a Master’s degree in Business Administration from Hong Kong Science Management Institute.

 

Xinchuang Li. Mr. Li has been a member of our Board since February 2008. Since 2009, Mr. Li has served as the Director of China Metallurgical Industry Planning & Research Institute (CMIPRI) in Beijing. From 2008 to 2009, Mr. Li served as the Executive Director of CMIPRI. From 2002 to 2008, Mr. Li served as the Vice Director and Chief Engineer of CMIPRI. From 1998 to 2002, Mr. Li served as the Vice-Chief Engineer of CMIPRI. Mr. Li has significant experience in the operations of companies engaged in steel production with a particular focus and specialization in the operations, planning and strategic focus of companies operating in the Chinese steel industry. Mr. Li holds a Master’s degree in Business Administration from Fordham University and Beijing University.

 

There are no agreements or understandings for any of our executive officers or director to resign at the request of another person and no officer or director is acting on behalf of nor will any of them act at the direction of any other person.

 

Directors are elected until their successors are duly elected and qualified.

 

Director Qualifications

 

Directors are responsible for overseeing the Company’s business consistent with their fiduciary duty to shareholders. This significant responsibility requires highly-skilled individuals with various qualities, attributes and professional experience. The Board believes that there are general requirements for service on the Company’s Board of Directors that are applicable to all directors and that there are other skills and experience that should be represented on the Board as a whole but not necessarily by each director. The Board and the Governance and Nominating Committee of the Board consider the qualifications of directors and director candidates individually and in the broader context of the Board’s overall composition and the Company’s current and future needs.

 

Qualifications for All Directors

 

In its assessment of each potential candidate, including those recommended by shareholders, the Governance and Nominating Committee considers the nominee’s judgment, integrity, experience, independence, understanding of the Company’s business or other related industries and such other factors the Governance and Nominating Committee determines are pertinent in light of the current needs of the Board. The Governance and Nominating Committee also takes into account the ability of a director to devote the time and effort necessary to fulfill his or her responsibilities to the Company.

 

The Board and the Governance and Nominating Committee require that each director be a recognized person of high integrity with a proven record of success in his or her field. Each director must demonstrate innovative thinking, familiarity with and respect for corporate governance requirements and practices, an appreciation of multiple cultures and a commitment to sustainability and to dealing responsibly with social issues. In addition to the qualifications required of all directors, the Board assesses intangible qualities including the individual’s ability to ask difficult questions and, simultaneously, to work collegially.

 

The Board does not have a specific diversity policy, but considers diversity of race, ethnicity, gender, age, cultural background and professional experiences in evaluating candidates for Board membership. Diversity is important because a variety of points of view contribute to a more effective decision-making process.

 

Qualifications, Attributes, Skills and Experience to be Represented on the Board as a Whole

 

The Board has identified particular qualifications, attributes, skills and experience that are important to be represented on the Board as a whole, in light of the Company’s current needs and business priorities. The Company’s services are performed in areas of future growth located outside of the United States. Accordingly, the Board believes that international experience or specific knowledge of key geographic growth areas and diversity of professional experiences should be represented on the Board. In addition, the Company’s business is multifaceted and involves complex financial transactions. Therefore, the Board believes that the Board should include some directors with a high level of financial literacy and some directors who possess relevant business experience members of senior management teams. Our business involves complex technologies in a highly specialized industry, and therefore, the Board believes that extensive knowledge of the Company’s business and industry should be represented on the Board.

 

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Summary of Qualifications of Directors

 

Set forth below is a narrative disclosure that summarizes some of the specific qualifications, attributes, skills and experiences of our directors. For more detailed information, please refer to the biographical information for each director set forth above.

 

Lifang Chen. Ms. Chen has extensive senior management experience in the industry in which we operate, having served as our Chairman since February 2007 and Chief Executive Officer since May 2008. In addition, Ms. Chen has worked extensively with various governmental agencies in connection with our industry.

 

Yongfei Jiang. Mr. Jiang has extensive experience in our industry, as well as ten years of experience in working on corporate accounting, finance and capital management matters.

 

Gerard Pascale. Mr. Pascale brings to the Board a high level of financial literacy and sophistication, and extensive financial and capital markets experience, including M&A, debt and equity financings, restructuring and business expansion. In addition, Mr. Pascale has extensive experience dealing with corporate governance matters and filings with the SEC.

 

Guoyou Shao.Mr. Shao has extensive securities investment, asset management and investor relations experience. 

 

Xinchuang Li. Mr. Li has significant experience in the operations of companies engaged in steel production with a particular focus and specialization in the operations, planning and strategic focus of companies operating in the Chinese steel industry.

 

Family Relationships

 

There are no family relationships among our directors or officers.

 

Involvement in Certain Legal Proceedings

 

To the best of our knowledge, none of our directors or executive officers has, during the past ten years:

 

·been convicted in a criminal proceeding or been subject to a pending criminal proceeding (excluding traffic violations and other minor offences);

 

·had any bankruptcy petition filed by or against the business or property of the person, or of any partnership, corporation or business association of which he was a general partner or executive officer, either at the time of the bankruptcy filing or within two years prior to that time;

 

·been subject to any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction or federal or state authority, permanently or temporarily enjoining, barring, suspending or otherwise limiting, his involvement in any type of business, securities, futures, commodities, investment, banking, savings and loan, or insurance activities, or to be associated with persons engaged in any such activity;

 

·been found by a court of competent jurisdiction in a civil action or by the Securities and Exchange Commission or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended, or vacated;

 

·been the subject of, or a party to, any federal or state judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated (not including any settlement of a civil proceeding among private litigants), relating to an alleged violation of any federal or state securities or commodities law or regulation, any law or regulation respecting financial institutions or insurance companies including, but not limited to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist order, or removal or prohibition order, or any law or regulation prohibiting mail or wire fraud or fraud in connection with any business entity; or

 

·been the subject of, or a party to, any sanction or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the Exchange Act (15 U.S.C. 78c(a)(26))), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act (7 U.S.C. 1(a)(29))), or any equivalent exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member.

 

42
 

 

Except as set forth in our discussion below in Item 13, “Certain Relationships and Related Transactions,and Director Independence – Transactions with Related Persons,” none of our directors, director nominees or executive officers has been involved in any transactions with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed pursuant to the rules and regulations of the SEC.

 

Board Composition and Committees

 

Our board of directors is comprised of Lifang Chen, Yongfei Jiang, Gerard Pascale, Guoyou Shao and Xinchuang Li.

 

Messrs. Gerard Pascale, Guoyou Shao, and Xinchuang Li each serves on our board of directors as an “independent director” as defined by as defined by Rule 5605(a)(2) of the NASDAQ Listing Rules. Our board of directors has determined that Gerard Pascale possesses the accounting or related financial management experience that qualifies him as financially sophisticated within the meaning of Rule 5605(c)(2)(A) of the NASDAQ Listing Rule and that he is an “audit committee financial expert” as defined by the rules and regulations of the SEC.

 

Our board of directors currently has three standing committees which perform various duties on behalf of and report to the board of directors: (i) audit committee, (ii) compensation committee and (iii) governance and nominating committee. Each of the three standing committees is comprised entirely of independent directors. From time to time, the board of directors may establish other committees.

 

Audit Committee

 

Our board of directors established an audit committee in February 2008. Our audit committee consists of three members: Gerard Pascale, Guoyou Shao, and Xinchuang Li. Our audit committee oversees our accounting and financial reporting processes and the audits of the financial statements of our company. Mr. Pascale serves as our audit committee chairman.

 

Our audit committee is responsible for, among other things:

 

·selecting our independent auditors and pre-approving all auditing and non-auditing services permitted to be performed by our independent auditors;

 

·reviewing with our independent auditors any audit problems or difficulties and management’s response;

 

·reviewing and approving all proposed related-party transactions, as defined in Item 404 of Regulation S-K under the Securities Act;

 

·discussing the annual audited financial statements with management and our independent auditors;

 

·reviewing major issues as to the adequacy of our internal controls and any special audit steps adopted in light of significant internal control deficiencies;

 

·annually reviewing and reassessing the adequacy of our audit committee charter;

 

·meeting separately and periodically with management and our internal and independent auditors;

 

·reporting regularly to the full board of directors; and
·such other matters that are specifically delegated to our audit committee by our board of directors from time to time.

 

Compensation Committee

 

Our board of directors established a compensation committee in February 2008. Our compensation committee consists of three members: Gerard Pascale, Guoyou Shao, and Xinchuang Li. Mr. Shao serves as the chairman of our compensation committee. Our compensation committee assists the board of directors in reviewing and approving the compensation structure of our directors and executive officers, including all forms of compensation to be provided to our directors and executive officers. Our Chief Executive Officer may not be present at any meeting of our compensation committee during which her compensation is deliberated.

 

Our compensation committee is responsible for, among other things:

 

43
 

 

·approving and overseeing the compensation package for our executive officers;

 

·reviewing and approving corporate goals and objectives relevant to the compensation of our Chief Executive Officer;

 

·evaluating the performance of our Chief Executive Officer in light of those goals and objectives, and setting the compensation level of our Chief Executive Officer based on this evaluation; and
   
·reviewing periodically and making recommendations to the board of directors regarding any long-term incentive compensation or equity plans, programs or similar arrangements, annual bonuses, employee pension and welfare benefit plans.

 

Governance and Nominating Committee

 

Our board of directors established a governance and nominating committee in February 2008. Our governance and nominating committee consists of three members: Gerard Pascale, Guoyou Shao, and Xinchuang Li. Mr. Li serves as the chairman to our governance and nominating committee. The governance and nominating committee assists the board of directors in identifying individuals qualified to become our directors and in determining the composition of the board of directors and its committees.

 

Our governance and nominating committee is responsible for, among other things:

 

·identifying and recommending to the board of directors nominees for election or re-election to the board of directors, or for appointment to fill any vacancy;

 

·reviewing annually with the board of directors the current composition of the board of directors in light of the characteristics of independence, age, skills, experience and availability of service to us; and

 

·identifying and recommending to the board of directors the directors to serve as members of the committees.

 

Section 16(A) Beneficial Ownership Reporting Compliance

 

Under U.S. securities laws, directors, certain executive officers and persons holding more than 10% of our common stock must report their initial ownership of the common stock, and any changes in that ownership, to the SEC. The SEC has designated specific due dates for these reports. In fiscal year 2012, all such reports were timely filed. In making these statements, we have relied upon examination of the copies of all Section 16(a) forms provided to us and the written representations of our executive officers, directors and beneficial owner of more than 10% of a registered class of our equity securities.

 

Code of Ethics

 

On January 31, 2007, our board of directors adopted a new code of ethics that applies to all of our directors, officers and employees, including our principal executive officer, principal financial officer and principal accounting officer. The new code replaces our prior code of ethics that applied only to our principal executive officer, principal financial officer, principal accounting officer or controller and any person who performed similar functions, and addresses, among other things, honesty and ethical conduct, conflicts of interest, compliance with laws, regulations and policies, including disclosure requirements under the federal securities laws, confidentiality, trading on inside information, and reporting of violations of the code.  A copy of the Code of Ethics has been filed as Exhibit 14 to our current report on Form 8-K, filed on February 2, 2007.

 

ITEM 11. EXECUTIVE COMPENSATION.

 

Summary Compensation Table – Fiscal Years Ended June 30, 2012 and 2011

 

The following table sets forth information concerning all cash and non-cash compensation awarded to, earned by or paid to the named persons for services rendered in all capacities during the noted periods. No other executive officer received total annual salary and bonus compensation in excess of $100,000.

 

44
 

 

Name and Principal Position  Year   Salary
($)
   Bonus
($)
  

Stock

Awards

($)(1)

   All Other
Compensation
($)
   Total
($)
 
Lifang Chen, CEO (2)   2012    120,831         25,530         146,361 
    2011    100,000    -    25,390    -    125,390 
Naijiang Zhou, VP Finance(3)   2012    101,426         70,327         171,753 
    2011    90,527    -    67,776    -    158,303 

 

(1) This amount represents the compensation expense that the Company recognized for financial statement reporting purposes in the applicable fiscal year for the portion of the fair value of equity awards granted to the named executive officer in such fiscal year, in accordance with ASC 718-10, “Share-Based Payment,” and ASC 505-50, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services,” respectively.  Such amount thus does not reflect the amount of compensation actually received by the named executive officer during the applicable fiscal year.  For a description of the assumptions used in calculating the fair value of these equity awards, see Note 10 to the consolidated financial statements included elsewhere in this report.

 

(2) Pursuant to the Company’s 2009 Equity Incentive Plan, we granted options to purchase 40,000 shares of our common stock to Ms. Chen with an exercise price of $2.71 per share on April 27, 2010. One-third of the option will each vest on the first, second and third anniversaries of the date of grant.

 

(3) Pursuant to the Company’s 2009 Equity Incentive Plan, we granted options to purchase 20,000 shares of our common stock to Mr. Zhou with an exercise price of $2.71 per share on April 27, 2010.One-third of the option will each vest on the first, second and third anniversaries of the date of grant. In addition, Mr. Zhou received 20,000 restricted shares of common stock as part of his compensation for services from February 1, 2010 to January 31, 2011. According to the amendment to the employment agreement entered into on February 23, 2011, Mr. Zhou received 30,000 additional restricted shares of common stock as part of his annual compensation to be vested over a twelve month period. On February 9, 2012, the parties amended Mr. Zhou’s employment agreement further, under which amendment Mr. Zhou’s monthly base salary was increased from RMB 50,000 to RMB 58,000 (approximately $9,200) and the Company granted 50,000 restricted shares to Mr. Zhou on February 21, 2012 under the 2009 Equity Incentive Plan, which shares vest on the 12-month anniversary date of the grant date.

 

Employment Agreements

 

On February 9, 2012, our subsidiary, Sutor Steel Technology Co., Ltd. (“Sutor BVI”) entered into an employment agreement with Ms. Chen, our Chief Executive Officer, under which Ms. Chen will receive an annual salary of $150,000. Ms. Chen’s employment with us is at-will and can be terminated by either party at any time with or without cause.

 

On February 9, 2012, Sutor BVI also entered into an employment agreement with Mr. Jiang, our Chief Financial Officer, under which Mr. Jiang will receive an annual salary of $120,000. Mr. Jiang’s employment with us is at-will and can be terminated by either party at any time with or without cause.

 

On December 18, 2009, we entered into an employment agreement with Mr. Naijiang Zhou, our Vice President of Finance, under which Mr. Zhou will receive a monthly salary of RMB50,000 (approximately $7,740) and 20,000 shares of the Company’s common stock per year. The employment contract has a one year term, starting from February 1, 2010, which will be automatically renewed unless terminated or modified by the parties. On February 23, 2011, we entered into an amendment to Mr. Zhou’s employment agreement, which provides for an increase in the number of shares issued to Mr. Zhou annually under the employment agreement from 20,000 to 30,000 shares of common stock. On February 9, 2012, the parties amended Mr. Zhou’s employment agreement further, under which amendment Mr. Zhou’s monthly base salary was increased from RMB 50,000 to RMB 58,000 (approximately $9,200). In addition, the Company granted 50,000 restricted shares to Mr. Zhou on February 21, 2012,vesting on the 12-month anniversary date of the grant date. The contract is for one year and will not be automatically renewed.

 

We have not provided retirement benefits (other than a state pension scheme in which all of our employees in China participate) or severance or change of control benefits to our named executive officer.

 

Outstanding Equity Awards at Fiscal Year End

 

The following table sets forth the equity awards outstanding at June 30, 2012 for each of our named executive officers.

 

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   OPTION AWARDS(1)   STOCK AWARDS 
Name  Number of
Securities
Underlying
Unexercised
Options (#)
Exercisable
   Number of
Securities
Underlying
Unexercised
Options (#)
Unexercisable
   Equity
Incentive
Plan Awards:
Number of
Securities
Underlying
Unexercised
Unearned
Options
(#)
   Option
Exercise
Price
($)
   Option
Expiration
Date
  Number of
Shares or
Units of
Stock That
Have Not
Vested
(#)
   Market Value 
of Shares or
Units of Stock
 That Have Not
Vested
($)
  

Equity

Incentive Plan 
Awards:

Number of

Unearned

Shares, Units

or Other

Rights That

Have Not

Vested

(#)(2)

  

Equity

Incentive

Plan Awards:

Market or

Payout Value of 
Unearned

Shares, Units or 
Other Rights 
That Have Not

Vested

(#)(3)

 
Lifang Chen   26,667    -    13,333    2.71   4/27/2015   -    -    -    - 
Naijiang Zhou   13,333    -    6,667    2.71   4/27/2015   50,000    46,000    -    - 

 

(1)On April 27, 2010, we issued options to our executive officers under the Sutor Technology Group Limited 2009 Equity Incentive Plan. One-third of the option will each vest on the first, second and third anniversaries of the date of grant.

 

(2)Pursuant to the amendment to the employment agreement dated February 23, 2011, we granted Mr. Zhou 30,000 shares to be vested over a twelve month period. On February 21, 2012, we granted additional 50,000 restricted shares to Mr. Zhou, vesting on the 12-month anniversary date of the grant date.

 

(3)Values are based on the closing stock price of $0.92per share on June 29, 2012.

 

Compensation of Directors

 

The table below sets forth the compensation of our directors for the fiscal year ended June 30, 2012:

 

  

  

  

Name

  Fees Earned
or Paid inCash
($)
  

 

Stock

Awards

($)

  

 

Option

Awards

($)

   Non-Equity
Incentive Plan
Compensation
($)
  

 

All Other

Compensation

($)

  

 

 

Total

($)

 
Gerard Pascale   55,000    4,403    2,030    -    -    61,433 
Guoyou Shao   20,919    -    -    -    -    20,919 
Xinchuang Li   20,919    -    -    -    -    20,919 

 

Under the terms of the independent director contract that we entered into with each above independent directors in February 2012, Mr. Pascale is entitled to $55,000 in cash and 10,000 restricted shares of the Company, vesting on the 12-month anniversary date of the grant date, Mr. Shao is entitled to RMB 132,000 (approximately $20,433) and Mr. Li is entitled to RMB 132,000 (approximately $20,433), as annual compensation for their service as independent directors, and as chairpersons of various board committees, as applicable. Mr. Pascale’s compensation is greater because he has greater responsibilities as the Audit Committee Chairman. Under the terms of the agreements, we will reimburse our directors for reasonable travel expenses related to attendance at board and committee meetings.

 

Additionally, we entered into Indemnification Agreements with each of Messrs. Pascale, Shao and Li.  Under the terms of these Indemnification Agreements, the Company agreed to indemnify the independent directors against expenses, judgments, fines, penalties or other amounts actually and reasonably incurred by the independent directors in connection with any proceeding (other than a proceeding by or in the right of the Company) if the independent director acted in good faith and in the best interests of the Company, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the independent director’s conduct was unlawful.  The Company also agreed to pay any such expenses to an independent director in advance of the final disposition of any such proceeding if the director agrees to repay such amount to the extent it is ultimately determined they are not entitled to indemnification; provided, however, that the Company is not obligated to make any such advance payment if the board of directors determines, in its sole discretion, that it does not appear that such director has met the standards of conduct which make it permissible under applicable law to indemnify such director, and that the advancement of expenses would not be in the best interests of the Company and its stockholders.

 

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ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

 

Security Ownership of Certain Beneficial Owners and Management

 

The following table sets forth information regarding beneficial ownership of our common stock as of September 10, 2012 (i) by each person who is known by us to beneficially own more than 5% of our common stock; (ii) by each of our officers and directors; and (iii) by all of our officers and directors as a group. Unless otherwise specified, the address of each of the persons set forth below is in care of Sutor Technology Group Limited, No. 8, Huaye Road, Dongbang Industrial Park Changshu, China, 215534.

 

Name & Address of

Beneficial Owner

  Office, If Any   Title of Class    

Amount &

Nature of

Beneficial

Ownership(1)

   

Percent 
of

Class(2)

 
Officers and Directors  
Lifang Chen   Chairman and Chief Executive Officer   Common Stock       30,364,716 (3) (4)      75.5
Yongfei Jiang   Chief Financial Officer   Common Stock       17,333 (5)      *  
Naijiang Zhou   VP of Finance   Common Stock       113,333 (6)      *  
Gerard Pascale   Director   Common Stock       16,625 (7)      *  
Guoyou Shao   Director   Common Stock       -       *  
Xinchuang Li   Director   Common Stock       -       *  
All Officers and Directors as a group (6 persons named above)               30,512,007       75.5
5% Security Holders  
Total Raise Investments Ltd.       Common Stock       30,338,050       75.4
Lifang Chen Common Stock       30,364,716 (3)     75.5 %

  

* Less than 1%.

  

(1)Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities.

 

(2)A total of 40,214,764shares of our common stock are considered to be outstanding as of September 10, 2012. For each beneficial owner above, any options exercisable within 60 days have been included in the denominator pursuant to Rule 13d-3(d)(1).

 

(3)Includes 30,338,050 shares of common stock owned by Total Raise Investments Ltd., a BVI company wholly owned by Ms. Chen. Ms. Chen disclaims beneficial ownership of such shares except to the extent of her pecuniary interest therein.

 

(4)Pursuant to the Company’s 2009 Equity Incentive Plan, we granted Ms. Chen an option to purchase 40,000 shares of common stock with an exercise price of $2.71 per share on April 27, 2010. One-third of the option will each vest on the first, second and third anniversaries of the date of grant.

 

(5)Pursuant to the Company’s 2009 Equity Incentive Plan, we granted Mr. Jiang an option to purchase 26,000 shares of common stock with an exercise price of $2.71 per share on April 27, 2010. One-third of the option will each vest on the first, second and third anniversaries of the date of grant.

 

(6)On February 1, 2010, Mr. Zhou received 20,000 shares of our common stock in accordance with the terms of the employment agreement, to vest in equal installments over a twelve month period.  As of October 10, 2011, all of these shares have vested. In addition, on February 23, 2011, Mr. Zhou was granted 30,000 shares of our common stock in accordance with the terms of the employment agreement, to vest in equal installments over a twelve month period. Pursuant to the Company’s 2009 Equity Incentive Plan, we also granted Mr. Zhou an option to purchase 20,000 shares of common stock with an exercise price of $2.71 per share on April 27, 2010. One-third of the option will each vest on the first, second and third anniversaries of the date of grant. On February 9, 2012, the parties amended Mr. Zhou’s employment agreement further, under which amendment the Company granted 50,000 restricted shares to Mr. Zhou on February 21, 2012,vesting on the 12-month anniversary date of the grant date.

 

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(7)Pursuant to the Company’s 2009 Equity Incentive Plan, we granted Mr. Pascale an option to purchase 5,000 shares of common stock with an exercise price of $2.71 per share which will vest monthly in equal installments over a 12-month period starting February 23, 2011.On February 21, 2012, we granted 10,000 restricted shares to Mr. Pascale, which will vest on the one-year anniversary date of the grant date.

 

Changes in Control 

 

There are no arrangements known to us, including any pledge by any person of our securities, the operation of which may at a subsequent date result in a change in control of the Company.

 

Securities Authorized for Issuance Under Equity Compensation Plans

 

The following table includes the information as of the end of fiscal year 2012 for each category of our equity compensation plan:

 

  

  

  

  

  

Plan category

  Number of securities
to be issued upon
exercise of
outstanding options,
restricted stock,
warrants and rights
(a)
   Weighted-average
exercise price of
outstanding
 options, restricted 
stock, warrants
 and rights
(b)
   Number of securities
remaining available for
future issuance under
equity compensation 
plans (excluding securities
reflected in column (a))
(c)
 
Equity compensation plans approved by security holders(1)   105,000 (2)   $2.71    1,785,000 
Equity compensation plans not approved by security holders   -    -    - 
Total   105,000   $2.71    1,785,000 

 

(1)On April 15, 2009, our board of directors authorized the establishment of the Sutor Technology Group Limited 2009 Equity Incentive Plan, whereby we are authorized to issue shares of our Common Stock to certain employees, directors and consultants. The maximum aggregate number of shares of our common stock that may be issued under the Plan is 2,000,000 shares. The Plan was approved by our stockholders on June 16, 2009.

 

(2)On April 27, 2010, we granted options to purchase a total of 100,000 shares of our common stock to certain officers, directors and employees with an exercise price of $2.71 per share. One third of the option will vest and become exercisable on the first, second and third anniversaries of the date of grant.  On February 1, 2010, Mr. Zhou received 20,000 shares of our common stock in accordance with the terms of the employment agreement, to vest in equal installments over a twelve month period. On February 23, 2011, we issued 30,000 shares of our common stock to Mr. Naijiang Zhou under the 2009 Equity Incentive Plan, to vest in equal installments over a twelve month period. On February 21, 2012, the Company granted 50,000 restricted shares to Mr. Zhou, vesting on the 12-month anniversary date of the grant date. On February 23, 2011, we granted Mr. Pascale an option to purchase 5,000 shares of common stock with an exercise price of $2.71 per share which will vest monthly in equal installments over a 12-month period starting February 23, 2011.On February 21, 2012, we granted 10,000 restricted shares to Mr. Pascale, which will vest on the one-year anniversary date of the grant date.

 

ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

 

Transactions with Related Persons

 

The following includes a summary of transactions since the beginning of our 2012 fiscal year, or any currently proposed transaction, in which we were or are to be a participant and the amount involved exceeded or exceeds the lesser of $120,000 or one percent of the average of our total assets at year-end for the last two completed fiscal years, and in which any related person had or will have a direct or indirect material interest (other than compensation described under Item 11, “Executive Compensation”). We believe the terms obtained or consideration that we paid or received, as applicable, in connection with the transactions described below were comparable to terms available or the amounts that would be paid or received, as applicable, in arm’s-length transactions.

 

48
 

 

·We sell our products to and buy raw materials from various companies which are beneficially owned or controlled by our CEO and President, Ms. Lifang Chen. The amounts charged for products to our Company by such related party are under the same pricing, terms and conditions as those charged to third parties. See Note 9,“Related Parties” to the consolidated financial statements included elsewhere in this report. The transactions relating to the sale of our products are set forth below:

 

      Amount of Transaction 
Related Party  Nature of Transaction   Fiscal 2012   Fiscal 2011 
Changshu Diemate Steel Processing Co. Ltd.  Sale of products by Company   $-   $1,015 
HangzhouXiaoshan Southern Industry Co., Ltd.  Sale of products by Company    297,253    - 
Ningbo Huaye Steel Processing Co., Ltd.  Sale of products by Company    671,302    216,965 
Shanghai Huaye Steel Processing Co., Ltd.  Sale of products by Company    4,341,513    19,661,583 
Shanghai Huaye Steel Group Co., Ltd.  Sale of products by Company    138,156,998    140,213,706 
WuxiHaide Steel Processing Co., Ltd.  Sale of products by Company    7,058,099    - 
Zhejiang Nanye Metal Cutting & Delivery Co., Ltd.  Sale of products by Company    487,476    60,717 
GuangzhouQiyuan Steel Processing Co., Ltd.  Sale of products by Company    4,663,808    - 
Tianjin Huaye Steel processing Co., Ltd.  Sale of products by Company    -    5,415,935 
                

For the years ended June 30, 2012 and 2011, purchases from related parties beneficially owned or controlled by Ms. Chen totaled $168,095,827 and $237,261,815, respectively.

 

·At June 30, 2012 and 2011, the Company had letters of credit totaling $82,669,496 and $38,972,693, respectively, in the form of banker’s acceptance notes that are held by related parties in connection with purchases from related parties. The banker’s acceptance notes carry a 0% interest rate, can be presented to the respective banks in 90 to 180 days from the dates they were written, are secured by cash on deposit with the respective banks and are guaranteed by related parties.

 

·During the years ended June 30, 2012 and 2011, the Company repaid nil and $600,000 loans from related parties. As of June 30, 2012 and 2011, the Company had loans from related parties totaling $8,815,502 and $8,800,879, respectively; and accrued interest totaling $1,621,842 and $1,250,812, respectively. The loans from related parties and accrued interest have been recorded as a reduction of advances to suppliers, related parties in the accompanying consolidated balance sheet as of June 30, 2012 and 2011.

 

·Some of our notes payables are guaranteed by Shanghai Huaye and its affiliates, as disclosed under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources.” We did not pay any stated or unstated consideration to Shanghai Huaye or its affiliates for their guarantees of our note payables.

 

·On August 6, 2004, our subsidiary Ningbo Zhehua entered into a lease agreement with Ningbo Huaye Steel Processing Co., Ltd., a subsidiary of Shanghai Huaye, pursuant to which Ningbo Zhehua leased a factory building located at the Ningbo Camel Machinery & Electronics Industrial Park. The lease agreement has a term of 10 years which will expire on August 31, 2013 and the annual rent is RMB 960,000 (approximately $0.14 million).

 

Except as set forth in our discussion above, none of our directors, director nominees or executive officers has been involved in any transactions with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed pursuant to the rules and regulations of the SEC.

 

Promoters and Certain Control Persons

 

We did not have any promoters at any time during the past five fiscal years.

 

49
 

 

Parents of the Company

 

Total Raise Investments Ltd., an entity owned and controlled by Ms. Lifang Chen, our Chairman and Chief Executive Officer, currently owns approximately 75.5% of our common stock.

 

Director Independence

 

Messrs. Gerard Pascale, Guoyou Shao, and Xinchuang Li each serves on our board of directors as an “independent director” as defined by Rule 5605(a)(2) of the NASDAQ Listing Rules.

 

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.

 

Independent Registered Public Accounting Firm’s Fees

 

The following is a summary of the fees billed to the Company by its independent registered public accounting firms for professional services rendered for the fiscal years ended June 30, 2012 and 2011:

 

(in thousands of U.S. dollars)

 

   June 30,2012   June 30,2011 
Audit fees(1)  $411.6   $484.8 
Audit-related fees(2)    7.0    6.8 
Tax fees   -    - 
All other fees   -    - 
Total   418.6    491.6 

 

(1)Consists of fees billed for the audit of our annual financial statements, review of financial statements included in our Quarterly Reports on Form 10-Q and services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements.

 

(2)Consists of assurance and related services that are reasonably related to the performance of the audit and reviews of our financial statements and are not included in “audit fees” in this table. The services provided by our accountants within this category consisted of advice relating to SEC matters and employee benefit matters.

 

Pre-Approval Policies and Procedures

 

Under the Sarbanes-Oxley Act of 2002, all audit and non-audit services performed by our auditors must be approved in advance by our Board to assure that such services do not impair the auditors’ independence from us. In accordance with its policies and procedures, our Board pre-approved the audit service performed by our principal accountant for the consolidated financial statements as of and for the year ended June 30, 2012.

 

PART IV

  

ITEM 15.EXHIBITS, FINANCIAL STATEMENT SCHEDULES.

 

Financial Statements and Schedules

 

The financial statements are set forth under Item 8 of this annual report on Form 10-K.

 

The following financial statement schedule is filed herewith: Schedule I - Sutor Technology Group Limited (parent only) unconsolidated financial statements as of and for the years ended June 30, 2012 and 2011.

Schedules other than that listed above have been omitted because they are not applicable or the required information is included in the financial statements or notes thereto.

 

Exhibit List

 

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

 

50
 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Date: September 14, 2012

 

SUTOR TECHNOLOGY GROUP LIMITED
   
By: /s/Lifang Chen  
  Lifang Chen
  Chief Executive Officer
   
By: /s/Yongfei Jiang  
  Yongfei Jiang
  Chief Financial Officer

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Signature   Title   Date
         
/s/ Lifang Chen     Chairman and Chief Executive Officer   September 14, 2012
Lifang Chen   (Principal Executive Officer)    
         
/s/ Yongfei Jiang     Director, Chief Financial Officer   September 14, 2012
Yongfei Jiang   (Principal Financial and Accounting Officer)    
         
/s/ Gerard Pascale     Director   September 14, 2012
Gerard Pascale        
         
/s/ Guoyou Shao     Director   September 14, 2012
Guoyou Shao        
         
/s/ Xinchuang Li     Director   September 14, 2012
Xinchuang Li        
         

 

51
 

 

X:\TQData\VINEYARD\Live Jobs\2012\09 Sep\13 Sep\Shift II\Sutor Technology 10-K\Draft\03-Production

 

 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

 

  Page
   
Report of Independent Registered Public Accounting Firm, Grant Thornton F-1
   
Report of Independent Registered Public Accounting Firm, Hansen, Barnett & Maxwell, P.C. F-2
   
Consolidated Balance Sheets as of June 30, 2012 and 2011 F-3
   
Consolidated Statements of Operations and Comprehensive Income for the Years Ended June 30, 2012 and 2011 F-4
   
Consolidated Statements of Stockholders’ Equity for the Years Ended June 30, 2012 and 2011 F-5
   
Consolidated Statements of Cash Flows for the Years Ended June 30, 2012 and 2011 F-6
   
Notes to the Consolidated Financial Statements for the Years Ended June 20, 2012 and 2011 F-7 – F-25

 

 
 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

Board of Directors and Shareholders

Sutor Technology Group Limited and subsidiaries

 

We have audited the accompanying consolidated balance sheet of Sutor Technology Group Limited and subsidiaries (the “Company”) as of June 30, 2012 and the related consolidated statements of operations and comprehensive income, stockholders’ equity, and cash flows for the year then ended. Our audit of the basic consolidated financial statements included the financial statement schedule listed in the index appearing under Item 15. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management.Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting.Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sutor Technology Group Limited and subsidiariesas of June 30, 2012, and the results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

 

/s/ Grant Thornton

 

Beijing, China

September 14, 2012

  

F-1
 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and the Stockholders of

Sutor Technology Group Limited

 

We have audited the accompanying consolidated balance sheet of Sutor Technology Group Limited and subsidiaries as of June 30, 2011, and the related consolidated statements of operations and comprehensive income, stockholders’ equity, and cash flows for the year then ended. Our audit of the basic consolidated financial statements included the financial statement schedule listed under Item 15. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis of designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sutor Technology Group Limited and subsidiaries as of June 30, 2011 and the results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

 

  /s/ HANSEN, BARNETT & MAXWELL, P.C.
Salt Lake City, Utah  
October 13, 2011  

 

F-2
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

   June 30,   June 30, 
   2012   2011 
         
ASSETS          
Current Assets:          
Cash and cash equivalents  $9,530,531   $21,324,931 
Restricted cash   111,582,149    72,326,482 
Short-term investments   4,849,112    - 
Trade accounts receivable, net of allowance for doubtful accounts of $1,306,099 and $856,554, respectively   7,023,880    3,969,090 
Notes receivable   475,112    168,029 
Other receivables and prepayments, net of allowance for doubtful accounts of $351,372 and $529,068, respectively   4,275,817    2,004,044 
Advances to suppliers, unrelated parties, net of allowance for doubtful accounts of $366,697 and $493,761, respectively   27,446,626    42,067,716 
Advances to suppliers, related parties, net of allowance for doubtful accounts of nil and $127,903, respectively   121,884,833    116,772,842 
Inventories, net   50,432,279    46,197,179 
Deferred tax assets   709,688    363,497 
Total Current Assets   338,210,027    305,193,810 
Non-current Assets:          
Advances for purchase of long term assets   15,001,088    81,191 
Property, plant and equipment, net   77,231,273    79,103,131 
Intangible assets, net   3,082,877    3,083,569 
Total Non-current Assets   95,315,238    82,267,891 
TOTAL ASSETS  $433,525,265   $387,461,701 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY          
Current Liabilities:          
Short-term loans  $111,166,838   $95,494,490 
Long-term loans, current portion   27,762,975    - 
Accounts payable   57,079,617    55,674,454 
Other payables and accrued expenses   8,820,064    4,840,135 
Other payables, related parties   -    594,105 
Advances from customers   7,924,812    11,737,085 
Warrant liabilities   47,404    399,572 
Total Current Liabilities   212,801,710    168,739,841 
Long-Term Loans   8,490,772    23,626,900 
Total Liabilities   221,292,482    192,366,741 
Stockholders' Equity          
Undesignated preferred stock - $0.001 par value; 1,000,000 shares authorized; nil shares outstanding   -    - 
Common stock - $0.001 par value;          
authorized: 500,000,000 shares as of June 30, 2012 and June 30, 2011;          
issued: 40,805,602 shares and 40,745,602 shares as of June 30, 2012 and June 30, 2011, respectively   40,805    40,745 
Additional paid-in capital   41,344,306    41,216,546 
Statutory reserves   18,100,361    15,662,039 
Retained earnings   117,732,738    108,106,069 
Accumulated other comprehensive income   35,622,241    30,069,561 
Less: Treasury stock, at cost, 544,477and nil shares as of June 30, 2012 and June 30, 2011, respectively   (607,668)   - 
Total Stockholders' Equity   212,232,783    195,094,960 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY  $433,525,265   $387,461,701 

 

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

  

F-3
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME

 

   For The Years Ended 
   June 30 
   2012   2011 
         
Revenue:          
Revenue from unrelated parties  $375,947,830   $266,126,597 
Revenue from related parties   155,675,893    165,569,921 
    531,623,723    431,696,518 
           
Cost of Revenue          
Cost of revenue from unrelated parties   (347,052,327)   (240,847,808)
Cost of revenue from related parties   (142,848,128)   (150,397,400)
    (489,900,455)   (391,245,208)
           
Gross Profit   41,723,268    40,451,310 
           
Operating Expenses:          
           
Selling expenses   (7,236,095)   (7,503,738)
General and administrative expenses   (10,781,178)   (7,813,711)
Total Operating Expenses   (18,017,273)   (15,317,449)
Income from Operations   23,705,995    25,133,861 
           
Other Incomes/(Expenses):          
Interest income   2,831,798    901,511 
Interest expense   (13,317,274)   (7,971,129)
Changes in fair value of warrant liabilities   352,168    607,331 
Other income   408,703    163,977 
Other expense   (918,090)   (793,540)
Total Other Incomes/(Expenses)   (10,642,695)   (7,091,850)
           
Income Before Taxes   13,063,300    18,042,011 
Income tax expense   (998,309)   (3,429,507)
Net Income  $12,064,991   $14,612,504 
           
Basic Earnings per Share  $0.30   $0.36 
Diluted Earnings per Share  $0.30   $0.36 
           
Basic Weighted Shares Outstanding   40,533,158    40,726,123 
Diluted Weighted Shares Outstanding   40,533,158    40,726,123 
           
Net Income  $12,064,991   $14,612,504 
Foreign currency translation adjustment   5,552,680    10,537,629 
Comprehensive Income  $17,617,671   $25,150,133 

 

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

 

F-4
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

 

                       Accumulated         
           Additional           Other         
   Common Stock   Paid-in   Statutory   Retained   Comprehensive   Treasury     
   Number   Amount   Capital   Reserves   Earnings   Income   Stock   Total 
                                 
Balance as of June 30, 2010   40,715,602   $40,715   $41,097,153   $12,629,151   $96,526,453   $19,531,932   $-   $169,825,404 
Stock-based compensation   30,000    30    119,393    -    -    -    -    119,423 
Provision of statutory reserves   -    -    -    3,032,888    (3,032,888)   -    -    - 
Net income for the year   -    -    -    -    14,612,504    -    -    14,612,504 
Foreign currency translation adjustment   -    -    -    -    -    10,537,629    -    10,537,629 
Balance as of June 30, 2011   40,745,602   $40,745   $41,216,546   $15,662,039   $108,106,069   $30,069,561   $-   $195,094,960 
Stock-based compensation   60,000    60    127,760    -         -    -    127,820 
Provision of statutory reserves   -    -    -    2,438,322    (2,438,322)   -    -    - 
Net income for the year   -    -    -    -    12,064,991    -    -    12,064,991 
Foreign currency translation adjustment   -    -    -    -    -    5,552,680    -    5,552,680 
Repurchase of common stock   -    -    -    -    -    -    (607,668)   (607,668)
Balance as of June 30, 2012   40,805,602   $40,805   $41,344,306   $18,100,361   $117,732,738   $35,622,241   $(607,668)  $212,232,783 

 

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

 

F-5
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

   For The Years Ended 
   June 30 
   2012   2011 
Cash Flows from Operating Activities:          
Net income  $12,064,991   $14,612,504 
Adjustments to reconcile net income to net cash provided by/(used in) operating activities          
Depreciation and amortization   8,623,056    7,684,071 
(Reversal)/provision for doubtful accounts   (30,366)   457,110 
Write downs of inventories   25,015    - 
Stock-based compensation   127,820    119,423 
Foreign currency exchange gain   (402,700)   (48,495)
Loss/(gain) on disposal of property, plant and equipment   36,422    (4,481)
Interest income from short-term investments carried at amortized cost   (97,412)   - 
Deferred income taxes   (335,604)   (16,086)
Changes in fair value of warrant liabilities   (352,168)   (607,331)
Changes in current assets and liabilities:          
Restricted cash   (16,778,737)   (20,899,568)
Trade accounts receivable   (3,392,490)   6,987,250 
Notes receivable   (301,319)   (88,423)
Other receivables and prepayments   (2,022,785)   (787,861)
Advances to suppliers, unrelated parties   15,660,580    (32,418,331)
Advances to suppliers, related parties   (2,051,343)   (13,399,681)
Inventories   (3,149,913)   (3,757,906)
Accounts payable   6,196,904    29,686,859 
Other payables and accrued expenses   3,999,210    (438,981)
Other payables, related parties   (604,544)   217,267 
Advances from customers   (4,045,719)   4,525,550 
Net Cash Provided by/(Used In) Operating Activities   13,168,898    (8,177,110)
           
Cash Flows from Investing Activities:          
Purchase of property, plant and equipment   (25,868,522)   (12,908,403)
Proceeds from disposal of property, plant and equipment   63,526    6,067 
Purchase of short-term investments   (4,722,996)   - 
Net Cash Used In Investing Activities   (30,527,992)   (12,902,336)
           
Cash Flows from Financing Activities:          
Proceeds from loans   155,351,324    149,159,704 
Payments of loans   (128,992,840)   (120,718,568)
Changes in restricted cash   (20,545,678)   - 
Payments on repurchase of common stock   (607,668)   - 
Net Cash Provided By Financing Activities   5,205,138    28,441,136 
           
Effect of Exchange Rate Changes on Cash   359,556    626,505 
           
Net Change in Cash and Cash Equivalents   (11,794,400)   7,988,195 
Cash and Cash Equivalents at Beginning of Year   21,324,931    13,336,736 
Cash and Cash Equivalents at End of Year  $9,530,531   $21,324,931 
           
Supplemental Non-Cash Information:          
Offset of notes payable to related parties against receivable from related parties (Note 9)  $10,437,344   $10,051,691 
Supplemental Cash Flow Information:          
Cash paid during the year for interest expense  $(12,809,907)  $(7,441,918)
Cash paid during the year for income tax  $(1,015,879)  $(2,118,597)

 

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

 

F-6
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1 - ORGANIZATION AND NATURE OF OPERATIONS

 

Sutor Technology Group Limited (“Sutor”) was incorporated on May 1, 1997 in the State of Nevada under the name of Bronze Marketing, Inc. and changed the name to Sutor Technology Group Limited effective March 6, 2007. Its principal activity is investment holding. The principal activities of its subsidiaries are described in the table below. Sutor together with its subsidiaries listed below are referred to as the “Company” hereinafter.

 

As of June 30, 2012, the Company’s subsidiaries included the following entities:

 

Name of subsidiary  

Date of

incorporation

 

Place of

incorporation

 

Percentage of

shareholding

  Principal activities
                 

Sutor Steel Technology Co., Ltd.

(“Sutor BVI”)

  Aug 15, 2006  

British Virgin

Islands

  100%   Investment holding
                 

Changshu Huaye Steel Strip Co., Ltd.

(“Changshu Huaye”)

  Aug 28, 2003   PRC   100%   Manufactures of hot-dip galvanized steel and pre-painted galvanized steel
                 

Jiangsu Cold-Rolled Technology Co., Ltd.

(“Jiangsu Cold-Rolled”)

  Aug 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”) (1)

  Apr 5, 2004   PRC   100%   Manufactures heavy steel pipe
                 

Sutor Technology Co., Ltd.

(“Sutor Technology”)

  Feb 24, 2010   PRC   100%   Trading of steel products

 

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

 

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation - The consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States (“US GAAP”).

 

Principles of Consolidation – The accompanying consolidated financial statements include the accounts and transactions of the Company for all years presented. All significant intercompany accounts and transactions have been eliminated in consolidation.

 

Reclassifications - Certain comparative figures have been reclassified to conform to the current year presentation.

 

F-7
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES - continued

 

Functional Currency and Translating Financial Statements - Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transaction. Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency using the applicable exchange rates at the balance sheet dates. The resulting exchange differences are recorded in the 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 Company's subsidiaries in the PRC 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 within the statement of changes in stockholders’ equity.

 

Translation of amounts from RMB into US$1 has been made at the following exchange rates for the respective years:

 

   June 30, 
2012
   June 30,
2011
 
Closing RMB : USD exchange rate at the year end   6.3143    6.4635 
Average RMB : USD exchange rate for the year   6.3519    6.6278 

 

The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into US$ at the rates used in translation.

 

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

 

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, 2012, 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-8
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES - continued

 

Inventories - Inventories are stated at the lower of cost or market. The cost of inventories is determined using first-in-first-out method, and includes expenditure incurred in acquiring the inventories and bringing them to their existing location and condition. In case of finished goods and work in progress, cost includes an appropriate share of production overhead based on normal operating capacity. The Company regularly reviews the cost of inventories against their estimated fair market value and records a lower of cost or market write-down for inventories that have cost in excess of estimated market value.

 

Property, Plant and Equipment – Property, plant and equipment are stated at cost and are depreciated using the straight-line method over the estimated useful lives of the assets as follows:

 

  Life
Buildings and plant 20 years
Machinery 10 years
Office and other equipment 10 years
Vehicles 5 years

 

Repair and maintenance costs are charged to expense as incurred, whereas the costs of betterments that extend the useful life of property, plant and equipment are capitalized as additions to the related assets. Retirements, sale and disposals of assets are recorded by removing the cost and accumulated depreciation with any resulting gain or loss reflected in the consolidated statements of operations.

 

Property, plant and equipment that are purchased or constructed which require a period of time before the assets are ready for their intended use are accounted for as construction-in-progress. Construction-in-progress is recorded at acquisition cost, including installation costs. Construction-in-progress is transferred to specific property, plant and equipment accounts and commences depreciation when these assets are ready for their intended use.

 

Interest costs are capitalized if they are incurred during the acquisition, construction or production of a qualifying asset and such costs could have been avoided if expenditures for these assets have not been made. Capitalization of interest costs commences when the activities to prepare the asset are in progress and expenditures and borrowing costs are incurred. Interest costs are capitalized until the assets are ready for their intended use.

 

Foreign invested enterprises and foreign enterprises running business in the PRC are generally able to receive a refund of the value-added tax paid on property, plant and equipment purchased and manufactured within the PRC. The Company recognizes refunds of value-added tax as a reduction of property, plant and equipment when the refunds are collected.

 

Intangible Assets - Acquisition costs of land use rights are capitalized and amortized using the straight-line method over their estimated useful lives.

 

Impairment of Long-lived Assets - The Company evaluates its long-lived assets or asset group, including intangible assets with finite lives, for impairment whenever events or changes in circumstances (such as a significant adverse change to market conditions that will impact the future use of the assets) indicate that the carrying amount of an asset or a group of long-lived assets may not be recoverable. When these events occur, the Company evaluates for impairment by comparing the carrying amount of the assets to future undiscounted net cash flows expected to result from the use of the assets and their eventual disposition. If the sum of the expected undiscounted cash flow is less than the carrying amount of the assets, the Company would recognize an impairment loss based on the excess of the carrying amount of the asset group over its fair value. Fair value is generally determined by discounting the cash flows expected to be generated by the assets, when the market prices are not readily available for the long-lived assets. No impairment charge was recognized for each of the two years ended June 30, 2012 and 2011.

 

F-9
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES - continued

 

Fair Values of Financial Instruments - The Company adopted Accounting Standards Codification (“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 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.

 

ASC 820-10 describes three main approaches to measuring the fair value of assets and liabilities: (1) market approach; (2) income approach and (3) cost approach. The market approach uses prices and other relevant information generated from market transactions that involve identical or comparable assets or liabilities. The income approach uses valuation techniques to convert future amounts to a single present value amount. The measurement is based on the value indicated by current market expectations about the future amount. The cost approach is based on the amount that would currently be required to replace an asset.

 

Financial instruments of the Company primarily comprise of cash and cash equivalents, restricted cash, trade accounts receivable, other receivables, loans, accounts payable, other payables and warrant liabilities. As of June 30, 2012 and 2011, carrying values of these financial instruments except warrant liabilities approximated their fair values because of their generally short maturities. 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.

 

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

 

   Balance as of June 30, 2012 
       Fair Value Measurements 
   Carrying Value   Level 1   Level 2   Level 3 
Short-term investments                    
- Fixed rate time deposits  $4,849,112   $4,849,112   $-   $- 

 

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

 

   Balance as of June 30, 2012 
       Fair Value Measurements 
   Carrying Value   Level 1   Level 2   Level 3 
                     
Warrant liabilities  $47,404   $-   $-   $47,404 

 

   Balance as of June 30, 2011 
       Fair Value Measurements 
   Carrying Value   Level 1   Level 2   Level 3 
                     
Warrant liabilities  $399,572   $-   $-   $399,572 

 

For a summary of changes in short-term investments for the years ended June 30, 2012 and 2011, please see Note 4.

 

For a summary of changes in warrant liabilities for the years ended June 30, 2012 and 2011, please see Note 11.

 

F-10
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES - continued

 

Statutory Reserves - In accordance with the PRC Regulations on Enterprises with Foreign Investment, an enterprise established in the PRC with foreign investment is required to provide for certain statutory reserves, namely (i) General Reserve Fund, (ii) Enterprise Expansion Fund and (iii) Staff Welfare and Bonus Fund, which are appropriated from net profit as reported in the enterprise’s PRC statutory accounts. A wholly owned foreign enterprise (“WOFE”) is required to allocate at least 10% of its annual after-tax profit to the General Reserve Fund until the balance of such fund has reached 50% of its respective registered capital. A non-wholly owned foreign invested enterprise is permitted to provide for the above allocation at the discretion of its board of directors. Appropriations to the Enterprise Expansion Fund and Staff Welfare and Bonus Fund are at the discretion of the board of directors for all foreign invested enterprises. The aforementioned reserves can only be used for specific purposes and are not distributable as cash dividends.

 

Accumulated Other Comprehensive Income - Accumulated other comprehensive income presented in the accompanying consolidated financial statements consists of foreign currency translation adjustments.

 

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

 

The Company sells some products to related parties, who in turn sell the product to various other unrelated party customers. The price, terms and conditions on the sales to related parties are the same as those to unrelated parties. Revenue is considered realized or realizable and earned when the related parties ship the products to unrelated party customers. A fee of 0.5% of the sales is paid to the related parties for handling the product. Handling fees were $83,739 and $422,119 for the years ended June 30, 2012 and 2011 respectively and 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.

 

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.

 

Share 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.

 

F-11
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES - continued

 

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 years ended June 30, 2012 and 2011.

 

If the amount of the Company’s taxable income or income tax liability is a determinant of the amount of a grant, the grant is treated as a reduction of the income tax provision in the year the grant is realized.

 

Earnings Per Share – Earnings per share are calculated in accordance with ASC subtopic 260-10 (“ASC 260-10”), Earnings Per Share: Overall. Basic earnings per share is computed by dividing net income attributable to holders of ordinary shares by the weighted average number of ordinary shares outstanding during the period. Diluted earnings per share are computed using the weighted average number of shares and dilutive equivalent shares outstanding during the period. Dilutive equivalent shares consist of ordinary shares issuable upon the exercise of stock options granted, with an exercise price less than the average fair market value for such period, using the treasury stock method. Dilutive equivalent shares are excluded from the computation of diluted earnings per share if their effects would be anti-dilutive.

 

Share Repurchase Program – Pursuant to a Board of Directors’ resolution on August 29, 2011, the Company’s management is authorized to repurchase up to $5 million of the Company’s outstanding common stock over the next year in the open market, in privately negotiated transactions or as otherwise may be determined by the Chief Executive Offer and the Chief Financial Officer (“Authorized Officers”) and will be funded from available working capital. The timing and extent of any purchases depend upon the trading price of the Company’s common stock, general business and market conditions and other investment opportunities. The Company accounted for those shares repurchase as Treasury Stock at cost in accordance to ASC Subtopic 505-30 (“ASC 505-30”), Treasury Stock and is shown separately in the stockholders’ equity as the Company has not yet decided on the ultimate disposition of those repurchased stocks. The treasury stock may be retired or used by the Company to finance or execute acquisitions or other arrangements. As of June 30, 2012, the Company had repurchased 544,477 shares of its common stock at a total cost of $607,668.

 

Treasury stock reissuance – Shares of common stock repurchased by the Company that are not retired are recorded at cost as treasury stock and result in a reduction of stockholders' equity in the Company's consolidated balance sheets. From time to time, treasury shares may be reissued as part of the Company's stock-based compensation programs. When shares are reissued, the Company uses the weighted average cost method for determining cost. If the issuance price is higher than the cost, the excess of the issuance price over cost is credited to additional paid-in capital (“APIC”). If the issuance price is lower than the cost, the difference is first charged against any credit balance in APIC from treasury stock and the balance is charged to retained earnings. During the years ended June 30, 2012 and June 30, 2011, the Company did not reissue shares from treasury stock.

 

F-12
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES - continued

 

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

 

In June 2011, the FASB issued Accounting Standards Update 2011-05 (ASU 2011-05), “Presentation of Comprehensive Income.” ASU 2011-05 eliminates the option to report other comprehensive income and its components in the statement of changes in shareholders’ equity and requires an entity to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement or in two separate but consecutive statements. This pronouncement is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. In December 2011, the FASB issued ASU 2011- 12 (ASU 2011-12), Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. ASU 2011-12 defers the requirement in ASU 2011-05 that entities present reclassification adjustments for each component of accumulated other comprehensive income (“AOCI”) in both net income and other comprehensive income on the face of the financial statements. ASU 2011-12 requires entities to continue to present amounts reclassified out of AOCI on the face of the financial statements or disclose those amounts in the notes to the financial statements. The effective date of ASU 2011-12 is consistent with ASU 2011-05, which is effective for fiscal years and interim periods beginning after December 15, 2011 for public entities. The provisions of ASU 2011-05 and ASU 2011-12 are not expected to have a material impact on the presentation of the Company’s consolidated financial statements.

 

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

 

F-13
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 3 – REVISION OF PRIOR YEAR FINANCIAL STATEMENTS

 

During the year ended June 30, 2012, the Company identified an error related to the classification of the warrants to purchase up to 685,000 shares of common stock (with the fair value of $1.3 million at the issuance date of March 10, 2010). Previously, the Warrants were reflected as a component of equity as opposed to liabilities on the consolidated balance sheets and the consolidated statements of operations did not include the subsequent non-cash changes in estimated fair value of the Warrants. However, since the Company is obliged to deliver registered shares to the warrant holders upon exercise, the warrants should be classified as liabilities in accordance with Accounting Standards Codification 815 (“ASC 815”) because there are further registration and prospectus delivery requirements that are outside of the control of the Company. The Company assessed the materiality of this error on prior periods’ financial statements in accordance with the SEC’s Staff Accounting Bulletin No. 99 (“SAB 99”), and concluded that the error was not material to any of its prior annual or interim financial statements. As a result, the Company elected to revise its previously issued consolidated financial statements the next time they are filed as permitted in SEC’s Staff Accounting Bulletin No.108 (“SAB 108”) regarding immaterial revisions. As each subsequent filing is made in the future, the previous period consolidated financial statements affected by the errors will be revised. The Company has revised the consolidated balance sheet as of June 30, 2011 and the consolidated statements of operations for the year ended June 30, 2011 included herein to reflect the correct balances. The opening additional paid-in capital and retained earnings as of June 30, 2010 also have been corrected as shown in the consolidated statements of stockholders’ equity to reflect the adjustments made to the warrants and changes in estimated fair value. The impact of correcting this error on net income as reported for the year ended June 30, 2011 was an increase of $607,331.

 

Set out below are the line items within the consolidated balance sheet as of June 30, 2011 and consolidated statement of operations for the year then ended have been affected by the revisions. The revisions had no impact on the Company’s total cash flows from operating, investing or financing activities.

 

   As of June 30, 2011 
   Previously
reported
   Adjustments   Revised 
Consolidated Balance Sheet               
                
Warrant liabilities  $-   $399,572   $399,572 
Total Current Liabilities   168,340,269    399,572    168,739,841 
Total Liabilities   191,967,169    399,572    192,366,741 
Additional paid-in capital   42,584,974    (1,368,428)   41,216,546 
Retained earnings   107,137,213    968,856    108,106,069 
Total Stockholders' Equity  $195,494,532   $(399,572)  $195,094,960 

 

   For the year ended June 30, 2011 
   Previously
reported
   Adjustments   Revised 
Consolidated Statement of Operations               
                
Changes in fair value of warrant liabilities  $-   $607,331   $607,331 
Total Other Incomes/(Expenses)   (7,699,181)   607,331    (7,091,850)
Income Before Taxes   17,434,680    607,331    18,042,011 
Net Income  $14,005,173   $607,331   $14,612,504 
                
Basic Earnings per Share  $0.34   $0.02   $0.36 
Diluted Earnings per Share  $0.34   $0.02   $0.36 
                
Comprehensive Income  $24,542,802   $607,331   $25,150,133 

 

F-14
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 4 – SHORT-TERM INVESTMENTS

 

Short-term investments as of June 30, 2012 consisted of the following:

 

   Carrying   Unrealized   Estimated 
   Value   Gains/(Losses)   Fair Value 
             
Held-to-maturity securities               
- Fixed rate time deposits  $4,849,112   $-   $4,849,112 

 

The Company recorded interest income related to its short-term investments amounted to $97,992 for the year ended June 30, 2012 in the consolidated statements of operations. No interested income was recorded for the year ended June 30, 2011, as no such investment was held.

 

The following table summarizes the movement of short-term investments for the years ended June 30, 2012 and 2011:

 

   Amount 
Balance as of June 30, 2011   - 
Payment for fixed rate time deposits   4,722,996 
Interest income recognized during the year   97,412 
Foreign currency translation difference   28,704 
Balance as of June 30, 2012  $4,849,112 

 

NOTE 5 – INVENTORIES

 

Inventories consisted of the following:

 

   June 30,   June 30, 
   2012   2011 
Raw materials  $21,486,439   $18,991,085 
Finished goods   29,061,437    27,294,440 
    50,547,876    46,285,525 
Less: allowance for obsolescence   (115,597)   (88,346)
Inventories, net  $50,432,279   $46,197,179 

 

NOTE 6 – PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment as of June 30, 2012 and 2011 consisted of the following:

 

   June 30,   June 30, 
   2012   2011 
Buildings and plant  $43,402,250   $40,388,929 
Machinery   71,825,535    69,744,627 
Office and other equipment   1,383,305    1,252,653 
Vehicles   488,268    434,288 
    117,099,358    111,820,497 
Less: accumulated depreciation   (44,421,165)   (35,081,522)
    72,678,193    76,738,975 
Construction in progress   4,553,080    2,364,156 
Property, Plant and Equipment, net  $77,231,273   $79,103,131 

 

As of June 30, 2012 and 2011, certain of the Company’s property, plant and equipment amounted to approximately $45 million and $39 million, respectively, was pledged to banks to secure the loan granted to the Company.

 

Depreciation expense for the years ended June 30, 2012 and 2011 was $8,549,938 and $7,613,997, respectively.

 

F-15
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 7 INTANGIBLE ASSETS

 

Intangible assets as of June 30, 2012 and 2011 consisted of the following:

 

   June 30,   June 30, 
   2012   2011 
Cost  $3,677,663   $3,592,769 
Less: Accumulated amortization   (594,786)   (509,200)
Intangible Assets, net  $3,082,877   $3,083,569 

 

The Company’s intangible assets represented several land use rights, which are amortized using the straight-line method over the lease term of 50 years. Amortization expense for the years ended June 30, 2012 and 2011 was $73,118 and $70,074, respectively.

 

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

 

ESTIMATED AMORTIZATION EXPENSE     
For the year ending June 30, 2013  $73,553 
For the year ending June 30, 2014   73,553 
For the year ending June 30, 2015   73,553 
For the year ending June 30, 2016   73,553 
For the year ending June 30, 2017   73,553 
For the year ending June 30, 2018 and thereafter   2,715,112 
Total  $3,082,877 

 

NOTE 8 LOANS

 

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

 

Short-term loans as of June 30, 2012 comprised of the following:

 

        June 30, 
    Maturity Date   2012 
Bank loan at 5.90% interest, guaranteed by related party   7/21/2012    7,443,422 
Bank loan at 2.55% interest, secured by cash deposit   7/29/2012    10,000,000 
Bank loan at 6.89% interest, guaranteed by related party   8/16/2012    6,334,827 
Bank loan at 7.22% interest, guaranteed by related party   8/23/2012    1,583,707 
Bank loan at 6.89% interest, guaranteed by related party   9/5/2012    4,751,120 
Bank loan at 5.97% interest, secured by property, plant and equipment   9/27/2012    6,334,827 
Bank loan at 5.97% interest, secured by property, plant and equipment   10/24/2012    2,533,931 
Bank loan at 5.97% interest, secured by property, plant and equipment   11/9/2012    7,918,534 
Bank loan at 7.87% interest, guaranteed by related party   11/14/2012    3,167,414 
Bank loan at 6.56% interest, secured by property, plant and equipment   11/16/2012    6,334,827 
Bank loan at 5.97% interest, secured by property, plant and equipment   11/20/2012    5,384,603 
Bank loan at 5.97% interest, secured by property, plant and equipment   11/27/2012    3,167,414 
Bank loan at 5.97% interest, secured by property, plant and equipment   12/11/2012    10,294,093 
Bank loan at 4.38% interest, secured by cash deposit   12/13/2012    9,500,000 
Bank loan at 6.56% interest, secured by property, plant and equipment   12/21/2012    3,959,267 
Bank loan at 6.56% interest, unsecured   12/26/2012    1,583,707 
Bank loan at 6.10% interest, secured by property, plant and equipment   7/30/2012    888,460 
Bank loan at 6.10% interest, unsecured   8/9/2012    3,167,414 
Bank loan at 6.10% interest, secured by notes receivable   8/14/2012    4,814,469 
Bank loan at 6.04% interest, secured by property, plant and equipment   1/5/2013    2,375,560 
Bank loan at 6.56% interest, secured by property, plant and equipment   4/26/2013    3,167,414 
Bank loan at 6.56% interest, unsecured   4/26/2013    633,483 
Bank loan at 6.56% interest, unsecured   4/26/2013    2,533,931 
Bank loan at 4.07% interest, secured by accounts receivable   8/3/2012    127,000 
Bank loan at 6.56% interest, secured by property, plant and equipment   5/28/2013    3,167,414 
Total Short-term loans      $111,166,838 

 

F-16
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 8 LOANS - continued

 

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

 

        June 30, 
    Maturity Date   2011 
Bank loan at 4.78% interest, guaranteed by related party   7/8/2011    3,867,873 
Bank loan at 4.78% interest, guaranteed by related party   7/28/2011    7,271,602 
Bank loan at 2.85% interest, guaranteed by related party   8/17/2011    2,155,000 
Bank loan at 2.85% interest, guaranteed by related party   8/18/2011    2,130,000 
Bank loan at 4.78% interest, guaranteed by related party   8/20/2011    1,547,149 
Bank loan at 4.78% interest, guaranteed by related party   8/22/2011    6,188,598 
Bank loan at 5.85% interest, guaranteed by related party   8/30/2011    541,502 
Bank loan at 4.78% interest, guaranteed by related party   9/6/2011    6,188,598 
Bank loan at 4.78% interest, secured by property, plant and equipment   9/30/2011    7,735,747 
Bank loan at 4.92% interest, guaranteed by related party   10/13/2011    302,197 
Bank loan at 5.81% interest, guaranteed by related party   10/18/2011    3,094,299 
Bank loan at 0.43% interest, guaranteed by related party   10/21/2011    556,000 
Bank loan at 5.00% interest, secured by property, plant and equipment   10/24/2011    2,475,439 
Bank loan at 5.27% interest, guaranteed by related party   10/26/2011    3,094,299 
Bank loan at 5.00% interest, guaranteed by related party   11/10/2011    10,830,045 
Bank loan at 6.31% interest, guaranteed by related party   11/15/2011    3,094,299 
Bank loan at 5.00% interest, guaranteed by related party   11/17/2011    6,188,598 
Loan at 6.00% interest, unsecured (1)   11/20/2011    2,859,995 
Bank loan at 5.27% interest, guaranteed by related party   11/24/2011    5,260,308 
Bank loan at 5.27% interest, guaranteed by related party   12/15/2011    10,056,471 
Bank loan at 5.91% interest, guaranteed by related party   12/26/2011    1,547,149 
Bank loan at 5.23% interest, guaranteed by related party   1/20/2012    2,320,724 
Bank loan at 6.06% interest, guaranteed by related party   2/29/2012    3,094,299 
Bank loan at 6.31% interest, secured by property, plant and equipment   5/19/2012    3,094,299 
Total Short-term loans      $95,494,490 

 

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

        June 30,   June 30, 
    Maturity Date   2012   2011 
Bank loan at 3.99% interest, secured by cash deposit   2/21/2013    17,124,500    - 
Bank loan at 3.97% interest, secured by cash deposit   2/21/2013    6,502,400    - 
Bank loan at 7.65% interest, unsecured   Repaid quarterly within one year    4,136,075    - 
Total Long-term loans, current portion      $27,762,975   $- 

 

An amount of $27,762,975 has been reclassified from long-term loans, non-current to long-term loans, current as of June 30, 2012 to reflect amounts will be due and paid during the year ending June 30, 2013.

 

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

        June 30,   June 30, 
    Maturity Date   2012   2011 
Long-term bank loan at 3.99% interest, secured by cash deposit   2/21/2013    -    17,124,500 
Long-term bank loan at 3.97% interest, secured by cash deposit   2/21/2013    -    6,502,400 
Long-term loan at 6.00% interest, unsecured (1)   12/31/2013    2,859,995    - 
Long-term bank loan at 7.65% interest, unsecured   Repaid quarterly within two to three years    5,630,777    - 
Total Long-term loans      $8,490,772   $23,626,900 

 

F-17
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 8 LOANS - continued

 

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

 

The weighted average interest rate for the short-term and long term loans outstanding as of June 30, 2012 and 2011 were 5.22% and 4.87%, respectively.

 

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. Management believes that the Company had complied with such financial covenants as of June 30, 2012, and will continue to comply with them.

 

NOTE 9 – RELATED PARTY TRANSACTIONS

 

Sales to and Purchases from Related Parties

The Company sells its products to and buys raw materials from a number of companies which are ultimately owned or controlled by the same party (“Principal Stockholder”) as the Company. Revenues related to these transactions are shown separately in the accompanying consolidated statements of operations. For the years ended June 30, 2012 and 2011, purchases from these related parties totaled of $168,095,827 and $237,261,815, respectively.

 

Due from Related Parties

The amounts due to related parties are non-interest bearing and were incurred in the normal course of business. Receivables from, advanced purchase deposits to, loans, payables to and advanced sales deposits from related parties have been netted due to the right of offset. As of June 30, 2012 and 2011, the net amounts due from related parties were $121,884,833 and $116,772,842, respectively. The amounts charged for products to the Company by the related parties are under the same pricing, terms and conditions as those charged to third parties, and are due upon receipt. It is common for the Company with its related parties to accommodate an extension of 90 to 180 days. Amounts receivable from related parties are also due upon delivery. Advances to suppliers which are related parties, are relieved once the goods are received.

 

Letters of Credit Held by Related Parties

As of June 30, 2012 and 2011, the Company had letters of credit totaling $82,669,496 and $38,972,693, respectively, in the form of banker’s acceptance notes that are held by related parties in connection with purchases from related parties. The banker’s acceptance notes carry an interest-free rate, can be presented to the respective banks in 90 to 180 days from the dates they were written, are secured by cash on deposit with the respective banks and are guaranteed by related parties. These letters of credit were included in accounts payable, related parties and have been netted off with the advances to suppliers, related parties due to the right of offset.

 

Loans from Related Parties

During the years ended June 30, 2012 and 2011, the Company repaid nil and $600,000 loans from related parties. As of June 30, 2012 and 2011, the Company had loans from related parties totaling $8,815,502 and $8,800,879, respectively; and accrued interest totaling $1,621,842 and $1,250,812, respectively. The loans from related parties and accrued interest have been recorded as a reduction of advances to suppliers, related parties in the accompanying consolidated balance sheet as of June 30, 2012 and 2011.

 

Rental Expenses Incurred in respect of Related Party Lease Arrangement

The Company entered into agreements with its related parties to lease buildings from related parties, and the Company pays the related parties rental fees at a pre-determined rate. For the years ended June 30, 2012 and 2011, the rental fees incurred in respect of the related party lease arrangements amounted to $151,136 and $356,948, respectively.

 

F-18
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 10 – INCOME TAXES

 

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

 

Sutor BVI is a tax-exempt company incorporated in British Virgin Islands.

 

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

 

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

 

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

 

Income tax payable as of June 30, 2012 and 2011 were $2,998,368 and $2,645,198, respectively, which were presented as a component of other payables and accrued expenses in the accompanying consolidated balance sheets.

 

The reconciliation of tax computed by applying the statutory income tax rate applicable to PRC operations to income tax expense is as following:

 

   For The Years Ended 
   June 30, 
   2012   2011 
Income before tax  $13,063,300   $18,042,011 
Income tax calculated at statutory rates   3,265,825    4,510,503 
Benefit of favorable rates   (904,633)   (1,823,873)
Tax refund due to High-New-Tech Enterprise Certificate   (337,031)   - 
Tax refund due to purchase of Domestic Equipments   (1,137,457)   - 
Tax effect of parent   (49,650)   1,754,539 
Changes in valuation allowance   521,173    (1,009,453)
Others   (359,918)   (2,209)
Total Income tax expense  $998,309   $3,429,507 

 

Deferred tax assets as of June 30, 2012 and 2011 comprised of the following:

 

   June 30,   June 30, 
   2012   2011 
Net tax loss carry forward  $811,951   $72,752 
Stock-based compensation   96,528    53,069 
Allowance for doubtful trade accounts receivable   309,792    211,945 
Allowance for doubtful other receivables   82,895    111,158 
Allowance for doubtful advances to suppliers   74,965    66,656 
Allowance for inventory obsolescence   28,899    22,086 
Less: Valuation allowance   (695,342)   (174,169)
Total Deferred tax assets  $709,688   $363,497 

 

As of June 30, 2012, the Company has a tax loss for PRC enterprise income tax purposes of $1,848,626 which are available to offset future taxable income, if any, through 2017; the Company has a tax loss for United States federal income tax purposes of $1,028,809 which are available to carry back two years or offset future taxable income, if any, through 2032.

 

F-19
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 10 – INCOME TAXES - continued

 

The income tax expense for the years ended June 30, 2012 and 2011 comprised of the following:

 

   For The Years Ended 
   June 30, 
   2012   2011 
Current  $1,333,913   $3,445,593 
Deferred   (335,604)   (16,086)
Total Income tax expense  $998,309   $3,429,507 

 

NOTE 11 – 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:

 

   March 10, 2010   June 30, 2010   June 30, 2011   June 30, 2012 
   Issuance date   Year end date   Year end date   Year end date 
Warrants indexed to common stock   685,000    685,000    685,000    685,000 
Trading market price  $2.99   $1.99   $1.26   $0.92 
Exercise price  $3.76   $3.76   $3.76   $3.76 
Estimated Term (Year)   5.00    4.67    3.67    2.67 
Expected volatility   90.00%   118.37%   98.43%   62.64%
Risk-free rate   2.39%   1.79%   1.76    0.72%
Dividend yield rates   0.00%   0.00%   0.00%   0.00%
Fair value of warrants  $1,368,428   $1,006,903   $399,572   $47,404 

 

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 changes in estimated fair value for the years ended June 30, 2012 and 2011:

 

   Estimated Fair Value 
Balance as of June 30, 2010  $1,006,903 
Changes in fair value   (607,331)
Balance as of June 30, 2011   399,572 
Changes in fair value   (352,168)
Balance as of June 30, 2012  $47,404 

 

NOTE 12 – 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.

 

F-20
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 12 – STOCK-BASED COMPENSATION - continued

 

Non-Vested Stock Grants

 

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

 

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

 

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

 

Stock-based compensation expense for the years ended June 30, 2012 and 2011 was $61,965 and $54,863, respectively. The remaining $47,385 stock-based compensation will be expensed over the remainder of the one year service period. The value of the non-vested stock at June 30, 2012 is $55,200.

 

Options

 

Stock Options granted to key employees

 

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

 

Stock Options granted to a director

 

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

 

Stock-based compensation expense for the years ended June 30, 2012 and 2011 on the stock options were $65,855 and $64,560, respectively.  The remaining $52,316 stock-based compensation expenses will be recorded over a weighted average service period of 0.8 year.

 

The following table summarizes the options activity for the years ended June 30, 2012 and 2011:

 

   Options   Weighted-average
exercise price
   Weighted average remaining
contractual life (years)
   Aggregate Intrinsic
Value
 
Outstanding as of June 30, 2010   100,000   $2.71    3.83   $- 
Issued   5,000    2.71    4.65    - 
Exercised   -    -    -    - 
Expired   -    -    -    - 
Outstanding as of June 30, 2011   105,000    2.71    3.87    - 
Issued   -    -    -    - 
Exercised   -    -    -    - 
Expired   -    -    -    - 
Outstanding as of June 30, 2012   105,000   $2.71    2.86   $- 

 

F-21
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Total intrinsic value of stock options outstanding as of June 30, 2012 and 2011 was nil.

 

NOTE 13 – EARNINGS PER SHARE

 

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

 

   For The Years Ended 
   June 30, 
   2012   2011 
         
Net income attributable to the common stockholders  $12,064,991   $14,612,504 
           
Basic weighted-average common shares outstanding   40,533,158    40,726,123 
Dilutive effect of warrants and options   -    - 
Diluted weighted-average common shares outstanding   40,533,158    40,726,123 
           
Earnings per share:          
Basic  $0.30   $0.36 
Diluted  $0.30   $0.36 

 

Warrants and options to purchase 685,000, and 105,000 shares of common stock, respectively were outstanding during the year ended June 30, 2012, but were excluded from the computation of diluted earnings per share as their effect would have been anti-dilutive because the exercise prices of the warrants and options were larger than the average share price during the year.

 

NOTE 14 - COMMITMENTS AND CONTINGENCIES

 

Operating lease commitments - As of June 30, 2012, the Company has future minimum lease payments under non-cancelable operating leases in relation to office premises consisting of the following:

 

   Lease Payment 
For the year ending June 30, 2013   152,036 
For the year ending June 30, 2014   152,036 
For the year ending June 30, 2015   12,670 
Total  $316,742 

  

Capital commitments – The Company entered into agreements with suppliers to purchase property, plant and equipment. As of June 30, 2012 and 2011, the Company had purchase obligations totaled $8,153,319 and $324,762, respectively.


Indemnification Obligations – The Company entered into agreements whereby its directors are indemnified for certain events or occurrences while the director is, or was, serving at the Company's request in such capacity. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has a directors' liability insurance policy that reduces its exposure and enables the Company to recover a portion of future amounts paid. As a result of the Company's insurance policy coverage, the Company believes the estimated fair value of these indemnification agreements is minimal. Accordingly, no liabilities have been recorded for these agreements as of June 30, 2012.

 

F-22
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 15 – SIGNIFICANT CONCENTRATIONS

 

Concentration of credit risk

 

Assets that potentially subject the Company to significant concentrations of credit risk consist primarily of cash and cash equivalents, restricted cash, trade accounts receivable and advances to suppliers. The Company performs ongoing credit evaluations with respect to the financial condition of its debtors, but does not require collateral. As of June 30, 2012 and 2011, 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, 28.4% and 38.4% of the Company’s revenue was derived from Shanghai Huaye and its subsidiaries for the years ended June 30, 2012 and 2011, 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 36.3% and 66.0% of the Company’s total purchases for the years ended June 30, 2012 and 2011, 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-23
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 16 – SEGMENT INFORMATION

 

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

 

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

 

Certain segment information is presented below:

 

As of June 30, 2012 and for the
year then ended
  Changshu
Huaye
   Jiangsu
Cold-Rolled
   Ningbo
Zhehua
   Sutor
Technology
   Inter-Segment and
Reconciling Items
   Total 
                         
Revenue from unrelated parties  $136,717,361   $173,920,159   $42,259,852   $7,360,539   $15,689,919   $375,947,830 
Revenue from related parties   18,142,548    137,386,793    146,552    -    -    155,675,893 
Revenue from other operating segments   44,951,540    92,509,764    -    -    (137,461,304)   - 
Total operating expenses   10,414,725    2,668,532    3,467,917    726,112    739,987    18,017,273 
Interest income   1,507,134    1,174,303    149,698    622    41    2,831,798 
Interest expense   2,682,449    8,762,409    360,824    -    1,511,592    13,317,274 
Depreciation and amortization expense   2,322,866    4,843,075    928,189    528,926    -    8,623,056 
Income tax expense   (128,032)   1,167,647    (152,861)   -    111,555    998,309 
Net segment profit/(loss)   1,605,687    12,191,611    (401,965)   (694,061)   (636,281)   12,064,991 
Capital expenditures   2,002,863    17,279,316    123,283    355,261    -    19,760,723 
Segment assets   227,683,067    326,710,440    29,900,694    33,556,064    (184,325,000)   433,525,265 

 

As of June 30, 2011 and for the
year then ended
  Changshu
Huaye
   Jiangsu
Cold-Rolled
   Ningbo
Zhehua
   Sutor
Technology
   Inter-Segment and
Reconciling Items
   Total 
                         
Revenue from unrelated parties  $98,489,636   $108,059,017   $31,319,789   $-   $28,258,155   $266,126,597 
Revenue from related parties   59,414,139    105,950,493    205,289    -    -    165,569,921 
Revenue from other operating segments   27,399,806    125,831,131    -    -    (153,230,937)   - 
Total operating expenses   8,855,792    1,945,438    3,600,711    264,759    650,749    15,317,449 
Interest income   434,422    405,367    61,722    -    -    901,511 
Interest expense   1,000,930    6,255,069    198,635    -    516,495    7,971,129 
Depreciation and amortization expense   2,177,963    4,634,889    871,219    -    -    7,684,071 
Income tax expense   1,032,319    1,182,091    4,845    -    1,210,252    3,429,507 
Net segment profit/(loss)   5,436,158    8,212,092    302,836    (264,759)   926,177    14,612,504 
Capital expenditures   174,031    1,664,760    67,232    -    -    1,906,023 
Segment assets   215,704,232    302,019,904    32,944,913    39,162,754    (202,370,102)   387,461,701 

 

F-24
 

 

SUTOR TECHNOLOGY GROUP LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 17 – GEOGRAPHIC INFORMATION

 

The following schedule summarizes the sources of the Company’s revenue by geographic regions for the years ended June 30, 2012 and 2011:

 

   For the Years Ended June 30, 
Geographic Area  2012   2011 
PRC  $471,556,992   $369,506,388 
Other Countries   60,066,731    62,190,130 
Total  $531,623,723   $431,696,518 

 

NOTE 18 – SUBSEQUENT EVENTS

 

On June 5, 2012, Jiangsu Cold-Rolled, one of the Company’s subsidiaries, entered into an investment agreement with two unrelated party companies. Under this agreement, Jiangsu Cold-Rolled and the other two companies would jointly invest in a newly established company (the “Joint Venture Company”). The Joint Venture Company would have a registered capital of RMB 100 million, of which Jiangsu Cold-Rolled would contribute RMB 39 million (39%) and the other two companies would contribute RMB 51 million (51%) and RMB 10 million (10%) respectively. After the investment, Jiangsu Cold-Rolled would have significant influence on the Joint Venture Company. On July 27, 2012, Jiangsu Cold-Rolled made the payment of RMB 39 million to the Joint Venture Company. As of August 1, 2012, the registered capital of the Joint Venture Company had been fully paid in accordance with the investment agreement mentioned above. The Joint Venture Company obtained business license and was formally established on August 10, 2012 with operation period of 20 years and named China Railway Materials Suzhou Company Limited (“CRM Suzhou”).

 

F-25
 

 

SCHEDULE I

 

Sutor Technology Group Limited (parent only) unconsolidated financial statements as of and for the years ended June 30, 2012 and 2011

 

SUTOR TECHNOLOGY GROUP LIMITED

(Unconsolidated – based on the parent company)

Condensed Balance Sheets

 

   June 30,   June 30, 
   2012   2011 
           
ASSETS          
Current Assets:          
Cash and cash equivalents  $58,096   $58,163 
Other receivables   101,973    - 
Other receivables, related parties   -    322,722 
Total Current Assets   160,069    380,885 
           
Investments in Subsidiaries   238,493,233    219,959,535 
TOTAL ASSETS  $238,653,302   $220,340,420 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY          
Current Liabilities:          
Long-term loans, current portion  $23,626,900   $- 
Other payables and accrued expenses   1,330,543    1,218,988 
Other payables, related parties   1,415,672    - 
Warrant liabilities   47,404    399,572 
Total Current Liabilities   26,420,519    1,618,560 
           
Long-Term Loans   -    23,626,900 
Total Liabilities   26,420,519    25,245,460 
           
Stockholders' Equity          
Common stock   40,805    40,745 
Additional paid-in capital   76,966,547    71,286,107 
Retained earnings   135,833,099    123,768,108 
Less: Treasury stock, at cost   (607,668)   - 
Total Stockholders' Equity   212,232,783    195,094,960 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY  $238,653,302   $220,340,420 

 

S-1
 

 

SUTOR TECHNOLOGY GROUP LIMITED

(Unconsolidated – based on the parent company)

Condensed Statements of Operations

 

   For The Years Ended 
   June 30 
   2012   2011 
         
Operating Expenses:          
General and administrative expenses  $(138,180)  $(79,101)
Loss from Operations   (138,180)   (79,101)
           
Other Incomes/(Expenses):          
Investment income   12,981,008    15,404,185 
Interest income   42    36 
Interest expense   (1,018,492)   (109,695)
Changes in fair value of warrant liabilities   352,168    607,331 
Total Other Income/(Expense)   12,314,726    15,901,857 
           
Income Before Taxes   12,176,546    15,822,756 
Income tax expense   (111,555)   (1,210,252)
Net Income  $12,064,991   $14,612,504 

 

S-2
 

 

SUTOR TECHNOLOGY GROUP LIMITED

(Unconsolidated – based on the parent company)

Condensed Statements of Cash Flows

 

   For The Years Ended 
   June 30 
   2012   2011 
         
Net Cash Used In Operating Activities   (138,180)   (79,101)
           
Net Cash Used In Investing Activities   (10)   (23,499,990)
           
Net Cash Provided By Financing Activities   138,123    23,636,875 
           
Net Change in Cash and Cash Equivalents   (67)   57,784 
Cash and Cash Equivalents at Beginning of Year   58,163    380 
Cash and Cash Equivalents at End of Year  $58,096   $58,163 

 

S-3
 

 

SUTOR TECHNOLOGY GROUP LIMITED

(Unconsolidated – based on the parent company)

Notes to the condensed financial statements

 

Note 1 – Basis of presentation

 

The accompanying condensed financial statements reflect the financial position, results of operations and cash flows of Sutor Technology Group Limited (“Sutor”) on a separate, parent company basis. All subsidiaries of Sutor are reflected as investments in subsidiaries accounted for using the equity method. For accounting policies and other information, see the Notes to Consolidated Financial Statements included elsewhere herein.

 

Note 2 – Other payables and accrued expenses

 

Other payables and accrued expenses as of June 30, 2012 and 2011 comprised of the following:

 

   June 30,   June 30, 
   2012   2011 
Income tax payable  $1,321,807   $1,210,252 
Accrued expenses   8,736    8,736 
Total Other payables and accrued expenses  $1,330,543   $1,218,988 

 

Note 3 – Loans

 

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

 

     June 30,   June 30, 
  Maturity Date   2012   2011 
Bank loan at 3.99% interest, secured by cash deposit   2/21/2013    17,124,500    - 
Bank loan at 3.97% interest, secured by cash deposit   2/21/2013    6,502,400    - 
Total Long-term loans, current portion      $23,626,900   $- 

 

An amount of $23,626,900 has been reclassified from long-term loans, non-current to long-term loans, current as of June 30, 2012 to reflect amounts will be due and paid during the year ending June 30, 2013.

 

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

 

     June 30,   June 30, 
  Maturity Date   2012   2011 
Long-term bank loan at 3.99% interest, secured by cash deposit   2/21/2013    -    17,124,500 
Long-term bank loan at 3.97% interest, secured by cash deposit   2/21/2013    -    6,502,400 
Total Long-term loans      $-   $23,626,900 

 

Note 4 –Related party transactions and balances

 

During the year ended June 30, 2011, Sutor made advances to its subsidiary amounted to $322,722.

 

During the year ended June 30, 2012, Sutor repaid the advances received during the year ended June 30, 2011. In addition, during the same year, a subsidiary of Sutor made advances to Sutor amounted to $1,415,672.

 

As of June 30, 2012 and 2011, the amount due from related parties was nil and $322,722, respectively; the amount due to related parties was $1,415,672 and nil, respectively. All balances with related parties were unsecured, non-interesting bearing and repayable on demand.

 

S-4
 

 

Note 5 – Income taxes

 

As of June 30, 2012, Sutor has a tax loss for United States federal income tax purposes of $1,028,809 which are available to carry back two years or offset future taxable income, if any, through 2032.

 

S-5
 

 

EXHIBIT INDEX

 

Exhibit No.   Description
     
1.1   Placement Agency Agreement, dated as of March 4, 2010, by and among the registrant and Roth Capital Partners, LLC.[Incorporated by reference to Exhibit 1.1 to the registrant’s current report Form 8-K filed on March 8, 2010]
     
3.1   Articles of Incorporation of the registrant as filed with the Secretary of State of Nevada, as amended to date. [incorporated by reference to Exhibit 3.1 to the registrant’s annual report on Form 10K-SB filed on March 30, 2007]
     
3.2   Amended and Restated Bylaws of the registrant. [Incorporated by reference to Exhibit 3.2 to the registrant’s registration statement on Form SB-2 filed on July 21, 1999]
     
4.1   Sutor Technology Group Limited 2009 Equity Incentive Plan [Incorporated by reference to Exhibit B to the registrant’s proxy statement dated May 13, 2009 relating to the registrant’s 2009 Annual Meeting of Shareholders]