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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 10-K

 

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

 

For the Fiscal Year Ended December 31, 2014

OR

 

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

 

Commission file number: 001-33717

 

General Steel Holdings, Inc.

(Exact Name of Registrant as Specified in its Charter)

 

Nevada 41-2079252
(State of Incorporation) (I.R.S. Employer
  Identification Number)

 

Level 21, Tower B, Jiaming Center

No. 27 Dong San Huan North Road

Chaoyang District,

Beijing, China, 100020

(Address of Principal Executive Offices, Including Zip Code)

Registrant’s telephone number: +86 (10) 5775 7648

 

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

 

Common Stock, $0.001 par value per share New York Stock Exchange
(Title of each class) (Name of each exchange on which registered)

 

Securities registered pursuant to Section 12(g) of the 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 (§229.405 of this chapter) 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  ¨   Accelerated filer  ¨
     
Non-accelerated filer  ¨
(Do not check if a smaller reporting company)
  Smaller reporting company  x

  

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

 

The aggregate market value of the voting common equity held by non-affiliates as of June 30, 2014, the last business day of the registrant’s most recently completed second fiscal quarter, based upon the price of $1.00 that was the closing price of the common stock as reported on the New York Stock Exchange under the symbol “GSI” on such date, was approximately $22.2 million. The registrant has no non-voting common equity. 

 

As of April 8, 2015, 61,986,282 (excluding 2,472,306 shares of treasury stock) shares of common stock, par value $0.001 per share, were outstanding. 

 

 
 

  

TABLE OF CONTENTS

 

PART I
     
ITEM 1. BUSINESS. 4 
ITEM 1A. RISK FACTORS. 11
ITEM 1B. UNRESOLVED STAFF COMMENTS. 23
ITEM 2. PROPERTIES. 23
ITEM 3. LEGAL PROCEEDINGS. 24
ITEM 4. MINE SAFETY DISCLOSURES. 24
     
PART II
     
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES. 24
ITEM 6. SELECTED FINANCIAL DATA. 25
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. 25
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. 45
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. 45
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. 96
ITEM 9A. CONTROLS AND PROCEDURES. 96
ITEM 9B. OTHER INFORMATION. 97
     
PART III
     
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE. 98
ITEM 11. EXECUTIVE COMPENSATION. 102
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. 103
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. 104
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES. 110
     
PART IV
     
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES. 112
   
SIGNATURES. 115

 

2
 

 

Cautionary Statement

 

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements relate to future events or the Company’s future financial performance. The Company has attempted to identify forward-looking statements by terminology including “anticipates,” “believes,” “expects,” “can,” “continues,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “should” or “will” or the negative of these terms or other comparable terminology. Such statements are subject to certain risks and uncertainties, including the matters set forth in this Annual Report on Form 10-K or other reports or documents the Company files with the Securities and Exchange Commission from time to time, which could cause actual results or outcomes to differ materially from those projected. Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, levels of activity, performance or achievements. Undue reliance should not be placed on these forward-looking statements which speak only as of the date hereof. The Company’s expectations are as of the date this Annual Report on Form 10-K is filed, and the Company does not intend to update nor is obligated to update any of the forward-looking statements after the date this Annual Report on Form 10-K is filed to confirm these statements to actual results, unless required by applicable law.

 

3
 

 

PART I

 

ITEM 1. BUSINESS.

 

Overview

 

We were incorporated on August 5, 2002, in the State of Nevada. We are headquartered in Beijing, China and operate a portfolio of Chinese steel companies. We serve various industries and produce a variety of steel products including, but not limited to: reinforced bars (“rebar”), hot-rolled sheets and high-speed wire. Our current aggregate annual production capacity of crude steel products under management, consisting mainly of steel rebar, is 7 million metric tons. Our products have a variety of demand drivers, such as infrastructure construction and and rural income. Domestic economic conditions are also an overall demand driver for all our products.

 

In June 2014, the Board approved our plan to transform from an integrated steel producer into a multi-faceted, synergistic platform that will comprise not only steel-related businesses but also high-growth, high-margin non-steel businesses. In February 2015, we established a radio-frequency identification “RFID” joint venture to pursue Internet-of-Things (“IoT”) opportunities.

 

Our growth strategy is a combination of optimizing operating efficiencies in our steel business and expanding into other high-growth and high-margin non-steel industries:

 

·We aim to drive profitability through improved operational efficiencies and optimization of our cost structure and continual cooperation and partnerships with leading state-owned enterprises (SOEs).
·We aim to expand into other high-growth and high-margin non-steel industries, such as logistics and Internet-of-Things.

 

Unless the context indicates otherwise, as used herein the terms “General Steel”, the “Company”, “we”, “our” and “us” all refer to General Steel Holdings, Inc. 

 

Steel Related Subsidiaries and IoT Technology Company

 

We presently have controlling interests in three steel-related subsidiaries and one IoT Technology company:

 

  · General Steel (China) Co., Ltd. (“General Steel (China)”);
  · Shaanxi Longmen Iron and Steel Co., Ltd. (“Longmen Joint Venture”);
  · Maoming Hengda Steel Co., Ltd. (“Maoming Hengda”); and
  · Tianjin General Shengyuan IoT Technology Co., Ltd. (“General Shengyuan IoT”).

 

Our Company, together with our subsidiaries, majority owned subsidiaries and variable interest entity are referred to as the “Group.” Longmen Joint Venture, which is currently consolidated into our Company, represents the majority of our revenue and assets. It was determined to be a variable interest entity in which we are considered the primary beneficiary, as fully explained below.

 

In view of the near-term challenges for the steel sector, we are strategically accelerating our business transformation. Our transformation strategy is to pursue opportunities that offer compelling benefits to our organization and shareholders, including:

 

·First, strengthen our financials while providing the financial flexibility to pursue higher return, higher growth opportunities;
·Second, reduce the complexity of our business structure, which is consistent with our objectives for internal simplification and operating efficiency;
·Third, diversify operating risk in order to lower our high reliance on steel business, while at the same time leverage on our vast vertical resources in the steel industry; and
·Fourth, pursue opportunities for additional value creation.

 

We formed a joint venture in February of 2015 with an RFID Expert team to develop and commercialize RFID technologies and data solutions. The formation of this joint venture represents a unique opportunity to accelerate our expansion into the vibrant logistics and Internet-of-Things sectors.

 

General Steel (China) Co., Ltd

 

General Steel (China), formerly known as “Tianjin Daqiuzhuang Metal Sheet Co., Ltd.” started operations in 1988.

 

On May 14, 2009, General Steel (China) changed its official name from “Tianjin Daqiuzhuang Metal Sheet Co., Ltd.” to better reflect its role as a merger and acquisition platform for steel company investments in China.  In some instances, General Steel (China) retains the use of the name “Daqiuzhuang Metal” for brand recognition purposes within the industry.

 

On January 1, 2010, General Steel (China) entered into a lease agreement with Tianjin Shuangjie Liansheng Rolled Steel Co., Ltd. (the “Lessee”), whereby General Steel (China) leased parts of its facility located at No. 1, Tonga Street, Daqiuzhuang Town, Jinghai County, Tianjin City to the Lessee for a monthly payment of $0.1 million (RMB 0.5 million). The lease expires in May 2021. Management evaluates the fair value of its long-term assets on an annual basis, or upon a triggering event which would require an assessment sooner, and is of the opinion that the fair value of the property, plant and equipment as supported by the operating lease approximates its current carrying value.

 

4
 

 

Shaanxi Longmen Iron and Steel Co., Ltd

 

Effective June 1, 2007, through General Steel (China) and Tianjin Qiu Steel Investment Co., Ltd. (“Qiu Steel”), a 99% owned subsidiary of General Steel (China), we entered into a Joint Venture Agreement with Shaanxi Longmen Iron & Steel Group Co., Ltd. (“Long Steel Group”) to form Shaanxi Longmen Iron and Steel Co., Ltd. (“Longmen Joint Venture”). Through General Steel (China) and Qiu Steel, we invested approximately $39.3 million in cash and collectively held a 60% ownership interest in Longmen Joint Venture until April 29, 2011, when a 20-year Unified Management Agreement (the “Unified Management Agreement”) was entered into between our Company, Longmen Joint Venture, Shaanxi Coal and Shaanxi Steel. Longmen Joint Venture was determined to be a Variable Interest Entity (“VIE”) and we are the primary beneficiary.

 

Currently, Longmen Joint Venture has five branch offices, four consolidated subsidiaries and one entity in which it has a noncontrolling interest. It employs approximately 8,400 full-time workers.  In addition to steel production, Longmen Joint Venture operates transportation services through its Changlong Branch, located in Hancheng city, Shaanxi Province. Changlong Branch owns 177 vehicles and provides transportation services exclusively to Longmen Joint Venture.

 

Longmen Joint Venture’s rebar products are categorized within the steel industry as “longs” (in reference to their shape). Rebar is generally considered a regional product because its weight and dimension make it ill-suited for cost-effective long-haul ground transportation. By our estimates, the market demand for rebar in Shaanxi Province is six to eight million metric tons per year. Slightly more than half of this demand comes from Xi’an, the capital of Shaanxi Province, located 180km from Longmen Joint Venture’s main steel production site. Currently, we estimate that we have approximately a 72% share of the Xi’an market for rebar.

 

An established regional network of one hundred and twelve distributors, together with smaller distributors and eight sales offices sell Longmen Joint Venture’s products. All products are sold under the registered brand name of “Yulong”, which has strong regional recognition and awareness. Rebar and billet products carry ISO 9001 and 9002 certification and other Longmen Joint Venture’s products have won national quality awards. Products produced at the facility have been used in the construction of the Yangtze River Three Gorges Dam, the Xi’an International Airport, the Xi’an city subway system and the Xi Luo Du and Xiang Jia Ba hydropower projects.

 

From June 2009 to March 2011, we worked with Shaanxi Steel to build new iron and steel making facilities, including two 1,280 cubic meter blast furnaces, two 120 metric ton converters, one 400 square meter sintering machine and some auxiliary systems.  As a result, Longmen Joint Venture incurred certain costs of construction as well as economic losses on suspended production of certain small furnaces and other equipment to accommodate the construction of the new equipment, on behalf of Shaanxi Steel. See Note 14 - “Deferred lease income” of the Notes to Consolidated Financial Statements included herein

 

On April 29, 2011, a 20-year Unified Management Agreement (“the Agreement”) was entered into between the Company, the Company’s 60%-owned subsidiary Shaanxi Longmen Iron and Steel Co., Ltd. (“Longmen Joint Venture”), Shaanxi Coal and Chemical Industry Group Co., Ltd. (“Shaanxi Coal”) and Shaanxi Iron and Steel Group (“Shaanxi Steel”). Shaanxi Steel is the controlling shareholder of Shaanxi Longmen Iron and Steel Group Co., Ltd (“Long Steel Group”) which is the non-controlling interest holder in Longmen Joint Venture, and Shaanxi Coal, a state owned entity, is the parent company of Shaanxi Steel. Under the terms of the Agreement, all manufacturing machinery and equipment of Longmen Joint Venture and the $605.8 million (or approximately RMB 3.7 billion) of the constructed iron and steel making facilities owned by Shaanxi Steel, which includes one 400 m 2 sintering machine, two 1,280 m 3 blast furnaces, two 120 ton converters and some auxiliary systems, are managed collectively as a single virtual asset pool (“Asset Pool”). Longmen Joint Venture manages the Asset Pool as the principal operating entity and is responsible for the daily operations of the new and existing facilities. The Agreement leverages each of the parties’ operating strengths, allowing Longmen Joint Venture to derive the greatest benefit from the cooperation and the newly constructed iron and steel making facilities. At the designed efficiency level, the facilities contribute three million tons of crude steel production capacity per year.

 

Longmen Joint Venture pays Shaanxi Steel for the use of the constructed iron and steel making facilities an amount equaling the depreciation expense on the equipment constructed by Shaanxi Steel as well as 40% of the pre-tax profit generated by the Asset Pool. The remaining 60% of the pre-tax profit is allocated to Longmen Joint Venture. As a result, the Company’s economic interest in the profit or loss generated by Longmen Joint Venture decreased from 60% to 36%. However, the overall capacity under the management of Longmen Joint Venture increased by three million tons, or 75%. The Agreement improved Longmen Joint Venture’s cost structure through sustainable and steady sourcing of key raw materials and reduced transportation costs. The distribution of profit is subject to a prospective adjustment after the first two years based on each entity’s actual investment of time and resources into the Asset Pool. There has been no adjustment to the Agreement from its inception to the present time, nor intention to make future adjustment by the Company and Shaanxi Steel.

 

5
 

 

The parties to the Agreement established the Shaanxi Longmen Iron and Steel Unified Management Supervisory Committee ("Supervisory Committee") to ensure that the facilities and related resources are operated and managed according to the stipulations set forth in the Agreement. The Board of Directors of Longmen Joint Venture, of which the Company holds 4 out of 7 seats, requires a simple majority vote and remains the controlling decision-making body of Longmen Joint Venture and the Asset Pool. See Note 2(c) “Consolidation of VIE.”

 

The Agreement constitutes an arrangement that involves a lease which meets certain of the criteria of a capital lease and therefore the assets constructed by Shaanxi Steel are accounted for by Longmen Joint Venture as a capital lease. The profit sharing liability portion of the lease obligation, representing 40% of the pre-tax profit generated by the Asset Pool, is accounted for by Longmen Joint Venture as a derivative financial instrument at fair value. See Notes 2 “Summary of significant accounting policies”, 15 “Capital lease obligations” and 16 “Profit sharing liability”.

 

In November 2010, we brought online a 1,200,000 metric ton capacity rebar production line, which was renovated based on an existing 800,000 metric ton capacity rebar production line. In July 2011, we brought online a 1,000,000 metric ton capacity high speed wire production line. These two newly installed production lines were both relocated from the Maoming Hengda (as defined below) facility and consume less energy when running at maximum efficiency compared to our previous production line.

 

Maoming Hengda Steel Co., Ltd

 

On June 25, 2008, through our subsidiary Qiu Steel, we paid approximately $7.1 million (RMB 50 million) in cash to purchase 99% of Maoming Hengda Steel Group, Ltd. (“Maoming Hengda”).  The total registered capital of Maoming Hengda is approximately $77.8 million (RMB 544.6 million).

 

Maoming Hengda’s core business was the production of rebar products used in the construction industry.  Located on 140 hectares (approximately 346 acres) in Maoming city, Guangdong Province, the Maoming Hengda facility previously had two production lines capable of annual production capacities of 1.8 million metric tons of 5.5mm to 16mm diameter high-speed wire and 12mm to 38mm diameter rebar. The products were sold through nine distributors that targeted customers in Guangxi Province and the western region of Guangdong. To take advantage of a stronger market demand in Shaanxi Province, between 2009 and 2010, we relocated the 1.8 million metric ton capacity rebar production line and high-speed wire production line from Maoming Hengda's facility to Longmen Joint Venture.

 

In December 2010, we brought online a new 400,000 ton capacity rebar production line. On December 15, 2013, Maoming Hengda entered into a lease agreement with Zhongshan Baohua Rebar Factory, with which Maoming Hengda leased the 400,000 ton capacity rebar production line and various other buildings and equipment to Zhongshan Baohua Rebar Factory, for an annual payment of $1.2 million (RMB 7.2 million) for eight years between March 2014 and February 2022.

 

Tianjin General Shengyuan IoT Technology Co., Ltd

 

On February 10, 2015, we reached a definitive agreement (“the Agreement”) to form a joint venture with a team of RFID experts (the “Expert Team”), to develop and commercialize RFID technology data solutions. The joint venture entity named Tianjin General Shengyuan IoT Technology Co., Ltd. (“General Shengyuan IoT”) obtained its business license on February 13, 2015.

 

The Expert Team includes several forerunners in the data integration and logistics industries, led by Mr. Michael Au, a veteran with over 17 years experience and more than a dozen patents in RFID technology. In 1997, Mr. Au developed and patented the first non-contact RFID device for moving vehicles that is still being used today for highway toll collections in the Guangdong Province. In 2005, Mr. Au co-founded Xindeco IoT (formerly Xinda Huicong Technology Company), the first China-based company specializing in the development and production of UHF RFID tags. Supporting Mr. Au and acting as the Expert Team’s chief technical adviser will be Dr. Changyu Wu, a member of the US Institute of Electrical and Electronics Engineers with over 20 years experience in the development of data-integration devices. Michael Au was appointed as CEO of General Shengyuan IoT.

 

The joint venture brings together the strength and expertise of each partner in developing and commercializing RFID technologies and a cloud-based, Internet-of-Things platform. We own 70% of General Shengyuan IoT by contributing $1.6 million (RMB 10.0 million), while the Expert Team contributes intellectual property, including proprietary RFID technologies, licensed patents and domain expertise. The venture’s proprietary RFID tags and related applications can effectively track supplies, inventories, and goods throughout the manufacturing process, as well as, finished goods and merchandises in transit. Meanwhile, the venture’s cloud-based Internet-of-Things platform for bulk commodity logistics provides real-time data on supplies, inventory, and goods, thereby greatly enhancing its customers’ administration and planning processes, as well as, asset tracking and supply chain management.

 

6
 

 

Steel Production Capacity Information Summary by Subsidiaries

 

Annual Production
Capacity (metric tons)
  General Steel 
(China) (1)
  Longmen Joint
Venture
  Maoming
Hengda (1)
          
Crude Steel  -  7 million  -
Processing  400,000  5 million  400,000
Main Products  Hot-rolled sheet  Rebar/High-speed wire  Rebar
Main Application  Light agricultural vehicles  Infrastructure and construction  Infrastructure and construction

 

(1)The production facilities of General Steel (China) and Maoming Hengda currently are leased to unrelated parties.

 

Marketing and Customers

 

We sell our products primarily to distributors and related parties, and we typically collect payment from these distributors in advance.  Our marketing efforts are mainly directed toward those customers who have demanding requirements for on-time delivery, timeliness of customer services, and product quality.  We believe that these requirements, as well as product planning, are critical factors in our ability to serve this segment of the market.

 

Our revenue is dependent, in large part, on significant contracts with a limited number of large customers. For the year ended December 31, 2014, approximately 24.7% of our sales were to five customers. We believe that revenue derived from our current and future large customers will continue to represent a significant portion of our total revenue.

 

Moreover, our success will depend in part upon our ability to obtain orders from new customers, as well as the financial condition and success of our customers and general economic conditions in China.

 

Demand for our Products

 

For the years ended December 31, 2014 and 2013, rebar, our major product, comprised of more than 99% and 99% of our sales, respectively. Overall, domestic economic growth is an important driver of demand for our major product, especially from construction and infrastructure projects.

 

At Longmen Joint Venture, growth in regional construction and infrastructure projects drives demand for our products. According to the 12th Five Year National Economic and Social Development Plan (“NESDP”) (2011-2015), development of China’s western region is one of China’s top five economic priorities. Shaanxi Province, where Longmen Joint Venture is located, has been designated as a focal point for development in the Western region, and Xi’an, the provincial capital, has been designated as a focal point for this development in China. Longmen Joint Venture is 180 kilometers from Xi’an and it does not have a major competitor within a 250 km radius.

 

The Western region of China, where our major sales market is located, has experienced a higher rate of growth than other Chinese regions in recent years. Compared to an increase of 7.4% for the national GDP, a GDP increase of 9.7% was reported by Shaanxi Province in 2014. Additionally, according to Accounting and Corporate Finance Production Statistics in China, Sichuan Province also reported a healthy GDP increase of 8.5% in 2014. We have a sales office in Chengdu City, Sichuan Province to meet the increasing demand for the production of steel.

 

According to the Shaanxi provincial government, the total fixed asset investment for the Shaanxi Province was approximately $299 billion (RMB 1.84 trillion) for the year ended December 31, 2014, an increase of 17.8% over the same period in 2013.

 

At the end of June 2009, the State Council Office announced that it approved the Guanzhong-Tianshui Economic Zone development program. This program covers the development of two western provinces and seven cities from 2009 to 2020.

 

7
 

 

In addition, the Guanzhong-Tianshui Economic Zone will concentrate on the development of the Xi’an area. The metropolitan area construction program focuses on the cities of Xi’an, Xianyang, and their surrounding areas, covering up to 12,000 square kilometers, including the construction of railways, highways, subways, airport expansion and newly developed areas. Under this program, the Shaanxi provincial government has announced that it will build approximately 4,500 kilometers of railway with an investment of approximately $40.2 billion (RMB 260 billion) by 2015 and 8,080 kilometers of highway by 2020. The infrastructure and construction projects provide strong and stable demand for our steel products in this area, in which we have over 70% of the market share.

 

In January 2011, the Shaanxi provincial government announced that it would invest approximately $12.2 billion (RMB 80 billion) in the construction of hydro projects, which is three times the amount invested during the 11th Five Year National Economic and Social Development Plan.  In addition to hydro projects, according to the central government, 16,000 total kilometers of high speed railway will be built by 2020. 

 

In May 2011, the central government passed the Cheng-Yu Economic Zone Plan focusing on Chongqing City and Sichuan Province, covering 206,000 square kilometers, to further accelerate the development of the western region of China.  We anticipate that in the near future, the demand for our products will increase in those areas, and we expect that our expanded production capacity will be able to successfully meet the increase in demand. Furthermore, we have a sales office located in Chengdu to help facilitate such increased demand.

 

In February 2012, the government approved the Western Development 12th Five Year Plan, which continues the efforts to develop the Western areas. The Plan is centered on the infrastructure and construction, highlighted by the development of economic zones, construction of roads/railway and hydro projects, which drive the local demand for steel products.

 

In February 2014, National Development and Reform Commission (“NDRC”) announced nine focal points of the western development, which will speed up the major infrastructure construction in the western areas, including the construction of railway, highway and hydro-projects.

 

China’s central government also introduced the One Belt and One Road (“OBAOR”) strategy, with an aim to create new markets for China’s products by promoting China’s infrastructure investments in less-developed countries. “One Road” refers to the 21st century Maritime Silk Road initiative, which seeks to extend China’s trading and infrastructure investments into Southeast Asian nations and further afield to south Asia and Africa. “One Belt” refers to the Silk Road Economic Belt, which extends into central Asian nations.

 

According to figures released by China’s National Development and Reform Commission, 33 infrastructure projects kicked off in 2014 in Western China, worth a total investment of RMB 835.3 billion ($134.7 billion), more than doubled from a total investment of RMB 326.5 billion on 20 projects in 2013.

 

We anticipate strong demand for our products driven by these and many other construction and infrastructure projects. We believe there will be sustained regional demand for several years as both the central and provincial governments continue to drive western region development efforts.

 

Supply of Raw Materials

 

The primary raw materials we use for steel production are iron ore, coke, hot-rolled steel coil and steel billets.  Longmen Joint Venture uses iron ore and coke as its main raw materials.  Maoming Hengda uses steel billets as its main raw material. Iron ore is the main raw material used to produce hot-rolled steel coil and steel billets. Therefore, the prices of iron ore and coke are the primary raw material cost drivers for our products.

 

Iron Ore

 

Longmen Joint Venture has 7 million tons of annual crude steel production capacity. At Longmen Joint Venture, approximately 72% of production costs are associated with raw materials, with iron ore being the largest component.

  

According to the China Iron and Steel Association, approximately 60% of the Chinese domestic steel industry’s demand for iron ore must be filled by imports. At Longmen Joint Venture, we purchase iron ore from four primary sources: Mulonggou mine (owned by Longmen Joint Venture), Daxigou mine (owned by Long Steel Group, our partner in Longmen Joint Venture), surrounding local mines and mines located abroad.

 

8
 

 

Coke

 

Coke, produced from metallurgical coal (also known as coking coal), is our second most consumed raw material, after iron ore. It requires approximately 550kg to 600kg of coke to make one metric ton of crude steel.

 

Under the terms of the Unified Management Agreement, our partner, Shaanxi Coal, has committed to providing coke and coal to us at a cost not higher than the market price.

 

Our Longmen Joint Venture facility is located in the center of China’s coal belt. We source all coke used at Longmen Joint Venture from the town in which Longmen Joint Venture is located. This ensures a dependable, local supply and minimum transportation costs.

 

The sources and/or our top five major suppliers of our raw materials for the year ended December 31, 2014 are as follows:

 

Name of the Major Suppliers  Raw Material
Purchased
  % of Total Raw
Material Purchased
   Relationship with
Company
Longgang Group Import & Export Co., Ltd.  Iron Ore   9.2%  Related Party
Shaanxi Longmen Coal Chemical Industry Co., Ltd.  Coke   6.4%   Third Party
Shaanxi Haiyan Coal Chemical Industry Co., Ltd.  Coke   6.2%  Related Party
Tianwu General Steel Material Trading Co., Ltd.  Iron Ore   4.2%  Related Party
Long Steel Group  Iron Ore   4.0%  Related Party
   Total   30.0%   

 

Industry Environment

 

Despite demand growth experienced throughout the past years, the overall nationwide steelmaking capacity still exceeds steel demand. There is significant over-capacity in the Chinese steel sector which is putting pressure on operators’ profitability and has become the most significant challenge in the steel manufacturing business. Chinese crude steel production reached a record high of 823 million tons in 2014, an increase of 0.89% over 2013, while the total consumption of crude steel was only 738 million tons in 2014, a decrease of 3.4% from the same period last year, according to the China Iron and Steel Association.

 

For steelmakers, operating performance depends on the volatility of the cost of raw materials. The shortage of these raw materials in the market has allowed suppliers of iron ore and metallurgical coal to rebuild the pricing mechanisms through the shift from annual to shorter-term price contracts. This has created numerous challenges for steelmakers as they must now deal with volatility in raw material prices, as well as maintain margins with fluctuating demand. Over the past few years, we have witnessed perseverance in steel prices that has given iron ore producers an opportunity to increase the prices in the next contract; however the reverse may not be true as steel companies cannot always pass on the rise in iron ore prices to end consumers due to the market overcapacity and fragmentation.

 

China’s steel industry is highly fragmented, and the Chinese government continues to encourage industry consolidation. The Chinese central government has had a long-stated goal to consolidate 60% of domestic steel production among the top ten producers by 2015, and expanding to 70% by 2020. The top ten producers’ output fell to 39% of the national output in 2013 from 49% in 2010, which is still below the 60% target for 2015 set in the 12th year plan.

 

Meanwhile, the Ministry of Industry and Information Technology of the People's Republic of China is targeting to cut up to 80 million metric tons of capacity by the end of 2018. In April 2012, the central government announced its goal of reducing obsolete iron and steel capacities by 17.8 million tons in 2012 and successfully reached the goal and eliminated 20.2 million tons of obsolete iron and steel capacity. In April 2013, the central government published the industry target of eliminating 10.4 million tons of obsolete iron and steel capacities in 2013 and successfully eliminated 16.9 million tons of obsolete iron and steel capacity. In May 2014, the government reaffirmed its determination of industry consolidation, and announced that it plans to eliminate 28.7 million tons of obsolete iron and steel capacity in 2014 and successfully eliminated 31.1 million tons, which was more than the original target amount. Such industry consolidation through the reduction of obsolete iron and steel capacities are not expected to directly impact our Company because we continue to see a strong demand for our products, especially in Western China, and believe there are significant growth opportunities in the industry and market we serve.

 

 

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Despite the government’s initiatives to encourage industry consolidation and cut over-capacity, it is estimated that new capacity of approximately 20~25 million metric tons was added in 2014. Excess supply, weakening economic growth, and sagging prices have resulted in depressed margins and operating losses. According to statistics by China Iron and Steel Association, the blended net margin of China steel enterprises in 2014 was only 0.85%, with approximately 15% of major steel companies monitored by China Iron and Steel Association still incurring operating losses.

 

 On July 12, 2010, the Ministry of Industry & Information Technology enacted the Steel Industry Admittance and Operation Qualifications standards. The new standards specify requirements for all aspects of steel production in China, which include: size of blast furnaces, size of converters, emission of waste water, dust per ton from steel production, quantity of coal used for each process in steel production and output capacity.  According to the new standards, blast furnaces under 450 cubic meters are targeted to be eliminated. These standards once again confirmed the central government’s determination to push forward the consolidation of this fragmented industry.  

 

Since 2013, the government has exerted a more stringent environment protection policy on the steel industry. In January 2014, the Ministry of Industry and Information Technology of the People's Republic of China (the "MIIT") announced a List of Enterprises Fulfilling the Iron and Steel Industry Specification (the "List").  The List includes a highly-selected group of large and medium steel manufacturers that have met or exceeded more stringent national requirements and standards on product quality, environmental protection, energy consumption, workmanship and equipment, production scale, as well as work safety and social responsibility. The MIIT will collaborate with China's other governmental agencies to provide support to the List's members and to speed up the steel industry's restructuring and consolidation. Steel makers omitted from the List will most likely face higher electricity costs, more restrictive administrative measures, and adverse effects of forceful regulations intent on reducing the nation's overcapacity. Longmen Joint Venture, the major facility of General Steel, has been included on the List as one of the key steel enterprises in China’s Shaanxi Province.

 

Intellectual Property Rights

 

“Qiu Steel” is the registered trademark under which we sell hot-rolled carbon and silicon steel sheets products produced at General Steel (China). The “Qiu Steel” logo has been registered with the China National Trademark Bureau under No. 586433. “Qiu Steel” is registered under the GB 912-89 national quality standard and certified under the National Quality Assurance program.

 

“Yu Long” is the registered trademark under which we sell rebar and high-speed wire products produced in Longmen Joint Venture. The trademark is registered under the ISO9001:2000 international quality standard.

 

“Heng Da” is the registered trademark under which we sell high-speed wire and rebar products produced at our Maoming facility. The trademark is registered under the ISO9001:2000 international quality standard.

 

Employees

 

As of December 31, 2014, we had approximately 8,505 full-time employees. 

 

Executive Officers of the Registrant

 

The following sets forth certain information as of March 25, 2015 concerning our executive officers.

 

Name   Age   Title
Zuosheng Yu   50   Chairman and Chief Executive Officer
John Chen   43   Chief Financial Officer

 

Mr. Zuosheng Yu, age 50, Chairman of the Board of Directors.  Mr. Yu joined our Company in October 2004 and became Chairman of the Board at that time. He also serves as our Chief Executive Officer. Since February 2001, he has been President and Chairman of the Board of Directors of Beijing Wendlar Investment Management Group, Beijing, China. Mr. Yu graduated in 1985 from Sciences and Engineering Institute, Tianjin, China. In July 1994, he received a Bachelor’s degree from Institute of Business Management for Officers. Mr. Yu received the title of “Senior Economist” from the Committee of Science and Technology of Tianjin City in 1994. In July 1997, he received an MBA degree from the Graduate School of Tianjin Party University. Since April 2003, Mr. Yu has held a position as a member of China’s APEC (Asia Pacific Economic Co-operation) Development Council.  

 

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Mr. John Chen, age 43, Director.  Mr. Chen joined our Company in May 2004 and was elected as a director in March 2005. He also serves as our Chief Financial Officer. From August 1997 to July 2003, he served as a senior accountant at Moore Stephens, Wurth, Frazer and Torbet, LLP in Los Angeles, California. Mr. Chen graduated from Norman Bethune University of Medical Science, Changchun City, Jilin Province, China in September 1992. He received a B.S. degree in accounting from California State Polytechnic University, Pomona, California, U.S. in July 1997.   He currently also serves on the board of directors of China Carbon Graphite Group, Inc. (OTCBB: CHGI), SGOCO Group, Ltd. (NASDAQ: SGOC), and China HGS Real Estate Inc. (NASDAQ: HGSH).

 

ITEM 1A. RISK FACTORS.

 

Our business, financial condition and results of operations are subject to various risks, including those discussed below, which may affect the value of our securities. The risks discussed below are those that we believe are currently the most significant, although additional risks not presently known to us or that we currently deem less significant may also impact our business, financial condition and results of operations, perhaps materially.

 

Risks Related to Our Business

 

We face substantial competition which, among other things, may lead to price pressure and adversely affect our sales.

 

We compete with other market players on the basis of product quality, responsiveness to customer needs and price. There are two types of steel and iron companies in China: state-owned enterprises (“SOEs”) and privately owned companies.

 

Criteria important to our customers when selecting a steel supplier include:

 

  Quality;
  Price/cost competitiveness;
  System and product performance;
  Reliability and timeliness of delivery;
  New product and technology development capability;
  Excellence and flexibility in operations;
  Degree of global and local presence;
  Effectiveness of customer service; and
  Overall management capability.

 

We compete with both SOEs and privately owned steel manufacturers. While we believe that our price and quality are superior to other manufacturers, many of our competitors are better capitalized, more experienced, and have deeper ties in the Chinese marketplace. We consider there to be the following major competitors of similar size, production capability and product line in the marketplace competing against our three operating subsidiaries as indicated:

 

Competitors of General Steel (China) include: Tianjin No. 1 Rolling Steel Plant, Tianjin Yinze Metal Sheet Plant and Tangshan Fengrun Metal Sheet Plant;
Competitors of Longmen Joint Venture include: Shanxi Haixin Iron and Steel Co., Ltd. and Gansu Jiuquan Iron and Steel Co., Ltd.;
Competitors of Maoming Hengda include: Guangdong Shao Guan Iron and Steel Group and Zhuhai Yue Yu Feng Iron and Steel Co., Ltd.

 

In addition, with China’s entry into the World Trade Organization and China’s agreements to lift many of the barriers to foreign competition, we believe that competition will increase as a whole with the entry of foreign companies into this market. This may limit our opportunities for growth, lead to price pressure and reduce our profitability. We may not be able to compete favorably and this increased competition may harm our business, our business prospects and results of operations.

 

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Our inability to fund our capital expenditure requirements may adversely affect our growth and profitability.

 

Our continued growth is dependent upon our ability to raise additional capital from outside sources. Our strategy is to grow through mergers, joint ventures and acquisitions targeting SOE steel companies and selected entities we believe have outstanding potential. Our growth strategy will require us to obtain additional financing through capital markets. In the future, we may be unable to obtain the necessary financing on a timely basis and on favorable terms, if at all, and our failure to do so may weaken our financial position, reduce our competitiveness, limit our growth and reduce our profitability. Our ability to obtain acceptable financing at any given time may depend on a number of factors, including:

 

Our financial condition and results of operations;
The condition of the PRC economy and the industry sectors in which we operate; and
Conditions in relevant financial markets in the United States, the PRC and elsewhere in the world.

 

Future disruptions in world financial markets and the resulting governmental action of the United States and other countries could have a material adverse impact on our ability to obtain financing, our results of operations, financial condition and cash flow and could cause the market price of our common stock to decline.

 

The credit markets worldwide and in the United States have experienced significant contraction, de-leveraging and reduced liquidity in the past, and the United States government and foreign governments have either implemented or are considering a broad variety of governmental action and/or new regulation of the financial markets to prevent these from occurring again. Securities and futures markets and the credit markets are subject to comprehensive statutes, regulations and other requirements.

 

The uncertainty surrounding the future of the global credit markets has resulted in reduced access to credit worldwide. Major market disruptions, the current adverse changes in global market conditions, and the regulatory climate in the United States and worldwide may adversely affect our business or impair our ability to borrow funds as needed. The current market conditions may last longer than we anticipate. Such economic and governmental factors may have a material adverse effect on our results of operations, financial condition or cash flows and could cause the price of our common stock to decline significantly.

 

We have made and may continue to make acquisitions which could divert management's attention, cause ownership dilution to our stockholders, or be difficult to integrate, which may adversely affect our financial results.

 

We have made a number of acquisitions, and it is our current plan to continue to acquire companies and technologies that we believe are strategic to our future business. Integrating newly acquired businesses or technologies could put a strain on our resources, could be costly and time consuming, and might not be successful. Such acquisitions could divert our management's attention from other business concerns. In addition, we might lose key employees while integrating new organizations. Acquisitions could also result in customer dissatisfaction, performance problems with an acquired company or technology, potentially dilutive issuances of equity securities or the incurrence of debt, assumption or incurrence of contingent liabilities, possible impairment charges related to goodwill or other intangible assets or other unanticipated events or circumstances, any of which could harm our business. We might not be successful in integrating any acquired businesses, products or technologies, and might not achieve anticipated revenues and cost benefits.

 

We may not be able to effectively control and manage our growth.

 

If our business and markets grow and develop, it will be necessary for us to finance and manage such an expansion in an orderly fashion. This growth will lead to an increase in the responsibilities of existing personnel, the hiring of additional personnel and expansion of our scope of operations. It is possible that we may not be able to obtain the required financing under terms that are acceptable to us or hire additional personnel to meet the needs of our expansion.

 

Our new growth strategy into the Internet-of-Things sector may not be successful.

 

In June 2014, the Board approved our plan to transform from an integrated steel producer into a multi-faceted, synergistic platform that will comprise not only steel-related businesses but also high-growth, high-margin non-steel businesses. In February 2015, we established a radio-frequency identification “RFID” joint venture to pursue Internet-of-Things opportunities. Our growth strategy is a combination of optimizing operating efficiencies in our steel business and expanding into other high-growth and high margin non-steel industries:

 

There, we expect that a significant portion of our future revenue will be derived from this RFID joint venture and other Internet-of-Things opportunities, along with opportunities in other new high margin non-steel industries. The market for these products is characterized by rapidly changing technology, evolving industry standards and changes in customer needs. If we fail to respond such to changes in technology, industry standards or customer needs, these opportunities could become less competitive or obsolete. We must continue to make smart and efficient investments in these areas in order to make them profitable. However, there can be no assurance that such opportunities and investments will be successful or profitable and could result in additional expenses.

 

If we are unable to successfully enter the Internet-of-Things sector or other new high margin non-steel industries, our future results of operations would be adversely affected. Our pursuit of such new opportunities will require substantial time and expense. We may need to license new technologies to respond to technological change. These licenses may not be available to us on terms that we can accept or may materially change the gross profits that we are able to obtain on our products. Further, we may not succeed in adapting our business model to new technologies and industries as they emerge, which could materially harm our expansion and future growth.

 

Our business, revenues and profitability are dependent on a limited number of large customers.

 

Our revenue is dependent, in large part, on significant contracts with a limited number of large customers. For the year ended December 31, 2014, approximately 24.7% of our sales were to five customers. We believe that revenue derived from our current and future large customers will continue to represent a significant portion of our total revenue. Our inability to continue to secure and maintain a sufficient number of large contracts or the loss of, or significant reduction in purchases by, one or more of our major customers would have the effect of reducing our revenues and profitability.

 

Moreover, our success will depend in part upon our ability to obtain orders from new customers, as well as the financial condition and success of our customers and general economic conditions in China.

 

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Steel consumption is cyclical and worldwide overcapacity in the steel industry and the availability of alternative products have resulted in intense competition, which may have an adverse effect on profitability and cash flow.

 

Steel consumption is highly cyclical and follows general economic and industrial conditions both worldwide and in regional markets. The steel industry has historically been characterized by an excess in the world supply, which has led to substantial price decreases during periods of economic weakness. We currently have an annual steel production capacity of 7 million metric tons of crude steel and if the market for steel cannot support such production levels, the price for our products may go down. In addition, future economic downturns could decrease the demand for our products. Substitute materials are increasingly available for many steel products, which further reduces demand for steel.

 

We may not be able to pass on to customers the increases in the costs of our raw materials, particularly iron-ore, coke, steel billets and steel coil.

 

The major raw materials that we purchase for production are iron-ore, coke, steel billets and steel coil. The price and availability of these raw materials are subject to market conditions affecting supply and demand. Our financial condition or results of operations may be impaired by further increases in raw material costs to the extent we are unable to pass those increases to our customers. In addition, if these materials are not available on a timely basis or at all, we may not be able to produce our products and our sales may decline.

 

The price of steel may continue declining due to overproduction by the Chinese steel companies.

 

According to the China Iron and Steel Association, there are approximately 800 to 1,000 steel companies in China. Each steel company has its own production plan. The Chinese government released new guidance on the steel industry to encourage consolidation within the fragmented steel sector to mitigate problems of low-end repetitive production and inefficient use of resources. The current overproduction may not be solved by these measures enacted by the Chinese government. If the current overproduction continues, our product shipments could decline, our inventory could build up and eventually we may be required to decrease our sales price, which may decrease our profitability.

 

Disruptions to our manufacturing processes could adversely affect our operations, customer service and financial results.

 

Steel manufacturing processes are dependent on critical steel-making equipment, such as furnaces, continuous casters, rolling mills and electrical equipment (such as transformers), and such equipment may become temporarily inoperable as a result of unanticipated malfunctions or other events, such as fires or furnace breakdowns. Although our manufacturing plants have not experienced plant shutdowns or periods of reduced production as a result of such equipment failures or other events, we may experience such problems in the future. To the extent that lost production as a result of such a disruption could not be recovered by unaffected facilities, such disruptions could have an adverse effect on our operations, customer service and financial results.

 

Because we are a holding company with substantially all of our operations conducted through our subsidiaries, our performance will be affected by the performance of such subsidiaries.

 

We have no operations other than General Steel (China), Longmen Joint Venture, and Maoming Hengda, and our principal assets are our investments in these subsidiaries and VIE. As a result, we are dependent upon the performance of our subsidiaries and VIE and we will be subject to the financial, business and other factors affecting them as well as general economic and financial conditions. As substantially all of our operations are and will be conducted through our subsidiaries and VIE, we will be dependent on the cash flow of our subsidiaries to meet our obligations.

 

Because virtually all of our assets are and will be held by operating subsidiaries and VIE, the claims of our stockholders will be structurally subordinate to all existing and future liabilities and obligations, and trade payables of such subsidiaries and VIE. In the event of our bankruptcy, liquidation or reorganization, our assets and those of our subsidiaries will be available to satisfy the claims of our stockholders only after all of our subsidiaries’ and VIE’s liabilities and obligations have been paid in full.

 

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Because we have entered into a significant number of related party transactions through the course of our routine business operations, there is a risk that we may not be able to control the valuation of such transactions, which could then adversely impact our profitability.

 

In the course of our normal business, we have purchased raw materials and supplies from our related parties and also engaged in sales of our products to our related parties. Because such related party transactions may not always be completed at arm’s length due to their nature, we may not be able to control the valuation of such transactions and as a result, there is a risk that the value of such related party transactions exceeds market value, which could ultimately impact our profitability.

 

We depend on bank financing for our working capital needs.

 

We have various financing facilities which are due on demand or within one year. So far, we have not experienced any difficulties in repaying such financing facilities. However, we may in the future encounter difficulties in repaying or refinancing such financings on time and may face severe difficulties in our operations and financial position.

 

Our bank loans may not be renewed if certain covenants of the loan agreements are not met.

 

We have various financing facilities with banks which are due on demand or within one year. So far, we have not experienced any difficulties in repaying such financing facilities. As of December 31, 2014, we have not satisfied our financial covenants stipulated by certain loan agreements because of debt to asset ratios. Furthermore, we are party to loan agreements with cross default clause where any breach of other loan covenants will automatically result in default of such loans. According to the loan agreements, the bank could request more collateral or guarantees if the covenant is not satisfied or request early repayment of the loan if we cannot remedy the default within a period of time. As of today, we have not received any notice from the banks requesting more collateral, guarantees or early repayment of our short term loans due to a breach. However, we may in the future encounter difficulties in repaying or refinancing such loans on time, or providing more collateral or guarantees to the banks or making early repayment of our loans.

 

We depend on our affiliates financing for our working capital needs. We have various types of financing with our affiliates.

 

We rely on Mr. Zuosheng Yu for important business leadership.

 

We depend, to a large extent, on the abilities and operations of our current management team. However, we have a particular reliance upon Mr. Zuosheng Yu, our Chairman, Chief Executive Officer and significant shareholder, for the direction of our business and leadership in our growth efforts. The loss of the services of Mr. Yu, for any reason, may have a material adverse effect on our business and prospects. We cannot guarantee that Mr. Yu will continue to be available to us, or that we will be able to find a suitable replacement for Mr. Yu on a timely basis.

 

The report of our independent registered public accounting firm expresses substantial doubt about the Company’s ability to continue as a going concern.

 

Our auditors, Friedman LLP, have indicated in their report on the Company’s financial statements for the fiscal year ended December 31, 2014 that conditions exist that raise substantial doubt about our ability to continue as a going concern.  Our ability to continue as a going concern could impair our ability to finance our operations through the sale of equity, incurring debt, or other financing alternatives, and depends upon aligning our sources of funding (debt and equity) with our expenditure requirements and repayment of the short-term debt facilities as and when they become due.  If we are unable to achieve these goals, our business would be jeopardized and the Company may not be able to continue. If we ceased operations, it is likely that all of our investors would lose their investment.

 

Failure to achieve and maintain effective internal control over financial reporting could have a material adverse effect on our business, results of operations and the trading rice of our common stock. Also, we are exposed to potential risks from regulations requiring companies to evaluate controls under Section 404 of the Sarbanes-Oxley Act of 2002.

 

We are exposed to potential risks from regulations requiring companies to evaluate controls under Section 404 of the Sarbanes-Oxley Act of 2002. Ensuring that we have adequate internal financial and accounting controls and procedures in place to produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be re-evaluated frequently. Failure on our part to have effective internal financial and accounting controls, including the material weakness, had and could in the future cause our financial reporting to be unreliable, had and could in the future have a material adverse effect on our business, operating results, and financial condition, and had and could in the future cause the trading price of our common stock to fall dramatically.

 

Under the supervision and with the participation of our management, we have and will continue to evaluate our internal controls systems in order to allow management to report on our internal controls, as required by Section 404 of the Sarbanes-Oxley Act. We have and will continue to perform the system and process evaluation and testing required in an effort to comply with the management certification and auditor attestation requirements of Section 404. As a result, we have and will continue to incur additional expenses and a diversion of management’s time. If we are not able to meet the requirements of Section 404 in a timely manner or with adequate compliance, we might be subject to sanctions or investigation by regulatory authorities, such as the SEC or the New York Stock Exchange. Any such action could adversely affect our financial results and the market price of our stock.

 

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We do not presently maintain product liability insurance in China, and our property and equipment insurance does not cover the full value of our property and equipment, which leaves us with exposure in the event of loss or damage to our properties or claims filed against us.

 

We currently do not carry any product liability or other similar insurance in China. We cannot assure you that we would not face liability in the event of the failure of any of our products.

 

We have purchased automobile insurance with third party liability coverage for our vehicles. In addition, we have purchased property insurance to cover production equipment. Except for property and automobile insurance, we do not have other insurance such as business liability or disruption insurance coverage for our operations in China. In the event of a significant product liability claim or other uninsured event, our financial results and the price of our common stock may be adversely affected.

 

Risks Related to Operating Our Business in China

 

We face the risk that changes in the policies of the Chinese government could have significant impact upon the business we may be able to conduct in China and the profitability of such business.

 

The economy in China is transitioning from a planned economy to a market oriented economy, subject to five-year and annual plans adopted by the government that set forth national economic development goals. Policies of the Chinese government can have significant effects on the economic conditions of China. The Chinese government has confirmed that economic development will follow a model of a market economy under socialism. Under this direction, we believe that China will continue to strengthen its economic and trading relationships with foreign countries and business development in China will follow market forces. While we believe that this trend will continue, there can be no assurance that such will be the case. A change in policies by the Chinese government could adversely affect our interests through, among other factors: changes in laws; regulations or the interpretation thereof; confiscatory taxation; restrictions on currency conversion; imports or sources of supplies; or the expropriation or nationalization of private enterprises. Although the Chinese government has been pursuing economic reform policies for approximately two decades, the Chinese government may significantly alter such policies, especially in the event of a change in leadership, social or political disruption, or other circumstances affecting China’s political, economic and social climate.

 

The PRC laws and regulations governing our current business operations and contractual arrangements are uncertain, and if we are found to be in violation of such laws and regulations, we could be subject to sanctions, which along with, any changes in such laws and regulations may have a material and adverse effect on our business.

 

There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including but not limited to the laws and regulations governing our business, or the enforcement and performance of our arrangements with customers in the event of the imposition of statutory liens, bankruptcy, or criminal proceedings against us or our customers. Along with our subsidiaries, we are considered foreign persons or foreign funded enterprises under PRC law, and, as a result, we are required to comply with certain PRC laws and regulations. These laws and regulations are relatively new and may be subject to future changes, and their official interpretation and enforcement may involve substantial uncertainty. The effectiveness of newly enacted laws, regulations or amendments may be delayed, resulting in detrimental reliance by foreign investors. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively. In addition, the Chinese authorities retain broad discretion in dealing with violations of laws and regulations, including levying fines, revoking business licenses and requiring actions necessary for compliance. In particular, licenses, permits and beneficial treatment issued or granted to us by relevant governmental bodies may be revoked at a later time under contrary findings of higher regulatory bodies. We cannot predict what effect the interpretation of existing or new PRC laws or regulations may have on our businesses. We may be subject to sanctions, including fines, and could be required to restructure our operations. Such restructuring may not be deemed effective or may encounter similar or other difficulties. As a result of these substantial uncertainties, there is a risk that we may be found in violation of current or future PRC laws or regulations. In addition, PRC laws and regulations relating to land use have caused, and may cause again in the future, us to pay fines relating to the alleged misuse of certain agricultural land for industrial purposes.  When such misuse is alleged, the PRC also reserves the right to seize, and may seize, our equipment on the land in question. 

 

A slowdown or other adverse developments in the Chinese economy may materially and adversely affect our customers, demand for our services and our business.

 

Substantially all of our assets, and the assets of our operating subsidiaries and VIE, are located in China and our revenue is derived from our operations in China. We anticipate that our revenues generated in China will continue to represent all of our revenues in the near future. Accordingly, our results of operations and prospects are subject, to a significant extent, to the economic, political and legal developments in China. Although the PRC economy has grown significantly in recent years, we cannot assure you that such growth will continue. In addition, the Chinese government also exercises significant control over Chinese economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. Efforts by the Chinese government to slow the pace of growth of the Chinese economy could result in reduced demand for our products. A slowdown in overall economic growth, an economic downturn or recession or other adverse economic developments in the PRC may materially reduce the demand for our products and materially and adversely affect our business.

 

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The PRC government’s recent measures to curb inflation rates could adversely affect future results of operations.

 

In recent years, the Chinese economy has experienced periods of rapid expansion and high rates of inflation. Rapid economic growth can lead to growth in the money supply and rising inflation. China’s Consumer Price Index increased by 2.0% for full year of 2014 according to the National Bureau of Statistics of China, or the NBS. If prices for our products rise at a rate that is insufficient to compensate for the rise in the costs of supplies, it may have an adverse effect on profitability. These factors have led to the adoption by the Chinese government, from time to time, of various corrective measures designed to restrict the availability of credit or regulate growth and contain inflation. High inflation may in the future cause the Chinese government to impose controls on credit and/or prices, or to take other action, which could inhibit economic activity in China, and thereby harm the market for our products.

 

In recent years, the government of China has undertaken various measures to alleviate the effects of inflation, especially with respect to key commodities. From time to time, the PRC National Development and Reform Commission announces national price controls on various products. The government of China has also encouraged local governments to institute price controls products. Such price controls could adversely affect our future results of operations and, accordingly, the price of our common stock.

 

If relations between the United States and China deteriorate, our stock price may decrease and we may experience difficulties accessing the United States capital markets.

 

At various times during recent years, the United States and China have had disagreements over political and economic issues. Controversies may arise in the future between these two countries. Any political or trade controversies between the United States and China could impact the market price of our common stock and our ability to access United States capital markets.

 

The Chinese Government could change its policies toward private enterprises, which could result in the total loss of our investments in China.

 

Our business is subject to political and economic uncertainties in China and may be adversely affected by its political, economic and social developments. Over the past several years, the Chinese government has pursued economic reform policies including the encouragement of private economic activity and greater economic decentralization. The Chinese government may not continue to pursue these policies or may alter them to our detriment. Conducting our business might become more difficult or costly due to changes in policies, laws and regulations, or in their interpretation or the imposition of confiscatory taxation, restrictions on currency conversion, restrictions or prohibitions on dividend payments to stockholders, devaluations of currency or the nationalization or other expropriation of private enterprises. In addition, nationalization or expropriation could result in the total loss of our investments in China.

 

The Chinese State Administration of Foreign Exchange, or SAFE, requires Chinese residents to register with, or obtain approval from SAFE regarding their direct or indirect offshore investment activities.

 

China’s State Administration of Foreign Exchange Regulations regarding offshore financing activities by Chinese residents has undertaken continuous changes which may increase the administrative burden we face and create regulatory uncertainties that could adversely affect the implementation of our acquisition strategy. A failure by our shareholders who are Chinese residents to make any required applications and filings pursuant to such regulations may prevent us from being able to distribute profits and could expose us and our Chinese resident shareholders to liability under PRC law.

 

Our business, results of operations and overall profitability are linked to the economic, political and social conditions in China.

 

All of our business, assets and operations are located in China. The economy of China differs from the economies of most developed countries in many respects, including government involvement, level of development, growth rate, control of foreign exchange, and allocation of resources. The economy of China has been transitioning from a planned economy to a more market-oriented economy. Although the Chinese government has implemented measures emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets and the establishment of sound corporate governance in business enterprises, a substantial portion of productive assets in China is still owned by the Chinese government. In addition, the Chinese government continues to play a significant role in regulating industry by imposing industrial policies. It also exercises significant control over China’s economic growth through the allocation of resources, controlling payment of foreign currency denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. Therefore, the Chinese government’s involvement in the economy may negatively affect our business operations, results of operations and our financial condition.

 

16
 

 

If there will be any changes in PRC Law, the PRC legal system could limit our Company’s ability to enforce the Unified Management Agreement, which in turn may lead to reconsideration of the VIE assessment with respect to Longmen Joint Venture.

 

Prior to entering into the Unified Management Agreement, Longmen Joint Venture had been consolidated as our 60% directly owned subsidiary. Upon entering into the Unified Management Agreement on April 29, 2011, Longmen Joint Venture was considered to be a VIE of which we are the primary beneficiary and therefore we continue to consolidate Longmen Joint Venture.

 

We believe that the Unified Management Agreement between Longmen Joint Venture and Shaanxi Coal is in compliance with PRC law and is legally enforceable. The Board of Directors of Longmen Joint Venture continues to be the controlling decision-making body with respect to Longmen Joint Venture. We control 60% of the voting rights of the Board of Directors, and have control over the operations of Longmen Joint Venture. As such, we believe we have the power to control the activities of the VIE. However, uncertainties in the PRC legal system could limit our ability to enforce the Unified Management Agreement, which in turn, may lead to reconsideration of, and a different conclusion under the VIE assessment.

 

Governmental control of currency conversion may cause the value of your investment in our common stock to decrease.

 

The Chinese government imposes controls on the conversion of Renminbi or RMB into foreign currencies and, in certain cases, the remittance of currency out of China. We receive substantially all of our revenues in Renminbi, which is currently not a freely convertible currency. Shortages in the availability of foreign currency may restrict our ability to remit sufficient foreign currency to pay dividends, or otherwise satisfy foreign currency denominated obligations. Under existing Chinese foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from a transaction, can be made in foreign currencies without prior approval from China’s State Administration of Foreign Exchange by complying with certain procedural requirements. However, approval from appropriate governmental authorities is required where Renminbi is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of bank loans denominated in foreign currencies.

 

The Chinese government may also at its discretion restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay certain of our expenses as they come due.

 

Currency fluctuations and restrictions on currency exchanges may adversely affect our business, including limiting our ability to convert RMB into foreign currencies and, if RMB were to decline in value, reducing our revenue in U.S. dollar terms.

 

Our reporting currency is the U.S. dollar and our operations in China use their local currency as their functional currencies. Substantially all of our revenue and expenses are in Renminbi, or RMB. We are subject to the effects of exchange rate fluctuations with respect to local currencies. For example, the value of the RMB depends to a large extent on Chinese government policies and China’s domestic and international economic and political developments, as well as supply and demand in the local market. Prior to July 21, 2005, the official exchange rate for the conversion of RMB to the U.S. dollar had generally been stable and the RMB had appreciated slightly against the U.S. dollar. However, on July 21, 2005, the Chinese government changed its policy of pegging the value of RMB to the U.S. dollar. Under the new policy, RMB may fluctuate within a narrow and managed band against a basket of certain foreign currencies. The four main currencies in the basket are the U.S. dollar, the Euro, the Japanese yen and the Korean won. In the three years that followed, a slight appreciation against the U.S. currency occurred and by the end of October 2008, the RMB exchange rate with the U.S. dollar had risen to nearly 6.8 to the U.S. dollar. Since mid-2008, the RMB has been held stable as the Chinese government considers how best to respond to the global economic crisis. In June 2010, the temporary dollar peg was again abandoned, after the Chinese RMB rose approximately 16% against the Euro as a result of the Greek fiscal crisis. However, the Chinese government has signaled that going forward its currency will only be allowed to appreciate gradually against the dollar. It is possible that the Chinese government could adopt a more flexible currency policy, which could result in more significant fluctuation of RMB against the U.S. dollar. We can offer no assurance that RMB will be stable against the U.S. dollar or any other foreign currency. Our financial statements are translated into U.S. dollars at the average exchange rates in each applicable period. To the extent the U.S. dollar strengthens against foreign currencies, the translation of these foreign currency-denominated transactions results in reduced revenue, operating expenses and net income for our international operations. Similarly, to the extent the U.S. dollar weakens against foreign currencies, the translation of these foreign currency-denominated transactions results in increased revenue, operating expenses and net income for our international operations. We are also exposed to foreign exchange rate fluctuations as we convert the financial statements of our foreign consolidated subsidiaries into U.S. dollars in consolidation. If there is a change in foreign currency exchange rates, the conversion of the foreign consolidated subsidiaries’ financial statements into U.S. dollars will lead to a translation gain or loss which is recorded as a component of other comprehensive income. In addition, we have certain assets and liabilities that are denominated in currencies other than the relevant entity’s functional currency. Changes in the functional currency value of these assets and liabilities create fluctuations that will lead to a transaction gain or loss. We have not entered into agreements or purchased instruments to hedge our exchange rate risks, although we may do so in the future. The availability and effectiveness of any hedging transaction may be limited and we may not be able to hedge our exchange rate risks.

 

17
 

 

We are subject to environmental and safety regulations, which may increase our compliance costs and reduce our overall profitability.

 

We are subject to the requirements of environmental and occupational safety and health laws and regulations in China. We may incur substantial costs or liabilities in connection with these requirements. Additionally, these regulations may become stricter, which will increase our costs of compliance in a manner that could reduce our overall profitability. The capital requirements and other expenditures that may be necessary to comply with environmental requirements could increase and become a significant expense linked to the conduct of our business.

 

Our operating subsidiaries must comply with environmental protection laws that could adversely affect our profitability.

 

We are required to comply with the environmental protection laws and regulations promulgated by the national and local governments of China. Yearly inspections of waste treatment systems require the payment of a license fee which could become a penalty fee if standards are not maintained. If we fail to comply with any of these environmental laws and regulations in China, depending on the types and seriousness of the violation, we may be subject to, among other things, warning from relevant authorities, imposition of fines, specific performance and/or criminal liability, forfeiture of profits made, being ordered to close down our business operations and suspension of relevant permits.

 

Because the Chinese legal system is not fully developed, our legal protections may be limited.

 

The Chinese legal system is based upon written statutes. Prior court decisions may be cited for reference but are not binding on subsequent cases and have limited value as precedent. Since 1979, China’s legislative bodies have promulgated laws and regulations dealing with economic matters such as foreign investment, corporate organization and governance, commerce, taxation and trade. However, China has not developed a fully integrated legal system and the array of new laws and regulations may not be sufficient to cover all aspects of economic activities in China. In particular, because these laws and regulations are relatively new, and because of the limited volume of published decisions and their non-binding nature, the interpretation and enforcement of these laws and regulations involves uncertainties. In addition, published government policies and internal rules may have retroactive effects and, in some cases, the policies and rules are not published at all. As a result, we may be unaware of our violation of these policies and rules until sometime later. The laws of China govern our contractual arrangements with our affiliated entities and the enforcement of these contracts and the interpretation of the laws governing these relationships are subject to uncertainty.

 

In addition, our VIE and all of our subsidiaries that are incorporated in China are subject to all applicable PRC laws and regulations. Because of the relatively short period for enacting such a comprehensive legal system, the laws, regulations and legal requirements are relatively recent, and their interpretation and enforcement involve uncertainties. These uncertainties could limit the legal protections available to us and other foreign investors, including you, and may lead to penalties imposed on us because of the different understanding between the relevant authority and us. For example, according to current tax laws and regulations, we are responsible to pay business tax on a “Self-examination and Self-application” basis. However, since there is no clear guidance as to the applicability of certain preferential tax treatments, we may be found in violation of the interpretation of local tax authorities with regard to the scope of taxable services and the percentage of tax rate and therefore might be subject to penalties, including but not limited to, monetary penalties. In addition, we cannot predict the effect of future developments in the PRC legal system, including the promulgation of new laws, changes to existing laws or the interpretation or enforcement thereof, or the preemption of local regulations by national laws.

 

The resolution of these matters may be subject to the exercise of considerable discretion by agencies of the Chinese government, and forces unrelated to the legal merits of a particular matter or dispute may influence their determination. Any rights we may have to specific performance or to seek an injunction under PRC law, in either of these cases, are severely limited, and without a means of recourse by virtue of the Chinese legal system, we may be unable to prevent these situations from occurring. Although legislation in China over the past 30 years has significantly improved the protection afforded to various forms of foreign investment and contractual arrangements in China, these laws, regulations and legal requirements are relatively new and their interpretation and enforcement involve uncertainties, which could limit the legal protection available to us and foreign investors, including you.

 

18
 

 

The PRC State Administration of Foreign Exchange, or SAFE, restrictions on currency exchange may limit our ability to receive and use our sales revenue effectively and to pay dividends.

 

All of our sales revenues and expenses are denominated in RMB. Under PRC law, RMB is currently convertible under the “current account,” which includes dividends and trade and service-related foreign exchange transactions, but not under the “capital account,” which includes foreign direct investment and loans. 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 SAFE, by complying with certain procedural requirements. However, the relevant PRC government authorities may limit or eliminate our ability to purchase foreign currencies in the future. Since substantially all of our future revenue will be denominated in RMB, any existing and future restrictions on currency exchange may limit our ability to utilize revenue generated in RMB to fund our business activities outside China that are denominated in foreign currencies.

 

Foreign exchange transactions by PRC operating subsidiaries under the capital account continue to be subject to significant foreign exchange controls and require the approval of or need to register with PRC government authorities, including 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 our PRC operating subsidiaries by means of additional capital contributions, these capital contributions must be approved by certain government authorities, including the Ministry of Commerce People’s Republic of China, or their respective local counterparts. These limitations could affect our PRC operating subsidiaries’ ability to obtain foreign exchange through debt or equity financing.

 

The PRC government also may at its discretion restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining foreign currency, we may be unable to meet obligations that may be incurred in the future that require payment in foreign currency.

 

Under the EIT Law, as defined below, we may be classified as a “resident enterprise” of China, which would likely result in unfavorable tax consequences to us and our non-PRC shareholders.

 

Under China’s Enterprise Income Tax Law, or the “EIT Law”, and its implementing rules, which became effective in 2008, an enterprise established 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. Under the implementing rules of the New EIT Law, de facto management means substantial and overall management and control over the production and operations, personnel, accounting, and properties of the enterprise. Because the New EIT Law and its implementing rules are new, it is unclear how tax authorities will determine tax residency based on the facts of each case.

 

In April 2009, the State Administration of Taxation (“SAT”) issued a new circular to clarify the criteria for recognizing the resident enterprise status for Chinese controlled foreign companies. According to the Circular Regarding the Determination Criteria on Chinese Controlled Offshore Companies as Resident Enterprises (Circular Guoshuifa 2009 No. 82), if a foreign company simultaneously satisfies the following four criteria it will have resident enterprise status:

 

  · It constitutes a Chinese controlled foreign company and shall be deemed to be a PRC resident enterprise.
  · The premises where the senior management and the senior management bodies responsible for the routine production and business management of the enterprise perform their functions are mainly located within China.
  · The financial decisions (including, borrowing, lending, financing, financial risk management, etc.) and the personnel decisions (for example, appointment, dismissal, remuneration, etc.) of the enterprise are made by the bodies or persons within China or are subject to the approval of the bodies or persons within China.
  · The enterprise’s primary properties, accounting books, company seals, minutes and archives of the meetings of the board of directors and shareholders are located or preserved within China. The enterprise’s directors or senior management with fifty percent or more of the voting rights usually live in China.

 

19
 

 

Despite the issuance of the new clarifying circular referenced above, the application of these standards remains uncertain. If the PRC tax authorities determine that we are a “resident enterprise” for PRC enterprise income tax purposes, unfavorable PRC tax consequences could follow. First, we will be subject to enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations. Second, although under the EIT Law and its implementing rules dividends paid to us from our PRC subsidiaries would qualify as “tax-exempt income,” such dividends may 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 would result in a situation in which a 10% withholding tax is imposed on dividends we pay to our non-PRC shareholders and with respect to gains derived by our non-PRC shareholders from transferring our shares.

 

If we were treated as a “resident enterprise” by PRC tax authorities, we would be subject to tax in both the U.S. and China, and our PRC tax may not be creditable against our U.S. tax. In addition, we have not accrued any tax liability associated with the possible payment of dividends to our U.S. parent company. Such a tax would be an added expense appearing on our income statement, which would reduce our net income.

 

Failure to comply with the U.S. Foreign Corrupt Practices Act could subject us to penalties and other adverse consequences.

 

We are subject to the U.S. Foreign Corrupt Practices Act, or FCPA, which generally prohibits United States companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. In addition, we are required to maintain records that accurately and fairly represent our transactions and have an adequate system of internal accounting controls. Foreign companies, including some that may compete with us, are not subject to these prohibitions, and therefore may have a competitive advantage over us. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in the PRC. We can make no assurance that our employees or other agents will not engage in such conduct for which we might be held responsible. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties and other consequences that may have a material adverse effect on our business, financial condition and results of operations.

 

If we become 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 such allegations, which could harm our business operations, stock price and reputation, 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 our business operations will be severely impacted and your investment in our stock could be rendered worthless.

 

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 substantially all of our operations and business are located had 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 of 1933 and the Securities Exchange Act of 1934. Since substantially all of our operations and business takes place in China, it may be more difficult for the SEC to overcome the geographic and cultural obstacles 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 Chinese Securities Regulatory Commission, 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.

 

20
 

 

We make equity compensation grants to persons who are PRC citizens and they may be required to register with SAFE. We may also face regulatory uncertainties that could restrict our ability to adopt equity compensation plans for our directors and employees and other parties under PRC laws.

 

On March 28, 2007, SAFE issued the “Operating Procedures for Administration of Domestic Individuals Participating in the Employee Stock Ownership Plan or Stock Option Plan of An Overseas Listed Company,” also known as “Circular 78.” It is not clear whether Circular 78 covers all forms of equity compensation plans or only those which provide for the granting of stock options. For any plans which are so covered and are adopted by a non-PRC listed company, such as our Company, after March 28, 2007, Circular 78 requires all participants who are PRC citizens to register with and obtain approvals from SAFE prior to their participation in the plan. In addition, Circular 78 also requires PRC citizens to register with SAFE and make the necessary applications and filings if they participated in an overseas listed company’s covered equity compensation plan prior to March 28, 2007. We believe that the registration and approval requirements contemplated in Circular 78 are burdensome and time consuming.

 

We currently have an effective equity incentive plan and make numerous stock grants under the plan to our officers, directors and employees, some of whom are PRC citizens and may be required to register with SAFE. If it is determined that any of our equity compensation plans are subject to Circular 78, failure to comply with relevant provisions may subject us and participants of any such equity incentive plan who are PRC citizens to fines and legal sanctions and prevent us from being able to grant equity compensation to our PRC employees. In that case, our ability to compensate our employees and directors through equity compensation and to attract and retain employees and directors may be hindered and our business operations may be adversely affected.

 

Due to various restrictions under PRC law on the distribution of dividends by our PRC operating companies, we may not be able to pay dividends to our shareholders.

 

The Wholly-Foreign Owned Enterprise Law (1986) (“WFOE”), as amended and the Wholly-Foreign Owned Enterprise Law Implementing Rules (1990), as amended and the Company Law of the PRC (2006) contain the principal regulations governing dividend distributions by wholly foreign owned enterprises. Under these regulations WFOE’s may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. Additionally, a WFOE is required to set aside a certain amount of its accumulated profits each year, if any, to fund certain reserve funds. These reserves are not distributable as cash dividends, except in the event of liquidation, and cannot be used for working capital purposes.

 

Furthermore, if any of our consolidated subsidiaries in China incurs debt in the future, the instruments governing the debt may restrict our ability to pay dividends or make other payments. If we or our consolidated subsidiaries are unable to receive all of the revenues from our operations due to these contractual or dividend arrangements, we may be unable to pay dividends on our common stock. In addition, under WFOE regulations mentioned above, we must retain a reserve equal to 10 percent of net income after taxes, not to exceed 50 percent of registered capital. Accordingly, this reserve will not be available to be distributed as dividends to our shareholders. We presently do not intend to pay dividends in the foreseeable future. Our management intends to follow a policy of retaining all of our earnings to finance the development and execution of our strategy and the expansion of our business.

 

We may have difficulty establishing adequate management, legal and financial controls in the PRC.

 

The PRC historically has been deficient in western style management and financial reporting concepts and practices, as well as in modern banking and other control systems. We may have difficulty in hiring and retaining a sufficient number of qualified employees to work in the PRC. As a result of these factors, and especially given that we are an exchange listed company in the U.S. and subject to regulation as such, we may experience difficulty in establishing management, legal and financial controls, collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet western standards. As there is a shortage of well-educated and experienced professionals who have bilingual and bicultural backgrounds in China, especially in remote areas where our factories are located, we may experience high turnover in our staff. Therefore, we may, in turn, experience difficulties in implementing and maintaining adequate internal controls as required under Section 404 of the Sarbanes-Oxley Act and other applicable laws, rules and regulations. This may result in significant deficiencies or material weaknesses in our internal controls which could impact the reliability of our financial statements and prevent us from complying with SEC rules and regulations and the requirements of the Sarbanes-Oxley Act. Any such deficiencies, weaknesses or lack of compliance could have a material adverse effect on our results of operations and the public announcement of such deficiencies could adversely impact our stock price.

 

21
 

 

Risks Related to Our Common Stock

 

Our officers, directors and affiliates control us through their positions and stock ownership and their interests may differ from other stockholders.

 

Our officers, directors and affiliates beneficially own approximately 45.7% of our common stock. Mr. Zuosheng Yu, our major stockholder, beneficially owns approximately 45.0% of our common stock. Mr. Yu can effectively control us and his interests may differ from other stockholders.

 

All of our subsidiaries and substantially all of our assets are located outside the United States.

 

All our subsidiaries are located in China and substantially all of our assets are located outside the United States. It may therefore be difficult for investors in the United States to enforce their legal rights based on the civil liability provisions of the U.S. federal securities laws against us in the courts of either the United States or China and, even if civil judgments are obtained in United States courts, such judgments may not be enforceable in Chinese courts. Most of our directors and officers reside outside of the United States. It is unclear if extradition treaties now in effect between the United States and China would permit effective enforcement against us or our officers and directors of criminal penalties under the U.S. federal securities laws or otherwise.

 

We have never paid cash dividends and are not likely to do so in the foreseeable future.

 

We currently intend to retain any future earnings for use in the operation and expansion of our business. We do not expect to pay any cash dividends in the foreseeable future but will review this policy as circumstances dictate.

 

Our common stock is subject to price volatility unrelated to our operations.

 

The market price of our common stock could fluctuate substantially due to a variety of factors, including market perception of our ability to achieve our planned growth, quarterly operating results of other steel makers, trading volume in our common stock, changes in general conditions in the economy and the financial markets or other developments affecting our competitors or us. In addition, the stock market is subject to extreme price and volume fluctuations. This volatility has had a significant effect on the market price of securities issued by many companies for reasons unrelated to their operating performance and could have the same effect on our common stock.

 

Our failure to comply with conditions required for our common stock to be listed on the New York Stock Exchange (“NYSE”) could result in delisting of our common stock from the NYSE and have a significant negative effect on the value and liquidity of our securities as well as other matters.

 

On January 9, 2015, we received a notice from NYSE Regulations, Inc. that we were not in compliance with the continued listing standard set forth in Section 802.01B of the Listed Company Manual of the NYSE (the “Manual”). Noncompliance with Section 802.01B of the Manual (the “Market Cap Standard”) is due to the Company not maintaining an average market capitalization of at least fifty million dollars ($50,000,000.00) over a consecutive 30 trading-day period.  We have also in the past not been in compliance with the continued listing standard set forth in Section 802.01C of the Manual, which is triggered when the average closing price of the Company’s common stock is less than $1.00 over a consecutive 30 trading-day period.  As a result of the Company’s non-compliance with the Market Cap Standard, we submitted a business plan to the NYSE on February 23, 2015 that had been reviewed and approved by the NYSE. We remain subject to quarterly monitoring for compliance with both continued listing standards.

 

We are required to comply with all of the applicable continued listing standards set forth in the Manual as a condition for our common stock to continue to be listed on the NYSE. We intend to appeal any decision to delist our shares from the NYSE, but cannot provide any assurance that our appeal will be successful. Any such appeal will not stay the decision to delist our shares. If our common stock is delisted from the NYSE, such securities may be traded over-the-counter on the “pink sheets.” The alternative market, however, is generally considered to be less efficient than, and not as broad as, the NYSE. Accordingly, delisting of our common stock from the NYSE could have a significant negative effect on the value and liquidity of our securities. In addition, the delisting of such stock could adversely affect our ability to raise capital on terms acceptable to us or at all. In addition, delisting of our common stock may preclude us from using exemptions from certain state and federal securities regulations, including the SEC’s “penny stock” rules.

 

22
 

 

ITEM 1B. UNRESOLVED STAFF COMMENTS.

 

Not Applicable.

 

ITEM 2. PROPERTIES.

 

General Steel (China)

 

The properties of General Steel (China) consist of manufacturing sites and office buildings located in Jinghai county, about 20 miles (45 kilometers) southwest of the Tianjin city center on a total of 17.81 acres (7.21 hectares) of land, which includes 320,390 square feet (29,667 square meters) of building space.

 

Under PRC law, all land in China is owned by the government, which grants a “land use right” to an individual or entity after a purchase price for such “land use right” is paid to the government. The land use right allows the holder the right to use the land for a specified long-term period of time and enjoy all the ownership incidents to the land. We are the registered owner of the land use rights for the parcels of land identified in the chart below.

 

Registered Owner of
Land Use Right
  Location & Certificate of
Land Use Right
  Usage   Space
(acres)
    Life of Land
Use Right
  Remaining
Life
                       
Tianjin Daqiuzhuang Metal Sheet Co., Ltd   No. 6 West Gangtuan Road, Daqiuzhuang, Jinghai Country, Tianjin   Industrial Use     6.78     50 years   37 years
                         
Tianjin Daqiuzhuang Metal Sheet Co., Ltd   No. 35 Baiyi Road, Daqiuzhuang, Jinghai County, Tianjin   Industrial Use     9.89     50 years   37 years
                         
Tianjin Daqiuzhuang Metal Sheet Co., Ltd   Ying Feng Road North, Daqiuzhuang, Jinghai country Tianjin   Commercial Use     1.14     50 years   37 years

 

Longmen Joint Venture

 

The properties of Longmen Joint Venture consist of production and administrative sites located in various locations throughout the southern half of Shaanxi province on land totaling approximately 307 acres (124.4 hectares).

 

Longmen Joint Venture is the registered owner of the land use rights for the parcel of land identified in the chart below.

 

Registered Owner of
Land Use Right
  Location & Certificate
Of Land Use Right
  Usage   Space
(acres)
    Life of Land
Use Right
  Remaining
Life
                         
Longmen Joint Venture   North Huanyuan Road, Weiyang District, Xi'an, Shaanxi   Industrial Use     19.1     50 Years   32 Years
Longmen Joint Venture   Longmen Town, Hancheng, Shaanxi   Industrial Use     179.6     40-48 Years   32-36 Years*
Longmen Joint Venture   Sanping Village, Shipo Town, Zhashui County, Shaanxi   Industrial Use     103.2     50 Years   38 Years
Longmen Joint Venture   Zhaikouhe Village, Xunjian Town, Zhashui County, Shaanxi   Industrial Use     1.9     50 Years   37 Years
Longmen Joint Venture   East Taishi Avenue, Xincheng District, Hancheng, Shaanxi   Commercial Use     3.6     40 Years   28 Years

 

*This location consists of six land use rights with various remaining useful lives.

 

23
 

 

Maoming Hengda

 

The properties of Maoming Hengda consist of our production and administrative sites located in two separated sites inside Maoming city, Guangdong province, on land totaling approximately 240 acres (96.9 hectares).

 

Maoming Hengda is the registered owner of the land use rights for the parcels of land identified in the chart below.

 

Registered Owner
Of Land Use Right
  Location & Certificate
Of Land Use Right
  Usage   Space
(acres)
    Life of Land
Use
Right
  Remaining
Life
                         
Maoming Hengda   Diancheng Town,
Dianbai County, Maoming City, Industrial Zone of Bohe Port, Guangdong
  Industrial Use     240     50 Years   40 Years

 

 ITEM 3. LEGAL PROCEEDINGS.

 

From time to time, we are subject to certain legal proceedings, claims and disputes that arise in the ordinary course of our business. Although we cannot predict the outcomes of these legal proceedings, we do not believe these actions, in the aggregate, will have a material adverse impact on our financial position, results of operations or liquidity. We are currently not a party to any material legal proceedings.

 

ITEM 4. MINE SAFETY DISCLOSURES.

 

The information required by Item 4 is not applicable to us, as we have no mining operations in the United States.

 

PART II

 

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

 

Our common stock is listed on the New York Exchange under the symbol “GSI”. The high and low closing common stock price for each quarter of the last two years is as follows:

 

HIGH AND LOW SALES PRICES  1ST QTR   2ND QTR   3RD QTR   4TH QTR 
2013                    
High  $1.35   $1.12   $1.04   $1.09 
Low  $0.94   $0.94   $0.83   $0.85 
2014                    
High  $1.47   $1.32   $1.19   $1.06 
Low  $0.90   $0.90   $0.97   $0.64 

 

As of April 8, 2015, there were approximately 319 holders of record of our common stock. On the same date, the trading price of our common stock closed at $1.00 per share. 

 

Dividend Policy

 

Our Board of Directors currently does not intend to declare dividends or make any other distributions to our shareholders. Any determination to pay dividends in the future will be at our board’s discretion and will depend upon our results of operations, financial condition and prospects as well as other factors deemed relevant by our Board of Directors.

 

Recent Sales of Unregistered Sale Securities

 

None.

 

24
 

 

ITEM 6. SELECTED FINANCIAL DATA.

 

Not Applicable.

 

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

 

Forward-Looking Statements:

 

The following discussion of the financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes thereto included elsewhere in this Annual Report. The following discussion contains forward-looking statements. General Steel Holdings, Inc. is referred to herein as “we”, “our,” “us” and “the Company.” The words or phrases “would be,” “will allow,” “expect to”, “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” or similar expressions are intended to identify forward-looking statements. Such statements include those concerning our expected financial performance, our corporate strategy and operational plans. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of risks and uncertainties, including: (a) those risks and uncertainties related to general economic conditions in People’s Republic of China, including regulatory factors that may affect such economic conditions; (b) whether we are able to manage our planned growth efficiently and operate profitable operations, including whether our management will be able to identify, hire, train, retain, motivate and manage required personnel or that management will be able to successfully manage and exploit existing and potential market opportunities; (c) whether we are able to generate sufficient revenues or obtain financing to sustain and grow our operations; and (d) whether we are able to successfully fulfill our primary requirements for cash which are explained below under “Liquidity and Capital Resources” as well as other factors described in “Item 1A: Risk Factors” in this Annual Report. You should carefully review all of these factors, as well as the comprehensive discussion of forward-looking statements on page 4 of this Annual Report. Unless otherwise required by applicable law, we do not undertake, and we specifically disclaim any obligation, to update any forward-looking statements to reflect occurrences, developments, unanticipated events or circumstances after the date of such statement.

 

OVERVIEW

 

We were founded on the strategy to merge, partner with, and acquire State-owned enterprises and selected steel companies with great growth potential within China’s highly fragmented steel industry. As of December 31, 2014, we were comprised of three steel producing and processing subsidiaries/VIE of which Longmen Joint Venture is the largest. Located in Shaanxi province, Longmen Joint Venture contributed approximately 99.8% and 99.5% of our total revenue for the 2014 and 2013 fiscal years, respectively.

 

Fiscal year 2014 financial highlights:

 

  · Sales revenue decreased by $174.3 million, or (7.1)% year-over-year to $2.3 billion, down from $2.5 billion in 2013, mainly due to the decrease in average selling price of our rebar products despite an increase in our sales volume. For the year of 2014, sales volume in Longmen Joint Venture totaled 5.4 million metric tons, an increase of 0.3 million metric tons, or 6.3%, compared to 5.1 million metric tons in the year of 2013, with an average selling price of rebar of $422.2 per ton in the year of 2014, compared to $490.7 per ton in the year of 2013.

 

  · Gross loss in the year of 2014 totaled $(19.2) million, or (0.8)% of total revenue, as compared to $(55.9) million, or (2.3)% of total revenue in the year of 2013.

 

  · Total finance expenses in the year of 2014 were $96.7 million, as compared to $91.9 million in the year of 2013. Finance expenses mainly consisted of interest expense on capital lease, which was $21.3 million and $20.8 million in the year of 2014 and 2013, respectively, and interest expense on bank loans and discounted notes receivable, which was $75.4 million and $71.1 million in years of 2014 and 2013, respectively.

 

Fiscal year 2014 operational highlights:

 

·Fully utilized the two additional continuous rolling rebar production lines constructed at Longmen Joint Venture in 2013, to drive savings in unit production cost by the end of the first quarter of 2014.

 

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·In April 2014, we signed a direct purchase agreement with Rio Tinto to procure imported iron ore, which ensured timely deliveries of the highest quality imported iron ore and effectively lowered our sourcing costs.

 

·In June 2014, the Board approved our plan to accelerate business transformation by expanding our business scope to include other non-steel industries, to further utilize our proven corporate development team and sizable human capital, and increase overall profitability and return on investments. We signed a Memorandum of Understanding with Tewoo Group to co-develop bulk commodity e-commerce in October 2014; and established a RFID joint venture with an Expert Team to pursue Internet-of-Things opportunities in February 2015.

 

·During the fourth quarter of 2014, we upgraded an existing 450 cubic-meter blast furnace to a much larger and more efficient 1,800 cubic-meter blast furnace, as well as commissioned a newly built 450 square meter sintering machine at Longmen Joint Venture.

 

·On December 31, 2014, we sold our 80% stake in Baotou General Steel Special Steel Pipe Joint Venture Company Limited (“Baotou Steel Pipe Joint Venture”). The assets, liabilities and the operating results of Baotou Steel Pipe Joint Venture were immaterial to the Company’s consolidated financial statements as of and during the years ended December 31, 2014 and 2013. We believe the disposal of low-efficiency, non-core assets and restructure idle land resources will help to unlock their hidden fair value.

 

Our management remains committed to continually enhancing operations for our steel business or exploring different opportunities for the possibility of restructuring our steel business and unlocking considerable value for shareholders. Our growth strategy is a combination of optimizing operating efficiencies in our steel business and expanding and focusing into other high-growth and high-margin non-steel industries:

 

·We aim to drive profitability through improved operational efficiencies and optimization of our cost structure and continual cooperation and partnerships with leading state-owned enterprises (SOEs) or exploring different opportunities for the possibility of restructuring our steel business.
·We aim to expand and focus into other high-growth and high-margin non-steel industries, such as logistics and Internet-of-Things.

 

Due to the near-term challenges for the steel sector, we are strategically accelerating our business transformation. Our transformation strategy is to pursue opportunities that offer compelling benefits to our organization and shareholders, including:

 

·First, strengthen our financials while providing the financial flexibility to pursue higher return, higher growth opportunities;
·Second, reduce the complexity of our business structure, which is consistent with our objectives for internal simplification and operating efficiency;
·Third, diversify operating risk in order to lower our high reliance on steel business, while at the same time leverage on our vast vertical resources in the steel industry; and
·Fourth, pursue opportunities for additional value creation.

 

We formed a joint venture in February of 2015 with an RFID Expert team to develop and commercialize RFID technologies and data solutions. The formation of this joint venture represents a unique opportunity to accelerate our expansion into the vibrant logistics and Internet-of-Things sectors.

 

Industry Environment

 

Despite demand growth experienced throughout the past years, the overall nationwide steelmaking capacity still exceeds steel demand. There is significant over-capacity in the Chinese steel sector which is putting pressure on operators’ profitability and has become the most significant challenge in the steel manufacturing business. Chinese crude steel production reached a record high of 823 million tons in 2014, an increase of 0.89% over 2013, while the total consumption of crude steel was only 738 million tons in 2014, a decrease of 3.4% from the same period last year, according to the China Iron and Steel Association.

 

For steelmakers, operating performance depends on the volatility of the cost of raw materials. The shortage of these raw materials in the market has allowed suppliers of iron ore and metallurgical coal to rebuild the pricing mechanisms through the shift from annual to shorter-term price contracts. This has created numerous challenges for steelmakers as they must now deal with volatility in raw material prices, as well as maintain margins with fluctuating demand. Over the past few years, we have witnessed perseverance in steel prices that has given iron ore producers an opportunity to increase the prices in the next contract; however the reverse may not be true as steel companies cannot always pass on the rise in iron ore prices to end consumers due to the market overcapacity and fragmentation.

 

China’s steel industry is highly fragmented, and the Chinese government continues to encourage industry consolidation. The Chinese central government has had a long-stated goal to consolidate 60% of domestic steel production among the top ten producers by 2015, and expanding to 70% by 2020. The top ten producers’ output fell to 39% of the national output in 2013 from 49% in 2010, which is still below the 60% target for 2015 set in the 12th year plan.

 

Meanwhile, the Ministry of Industry and Information Technology of the People's Republic of China is targeting to cut up to 80 million metric tons of capacity by the end of 2018. In April 2012, the central government announced its goal of reducing obsolete iron and steel capacities by 17.8 million tons in 2012 and successfully reached the goal and eliminated 20.2 million tons of obsolete iron and steel capacity. In April 2013, the central government published the industry target of eliminating 10.4 million tons of obsolete iron and steel capacities in 2013 and successfully eliminated 16.9 million tons of obsolete iron and steel capacity. In May 2014, the government reaffirmed its determination of industry consolidation, and announced that it plans to eliminate 28.7 million tons of obsolete iron and steel capacity in 2014 and successfully eliminated 31.1 million tons, which was more than the original target amount. Such industry consolidation through the reduction of obsolete iron and steel capacities are not expected to directly impact our Company because we continue to see a strong demand for our products, especially in Western China, and believe there are significant growth opportunities in the industry and market we serve.

 

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Despite the government’s initiatives to encourage industry consolidation and cut over-capacity, it is estimated that new capacity of approximately 20~25 million metric tons was added in 2014. Excess supply, weakening economic growth, and sagging prices have resulted in depressed margins and operating losses. According to statistics by China Iron and Steel Association, the blended net margin of China steel enterprises in 2014 was only 0.85%, with approximately 15% of major steel companies monitored by China Iron and Steel Association still incurring operating losses.

 

On July 12, 2010, the Ministry of Industry & Information Technology Commission enacted the Steel Industry Admittance and Operation Qualifications standards. These new standards set forth requirements for all aspects of steel production in China, which include: size of blast furnaces, size of converters, emission of waste water, dust per ton from steel production, quantity of coal used for each process in steel production and output capacity.  According to the new standards, blast furnaces under 450 cubic meters are targeted to be eliminated. These standards once again confirmed the central government’s determination to push forward the consolidation of this fragmented industry.  

 

Since 2013, the Chinese government has exerted a more stringent environmental protection policy on the steel industry. In January 2014, the Ministry of Industry and Information Technology of the People's Republic of China (the "MIIT") announced a List of Enterprises Fulfilling the Iron and Steel Industry Specification (the "List").  The List includes a highly-selected group of large and medium steel manufacturers that have met or exceeded more stringent national requirements and standards on product quality, environmental protection, energy consumption, workmanship and equipment, production scale, as well as work safety and social responsibility. The MIIT will collaborate with China's other governmental agencies to provide support to the List's members and to speed up the steel industry's restructuring and consolidation. Steel makers omitted from the List will most likely face higher electricity costs, more restrictive administrative measures, and adverse effects of forceful regulations intent on reducing the nation's overcapacity. Longmen Joint Venture, the major facility of General Steel was included on the List as one of the key steel enterprises in China’s Shaanxi Province.

 

Due to the near-term challenges for the steel sector, we are strategically accelerating our business transformation. Our transformation strategy is to pursue opportunities that offer compelling benefits to our organization and shareholders, including:

 

·First, strengthen our financials while providing the financial flexibility to pursue higher return, higher growth opportunities;
·Second, reduce the complexity of our business structure, which is consistent with our objectives for internal simplification and operating efficiency;
·Third, diversify operating risk in order to lower our high reliance on steel business, while at the same time leverage on our vast vertical resources in the steel industry; and
·Fourth, pursue opportunities for additional value creation.

 

We formed a joint venture in February of 2015 with an RFID Expert team to develop and commercialize RFID technologies and data solutions. The formation of this joint venture represents a unique opportunity to accelerate our expansion into the vibrant logistics and Internet-of-Things sectors.

 

RESULTS OF OPERATIONS

 

Statements of Operations for the years ended December 31, 2014 and 2013:

 

(In thousands except share data)  2014   2013   Change   Percentage
Change
 
Sales  $2,289,412   $2,463,747   $(174,335)   (7.1)%
Cost of Goods Sold   2,308,578    2,519,685    (211,107)   (8.4)%
Gross Loss   (19,166)   (55,938)   36,772    (65.7)%
Gross Loss Margin %   (0.8)%   (2.3)%   1.5%     
Selling, General and Administrative Expenses   (78,555)   (84,226)   5,671    (6.7)%
Change in Fair Value of Profit Sharing Liability   91,018    174,569    (83,551)   (47.9)%
Income (Loss) from Operations   (6,703)   34,405    (41,108)   (119.5)%
                     
Other Expense, net   (71,304)   (76,676)   5,372    (7.0)%
Loss Before Provision for Income Taxes and Noncontrolling Interest   (78,007)   (42,271)   (35,736)   84.5%
Provision for Income Taxes   269    354    (85)   (24.0)%
Net Loss   (78,276)   (42,625)   (35,651)   83.6%
Less: Net Loss Attributable to Noncontrolling Interest   (29,553)   (9,609)   (19,944)   207.6%
Net Loss Attributable to General Steel Holdings, Inc.  $(48,723)  $(33,016)  $(15,707)   47.6%
Loss Per Share                    
Basic and Diluted  $(0.86)  $(0.60)  $(0.26)   43.3%

 

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Sales

 

Fiscal year ended December 31, 2014 compared to fiscal year ended December 31, 2013

 

Sales by Subsidiary and Product

 

(in thousands)     2014   2013   Change   Percentage
Change
 
Subsidiary  Product                    
Longmen Joint Venture  Rebar  $2,284,485   $2,450,256   $(165,771)   (6.8)%
Others      4,927    13,491    (8,564)   (63.5)%
Total Sales     $2,289,412   $2,463,747   $(174,335)   (7.1)%

 

(In thousand metric tons)     2014   2013   Change   Percentage
Change
 
Subsidiary  Product                    
Longmen Joint Venture  Rebar   5,411    4,994    417    8.4%
Others      12    106    (94)   (88.7)%
Total Sales Volume      5,423    5,100    323    6.3%

 

Total sales for the fiscal year 2014 decreased by $174.3 million or (7.1)% to $2.3 billion from $2.5 billion in 2013. The decrease in sales compared to 2013 was due to the decrease in average selling price of our rebar products. Longmen Joint Venture comprised 99.8% and 99.5% of total sales for the years ended 2014 and 2013, respectively.  Sales volume of rebar increased by 0.3 million metric tons, or 6.3% to 5.4 million metric tons, compared to 5.1 million metric tons in 2013. The average selling price of rebar decreased by 14.0% to approximately $422.2 per ton in 2014 from approximately $490.7 per ton in 2013.

  

As a result of the China and global steel industry over-capacity, Chinese economic control polices and weakened global economy, commodity prices dropped, and the price of steel had been on a declining trend from the third quarter of 2012 to 2014. The over-capacity issue impacted our results since the third quarter of 2012 and continued to do so in 2013 and 2014. At the same time, we strategically discounted our products in order to establish a foothold into neighboring markets and expand our presence in Western China in 2014. As such, our sales prices have shown a continued decline.

 

Our five major customers were distributors and collectively represented approximately 24.7% of our total sales for the year ended December 31, 2014 in comparison to 22.1% of our total sales for year ended December 31, 2013. These five customers included related parties and major distributors owned by the Chinese central government. As we are the largest supplier in Shaanxi Province, we maintain a good relationship with these five customers to stabilize our sales channel.

 

Cost of Goods Sold

 

Fiscal year ended December 31, 2014 compared with fiscal year ended December 31, 2013

 

 (in thousands)  2014   2013   Change   Percentage
Change
 
Subsidiary                    
Longmen Joint Venture  $2,303,981   $2,506,322   $(202,341)   (8.1)%
Others   4,597    13,363    (8,766)   (65.6)%
Total Cost of Goods Sold  $2,308,578   $2,519,685   $(211,107)   (8.4)%

 

Our primary cost of goods sold is the cost of raw materials, such as iron ore, coke, alloy and scrap steel. The costs of iron ore and coke account for approximately 65.8% of our total cost of sales. Cost of goods sold decreased by $211.1 million or (8.4)% to $2.3 billion in 2014 from $2.5 billion in 2013. This decrease was mainly driven by the decreased unit costs of raw materials as a result of the decline in iron ore and coke purchase prices of approximately 17.4% and approximately 18.6%, respectively, for the year ended December 31, 2014 as compared to the same period in 2013.

 

As such, the average costs of rebar manufactured decreased 15.2% to approximately $425.8 per ton during the year ended December 31, 2014 from approximately $501.9 per ton in the same period 2013.

 

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Gross Loss

 

Fiscal year ended December 31, 2014 compared to fiscal year ended December 31, 2013

 

(in thousands)  2014   2013   Change   Percentage
Change
 
Gross Loss  $(19,166)  $(55,938)  $36,772    (65.7)%
Gross Loss Margin   (0.8)%   (2.3)%          

 

Gross loss for the year of 2014 was $19.2 million, or (0.8)% of total sales, as compared to $55.9 million, or (2.3)% of total sales in the same period in 2013. The increase in gross margin percentage was mainly attributable to the percentage decrease in the cost of rebar manufactured of 15.2% being higher than the percentage decrease in the average rebar selling price of 14.0% for the year of 2014 as compared to the same period of 2013. As the cost of iron ore and coke decreased by 17.4% and 18.6% year-over-year, respectively, we were able to achieve leverage from the increased sales volume and expanded our gross margin in 2014 compared to 2013.

 

Gross Profit (Loss) and Gross Profit (Loss) Margin by Quarters

 

The over-capacity issue in the Chinese and global steel industry affected our results during 2013 and the Chinese economy remained weak, which indirectly affected our industry, and our selling prices suffered a decline during the first two quarters of 2013. At the same time, the prices of iron ore and coke, which accounted for the majority of our cost goods sold, had risen slightly at the beginning of 2013 before declining again in the second and third quarters of 2013. Consequently our selling prices in the second quarter of 2013 dropped below the cost of raw materials purchased earlier in the year, resulting in a gross loss. In the third quarter of 2013, demand and prices of our products rose slightly while unit cost declined further as a result of decreasing cost of raw materials purchased earlier in the year, leading to an increase in gross margins. However, the combination of a slight climb in raw material costs and Longmen Joint Venture’s production line stoppage due to mechanical repairs, which increased our unit cost, caused our unit cost of goods sold to increase above the unit selling price again, leading to a drop in gross margin in the fourth quarter of 2013.

 

As raw material costs for iron ore and coke continued to decline in the first two quarters of 2014 at a faster rate than rebar selling prices, our gross margin recovered to positive margin by the second quarter of 2014. By the third quarter of 2014, our gross margin declined slightly as we strategically discounted our products in order to establish a foothold into neighboring markets and expand our presence in Western China. In the fourth quarter of 2014, the Chinese steel market winter slow-down kicked in, and rebar selling prices decreased at a faster rate than the decrease in raw material costs, which led to a further decline in our gross margin.

 

Selling, General and Administrative Expenses

 

Fiscal year ended December 31, 2014 compared with fiscal year ended December 31, 2013

 

               Percentage 
(in thousands)  2014   2013   Change   Change 
                 
Selling, General and Administrative expenses  $(78,555)  $(84,226)  $5,671    (6.7)%
SG&A expenses as percentage of total revenue   (3.4)%   (3.4)%          

 

Selling, general and administrative (“SG&A”) expenses decreased by $5.7 million, or 6.7% to $78.6 million for the year ended December 31, 2014, compared to $84.2 million for of the same period in 2013.

 

Selling expenses decreased by 0.1% to $34.08 million for the year ended December 31, 2014 as compared to $34.13 million in the same period of 2013. The decrease was mainly due to the decrease in sales tax expense along with the decrease in sales for the year ended December 31, 2014 as compared to 2013, which was offset by an increase in freight expense for the year ended December 31, 2014 as we expanded sales into neighboring provincial markets.

 

In addition, general and administrative (“G&A”) expenses decreased by 11.2% to $44.5 million for the year ended December 31, 2014 as compared to $50.1 million in the same period of 2013. The decrease was mainly due to Longmen Joint Venture decreased employee base salaries and employee training expenses during 2014.

 

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Change in Fair Value of Profit Sharing Liability

 

Fiscal year ended December 31, 2014 compared with fiscal year ended December 31, 2013

 

(in thousands)  2014   2013   Change   Change % 
                
Change in fair value of profit sharing liability (gain (loss))  $91,018   $174,569    (83,551)   (47.9)%

 

For 2013, we considered the recent changes in China’s economic situation, which included a new estimation and downgrade of 2014 GDP by major investment bankers in June 2013, and a steel industry outlook reports issued for 2014. Also, there was a tightening of the monetary policy by the Chinese policy makers since June 20, 2013 by increasing the short-term borrowing rates of approximately 1% in China, and removal of the floor rate charged to customers by the Chinese central bank. As a result, we re-evaluated our projected operating profit (loss) taking into consideration the recent macroeconomic events in China, as well as our fourth quarter and year to date operating results. Due to the continued decrease in our rebar selling price, the market slow-down in the fourth quarter of 2013, and the lack of gross profit recovery as quickly as expected in the year ended December 31, 2013, we foresaw a greater downward trend in 2014 through 2016 than previously anticipated. As our projected profit (loss) decreased, the fair value of our profit sharing liability was reduced as compared to our previous estimates in 2012 and we recognized a gain of $174.6 million in our income from operations for the year ended December 31, 2013.

 

In September 2014, Goldman Sachs published its latest global economic forecast, which showed a greater downgrade of China’s GDP growth rate from 2014 to 2017 than projected in prior year. Thus we re-evaluated our projected operating profit (loss) taking into consideration both the projected GDP downgrade in China and our recent operating results in the third quarter of 2014. On January 20, 2015, the International Monetary Fund (“IMF”) published its latest “World Economic Outlook,” in which it downgraded its projected 2015 and 2016 GDP% for China from its October 2014 projections mainly as a result of China’s sluggish infrastructure investment and consumption growth in 2014 and the downgrade in overall world economic forecast. Thus we re-evaluated our projected operating profit (loss) taking into consideration both the latest projected GDP downgrade in China and our recent operating results in the fourth quarter of 2014. As a result, we recognized a gain of $91.0 million on the change in the fair value of the profit sharing liability primarily due to the reduction in the fair value of profit sharing liability as a result of the change in estimate of future operating results for the year ended December 31, 2014.

 

Income (Loss) from Operations

 

Fiscal year ended December 31, 2014 compared to fiscal year ended December 31, 2013

 

( in thousands)  2014   2013   Change   Percentage
Change
 
Income (Loss) from Operations  $(6,703)  $34,405   $(41,108)   (119.5)%

 

Loss from operations for the year ended December 31, 2014 was $(6.7) million as compared to $34.4 million income from operations for the same period in 2013. The decrease in income from operations was predominantly due to decrease in the gain from change in fair value of profit sharing liability offset by the decrease in gross loss and SG&A expenses.

 

Total Other Income (Expense), Net

 

Fiscal year ended December 31, 2014 compared with fiscal year ended December 31, 2013

 

Other Income (Expense)

 

(in thousands)  2014   2013   Change   Percentage
Change
 
Interest Income  $21,700   $11,214   $10,486    93.5%
Finance/Interest Expense   (75,421)   (71,079)   (4,342)   6.1%
Financing Cost on Capital Lease   (21,252)   (20,799)   (453)   2.2%
Gain (Loss) on Disposal of Equipment and Intangible Assets   (1,125)   424    (1,549)   (365.3)%
Government Grant   327    4,216    (3,889)   (92.2)%
Income from Equity Investments   139    203    (64)   (31.5)%
Foreign Currency Transaction (Loss) Gain   786    1,394    (608)   (43.6)%
Lease income   2,175    2,158    17    0.8%
Gain on deconsolidation of a subsidiary   1,795    1,011    784    77.5%
Payment for public highway construction   -    (6,462)   6,462    (100.0)%
Other non-operating income (expense), net   (428)   1,044    (1,472)   (141.0)%
Total Other Expense, Net  $(71,304)  $(76,676)  $5,372    (7.0)%

 

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Total other expense, net for the year ended December 31, 2014 were $71.3 million compared to $76.7 million in 2013. The decrease of $5.4 million or 7.0% was mainly a result of the $10.5 million increase in interest income and $6.5 million decrease in payment for public highway construction offset by $4.3 million increase in finance/interest expense, $1.5 million decrease in gain on disposal of equipment and $3.9 million decrease in gain from government grant. Interest income increased by 93.5% in 2014 compared to 2013 mainly as a result of increased loans receivable, including related parties, in 2014 compared to 2013. Interest expense for early submission request of payment increased by $11.4 million or 30.1% to $49.3 million for the year ended December 31, 2014 from $37.9 million for the year ended December 31, 2013. The increase in discounted interest on notes receivable in 2014 as compared to 2013 was mainly due to more conversions of notes receivable before maturity date into cash for financing our operations in 2014 as compared to 2013. Short-term loan interest expense decreased by $7.1 million to $26.1 million from $33.2 million in 2013 mainly as a result of decreased borrowings from banks, which offered higher interest rates than unrelated and related party business lenders, during 2014 as compared to 2013.

 

Income Taxes

 

For the years ended December 31, 2014 and 2013, we had a total tax provision from our profitable subsidiaries of $0.3 million and $0.4 million, respectively. For the years ended December 31, 2014 and 2013, we evaluated the deferred tax assets and concluded the net operating loss may not be fully realizable and provided 100% valuation allowance for the deferred tax assets. No deferred income tax benefit was recorded for the year ended December 31, 2014 as the resulting deferral of tax assets had been fully reserved because the benefit was not considered to be realizable due to recent historical experience.

 

For the years ended December 31, 2014 and 2013, we had effective tax rates of (0.3)% and of (0.8)%, respectively. The negative effective tax rates for the years ended December 31, 2014 and 2013 were mainly due to a consolidated loss before income tax while we provided 100% valuation allowance for the deferred tax assets at subsidiaries with losses and incurred income tax expenses in our profitable subsidiaries.

   

Net Loss

 

Fiscal year ended December 31, 2014 compared with fiscal year ended December 31, 2013

 

( in thousands)  2014   2013   Change   Percentage
Change
 
Net loss  $(78,276)  $(42,625)  $(35,651)   83.6%

 

Net Loss Attributable to General Steel Holdings, Inc.

 

Fiscal year ended December 31, 2014 compared to fiscal year ended December 31, 2013

 

( in thousands)  2014   2013   Change   Percentage
Change
 
                 
Net loss  $(78,276)  $(42,625)  $(35,651)   83.6%
Less: Net loss attributable to noncontrolling interest   (29,553)   (9,609)   (19,944)   207.6%
Net loss attributable to General Steel Holdings, Inc.  $(48,723)  $(33,016)  $(15,707)   47.6%

  

Net loss attributable to us for the year ended December 31, 2014 increased to $48.7 million compared to $33.0 million for the year ended December 31, 2013. The increase in net loss attributable to us for the year ended December 31, 2014 was mainly a result of a decrease in $83.6 million in the change in fair value of profit sharing liability, offset by a $36.8 million decrease in gross loss, a $5.7 million decrease in SG&A expense, a $5.4 million decrease in other expense, net and a $19.9 million increase in net loss attributable to noncontrolling interest for the year ended December 31, 2014 as compared to the same period in 2013.

 

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We have subsidiaries in which we do not have a 100% ownership interest. Allocation of income or loss to these non-controlling interests is based on the percentage of their equity investment times the subsidiaries’ net income or loss.

  

LIQUIDITY AND CAPITAL RESOURCES

 

As of December 31, 2014, our current liabilities exceeded the current assets by approximately $1.3 billion. Given our expected capital expenditure in the foreseeable future, we have comprehensively considered our available sources of funds as follows:

 

  · Financial support and credit guarantee from related parties; and

 

  · Other available sources of financing from domestic banks and other financial institutions given our credit history.

 

Based on the above considerations, our Board of Directors is of the opinion that we have sufficient funds to meet our working capital requirements and debt obligations as they become due. However, this opinion is based on the demand of our products, economic conditions, the overcapacity issue in the steel industry and our operating results not continuing to deteriorate and on our vendors and related parties being able to provide continued liquidity.  Therefore, as noted in the Liquidity and Going Concern section below, this raises substantial doubt about our ability to continue as a going concern.

 

As of December 31, 2014, we had cash and restricted cash aggregating $367.3 million, of which $355.7 million was restricted. As of December 31, 2013, we had cash and restricted cash aggregating $431.3 million, of which $399.3 million was restricted.

 

The steel business is capital intensive and we utilize leverage greater than our industry peers, which we believe enables us to generate revenue compared to our shareholder equity at a rate higher than our industry peers. We utilize leverage in the form of credit from banks, vendor financing, customer deposits and from other sources. This blended form of financing reduces our reliance on any single source.

 

Substantially all our operations are conducted in China and all of our revenues are denominated in Renminbi (RMB). RMB is subject to the exchange control regulation in China, and, as a result, we may have difficulty distributing any dividends outside of China due to PRC exchange control regulations that restrict its ability to convert RMB into U.S. Dollars.

 

Under applicable PRC regulations, foreign-invested enterprises in China may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, a foreign-invested enterprise in China is required to set aside at least 10.0% of its after-tax profit based on PRC accounting standards each year to its general reserves until the accumulative amount of such reserves reaches 50.0% of its registered capital. These reserves are not distributable as cash dividends. The board of directors of a foreign-invested enterprise has the discretion to allocate a portion of its after-tax profits to staff welfare and bonus funds, which may not be distributed to equity owners except in the event of liquidation. Under PRC law, RMB is currently convertible into U.S. Dollars under a company’s “current account,” which includes dividends, trade and service-related foreign exchange transactions, without prior approval of the State Administration of Foreign Exchange (SAFE), but is not from a company’s “capital account,” which includes foreign direct investments and loans, without the prior approval of the SAFE.

 

We have previously raised money in the U.S. capital markets which provided the capital needed for our operations and for General Steel Investment Co, Ltd. (“General Steel Investment”). Thus the foreign currency restrictions and regulations in the PRC on the dividends distribution will not have a material impact on the liquidity, financial condition and results of operations of General Steel Holdings, Inc. and General Steel Investment.

 

Although the steel industry is slowing down due to over-capacity issues in the PRC, in order for us to stay competitive, we continue to look for opportunities to improve the efficiency on our production lines. In addition to the 1,200,000 metric ton capacity rebar production renovation of an existing 800,000 metric ton capacity rebar production line that we brought online in November 2010, in July 2011, we also brought online a 1,000,000 metric ton capacity high speed wire production line. These two newly installed production lines were both relocated from the Maoming Hengda (as defined below) facility and are expected to consume less energy when running at maximum efficiencies compared to our previous production line. In September 2012 we began the construction of a 900,000 metric ton capacity rebar production line, which was completed and put into production in September 2013. In March 2013, we began the construction of a 1,200,000 metric ton capacity rebar production line for the purpose of reducing our reprocessing cost and to increase our profit margin. The 1,200,000 metric ton capacity rebar production lines was completed and put into test production in November 2013. Any future facility expansion will require additional financing and/or equity capital and will be dependent upon the availability of financing arrangements and capital at the time.

 

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Short-term Notes Payable

 

As of December 31, 2014, we had $661.6 million in short-term notes payables, which are secured by restricted cash of $339.4 million. These are lines of credit extended by banks for a maximum of six months and are used to finance working capital. The short-term notes payable must be paid in full at maturity and credit availability is continued upon payment at maturity. There are no additional significant financial covenants. We pay zero interest on this type of credit as this is a monetary tool used by China’s central bank to control liquidity over the Chinese monetary system. However, we are subject to pay a transaction fee of 0.05% of the notes’ value. In addition, the banks usually require us to deposit either a certain amount of cash at the bank as a guarantee deposit or provide notes receivable as security.

 

Short-term Loans – Banks

 

As of December 31, 2014, we had $257.5 million in short-term bank loans. We believe our current creditors will renew their loans to us after our loans mature as they did in the past. Longmen Joint Venture has been included in the List of Enterprises Fulfilling the Iron and Steel Industry Specification (the "List") released by the MIIT in January 2014. The MIIT will collaborate with China's other governmental agencies to provide various supports to the List's members, which includes financing supports from the banks.

 

We are able to repay our short-term notes payables and short term bank loans upon maturity using available capital resources.

 

For more details about our debts, please see Note 10 in our Notes to the consolidated financial statements included in this Annual Report.

 

For more details about our related party debt financing, see Note 20 in our Notes to the consolidated financial statements included in this Annual Report.

 

As part of our working capital management, Longmen Joint Venture has entered into a number of sale and purchase back contracts (“Contracts”) with third party companies and two 100% owned subsidiaries of Longmen Joint Venture, named Yuxin Trading Co., Ltd. (“Yuxin”) and Yuteng Trading Co., Ltd. (“Yuteng”). Pursuant to the Contracts, Longmen Joint Venture sells rebar to the third party companies at a certain price, and within the same month, Yuxin and Yuteng will purchase back the rebar from the third party companies at a price of 4.6% to 12.0% higher than the original selling price from Longmen Joint Venture (this transaction is referred to as “financing sales”). Based on the Contract terms, Longmen Joint Venture is paid in advance for the rebar sold to the third party companies and Yuxin and Yuteng are given a credit period of several months to one year from the third party companies. There is no physical movement of the inventory during the sale and purchase back arrangement. A margin of between 4.6% and 12.0% is determined by reference to the bank loan interest rates at the time when the Contracts are entered into, plus an estimated premium based on the financing sale amount, which represents the interest charged by the third party companies for financing Longmen Joint Venture through the above sale and purchase back arrangement. As such, the revenue and cost of goods sold arising from the above transactions are recorded on a net basis and the incremental amounts paid by Yuxin and Yuteng to purchase back the goods are treated as financing costs in the consolidated financial statements.

 

Total financing sales for the years ended December 31, 2014 and 2013 amounted to $922.6 million and $724.3 million, respectively, which were eliminated in our consolidated financial statements. The financial cost related to financing sales for the year ended December 31, 2014 and 2013, accounted to $4.2 million and $5.4 million, respectively.

 

 Liquidity and Going Concern

 

Our accounts have been prepared assuming that we will continue as a going concern basis. The going concern basis assumes that assets are realized and liabilities are extinguished in the ordinary course of business at amounts disclosed in the financial statements. Our ability to continue as a going concern depends upon aligning our sources of funding (debt and equity) with our expenditure requirements and repayment of the short-term debt facilities as and when they become due. The steel business is capital intensive and as a normal industry practice in PRC, our Company is highly leveraged. Debt financing in the form of short term bank loans, loans from related parties, financing sales, bank acceptance notes, and capital leases have been utilized to finance the working capital requirements and the capital expenditures of our Company. As a result, our debt to equity ratio as of December 31, 2014 and 2013 were (5.6) and (6.5), respectively. As of December 31, 2014, our current liabilities exceed current assets (excluding deferred lease income) by $1.3 billion, which raises substantial doubt about our ability to continue as a going concern.

 

Our steel business has faced very tough market conditions and challenging profitability over the last several years, and based on current trends, we think the near-term challenges for the steel sector will likely linger. In reaction to this challenging market, we are proactively reviewing our strategy and asset portfolio and seeking to restructure low-efficient, non-core assets, as well as idle land resources to unlock hidden fair value.

 

We aim to transform into a leaner and fitter organization with better profitability. As such, we are strategically accelerating our business transformation to pursue opportunities that offer compelling benefits to our organization and shareholders, including:

 

·First, strengthen our financials while providing the financial flexibility to pursue higher return, higher growth opportunities;
·Second, reduce the complexity of our business structure, which is consistent with our objectives for internal simplification and operating efficiency;
·Third, diversify operating risk in order to lower our high reliance on steel business, while at the same time leverage on our vast vertical resources in the steel industry; and
·Fourth, pursue opportunities for additional value creation.

 

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Management has implemented the following plans that are intended to mitigate the conditions or events that raise substantial doubt about the Company’s ability to continue as a going concern.

 

Longmen Joint Venture, as our most important subsidiary, accounted for a majority of our total sales. As such, the majority of our working capital needs to come from Longmen Joint Venture. Our ability to continue as a going concern depends heavily on Longmen Joint Venture’s operations. Longmen Joint Venture has obtained different types of financial supports, which include line of credit from banks, vendor financing, financing sales, other financing and sales representative financing.

 

For more details and terms about our financial supports, see Note 2(d) in our Notes to the consolidated financial statements included in this Annual Report.

 

With the financial support from the banks and the companies, management is of the opinion that we have sufficient funds to meet our future operations, working capital requirements and debt obligations until the end of December 31, 2015. However, this opinion is based on the demand of our products, economic conditions, the overcapacity issue in the steel industry and our operating results not continuing to deteriorate and on our vendors and related parties being able to provide continued liquidity, as summarized below. The detailed breakdown of Longmen Joint Venture’s estimated cash flows items are listed below.

 

   Cash inflow (outflow)
(in millions)
 
   For the twelve months ended
December 31, 2015
 
Estimated current liabilities over current assets (excluding deferred lease income) as of December 31, 2014  $(1,278.8)
Projected cash financing and outflows:     
Cash provided by line of credit from banks   141.7 
Cash provided by vendor financing   896.0 
Cash provided by other financing   363.3 
Cash provided by sales representatives   20.4 
Cash projected to be used in operations in the twelve months ended December 31, 2015   (37.2)
Cash projected to be used for financing cost in the twelve months ended December 31, 2015   (50.1)
Net projected change in cash for the twelve months ended December 31, 2015  $55.3 

 

Cash-flow

 

Operating activities

 

Net cash provided by operating activities for the year ended December 31, 2014 was $137.9 million compared to $163.9 million used in operating activities for the year ended December 31, 2013. This change was mainly due to the combination of the following factors:

 

The impact of non-cash items included in net loss was $34.3 million in the year ended December 31, 2014, compared to $(69.1) million for the same period in 2013. The non-cash items are the following:

 

  - Depreciation, amortization and depletion;
  - Change in fair value of derivative liabilities;
  - Gain/loss on disposal of equipment and intangible assets;
  - Provision (recovery) for doubtful accounts;
  - Reservation of mine maintenance fee;
  - Stock issued for services and compensation;
  - Amortization of deferred financing cost on capital lease;
  - Income from equity investments;

 

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  - Foreign currency transaction gain/loss;
- Gain on deconsolidation of a subsidiary;
  - Deferred lease income; and
  - Change in fair value of profit sharing liability.

 

The other primary reasons for the material fluctuations in cash inflow from operations are as follows:

 

  - Notes receivable: The decrease of notes receivable was mainly due to our acceptance of fewer notes receivables as a substitute for cash receipts during year ended December 31, 2014;
  - Other receivables - related parties: The decrease in other receivables – related parties was mainly due to the increase in business related expenses imbursement and advances returned to the Company with related parties during the year ended December 31, 2014;
  - Inventories: The decrease in inventories in the year of 2014 was mainly due to the decrease in the price of raw materials during the year, which also decreased finished goods cost;
  - Advance on inventory purchases – related parties: The decrease in advance on inventory purchases to related parties was mainly due to more advances being paid to third party vendors instead of related parties for the year ended December 31, 2014.
  - Accounts payable: The increase in accounts payable was mainly due to Longmen Joint Venture paying less to its suppliers as compared to the same period in 2013. Pursuant to the supplier financing agreements signed between Longmen Joint Venture and its suppliers, those suppliers agreed not to demand certain cash payment for a period of time under the agreements;
  - Other payables and accrued liabilities: The increase in other payables and accrued liabilities was mainly due to Longmen Joint Venture incurring more miscellaneous payables to third parties during the year ended December 31, 2014; and
  - Customer deposits, including related parties: The increase in customer deposits, including related parties was mainly due to more of our customers making prepayment to us prior to the end of 2014. These deposits were subsequently recognized as sales after December 31, 2014 in accordance with our sales recognition policy.

 

The primary reasons for the material fluctuations in cash outflows are as follows:

 

  - Accounts receivable, including related parties: The increase was mainly due to more credit sales to both third parties and related parties were incurred that have not yet been collected for the year ended December 31, 2014 compared with the same period in 2013;
  - Other receivables: The increase was mainly due to an increase in receivables incurred with third parties for cash flow purpose for doing business on our behalf;
  - Advances on inventory purchases: The increase was mainly due to the fact that more advance payments were made for raw material purchases to meet future production capacity. Advance payment is a prevailing requirement on iron ore purchases in the steel production industry;
  - Prepaid expense and other: The increase was mainly due to more prepayments being made for miscellaneous expenses at the end of 2014 compared to the prior year;
  - Accounts payable – related parties: The decrease in accounts payable – related parties was mainly due to Longmen Joint Venture making fewer purchases from related parties during the year ended December 31, 2014 compared with the same period in 2013. Pursuant to the supplier financing agreements signed between Longmen Joint Venture and its suppliers, those suppliers agreed not to demand certain cash payments for a certain period; and
  - Other payables – related parties: The decrease in other payables – related parties was mainly due to an increase in payments to various related parties for the year ended December 31, 2014 compared to the prior year.

 

Investing activities

 

Net cash used in investing activities was $229.0 million and $105.8 million for the year ended December 31, 2014 and 2013, respectively. Cash inflow from investing activities mainly came from the decrease in our restricted cash used as a pledge for our notes payable as required by banks and the increase in loan receivable repayment from related parties during 2014. The increase in cash provided was partially offset by the increase in loans to unrelated parties. We also incurred additional spending on equipment purchase of $239.6 million mainly for the construction of a new blast furnace and miscellaneous production support facilities.

 

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Financing activities

 

Net cash provided by financing activities was $70.6 million for the year ended December 31, 2014 compared to $254.0 million for the year ended December 31, 2013. The increase of cash inflow from financing activities was mainly driven by the following:

 

  - Notes receivable - restricted: The decrease in notes receivable – restricted was mainly due to less notes receivable was used as guarantee for notes payable and bank loans during the year ended December 31, 2014; and
  - Long term loans – related party: We borrowed more long term loans from related party during the year ended December 31, 2014.

 

The cash inflow was offset by the following cash outflow:

 

  - Short term notes payable: We repaid more short term notes payable during the year ended December 31, 2014 compared to the prior year;
  - Short term loans: We repaid more money to banks, unrelated parties and related parties during the year ended December 31, 2014 as short term loans became due;
  - Deposits due to sales representatives: We repaid more deposits to third party sales representatives during the year ended December 31, 2014; and
  - Capital lease obligation: we made more principal payment on capital lease obligations during the year ended December 31, 2014.

 

Restrictions on our ability to distribute dividends

 

Substantially all of our assets are located within the PRC. Under the laws of the PRC governing foreign invested enterprises, dividend distribution and other funds transfers are allowed but subject to special procedures under relevant rules and regulations. Foreign-invested enterprises in China may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, a foreign-invested enterprise in China is required to set aside at least 10.0% of its after-tax profit based on PRC accounting standards each year to its general reserves until the accumulative amount of such reserves reaches 50.0% of its registered capital. These reserves are not distributable as cash dividends. The board of directors of a foreign-invested enterprise has the discretion to allocate a portion of its after-tax profits to staff welfare and bonus funds, which may not be distributed to equity owners except in the event of liquidation. Under PRC regulations, RMB is currently convertible into U.S. Dollars under a company’s “current account” which includes dividends, trade and service-related foreign exchange transactions, without prior approval of the State Administration of Foreign Exchange (SAFE). Transfers from a company’s “capital account,” which includes foreign direct investments and loans, can’t be executed without the prior approval of the SAFE.

 

There are no restrictions to distribute or transfer other funds from General Steel Investment to us.

 

We have never declared or paid any cash dividends to our shareholders. We do not plan to pay any dividends out of our retained earnings for the year ended December 31, 2014. With respect to retained earnings accrued after such date, our Board of Directors may declare dividends after taking into account our operations, earnings, financial condition, cash requirements and availability and other factors as it may deem relevant at such time. Any declaration and payment, as well as the amount, of dividends will be subject to our By-Laws, charter and applicable Chinese and U.S. state and federal laws and regulations, including the approval from the shareholders of each subsidiary which intends to declare such dividends, if applicable.

 

We have previously raised money in the U.S. capital markets which has provided the capital needed for our operations and investments activities. Thus, the foreign currency restrictions and regulations in the PRC on the dividends distribution will not have a material impact on our liquidity, financial condition, and results of operation.

  

Impact of Inflation

 

We are subject to commodity price risks arising from price fluctuations in the market prices of the raw materials. We have generally been able to pass on cost increases through price adjustments. However, the ability to pass on these increases depends on market conditions influenced by the overall economic conditions in China. We manage our price risks through productivity improvements and cost-containment measures. We do not believe that inflation risk is material to our business or our financial position, results of operations or cash flows.

 

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Compliance with environmental laws and regulation

 

Longmen Joint Venture:

 

In 2005, we received ISO 14001 certification for our overall environmental management system. We have received several awards from the Shaanxi provincial government as a result of our increased effort in environmental protection.

 

We have a comprehensive waste water recycling and water treatment system. The 2,000 cubic meter/h treatment capacity systems were implemented at the end of 2005. In 2010, 0.9 metric tons of new water was consumed per metric ton of steel produced.

 

We have one 10,000 cubic meter coke-oven gas tank, one 50,000 cubic meter blast furnace coal gas tank and one 80,000 cubic meter converter furnace coal gas tank to collect the residual coal gas produced from our facility and that of surrounding enterprises. We also have spent $35.6 million (RMB 230 million) on a thermal power plant with two 25 Kilowatt generators that use the residual coal gas from the blast furnaces and converters as fuel to generate power.

 

We have several plants to further process solid waste generated from the steel making process into useful products such as construction materials, building blocks, porcelain tiles, curb tops, ornamental tiles, as well as other products.

 

In 2009, we treated and recycled about 6.8 million tons of waste water, 335,320 tons of slag, 130 million m³ of gas from the converters and 6.1 billion m³ of gas from the blast furnaces. We also reused 855,714 tons of hot steam and generated 433 million KWH of electricity.

 

During 2010 and 2011, more than $9.6 million (RMB 60 million) was used on the technical upgrade and renovation of our converters and $0.88 billion (RMB 5.5 billion) was spent on the upgrade of the blast furnaces and sintering machines.

 

In 2012, we installed desulfidation equipment for two sintering machines, which started operating in June 2012.

  

OFF-BALANCE SHEET ARRANGEMENTS

 

There were no off-balance sheet arrangements for the 2014 fiscal year that have or that in the opinion of management are likely to have, a current or future material effect on our financial condition or results of operations.

 

Contractual Obligations and Commercial Commitments

 

We have certain fixed contractual obligations and commitments that include future estimated payments. Changes in our business needs, cancellation provisions, changing interest rates, and other factors may result in actual payments differing from the estimates. We cannot provide certainty regarding the timing and amounts of payments. Throughout our operating history, we have funded our contractual obligations and commercial commitments through financing arrangements and operating cash flow, including, but not limited to, the operating income, payments collected from the customers in advance and stock issuances. Below, we have presented a summary of the most significant contractual obligations and commercial commitments in the tables, in order to assist in the review of this information within the context of our consolidated financial position, results of operations, and cash flows.

 

The following tables summarize our contractual obligations as of December 31, 2014 and the effect these obligations are expected to have on our liquidity and cash flows in future periods.

 

   Principal due by period     
       Less than             
Contractual obligations  Total   1 year   1-3 years   3- 5 years   5 years after 
   (in thousands)     
Note payable  $661,635   $661,635   $-   $-   $- 
Bank loans   257,502    257,502    -    -    - 
Other loans, including related parties   107,097    107,097    -    -    - 
Deposits due to sales representatives, including related parties   20,380    20,380    -    -    - 
Operating lease obligations   50,137    3,109    3,900    2,540    40,588 
Construction obligations - Longmen Joint Venture   7,996    7,996    -    -    - 
Long term loan – Shaanxi Steel   339,549    -    339,549    -    - 
Capital lease obligations   401,760    8,508    144,599    27,617    221,036 
Profit sharing liability   70,422    -    -    -    70,422 
Total  $1,916,478   $1,066,227   $488,048   $30,157   $332,046 

 

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Bank loans in the PRC are due either on demand or, more typically, within one year. These loans can be renewed with the banks subject to bank’s credit reevaluation. This amount includes estimated interest payments as well as principal repayment.

 

As of December 31, 2014, Longmen Joint Venture guaranteed bank loans for related parties and third parties, including lines of credit, amounting to $103.4 million, as follows:

 

Nature of guarantee  Guarantee
amount
   Guaranty Expiration Date
   (In thousands)    
Line of credit  $100,265   Various from January 2015 to August 2017
Financing by the rights of goods delivery in future   3,095   June 2015
Total  $103,360    

 

As of December 31, 2014, we did not accrue any liability for the amount guaranteed for third and related parties because those parties are current in their payment obligations and we have not experienced any loss from providing guarantees. We evaluated the debt guarantees and concluded that the likelihood of having to make payments under the guarantees is remote and that the fair value of the stand-ready obligation under these commitments is not material.

 

Critical Accounting Policies

 

Management’s discussion and analysis of its financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. Our financial statements reflect the selection and application of accounting policies which require management to make significant estimates and judgments. See Note 2 to our consolidated financial statements, “Summary of Significant Accounting Policies.” Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

 

We believe that the following reflect the more critical accounting policies that currently affect our financial condition and results of operations.

 

Principles of consolidation – subsidiaries

 

The accompanying consolidated financial statements include the financial statements of our Company, our subsidiaries, our variable interest entity (“VIE”) for which we are the ultimate primary beneficiary, and the VIE’s subsidiaries.

 

The consolidated financial statements have been prepared on a historical cost basis to reflect the financial position and results of operations of our Company in accordance with the generally accepted accounting principles in the United States of America (“U.S. GAAP”).

 

Subsidiaries are those entities in which our Company, directly or indirectly, controls more than one half of the voting power; or has the power to govern the financial and operating policies, to appoint or remove the majority of the members of the board of directors, or to cast a majority of votes at the meeting of directors. 

 

A VIE is an entity in which our Company, or our subsidiary, through contractual arrangements, bears the risks of, and enjoys the rewards normally associated with, ownership of the entity, and therefore our Company or our subsidiary is the primary beneficiary of the entity.

 

All significant inter-company transactions and balances have been eliminated upon consolidation.

 

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Consolidation of VIE

 

Prior to entering into the Unified Management Agreement on April 29, 2011, Longmen Joint Venture had been consolidated as our 60% direct owned subsidiary. Upon entering into the Unified Management Agreement on April 29, 2011, Longmen Joint Venture was re-evaluated by us to determine if Longmen Joint Venture is a VIE and if we are the primary beneficiary.

 

Longmen Joint Venture’s equity at risk is considered insufficient to finance its activities and therefore Longmen Joint Venture is considered to be a VIE.

 

We would be considered the primary beneficiary of the VIE if it has both of the following characteristics:

 

  a. The power to direct the activities of the VIE that most significantly impact the VIE’s economic performance; and
  b. The obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE.

 

A Supervisory Committee was formed during the negotiation of the Unified Management Agreement. Given there is both a Supervisory Committee and a Board of Directors with respect to Longmen Joint Venture , the powers (rights and roles) of both bodies were considered to determine which party has the power to direct the activities of Longmen Joint Venture, and by extension, whether we continue to have the power to direct Longmen Joint Venture’s activities after this Supervisory Committee was formed and the significant investment in plant and equipment by owners of the Longmen Joint Venture partner. The Supervisory Committee, in which we hold 2 out of 4 seats, requires a ¾ majority vote, while the Board of Directors, on which we hold 4 out of 7 seats, requires a simple majority vote. As the Supervisory Committee’s role is limited to supervising and monitoring management of Longmen Joint Venture and in the event there is any disagreement between the Board and the Supervisory Committee, the Board prevails, the Supervisory Committee is considered subordinate to the Board. Thus, the Board of Directors of Longmen Joint Venture continues to be the controlling decision-making body with respect to Longmen Joint Venture. We, which controls 60% of the voting rights of the Board of Directors, have control over the operations of Longmen Joint Venture and as such, have the power to direct the activities of the VIE that most significantly impact Longmen Joint Venture’s economic performance.

 

In connection with the Unified Management Agreement, we, Shaanxi Coal and Shaanxi Steel may provide such support on a discretionary basis or as needed in the future. See Note 2(d) Liquidity.

 

We have the obligation to absorb losses and the rights to receive benefits based on the profit allocation as stipulated by the Unified Management Agreement that are significant to the VIE. As both conditions are met, we are the primary beneficiary of Longmen Joint Venture and therefore, continue to consolidate Longmen Joint Venture as a VIE.

 

We believe that the Unified Management Agreement between Longmen Joint Venture and Shaanxi Coal is in compliance with PRC law and is legally enforceable. However, PRC law and/or uncertainties in the PRC legal system could limit our ability to enforce the Unified Management Agreement, which in turn, may lead to reconsideration of the VIE assessment and the potential for a different conclusion. If the Unified Management Agreement cannot be enforced, we would not consolidate Longmen Joint Venture as a VIE. However, the current PRC legal system has not limited our ability to enforce the Unified Management Agreement nor do we believe it is likely to do so in the future. We make an ongoing assessment to determine whether Longmen Joint Venture is a VIE.

 

Longmen Joint Venture has two 100% owned subsidiaries, Yuxin Trading Co., Ltd. (“Yuxin”) and Yuteng Trading Co., Ltd. (“Yuteng”). Longmen Joint Venture has two consolidated subsidiaries, Hualong Fire Retardant Material Co., Ltd. (“Hualong”) and Beijing Huatianyulong International Steel Trading Co., Ltd. (“Huatianyulong”), in which it does not hold a controlling interest. Hualong and Huatianyulong are separate legal entities which were established in the PRC as limited liability companies and subsequently invested in by Longmen Joint Venture in June 2007 and July 2008, respectively. However, these two entities do not meet the definition of variable interest entities. Further consideration was given to whether consolidation was appropriate under the voting interest model, specifically where the power of control may exist with a lesser percentage of ownership (i.e. less than 50%), for example, by contract, lease, agreement with other stockholders or by court decree.

 

Hualong

 

Longmen Joint Venture, the single largest shareholder, holds a 36.0% equity interest in Hualong. The other two shareholders, who own 34.67% and 29.33% respectively, assigned their voting rights to Longmen Joint Venture in writing at the time of the acquisition of Hualong. The voting rights have been assigned through the date Hualong ceases its business operation or the other two shareholders sell their interest in Hualong. Hualong’s main business is to supply refractory. The assets, liabilities and the operating results of Hualong are immaterial to our consolidated financial statements as for and during the years ended December 31, 2014 and 2013.

  

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Huatianyulong

 

Longmen Joint Venture holds a 50.0% equity interest in Huatianyulong and the other unrelated shareholder holds the remaining 50.0%. The other shareholder assigned its voting rights to Longmen Joint Venture in writing at the time of acquisition of Huatianyulong. The voting rights have been assigned through the date Huatianyulong ceases its business operation or the other unrelated shareholder sells its interest in Huatianyulong. Huatianyulong mainly sells imported iron ore. The assets, liabilities and the operating results of Huatianyulong are immaterial to our consolidated financial statements as for and during the years ended December 31, 2014 and 2013.

 

We have determined that it is appropriate for Longmen Joint Venture to consolidate Hualong and Huatianyulong with appropriate recognition in our financial statements of the non-controlling interests in each entity, beginning on the acquisition dates as these were also the effective dates of the agreements with other stockholders granting a majority voting rights in each entity, and thereby, the power of control, to Longmen Joint Venture. \.

 

Revenue recognition

 

We follow U.S. GAAP regarding revenue recognition. Sales revenue is recognized at the date of shipment to customers when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, we have no other significant obligations and collectability is reasonably assured. Payments received before all of the relevant criteria for revenue recognition are recorded as customer deposits. Sales revenue represents the invoiced value of goods, net of value-added tax (VAT). All our products sold in the PRC are subject to a Chinese VAT at a rate of 13% to 17% of the gross sales price. This VAT may be offset by VAT paid by us on raw materials and other materials included in the cost of producing the finished product.

 

We infrequently engage in trading transactions in which we act as an agent between the suppliers and the customers. The trading arrangements are such that the suppliers are the primary obligors, we do not have any general inventory risk, physical inventory loss risk or credit risk, and we do not have latitude in establishing price. Sales and cost of goods sold from these trading arrangements are recorded at the net amount in accordance with ASC 605-45.

 

Accounts receivable, other receivables and allowance for doubtful accounts

 

Accounts receivable include trade accounts due from customers and other receivables from cash advances to employees, related parties or third parties. An allowance for doubtful accounts is established and recorded based on managements’ assessment of potential losses based on the credit history and relationships with the customers. Management reviews its receivable on a regular basis to determine if the bad debt allowance is adequate, and adjusts the allowance when necessary. Delinquent account balances are written-off against allowance for doubtful accounts after management has determined that the likelihood of collection is not probable.

 

Useful lives of plant and equipment

 

Plant and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets with a 3%-5% residual value. The depreciation expense on assets acquired under capital leases is included with depreciation expense on owned assets.

 

The estimated useful lives are as follows:

 

Buildings and Improvements     10-40 Years  
Machinery     10-30 Years  
Machinery under capital lease     10-20 Years  
Other equipment     5 Years  
Transportation Equipment     5 Years  

 

We have re-evaluated the useful lives of depreciation and amortization to determine whether subsequent events and circumstances warrant any revisions.

 

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Impairment of long-lived assets

 

The carrying values of long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Based on the existence of one or more indicators of impairment, we measure any impairment of long-lived assets using the projected undiscounted cash flow method, which includes future cash inflows less associated cash outflows that are directly associated with and that are expected to arise as a direct result of the use and eventual disposition of the assets. The estimation of future cash flows requires significant management judgment based on our historical results and anticipated results and is subject to many factors.

 

The discount rate that is commensurate with the risk inherent in our business model is determined by our management. An impairment charge would be recorded if we determined that the carrying value of long-lived assets may not be recoverable. The impairment to be recognized is measured by the amount by which the carrying values of the assets exceed the fair value of the assets. We used the discounted cash flows model to determine the fair value of these assets. The key assumptions that were included in the model are projected selling units and growth in the steel market, projected unit selling price in the steel market, projected unit purchase cost in the coal and iron ore markets, selling and general and administrative expenses to be in line with the growth in the steel market, and projected bank borrowings. We believed these assumptions provided us the best estimates of projecting our future cash flows on these assets, net of any related cash outflow of our cost, expenses and taxes in related to these revenues. The estimated fair value of these assets may be lower than their current fair value, thus could result in future impairment charge if potential events occur to further reduce the current selling price or product demand in the steel market or increase our cost that are associated with our revenues. In addition, competitive pricing pressure and changes in interest rates could materially and adversely affect our estimates of future net cash flows to be generated by our long-lived assets, and thus could result in future impairment losses.

 

As of December 31, 2014, the fair value of our plant and equipment, which was estimated using the undiscounted cash flow method, exceeded our carrying value of these assets by approximately 18.2%.

 

Use of estimates

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Significant accounting estimates reflected in our financial statements include the useful lives of and impairment for property, plant and equipment, potential losses on uncollectible receivables, the recognition of contingent liabilities, the interest rate used in financing sales, the fair value of the assets recorded under capital lease, the present value of the net minimum lease payments of the capital lease and the fair value of the profit share liability. Actual results could differ from these estimates.

 

Financial instruments

 

The accounting standard regarding “Disclosures about fair value of financial instruments” defines financial instruments and requires disclosure of the fair value of financial instruments held by us. We consider the carrying amount of cash, accounts receivable, other receivables, accounts payable and accrued liabilities to approximate their fair values because of the short period of time between the origination of such instruments and their expected realization. For short-term loans and notes payable, we concluded the carrying values are a reasonable estimate of fair value because of the short period of time between the origination and repayment and their stated interest rate approximates current rates available.

 

We also analyze all financial instruments with features of both liabilities and equity under the accounting standard establishing, “accounting for certain financial instruments with characteristics of both liabilities and equity,” the accounting standard regarding “accounting for derivative instruments and hedging activities” and “accounting for derivative financial instruments indexed to, and potentially settled in, a company’s own stock.” Additionally, we analyze registration rights agreements associated with any equity instruments issued to determine if penalties triggered for late filing should be accrued under accounting standard establishing “accounting for registration payment arrangements.”

 

Fair value measurements

 

The accounting standards regarding fair value of financial instruments and related fair value measurement define fair value, establish a three-level valuation hierarchy for disclosures of fair value measurement and enhance disclosures requirements for fair value measures. The three levels are defined as follow:

 

Level 1: inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

 

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Level 2: inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.

 

Level 3: inputs to the valuation methodology are unobservable and significant to the fair value.

 

We analyze all financial instruments with features of both liabilities and equity, pursuant to which warrants previously issued by us were required to be recorded as a liability at fair value and marked to market each reporting period. The warrants were accounted for as derivative liabilities and recorded at their fair value, with the change in fair value charged or credited to income each period.  The warrants expired unexercised on May 13, 2013. Prior to their expiration, the fair value of the warrants was estimated using a binomial lattice model, using level 3 inputs.

 

We determined that the carrying value of the profit sharing liability using Level 3 inputs by taking consideration of the present value of our projected profits/losses with the discount interest rate of 6.9% based on our average borrowing rate. The projected profits/losses in Longmen Joint Venture were based upon, but not limited to, the following assumptions until April 30, 2031:

 

  · projected selling units and growth in the steel market;
  · projected unit selling price in the steel market;
  · projected unit purchase cost in the coal and iron ore markets;
  · selling and general and administrative expenses to be in line with the growth in the steel market;
  · projected bank borrowing;
  · interest rate index;
  · gross nation product index;
  · industry index; and
  · government policy.

 

Income tax

 

We did not conduct any business and did not maintain any branch office in the United States during the years ended December 31, 2014 and 2013. Therefore, no provision for withholding of U.S. federal or state income taxes has been made. The tax impact from undistributed earnings from overseas subsidiaries is not recognized as there is no intension for future repatriation of these earnings.

 

General Steel (China) is located in Tianjin Costal Economic Development Zone and is subject to an income tax rate of 25%.

 

Longmen Joint Venture is located in the Mid-West Region of China. It qualifies for the “Go-West” tax rate of 15% promulgated by the government. In 2010, the central government announced that the “Go-West” tax initiative was extended for 10 years, and thus, the preferential tax rate of 15% will be in effect until 2020. This special tax treatment will be evaluated on a year-to-year basis by the local tax bureau.

 

Maoming Hengda is located in Guangdong Province and is subject to an income tax rate of 25%.

 

For the years ended December 31, 2014 and 2013, we had total tax provisions of $0.3 million and $0.4 million, respectively.

 

Deferred lease income

 

From June 2009 to March 2011, we worked with Shaanxi Steel to build new state-of-the-art equipment at the site of Longmen Joint Venture. To compensate Longmen Joint Venture for costs and economic losses incurred during construction of the new iron and steel making facilities owned by Shaanxi Steel, Shaanxi Steel reimbursed Longmen Joint Venture $11.4 million (RMB 70.1 million) in the fourth quarter of 2010 for the value of assets dismantled and rent under a 40-year property sub-lease that was entered into by the parties in June 2009, and $29.8 million (RMB 183.1 million) for the reduced production efficiency caused by the construction. In addition, in 2010 and 2011, Shaanxi Steel reimbursed Longmen Joint Venture $14.6 million (RMB 89.5 million) and $14.6 million (RMB 89.3 million), respectively, for trial production costs related to the new iron and steel making facilities.

 

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During the period June 2010 to March 2011, as construction progressed and certain of the assets came online, Longmen Joint Venture used the assets free of charge to produce saleable units of steel products during this period. As such, the cost of using these assets was imputed with reference to what the depreciation charge would have been on these assets had they been owned or under capital lease to Longmen Joint Venture during the free use period. This cost of $7.2 million (RMB 43.9 million) each year were deferred and will be recognized over the term of the land sub-lease similar to the other charges and credits related to the construction of these assets.

 

The deferred lease income is amortized to income over the remaining term of the 40-year land sub-lease.

 

Capital lease obligations

 

Iron and steel production facilities

 

On April 29, 2011, our subsidiary, Longmen Joint Venture entered into a Unified Management Agreement with Shaanxi Steel and Shaanxi Coal under which Longmen Joint Venture uses new iron and steel making facilities including one sintering machine, two converters, two blast furnaces and other auxiliary systems constructed by Shaanxi Steel. As the 20-year term of the agreement exceeds 75% of the assets’ useful lives, this arrangement is accounted for as a capital lease. The ongoing lease payments are comprised of two elements: (1) a monthly payment based on Shaanxi Steel’s cost to construct the assets of $2.3 million (RMB 14.6 million) to be paid over the term of the Unified Management Agreement of 20 years; and (2) 40% of any remaining pre-tax profits from the Asset Pool which includes Longmen Joint Venture and the newly constructed iron and steel making facilities. In February 2014, Shaanxi Steel agreed that it would not demand capital lease payment from Longmen Joint Venture until February 2017. The profit sharing component does not meet the definition of contingent rent because it is based on future revenue and is therefore considered part of the financing for the capital leased assets which is related to the Unified Management Agreement. For purposes of determining the value of the leased asset and obligation at the inception of the lease, the lease liability is then reduced by the value of the profit sharing component, which is recognized as a separate financial liability carried at fair value. See Note 17 – “Profit sharing liability”.

 

Energy-saving equipment

 

During 2013, our subsidiary, Longmen Joint Venture, entered into capital lease agreements for energy-saving equipment to be installed throughout the production chain. Under these agreements, Longmen Joint Venture uses the energy-saving equipment for which the vendors are responsible for the design, purchase, installation, and on-site testing, as well as the ownership rights to the equipment during the lease periods. The lease periods, which vary between four to six years, begin upon the completion of the equipment installation, testing, and the issuance of the energy-saving rate reports to be agreed upon by both the vendors and Longmen Joint Venture. As the ownership rights of the equipment transfer to Longmen Joint Venture at the end of the lease periods, these agreements are accounted for as capital leases.

 

The minimum lease payments are based on the energy cost saved during the lease periods, which is determined by the estimated annual equipment operating hours per the lease agreements. If the actual annual equipment operating hours are less than the estimated amount, the lease periods may be extended, subject to further negotiation and agreement between us and the vendors. If the actual annual equipment operating hours exceed the estimated amount, we are obligated to pay the additional lease payment based on the additional energy cost saved during the lease period and recognize the additional lease payments as contingent rent expense. As of December 31, 2014, $23.9 million (RMB $146.5 million) energy-saving equipment under these lease agreements have been capitalized and no contingent rent expense has been incurred.

  

Profit sharing liability

 

The profit sharing liability is recognized initially at its estimated fair value at the lease commencement date and included in the initial measurement and recognition of the capital lease in addition to the fixed payment component of the minimum lease payments. This financial instrument is accounted for separately from the lease accounting (Note 16 - “Capital lease obligation” to the Notes to Consolidated Financial Statements) and has met the definition of a derivative instrument under ASC 815-10-15-83; as such, the profit sharing liability is treated as a derivative liability. The value of the profit sharing liability will be reassessed each reporting period with any change in fair value accounted for on a prospective basis. Refer to Note 2(i) – “Financial instruments” to the Notes to Consolidated Financial Statements for details.

 

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Based on the performance of the Asset Pool, no profit sharing payment, which is not required until net cumulative profits are achieved, was made for the years ended December 31, 2014 and 2013. Payments to Shaanxi Steel for the profit sharing are made based on net cumulative profits.

 

Recently Issued Accounting Pronouncements 

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers: Topic 606. This Update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards. The guidance in this Update supersedes the revenue recognition requirements in Topic 605, Revenue Recognition and most industry-specific guidance. The core principle of the guidance is that an entity should recognize revenue to illustrate the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new guidance also includes a cohesive set of disclosure requirements that will provide users of financial statements with comprehensive information about the nature, amount, timing, and uncertainty of revenue and cash flows arising from a reporting organization’s contracts with customers. This ASU is effective retrospectively for fiscal years, and interim periods within those years beginning after December 15, 2016 for public companies and 2017 for non-public entities. Management is evaluating the effect, if any, on our financial position and results of operations. 

 

In November 2014, FASB issued ASU No. 2014-17, Business Combinations (Topic 805):  Pushdown Accounting (a consensus of the FASB Emerging Issues Task Force.  The amendments in this update provide an acquired entity with an option to apply pushdown accounting in its separate financial statements upon occurrence of an event in which an acquirer obtains control of the acquired entity.  An acquired entity may elect the option to apply pushdown accounting in the reporting period in which the change-in-control event occurs.  An acquired entity should determine whether to elect to apply pushdown accounting for each individual change-in-control event in which an acquirer obtains control of the acquired entity.  If pushdown accounting is not applied in the reporting period in which the change-in-control event occurs, an acquired entity will have the option to elect to apply pushdown accounting in a subsequent reporting period to the acquired entity’s most recent change-in-control event.  An election to apply pushdown accounting in a reporting period after the reporting period in which the change-in-control event occurred should be considered a change in accounting principle in accordance with Topic 250, Accounting Changes and Error Corrections.  If pushdown accounting is applied to an individual change-in-control event, that election is irrevocable. The amendments in this ASU are effective on November 18, 2014.  After the effective date, an acquired entity can make an election to apply the guidance to future change-in-control events or to its most recent change-in-control event.  However, if the financial statements for the period in which the most recent change-in-control event occurred already have been issued or made available to be issued, the application of this guidance would be a change in accounting principle.  The adoption of ASU 2014-17 did not have a material impact on our consolidated financial statements.

 

In January 2015, FASB issued ASU No. 2015-01, Income Statement—Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items.  This Update is issued as part of its initiative to reduce complexity in accounting standards (the Simplification Initiative). The objective of the Simplification Initiative is to identify, evaluate, and improve areas of generally accepted accounting principles (GAAP) for which cost and complexity can be reduced while maintaining or improving the usefulness of the information provided to the users of financial statements. This Update eliminates from GAAP the concept of extraordinary items.  The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the amendments prospectively. A reporting entity also may apply the amendments retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The effective date is the same for both public business entities and all other entities.  We do not expect the adoption of ASU 2015-01 to have material impact on our consolidated financial statements.

 

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In February 2015, FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. This Update focuses on the consolidation evaluation for reporting organizations that are required to evaluate consolidation of certain legal entities by reducing the number of consolidation models from four to two and is intended to improve current GAAP. The amendments in the ASU are effective beginning after December 15, 2016. We do not expect the adoption of ASU 2015-02 to have a material impact on our consolidated financial statements.

  

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

 

Not Applicable.

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

 

GENERAL STEEL HOLDINGS, INC.

CONSOLIDATED FINANCIAL STATEMENTS

Index to consolidated financial statements

  

 

Page

Number 

   
Report of Independent Registered Public Accounting Firm – Friedman LLP 46 
   
Consolidated Balance Sheets as of December 31, 2014 and 2013 47
   
Consolidated Statements of Operations and Comprehensive Loss for the years ended December 31, 2014 and 2013 48
   
Consolidated Statements of Changes in Deficiency for the years ended December 31, 2014 and 2013 49
   
Consolidated Statements of Cash Flows for the years ended December 31, 2014 and 2013 50
   
Notes to Consolidated Financial Statements 51

 

45
 

 logo

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

 

 

To the Board of Directors and Stockholders

General Steel Holdings, Inc.

 

 

We have audited the accompanying consolidated balance sheets of General Steel Holdings, Inc. and Subsidiaries (the “Company”) as of December 31, 2014 and 2013, and the related consolidated statements of operations and comprehensive loss, changes in deficiency and cash flows for the years then ended. General Steel Holdings, Inc.’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits 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 audits 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 audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of General Steel Holdings, Inc. and Subsidiaries as of December 31, 2014 and 2013, and the consolidated results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

 

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As more fully discussed in Note 2(d) to the consolidated financial statements, the Company has an accumulated deficit, has incurred a gross loss from operations, and has a working capital deficiency at December 31, 2014. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans regarding this matter are also described in Note 2(d). The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. If the Company is unable to successfully obtain and receive the alternative forms of financing specified in Note 2(d) and/or achieve operating profitability, there could be a material adverse effect on the Company.

 

 

 

/s/ Friedman LLP

 

New York, New York

April 10, 2015

  

 

  

46
 

 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

(In thousands)

  

   December 31,   December 31, 
   2014   2013 
ASSETS          
           
CURRENT ASSETS:          
Cash  $11,641   $31,967 
Restricted cash   355,685    399,333 
Notes receivable   10,290    60,054 
Restricted notes receivable   111,801    395,589 
Loan receivable   36,001    - 
Loan receivable - related party   34,713    4,540 
Accounts receivable, net   9,321    4,078 
Accounts receivable - related parties, net   8,498    2,942 
Other receivables, net   63,746    54,716 
Other receivables - related parties, net   39,670    54,106 
Inventories   156,327    212,921 
Advances on inventory purchase, net   73,819    44,897 
Advances on inventory purchase - related parties   45,617    83,003 
Prepaid expense and other   4,803    1,388 
Prepaid taxes   5,789    28,407 
Short-term investment   2,688    2,783 
TOTAL CURRENT ASSETS   970,409    1,380,724 
           
PLANT AND EQUIPMENT, net   1,543,136    1,271,907 
           
OTHER ASSETS:          
Advances on equipment purchase   11,438    6,409 
Investment in unconsolidated entities   16,823    16,943 
Long-term deferred expense   458    668 
Intangible assets, net of accumulated amortization   22,960    23,707 
TOTAL OTHER ASSETS   51,679    47,727 
           
TOTAL ASSETS  $2,565,224   $2,700,358 
           
LIABILITIES AND DEFICIENCY          
           
CURRENT LIABILITIES:          
Short term notes payable  $661,635   $1,017,830 
Accounts payable   612,801    434,979 
Accounts payable - related parties   207,783    235,692 
Short term loans - bank   257,502    301,917 
Short term loans - others   60,717    62,067 
Short term loans - related parties   46,380    126,693 
Current maturities of long-term loans - related party   -    53,013 
Other payables and accrued liabilities   55,488    45,653 
Other payable - related parties   87,252    94,079 
Customer deposits   92,974    87,860 
Customer deposits - related parties   132,616    64,881 
Deposit due to sales representatives   17,871    24,343 
Deposit due to sales representatives - related parties   2,509    1,997 
Taxes payable   5,201    4,628 
Deferred lease income, current   2,176    2,187 
Capital lease obligations, current   8,508    4,321 
TOTAL CURRENT LIABILITIES   2,251,413    2,562,140 
           
NON-CURRENT LIABILITIES:          
Long-term loans - related party   339,549    19,644 
Deferred lease income, noncurrent   72,713    75,257 
Capital lease obligations, noncurrent   393,252    375,019 
Profit sharing liability at fair value   70,422    162,295 
TOTAL NON-CURRENT LIABILITIES   875,936    632,215 
           
TOTAL LIABILITIES   3,127,349    3,194,355 
           
COMMITMENTS AND CONTINGENCIES          
           
DEFICIENCY:          
Preferred stock, $0.001 par value, 50,000,000 shares authorized, 3,092,899 shares issued and outstanding as of December 31, 2014 and 2013   3    3 
Common stock, $0.001 par value, 200,000,000 shares authorized, 64,458,588 and 58,234,688 shares issued, 61,986,282 and 55,762,382 shares outstanding as of December 31, 2014 and 2013, respectively   64    58 
Treasury stock, at cost, 2,472,306 shares as of December 31, 2014 and 2013   (4,199)   (4,199)
Paid-in-capital   115,494    106,878 
Statutory reserves   6,472    6,243 
Accumulated deficits   (463,521)   (414,798)
Accumulated other comprehensive income   644    729 
TOTAL GENERAL STEEL HOLDINGS, INC. DEFICIENCY   (345,043)   (305,086)
           
NONCONTROLLING INTERESTS   (217,082)   (188,911)
           
TOTAL DEFICIENCY   (562,125)   (493,997)
           
TOTAL LIABILITIES AND DEFICIENCY  $2,565,224   $2,700,358 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

47
 

 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

FOR THE YEARS ENDED DECEMBER 31, 2014 AND 2013

(In thousands, except per share data)

 

   2014   2013 
         
SALES  $1,900,292   $2,016,548 
           
SALES - RELATED PARTIES   389,120    447,199 
TOTAL SALES   2,289,412    2,463,747 
           
COST OF GOODS SOLD   1,913,549    2,062,570 
           
COST OF GOODS SOLD - RELATED PARTIES   395,029    457,115 
TOTAL COST OF GOODS SOLD   2,308,578    2,519,685 
           
GROSS LOSS   (19,166)   (55,938)
           
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES   (78,555)   (84,226)
CHANGE IN FAIR VALUE OF PROFIT SHARING LIABILITY   91,018    174,569 
           
INCOME (LOSS) FROM OPERATIONS   (6,703)   34,405 
           
OTHER INCOME (EXPENSE)          
Interest income   21,700    11,214 
Finance/interest expense   (96,673)   (91,878)
Gain (loss) on disposal of equipment and intangible assets   (1,125)   424 
Government grant   327    4,216 
Income from equity investments   139    203 
Foreign currency transaction gain   786    1,394 
Lease income   2,175    2,158 
Gain on deconsolidation of a subsidiary   1,795    1,011 
Payment for public highway construction   -    (6,462)
Other non-operating (expense) income, net   (428)   1,044 
Other expense, net   (71,304)   (76,676)
           
LOSS BEFORE PROVISION FOR INCOME TAXES AND NONCONTROLLING INTEREST   (78,007)   (42,271)
           
PROVISION FOR INCOME TAXES   269    354 
           
NET LOSS   (78,276)   (42,625)
           
Less: Net loss attributable to noncontrolling interest   (29,553)   (9,609)
           
NET LOSS ATTRIBUTABLE TO GENERAL STEEL HOLDINGS, INC.  $(48,723)  $(33,016)
           
NET LOSS  $(78,276)  $(42,625)
           
OTHER COMPREHENSIVE LOSS          
Foreign currency translation adjustments   590    (14,425)
           
COMPREHENSIVE LOSS   (77,686)   (57,050)
           
Less: Comprehensive loss attributable to noncontrolling interest   (28,652)   (15,107)
           
COMPREHENSIVE LOSS ATTRIBUTABLE TO GENERAL STEEL HOLDINGS, INC.  $(49,034)  $(41,943)
           
WEIGHTED AVERAGE NUMBER OF SHARES          
Basic and Diluted   56,841    55,126 
           
LOSS PER SHARE          
Basic and Diluted  $(0.86)  $(0.60)

 

The accompanying notes are an integral part of these consolidated financial statements.

 

48
 

 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CHANGES IN DEFICIENCY

(In thousands)

 

   Preferred stock   Common stock   Treasury stock       Retained earnings /
Accumulated deficits
   Accumulated other         
                           Paid-in   Statutory       comprehensive   Noncontrolling     
   Shares   Par value   Shares   Par value   Shares   At cost   capital   reserves   Unrestricted   income   interest   Total 
BALANCE, December 31, 2012   3,093   $3    57,270   $57    (2,472)  $(4,199)  $105,714   $6,076   $(381,782)  $10,185   $(172,063)  $(436,009)
                                                             
Net loss attributable to General Steel Holdings, Inc.                                           (33,016)             (33,016)
Net loss attributable to noncontrolling interest                                                     (9,609)   (9,609)
Addition to special reserve                                      619              553    1,172 
Usage of special reserve                                      (452)             (393)   (845)
Common stock transferred by CEO for compensation                                 276                        276 
Common stock issued for compensation             665    1              633                        634 
Common stock issued for services             300                   255                        255 
Addition to Tianwu paid-in capital                                                     18,028    18,028 
Deconsolidation of a subsidiary                                                (529)   (19,929)   (20,458)
Foreign currency translation adjustments                                                (8,927)   (5,498)   (14,425)
                                                             
BALANCE, December 31, 2013   3,093   $3    58,235   $58    (2,472)  $(4,199)  $106,878   $6,243   $(414,798)  $729   $(188,911)  $(493,997)
                                                             
Net loss attributable to General Steel Holdings, Inc.                                           (48,723)             (48,723)
Net loss attributable to noncontrolling interest                                                     (29,553)   (29,553)
Addition to special reserve                                      605              451    1,056 
Usage of special reserve                                      (376)             (384)   (760)
Common stock transferred by CEO for compensation                                 276                        276 
Common stock issued for services             1,224    1              845                        846 
Common stock issued to CEO             5,000    5              7,495                        7,500 
Deconsolidation of a subsidiary                                                226    414    640 
Foreign currency translation adjustments                                                (311)   901    590 
                                                             
BALANCE, December 31, 2014   3,093   $3    64,459   $64    (2,472)  $(4,199)  $115,494   $6,472   $(463,521)  $644   $(217,082)  $(562,125)

 

The accompanying notes are an integral part of these consolidated financial statements.

 

49
 

 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2014 AND 2013

(In thousands)

 

   2014   2013 
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net loss  $(78,276)  $(42,625)
Adjustments to reconcile net loss to cash provided by (used in) operating activities:          
Depreciation, amortization and depletion   96,277    89,048 
Change in fair value of derivative liabilities   -    (1)
Change in fair value of profit sharing liability   (91,018)   (174,569)
(Gain) loss on disposal of equipment and intangible assets   1,125    (424)
Provision (recovery) of doubtful accounts   10,110    (677)
Reservation of mine maintenance fee   296    327 
Stock issued for services and compensation   1,122    1,165 
Amortization of deferred financing cost on capital lease   21,252    20,799 
Income from equity investments   (139)   (203)
Foreign currency transaction gain   (786)   (1,394)
Deferred lease income   (2,175)   (2,158)
Gain on deconsolidation of a subsidiary   (1,795)   (1,011)
Changes in operating assets and liabilities          
Notes receivable   51,841    25,555 
Accounts receivable   (6,037)   1,281 
Accounts receivable - related parties   (5,694)   12,161 
Other receivables   (13,029)   (1,116)
Other receivables - related parties   8,005    (48,017)
Inventories   50,950    (40,632)
Advances on inventory purchases   (32,293)   25,414 
Advances on inventory purchases - related parties   8,332    (145,686)
Prepaid expense and other   (3,418)   (916)
Long-term deferred expense   206    422 
Prepaid taxes   22,464    (3,485)
Accounts payable   49,705    23,760 
Accounts payable - related parties   (26,227)   113,034 
Other payables and accrued liabilities   8,580    (10,508)
Other payables - related parties   (6,370)   8,332 
Customer deposits   6,134    (41,069)
Customer deposits - related parties   68,007    41,636 
Taxes payable   735    (12,367)
Net cash provided by (used in) operating activities   137,884    (163,924)
           
CASH FLOWS FROM INVESTING ACTIVITIES:          
Restricted cash   41,669    (64,860)
Proceeds from dividends declared   545    - 
Loan to unrelated parties   (35,977)   - 
Loans to related parties   -    (200)
Repayments from related parties   4,540    1,660 
Cash proceeds from short term investment   81    (81)
Cash proceeds from sales of equipment and intangible assets   36    160 
Equipment purchase and intangible assets   (239,633)   (43,355)
Cash proceeds from sale of equity ownership   -    13,619 
Effect on cash due to deconsolidation of a subsidiary   (267)   (12,735)
Net cash used in investing activities   (229,006)   (105,792)
           
CASH FLOWS FINANCING ACTIVITIES:          
Capital contributed by noncontrolling interest   -    18,028 
Restricted notes receivable   281,665    (26,066)
Borrowings on short term notes payable   1,570,660    1,913,987 
Payments on short term notes payable   (1,921,644)   (1,911,006)
Borrowings on short term loans - bank   358,001    371,685 
Payments on short term loans - bank   (402,259)   (222,104)
Borrowings on short term loan - others   47,797    69,632 
Payments on short term loans - others   (53,403)   (72,989)
Borrowings on short term loan - related parties   -    393,833 
Payments on short term loans - related parties   (28,712)   (248,119)
Deposits due to sales representatives   (6,348)   (10,455)
Deposit due to sales representatives - related parties   521    711 
Borrowings on long-term loans - related party   219,929    - 
Payments on long-term loans - related party   (1,700)   (22,940)
Principal payment on capital lease obligation   (1,375)   (218)
Proceed from common stock issued to CEO   7,500    - 
Net cash provided by financing activities   70,632    253,979 
           
EFFECTS OF EXCHANGE RATE CHANGE IN CASH   164    1,237 
           
DECREASE IN CASH   (20,326)   (14,500)
           
CASH, beginning of year   31,967    46,467 
           
CASH, end of year  $11,641   $31,967 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

50
 

  

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1 – Organization and Operations

 

General Steel Holdings, Inc. (the “Company”) was incorporated on August 5, 2002 in the state of Nevada. The Company through its 100% owned subsidiary, General Steel Investment, operates steel companies serving various industries in the People’s Republic of China (“PRC”). The Company’s main operation is manufacturing and sales of steel products such as steel rebar, hot-rolled carbon and silicon sheets and spiral-weld pipes. The Company, together with its subsidiaries, majority owned subsidiaries and variable interest entity, is referred to as the “Group”.

  

On April 29, 2011, a 20-year Unified Management Agreement (“the Agreement”) was entered into between the Company, the Company’s 60%-owned subsidiary Shaanxi Longmen Iron and Steel Co., Ltd. (“Longmen Joint Venture”), Shaanxi Coal and Chemical Industry Group Co., Ltd. (“Shaanxi Coal”) and Shaanxi Iron and Steel Group (“Shaanxi Steel”). Shaanxi Steel is the controlling shareholder of Shaanxi Longmen Iron and Steel Group Co., Ltd (“Long Steel Group”) which is the non-controlling interest holder in Longmen Joint Venture, and Shaanxi Coal, a state owned entity, is the parent company of Shaanxi Steel. Under the terms of the Agreement, all manufacturing machinery and equipment of Longmen Joint Venture and the $605.8 million (or approximately RMB 3.7 billion) of the constructed iron and steel making facilities owned by Shaanxi Steel, which includes one 400 m 2 sintering machine, two 1,280 m 3 blast furnaces, two 120 ton converters and some auxiliary systems, are managed collectively as a single virtual asset pool (“Asset Pool”). Longmen Joint Venture manages the Asset Pool as the principal operating entity and is responsible for the daily operations of the new and existing facilities. The Agreement leverages each of the parties’ operating strengths, allowing Longmen Joint Venture to derive the greatest benefit from the cooperation and the newly constructed iron and steel making facilities. At the designed efficiency level, the facilities contribute three million tons of crude steel production capacity per year.

 

Longmen Joint Venture pays Shaanxi Steel for the use of the constructed iron and steel making facilities an amount equaling the depreciation expense on the equipment constructed by Shaanxi Steel as well as 40% of the pre-tax profit generated by the Asset Pool. The remaining 60% of the pre-tax profit is allocated to Longmen Joint Venture. As a result, the Company’s economic interest in the profit or loss generated by Longmen Joint Venture decreased from 60% to 36%. However, the overall capacity under the management of Longmen Joint Venture increased by three million tons, or 75%. The Agreement improved Longmen Joint Venture’s cost structure through sustainable and steady sourcing of key raw materials and reduced transportation costs. The distribution of profit is subject to a prospective adjustment after the first two years based on each entity’s actual investment of time and resources into the Asset Pool. There has been no adjustment to the Agreement from its inception to the present time nor intention to make future adjustment by the Company and Shaanxi Steel.

 

The parties to the Agreement established the Shaanxi Longmen Iron and Steel Unified Management Supervisory Committee ("Supervisory Committee") to ensure that the facilities and related resources are operated and managed according to the stipulations set forth in the Agreement. The Board of Directors of Longmen Joint Venture, of which the Company holds 4 out of 7 seats, requires a simple majority vote and remains the controlling decision-making body of Longmen Joint Venture and the Asset Pool. See Note 2(c) “Consolidation of VIE.”

 

The Agreement constitutes an arrangement that involves a lease which meets certain of the criteria of a capital lease and therefore the assets constructed by Shaanxi Steel are accounted for by Longmen Joint Venture as a capital lease. The profit sharing liability portion of the lease obligation, representing 40% of the cumulative pre-tax profit generated by the Asset Pool, is accounted for by Longmen Joint Venture as a derivative financial instrument at fair value. See Notes 2 “Summary of significant accounting policies”, Note 16 “Capital lease obligations” and Note 17 “Profit sharing liability”.

 

In view of the near-term challenges for the steel sector (see Note 2(d) Liquidity and Going Concern), the Company strategically accelerating the Company’s business transformation. The Company’s transformation strategy is to pursue opportunities that offer compelling benefits to our organization and shareholders, including:

 

·First, strengthen the Company’s financials while providing the financial flexibility to pursue higher return, higher growth opportunities;
·Second, reduce the complexity of the Company’s business structure, which is consistent with the Company’s objectives for internal simplification and operating efficiency;
·Third, diversify operating risk in order to lower the Company’s high reliance on steel business, while at the same time leverage on the Company’s vast vertical resources in the steel industry; and
·Fourth, pursue opportunities for additional value creation.

 

The Company formed a joint venture in February of 2015 with an RFID Expert team to develop and commercialize RFID technologies and data solutions. The formation of this joint venture represents a unique opportunity to accelerate the Company’s expansion into the vibrant logistics and Internet-of-Things sectors.

 

Note 2 – Summary of significant accounting policies

 

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for information pursuant to the rules and regulations of the Securities Exchange Commission (“SEC”). The financial statements include the accounts of all directly, indirectly owned subsidiaries and the variable interest entity listed below. All material intercompany transactions and balances have been eliminated in consolidation.

 

(a)Basis of presentation

 

The consolidated financial statements of the Company reflect the activities of the following major directly owned subsidiaries: 

 

Subsidiary  Percentage
of Ownership
 
General Steel Investment Co., Ltd.  British Virgin Islands   100.0%
General Steel (China) Co., Ltd. (“General Steel (China)”)  PRC   100.0%
Yangpu Shengtong Investment Co., Ltd. (“Yangpu Shengtong”)  PRC   99.1%
Tianjin Qiu Steel Investment Co., Ltd. (“Qiu Steel”)  PRC   98.7%
Longmen Joint Venture  PRC   VIE/60.0%
Maoming Hengda Steel Company, Ltd. (“Maoming Hengda”)  PRC   99.0%

 

51
 

 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Tianwu

 

Prior to November 19, 2013, the Company held a 60.0% equity interest in Tianwu General Steel Material Trading Co., Ltd. (“Tianwu”). 32% interest was held by General Steel (China) and 28% interest was held by Yangpu Shengtong. On November 19, 2013, the Company sold its 28% equity interest of Tianwu held by Yangpu Shengtong to Tianjin Dazhan Industry Co., Ltd., a related party through indirect common ownership, for $13.6 million (RMB 84.3 million) while retaining 32% interest held by General Steel (China). As a result of this transaction, the Company met the criteria under ASC 810-10-40-4 to deconsolidate Tianwu at disposal date and recognized a gain in accordance with ASC 810-10-40-5. See Note 17 – Other income (expense) under the section “Gain on deconsolidation of a subsidiary” for details. At the same time, General Steel (China)’s remaining 32% interest is accounted for as an investment in unconsolidated subsidiaries using the equity method. See Note 2(u) - Investments in unconsolidated entities for details.

 

Baotou Steel

 

Prior to December 31, 2014, the Company held an 80.0% equity interest in Baotou Steel – General Steel Special Steel Pipe Joint Venture Co., Ltd. (“Baotou Steel”) through General Steel (China). On December 31, 2014, the Company sold its 80.0% equity interest in Baotou Steel to Tianjin Shuangjie Liansheng Rolled Steel Co., Ltd., an unrelated party for $0.7 million (RMB 4.0 million), receivable within one year of the sale. As a result of this transaction, the Company met the criteria under ASC 810-10-40-4 to deconsolidate Baotou Steel at disposal date and recognized a gain in accordance with ASC 810-10-40-5. See Note 18 – Other income (expense) under the section “Gain on deconsolidation of a subsidiary” for details.

  

(b)Principles of consolidation – subsidiaries

  

The accompanying consolidated financial statements include the financial statements of the Company, its subsidiaries, its variable interest entity (“VIE”) for which the Company is the ultimate primary beneficiary, and the VIE’s subsidiaries.

 

Subsidiaries are those entities in which the Company, directly or indirectly, controls more than one half of the voting power; or has the power to govern the financial and operating policies, to appoint or remove the majority of the members of the board of directors, or to cast a majority of votes at the meeting of directors.  

 

A VIE is an entity in which the Company, or its subsidiary, through contractual arrangements, bears the risks of, and enjoys the rewards normally associated with ownership of the entity, and therefore the Company or its subsidiary is the primary beneficiary of the entity. 

 

All significant inter-company transactions and balances have been eliminated upon consolidation.

 

(c)Consolidation of VIE

 

Prior to entering into the Unified Management Agreement on April 29, 2011, Longmen Joint Venture had been consolidated as the Company’s 60% direct owned subsidiary. Upon entering into the Unified Management Agreement on April 29, 2011, Longmen Joint Venture was re-evaluated by the Company to determine if Longmen Joint Venture is a VIE and if the Company is the primary beneficiary.

 

Longmen Joint Venture’s equity at risk is considered insufficient to finance its activities and therefore Longmen Joint Venture is considered to be a VIE.

 

The Company would be considered the primary beneficiary of the VIE if it has both of the following characteristics:

 

a.The power to direct the activities of the VIE that most significantly impact the VIE’s economic performance; and
b.The obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE.

 

52
 

 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

A Supervisory Committee was formed during the negotiation of the Unified Management Agreement. Given there is both a Supervisory Committee and a Board of Directors with respect to Longmen Joint Venture , the powers (rights and roles) of both bodies were considered to determine which party has the power to direct the activities of Longmen Joint Venture, and by extension, whether the Company continues to have the power to direct Longmen Joint Venture’s activities after this Supervisory Committee was formed and the significant investment in plant and equipment by owners of the Longmen Joint Venture partner. The Supervisory Committee, in which the Company holds 2 out of 4 seats, requires a ¾ majority vote, while the Board of Directors, on which the Company holds 4 out of 7 seats, requires a simple majority vote. As the Supervisory Committee’s role is limited to supervising and monitoring management of Longmen Joint Venture and in the event there is any disagreement between the Board and the Supervisory Committee, the Board prevails, the Supervisory Committee is considered subordinate to the Board. Thus, the Board of Directors of Longmen Joint Venture continues to be the controlling decision-making body with respect to Longmen Joint Venture. The Company, which controls 60% of the voting rights of the Board of Directors, has control over the operations of Longmen Joint Venture and as such, has the power to direct the activities of the VIE that most significantly impact Longmen Joint Venture’s economic performance.

 

In connection with the Unified Management Agreement, the Company, Shaanxi Coal and Shaanxi Steel may provide such support on a discretionary basis or as needed in the future. See Note 2(d) Liquidity.

 

The Company has the obligation to absorb losses and the rights to receive benefits based on the profit allocation as stipulated by the Unified Management Agreement that are significant to the VIE. As both conditions are met, the Company is the primary beneficiary of Longmen Joint Venture and therefore, continues to consolidate Longmen Joint Venture as a VIE.

 

The Company believes that the Unified Management Agreement between Longmen Joint Venture and Shaanxi Coal is in compliance with PRC law and is legally enforceable. However, PRC law and/or uncertainties in the PRC legal system could limit the Company’s ability to enforce the Unified Management Agreement, which in turn, may lead to reconsideration of the VIE assessment and the potential for a different conclusion. If the Unified Management Agreement cannot be enforced, the Company would not consolidate Longmen Joint Venture as a VIE. However, the current PRC legal system has not limited the Company’s ability to enforce the Unified Management Agreement nor does the Company believe it is likely to do so in the future. The Company makes an ongoing assessment to determine whether Longmen Joint Venture is a VIE.

 

The carrying amount of the VIE and its subsidiaries’ consolidated assets and liabilities are as follows:

 

   December 31, 2014   December 31, 2013 
   (in thousands)   (in thousands) 
Current assets  $837,135   $1,282,054 
Plant and equipment, net   1,537,687    1,262,144 
Other noncurrent assets   33,396    29,014 
Total assets   2,408,218    2,573,212 
Total liabilities   (2,946,126)   (3,040,879)
Net liabilities  $(537,908)  $(467,667)

 

VIE and its subsidiaries’ liabilities consist of the following:

 

   December 31, 2014   December 31, 2013 
   (in thousands)   (in thousands) 
Current liabilities:          
Short term notes payable  $638,829   $988,364 
Accounts payable   605,025    393,816 
Accounts payable - related parties   205,914    235,116 
Short term loans - bank   216,940    267,688 
Short term loans - others   54,524    55,844 
Short term loans - related parties   45,710    125,236 
Current maturities of long-term loans – related party   -    56,614 
Other payables and accrued liabilities   47,121    37, 028 
Other payables - related parties   78,615    88,914 
Customer deposits   87,372    87,661 
Customer deposits - related parties   34,895    18,359 
Deposit due to sales representatives   17,871    24,343 
Deposit due to sales representatives – related parties   2,509    1,997 
Taxes payable   4,026    3,357 
Deferred lease income   2,176    2,187 
Capital lease obligations, current   8,508    4,321 
Intercompany payable to be eliminated   20,155    21,420 
Total current liabilities   2,070,190    2,412,265 
Non-current liabilities:          
Long term loans - related parties   339,549    16,043 
Long-term other payable – related party   -    - 
Deferred lease income - noncurrent   72,713    75,257 
Capital lease obligations, noncurrent   393,252    375,019 
Profit sharing liability   70,422    162,295 
Total non-current liabilities   875,936    628,614 
Total liabilities of consolidated VIE  $2,946,126   $3,040,879 

 

53
 

 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

   For the year ended
December 31, 2014
   For the year ended
December 31, 2013
 
   (in thousands)   (in thousands) 
Sales  $2,284,485   $2,450,256 
Gross loss  $(19,496)  $(56,065)
Income from operations  $4,219   $45,161 
Net loss attributable to controlling interest  $(45,425)  $(16,457)

 

Longmen Joint Venture has two 100% owned subsidiaries, Yuxin Trading Co., Ltd. (“Yuxin”) and Yuteng Trading Co., Ltd. (“Yuteng”). Longmen Joint Venture has two consolidated subsidiaries, Hualong Fire Retardant Material Co., Ltd. (“Hualong”) and Beijing Huatianyulong International Steel Trading Co., Ltd. (“Huatianyulong”), in which it does not hold a controlling interest. Hualong and Huatianyulong are separate legal entities which were established in the PRC as limited liability companies and subsequently invested in by Longmen Joint Venture in June 2007 and July 2008, respectively. However, these two entities do not meet the definition of variable interest entities. Further consideration was given to whether consolidation was appropriate under the voting interest model, specifically where the power of control may exist with a lesser percentage of ownership (i.e. less than 50%), for example, by contract, lease, agreement with other stockholders or by court decree.

 

Hualong

 

Longmen Joint Venture, the single largest shareholder, holds a 36.0% equity interest in Hualong. The other two shareholders, who own 34.67% and 29.33% respectively, assigned their voting rights to Longmen Joint Venture in writing at the time of the acquisition of Hualong. The voting rights have been assigned through the date Hualong ceases its business operations or the other two shareholders sell their interest in Hualong. Hualong’s main business is to supply refractory. The assets, liabilities and the operating results of Hualong are immaterial to the Company’s consolidated financial statements as for and during the years ended December 31, 2014 and 2013.

 

Huatianyulong

 

Longmen Joint Venture holds a 50.0% equity interest in Huatianyulong and the other unrelated shareholder holds the remaining 50.0%. The other shareholder assigned its voting rights to Longmen Joint Venture in writing at the time of acquisition of Huatianyulong. The voting rights have been assigned through the date Huatianyulong ceases its business operation or the other unrelated shareholder sells its interest in Huatianyulong. Huatianyulong mainly sells imported iron ore. The assets, liabilities and the operating results of Huatianyulong are immaterial to the Company’s consolidated financial statements as for and during the years ended December 31, 2014 and 2013.

 

The Company has determined that it is appropriate for Longmen Joint Venture to consolidate Hualong and Huatianyulong with appropriate recognition in the Company’s financial statements of the non-controlling interests in each entity, beginning on the acquisition dates as these were also the effective dates of the agreements with other stockholders granting a majority voting rights in each entity, and thereby, the power of control, to Longmen Joint Venture.

 

54
 

 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(d)Liquidity and going concern

 

The Company’s accounts have been prepared assuming that the company will continue as a going concern basis. The going concern basis assumes that assets are realized and liabilities are extinguished in the ordinary course of business at amounts disclosed in the financial statements. The Company’s ability to continue as a going concern depends upon aligning its sources of funding (debt and equity) with the expenditure requirements of the Company and repayment of the short-term debt facilities as and when they fall due.

 

Our steel business has faced very tough market conditions and challenging profitability over the last several years, and based on current trends, we think the near-term challenges for the steel sector will likely linger. In reaction to this challenging market, we are proactively reviewing our strategy and asset portfolio and seeking to restructure low-efficient, non-core assets, as well as idle land resources to unlock hidden fair value.

 

The Company aims to transform into a leaner and fitter organization with better profitability. As such, the Company is strategically accelerating its business transformation to pursue opportunities that offer compelling benefits to the Company and shareholders, including:

 

·First, strengthen the Company’s financials while providing the financial flexibility to pursue higher return, higher growth opportunities;
·Second, reduce the complexity of the Company’s business structure, which is consistent with our objectives for internal simplification and operating efficiency;
·Third, diversify operating risk in order to lower the Company’s high reliance on steel business, while at the same time leverage on the Company’s vast vertical resources in the steel industry; and
·Fourth, pursue opportunities for additional value creation.

 

The steel business is capital intensive and as a normal industry practice in PRC, the Company is highly leveraged. Debt financing in the form of short term bank loans, loans from related parties, financing sales, bank acceptance notes, and capital leases have been utilized to finance the working capital requirements and the capital expenditures of the Company. As a result, the Company’s debt to equity ratio as of December 31, 2014 and 2013 were (5.6) and (6.5), respectively. As of December 31, 2014, the Company’s current liabilities exceed current assets (excluding non-cash item) by $1.3 billion, which together with the gross loss from operations raises substantial doubt about its ability to continue as a going concern.

 

Management has implemented the following plans that are intended to mitigate the conditions or events that raise substantial doubt about the Company’s ability to continue as a going concern.

 

Longmen Joint Venture, as the most important entity of the Company, accounted for majority of total sales of the Company. As such, the majority of the Company’s working capital needs come from Longmen Joint Venture. The Company’s ability to continue as a going concern depends heavily on Longmen Joint Venture’s operations. Longmen Joint Venture has obtained different types of financial supports, which are listed below by category:

 

Line of credit

 

The Company has lines of credit from the listed major banks totaling $141.7 million with expiration dates ranging from January 21, 2016 to October 14, 2016.

 

Banks  Amount of
Line of Credit
(in millions)
   Repayment Date
China Everbright Bank   19.5   January 21, 2016
Huaxia Bank   24.4   January 30, 2016
Bank of Beijing   81.5   October 14, 2016
Bank of Xi’an   16.3   February 4, 2016
Total  $141.7    

 

As of the date of this report, the Company utilized $39.4 million of these lines of credit.

 

Vendor financing

 

Longmen Joint Venture signed additional vendor financing agreements, which will provide liquidity to the Company in a total amount of $896.0 million with the following companies:

 

Company  Financing Period  Financing Amount
(in millions)
 
        
Company A – related party  July 30, 2014 – July 30, 2019  $244.4 
Company B – third party  January 22, 2014 – January 22, 2017   162.9 
Company C – third party  October 1, 2013 – March 31, 2016   488.7 
Total     $896.0 

 

Company A, a related party company and Company B, a third party company, are both Longmen Joint Venture’s major coke suppliers. They have been doing business with Longmen Joint Venture for many years. On July 30, 2014, Company A signed a five-year agreement with Longmen Joint Venture to finance its coke purchases up to $244.4 million. Company B signed a three-year agreement with Longmen Joint Venture on January 22, 2014 to finance its coke purchases up to $162.9 million. According to the above signed agreements, both Company A and B will not demand any cash payments during their respective financing periods. As of the date of this report, the Company’s payables to Company A and Company B were approximately $64.3 million and $61.4 million, respectively.

 

Company C is a Fortune 500 Company. On June 28, 2013, Company C signed an agreement with Longmen Joint Venture to finance Longmen Joint Venture’s purchase of iron ore for an amount up to $488.7 million to commence on October 1, 2013 and end on March 31, 2015. On August 1, 2014, Company C signed an extension agreement with the Company and extended the financing terms to March 31, 2016. Subject to the terms of the agreement, Longmen Joint Venture is subject to a penalty of 0.05% of the daily outstanding balance owed to Company C in an event of late payment. As of the date of this report, the Company’s payable to Company C was approximately $24.7 million

 

55
 

 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Other financing

 

On March 5, 2014, April 22, 2014, April 23, 2014, and October 30, 2014, Longmen Joint Venture signed two-to-three-year payment extension agreements with Company D, E, F, G and H listed below. In total, Longmen Joint Venture can obtain $363.3 million in financial support from payment extensions granted by the following six companies:

 

Company  Financing Period  Financing Amount
(in millions)
 
        
Company D – related party  April 22, 2014 – April 22, 2017  $81.5 
Company E – related party  April 23, 2014 – April 23, 2017   86.3 
Company F – related party  April 22, 2014 – April 22, 2017   81.5 
Company G – related party  March 5, 2014 – March 5, 2016   57.0 
Company H – related party  March 5, 2014 – March 5, 2016   57.0 
Total     $363.3 

 

As of the date of this report, our payables to Company D, Company E, Company F, Company G, and Company H are approximately $16.3 million, $0, $34.1 million, $0, and $0.9 million, respectively.

 

Amount due to sales representatives

 

Longmen Joint Venture entered into agreements with various entities to act as the Company’s exclusive sales agents in specified geographic areas.  These exclusive sales agents must meet certain criteria and are required to deposit a certain amount of money with the Company. In return, the sales agents receive exclusive sales rights in a specified area and discounted prices on products they order. These deposits bear no interest and are required to be returned to the sales agent once the agreement is terminated. As of December 31, 2014, Longmen Joint Venture has collected a total amount of $20.4 million. Historically, this amount is quite stable and we do not expect a big fluctuation in this amount for the next twelve months from December 31, 2014 onwards.

 

With the financial support from the banks and the companies above, management is of the opinion that the Company has sufficient funds to meet its future operations, working capital requirements and debt obligations until the end of December 31, 2015. However, this opinion is based on the demand of the Company's products, economic conditions, the overcapacity issue in the steel industry and the Company's operating results not continuing to deteriorate and on our vendors and related parties being able to provide continued liquidity, as summarized below. The detailed breakdown of Longmen Joint Venture’s estimated cash flows items are listed below.

 

   Cash inflow (outflow)
(in millions)
 
   For the twelve months
ended December 31,
2015
 
Current liabilities over current assets (excluding non-cash items) as of December 31, 2014  $(1,278.8)
Projected cash financing and outflows:     
Cash provided by line of credit from banks   141.7 
Cash provided by vendor financing   896.0 
Cash provided by other financing   363.3 
Cash provided by sales representatives   20.4 
Cash projected to be used in operations in the twelve months ended December 31, 2015   (37.2)
Cash projected to be used for financing cost in the twelve months ended December 31, 2015   (50.1)
Net projected change in cash for the twelve months ended December 31, 2015  $55.3 

 

56
 

 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(e)Use of estimates

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the accompanying consolidated financial statements and footnotes. Significant accounting estimates reflected in the Company’s consolidated financial statements include the fair value of the profit sharing liability, the useful lives of and impairment for property, plant and equipment, and potential losses on uncollectible receivables, allowance for inventory valuation, the interest rate used in the financing sales, the fair value of the assets recorded under capital lease and the present value of the net minimum lease payments of the capital lease. Actual results could differ from these estimates.

 

(f)Concentration of risks and uncertainties

 

The Company’s operations are carried out in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environment in the PRC, and by the general state of the PRC’s economy. The Company’s operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in North America and Western Europe. The Company’s results may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.

 

The Company has significant exposure to the fluctuation of raw materials and energy prices as part of its normal operations. As of December 31, 2014 and 2013, the Company does not have any open commodity contracts to mitigate such risks.

 

Cash includes demand deposits in accounts maintained with banks within the PRC, Hong Kong and the United States. Total cash (including restricted cash balances) in PRC banks on December 31, 2014 and 2013 amounted to $367.2 million and $431.2  million, including $1.0 million and $2.0 million that were deposited in Shaanxi Coal and Chemical Industry Group Financial Co., Ltd., a related party, respectively. As of December 31, 2014 and 2013, $0.1 million and $0.1 million cash in the U.S. and Hong Kong banks was covered by insurance, respectively. The Company has not experienced any losses in other bank accounts and believes it is not exposed to any risks on its cash in bank accounts.

 

None of the Company’s customers accounted for more than 10% of total sales for the years ended December 31, 2014 and 2013, respectively. Two customers individually accounted for 32.1% and 20.5% of total accounts receivable, including related parties as of December 31, 2014, respectively. Three customers individually accounted for 13.7%, 11.1% and 10.8% of total accounts receivable, including related parties as of December 31, 2013, respectively.

 

None of the Company’s suppliers individually accounted for more than 10% of the total purchases for the year ended December 31, 2014 and one of the Company’s suppliers individually accounted for 12.0% of the total purchases for the year ended December 31, 2013. None of the Company’s suppliers individually accounted for more than 10% of total accounts payable as December 31, 2014 and 2013.

 

(g)Revenue recognition

 

Sales is recognized at the date of shipment to customers when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, the Company has no other significant obligations and collectability is reasonably assured. Payments received before all of the relevant criteria for revenue recognition are recorded as customer deposits. Sales represent the invoiced value of goods, net of value-added tax (VAT). All of the Company’s products sold in the PRC are subject to a Chinese value-added tax at a rate of 13% or 17% of the gross sales price. This VAT may be offset by VAT paid by the Company on raw materials and other materials included in the cost of producing the finished product.

 

The Company infrequently engages in trading transactions in which the Company acts as an agent between the suppliers and the customers. The trading arrangements are such that the suppliers are the primary obligors, the Company does not have any general inventory risk, physical inventory loss risk or credit risk, and the Company does not have latitude in establishing price. Sales and cost of goods sold from these trading arrangements are recorded at the net amount in accordance with ASC 605-45.

 

(h)Foreign currency translation and other comprehensive income

 

The reporting currency of the Company is the U.S. dollar. The Company’s subsidiaries and VIE in China use the local currency, Renminbi (RMB), as their functional currency. Assets and liabilities are translated at the unified exchange rate as quoted by the People’s Bank of China at the end of the period. The statement of operations accounts are translated at the average translation rates and the equity accounts are translated at historical rates. Translation adjustments resulting from this process are included in accumulated other comprehensive income in the statement of equity. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.

 

57
 

 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Translation adjustments included in accumulated other comprehensive income amounted to $0.6 million and $0.7 million as of December 31, 2014 and 2013, respectively. The balance sheet amounts, with the exception of equity at December 31, 2014 and 2013 were translated at 6.14 RMB and 6.11 RMB to $1.00, respectively. The equity accounts were stated at their historical rate. The average translation rates applied to statement of operations accounts for the years ended December 31, 2014 and 2013 were 6.14 RMB and 6.19 RMB, respectively. Cash flows are also translated at average translation rates for the periods, therefore, amounts reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the consolidated balance sheet.

 

The PRC government imposes significant exchange restrictions on fund transfers out of the PRC that are not related to business operations. These restrictions have not had a material impact on the Company because it has not engaged in any significant transactions that are subject to the restrictions.

 

(i)Financial instruments

 

The accounting standard regarding fair value of financial instruments and related fair value measurements defines financial instruments and requires disclosure of the fair value of financial instruments held by the Company. The Company considers the carrying amount of cash, short term investments, accounts receivable, other receivables, accounts payable and accrued liabilities, to approximate their fair values because of the short period of time between the origination of such instruments and their expected realization. For short term loans and notes payable, the Company concluded the carrying values are a reasonable estimate of fair values because of the short period of time between the origination and repayment and as their stated interest rates approximate current rates available. The carrying value of the long term loans-related party approximates its fair value as of the reporting date as their stated interest rates approximate current rates available.

 

The accounting standards define fair value, establish a three-level valuation hierarchy for disclosures of fair value measurement and enhance disclosure requirements for fair value measures. The three levels are defined as follow:

 

·Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
·Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.
·Level 3 inputs to the valuation methodology are unobservable and significant to the fair value.

 

The Company analyzes all financial instruments with features of both liabilities and equity, pursuant to which warrants previously issued by the Company were required to be recorded as a liability at fair value and marked to market each reporting period. The warrants were accounted for as derivative liabilities and recorded at their fair value, with the change in fair value charged or credited to income each period.  The warrants expired unexercised on May 13, 2013. Prior to their expiration, the fair value of the warrants was estimated using a binomial lattice model, using level 3 inputs.

 

As described in Note 16 - Capital lease obligations, payments related to the capital lease of the Asset Pool consist of two components: (1) a fixed monthly payment of $2.3 million (RMB 14.6 million), based on Shaanxi Steel’s cost to construct the assets, to be paid for the 20 year term of the Unified Management Agreement; and (2) 40% of any remaining pre-tax profits from the Asset Pool, which includes Longmen Joint Venture and the constructed iron and steel making facilities. The aforementioned profit sharing component meets the definition of a derivative instrument under ASC 815-10-15-83 and, accordingly, the profit sharing liability is accounted for separately as a derivative liability. It was recognized initially at its estimated fair value at inception. The estimated fair value is adjusted each reporting period, with changes in the estimated fair value of the profit sharing liability charged or credited to operating income each period.

 

The Company determines the fair value of the profit sharing liability using Level 3 inputs by considering the present value of Longmen Joint Venture’s projected profits/losses, discounted based on our average borrowing rate, which is currently 6.9%.

 

The fair value of the profit sharing liability will change each period as a result of (a) any changes in our estimate of Longmen Joint Venture’s projected profits/losses over the remaining term of the Agreement, (b) any change in the discount rate used, based on changes in our current or expected borrowing rate, (c) the change in fair value related to the passage of time and change in the number of future periods over which the present value of future cash flows is estimated and (d) any difference between the previously estimated operating results for the current period and actual results.

 

58
 

 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Each period, the Company considers whether the discount rate based on the Company’s average borrowing rate should be adjusted based upon the current and expected future financial condition of the Company. On November 22, 2014, the People’s Bank of China decreased standard bank borrowing rate across the board by 0.4%. Accordingly, the Company adjusted down the present value discount rate for profit sharing liability by 0.4% from 7.3% to 6.9%.

 

The projected profits/losses in Longmen Joint Venture are based upon, but not limited to, the following assumptions:

 

·projected selling units and growth in the steel market
·projected unit selling price in the steel market
·projected unit purchase cost in the coal and iron ore markets
·selling and general and administrative expenses to be in line with the growth in the steel market
·projected bank borrowings
·interest rate index
·gross national product index
·industry index
·government policy

 

The above assumptions were reviewed by the Company at December 31, 2013 and the Company changed those assumptions as compared to the assumption used at December 31, 2012 and 2011 because of the changes in market conditions in PRC. Since the Company had the most updated information from the banks, GDP report, government policies, and the operating results from the year ended December 31, 2013, all of the above information indicated the downward trend in the steel manufacturing industry in the coming years. As a result, the Company re-measured the fair value of the 40% profit sharing liability as of the period ended December 31, 2013 and recorded a gain on change in fair value of profit sharing liability of $174.6 million for the year ended December 31, 2013. The above assumptions were again reviewed by the Company at December 31, 2014 and the assumptions related to the projected growth in the steel market and costs were revised, resulting in a further reduction of the estimated profit sharing liability.

 

The major drivers of the change in our estimate were the continuing decrease in the selling price of our products as well as a continuing downtrend in the sluggish infrastructure investment and consumption growth for the next ten years or so. As such, we have lowered our projected growth in the steel market for approximately ten years as compared to our previous estimates at December 31, 2013. The variables and the impact on our inputs to the 2014 valuation of profit sharing fair value, as compared to the 2013 valuation of the profit sharing fair value can be summarized as follows:

 

-Volume Inputs: The most recent 5 year China GDP forecast and Shaanxi GDP forecast decreased on average by 0.4% and 1.4%, respectively, versus the forecast used in 2013.

-Steel Sales Price Inputs: The most recent China Steel Association price index, together with our actual result decreased, on average, by 5.6% versus the same forecast used in 2013.

-Raw Material Cost Inputs: The most recent China Steel Association price index, together with the our actual result decreased, on average, by 4.7% versus the same forecast used in 2013

 

The above reduced our Gross Profit % over the next 5 years by, on average, 0.4% from the 2013 valuation. In addition, the above reduced our Gross Profit % over the remaining profit sharing period of 11.33 years by, on average, 1.75% from the 2013 valuation.

 

As a result of the changes in valuation inputs noted above for the year ended December 31, 2014, the Company recognized a gain on the change in the fair value of the profit sharing liability of $91.0 million due to a $110.6 million reduction in the fair value of profit sharing liability resulting from the change in estimates of future operating profits and a $0.1 million reduction resulting from the Asset Pool’s operating results for the year ended December 31, 2014 being slightly less favorable than previously estimated as of December 31, 2013, offset by a $8.1 million loss resulting from the 0.4% reduction of the present value discount rate and a $11.5 million loss from the present value discount. The estimated fair value of the profit sharing liability at December 31, 2014 is $70.4 million.

 

Changes in any of the assumptions used to estimate the fair value of the profit sharing liability will change the liability accordingly. If we were to reduce the projected bank borrowing rate used to discount the liability to a present value by 1.0% and other factors remained unchanged, our profit sharing liability as of December 31, 2014 would have been $80.8 million and we would decrease the gain from the change in the fair value of the profit sharing liability by $10.4 million. If we were to reduce the projected selling units and growth in the steel market rate by 1.0% and other factors remained unchanged, our profit sharing liability as of December 31, 2014 would have been $64.4 million and we would increase the gain from the change in the fair value of the profit sharing liability by $6.0 million.

 

The following table sets forth by level within the fair value hierarchy, the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of December 31, 2014:

 

(in thousands)  Carrying Value as
of December 31,
2014
   Fair Value Measurements at December 31,
2014
Using Fair Value Hierarchy
 
       Level 1   Level 2   Level 3 
Profit sharing liability  $70,422   $-   $-   $70,422 
Total  $70,422   $-   $-   $70,422 

 

The following table sets forth by level within the fair value hierarchy the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of December 31, 2013:

 

(in thousands)  Carrying Value as
of December 31,
2013
   Fair Value Measurements at December 31,
2013
Using Fair Value Hierarchy
 
       Level 1   Level 2   Level 3 
                 
Profit sharing liability  $162,295   $-   $-   $162,295 
Total  $162,295   $-   $-   $162,295 

 

59
 

 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following is a reconciliation of the beginning and ending balance of the assets and liabilities measured at fair value on a recurring basis for the years ended December 31, 2014 and 2013:

 

   December 31,
2014
   December 31,
2013
 
   (in thousands)   (in thousands) 
Beginning balance  $162,295   $328,828 
Change in fair value of profit sharing liability:          
Change in preset value of estimate of future operating profits   (110,589)   (183,528)
Change in discount rate   8,106    - 
Interest expense - present value discount amortization   11,544    16,872 
Difference between the previously estimated operating results for the current period and actual results   (79)   (7,913)
Change in derivative liabilities - warrants   -    1 
Exchange rate effect   (855)   8,035 
Ending balance  $70,422   $162,295 

 

Except for the derivative liabilities related to the profit sharing liability and to the warrants issued by the Company, which expired on May 13, 2013, the Company did not identify any other assets or liabilities that are required to be presented on the balance sheet at fair value.

 

(j)Cash

 

 Cash includes cash on hand and demand deposits in banks with original maturities of less than three months. 

 

(k)Restricted cash

 

The Company has notes payable outstanding with various banks and is required to keep certain amounts on deposit that are subject to withdrawal restrictions. The notes payable are generally short term in nature due to its maturity period of six months or less, thus restricted cash is classified as a current asset.

 

(l)Short term investment

 

Short-term investments are certificated deposits maintained with banks within the PRC with maturity date of less than one year.

 

(m)Loans receivable

 

Loans receivable, including to related parties represent interest-bearing amounts the Company expects to collect from unrelated and related parties with maturity dates of less than one year or due on demand.

 

(n)Accounts receivable and allowance for doubtful accounts

 

Accounts receivable include trade accounts due from customers and other receivables from cash advances to employees, related parties or third parties. An allowance for doubtful accounts is established and recorded based on managements’ assessment of potential losses based on the credit history and relationships with the customers. Management reviews its receivables on a regular basis to determine if the bad debt allowance is adequate, and adjusts the allowance when necessary. Delinquent account balances are written-off against allowance for doubtful accounts after management has determined that the likelihood of collection is not probable. 

 

(o)Notes receivable

 

Notes receivable represents trade accounts receivable due from various customers where the customers’ banks have guaranteed the payment. The notes are non-interest bearing and normally paid within three to six months. The Company has the ability to submit request for payment to the customer’s bank earlier than the scheduled payment date, but will incur an interest charge and a processing fee.

 

60
 

 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Restricted notes receivable represents notes receivable pledged as collateral for short-term loans and short-term notes payable issued by banks.

 

Interest expenses for early submission request of payment amounted to $49.3 million and $37.9 million, respectively, for the years ended December 31, 2014 and 2013.

 

(p)Advances on inventory purchase

 

Advances on inventory purchases are monies deposited or advanced to outside vendors or related parties on future inventory purchases. Due to the shortage of raw material in China, most of the Company’s vendors require a certain amount of money to be deposited with them as a guarantee that the Company will complete its purchases on a timely basis.

 

This amount is refundable and bears no interest. The Company has legally binding contracts with its vendors, which required the deposit to be returned to the Company when the contract ends. The inventory is normally delivered within one month after the monies have been advanced. 

 

(q)Inventories

 

Inventories are comprised of raw materials, work in progress and finished goods and are stated at the lower of cost or market using the weighted average cost method. Management reviews inventories for obsolescence and cost in excess of net realizable value at least annually and records a reserve against the inventory and additional cost of goods sold when the carrying value exceeds net realizable value. The Company had a net realizability adjustment of $15.3 million and $9.8 million inventory cost as of December 31, 2014 and 2013, respectively.

 

(r)Shipping and handling

 

Shipping and handling for raw materials purchased are included in cost of goods sold. Shipping and handling cost incurred to ship finished products to customers are included in selling expenses. Shipping and handling expenses for finished goods for the years ended December 31, 2014 and 2013 amounted to $25.5 million and $23.1 million, respectively.

 

(s)Plant and equipment, net

 

Plant and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets with a 3%-5% residual value. The depreciation expense on assets acquired under capital leases is included with depreciation expense on owned assets. The estimated useful lives are as follows:

 

Buildings and Improvements 10-40 Years
Machinery 10-30 Years
Machinery and equipment under capital lease 10-20 Years
Other equipment 5 Years
Transportation Equipment 5 Years

 

The Company assesses all significant leases for purposes of classification as either operating or capital. At lease inception, if the lease meets any of the four following criteria, the Company will classify it as a capital lease; otherwise it will be treated as an operating lease: a) transfer of ownership to lessee at the end of the lease term, b) bargain purchase option, c) lease term is equal to 75% or more of the estimated economic life of the leased property, d) the present value of the minimum lease payments is 90% or more of the fair value of the leased asset.

 

Construction in progress represents the costs incurred in connection with the construction of buildings or new additions to the Company’s plant facilities. No depreciation is provided for construction in progress until such time as the assets are completed and are placed into service, maintenance, repairs and minor renewals are charged directly to expense as incurred. Major additions and betterment to buildings and equipment are capitalized. Interest incurred during construction is capitalized into construction in progress. All other interest is expensed as incurred.

 

61
 

 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Long lived assets, including buildings and improvements, equipment and intangible assets are reviewed if events and changes in circumstances indicate that its carrying amount may not be recoverable, to determine whether their carrying value has become impaired. The Company considers assets to be impaired if the carrying value exceeds the future projected cash flows from related operations.

 

Due to the recurring losses in the Longmen Joint Venture’s operations, the Company has considered it is a triggering event that Longmen Joint Venture’s carrying amount may not be recoverable, to determine whether its carrying value has become impaired. The Company uses the undiscounted cash flow estimation approach for the purpose of performing a recoverability test which includes future cash inflows less associated cash outflows that are directly associated with and that are expected to arise as a direct result of the use and eventual disposition of the assets. For purposes of assessment, the long lived assets were grouped at the lowest level for which there is identifiable cash flows. The major groupings analyzed include Longmen Joint Venture, Maoming Hengda and General Steel (China). Further, our estimate of future cash flows includes estimated future cash flows necessary to maintain our existing production potential over the entire period and within the various groups. The projections are based on a best estimate approach as opposed to a probability weighted approach based on the likelihood of possible outcomes. When the Company identifies an impairment, the Company reduces the carrying amount of the asset to its estimated fair value based on a discounted cash flows method. As of December 31, 2014, the Company expects its long-lived assets to be fully recoverable.

 

The Company also re-evaluates the periods of depreciation and amortization to determine whether subsequent events and circumstances warrant revised estimates of useful lives.

 

(t)Intangible assets

 

Finite lived intangible assets of the Company are reviewed for impairment if events and circumstances require. The Company considers assets to be impaired if the carrying value exceeds the future projected cash flows from related operations. The Company also re-evaluates the periods of amortization to determine whether subsequent events and circumstances warrant revised estimates of useful lives.  As of December 31, 2014, the Company expects these assets to be fully recoverable.

 

Land use rights

 

All land in the PRC is owned by the government. However, the government grants “land use rights.”  General Steel (China) acquired land use rights in 2001 for a total of $3.9 million (RMB 23.7 million). These land use rights are for 50 years and expire in 2050 and 2053. The Company amortizes the land use rights over the twenty-year business term because its business license had a twenty-year term.

 

Long Steel Group contributed land use rights for a total amount of $24.2 million (RMB 148.3 million) to the Longmen Joint Venture. The contributed land use rights are for 50 years and expire in 2048 to 2052.

 

Maoming Hengda has land use rights amounting to $2.7 million (RMB 16.6 million) for 50 years that expire in 2054.

 

Other than the land use rights that General Steel (China) acquired in 2001, the Company amortizes the land use rights over their 50 year term.

  

Entity  Original Cost   Expires on 
   (in thousands)     
General Steel (China)  $3,865     2050 & 2053 
Longmen Joint Venture  $24,157     2048 & 2052 
Maoming Hengda  $2,704    2054 

 

Mining right

 

Mining rights are capitalized at cost when acquired, including amounts associated with any value beyond proven and probable reserves, and amortized to operations as depletion expense using the units-of-production method over the estimated proven and probable recoverable tons. Longmen Joint Venture has iron ore mining right amounting to $2.4 million (RMB 15.0 million), which is amortized over the estimated recoverable reserve of 4.2 million tons.

  

(u)Investments in unconsolidated entities

 

Entities in which the Company has the ability to exercise significant influence, but does not have a controlling interest, are accounted for using the equity method. Significant influence is generally considered to exist when the Company has an ownership interest in the voting stock between 20% and 50%, and other factors, such as representation on the Board of Directors, voting rights and the impact of commercial arrangements, are considered in determining whether the equity method of accounting is appropriate. The Company accounts for investments with ownership less than 20% using the cost method.

  

The table below summarizes Longmen Joint Venture’s investment holdings as of December 31, 2014 and 2013.

 

Unconsolidated entities  Year
acquired
   December 31,
2014
Net investment
(In thousands)
   Owned
%
   December 31,
2013
Net investment
(In thousands)
   Owned
%
 
Xi’an Delong Powder Engineering Materials Co., Ltd.   2007   $1,153    24.1   $1,215    24.1 
                          

 

62
 

 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The table below summarizes General Steel (China)’s investment holding (see Note 2(a) - Basis of presentation) as of December 31, 2014 and 2013.

 

Unconsolidated entities  Year
acquired
   December 31,
2014
Net investment
(In thousands)
   Owned
%
   December 31,
2013
Net investment
(In thousands)
   Owned
%
 
Tianwu General Steel Material Trading Co., Ltd.   2010   $15,670    32.0   $15,728    32.0 

 

Total investment income in unconsolidated subsidiaries amounted to $0.1 million and $0.2 million for the years ended December 31, 2014 and 2013, respectively, which was included in “Income from equity investments” in the consolidated statements of operations and comprehensive loss.

 

(v)Short-term notes payable

 

Short-term notes payable are lines of credit extended by banks. The banks in-turn issue the Company a bankers acceptance note, which can be endorsed and assigned to vendors as payments for purchases. The notes payable are generally payable at a determinable period, generally three to six months. This short-term notes payable bears no interest and is guaranteed by the bank for its complete face value and usually matures within three to six-month period. The banks usually require the Company to deposit a certain amount of cash at the bank as a guarantee deposit, which is classified on the balance sheet as restricted cash.

 

(w)Customer deposits 

 

Customer deposits represent amounts advanced by customers on product orders. The product normally is shipped within one month after receipt of the advance payment, and the related sale is recognized in accordance with the Company’s revenue recognition policy.

 

(x)Deferred lease income

 

To reimburse Longmen Joint Venture for certain construction costs incurred as well as economic losses on suspended production to accommodate the construction of the new iron and steel making facilities on behalf of Shaanxi Steel, in the fourth quarter of 2010, Shaanxi Steel reimbursed Longmen Joint Venture for the value of assets dismantled, various site preparation costs incurred and rent under a 40-year land sub-lease that was entered into by the parties in June 2009 (the "Longmen Sub-lease"), and for the reduced production efficiency caused by the construction. Applying the lease accounting guidance, the Company has concluded that, except for the reimbursement for site preparation costs incurred, the amount of reimbursement should be deferred and recognized as a component of the land that was sub-leased during the construction, to be amortized to income over the remaining term of the 40-year sub-lease. Deferred lease income represents the remaining balance of compensation being deferred. See Note 14 - “Deferred lease income”.

 

(y)Non-controlling Interest

 

Non-controlling interest mainly consists of Long Steel Group’s 40% interest in Longmen Joint Venture, an individuals’ 0.9% interest in Yangpu Shengtong, two individuals’ 1.3% interest in Qiu Steel, and an individual’s 1% interest in Maoming Hengda, The non-controlling interests are presented in the consolidated balance sheets, separately from equity attributable to the shareholders of the Company. Non-controlling interests in the results of the Company are presented on the face of the consolidated statement of operations as an allocation of the total income or loss for the year between non-controlling interest holders and the shareholders of the Company.

 

(z)Earnings (loss) per share

 

The Company has adopted the accounting principles generally accepted in the United States regarding earnings per share (“EPS”), which requires presentation of basic and diluted earnings (loss) per share in conjunction with the disclosure of the methodology used in computing such earnings (loss) per share.

 

Basic earnings (loss) per share are computed by dividing income available to common stockholders by the weighted average common shares outstanding during the period. Diluted earnings (loss) per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock.

 

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GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(aa)Treasury Stock

 

Treasury stock consists of shares repurchased by the Company that are no longer outstanding and are held by the Company. Treasury stock is accounted for under the cost method.

 

As of both December 31, 2014 and 2013, the Company had repurchased 2,472,306 total shares of its common stock under the share repurchase plan approved by the Board of Directors in December 2010.

 

(bb)Income taxes

 

The Company accounts for income taxes in accordance with the accounting principles generally accepted in the United States for income taxes. Under the asset and liability method as required by this accounting standard, the recognition of deferred income tax liabilities and assets for the expected future tax consequences of temporary differences between the income tax basis and financial reporting basis of assets and liabilities. Provision for income taxes consists of taxes currently due plus deferred taxes. The accounting principles generally accepted in the United States for accounting for uncertainty in income taxes clarify the accounting and disclosure for uncertain tax positions.  A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.

 

The charge for taxation is based on the results for the year as adjusted for items, which are non-assessable or disallowed. It is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date.

 

Deferred tax is accounted for using the balance sheet liability method in respect of temporary differences arising from differences between the carrying amount of assets and liabilities in the consolidated financial statements and the corresponding tax basis used in the computation of assessable tax profit. In principle, deferred tax liabilities are recognized for all taxable temporary differences. Deferred tax assets are recognized to the extent that it is probable that taxable profit will be available against which deductible temporary differences can be utilized. Deferred tax is calculated using tax rates that are expected to apply to the period when the asset is realized or the liability is settled. Deferred tax is charged or credited in the income statement, except when it is related to items credited or charged directly to equity, in which case the deferred tax is also dealt with in equity.

 

Deferred income taxes are recognized for temporary differences between the tax bases of assets and liabilities and their reported amounts in the financial statements, net operating loss carry forwards and credits, by applying enacted statutory tax rates applicable to future years. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Current income taxes are provided for in accordance with the laws of the relevant taxing authorities.

 

An uncertain tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. Penalties and interest incurred related to underpayment of income tax are classified as income tax expense in the period incurred. No significant penalties or interest relating to income taxes have been incurred during the years ended December 31, 2014, and 2013. As of December 31, 2014, the Company’s income tax returns filed for December 31, 2014, 2013, 2012, 2011 and 2010 remain subject to examination by the taxing authorities.

 

(cc)Share-based compensation

 

The Company accounts for equity instruments issued in exchange for the receipt of goods or services from other than employees in accordance with the accounting standards regarding accounting for stock-based compensation and accounting for equity instruments that are issued to other than employees for acquiring or in conjunction with selling goods or services. Costs are measured at the estimated fair market value of the consideration received or the estimated fair value of the equity instruments issued, whichever is more reliably determinable. The value of equity instruments issued for consideration other than employee services is determined on the earlier of a performance commitment or completion of performance by the provider of goods or services as defined by these accounting standards. In the case of equity instruments issued to consultants, the fair value of the equity instrument is recognized over the term of the consulting agreement.

 

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GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(dd)Recently issued accounting pronouncements

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers: Topic 606. This Update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards. The guidance in this Update supersedes the revenue recognition requirements in Topic 605, Revenue Recognition and most industry-specific guidance. The core principle of the guidance is that an entity should recognize revenue to illustrate the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new guidance also includes a cohesive set of disclosure requirements that will provide users of financial statements with comprehensive information about the nature, amount, timing, and uncertainty of revenue and cash flows arising from a reporting organization’s contracts with customers. This ASU is effective retrospectively for fiscal years, and interim periods within those years beginning after December 15, 2016 for public companies and 2017 for non-public entities. Management is evaluating the effect, if any, on the Company’s financial position and results of operations. 

 

In November 2014, FASB issued ASU No. 2014-17, Business Combinations (Topic 805):  Pushdown Accounting (a consensus of the FASB Emerging Issues Task Force.  The amendments in this update provide an acquired entity with an option to apply pushdown accounting in its separate financial statements upon occurrence of an event in which an acquirer obtains control of the acquired entity.  An acquired entity may elect the option to apply pushdown accounting in the reporting period in which the change-in-control event occurs.  An acquired entity should determine whether to elect to apply pushdown accounting for each individual change-in-control event in which an acquirer obtains control of the acquired entity.  If pushdown accounting is not applied in the reporting period in which the change-in-control event occurs, an acquired entity will have the option to elect to apply pushdown accounting in a subsequent reporting period to the acquired entity’s most recent change-in-control event.  An election to apply pushdown accounting in a reporting period after the reporting period in which the change-in-control event occurred should be considered a change in accounting principle in accordance with Topic 250, Accounting Changes and Error Corrections.  If pushdown accounting is applied to an individual change-in-control event, that election is irrevocable. The amendments in this ASU are effective on November 18, 2014.  After the effective date, an acquired entity can make an election to apply the guidance to future change-in-control events or to its most recent change-in-control event.  However, if the financial statements for the period in which the most recent change-in-control event occurred already have been issued or made available to be issued, the application of this guidance would be a change in accounting principle.  The adoption of ASU 2014-17 did not have a material impact on the Company’s consolidated financial statements.

 

In January 2015, FASB issued ASU No. 2015-01, Income Statement—Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items.  This Update is issued as part of its initiative to reduce complexity in accounting standards (the Simplification Initiative). The objective of the Simplification Initiative is to identify, evaluate, and improve areas of generally accepted accounting principles (GAAP) for which cost and complexity can be reduced while maintaining or improving the usefulness of the information provided to the users of financial statements. This Update eliminates from GAAP the concept of extraordinary items.  The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the amendments prospectively. A reporting entity also may apply the amendments retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The effective date is the same for both public business entities and all other entities.  The Company does not expect the adoption of ASU 2015-01 to have material impact on the Company’s consolidated financial statements.

 

65
 

 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

In February 2015, FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. This Update focuses on the consolidation evaluation for reporting organizations that are required to evaluate consolidation of certain legal entities by reducing the number of consolidation models from four to two and is intended to improve current GAAP. The amendments in the ASU are effective beginning after December 15, 2016. The Company does not expect the adoption of ASU 2015-02 to have a material impact on the consolidated financial statements.

 

Note 3 – Loans receivable

 

Loans receivable, including to related parties represent amounts the Company expects to collect from unrelated and related parties upon maturity.

 

The Company had the following loan receivable due within one year as of:

 

   December 31, 2014   December 31, 2013 
   (in thousands)   (in thousands) 
Loan to unrelated party; due on demand; interest rate is 8.0%.  $36,001   $- 

  

The Company has the following loans receivable – related parties due within one year as of:

 

   December 31, 2014   December 31, 2013 
   (in thousands)   (in thousands) 
Loan to Tianjin Hengying Trading Co., Ltd.; due on demand; interest rate is 10.0%.  $13,997   $- 
Loan to Tianjin Dazhan Industry Co., Ltd.; due on demand; interest rate is 10.0%.   14,617    - 
Loan to Beijing Shenghua Xinyuan Metal Materials Co., Ltd.; due on demand; interest rate is 10.0%.   6,099    - 
Loan to Teamlink Investment Co., Ltd; due in June, July and December 2014; interest rate was 4.75%   -    4,540 
Total loans receivable – related parties  $34,713   $4,540 

 

See Note 20 “Related party transactions and balances” for the nature of the relationship of related parties.

 

Total interest income for the loans amounted to $8.2 million and $0.3 million for the years ended December 31, 2014 and 2013, respectively.

 

Note 4 – Accounts receivable (including related parties), net

 

Accounts receivable, including related party receivables, net of allowance for doubtful accounts consists of the following:  

 

   December 31, 2014   December 31, 2013 
   (in thousands)   (in thousands) 
Accounts receivable  $9,804   $5,131 
Less: allowance for doubtful accounts   (483)   (1,053)
Accounts receivable – related parties   8,624    2,942 
Less: allowance for doubtful accounts – related parties   (126)   - 
Net accounts receivable  $17,819   $7,020 

 

Movement of allowance for doubtful accounts, including related parties, is as follows:

 

   December 31, 2014   December 31, 2013 
   (in thousands)   (in thousands) 
Beginning balance  $1,053   $1,367 
Charge to expense   368    96 
Less: recovery   (8)   (449)
Deconsolidation of Baotou Steel   (798)   - 
Exchange rate effect   (6)   39 
Ending balance  $609   $1,053 

 

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GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 5 – Other receivables (including related parties), net 

 

Other receivables, including related party receivables, net of allowance for doubtful accounts consists of the following:  

 

   December 31, 2014   December 31, 2013 
   (in thousands)   (in thousands) 
Other receivables  $73,944   $57,322 
Less: allowance for doubtful accounts   (10,198)   (2,606)
Other receivables – related parties   39,734    54,106 
Less: allowance for doubtful accounts – related parties   (64)   - 
Net other receivables  $103,416   $108,822 

 

Movement of allowance for doubtful accounts, including related parties, is as follows:

 

   December 31, 2014   December 31, 2013 
   (in thousands)   (in thousands) 
Beginning balance  $2,606   $2,849 
Charge to expense   7,670    48 
Less: recovery   (6)   (376)
Exchange rate effect   (8)   85 
Ending balance  $10,262   $2,606 

 

Note 6 – Inventories

 

Inventories consist of the following:

 

   December 31, 2014   December 31, 2013 
   (in thousands)   (in thousands) 
Supplies  $18,838   $21,040 
Raw materials   143,563    164,301 
Finished goods   12,301    42,977 
Less: allowance for inventory valuation   (18,375)   (15,397)
Total inventories  $156,327   $212,921 

 

Raw materials consist primarily of iron ore and coke at Longmen Joint Venture. The cost of finished goods includes direct costs of raw materials as well as direct labor used in production. Indirect production costs at normal capacity such as utilities and indirect labor related to production such as assembling, shipping and handling costs for purchasing are also included in the cost of inventory.

 

The Company values its inventory at the lower of cost or market, determined on a weighted average method, or net realizable value. As of December 31, 2014 and 2013, the Company had provided allowance for inventory valuation in the amounts of $18.4 million and $15.4 million, respectively.

 

Movement of allowance for inventory valuation is as follows:

 

   December 31, 2014   December 31, 2013 
   (in thousands)   (in thousands) 
Beginning balance  $15,397   $9,585 
Addition   18,362    15,194 
Less: net realizable value adjustment   (15,311)   (9,757)
Exchange rate effect   (73)   375 
Ending balance  $18,375   $15,397 

 

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GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 7 – Advances on inventory purchases

 

Advances on inventory purchases, including related party, net of allowance for doubtful accounts consists of the following:  

 

   December 31, 2014   December 31, 2013 
   (in thousands)   (in thousands) 
Advances on inventory purchases  $76,320   $45,002 
Less: allowance for doubtful accounts   (2,501)   (105)
Advances on inventory purchases – related parties   45,617    83,003 
Net advances on inventory purchases  $119,436   $127,900 

 

Movement of allowance for doubtful accounts, including related parties, is as follows:

 

   December 31, 2014   December 31, 2013 
   (in thousands)   (in thousands) 
Beginning balance  $105   $97 
Charge to expense   2,395    5 
Exchange rate effect   1    3 
Ending balance  $2,501   $105 

 

Note 8 – Plant and equipment, net

 

Plant and equipment consist of the following:

 

   December 31, 2014   December 31, 2013 
   (in thousands)   (in thousands) 
Buildings and improvements  $279,776   $274,402 
Machinery   669,427    667,093 
Machinery under capital lease   626,735    623,895 
Transportation and other equipment   22,765    22,991 
Construction in progress   342,660    11,412 
Subtotal   1,941,363    1,599,793 
Less: accumulated depreciation   (398,227)   (327,886)
Total  $1,543,136   $1,271,907 

 

Construction in progress consisted of the following as of December 31, 2014:

 

Construction in progress  Value   Completion  Estimated
additional cost to
complete
 
description  (In thousands)   date  (In thousands) 
Sintering machine construction   107,139   March 2015   1,112 
#5 blast furnace construction   212,086   March 2015   2,204 
Reconstruction of miscellaneous factory buildings   5,349   December 2015   4,680 
Project materials   2,144       - 
Others   15,942       - 
Total  $342,660      $7,996 

  

The Company is obligated under a capital lease for the iron and steel making facilities, including one sintering machine, two converters, two blast furnaces and some auxiliary systems that expire on April 30, 2031. During 2013, Longmen Joint Venture entered into a number of capital lease agreements for energy-saving equipment installed throughout the steel production line. The Company is obligated under the capital lease for the equipment upon the confirmation of the energy-saving rate between the Company and its vendors.

 

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GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The carrying value of assets acquired under the capital lease consists of the following:

 

   December 31, 2014   December 31, 2013 
   (in thousands)   (in thousands) 
Machinery  $626,735   $623,895 
Less: accumulated depreciation   (107,782)   (77,086)
Carrying value of leased assets  $518,953   $546,809 

  

The Company assessed the recoverability of all of its remaining long lived assets at December 31, 2014 and 2013, and such assessment did not result in any impairment charges for the years ended December 31, 2014 and 2013, respectively.

  

Depreciation expense for the years ended December 31, 2014 and 2013 amounted to $95.3 million and $87.9 million, respectively. These amounts include depreciation of assets held under capital leases for the years ended December 31, 2014 and 2013, which amounted to $31.1 million and $28.7 million, respectively.

 

Note 9 – Intangible assets, net

 

Intangible assets consist of the following:

 

   December 31, 2014   December 31, 2013 
   (in thousands)   (in thousands) 
Land use rights  $30,726   $30,884 
Mining right   2,447    2,459 
Software   1,058    743 
Subtotal   34,231    34,086 
Less:          
Accumulated amortization – land use rights   (9,127)   (8,498)
Accumulated amortization – mining right   (1,431)   (1,320)
Accumulated amortization – software   (713)   (561)
Subtotal   (11,271)   (10,379)
Intangible assets, net  $22,960   $23,707 

 

The gross amount of the intangible assets amounted to $34.2 million and $34.1 million as of December 31, 2014 and 2013, respectively. The remaining weighted average amortization period is 32.7 years as of December 31, 2014.

 

Total amortization expense for the years ended December 31, 2014 and 2013 amounted to $0.9 million and $0.8 million, respectively.

 

Total depletion expense for the years ended December 31, 2014 and 2013 amounted to $0.1 million and $0.3 million, respectively.

 

The estimated aggregate amortization and depletion expenses for each of the five succeeding years is as follows:

 

Year ending  Estimated
amortization and
depletion expenses
   Gross carrying
Amount
 
   (in thousands)   (in thousands) 
December 31, 2015  $971    21,989 
December 31, 2016   971    21,018 
December 31, 2017   971    20,047 
December 31, 2018   971    19,076 
December 31, 2019   971    18,105 
Thereafter   18,105    - 
Total  $22,960      

 

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GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 10 – Debt

 

Short-term notes payable

 

Short-term notes payable are lines of credit extended by banks. Banks in turn issue the Company a bank acceptance note, which can be endorsed and assigned to vendors as payments for purchases. The notes payable are generally payable within three to six months. This short-term note payable is guaranteed by the bank for its complete face value. The banks do not charge interest on these notes, but usually charge a transaction fee of 0.05% of the notes value. In addition, the banks usually require the Company to deposit either a certain amount of cash at the bank as a guarantee deposit, which is classified on the balance sheet as restricted cash, or provide notes receivable as security, which are classified on the balance sheet as restricted notes receivable. Restricted cash as a guarantee for the notes payable amounted to $339.4 million and $399.4 million as of December 31, 2014 and 2013, respectively. Restricted notes receivable as a guarantee for the notes payable amounted to $0 and $231.7 million as of December 31, 2014 and 2013, respectively.

 

The Company had the following short-term notes payable as of:

 

   December 31, 2014   December 31, 2013 
   (in thousands)   (in thousands) 
General Steel (China): Notes payable to various banks in China, due various dates from January to June 2015. Restricted cash required of $14.7 million and $16.4 million as of December 31, 2014 and 2013, respectively; guaranteed by third parties. These notes payable were either repaid or renewed subsequently on the due dates.  $22,806   $29,466 
Longmen Joint Venture: Notes payable to various banks in China, due various dates from January to October 2014. $324.7 million restricted cash and $0 notes receivable are secured for notes payable as of December 31, 2014, and comparatively $383.0 million restricted cash and $231.7 million notes receivable secured as of December 31, 2013, respectively; some notes are further guaranteed by third parties. These notes payable were either repaid or renewed subsequently on the due dates.   638,829    988,364 
Total short-term notes payable  $661,635   $1,017,830 

 

Short-term loans

 

Short-term loans represent amounts due to various banks, other companies and individuals, including related parties, normally due within one year. The principal of the loans are d