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EX-32.1 - EXHIBIT 32.1 - GENERAL STEEL HOLDINGS INCv418385_ex32-1.htm
EX-32.2 - EXHIBIT 32.2 - GENERAL STEEL HOLDINGS INCv418385_ex32-2.htm
EX-31.1 - EXHIBIT 31.1 - GENERAL STEEL HOLDINGS INCv418385_ex31-1.htm
EX-31.2 - EXHIBIT 31.2 - GENERAL STEEL HOLDINGS INCv418385_ex31-2.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended June 30, 2015

 

or

 

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

 

For the transition period from __________ to __________

 

Commission File Number 001-33717

 

General Steel Holdings, Inc.

(Exact name of registrant as specified in its charter)

 

Nevada   41-2079252
(State or other Jurisdiction of   (I.R.S. Employer Identification No.)
Incorporation or Organization)    

 

Level 2, Building G,

No. 2A Chen Jia Lin, Ba Li Zhuang

Chaoyang District, Beijing, China 100025

 

(Address of Principal Executive Office, Including Zip Code)

 

+86 (10) 8572 3073

 

(Registrant's Telephone Number, Including Area Code)

 

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

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition 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  ¨   Smaller reporting company x
        (Do not check if a smaller reporting company)

 

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

 

As of August 14, 2015, 69,984,282  (excluding 2,472,306 shares of treasury stock) shares of common stock, par value $0.001 per share, were outstanding.

 

 

 

  

Table of Contents

 

    Page
Part I.  FINANCIAL INFORMATION 3
     
Item 1. Unaudited Financial Statements. 3
     
  Condensed Consolidated Balance Sheets as of June 30, 2015 and December 31, 2014. 3
     
  Condensed Consolidated Statements of Operations and Comprehensive Loss for the Three and Six Months Ended June 30, 2015 and 2014. 4
     
  Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2015 and 2014. 5
     
  Notes to Condensed Consolidated Financial Statements. 6
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. 44
     
Item 4. Controls and Procedures. 68
     
Part II. OTHER INFORMATION 69
     
Item 1. Legal Proceedings. 69
     
Item 1A. Risk Factors. 69
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. 69
     
Item 6. Exhibits. 70
     
Signatures 71

 

 2 

 

  

PART I – FINANCIAL INFORMATION

 

ITEM 1. UNAUDITED FINANCIAL STATEMENTS

  

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

(In thousands)

 

   June 30,   December 31, 
   2015   2014 
ASSETS        
         
CURRENT ASSETS:        
Cash  $36,250   $11,641 
Restricted cash   230,240    355,685 
Notes receivable   5,736    10,290 
Restricted notes receivable   39,111    111,801 
Loans receivable   42,595    36,001 
Loans receivable - related party   6,110    34,713 
Accounts receivable, net   11,205    9,321 
Accounts receivable - related parties, net   3,198    8,498 
Other receivables, net   62,626    63,746 
Other receivables - related parties, net   7,329    39,670 
Inventories   153,129    156,327 
Advances on inventory purchase, net   53,389    73,819 
Advances on inventory purchase - related parties   13,411    45,617 
Prepaid expense and other   6,230    4,803 
Prepaid taxes   4,242    5,789 
Short-term investment   7,670    2,688 
TOTAL CURRENT ASSETS   682,471    970,409 
           
PLANT AND EQUIPMENT, net   569,477    1,543,136 
           
OTHER ASSETS:          
Advances on equipment purchase   2,520    11,438 
Investment in unconsolidated entities   16,749    16,823 
Long-term deferred expense   446    458 
Intangible assets, net of accumulated amortization   22,706    22,960 
TOTAL OTHER ASSETS   42,421    51,679 
           
TOTAL ASSETS  $1,294,369   $2,565,224 
           
LIABILITIES AND DEFICIENCY          
           
CURRENT LIABILITIES:          
Short term notes payable  $531,869   $661,635 
Accounts payable   596,466    612,801 
Accounts payable - related parties   211,149    207,783 
Short term loans - bank   153,989    257,502 
Short term loans - others   65,158    60,717 
Short term loans - related parties   279,950    46,380 
Other payables and accrued liabilities   61,805    55,488 
Other payables - related parties   80,028    87,252 
Customer deposits   86,860    92,974 
Customer deposits - related parties   33,923    132,616 
Deposit due to sales representatives   15,782    17,871 
Deposit due to sales representatives - related parties   2,872    2,509 
Taxes payable   7,984    5,201 
Deferred lease income, current   2,180    2,176 
Capital lease obligations, current   9,942    8,508 
TOTAL CURRENT LIABILITIES   2,139,957    2,251,413 
           
NON-CURRENT LIABILITIES:          
Long-term loans - related party   353,067    339,549 
Deferred lease income, noncurrent   71,757    72,713 
Capital lease obligations, noncurrent   401,283    393,252 
Profit sharing liability at fair value   -    70,422 
TOTAL NON-CURRENT LIABILITIES   826,107    875,936 
           
TOTAL LIABILITIES   2,966,064    3,127,349 
           
COMMITMENTS AND CONTINGENCIES          
           
DEFICIENCY:          
Preferred stock, $0.001 par value, 50,000,000 shares authorized, 3,092,899 shares issued and outstanding as of June 30, 2015 and December 31, 2014   3    3 
Common stock, $0.001 par value, 200,000,000 shares authorized, 66,456,588 shares and 64,458,588 shares issued and 63,984,282 shares and 61,986,282 shares outstanding as of June 30, 2015 and December 31, 2014, respectively   66    64 
Treasury stock, at cost, 2,472,306 shares as of June 30, 2015 and December 31, 2014   (4,199)   (4,199)
Paid-in-capital   117,274    115,494 
Statutory reserves   6,583    6,472 
Accumulated deficits   (1,123,701)   (463,521)
Accumulated other comprehensive income   (1,259)   644 
TOTAL GENERAL STEEL HOLDINGS, INC. DEFICIENCY   (1,005,233)   (345,043)
           
NONCONTROLLING INTERESTS   (666,462)   (217,082)
           
TOTAL DEFICIENCY   (1,671,695)   (562,125)
           
TOTAL LIABILITIES AND DEFICIENCY  $1,294,369   $2,565,224 

 

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

 

 3 

 

 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2015 AND 2014

(UNAUDITED)

(In thousands, except per share data)

 

   For the three months ended June 30,   For the six months ended June 30, 
   2015   2014   2015   2014 
                 
SALES  $454,855   $508,637   $725,624   $1,020,642 
                     
SALES - RELATED PARTIES   73,926    79,376    131,321    161,582 
TOTAL SALES   528,781    588,013    856,945    1,182,224 
                     
COST OF GOODS SOLD   509,185    482,011    806,750    1,012,755 
                     
COST OF GOODS SOLD - RELATED PARTIES   83,865    77,908    146,611    163,936 
TOTAL COST OF GOODS SOLD   593,050    559,919    953,361    1,176,691 
                     
GROSS (LOSS) PROFIT   (64,269)   28,094    (96,416)   5,533 
                     
SELLING, GENERAL AND  ADMINISTRATIVE EXPENSES   (22,083)   (18,849)   (39,438)   (39,902)
EXCESS OVERHEAD DURING MAINTENANCE   (5,309)   -    (24,443)   - 
IMPAIRMENT CHARGE   (973,860)   -    (973,860)   - 
CHANGE IN FAIR VALUE OF PROFIT SHARING LIABILITY   57,499    (2,920)   70,423    (2,969)
                     
LOSS FROM OPERATIONS   (1,008,022)   6,325    (1,063,734)   (37,338)
                     
OTHER INCOME (EXPENSE)                    
Interest income   2,741    4,066    5,072    7,258 
Finance/interest expense   (29,575)   (26,619)   (50,145)   (55,314)
Loss on disposal of equipment and intangible assets   (44)   (142)   (28)   (96)
Income (loss) from equity investments   34    54    (3)   67 
Foreign currency transaction loss   (249)   (963)   (1,122)   (1,817)
Lease income   545    542    1,088    1,088 
Other non-operating income (expense), net   378    302    601    126 
Other expense, net   (26,170)   (22,760)   (44,537)   (48,688)
                     
LOSS BEFORE PROVISION FOR INCOME TAXES AND NONCONTROLLING INTEREST   (1,034,192)   (16,435)   (1,108,271)   (86,026)
                     
PROVISION FOR INCOME TAXES   111    107    141    112 
                     
NET LOSS   (1,034,303)   (16,542)   (1,108,412)   (86,138)
                     
Less: Net loss attributable to noncontrolling interest   (419,276)   (5,523)   (448,232)   (31,555)
                     
NET LOSS ATTRIBUTABLE TO GENERAL STEEL HOLDINGS, INC.  $(615,027)  $(11,019)  $(660,180)  $(54,583)
                     
NET LOSS  $(1,034,303)  $(16,542)  $(1,108,412)  $(86,138)
                     
OTHER COMPREHENSIVE LOSS                    
Foreign currency translation adjustments   (2,274)   (929)   (3,127)   3,741 
                     
COMPREHENSIVE LOSS   (1,036,577)   (17,471)   (1,111,539)   (82,397)
                     
Less: Comprehensive loss attributable to noncontrolling interest   (420,128)   (5,875)   (449,456)   (30,101)
                     
COMPREHENSIVE LOSS ATTRIBUTABLE TO GENERAL STEEL HOLDINGS, INC.  $(616,449)  $(11,596)  $(662,083)  $(52,296)
                     
WEIGHTED AVERAGE NUMBER OF SHARES                    
Basic and Diluted   62,777    55,842    62,384    55,828 
                     
LOSS PER SHARE                    
Basic and Diluted  $(9.80)  $(0.20)  $(10.58)  $(0.98)

 

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

 

 4 

 

  

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30, 2015 AND 2014

(UNAUDITED)

(In thousands)

 

   2015   2014 
CASH FLOWS FROM OPERATING ACTIVITIES:        
Net loss  $(1,108,412)  $(86,138)
Adjustments to reconcile net loss to cash provided by (used in) operating activities:          
Depreciation, amortization and depletion   56,596    47,788 
Impairment of plant and equipment   973,860    - 
Change in fair value of profit sharing liability   (70,423)   2,969 
Gain on disposal of equipment and intangible assets   28    96 
Provision (recovery) of doubtful accounts   2,548    (250)
Reservation of mine maintenance fee   187    278 
Stock issued for services and compensation   382    219 
Amortization of deferred financing cost on capital lease   9,765    9,253 
Income (loss) from equity investments   3    (67)
Foreign currency transaction loss   1,122    1,817 
Deferred lease income   (1,088)   (1,088)
Changes in operating assets and liabilities          
Notes receivable   5,238    45,931 
Accounts receivable   (1,888)   (1,008)
Accounts receivable - related parties   5,307    (2,875)
Other receivables   (1,188)   (307)
Other receivables - related parties   32,353    (4,275)
Inventories   2,631    1,286 
Advances on inventory purchases   20,528    (13,968)
Advances on inventory purchases - related parties   39,581    (36,971)
Prepaid expense and other   (19)   (1,947)
Long-term deferred expense   14    111 
Prepaid taxes   1,555    15,747 
Accounts payable   (22,969)   (18,050)
Accounts payable - related parties   2,978    28,204 
Other payables and accrued liabilities   6,223    2,637 
Other payables - related parties   (7,334)   4,824 
Customer deposits   (6,274)   49,187 
Customer deposits - related parties   (191,619)   78,667 
Taxes payable   2,769    (413)
Net cash (used in) provided by operating activities   (247,546)   121,657 
           
CASH FLOWS FROM INVESTING ACTIVITIES:          
Restricted cash   125,868    (51,820)
Loans to unrelated parties   (6,516)   - 
Loans receivable - related party   114,127    - 
Cash proceeds from short term investment   2,606    - 
Payments for short term investment   (7,575)   - 
Cash proceeds from sales of equipment and intangible assets   -    24 
Equipment purchase and intangible assets   (40,174)   (112,713)
Net cash provided by (used in) investing activities   188,336    (164,509)
           
CASH FLOWS FINANCING ACTIVITIES:          
Restricted notes receivable   72,762    286,485 
Borrowings on short term notes payable   497,497    900,202 
Payments on short term notes payable   (628,240)   (1,035,408)
Borrowings on short term loans - bank   97,026    185,023 
Payments on short term loans - bank   (201,944)   (285,100)
Borrowings on short term loan - others   109,420    19,949 
Payments on short term loans - others   (82,814)   (25,417)
Borrowings on short term loan - related parties   223,974    32,576 
Payments on short term loans - related parties   (56,394)   (19,233)
Deposits due to sales representatives   (2,119)   (2,736)
Deposits due to sales representatives - related parties   358    (326)
Borrowings on long-term loans - related party   56,201    - 
Payments on long-term loans - related party   (815)   - 
Principal payment on capital lease obligation   (1,077)   - 
Net cash provided by financing activities   83,835    56,015 
           
EFFECTS OF EXCHANGE RATE CHANGE IN CASH   (16)   (381)
           
INCREASE IN CASH   24,609    12,782 
           
CASH, beginning of period   11,641    31,967 
           
CASH, end of period  $36,250   $44,749 

 

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

 

 5 

 

  

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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 15 “Capital lease obligations” and Note 16 “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.

 

 6 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The Company formed a joint venture, Tianjin General Shengyuan IoT Technology Co., Ltd. (“General Shengyuan IoT”), 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. General Shengyuan IoT is still in the development stage and no revenues and significant operating expenses during the three and six months ended June 30, 2015.

 

Note 2 – Summary of significant accounting policies

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information pursuant to the rules and regulations of the Securities and 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. In the opinion of management, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation of the financial statements have been included. Interim results are not necessarily indicative of results to be expected for the full year. The information included in this Form 10-Q should be read in conjunction with information included in the 2014 annual report on Form 10-K filed on April 10, 2015.

 

(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 %
Tianjin General Shengyuan IoT Technology Co., Ltd. (“General Shengyuan”)   PRC     70.0 %
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 %

 

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.

 

General Shengyuan

 

On February 13, 2015, the Company formed a joint venture entity, Tianjin General Shengyuan IoT Technology Co., Ltd, with a team of radio-frequency identification (“RFID”) experts (the “Expert Team”), to develop and commercialize RFID technology data solutions. Under the terms of the Agreement, the Company owned 70% of the joint venture by contributing $1.6 million (RMB 10.0 million), while the Expert Team committed to contribute intellectual property, including proprietary RFID technologies, licensed patents and domain expertise.

 

(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.

 

 7 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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.

 

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 and Going Concern.

 

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:

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
Current assets  $641,541   $837,135 
Plant and equipment, net   565,978    1,537,687 
Other noncurrent assets   24,150    33,396 
Total assets   1,231,669    2,408,218 
Total liabilities   (2,876,140)   (2,946,126)
Net liabilities  $(1,644,471)  $(537,908)

 

 8 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

VIE and its subsidiaries’ liabilities consist of the following:

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
Current liabilities:          
Short term notes payable  $510,653   $638,829 
Accounts payable   588,959    605,025 
Accounts payable - related parties   206,777    205,914 
Short term loans – bank   113,352    216,940 
Short term loans – others   83,497    54,524 
Short term loans - related parties   279,280    45,710 
Other payables and accrued liabilities   54,028    47,121 
Other payables - related parties   53,796    78,615 
Customer deposits   83,519    87,372 
Customer deposits - related parties   24,311    34,895 
Deposit due to sales representatives   15,782    17,871 
Deposit due to sales representatives – related parties   2,872    2,509 
Taxes payable   6,816    4,026 
Deferred lease income   2,180    2,176 
Capital lease obligations, current   9,942    8,508 
Intercompany payable to be eliminated   14,269    20,155 
Total current liabilities   2,050,033    2,070,190 
Non-current liabilities:          
Long term loans - related parties   353,067    339,549 
Deferred lease income - noncurrent   71,757    72,713 
Capital lease obligations, noncurrent   401,283    393,252 
Profit sharing liability   -    70,422 
Total non-current liabilities   826,107    875,936 
Total liabilities of consolidated VIE  $2,876,140   $2,946,126 

 

   Three months
ended
June 30, 2015
   Three months
ended
June 30, 2014
 
   (in thousands)   (in thousands) 
Sales  $528,778   $587,314 
Gross (loss) profit  $(64,220)  $28,229 
(Loss) income from operations  $(1,005,820)  $8,128 
Net loss attributable to controlling interest  $(613,117)  $(8,077)

 

   Six months
ended
June 30, 2015
   Six months
ended
June 30, 2014
 
   (in thousands)   (in thousands) 
Sales  $856,936   $1,181,328 
Gross (loss) profit  $(96,367)  $6,010 
Loss from operations  $(1,059,318)  $(31,166)
Net loss attributable to controlling interest  $(655,522)  $(46,111)

 

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 and 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.

 

 9 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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 of June 30, 2015 and December 31, 2014 and for the three and six months ended June 30, 2015 and 2014, respectively.

 

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 of June 30, 2015 and December 31, 2014 and for the three and six months ended June 30, 2015 and 2014, respectively.

 

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.

 

(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.

 

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 June 30, 2015 and December 31, 2014 were (1.8) and (5.6), respectively. As June 30, 2015, the Company’s current liabilities exceed current assets (excluding non-cash item) by $1.5 billion, which together with the gross loss from operations raises substantial doubt about its 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.

 

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.

 

 10 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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 $150.2 million with expiration dates ranging from October 14, 2016 to December 26, 2016.

 

Banks  Amount of
Line of Credit
(in millions)
   Repayment Date
Bank of China   19.6   December 3, 2016
Bank of Beijing   81.6   October 14, 2016
Bank of Chongqing   49.0   December 26, 2016
Total  $150.2    

 

As of the date of this report, the Company utilized $nil 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 $1,060.8 million with the following companies:

 

Company  Financing Period  Financing Amount
(in millions)
 
        
Company A – related party  July 30, 2014 – July 30, 2019  $244.8 
Company B – third party  January 22, 2014 – January 22, 2017   163.2 
Company C – third party  October 1, 2013 – September 30, 2017   652.8 
Total     $1,060.8 

 

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 $244.8 million. Company B signed a three-year agreement with Longmen Joint Venture on January 22, 2014 to finance its coke purchases up to $163.2 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 $41.7 million and $55.0 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 $489.3 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. On August 1, 2015, Company C signed another extension agreement with the Company and extended the financing terms to September 30, 2017 with amount up to $652.8 million. 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 $nil.

 

 11 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Other financing

 

On April 22, 2014, April 23, 2014, and April 30, 2015, 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 $412.9 million in financial support from payment extensions granted by the following five companies:

 

Company  Financing Period  Financing Amount
(in millions)
 
        
Company D – related party  April 22, 2014 – April 22, 2017  $81.6 
Company E – related party  April 23, 2014 – April 23, 2017   86.5 
Company F – related party  April 22, 2014 – April 22, 2017   81.6 
Company G – related party  April 30, 2015 – April 30, 2018   81.6 
Company H – related party  April 30, 2015 – April 30, 2018   81.6 
Total     $412.9 

 

As of the date of this report, our payables to Company D, Company E, Company F, Company G, and Company H are approximately $0.2 million, $2.4 million, $21.6 million, $3.3 million, 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 June 30, 2015, Longmen Joint Venture has collected a total amount of $18.7 million. Historically, this amount is quite stable and we do not expect a big fluctuation in this amount for the next twelve months from June 30, 2015 onwards.

 

With the financial support from the banks and the companies above and management’s continued effort in obtaining additional financial supports from banks and other companies, management plans outlined above and summarized below are expected to provide sufficient funds to meet its future operations, working capital requirements and debt obligations until the end of June 30, 2016. However, these plans are 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 continued significant reliance on 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 June 30, 2016
 
Current liabilities over current assets (excluding deferred lease income) as of June 30, 2015 (unaudited)  $(1,455.3)
Projected cash financing and outflows:     
Cash provided by line of credit from banks   150.2 
Cash provided by vendor financing   1,060.8 
Cash provided by other financing   412.9 
Cash provided by sales representatives   18.7 
Cash projected to be used in operations in the twelve months ended June 30, 2016   (58.3)
Cash projected to be used for financing cost in the twelve months ended June 30, 2016   (59.6)
Net projected change in cash for the twelve months ended June 30, 2016  $69.4 

 

(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 the weighted average calculation used in the 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.

 

 12 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Impairment

 

One of the Company’s most significant estimates is the determination of fair value of the profit sharing liability see note 2(h). Since the liability is calculated and largely based on management’s expectations of product demand, pricing, raw materials cost and projected manufacturing efficiencies, it is susceptible to material changes when actual results deviate from those expectations. While management believes its current assumptions are reasonable and achievable, there is no assurance that those future expectations will be met or that significant adjustments won’t be required in the future.

 

(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.

 

Through the quarter ended June 30, 2015, the Company has incurred recurring losses from the Company’s operations from the last several years as the Company’s steel business has faced very tough market conditions and challenging profitability. Management has continued its effort to implementing cost savings on our manufacturing overhead costs and to reduce our unit production cost. The Company has forecasted its loss will be continued until year 2021 and expected to make a turning point and become profitable in year 2022 and beyond. The Company’s forecast is based on current market condition, if the future market condition is different from its forecast, the Company might continue to incur additional loss in 2022 and beyond and the Company’s assets pool of its long-lived assets may become further impaired see note 2(j).

 

The Company has significant exposure to the price fluctuation of raw materials and energy prices as part of its normal operations. As of June 30, 2015 and December 31, 2014, the Company did 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 these banks on June 30, 2015 and December 31, 2014 amounted to $266.5 million and $367.2 million, including $0.6 million and $1.0 million that were deposited in Shaanxi Coal and Chemical Industry Group Financial Co., Ltd., a related party, respectively. As of June 30, 2015, $0.02 million cash in the bank was covered by insurance. 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.

 

One of the Company’s customers individually accounted for 11.6% and 11.2% of total sales for the three and six months ended June 30, 2015 respectively. Two of the Company’s customers individually accounted for 28.3% and 10.7% of total accounts receivable, including related parties as of June 30, 2015. None of the Company’s customers accounted for more than 10% of total sales for the three and six months ended June 30, 2014. Two customers individually accounted for 32.1% and 20.5% of total accounts receivable, including related parties as of December 31, 2014, respectively.

 

One of the company’s supplier individually accounted for 16.6% and 10.5% of the total purchases for the three months and six months ended June 30, 2015, respectively. One of the Company’s suppliers individually accounted for 12.8% and 12.7% of the total purchases for the three and six months ended June 30, 2014. None of the Company’s suppliers individually accounted for more than 10% of total accounts payable as June 30, 2015 and December 31, 2014.

 

(g)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.

 

 13 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Translation adjustments included in accumulated other comprehensive income amounted to $(1.3) million and $0.6 million as of June 30, 2015 and December 31, 2014, respectively. The balance sheet amounts, with the exception of equity at June 30, 2015 and December 31, 2014 were translated at 6.13 RMB and 6.14 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 three months ended June 30, 2015 and 2014 were 6.12 RMB and 6.16 RMB, respectively. The average translation rates applied to statement of operations accounts for the six months ended June 30, 2015 and 2014 were 6.14 RMB and 6.14 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.

 

(h)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 market 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.

 

As described in Note 15 - 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 6.5%.

 

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.

 

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%. On May 11, 2015, the People’s Bank of China decreased the standard bank borrowing rate again across the board by 0.25%. Accordingly, the Company adjusted down the present value discount rate for profit sharing liability by 0.25% from 6.9% to 6.7%. On June 27, 2015 the People’s Bank of China decreased the standard bank borrowing rate again across the board by 0.25%. Accordingly, the Company adjusted down the present value discount rate for profit sharing liability by 0.25% from 6.7% to 6.5%.

 

 14 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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 June 30, 2015 and 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, as of December 31, 2014 financial statement issuance we had 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% of GDP, 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 at December 31, 2014.

 

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.

 

For the three months ended March 31, 2015, the Company recognized a $12.9 million reduction in the fair value of profit sharing liability resulting from the change in estimates of future operating profits based on the April 2015 actual operating results and consideration for the Chinese steel market trends in April 2015 as well as the May 11, 2015 change to the Borrowing Rate by 0.25%. These further recent changes in market conditions resulted in a decrease in the expected liability of $16.6 million primarily from adjustments to the 2015 and 2016 expected cash flows as well as a $2.5 million loss from the reduction in the present value discount rate of 0.25% and a $1.2 million loss from the present value discount.

 

The variables and the impact on the Company’s inputs to the first quarter of 2015 valuation of profit sharing fair value, as compared to the 2014 valuation of the profit sharing fair value can be summarized as follows:

 

-Volume Inputs: the Company reduced our projected sales volume in 2015 by 3% versus the forecast used in 2014.
-Steel Sales Price Inputs: the Company reduced our projected selling price in 2015 by 12% versus the forecast used in 2014 and reduced our projected selling price in 2016 by 7% versus the forecast used in 2014.

 

 15 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

For the three months ended June 30, 2015, the Company recognized a $57.5 million reduction in the fair value of profit sharing liability resulting from the change in estimates of future operating profits based on the actual operating results through June 2015 and the continued deterioration of steel market conditions in the second quarter of 2015, which deviated from our previously anticipated industry environment improvement, as well as the June 27, 2015 change to the Borrowing Rate by 0.25%. These further recent changes in market conditions resulted in a decrease in the expected liability of $54.8 million primarily from adjustments to the 2015 to 2031 expected cash flows as well as a $2.6 million loss from the reduction in the present value discount rate of 0.25%, a $1.2 million loss from the present value discount, and a $6.5 million gain resulting from the Asset Pool’s operating results for the three months ended June 30, 2015 being less favorable than previously estimated as of March 31, 2015. The estimated fair value of the profit sharing liability at June 30, 2015 was reduced to $0. At the same time, the reduction in the estimated future cash flows expected to be generated from Longmen Joint Venture’s operations caused the value of the Assets Pool to fall below the carrying value of Longmen Joint Venture’s long-lived assets, which triggered an impairment of $973.9 million (see Note 2(j)).

 

The variables and the impact on the Company’s inputs to the second quarter of 2015 valuation of profit sharing fair value, as compared to the first quarter valuation of the profit sharing fair value can be summarized as follows:

 

-Volume Inputs: the Company increased our projected sales volume between 2015 and 2031 in response to recent policy initiatives from the Chinese government to boost infrastructure investment and further steel industry consolidation.
-Steel Sales Price Inputs: the Company reduced our projected selling price in 2015 by 19% versus the forecast used in the first quarter of 2015 and reduced our projected selling price between 2016 and 2031 proportionally based on the reduction for 2015.
-Raw Material Cost Inputs: based on the actual results in the second quarter of 2015 and the latest market trends, the Company reduced cost of goods sold in 2015 by 12% versus the forecast used in the first quarter of 2015 and reduced our projected cost of goods sold between 2016 and 2031 proportionally based on the reduction for 2015.

 

Changes in any of the assumptions used to estimate the fair value of the profit sharing liability and to determine whether and how much the carrying value of Longmen Joint Venture’s long-lived assets has been impaired will change the discounted cash flows of Longmen Joint Venture and the impairment value accordingly. If we were to reduce the projected bank borrowings rate used to discount the liability to a present value by 1.0% and other factors remained unchanged, our profit sharing liability as of June 30, 2015 would have been $0 and we would decrease the impairment expense by $95.7 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 June 30, 2015 would have been $0 and we would increase the impairment expense by $54.6 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 

 

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 six months ended June 30, 2015 and for the year ended December 31, 2014:

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
Beginning balance  $70,422   $162,295 
Change in fair value of profit sharing liability:          
Change in preset value of estimate of future operating profits   (71,395)   (110,589)
Change in discount rate   5,012    8,106 
Interest expense - present value discount amortization   2,443    11,544 
Difference between the previously estimated operating results for the current period and actual results   (6,483)   (79)
Exchange rate effect   1    (855)
Ending balance  $-   $70,422 

 

 16 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The Company did not identify any other assets or liabilities that are required to be presented on the balance sheet at fair value.

 

(i)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.

 

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 $8.3 million and $12.8 million for the three months ended June 30, 2015 and 2014 respectively.

 

Interest expenses for early submission request of payment amounted to $16.3 million and $26.9 million for the six months ended June 30, 2015 and 2014, respectively.

 

(j)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.

 

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

 

Due to the recurring losses in the Longmen Joint Venture’s operations, the most recent economic down turn, the major sell off of the Chinese stock market and the lacking of government expansion in major infrastructure, the Company has considered Longmen Joint Venture’s carrying amount for property and equipment not being recoverable. The Company uses the undiscounted cash flow 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 analysis 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 of likely 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 June 30, 2015, the Company expects its long-lived assets to be not fully recoverable and recognized an impairment loss of $973.9 million to reduce its carrying value to its fair value. See note 8

 

 17 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

(k)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 June 30, 2015, 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)   $ 3,872       2050 & 2053  
Longmen Joint Venture   $ 24,201       2048 & 2052  
Maoming Hengda   $ 2,709       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 $2.5 million (RMB 15.0 million), which is amortized over the estimated recoverable reserve of 4.2 million tons.

 

(l)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 June 30, 2015 and December 31, 2014.

 

Unconsolidated entities  Year
acquired
   June 30, 2015
Net
investment
(In thousands)
   Owned %   December 31, 2014
Net
investment
(In thousands)
   Owned
%
 
Xi’an Delong Powder Engineering Materials Co., Ltd.   2007   $1,056    24.1   $1,153    24.1 

 

 18 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The table below summarizes General Steel (China)’s investment holding (see Note 2(a) - Basis of presentation) as of June 30, 2015 and December 31, 2014.

 

Unconsolidated 
 entities
  Year
acquired
   June 30, 2015
Net
investment
(In thousands)
   Owned %   December 31, 2014
Net
investment
(In thousands)
   Owned
%
 
Tianwu General Steel Material Trading Co., Ltd.   2010   $15,693    32.0   $15,670    32.0 

 

Total investment income in unconsolidated subsidiaries amounted to $34 thousand and $54 thousand for the three months ended June 30, 2015 and 2014, respectively, which was included in “Income from equity investments” in the condensed consolidated statements of operations and comprehensive loss. Total investment income (loss) in unconsolidated subsidiaries amounted to $(3) thousand and $67 thousand for the six months ended June 30, 2015 and 2014, respectively, which was included in “Income from equity investments” in the condensed consolidated statements of operations and comprehensive loss.

 

(m)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 obligators, 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 retained in accordance with ASC 605-45. Sales in trading transactions, which were netted against corresponding cost of goods sold, amounted to $127.1 million and $80.9 million for the three months ended June 30, 2015 and 2014, respectively, and $234.8 million and $119.1 million for the six months ended June 30, 2015 and 2014, respectively. The net gain (loss) in gross loss amounted to $(63,151) and $(159,258) for the three months ended June 30, 2015 and 2014, respectively, and $1,843 and $(447,771) for the six months ended June 30, 2015 and 2014, respectively.

 

(n)Recently issued accounting pronouncements

 

In February 2015, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2015-02, Amendments to the Consolidation Analysis. Under both current GAAP requirements and the amendments in this update, a decision maker is determined to be the primary beneficiary of a VIE if it satisfies both the power and the economics criteria. The primary beneficiary consolidates a VIE because it has a controlling financial interest. Under the requirements in current GAAP, if a fee arrangement paid to a decision maker, such as an asset management fee, is determined to be a variable interest in a VIE, the decision maker must include the fee arrangement in its primary beneficiary determination and could consolidate the VIE on the basis of power (decision-making authority) and economics (the fee arrangement). However, the amendments in this Update specify that some fees paid to a decision maker are excluded from the evaluation of the economics criterion if the fees are both customary and commensurate with the level of effort required for the services provided. Those amendments make it less likely for a decision maker to meet the economics criterion solely on the basis of a fee arrangement. The amendments in this update are effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. Management is evaluating the impact that will arise from these Amendments.

 

In April 2015, the FASB issued authoritative guidance on accounting for Interest-Imputation of Interest (Subtopic 835-30); Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”). This update requires that debt issuance cost related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the debt liability, consistent with debt discounts, without changing existing recognition and measurement guidance for debt issuance costs. The new guidance is required to be applied on a retrospective basis and to be accounted for as a change in an accounting principle. The amendments in this update are effective for financial statements issued for fiscal years beginning after December 15, 2015 and interim periods within those fiscal years and early adoption of the amendments in this update is permitted. The Company has applied early adoption of this standard in the second quarter of 2015. The implementation of this standard resulted in the reclassification of certain debt issuance costs from deferred financing cost to a reduction in the carrying amount of the related debt liability within the Company’s consolidated balance sheets.

 

 19 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

In July 2015, the FASB issued ASU No. 2015-11, an amendment to Topic 330 for simplifying the measurement of inventory. The update requires that inventory be measured at the lower of cost and net realizable value where net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Subsequent measurement is unchanged for inventory measured using LIFO or the retail inventory method. The amendment is intended to provide clarification on the measurement and disclosure of inventory in Topic 330 and not intended for those clarifications to result in any changes in practice. The ASU is effective for interim and annual periods beginning after December 15, 2016. Early application is permitted for all entities and should be applied prospectively. The Company does not expect the adoption of ASU 2015-11 to have material impact on the Company’s 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:

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
Loan to unrelated party; due on demand; interest rate is 8.0%.  $42,595   $36,001 

 

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

 

   June 30, 2015   December 31, 2014 
   (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%.   6,110    6,099 
Total loans receivable – related parties  $6,110   $34,713 

 

See Note 19 “Related party transactions and balances” for the nature of the relationship of related parties.

 

Total interest income for the loans amounted to $0.7 million and $0.05 million for the three months ended June 30, 2015 and 2014, respectively.

 

Total interest income for the loans amounted to $1.2 million and $0.1 million for the six months ended June 30, 2015 and 2014, 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:

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
Accounts receivable  $11,713   $9,804 
Less: allowance for doubtful accounts   (508)   (483)
Accounts receivable – related parties   3,325    8,624 
Less: allowance for doubtful accounts – related parties   (127)   (126)
Net accounts receivable  $14,403   $17,819 

 

 20 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Movement of allowance for doubtful accounts is as follows:

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
Beginning balance  $609   $1,053 
Charge to expense   25    368 
Less: recovery   -    (8)
Deconsolidation of Baotou Steel   -    (798)
Exchange rate effect   1    (6)
Ending balance  $635   $609 

 

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

 

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

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
Other receivables  $75,372   $73,944 
Less: allowance for doubtful accounts   (12,746)   (10,198)
Other receivables – related parties   7,393    39,734 
Less: allowance for doubtful accounts – related parties   (64)   (64)
Net other receivables  $69,955   $103,416 

 

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

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
Beginning balance  $10,262   $2,606 
Charge to expense   2,531    7,670 
Less: recovery   (7)   (6)
Exchange rate effect   24    (8)
Ending balance  $12,810   $10,262 

 

Note 6 – Inventories

 

Inventories consist of the following:

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
Supplies  $15,704   $18,838 
Raw materials   87,125    143,563 
Finished goods   78,157    12,301 
Less: allowance for inventory valuation   (27,857)   (18,375)
Total inventories  $153,129   $156,327 

 

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.

 

 21 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The Company values its inventory at the lower of cost or market, determined on a weighted average method, or net realizable value. As of June 30, 2015 and December 31, 2014, the Company had provided allowance for inventory valuation in the amounts of $27.8 million and $18.4 million, respectively.

 

Movement of allowance for inventory valuation is as follows:

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
Beginning balance   18,375   $15,397 
Addition   27,805    18,362 
Less: write-off   (18,374)   (15,311)
Exchange rate effect   51    (73)
Ending balance  $27,857   $18,375 

 

Note 7 – Advances on inventory purchases

 

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

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
Advances on inventory purchases  $55,895   $76,320 
Less: allowance for doubtful accounts   (2,506)   (2,501)
Advances on inventory purchases – related parties   13,411    45,617 
Net advances on inventory purchases  $66,800   $119,436 

 

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

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
Beginning balance  $2,501   $105 
Charge to expense   -    2,395 
Exchange rate effect   5    1 
Ending balance  $2,506   $2,501 

 

Note 8 – Plant and equipment, net

 

Plant and equipment consist of the following:

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
Buildings and improvements  $223,872   $279,776 
Machinery   464,127    669,427 
Machinery under capital lease   305,968    626,735 
Transportation and other equipment   16,271    22,765 
Construction in progress   14,219    342,660 
Subtotal   1,024,457    1,941,363 
Less: accumulated depreciation   (454,980)   (398,227)
Total  $569,477   $1,543,136 

 

 22 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Construction in progress consisted of the following as of June 30, 2015:

 

   Value   Completion  Estimated additional
cost to complete
 
Description  (In thousands)   Date  (In thousands) 
Restructuring of ventilation system   2   December 2015   980 
Energy management system   3,856   September 2015   1,926 
Reconstruction of miscellaneous factory buildings   7,773   December 2015   6,346 
Project materials   2,146       - 
Others   442       - 
Total  $14,219      $9,252 

 

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.

 

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

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
Machinery  $305,968   $626,735 
Less: accumulated depreciation   (123,917)   (107,782)
Carrying value of leased assets  $182,051   $518,953 

 

Long-lived assets, including construction in progress, 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 assessed the recoverability of all of its remaining long-lived assets at June 30, 2015 and December 31, 2014, respectively. While such assessment did not result in any impairment charges as of December 31, 2014, as the Chinese steel industry conditions continued to worsen during the three and six months ended June 30, 2015, which deviated from the Company’s previous anticipated industry environment improvement, the sum of the discounted cash flows expected to generate from the long-lived assets and their disposition were less than the carrying value by $973.9 million (RMB 6.0 billion). As a result, an impairment was recorded and included in operating expenses for the three and six months ended June 30, 2015 (see Note 2(j)). The discounted cash flows were determined using certain expected changes to the current operational assumptions using the average of three possible cash flow scenarios (see Note 2(j)). If those expectations are not met, the Company may be required to record additional impairment charges in future periods.

 

Depreciation expense for the three months ended June 30, 2015 and 2014 amounted to $31.3 million and $23.2 million, respectively. These amounts include depreciation of assets held under capital leases for the three months ended June 30, 2015 and 2014, which amounted to $7.8 million and $7.7 million, respectively.

 

Depreciation expense for the six months ended June 30, 2015 and 2014 amounted to $56.2 million and $47.3 million, respectively. These amounts include depreciation of assets held under capital leases for the six months ended June 30, 2015 and 2014, which amounted to $15.9 million and $15.6 million, respectively.

 

Note 9 – Intangible assets, net

 

Intangible assets consist of the following:

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
Land use rights  $30,782   $30,726 
Mining right   2,451    2,447 
Software   1,070    1,058 
Subtotal   34,303    34,231 
Less:          
Accumulated amortization – land use rights   (9,484)   (9,127)
Accumulated amortization – mining right   (1,347)   (1,431)
Accumulated amortization – software   (766)   (713)
Subtotal   (11,597)   (11,271)
Intangible assets, net  $22,706   $22,960 

 

 23 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The gross amount of the intangible assets amounted to $34.3 million and $34.2 million as of June 30, 2015 and December 31, 2014, respectively. The remaining weighted average amortization period is 32.3 years as of June 30, 2015.

 

Total amortization expense for the three months ended June 30, 2015 and 2014 amounted to $0.2 million and $0.3 million, respectively.

 

Total amortization expense for the six months ended June 30, 2015 and 2014 amounted to $0.4 million and $0.5 million, respectively.

 

Total depletion expense for the three months ended June 30, 2015 and 2014 amounted to $0.04 million and $0.04 million, respectively.

 

Total depletion expense for the six months ended June 30, 2015 and 2014 amounted to $0.08 million and $0.05 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) 
June 30, 2016  $949    21,757 
June 30, 2017   949    20,808 
June 30, 2018   949    19,859 
June 30, 2019   949    18,910 
June 30, 2020   949    17,961 
Thereafter   17,961    - 
Total  $22,706      

 

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 $210.1 million and $339.4 million as of June 30, 2015 and December 31, 2014, respectively. Restricted notes receivable as a guarantee for the notes payable amounted to $16.3 million and $0 as of June 30, 2015 and December 31, 2014, respectively.

 

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

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
General Steel (China): Notes payable to various banks in China, due various dates from October to December 2015. Restricted cash required of $13.1 million and $14.7 million as of June 30, 2015 and December 31, 2014, respectively; guaranteed by third parties. These notes payable were either repaid or renewed subsequently on the due dates.  $21,216   $22,806 
Longmen Joint Venture: Notes payable to various banks in China, due various dates from July to December 2015. $197.0 million restricted cash and $16.3 million notes receivable are secured for notes payable as of June 30, 2015, and comparatively $324.7 million restricted cash and $0 notes receivable are secured for notes payable as of December 31, 2014, respectively; some notes are further guaranteed by third parties. These notes payable were either repaid or renewed subsequently on the due dates.   510.653    638,829 
Total short-term notes payable  $531,869   $661,635 

 

 24 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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 due at maturity but can be renewed at the bank’s option. Accrued interest is due either monthly or quarterly.

 

Short term loans due to banks, related parties and other parties consisted of the following as of:

 

Due to banks

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
General Steel (China): Loans from various banks in China, due various dates from August 2015 to April 2016. Weighted average interest rate was 7.3% per annum and 7.2% per annum as of June 30, 2015 and December 31, 2014, respectively; some are guaranteed by third parties and related parties. These loans were either repaid or renewed subsequently on the due dates.  $40,637   $40,562 
Longmen Joint Venture: Loans from various banks in China, due various dates from July 2015 to May 2016. Weighted average interest rate was 7.7% per annum and 7.1% per annum as of June 30, 2015 and December 31, 2014, respectively; some are guaranteed by third parties and related parties, $19.8 million restricted cash and $22.8 million notes receivable and comparatively $16.3 million restricted cash and $111.8 million notes receivable were secured for the loans as of June 30, 2015 and December 31, 2014, respectively; These loans were either repaid or renewed subsequently on the due dates.   113,352    216,940 
Total short-term loans – bank  $153,989   $257,502 

 

As of June 30, 2015 and December 31, 2014, the Company had not met its financial covenants stipulated by certain loan agreements related to the Company’s debt to asset ratio. Two of General Steel (China)’s bank loans contained financial covenants stipulating debt to asset ratios below 70%. At June 30, 2015, General Steel (China)’s debt to asset ratio was 89.6%. At December 31, 2014, General Steel (China)’s debt to asset ratio was 90.8%.

 

Furthermore, the Company is a party to a loan agreement with a cross default clause whereby any breach of loan covenants will automatically result in default of the loan. The outstanding balance of the short term loans affected by the above breach of covenants and cross default as of June 30, 2015 and December 31, 2014 was $4.7 million and $4.7 million, respectively. According to the Company’s short term loan agreements, the banks have the rights to request for more collateral or additional guarantees if the breach of covenant is not remedied or request early repayment of the loan if the Company does not cure such breach within a certain period of time. As of the date of this report, the Company has not received any notice from the banks to request more collateral, additional guarantees or early repayment of the short term loans due to the breach of covenant.

 

Due to unrelated parties

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
Longmen Joint Venture: Loans from various unrelated companies and individuals, due various dates from July to November 2015, and weighted average interest rate was 13.6% per annum and 5.7% per annum as of June 30, 2015 and December 31, 2014, respectively. These loans were either repaid or renewed subsequently on the due dates.  $43,686   $16,999 
Longmen Joint Venture: Loans from financing sales.   15,268    37,525 
Maoming Hengda: Loans from one unrelated parties and one related party, due on demand, none interest bearing.   6,204    6,193 
Total short-term loans – others  $65,158   $60,717 

 

 25 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The Company had various loans from unrelated companies amounting to $65.2 million and $60.7 million as of June 30, 2015 and December 31, 2014, respectively. Of the $65.2 million, $6.2 million loans carry no interest, $15.3 million of financing sales are subject to interest rates ranging between 4.6% and 12.0%, and the remaining $43.7 million are subject to interest rates ranging from 5.0% to 24.0%. All short term loans from unrelated companies are payable on demand and unsecured.

 

As part of its working capital management, Longmen Joint Venture has entered into a number of sale and purchase back contracts ("contracts") with third party companies and Yuxin and Yuteng. According 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. 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. The margin of 4.6% to 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. The revenue and cost of goods sold arising from the above transactions are eliminated 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 three months ended June 30, 2015 and 2014 amounted to $107.1 million and $229.1 million, respectively, which are eliminated in the Company’s consolidated financial statements. The financial cost related to financing sales for the three months ended June 30, 2015 and 2014 amounted to $0.6 million and $0.8 million, respectively.

 

Total financing sales for the six months ended June 30, 2015 and 2014 amounted to $225.8 million and $459.6 million, respectively, which are eliminated in the Company’s consolidated financial statements. The financial cost related to financing sales for the six months ended June 30, 2015 and 2014 amounted to $1.3 million and $1.7 million, respectively.

 

Short term loans due to related parties

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
General Steel China: Loans from Yangpu Capital Automobile, due on demand, and interest rates is 10% per annum.  $670   $670 
Longmen Joint Venture: Loan from Shaanxi Coal and Chemical Industry Group Co., Ltd., due on demand, and interest rate is 7.0% per annum.   128    128 
Longmen Joint Venture: Loan from Shaanxi Steel Group due on December 2015, and interest rate is between 6.9% and 8.0% per annum.   159,316    - 
Longmen Joint Venture: Loan from Shaanxi Steel Group Hanzhong Steel Co., Ltd. due on demand, and interest rate is 8.0% per annum.   8,160    - 
Longmen Joint Venture: Loan from Long Steel Group due on demand, and interest rate is between 5.1% and 22.4% per annum.   32,609    - 
Longmen Joint Venture: Loan from Xi’an Pinghe Metallurgical Raw Material Co., Ltd. due in July 2015, and interest rate is 14.4% per annum.   8,160    - 
Longmen Joint Venture: Loan from Tianjin Hengying Trading Co., Ltd. due in July 2015, and interest rate is 5.0% per annum.   2,239    - 
Longmen Joint Venture: Loans from financing sales.   68,668    45,582 
Total short-term loans - related parties  $279,950   $46,380 

 

 26 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Long-term loans due to related party

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
Longmen Joint Venture: Loans from Shaanxi Steel Group, due on various dates through March 2018 and interest rate are 5.6% - 8.0% per annum.  $353,067   $339,549 

 

As of June 30, 2015 and December 31, 2014, total assets used by the Company as collateral for the aforementioned debts were $103.2 million and $96.9 million, respectively.

 

Total interest expense, net of capitalized interest, amounted to $16.1 million and $8.2 million for the three months ended June 30, 2015 and 2014, respectively.

 

Total interest expense, net of capitalized interest, amounted to $23.5 million and $17.7 million for the six months ended June 30, 2015 and 2014, respectively

 

Capitalized interest amounted to $nil and $0.2 million for the three months ended June 30, 2015 and 2014, respectively.

 

Capitalized interest amounted to $nil and $0.8 million for the six months ended June 30, 2015 and 2014, respectively.

 

Note 11 – 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. As of June 30, 2015 and December 31 2014, customer deposits amounted to $120.8 million and $225.6 million, respectively, including deposits received from related parties, which amounted to $33.9 million and $132.6 million, respectively.

 

Note 12 – Deposits due to sales representatives

 

Longmen Joint Venture entered into agreements with various entities to act as the Company’s exclusive sales agent in a specified geographic area.  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 at 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. The agreement is normally entered/or renewed on an annual basis. Termination of the agreement can be mutually agreed to by both parties at any time. The Company had $18.7 million and $20.4 million in deposits due to sales representatives, including deposits due to related parties, as of June 30, 2015 and December 31, 2014, respectively.

 

Note 13 - Supplemental disclosure of cash flow information

 

Interest paid, net of capitalized, amounted to $4.9 million and $12.4 million for the six months ended June 30, 2015 and 2014, respectively.

 

The Company paid income tax amounted to $0.2 million and $0.1 million for the six months ended June 30, 2015 and 2014, respectively.

 

During the six months ended June 30, 2015 and 2014, the Company converted $0.3 million and $0.05 million of equipment into inventory productions, respectively.

 

During the six months ended June 30, 2015 and 2014, the Company used $1.2 million $1.1 million inventory, respectively, in plant and equipment constructions.

 

During the six months ended June 30, 2015 and 2014, the Company incurred $5.5 million and $4.7 million accounts payable, respectively, to be paid for the purchase of equipment and construction in progress.

 

The Company had $0.7 million notes receivable from financing sales loans to be converted to cash as of June 30, 2015.

 

The Company transferred $7.4 million purchase deposits - related parties from loan receivables – related parties as of June 30, 2015.

 

 27 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The Company offset $92.9 million customer deposits – related parties with loan receivables – related parties for the six months ended June 30, 2015.

 

The Company had $2.3 million notes receivable from financing sales loans to be converted to cash as of June 30, 2014.

 

During the six months ended June 30, 2014, the Company had receivables of $0.01 million as a result of the disposal of equipment that has not been collected.

 

During the six months ended June 30, 2014, one of the Company’s unconsolidated entities declared a dividend and the Company is entitled to a dividend of $0.2 million, which has not yet been collected.

 

During the six months ended June 30, 2014, the Company acquired $5.9 million of equipment through capital leases.

 

Note 14 - Deferred lease income

 

To compensate the Company for costs and economic losses incurred during construction of the 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 (the "Longmen Sub-lease"), and $29.9 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 equipment.

 

During the period from 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 and therefore the fair value of the free rent received 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. For the three months ended June 30, 2015 and 2014, the Company recognized $0.5 million and $0.5 million, respectively. For the six months ended June 30, 2015 and 2014, the Company recognized $1.1 million and $1.1 million, respectively. As of June 30, 2015 and December 31, 2014, the balance of deferred lease income amounted to $73.9 million and $74.9 million, respectively, of which $2.2 million and $2.2 million represents balance to be amortized within one year. See Note 19 – Related party transactions and balances (k) – Deferred lease income for details.

 

Note 15 - Capital lease obligations

 

Iron and steel production facilities

 

On April 29, 2011, the Company’s 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 will 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 derivative liability, which is carried at fair value. See Note 16 – “Profit sharing liability”.

 

 28 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Energy-saving equipment

 

During 2013 and 2014, the Company’s 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 the Company and the vendors. If the actual annual equipment operating hours exceed the estimated amount, the Company is obligated to make additional lease payments based on the additional energy cost saved during the lease period and will recognize the additional lease payments as contingent rent expense. As of June 30, 2015, $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.

 

Presented below is a schedule of estimated minimum lease payments on the capital lease obligation for the next five years as of June 30, 2015:

 

Year ending June 30,  Capital Lease Obligations
Minimum Lease Payments
 
   (in thousands) 
2016  $11,937 
2017   182,668 
2018   33,086 
2019   30,194 
2020   29,323 
Thereafter   310,802 
Total minimum lease payments   598,010 
Less: amounts representing interest   (186,785)
Ending balance  $411,225 

 

Interest expense for the three months ended June 30, 2015 and 2014 on the capital lease obligations was $5.2 million and $5.7 million, respectively.

 

Interest expense for the six months ended June 30, 2015 and 2014 on the capital lease obligations was $10.4 million and $10.8 million, respectively.

 

Note 16 – Profit sharing liability

 

The profit sharing liability component of the capital lease obligation was 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. The profit sharing liability is accounted for separately from the fixed portion of the capital lease obligation (see Note 15 - “Capital lease obligation”) and is accounted for as a derivative instrument in accordance with ASC 815-10-15-83. The estimated fair value of the profit sharing liability is reassessed at the end of each reporting period, with any change in fair value charged or credited to income as “Change in Fair Value of Profit Sharing Liability”. As of June 30, 2015, the profit sharing liability is reduced to $0. See Note 2(h) – “Financial instruments” for details.

 

 29 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 17 – Other income (expense)

 

Lease income

 

The deferred lease income from the reimbursement from Shaanxi Steel for the net book value of the fixed assets that were demolished and for the inefficiency costs caused by the construction and loss incurred in the beginning stages of the system production is amortized to income over the remaining sub-lease term. For the three months ended June 30, 2015 and 2014, the Company recognized lease income of $0.5 million and $0.5 million, respectively. For the six months ended June 30, 2015 and 2014, the Company recognized lease income of $1.1 million and $1.1 million, respectively.

 

Note 18 – Taxes

 

Income tax

 

Significant components of the provision for income taxes on earnings and deferred taxes on net operating losses from operations for the three months ended June 30, 2015 and 2014 are as follows:

 

(In thousands)  The three months
ended
June 30, 2015
   The three months
ended
June 30, 2014
 
Current  $111   $107 
Deferred   -    - 
Total provision for income taxes  $111   $107 

 

 

(In thousands)  The six months
ended
June 30, 2015
   The six months
ended
June 30, 2014
 
Current  $141   $112 
Deferred   -    - 
Total provision for income taxes  $141   $112 

 

Under the Income Tax Laws of the PRC, General Steel (China) and Maoming Hengda (located in Guangdong province) are subject to income tax at a rate of 25%.

 

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

 

Deferred taxes assets – China

 

According to Chinese tax regulations, net operating losses can be carried forward to offset operating income for the next five years. The Group’s losses carried forward of $754.1 million will begin to expire in 2016. The Chinese government recently announced several policies to curb the real estate price increases across the country which led to a slowdown in demand for construction steel products. Additionally due to the continued global economic slowdown and the overcapacity issues in China's steel market, management expected there would be a sustained increase in margin pressure in the next five years until all the existing but outdated steel capacity across the whole industry are eliminated. Management took into consideration this potential negative impact on average selling price and gross margin of its products, re-performed an operating forecast for the next five years and concluded that the beginning-of-the-year balance of deferred tax assets mainly relating to the net operating loss carry forward may not be fully realizable due to the reduction in the projection of income to be available in the next 5 years. Management therefore decided to provide 100% valuation allowance for the deferred tax assets. The valuation allowance as of June 30, 2015 and December 31, 2014 was $236.8 million and $114.8 million, respectively. Management will review this valuation allowance periodically and make adjustments as warranted. Temporary differences represent tax and book differences in various items, such as receivable allowances, inventory allowances, impairments on fixed assets and deferred lease income.

 

 30 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Movement of valuation allowance:

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
Beginning balance  $114,820   $97,569 
Current period addition   122,132    18,951 
Current period reversal   (627)   (614)
Deconsolidation of Baotou Steel   -    (625)
Exchange difference   436    (461)
Ending balance  $236,761   $114,820 

 

Deferred taxes assets – U.S.

 

General Steel Holdings, Inc. was incorporated in the United States and has incurred net operating losses for income tax purposes for the six months ended June 30, 2015. The net operating loss carry forwards for United States income taxes amounted to $3.7 million, which may be available to reduce future years’ taxable income. These carry forwards will expire, if not utilized, starting from 2027 through 2034. Management believes that the realization of the benefits from these losses appears uncertain due to the Company’s limited operating history and continuing losses for United States income tax purposes. Accordingly, the Company has provided a 100% valuation allowance on the deferred tax asset benefit to reduce the asset to zero. The valuation allowance as of June 30, 2015 was $1.2 million. The net change in the valuation allowance for the six months ended June 30, 2015 was $0.1 million. Management will review this valuation allowance periodically and make adjustments as warranted.

 

The Company has no cumulative proportionate retained earnings from profitable subsidiaries as of June 30, 2015. Accordingly, no provision has been made for U.S. deferred taxes related to future repatriation of these earnings, nor is it practicable to estimate the amount of income taxes that would have to be provided if we concluded that such earnings will be remitted in the future.

 

Value added tax

 

Enterprises or individuals who sell commodities, engage in repair and maintenance or import and export goods in the PRC are subject to a value added tax in accordance with PRC laws. The value added tax (“VAT”) standard rates are 13% to 17% of the gross sales price. A credit is available whereby VAT paid on the purchases of semi-finished products or raw materials used in the production of the Company’s finished products can be used to offset the VAT due on sales of the finished product. As of June 30, 2015 and December 31, 2014, the Company had $1.5 million and $3.2 million in value added tax credit which are available to offset future VAT payables, respectively.

 

Sales and purchases are recorded net of VAT collected and paid as the Company acts as an agent for the government for VAT collection. VAT on sales and VAT on purchases amounted to $209.5 million and $203.4 million, respectively, for the three months ended June 30, 2015 and $178.6 million and $174.5 million, respectively, for the three months ended June 30, 2014. VAT on sales and VAT on purchases amounted to $348.6 million and $335.6 million, respectively, for the six months ended June 30, 2015 and $331.5 million and $326.4 million, respectively, for the six months ended June 30, 2014.

 

Taxes payable consisted of the following:

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
VAT taxes payable  $5,656   $3,147 
Income taxes payable   215    243 
Misc. taxes   2,113    1,811 
Totals  $7,984   $5,201 

 

 31 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 19 – Related party transactions and balances

 

Related party transactions

 

a.Capital lease

 

As disclosed in Notes 15 – “Capital lease obligations”, Longmen Joint Venture entered into a capital lease arrangement on April 29, 2011, with Shaanxi Coal and Shaanxi Steel, which are related parties of the Group. The following is an analysis of the leased assets under the capital lease:

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
Machinery  $294,538   $602,878 
Less: accumulated depreciation   (119,539)   (105,001)
Carrying value of leased assets  $174,999   $497,877 

 

b.The following chart summarized sales to related parties for the three and six months ended June 30, 2015 and 2014.

 

Name of related parties  Relationship  Three months
ended
June 30, 2015
   Three months
ended
June 30, 2014
 
      (in thousands)   (in thousands) 
Long Steel Group  Noncontrolling shareholder of Longmen Joint Venture  $38,260   $25,150 
Shaanxi Haiyan Trade Co., Ltd  Significant influence by Long Steel Group*   18,822    805 
Shaanxi Shenganda Trading Co., Ltd  Significant influence by Long Steel Group   860    26,967 
Shaanxi Steel  Majority shareholder of Long Steel Group   238    626 
Shaanxi Coal and Chemical Industry Group Co., Ltd.  Shareholder of Shaanxi Steel   15,746    16,420 
Shaanxi Long Steel Group Baoji Steel Rolling Co., Ltd  Subsidiary of Long Steel Group   -    5,117 
Shaanxi Junlong Rolling Co., Ltd  Investee of Long Steel Group   -    4,291 
Total     $73,926   $79,376 

 

*Long Steel Group has the ability to significantly influence the operating and financial decisions of the entity through equity ownership either directly or through key employees, commercial contractual terms, or the ability to assign management personnel.

 

Name of related parties  Relationship  Six months
ended
June 30, 2015
   Six months
ended
June 30, 2014
 
      (in thousands)   (in thousands) 
Long Steel Group  Noncontrolling shareholder of Longmen Joint Venture  $49,530   $69,950 
Shaanxi Haiyan Trade Co., Ltd  Significant influence by Long Steel Group   28,400    820 
Shaanxi Shenganda Trading Co., Ltd  Significant influence by Long Steel Group   16,858    47,703 
Shaanxi Steel  Majority shareholder of Long Steel Group   719    1097 
Shaanxi Coal and Chemical Industry Group Co., Ltd.  Shareholder of Shaanxi Steel   35,814    21,389 
Shaanxi Long Steel Group Baoji Steel Rolling Co., Ltd  Subsidiary of Long Steel Group   -    11,735 
Shaanxi Junlong Rolling Co., Ltd  Investee of Long Steel Group   -    8,888 
Total     $131,321   $161,582 

 

Sales to related parties in trading transactions, which were netted against the corresponding cost of goods sold, amounted to $104.0 million and $58.7 million for the three months ended June 30, 2015 and 2014, respectively. See Note 2(m) Revenue Recognition for details.

 

Sales to related parties in trading transactions, which were netted against the corresponding cost of goods sold, amounted to $195.0 million and $91.9 million for the six months ended June 30, 2015 and 2014, respectively. See Note 2(m) Revenue Recognition for details.

 

 32 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

c.The following charts summarize purchases from related parties for the three and six months ended June 30, 2015 and 2014.

 

Name of related parties  Relationship  Three months
ended
June 30, 2015
   Three months
ended
June 30, 2014
 
      (in thousands)   (in thousands) 
Long Steel Group  Noncontrolling shareholder of Longmen Joint Venture  $176,807   $100,504 
Hancheng Haiyan Coking Co., Ltd  Noncontrolling shareholder of Long   Steel Group   8,919    40,179 
Xi’an Pinghe Metallurgical Raw Material Co., Ltd  Noncontrolling shareholder of Long Steel Group   2    5,016 
Shaanxi Coal and Chemical Industry Group Co., Ltd  Shareholder of Shaanxi Steel   1,146    - 
Shaanxi Huafu New Energy Co., Ltd  Significant influence by the Long Steel Group   8,140    7,561 
Tianwu General Steel Material Trading Co., Ltd.  Investee of General Steel (China)   37,472    73,940 
Tianjin General Quigang Pipe Co., Ltd  Partially owned by CEO through indirect shareholding**   5,198    4,253 
Tianjin Dazhan Industry Co., Ltd  Partially owned by CEO through indirect shareholding   6,283    - 
Wendlar Tianjin Industry CO., Ltd  Partially owned by CEO through indirect shareholding   14,794    - 
Tianjin Hengying Trading Co., Ltd  Partially owned by CEO through indirect shareholding   -    17,721 
Others  Entities either owned or have significant influence by our affiliates or management   380    1,037 
Total     $259,141   $250,211 

 

**The CEO is referred to herein as the chief executive officer of General Steel Holdings, Inc. as of June 30, 2015, but Mr. Henry Yu has resigned and is no longer the CEO, although remains Chairman of the Board, as of the date of this filing. Ms. Yunshan Li is the current CEO.

 

Name of related parties  Relationship  Six months
ended
June 30, 2015
   Six months
ended
June 30, 2014
 
      (in thousands)   (in thousands) 
Long Steel Group  Noncontrolling shareholder of Longmen Joint Venture  $182,800   $252,276 
Hancheng Haiyan Coking Co., Ltd  Noncontrolling shareholder of Long   Steel Group   57,066    84,267 
Xi’an Pinghe Metallurgical Raw Material Co., Ltd  Noncontrolling shareholder of Long Steel Group   1,074    5,920 
Shaanxi Coal and Chemical Industry Group Co., Ltd  Shareholder of Shaanxi Steel   2,651    - 
Tianjin Dazhan Industry Co., Ltd  Partially owned by CEO through indirect shareholding   6,283    - 
Wendlar Tianjin Industry CO., Ltd  Partially owned by CEO through indirect shareholding   14,794    - 
              
Shaanxi Huafu New Energy Co., Ltd  Significant influence by the Long Steel Group   14,100    14,221 
Tianwu General Steel Material Trading Co., Ltd.  Investee of General Steel (China)   73,646    97,279 
Tianjin General Quigang Pipe Co., Ltd  Partially owned by CEO through indirect shareholding   8,485    8,528 
Tianjin Hengying Trading Co., Ltd  Partially owned by CEO through indirect shareholding   -    45,640 
Others  Entities either owned or have significant influence by our affiliates or management   711    1,084 
Total     $361,610   $509,215 

 

 33 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Related party balances

 

a.Loans receivable – related parties:

 

Name of related parties  Relationship  June 30, 2015   December 31, 2014 
      (in thousands)   (in thousands) 
Tianjin Hengying Trading Co., Ltd.*  Partially owned by CEO through indirect shareholding  $-   $13,997 
Tianjin Dazhan Industry Co., Ltd.*  Partially owned by CEO through indirect shareholding   -    14,617 
Beijing Shenghua Xinyuan Metal Materials Co., Ltd.  Partially owned by CEO through indirect shareholding   6,110    6,099 
Total     $6,110   $34,713 

 

*The Company reclassified advances for inventory purchase - related parties related to trading transactions, as noted in note 2(g), to loans receivable - related parties due to their interest-bearing nature.

 

The Company issued loans to these related parties for cash flow purposes to earn interest income, which have a higher interest rate than the bank financing interest rates.

 

See Note 3 – loans receivable – related parties for loan details.

 

b.Accounts receivables – related parties:

 

Name of related parties  Relationship  June 30, 2015   December 31, 2014 
      (in thousands)   (in thousands) 
Long Steel Group  Noncontrolling shareholder of Longmen Joint Venture  $570   $148 
Shaanxi Coal and Chemical Industry Group Co., Ltd.  Shareholder of Shaanxi Steel   651    - 
Shaanxi Shenganda Trading Co., Ltd.  Significant influence by Long Steel Group   325    5,715 
Tianjin Daqiuzhuang Steel Plates  Partially owned by CEO through indirect shareholding   19    19 
Shaanxi Steel  Majority shareholder of Long Steel Group   1,760    2,101 
Others      -    641 
Total     $3,325   $8,624 

 

c.Other receivables – related parties:

 

Other receivables - related parties are those nontrade receivables arising from transactions between the Company and its related parties, such as advances or payments made on behalf of these related parties.

  

Name of related parties  Relationship  June 30, 2015   December 31, 2014 
      (in thousands)   (in thousands) 
Long Steel Group  Noncontrolling shareholder of Longmen Joint Venture  $166   $165 
Shaanxi Steel  Majority shareholder of Long Steel Group   1,142    35,669 
Tianjin General Qiugang Pipe Co., Ltd  Partially owned by CEO through indirect shareholding   1,225    1,237 
Tianjin Dazhan Industry Co., Ltd  Partially owned by CEO through indirect shareholding   1,582    - 
Tianjin Hengying Trading Co., Ltd  Partially owned by CEO through indirect shareholding   1,213    721 
Beijing Shenghua Xinyuan Metal Materials Co., Ltd.  Partially owned by CEO through indirect shareholding   619    313 
Victory Energy Resource Co., Ltd.  Partially owned by CEO through indirect shareholding   1,101    1,101 
Others  Entities either owned or have significant influence by our affiliates or management   345    528 
Total     $7,393   $39,734 

 

 34 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

d.Advances on inventory purchase – related parties:

 

Name of related parties  Relationship  June 30, 2015   December 31, 2014 
      (in thousands)   (in thousands) 
Long Steel Group  Noncontrolling shareholder of Longmen Joint Venture  $2,395   $7,139 
Shaanxi Shenganda Trading Co., Ltd.  Significant influence by Long Steel Group   -    27,549 
Tianjin Hengying Trading Co., Ltd  Partially owned by CEO through indirect shareholding   4,015    3,807 
Tianjin General Qiugang Pipe Co., Ltd  Partially owned by CEO through indirect shareholding   33    7,091 
Shaanxi Coal and Chemical Industry Group Co., Ltd.  Shareholder of Shaanxi Steel   6,947    - 
Others  Entities either owned or have significant influence by our affiliates or management   21    31 
Total     $13,411   $45,617 

 

e.Accounts payable - related parties:

 

Name of related parties  Relationship  June 30, 2015   December 31, 2014 
      (in thousands)   (in thousands) 
Hancheng Haiyan Coking Co., Ltd  Noncontrolling shareholder of Longmen Joint Venture  $41,724   $64,276 
Long Steel Group  Noncontrolling shareholder of Longmen Joint Venture   100,927    79,886 
Shaanxi Coal and Chemical Industry Group Co., Ltd.  Shareholder of Shaanxi Steel   31,266    23,726 
Tianjin Dazhan Industry Co., Ltd  Partially owned by CEO through indirect shareholding   -    869 
Xi’an Pinghe Metallurgical Raw Material Co., Ltd  Noncontrolling shareholder of Long Steel Group   8,206    11,035 
Tianjin Hengying Trading Co., Ltd  Partially owned by CEO through indirect shareholding   -    1 
Henan Xinmi Kanghua Fire Refractory Co., Ltd  Noncontrolling shareholder of Longmen Joint Venture’s subsidiary   1,411    746 
Shaanxi Shenganda Trading Co., Ltd.  Significant influence by Long Steel Group   1,353    - 
Beijing Daishang Trading Co., Ltd  Noncontrolling shareholder of Longmen Joint Venture’s subsidiary   899    36 
Tianjin General Qiugang Pipe Co., Ltd  Partially owned by CEO through indirect shareholding   -    2,462 
Tianwu General Steel Material Trading Co., Ltd.  Investee of General Steel (China)   13,919    22,916 
Maoming Shengze Trading Co., Ltd  Partially owned by CEO through indirect shareholding   4,276    1,773 
Shaanxi Steel  Majority shareholder of Long Steel Group   7,168    - 
Others  Entities either owned or have significant influence by our affiliates or management   -    57 
Total     $211,149   $207,783 

 

 35 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

f.Short-term loans - related parties:

 

Name of related parties  Relationship  June 30, 2015   December 31, 2014 
      (in thousands)   (in thousands) 
Shaanxi Steel Group Hanzhong Steel Co., Ltd.  Subsidiary of Shaanxi Steel  $8,160   $- 
Shaanxi Steel  Majority shareholder of Long Steel Group   159,316    - 
Shaanxi Coal and Chemical Industry Group Co., Ltd  Shareholder of Shaanxi Steel   68,796    34,460 
Long Steel Group  Noncontrolling shareholder of Longmen Joint Venture   32,609    - 
Xi’an Pinghe Metallurgical Raw Material Co., Ltd.  Noncontrolling shareholder of Long Steel Group   8,160    - 
Tianjin Hengying Trading Co., Ltd  Partially owned by CEO through indirect shareholding   2,239    3,039 
Tianjin Dazhan Industry Co., Ltd  Partially owned by CEO through indirect shareholding   -    8,211 
Yangpu Capital Automobile  Partially owned by CEO through indirect shareholding   670    670 
Total     $279,950   $46,380 

 

See Note 10 – Debt for the loan details.

 

g.Other payables – related parties:

 

Other payables – related parties are those nontrade payables arising from transactions between the Company and its related parties, such as advances or payments from these related parties on behalf of the Group.

 

Name of related parties  Relationship  June 30,  2015   December 31, 2014 
      (in thousands)   (in thousands) 
Tianjin Hengying Trading Co, Ltd  Partially owned by CEO through indirect shareholding  $3,644   $378 
Long Steel Group  Noncontrolling shareholder of Longmen Joint Venture   18,867    33,968 
Shaanxi Steel  Majority shareholder of Long Steel Group   30,566    44,146 
Shaanxi Shenganda Trading Co., Ltd.  Significant influence by Long Steel Group   1,057    - 
Wendlar Investment & Management Group Co., Ltd  Common control under CEO   1,203    1,196 
Yangpu Capital Automobile  Partially owned by CEO through indirect shareholding   433    399 
Tianjin Dazhan Industry Co., Ltd  Partially owned by CEO through indirect shareholding   3,499    3,883 
Maoming Shengze Trading Co., Ltd  Partially owned by CEO through indirect shareholding   212    2,775 
Teamlink Investment Co., Ltd  Partially owned by CEO through indirect shareholding   20,500    - 
Others  Entities either owned or have significant influence by our affiliates or management   47    507 
Total     $80,028   $87,252 

 

 36 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

h.Customer deposits – related parties:

  

Name of related parties  Relationship  June 30, 2015   December 31, 2014 
      (in thousands)   (in thousands) 
Shaanxi Yuchang Trading Co., Ltd  Significant influence by Long Steel Group  $10   $10 
Shaanxi Coal and Chemical Industry Group Co., Ltd  Shareholder of Shaanxi Steel   6,938    4,467 
Shaanxi Haiyan Trade Co, Ltd  Significant influence by Long Steel Group   7,839    6,844 
Long Steel Group  Noncontrolling shareholder of Longmen Joint Venture   9,465    23,517 
Shaanxi Junlong Rolling Co., Ltd  Investee of Long Steel Group   58    57 
Tianwu General Steel Material Trading Co., Ltd.  Investee of General Steel (China)   9,613    97,721 
Total     $33,923   $132,616 

 

i.Deposits due to sales representatives – related parties

 

Name of related parties  Relationship  June 30, 2015   December 31, 2014 
      (in thousands)   (in thousands) 
Hancheng Haiyan Trade Co., Ltd  Significant influence by Long Steel Group  $652   $652 
Gansu Yulong Trading Co., Ltd.  Significant influence by Long Steel Group   1,534    1,075 
Long Steel Group  Noncontrolling shareholder of Longmen Joint Venture   -    196 
Chengdu Yusheng Steel Trading Co., Ltd  Subsidiary of Long Steel Group   98    - 
Shaanxi Yuchang Trading Co., Ltd  Significant influence by Long Steel Group   588    586 
Total     $2,872   $2,509 

  

j.Long-term loans – related party:

 

Name of related party  Relationship  June 30, 2015   December 31, 2014 
      (in thousands)   (in thousands) 
Shaanxi Steel  Majority shareholder of Long Steel Group  $353,067   $339,549 
Total     $353,067   $339,549 

 

The Company also provided guarantee on related parties’ bank loans amounting to $63.5 million and $82.3 million as of June 30, 2015 and as of December 31, 2014, respectively.

 

 37 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

k.Deferred lease income

 

   June 30, 2015   December 31, 2014 
   (in thousands)   (in thousands) 
Beginning balance  $74,889   $77,444 
Less: Lease income realized   (1,089)   (2,176)
Exchange rate effect   137    (379)
Ending balance   73,937    74,889 
Current portion   2,180    (2,176)
Noncurrent portion  $71,757   $72,713 

 

For the three months ended June 30, 2015 and 2014, the Company realized lease income from Shaanxi Steel, a related party, amounted to $0.5 million and $0.5 million, respectively.

 

For the six months ended June 30, 2015 and 2014, the Company realized lease income from Shaanxi Steel, a related party, amounted to $1.1 million and $1.1 million, respectively.

 

Note 20 – Equity

 

2015 Equity Transactions

 

On April 14, 2015, the Company granted 500,000 shares of common stock for investor relations consulting services under a service agreements dated April 14, 2015. The shares were valued at $0.98 per share, the quoted market price at the time the services were provided.

 

On June 9, 2015, the Company granted 1,498,000 shares of common stock to senior management personnel. The shares were valued at $0.77 per share, the quoted market price at the time the shares were granted.

 

Note 21 – Retirement plan

 

Regulations in the PRC require the Company to contribute to a defined contribution retirement plan for all employees. All the employees of the Company’s entities in China are entitled to a retirement pension amount calculated based upon their salary at their date of retirement and their length of service in accordance with a government managed pension plan. The PRC government is responsible for the pension liability to the retired staff. The Company’s entities in China are required to contribute based on the higher of 20% of the employees’ monthly base salary or 12% of the minimum social average salary of the city where the facilities are located. Employees are required to contribute 8% of their base salary to the plan. The minimum social average salary is announced by the local Social Security bureau and updated annually. Total pension expense incurred by the Company for the three months ended June 30, 2015 and 2014 amounted to $3.2 million and $3.0 million, respectively. Total pension expense incurred by the Company for the six months ended June 30, 2015 and 2014 amounted to $6.0 million and $5.8 million, respectively.

 

Note 22 – Statutory reserves

 

The laws and regulations of the People’s Republic of China require that before a foreign -invested enterprise distributes profits to its shareholders, it must first satisfy all tax liabilities, provision for losses in previous years, and make allocations, in proportions determined at the discretion of the board of directors, to the statutory reserves. The statutory reserves include the surplus reserve funds and the enterprise fund and these statutory reserves represent restricted retained earnings.

 

Surplus reserve fund

 

The Company is required to transfer 10% of its net income, as determined in accordance with the PRC accounting rules and regulations, to a statutory surplus reserve fund until such reserve balance reaches 50% of the Company’s registered capital.

 

The transfer to this reserve must be made before distribution of any dividend to shareholders. The surplus reserve fund is non-distributable other than during liquidation and can be used to fund previous years’ losses, if any, and may be utilized for business expansion or converted into share capital by issuing new shares to existing shareholders in proportion to their shareholding or by increasing the par value of the shares currently held by them, provided that the remaining reserve balance after such issue is not less than 25% of the registered capital. For the six months ended June 30, 2015 and 2014, the Company did not make any contributions to these reserves.

 

 38 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Special reserve

 

The Company is required by the PRC government to reserve safety and maintenance expense to the cost of production based on the actual quantity of mineral exploited.  The amount of reserves is determined within the unit price range provided by Ministry of Finance of PRC. For the six months ended June 30, 2015 and 2014, the Company made contributions of $0.4 million and $0.6 million to these reserves, respectively and used $0.2 million and $0.4 million of safety and maintenance expense, respectively.

 

Note 23 – Commitment and contingencies

 

Operating Lease Commitments

 

Total operating lease commitments for rental of offices, buildings, equipment and land use rights of the Company’s PRC subsidiaries as of June 30, 2015 is as follows:

 

Year ending June 30,  Minimum lease payment 
   (in thousands) 
2016  $2,132 
2017   1,951 
2018   1,704 
2019   1,209 
2020   1,209 
Years after   39,218 
 Total minimum payments required  $47,423 

 

 

Total rental expense was $0.8 million and $0.6 million for the three months ended June 30, 2015 and 2014, respectively.

 

Total rental expense was $0.9 million and $1.5 million for the six months ended June 30, 2015 and 2014, respectively.

 

Contractual Commitments

 

Longmen Joint Venture has $9.3 million contractual obligations related to construction projects as of June 30, 2015 estimated to be fulfilled between September and December 2015.

 

Contingencies

 

As of June 30, 2015, Longmen Joint Venture provided guarantees to related parties’ and third parties’ bank loans, including lines of credit and others, amounting to $63.5 million.

  

Nature of guarantee  Guarantee
amount
   Guaranty Due Date
   (In thousands)    
Line of credit  $51,082   Various from August 2015 to May 2016
Bank loan   12,403   Various from November 2015 to March 2016
Total  $63,485    

 

Name of parties being guaranteed 

Guarantee

amount

   Guaranty Due Date
   (In thousands)    
Long Steel Group  $27,255   Various from August 2015 to May 2016
Shaanxi Haiyan Coke Group Co., Ltd.   36,230   Various from September 2015 to April 2016
Total  $63,485    

 

As of June 30, 2015, the Company did not accrue any liability for the amounts the Group has guaranteed for third and related parties because those parties are current in their payment obligations and the Company has not experienced any losses from providing guarantees. The Company has 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.

 

 39 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 24 – Segments

 

The Company’s chief operating decision maker evaluates performance and determines resource allocations based on a number of factors, the primary measure being income from operations of the Group’s four regional divisions in the PRC: Longmen Joint Venture in Shaanxi province, Maoming Hengda in Guangdong province, Baotou Steel Pipe Joint Venture in Inner Mongolia province and General Steel (China) & General Shengyuan in Tianjin City.

 

The Group operates in two business segments, one consisting of General Shengyuan and one consisting of three different divisions including Longmen Joint Venture, Maoming Hengda and General Steel (China). These reportable divisions are consistent with the way the Company manages its business, each division operates under separate management groups and produces discrete financial information. The accounting principles applied at the operating division level in determining income from operations is generally the same as those applied at the consolidated financial statement level.

 

The following represents results of division operations for three months ended June 30, 2015 and 2014:

 

(In thousands)        
Sales:  2015   2014 
Longmen Joint Venture  $528,778   $587,314 
Maoming Hengda   3    215 
Baotou Steel Pipe Joint Venture   -    483 
General Shengyuan   -    - 
General Steel (China)   -    - 
Total sales   528,781    588,012 
Interdivision sales        1 
Consolidated sales  $528,781   $588,013 

  

Gross profit (loss):  2015   2014 
Longmen Joint Venture  $(64,220)  $28,229 
Maoming Hengda   (49)   21 
Baotou Steel   -    3 
General Shengyuan   -    - 
General Steel (China)   -    (159)
Total gross loss   (64,269)   28,094 
Interdivision gross profit   -    - 
Consolidated gross (loss) profit  $(64,269)  $28,094 

 

Income (loss) from operations:  2015   2014 
Longmen Joint Venture  $(1,005,820)  $8,128 
Maoming Hengda   (270)   (54)
Baotou Steel   -    (133)
General Shengyuan   -    - 
General Steel (China)   (849)   (720)
Total loss from operations   (1,006,939)   7,221 
Reconciling item (1)   (1,083)   (896)
Consolidated (loss) income from operations  $(1,008,022)  $6,325 

 

Net loss attributable to General Steel Holdings, Inc.:  2015   2014 
Longmen Joint Venture  $(613,117)  $(8,077)
Maoming Hengda   (255)   (123)
Baotou Steel   -    (106)
General Shengyuan   -    - 
General Steel (China)   (572)   (1,870)
Total net loss attributable to General Steel Holdings, Inc.   (613,944)   (10,176)
Reconciling item (1)   (1,083)   (843)
Consolidated net loss attributable to General Steel Holdings, Inc.  $(615,027)  $(11,109)

 

 40 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Depreciation, amortization and depletion:  2015   2014 
Longmen Joint Venture  $30,458   $22,778 
Maoming Hengda   304    158 
Baotou Steel   -    59 
General Shengyuan   -    - 
General Steel (China)   670    447 
Consolidated depreciation, amortization and depletion  $31,432   $23,442 

 

Finance/interest expenses:  2015   2014 
Longmen Joint Venture  $28,656   $25,131 
Maoming Hengda   -    - 
Baotou Steel   -    (1)
General Shengyuan   -    - 
General Steel (China)   918    1,488 
Reconciling item (1)   1    1 
Consolidated interest expenses  $29,575   $26,619 

 

Capital expenditures:  2015   2014 
Longmen Joint Venture  $8,583   $55,852 
Maoming Hengda   1    - 
Baotou Steel   -    - 
General Shengyuan   -    - 
General Steel (China)   1    - 
Reconciling item (1)   -    - 
Consolidated capital expenditures  $8,585   $55,852 

 

The following represents results of division operations for six months ended June 30, 2015 and 2014:

 

(In thousands)        
Sales:  2015   2014 
Longmen Joint Venture  $856,936   $1,181,328 
Maoming Hengda   9    251 
Baotou Steel Pipe Joint Venture   -    645 
General Shengyuan   -    - 
General Steel (China)   -    53 
Total sales   856,945    1,182,277 
Interdivision sales   -    (53)
Consolidated sales  $856,945   $1,182,224 

  

Gross profit (loss):  2015   2014 
Longmen Joint Venture  $(96,367)  $6,010 
Maoming Hengda   (49)   45 
Baotou Steel   -    (20)
General Shengyuan   -    - 
General Steel (China)   -    (502)
Total gross loss   (96,416)   5,533 
Interdivision gross profit   -    - 
Consolidated gross (loss) profit  $(96,416)  $5,533 

 

 41 

GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Loss from operations:  2015   2014 
Longmen Joint Venture  $(1,059,318)  $(31,166)
Maoming Hengda   (831)   (576)
Baotou Steel   -    (177)
General Shengyuan   -    - 
General Steel (China)   (1,583)   (3,286)
Total loss from operations   (1,061,732)   (35,205)
Reconciling item (1)   (2,002)   (2,133)
Consolidated loss from operations  $(1,063,734)  $(37,338)

 

Net loss attributable to General Steel Holdings, Inc.:  2015   2014 
Longmen Joint Venture  $(655,522)  $(46,111)
Maoming Hengda   (921)   (660)
Baotou Steel   -    (141)
General Shengyuan   -    - 
General Steel (China)   (1,735)   (5,713)
Total net loss attributable to General Steel Holdings, Inc.   (658,178)   (52,625)
Reconciling item (1)   (2,002)   (1,958)
Consolidated net loss attributable to General Steel Holdings, Inc.  $(660,180)  $(54,583)

 

Depreciation, amortization and depletion:  2015   2014 
Longmen Joint Venture  $54,644   $46,308 
Maoming Hengda   614    462 
Baotou Steel   -    121 
General Shengyuan   -    - 
General Steel (China)   1,338    897 
Consolidated depreciation, amortization and depletion  $56,596   $47,788 

 

Finance/interest expenses:  2015   2014 
Longmen Joint Venture  $47,804   $52,121 
Maoming Hengda   -    - 
Baotou Steel   -    - 
General Shengyuan   -    - 
General Steel (China)   2,339    3,097 
Reconciling item (1)   2    96 
Consolidated interest expenses  $50,145   $55,314 

 

Capital expenditures:  2015   2014 
Longmen Joint Venture  $39,208   $112,599 
Maoming Hengda   297    32 
Baotou Steel   -    - 
General Shengyuan   -    - 
General Steel (China)   669    820 
Reconciling item (1)   -    - 
Consolidated capital expenditures  $40,174   $112,713 

 

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GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Total Assets as of:  June 30,
2015
   December 31,
2014
 
Longmen Joint Venture  $1,231,669   $2,408,218 
Maoming Hengda   22,174    25,933 
General Shengyuan   1,142    - 
General Steel (China)   94,338    158,606 
Interdivision assets   (59,364)   (30,486)
Reconciling item (2)   4,410    2,953 
Total Assets  $1,294,369   $2,565,224 

 

(1)Reconciling item represents income or expenses of the Company, arising from General Steel Investment Co., Ltd, Yangpu Shengtong Investment Co., Ltd and Qiu Steel for the three and six months ended June 30, 2015 and 2014, which are non-operating entities.

 

(2)Reconciling item represents assets held at General Steel Holdings, Inc., General Steel Investment Co., Ltd, Yangpu Shengtong Investment Co., Ltd and Qiu Steel as of June 30, 2015 and December 31, 2014, which are non-operating entities.

 

Note 25 – Subsequent events

 

On July 17, 2015, the Company granted 6,000,000 shares of common stock for business growth and strategic consulting services under two six-month service agreements dated July 1, 2015. The shares were valued at $0.60 per share, the quoted market price at the time the shares were granted.

 

On July 23, 2015, Mr. Henry Yu resigned as the Chief Executive Officer of the Company and was succeeded by Ms. Yunshan Li. Mr. Henry Yu remains to serve as the Chairman of the Board of Directors of the Company and continues to work closely with Ms. Li to ensure a seamless transition.

 

On May 7, 2015, the Company was notified by the New York Stock Exchange, Inc. (the "NYSE") that it had fallen below the NYSE's continued listing standard that required a minimum average closing price of $1.00 per share of the Company's common stock over a consecutive 30-trading-day period. Under the NYSE regulations, the Company has a cure period of six months from receipt of the NYSE's notice to achieve compliance with the continued listing standard. The Company can regain compliance at any time during the six-month cure period through November 2015 if on the last trading day of any calendar month during the cure period, the Company has a closing share price and an average closing share price of at least $1.00 over the 30 trading-day period ending on the last trading day of that month. Subject to compliance with the NYSE's other continued listing standards and ongoing oversight, the Company's common stock will continue to be listed and traded on the NYSE during the six-month cure period, under the symbol "GSI", but will continue to be assigned a ".BC" indicator.

 

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ITEM 2. 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 unaudited condensed consolidated financial statements and related notes thereto. 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 the 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.” 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. Additional information regarding certain factors which could cause actual results to differ from such forward-looking statements include, but are not limited to, those described in Item 1A, “Risk Factors”, to our Annual Report on Form 10-K for the fiscal year ended December 31, 2014 filed with the SEC on April 10, 2015.

 

Recent Developments and Second Quarter Highlights

 

The second quarter of 2015 was highlighted with the following:

 

·Sales in the second quarter of 2015 decreased by 10.1% to $528.8 million, from $588.0 million in the second quarter of 2014, due to the decrease in rebar selling price despite an increase in our sales volume. For the second quarter of 2015, sales volume of rebar in Shaanxi Longmen Iron and Steel Co., Ltd. (“Longmen Joint Venture”) totaled 1.7 million metric tons, an increase of 30.2%, compared to 1.3 million metric tons in the second quarter of 2014, with an average selling price of $311.2 per ton, as compared to $450.0 per ton in the second quarter of 2014.

 

·Gross loss in the second quarter of 2015 was $(64.3) million, or (12.2) % of total revenue, as compared to a gross profit of $28.1 million, or 4.8% of total revenue in the second quarter of 2014.

 

·As the Chinese steel industry conditions continued to worsen, and the recent economic down turn, the major sell off of the Chinese stock market and the lacking of government expansion in major infrastructure in the second quarter of 2015, which deviated from our previously anticipated industry environment improvement, the sum of the discounted cash flows expected to result from Longmen Joint Venture’s long-lived assets and their disposition were less than the carrying value by approximately $974 million (RMB 6.0 billion), which was impaired and included in operating expenses in the second quarter of 2015.

 

·Total finance expense in the second quarter of 2015 was $29.6 million, as compared to $26.6 million for the same period in 2014. Finance expenses mainly consisted of interest expense on capital lease, which was $5.2 million and $5.7 million in the second quarter of 2015 and 2014, respectively, and interest expense on bank borrowings and discounted notes receivable, which was $24.4 million and $20.9 million in the second quarter of 2015 and 2014, respectively.

 

·Loss per share was $(9.80) and $(0.20) in the second quarter of 2015 and 2014, respectively. The increase in the loss in the second quarter was mainly due to the decrease in the average selling price of rebar decreasing more than the average cost, leading to an increase in gross loss, as well as the impairment of Longmen Joint Venture’s long-lived assets.

 

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 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.

 

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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”), an unrelated third party, 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 General Steel (China) long-lived assets on an annual basis, or upon a triggering event which would require an assessment sooner. As of June 30, 2015, Management is of the opinion that the fair value of the property, plant and equipment exceed their current carrying value by approximately 88.4%.

 

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 as a Variable Interest Entity (“VIE”) and we are the primary beneficiary.

 

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Currently, Longmen Joint Venture has five branch offices, four consolidated subsidiaries/VIE 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 approximately one hundred twenty-eight distributors, together with smaller distributors and three 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 of 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.

 

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.

 

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Due to recurring losses and the deterioration of steel industry conditions in the second quarter of 2015, Management downgraded the evaluated fair value of Longmen Joint Venture’s long-lived assets as of June 30, 2015, and an impairment charge of approximately $974 million was recorded (Also see critical accounting policies – impairment of long-lived assets below). As of June 30, 2015, Management is of the opinion that the fair value of the property, plant and equipment approximates their current carrying value net of impairment.

 

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.

 

Management evaluates the fair value of Maoming Hengda’s long-lived assets on an annual basis, or upon a triggering event which would require an assessment sooner. As of June 30, 2015, Management is of the opinion that the fair value of the property, plant and equipment exceed their current carrying value by approximately 4.1%.

 

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 of 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 of 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. General Shengyuan IoT is still in the development stage and did not incur revenues or significant operating expenses during the period.

 

Production Capacity Information Summary by Subsidiary

 

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.

 

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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 three and six months ended June 30, 2015, approximately 33.0% and 29.3% of our sales were to five customers, respectively. 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

 

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.

 

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 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.

 

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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 consistent 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 73% 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.

 

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.

 

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.

 

Results of Operations for the Three Months Ended June 30, 2015

 

Sales

 

Three months ended June 30, 2015 compared with three months ended June 30, 2014

 

The following table sets forth sales and volume in metric tons.

 

   Three months ended         
in thousands,  June 30, 2015   June 30, 2014   Change   Change 
except metric tons  Volume   Sales   %   Volume   Sales   %   Volume %   Sales % 
                                 
Longmen Joint Venture   1,699,265   $528,778    100.0%   1,305,127   $587,314    99.9%   30.2%   (10.0)%
Others   17    3    0.0%   1,312    699    0.1%   (98.7)%   (99.6)%
Total Sales    1,699,282   $528,781    100.0%   1,306,439   $588,013    100.0%   30.1%   (10.1)%

  

Total sales for the three months ended June 30, 2015 decreased by 10.1% to $528.8 million from $588.0 million for the same period in 2014. The decrease in sales compared to the same period in 2014 was predominantly due to the decreased average selling price despite the increase in sales volume. Longmen Joint Venture comprised approximately 100.0% and 99.9% of total sales for the second quarter of 2015 and 2014, respectively. Sales volume of rebar increased by 30.2% to 1.7 million metric tons as compared to 1.3 million metric tons in the same period in 2014. The average selling price of rebar decreased by 30.8% to approximately $311.2 per ton in the second quarter of 2015 compared to approximately $450.0 per ton in the same period of 2014.

 

As a result of the China and global steel industry over-capacity, Chinese economic control polices and slowdown in the China’s economic growth, commodity prices dropped, and the price of steel had been on a declining trend from the third quarter of 2012 to 2015. The over-capacity issue impacted our results since the third quarter of 2012 and continued to do so in 2014 and 2015. While rebar selling prices rebounded quarter-over-quarter by 8.8% to $422.2 per ton in the fourth quarter of 2014, which led us to have a more optimistic outlook on our future operations at the time, the declining trend continued in 2015 and our rebar selling prices decreased by 18.6% in the first quarter of 2015 to $343.8 per ton and decreased further by 9.5% quarter-over-quarter to $311.2 per ton in the second quarter of 2015. Given the uncertainty in future steel price, we increased our sales volume in the second quarter of 2015 compared to 2014 to prevent future inventory loss in the event of further steel price decline in the second half of the year.

 

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Our five major customers were distributors and collectively represented approximately 33.0% of our total sales for the three months ended June 30, 2015 as compared to 31.8% of our total sales for the three months ended June 30, 2014. These five customers included related parties and major distributors owned by the 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.

 

Six months ended June 30, 2015 compared with six months ended June 30, 2014

 

The following table sets forth sales and volume in metric tons.

 

   Six months ended         
in thousands,  June 30, 2015   June 30, 2014   Change   Change 
except metric tons  Volume   Sales   %   Volume   Sales   %   Volume %   Sales % 
                                 
Longmen Joint Venture   2,653,831   $856,936    100.0%   2,622,667   $1,181,328    99.9%   1.2%   (27.5)%
Others   46    9    0.0%   2,035    896    0.1%   (97.7)%   (99.0)%
Total Sales    2,653,877   $856,945    100.0%   2,624,702   $1,182,224    100.0%   1.1%   (27.5)%

 

Total sales for the six months ended June 30, 2015 decreased by 27.5% to $0.9 billion from $1.2 billion for the same period in 2014. The decrease in sales compared to the same period in 2014 was predominantly due to the decreased average selling price. Longmen Joint Venture comprised approximately 100.0% and 99.9% of total sales for the six months ended June 30, 2015 and 2014, respectively. Sales volume of rebar increased by 1.1% to 2.7 million metric tons as compared to 2.6 million metric tons in the same period in 2014.  The average selling price of rebar decreased by 28.3% to approximately $322.9 per ton in the six months ended June 30, 2015 compared to approximately $450.4 per ton in the same period of 2014.

 

As a result of the China and global steel industry over-capacity, Chinese economic control polices and slowdown in the China’s economic growth, commodity prices dropped, and the price of steel had been on a declining trend from the third quarter of 2012 to 2015. The over-capacity issue impacted our results since the third quarter of 2012 and continued to do so in 2014 and 2015.

 

Our five major customers were distributors and collectively represented approximately 29.3% of our total sales for the six months ended June 30, 2015 as compared to 24.4% of our total sales for the six months ended June 30, 2014. These five customers included related parties and major distributors owned by the 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

 

Three months ended June 30, 2015 compared with three months ended June 30, 2014

 

   Three months ended         
   June 30, 2015   June 30, 2014   Change   Change 
in thousands,
except metric tons
  Volume   Cost of
Goods Sold
   %   Volume   Cost of
Goods Sold
   %   Volume
%
   Cost of
Goods Sold
 %
 
                                 
Longmen Joint Venture   1,699,265   $592,999    100.0%   1,305,127   $559,084    99.9%   30.2%   6.1%
Others   17    51    0.0%   1,312    835    0.1%   (98.7)%   (93.9)%
Total Cost of Goods Sold    1,699,282   $593,050    100.0%   1,306,439   $559,919    100.0%   30.1%   5.9%

 

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 55.0% of our total cost of sales. The cost of goods sold increased by 5.9% to $593.1 million in the second quarter of 2015 from $559.9 million in the same period of 2014. The increase was mainly driven by the 30.1% increase in sales volume despite the decreased unit costs of raw materials. Iron ore and coke purchase prices declined by approximately 39.4% and 20.9%, respectively, for the three months ended June 30, 2015 as compared to the same period in 2014. As such, the average costs of rebar manufactured decreased 18.5% to approximately $349.0 per ton in the second quarter of 2015 from approximately $428.4 per ton in the same period of 2014.

 

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Six months ended June 30, 2015 compared with six months ended June 30, 2014

 

   Six months ended         
   June 30, 2015   June 30, 2014   Change   Change 
in thousands,
except metric tons
  Volume   Cost of
Goods Sold
   %   Volume   Cost of
Goods Sold
   %   Volume
%
   Cost of
Goods Sold
 %
 
                                 
Longmen Joint Venture   2,653,831   $953,304    100.0%   2,622,667   $1,175,318    99.9%   1.2%   (18.9)%
Others   46    57    0.0%   2,035    1,373    0.1%   (97.7)%   (95.8)%
Total Cost of Goods Sold    2,653,877   $953,361    100.0%   2,624,702   $1,176,691    100.0%   1.1%   (19.0)%

 

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 57.3% of our total cost of sales. The cost of goods sold decreased by 19.0% to $953.4 million in the six months ended June 30, 2015 from $1.2 billion in the same period of 2014. The 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 43.7% and 26.3%, respectively, for the six months ended June 30, 2015 as compared to the same period in 2014. As such, the average costs of rebar manufactured decreased 19.8% to approximately $359.2 per ton in the second quarter of 2015 from approximately $448.1 per ton in the same period of 2014.

 

Gross (Loss) Profit

 

Three months ended June 30, 2015 compared with three months ended June 30, 2014

 

   Three months ended     
   June 30, 2015   June 30, 2014   Change 
in thousands,
except metric tons
  Volume  

Gross

Loss

   Margin
%
   Volume  

Gross

Profit (Loss)

   Margin
%
   Gross
(Loss)
Profit
 
                             
Longmen Joint Venture   1,699,265   $(64,221)   (12.1)%   1,305,127   $28,230    4.8%   (327.5)%
Others   17    (48)   (1,600.0)%   1,312    (136)   (19.5)%   (64.7)%
Total Gross (Loss) Profit   1,699,282   $(64,269)   (12.2)%   1,306,439   $28,094    4.8%   (328.8)%

 

Gross loss for the second quarter of 2015 was $(64.3) million, or (12.2)% of total sales, as compared to a gross profit of $28.1 million, or 4.8% of total sales for the same period in 2014. The decrease in gross margin percentage was mainly attributable to the percentage decrease of average rebar selling price of 30.8% being higher than the percentage decrease of costs of rebar manufactured of 18.5% for the second quarter of 2015 as compared to the same period of 2014.

 

Six months ended June 30, 2015 compared with six months ended June 30, 2014

 

   Six months ended     
   June 30, 2015   June 30, 2014   Change 
in thousands,
except metric tons
  Volume  

Gross

Loss

   Margin
%
   Volume  

Gross

Profit (Loss)

   Margin
%
   Gross
(Loss)
Profit
 
                             
Longmen Joint Venture   2,653,831   $(96,368)   (11.2)%   2,622,667   $6,010    0.5%   (1,703.5)%
Others   46    (48)   (533.3)%   2,035    (477)   (53.2)%   (89.9)%
Total Gross Loss   2,653,877   $(96,416)   (11.3)%   2,624,702   $5,533    0.5%   (1,842.6)%

 

Gross loss for the six months ended June 30, 2015 was $(96.4) million, or (11.3)% of total sales, as compared to a gross profit of $5.5 million, or 0.5% of total sales for the same period in 2014. The decrease in gross margin percentage was mainly attributable to the percentage decrease of average rebar selling price of 28.3% being higher than the percentage decrease of costs of rebar manufactured of 19.8% for the six months ended June 30, 2015 as compared to the same period of 2014.

 

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Selling, General and Administrative Expenses (“SG&A”)

 

Three months ended June 30, 2015 compared with three months ended June 30, 2014

 

(in thousands)  Three months ended     
   June 30, 2015   June 30, 2014   Change % 
             
Selling, general and administrative expenses  $(22,083)  $(18,849)   17.2%
Excess overhead during maintenance  $(5,309)  $-    100.0%
Impairment charge  $(973,860)  $-    100.0%
SG&A expenses, excess overhead during maintenance and impairment charge as a percentage of total revenue   (189.4)%   (3.2)%     

 

SG&A expenses, such as travel expenses and transportation fees, entertainment, employee benefit, training, and travel expenses increased by 17.2% to $22.1 million for the three months ended June 30, 2015, compared to $18.8 million for the same period in 2014.

 

Selling expenses increased by 7.1% to $10.4 million for three months ended June 30, 2015 as compared to $9.7 million in the same period of 2014. The increase was mainly due to the $1.7 million or 25.1% increase in freight expenses along with the 30.1% increase in sales volume, which was offset by the $0.8 million or 52.5% decrease in the sales tax along with the decrease in sales revenue.

 

General and administrative (“G&A”) expenses were approximately $11.7 million and $9.1 million for three months ended June 30, 2015 and 2014, respectively. The increase was mainly due to Longmen Joint Venture’s increased waste and water treatment expenses to comply with the government’s increasingly stringent environmental regulations and increased local taxes in the second quarter of 2015 compared to the same period in 2014.

 

We had abnormally low production in May 2015 due to the temporary shutdown of one of our furnaces to perform maintenance and mechanical adjustments. As a result, we reallocated the corresponding fixed overheads expenses from cost of goods sold to G&A expense in accordance with ASC 330-10-30-6 as the amount of fixed overhead allocated to each unit of production shall not be increased as a consequent of abnormally low production or idle plant due to our plant and machinery maintenance.

 

We used the undiscounted cash flow approach for the purpose of performing a recoverability test on Longmen Joint Venture’s long-lived assets to determine whether the total undiscounted cash flows are greater than the carrying value of those assets as of June 30, 2015. As a result of the China and global steel industry over-capacity and slowdown in China’s economic growth, commodity prices dropped, and the price of steel had been on a declining trend from the third quarter of 2012 to 2015. The over-capacity issue impacted our results since the third quarter of 2012 and continued to do so in 2014 and 2015. While rebar selling prices rebounded quarter-over-quarter by 8.8% to $422.2 per ton in the fourth quarter of 2014 and our gross loss per ton narrowed to $(7.0), which led us to have a more optimistic outlook on our future operations at the time, the declining trend continued in 2015 and our rebar selling prices decreased by 18.6% in the first quarter of 2015 to $343.8 per ton and the gross loss per ton increased to $(33.7). With the second and third quarters historically being the best-performing quarters in our experience, we expected previously that the gross profit (loss) would begin to improve in the second quarter. However, as the Chinese steel industry conditions continued to worsen in the second quarter of 2015 with our average rebar selling prices decreasing further by 9.5% quarter-over-quarter to $311.2 per ton and gross loss per ton decreasing to $(37.8), which deviated from our previously anticipated industry environment improvement, we downgraded our previously forecasted operating profits (loss) for future periods. Accordingly, the sum of the discounted cash flows expected to be generated from Longmen Joint Venture’s long-lived assets became less than the carrying value by $973.9 million (RMB 6.0 billion), which was impaired and included in operating expenses for the second quarter of 2015. The discounted cash flows were determined using certain expected changes to the current operational assumptions using the average of three possible cash flow scenarios (Also see critical accounting policies - fair value measurements below).

 

Through the quarterly ended June 30, 2015, we have incurred recurring losses from our operations from the last several years as our steel business has faced very tough market conditions and challenging profitability. We have continued our effort to implementing cost savings on our manufacturing overhead costs and to reduce our unit production cost. We have forecasted our loss will be continued until year 2021 and expected to make a turning point and become profitable in year 2022 and beyond. Our forecast is based on current market condition, if the future market condition is different from our forecast, we might continue to incur additional loss in 2022 and beyond and we may be required to record additional impairment charges in future periods.

 

Six months ended June 30, 2015 compared with six months ended June 30, 2014

 

(in thousands)  Six months ended     
   June 30, 2015   June 30, 2014   Change % 
             
Selling, general and administrative expenses  $(39,438)  $(39,902)   (1.2)%
Excess overhead during maintenance  $(24,443)  $-    100.0%
Impairment charge  $(973,860)  $-    100.0%
SG&A expenses, excess overhead during maintenance and impairment charge as a percentage of total revenue   (121.1)%   (3.4)%     

 

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SG&A expenses, such as travel expenses and transportation fees, entertainment, employee benefit, training, and travel expenses decreased by 1.2% to $39.4 million for the six months ended June 30, 2015, compared to $39.9 million for the same period in 2014.

 

Selling expenses decreased by 7.0% to $16.8 million for six months ended June 30, 2015 as compared to $18.0 million in the same period of 2014. The decrease was mainly due to the decrease in sales tax expenses along with the decrease in sales revenue.

 

General and administrative (“G&A”) expenses were approximately $22.7 million and $21.9 million for six months ended June 30, 2015 and 2014, respectively. The increase was mainly due to Longmen Joint Venture’s increased waste and water treatment expenses to comply with the government’s increasingly stringent environmental regulations and increased local taxes in the first six months of 2015 compared to the same period in 2014.

 

We had abnormally low production between February and May 2015 due to our annual plant and machinery maintenance in an effort to prevent substantial loss from the significant decrease in rebar selling prices during the quarter. As a result, we reallocated the corresponding fixed overheads expenses from cost of goods sold to G&A expense in accordance with ASC 330-10-30-6 as the amount of fixed overhead allocated to each unit of production shall not be increased as a consequent of abnormally low production or idle plant due to our annual plant and machinery maintenance.

 

As the Chinese steel industry conditions continued to worsen in the six months ended June 30, 2015, which deviated from our previously anticipated industry environment improvement beginning in the second quarter, we used the undiscounted cash flow estimation approach for the purpose of performing a recoverability test on Longmen Joint Venture’s long-lived assets to determine whether the total undiscounted cash flows are greater than the carrying value of those assets as of June 30, 2015. As a result, we discounted the sum of the cash flows expected to generate from Longmen Joint Venture’s long-lived assets .The total discounted cash flows were less than the carrying value by $973.9 million (RMB 6.0 billion), which we recorded an impairment charge included in operating expenses for the six months ended June 30, 2015. The discounted cash flows were determined using certain expected changes to the current operational assumptions using the average of three possible cash flow scenarios (Also see critical accounting policies - fair value measurements below).

 

Through the quarterly ended June 30, 2015, we have incurred recurring losses from our operations from the last several years as our steel business has faced very tough market conditions and challenging profitability. We have continued our effort to implementing cost savings on our manufacturing overhead costs and to reduce our unit production cost. We have forecasted our loss will be continued until year 2021 and expected to make a turning point and become profitable in year 2022 and beyond. Our forecast is based on current market condition, if the future market condition is different from our forecast, we might continue to incur additional loss in 2022 and beyond and we may be required to record additional impairment charges in future periods.

 

Change in Fair Value of Profit Sharing Liability

 

Three months ended June 30, 2015 compared with three months ended June 30, 2014

 

(in thousands)  Three months ended     
   June 30, 2015   June 30, 2014   Change % 
                
Change in fair value of profit sharing liability  $57,499   $(2,920)   (2,069.1)%

 

For the three months ended June 30, 2014, we recognized a loss on change in fair value of profit sharing liability of $(2.9) million in our loss from operations primarily due to 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 was estimated. The fair value of the profit sharing liability at June 30, 2014 was not materially different from the previous reporting period.

 

For the three months ended June 30, 2015, we recognized a gain on change in fair value of profit sharing liability of $57.5 million in our loss from operations. Of the $57.5 million gain, $54.8 million gain was associated with the change in present value of estimate of future operating profits as a result of the re-evaluation of our projected operating profit (loss) based on our second quarter actual operating result and the latest Chinese steel industry information, with which we had lowered our 2015 through 2031 estimated unit selling price and raw material cost as compared to our evaluation at March 31, 2015, as well as increased our estimated sales volume in response to the Chinese government’s RMB 1 trillion infrastructure investment initiative announced in August 2015. In addition, we incurred $1.2 million loss from present value discount amortization for the three months ended June 30, 2015, $2.6 million loss from lowering the discount rate by 0.25% as the Chinese central bank had lower the borrowing rate by 0.25% on June 27, 2015, and $6.5 million gain from the difference between the previously estimated operating results for the current period as of March 31, 2015 and actual results for the second quarter of 2015.

 

 54 

 

 

Six months ended June 30, 2015 compared with six months ended June 30, 2014

 

(in thousands)  Six months ended     
   June 30, 2015   June 30, 2014   Change % 
                
Change in fair value of profit sharing liability  $70,423   $(2,969)   (2,471.9)%

 

For the six months ended June 30, 2014, we recognized a loss on change in fair value of profit sharing liability of $3.0 million in our loss from operations primarily due to 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 was estimated. The fair value of the profit sharing liability at June 30, 2014 was not materially different from the previous reporting period.

 

For the six months ended June 30, 2015, we recognized a gain on change in fair value of profit sharing liability of $70.4 million in our loss from operations. Of the $70.4 million gain, $71.4 million gain was associated with the change in present value of estimate of future operating profits as a result of the re-evaluation of our projected operating profit (loss) based on our June actual operating result and the latest Chinese steel industry information, with which we had lowered our 2015 to 2031 estimated unit selling price and raw material cost as compared to our evaluation at December 31, 2014, as well as increased our estimated sales volume in response to the Chinese government’s RMB 1 trillion infrastructure investment initiative announced in August 2015. In addition, we incurred $2.4 million loss from present value discount amortization for the six months ended June 30, 2015, $5.0 million loss from lowering the discount rate by 0.50% as the Chinese central bank lowered the borrowing rate by 0.25% twice on May 11, 2015 and June 27, 2015, and $6.5 million gain from the difference between the previously estimated operating results for the current period as of December 31, 2014 and actual results for the six months ended June 30, 2015.

 

(Loss) Income from Operations

 

Three months ended June 30, 2015 compared with three months ended June 30, 2014

 

(in thousands)  Three months ended     
   June 30, 2015   June 30, 2014   Change % 
                
(Loss) income from operations  $(1,008,022)  $6,325    (16,037.1)%

 

Loss from operations for the three months ended June 30, 2015 was $(1.0) billion as compared to an income of $6.3 million for the same period in 2014. The increase in loss from operations was predominantly due to the increase in gross loss, excess overhead during maintenance and impairment charge.

 

Six months ended June 30, 2015 compared with six months ended June 30, 2014

 

(in thousands)  Six months ended     
   June 30, 2015   June 30, 2014   Change % 
                
Loss from operations  $(1,063,734)  $(37,338)   2,748.9%

 

Loss from operations for the six months ended June 30, 2015 was $(1.1) billion as compared to $(37.3) million for the same period in 2014. The increase in loss from operations was predominantly due to the increase in gross loss, excess overhead during maintenance and impairment charge.

 

Other Income (Expense)

 

Three months ended June 30, 2015 compared with three months ended June 30, 2014

 

(in thousands)  Three months ended     
   June 30, 2015   June 30, 2014   Change % 
             
Interest income  $2,741   $4,066    (32.6)%
Finance/interest expense   (24,413)   (20,950)   16.5%
Financing cost on capital lease   (5,162)   (5,669)   (8.9)%
Loss on disposal of equipment   (44)   (142)   (69.0)%
Income from equity investment   34    54    (37.0)%
Foreign currency transaction loss   (249)   (963)   (74.1)%
Lease income   545    542    0.6%
Other non-operating income (expense), net   378    302    25.2%
Total other expense, net  $(26,170)  $(22,760)   15.0%

 

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Total other expense, net, for the three months ended June 30, 2015 was $26.2 million, a 15% increase compared to $22.8 million for the same period in 2014. The increase was mainly a result of the $3.5 million increase in finance/interest expenses, which was mainly due to the increase in the amount of borrowings from unrelated and related parties in the second quarter of 2015 as compared to the same period in 2014. As a result, interest expense on loan borrowings for the three months ended June 30, 2015 amounted to $16.1 million, a $7.9 million or 96.2% increase from $8.2 million for the same period in 2014 while notes receivable early redemption expenses for the three months ended June 30, 2015 amounted to $8.3 million, a $4.5 million or 35.2% decrease from $12.8 million for the same period in 2014.

 

Six months ended June 30, 2015 compared with six months ended June 30, 2014

 

(in thousands)  Six months ended     
   June 30, 2015   June 30, 2014   Change % 
             
Interest income  $5,072   $7,258    (30.1)%
Finance/interest expense   (39,790)   (44,559)   (10.7)%
Financing cost on capital lease   (10,355)   (10,755)   (3.7)%
Loss on disposal of equipment   (28)   (96)   (70.8)%
(Loss) income from equity investment   (3)   67    (104.5)%
Foreign currency transaction loss   (1,122)   (1,817)   (38.2)%
Lease income   1,088    1,088    -%
Other non-operating income (expense), net   601    126    377.0%
Total other expense, net  $(44,537)  $(48,688)   (8.5)%

 

Total other expense, net, for the six months ended June 30, 2015 was $44.5 million, an 8.5% decrease compared to $48.7 million for the same period in 2014. The decrease was mainly a result of the $4.8 million decrease in finance/interest expenses, which was offset by the $2.2 million decrease in interest income along with the decrease in notes receivable. The decrease in finance/interest expenses was mainly a result of the decrease in the amount of bank notes receivable redeemed early for the six month ended June 30, 2015 as compared to the same period in 2014. As a result, notes receivable early redemption expenses for the six months ended June 30, 2015 amounted to $16.3 million, a $10.6 million or 39.4% decrease from $26.9 million for the same period in 2014 while interest expense on loan borrowings for the six months ended June 30, 2015 amounted to $23.5 million, a $5.8 million or 32.7% increase from $8.2 million for the same period in 2014

 

Income Taxes

 

For the three months ended June 30, 2015 and 2014, we had a total tax provision from our profitable subsidiaries of $111 thousand and $107 thousand, respectively. For the three months ended June 30, 2015, we evaluated the deferred tax assets and concluded the net operating loss may not be fully realizable and to provide 100% valuation allowance for the deferred tax assets. No deferred income tax benefit was recorded for the three months ended June 30, 2015 as the resulting deferral of tax assets being fully reserved because the benefit was not considered to be realizable due to recent historical experience.

 

For the three months ended June 30, 2015 and 2014, we had effective tax rates of (0.01)% and (0.7)%, respectively.

 

For the six months ended June 30, 2015 and 2014, we had a total tax provision from our profitable subsidiaries of $141 thousand and $112 thousand, respectively. For the six months ended June 30, 2015, we evaluated the deferred tax assets and concluded the net operating loss may not be fully realizable and to provide 100% valuation allowance for the deferred tax assets. No deferred income tax benefit was recorded for the three months ended June 30, 2015 as the resulting deferral of tax assets being fully reserved because the benefit was not considered to be realizable due to recent historical experience.

 

For the six months ended June 30, 2015 and 2014, we had effective tax rates of (0.01)% and (0.1)%, respectively.

 

Net Loss

 

Three months ended June 30, 2015 compared with three months ended June 30, 2014

 

(in thousands)  Three months ended     
   June 30, 2015   June 30, 2014   Change % 
                
Net loss  $(1,034,303)  $(16,542)   6,152.6%

 

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Six months ended June 30, 2015 compared with six months ended June 30, 2014

 

(in thousands)  Six months ended     
   June 30, 2015   June 30, 2014   Change % 
                
Net loss  $(1,108,412)  $(86,138)   1,186.8%

 

Net Loss attributable to General Steel Holdings, Inc.

 

Three months ended June 30, 2015 compared with three months ended June 30, 2014

 

(in thousands)  Three months ended     
   June 30, 2015   June 30, 2014   Change % 
             
Net loss  $(1,034,303)  $(16,542)   6,152.6%
Less: Net loss attributable to the noncontrolling interest   (419,276)   (5,523)   7,491.5%
Net loss attributable to General Steel Holdings, Inc.  $(615,027)  $(11,019)   5,481.5%

 

Net loss attributable to us for the three months ended June 30, 2015 was $(615.0) million as compared to $(11.0) million for the same period in 2014. The increase in net loss attributable to us for the three months ended June 30, 2015 was mainly a result of the $92.4 million increase in gross loss, $3.2 million increase in SG&A expenses, $5.3 million increase in excess overhead during maintenance and $973.9 million impairment charge being offset by the $57.5 million increase in gain from change in fair value of profit sharing liability and the $3.5 million decrease in finance/interest expenses.

 

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.

 

Six months ended June 30, 2015 compared with six months ended June 30, 2014

 

(in thousands)  Six months ended     
   June 30, 2015   June 30, 2014   Change % 
             
Net loss  $(1,108,412)  $(86,138)   1,186.8%
Less: Net loss attributable to the noncontrolling interest   (448,232)   (31,555)   1,320.5%
Net loss attributable to General Steel Holdings, Inc.  $(660,180)  $(54,583)   1,109.5%

 

Net loss attributable to us for the six months ended June 30, 2015 was $(660.2) million as compared to $(54.6) million for the same period in 2014. The increase in net loss attributable to us for the six months ended June 30, 2015 was mainly a result of the $101.9 million increase in gross loss, $24.4 million increase in excess overhead during maintenance and $973.9 million impairment charge being offset by the $70.4 million increase in gain from change in fair value of profit sharing liability and the $4.8 million decrease in finance/interest expenses.

 

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 June 30, 2015, our current liabilities exceeded the current assets by approximately $1,457.5 million. 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.

 

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Based on the above considerations, our Board of Directors is of the opinion that we have a plan to obtain sufficient funds to meet our working capital requirements and debt obligations as they become due. However, this plan 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 continued heavy reliance 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 June 30, 2015, we had cash and restricted cash aggregating $266.5 million, of which $230.2 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 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.

 

Short-term Notes Payable

 

As of June 30, 2015, we had $531.9 million in short-term notes payable liabilities, which were secured by restricted cash of $210.1 million and restricted notes receivable of $16.3 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 June 30, 2015, we had $154.0 million in short-term bank loans. These were bank loans with a one year maturity and must be paid in full upon maturity. PRC banks have not been impacted as heavily by the financial crisis as U.S. banks and we believe our current creditors will renew their loans to us after our loans mature as they did in the past.

 

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 debt, see Note 10 in our Notes to the unaudited condensed consolidated financial statements included in this report.

 

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For more details about our related party debt financing, see Note 19 in our Notes to the unaudited condensed consolidated financial statements included in this 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 between 4.6% to 12.0% higher than the original selling price from Longmen Joint Venture. 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 for the purchase back of the inventory from the third party companies. There is no physical movement of the inventory during the sale and purchase back arrangement. The margin between 4.6% to 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 three months ended June 30, 2015 and 2014 amounted to $107.1 million and $229.1 million, respectively, which are eliminated in the Company’s consolidated financial statements. The financial cost related to financing sales for the three months ended June 30, 2015 and 2014 amounted to $0.6 million and $0.8 million, respectively.

 

Total financing sales for the six months ended June 30, 2015 and 2014 amounted to $225.8 million and $459.6 million, respectively, which are eliminated in the Company’s consolidated financial statements. The financial cost related to financing sales for the six months ended June 30, 2015 and 2014 amounted to $1.3 million and $1.7 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 June 30, 2015 and December 31, 2014 were (1.8) and (5.6), respectively. As of June 30, 2015, our current liabilities exceed current assets (excluding deferred lease income) by $1.5 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.

 

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.

 

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

 

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 June 30, 2016. 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 June 30, 2016
 
Current liabilities over current assets (excluding deferred lease income) as of June 30, 2015 (unaudited)  $(1,455.3)
Projected cash financing and outflows:     
Cash provided by line of credit from banks   150.2 
Cash provided by vendor financing   1,060.8 
Cash provided by other financing   412.9 
Cash provided by sales representatives   18.7 
Cash projected to be used in operations in the twelve months ended June 30, 2016   (58.3)
Cash projected to be used for financing cost in the twelve months ended June 30, 2016   (59.6)
Net projected change in cash for the twelve months ended June 30, 2016  $69.4 

 

Cash-flow

 

Operating Activities

 

Net cash used in operating activities for the six months ended June 30, 2015 and 2014 was $(247.5) million compared to $121.7 million net cash provided by operating activities, respectively. This change was mainly due to the combination of the following factors:

 

·The impact of some non-cash items included in net loss of $973.0 million for the six months ended June 30, 2015, compared to $61.0 million in the same period in 2014. The non-cash items include the following:

 

-Depreciation, amortization and depletion;
-Impairment of plant and equipment;
-Gain on disposal of equipment and intangible assets;
-Provision (recovery) for doubtful accounts;
-Reservation of mine maintenance fee;
-Stock issued for service and compensation;
-Amortization of deferred financing cost on capital lease;
-(Loss) income from equity investments;
-Foreign currency transaction loss;
-Deferred lease income; and
-Change in fair value of profit sharing liability.

 

·The primary reasons for the material fluctuations in cash inflow were 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 the six months ended June 30, 2015;
-Accounts receivable – related parties: The decrease was mainly due to less credit sales to related parties were incurred that were not yet collected for the six months ended June 30, 2015;
-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 six months ended June 30, 2015;
-Inventories: The decrease in inventories during the six months ended June 30, 2015 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, including related parties: The decrease in advance on inventory purchases, including related parties, was mainly due to the decrease in raw material prices leading to less payments being made to suppliers for raw material purchases to meet future production capacity. Advance payment is a prevailing requirement on iron ore purchases in the steel production industry;

 

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-Accounts payable – related parties: The increase in accounts payable – related parties was mainly due to Longmen Joint Venture paying less to its related party suppliers as compared to the same period in 2014. 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 an decrease in payments for the six months ended June 30, 2015 compared to the same period in 2014; and
-Taxes payable: The increase in taxes payable was mainly due to the VAT taxes payable as less VAT purchase tax was incurred during the six months ended June 30, 2015 to offset the VAT sales tax payable.

 

·The primary reasons for material fluctuations in cash outflow were as follows:

 

-Accounts receivable: The increase was mainly due to more credit sales to third parties were incurred that have not yet been collected for the six months ended June 30, 2015 compared with the same period in 2014;
-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;
-Accounts payable: The decrease in accounts payable was mainly due to Longmen Joint Venture making fewer purchases from third parties during the six months ended June 30, 2015 compared with the same period in 2014. 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;
-Other payables – related parties: The decrease in other payables – related parties was mainly due to an increase in payments made for the six months ended June 30, 2015 compared to the same period in 2014; and
-Customer deposits, including related parties: The decrease was mainly due to less of customers making prepayments to us prior to June 30, 2015. These deposits were subsequently recognized as sales or netted against the corresponding cost of goods sold in our trading transactions after June 30, 2015 in accordance with our revenue recognition policy.

 

Investing activities

 

Net cash provided by investing activities was $188.3 million for the six months ended June 30, 2015 compared to net cash used in investing activities of $(164.5) million for the six months ended June 30, 2014. Fluctuation in cash inflow between the two periods was mainly due to the decrease of restricted cash. Restricted cash was used as a pledge for our notes payable as required by the bank. In the first six months of 2015, such balance decreased because we needed less notes payable to settle with suppliers. The increase in cash inflow was also due to $114.1 million net loan repayment from related parties and $2.6 million proceeds from short term investments during the six months ended June 30, 2015. The increase in cash provided was partially offset by the increase in loan to unrelated parties, short-term investments, and equipment purchase.

 

Financing activities

 

Net cash provided by financing activities was $83.8 million for the six months ended June 30, 2015 compared to $56.0 million for the six months ended June 30, 2014. Compared to the same period in 2014, 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 six months ended June 30, 2015;
·Short term loans – others: We borrowed more from unrelated parties for the six months ended June 30, 2015 compared to the same period in 2014;
·Short term loans – related parties: We borrowed more and repaid fewer loans from related parties for the six months ended June 30, 2015 as compared to the same period in 2014; and
·Long-term loans – related party: we borrowed more long-term loans from related party during the six months ended June 30, 2015.

 

The cash inflow was offset by the following cash outflow:

 

·Short term notes payable: We repaid more short term notes payable during the six months ended June 30, 2015 compared to the same period in 2014; and
·Short term loans - bank: We repaid more loans from banks for the six months ended June 30, 2015 as they became due than we borrowed compared to the same period in 2014.

 

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 Regulations

 

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 period ended June 30, 2015 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 June 30, 2015 and the effect these obligations are expected to have on our liquidity and cash flows in future periods.

 

   Payment due by period 
       Less than             
Contractual obligations  Total   1 year   1-3 years   3- 5 years   5 years after 
       (in thousands)             
Notes payable  $531,869   $531,869   $-   $-   $- 
Bank loans   153,989    153,989    -    -    - 
Other loans, including related parties   345,108    345,108    -    -    - 
Deposits due to sales representatives, including related parties   18,654    18,654    -    -    - 
Operating lease commitments