Forward Looking 8/14/2015:
Government Grants:
Government grants include cash subsidies as well as other subsidies received from the PRC government by the subsidiaries of the Company. Such subsidies are generally provided as incentives from the local government to encourage the expansion of local business. Government grants are recognized when received and all the conditions specified in the grant have been met. Government grants recognized as other income were $475,928 and $0 for the six months ended June 30, 2015 and 2014, respectively.
Recently Issued Accounting Pronouncements:
In April 2015, the FASB issued ASU 2015-03, “Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs”. The amendments in the ASU are intended to simplify the presentation of debt issuance costs. These amendments require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU. The amendments in this ASU are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted for financial statements that have not been previously issued. The Company is currently in the process of evaluating the impact of the adoption on its consolidated financial statements.
In July 2015, the FASB issued ASU 2015-11, “Inventory (Topic 330): Simplifying the Measurement of Inventory”. The amendments in ASU 2015-11 require an entity to measure in scope inventory at the lower of cost and net realizable value. 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 amendments do not apply to inventory that is measured using last-in, first-out (LIFO) or the retail inventory method. The amendments apply to all other inventory, which includes inventory that is measured using first-in, first-out (FIFO) or average cost. The amendments in this ASU are effective for public business entities for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2016, and interim periods within fiscal years beginning after December 15, 2017. A reporting entity should apply the amendments prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. The adoption of ASU 2015-11 is not expected to have a material impact on the Company’s consolidated financial statements.
Reclassification:
Certain prior period amounts have been reclassified to conform to the current period presentation. The reclassification had no impact on net earnings and financial position.
Our Business and Recent Developments:
We import, sell and distribute to the metal refinery industry in China a variety of metal ore, including iron, chrome, nickel, titanium, copper and manganese ore, as well as non-ferrous metals and coal. We obtain these raw materials from global suppliers in Brazil, India, Oman, Turkey, Nigeria, Indonesia, and the Philippines and distribute them in the PRC. We also recycle scrap metal used by steel mills in the production of recycled steel. We also trade raw wood and barley.
Growth in China economy held at 7 percent in the second quarter, while the steel demand has been constantly declining this year because of the slowing economy. Total steel output declined 1.3 percent to 409.97 million tonnes for the first half of 2015 compared with the same period a year ago, and crude steel output dropped 0.8 percent in June from a year earlier, government data showed, with demand hit by slowing economic growth and property slowdown in China. Chinese steel prices are at their lowest in more than 20 years as the slowing economy cuts into demand for a range of commodities including iron ore and steel, especially the scrap steel, one of our major products. Consequently, the price decline in scrap steel resulted in an approximately $10 million of inventory write-down in our recycling business and a net loss of $7.6 million for the second quarter.
We formally commenced the operation of our scrap metal recycling facility in the Banqiao Industrial Zone of Lianyungang Economic Development Zone in the Jiangsu province, China, in the late third quarter of 2010. The facility recycles automobiles, machinery, building materials, dismantled ships and various other scrap metals. We sell and distribute the recycled scrap metal to the metal refinery industry in the PRC utilizing our existing network of metal ore customers while continuing to seek new customers. During the second quarter of 2015, our net revenue in the scrap metal recycling business decreased slightly by 2% to $25.7million from $26.1 million in the second quarter of 2014. Our production increased to 57,958 metric tons (“MT”) from 33,458 MT in the second quarter of 2014. For the second quarter of 2015, our scrap metal business sold approximately 42,498 MT of scrap metals, generating approximately $25.7 million of revenue and (- $8.1) million of gross profit; for the first half of 2015, our scrap metal business sold approximately 78,898 MT of scrap metals, generating approximately $40.9 million of revenue and (-$11.9) million of gross profit as result of a substantial inventory write-down.
In the trading business, the net revenue in the second quarter of 2015 increased by 40% to $11.2 million from $6.7 million in the second quarter of 2014 mainly due to the increase sales in raw wood of $9.2 million. The gross profit generated from trading business in the second quarter of 2015 is $2,896, representing a gross margin of $0.03%. For the first half of 2015, the net revenue in our trading business increased by 64% to $39.0 million from $14.0 million in the first half of 2014 primarily due to the increase sales in the new products raw wood of $18.0 million and barley of $15.9 million. The gross margins for the sales of raw wood are approximately 0.15% and 0.07% for the three months and six months ended on June 30, 2015, respectively. The gross margin for the sales of barley is approximately 0.11% for the first half of 2015 and no sales in barley in the second quarter. The gross profit in the trading business for the first half of 2015 was negative (-$28,709), representing a gross margin (-0.074%).
During the first half of 2015, in an effort to address the changing market conditions and unpredictable fluctuations in market prices, as well as to maintain our operation flexibility in our trading business, we continued to refine our business model and adjust our product line. We increased new products, such as wood and barley into our trading product line. We also expanded our business to exporting steel products to overseas market, such as Saudi Arabia, Vietnam and Turkey, while in the past we usually only dealt in importing metal ore and scraps into China. With recent tax elimination and reduction on export tariff by China government for some iron and steel products, we seek to grow our exporting business and expect to be benefited from the favorable export tariff change. To manage market risks, we are evaluating other potential methods such as further diversifying products and hedging tools.
We believe that our recycling business will become an increasingly strong driver in our company’s growth as natural resources continue to be depleted and PRC government continue to advocate sustainable and circular development with emphasis on environment protection, larger amounts of unprocessed scrap metal become available and increased in consumer demand in the long term. While we continue to work on improving our operation and developing our platform strategy, we are establishing an OTO (Online to Offline) platform for steel scrap business with business partners. This is a new strategic development for us to expand and enlarge the steel scrap business from traditional trading model to OTO platform with additional value-added services. The OTO platform will connect decentralized steel scrap suppliers from upstream with downstream steel mills via internet and provide the services for facilitating steel mill's purchase from and payment to suppliers. Currently and in the short term, it provides a match and complements our business; for the long term Creating the OTO platform is an important strategic development which could lead the business transition for the Company from solely selling steel scrap products in traditional methods to providing both services and products in the steel scrap business through the online platform. Once the platform grows to certain scale, we believe the greater sales revenue and profit for our steel scrap business could be expected. As of the filing date, we received business certificates for the new joint venture created for operating OTO platform and we are currently working on obtaining the license for operating internet services in China for the new joint venture.
Despite the ongoing slowdown of China economy, management believes our business will benefit from China recent development. Recently China’s top economic planning agency, the National Development and Reform Commission (NDRC), released a new action plan outlining key details of Beijing’s “One Belt, One Road” initiative. Initially billed as a network of regional infrastructure projects, this latest release indicates that the scope of the “Belt and Road” initiative has continued to expand and will now include promotion of enhanced policy coordination across the Asian continent, financial integration, trade liberalization, and people-to-people connectivity. In addition, China government is working on a development plan to boost the economic integration of Beijing and its surrounding provincial areas, namely Tianjin municipality and Hebei province. Better guidelines to promote the economic integration of the areas would help them complement each other with respective advantages, as well as propelling economic transformation and upgrading the Bohai Sea rim. These national economy development strategies will stimulate the investment and boost the demand for steel products, as well as our products.
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