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Tuesday, August 14, 2012 2:34:42 PM
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Tuesday, August 14 2012 2:33 PM, EST LONGHAI STEEL INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Edgar Online "Glimpses"
Special Note Regarding Forward Looking Statements
In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We use words such as "believe," "expect," "anticipate," "project," "target," "plan," "optimistic," "intend," "aim," "will" or similar expressions which are intended to identify forward-looking statements. Such statements include, among others, those concerning market and industry segment growth and demand and acceptance of new and existing products; any projections of sales, earnings, revenue, margins or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements regarding future economic conditions or performance; as well as all assumptions, expectations, predictions, intentions or beliefs about future events. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, including those identified in Item 1A "Risk Factors" included in our Annual Report on Form 10-K for the year ended December 31, 2011 , as well as assumptions, which, if they were to ever materialize or prove incorrect, could cause the results of the Company to differ materially from those expressed or implied by such forward-looking statements.
Readers are urged to carefully review and consider the various disclosures made by us in this report and our other filings with the SEC . These reports attempt to advise interested parties of the risks and factors that may affect our business, financial condition and results of operations and prospects. The forward-looking statements made in this report speak only as of the date hereof and we disclaim any obligation, except as required by law, to provide updates, revisions or amendments to any forward-looking statements to reflect changes in our expectations or future events.
Use of Terms
Except where the context otherwise requires and for the purposes of this report only:
"we," "us," "our," or the "Company" refers to the combined business of Longhai Steel and its consolidated subsidiaries; "Longhai Steel" refers to Longhai Steel Inc. , a Nevada corporation; "Longhai" refers to Xingtai Longhai Wire Rod Co. Ltd. , a PRC company; "Kalington" refers to Kalington Limited , a Hong Kong company; " Kalington Consulting " refers to Xingtai Kalington Consulting Service Co., Ltd. , a PRC company; "Hong Kong" refers to the Hong Kong Special Administrative Region of the People's Republic of China ; "MT" refers to metric tons; "PRC" and "China" refer to the People's Republic of China ; "SEC" refers to the Securities and Exchange Commission ; "Securities Act" refers to the Securities Act of 1933, as amended; "Exchange Act" refers to the Securities Exchange Act of 1934, as amended; "Renminbi" and "RMB" refer to the legal currency of China ; "U.S. dollars," "dollars" and "$"refer to the legal currency of the United States ; and "VIE" refers to variable interest entity.
Overview of our Business
Through our PRC operating variable interest entity, or VIE, Longhai, we are a manufacturer of steel wire products in eastern China . We produce steel wire ranging from 5.5 mm to 18 mm in diameter on two wire production lines which have a combined annual capacity of approximately 1.5 million metric tons (MMT) per year. Our products are sold to a number of distributors who transport the wire to nearby wire processing facilities. Our wire is then further processed by these third party wire refiners into a variety of products such as nails, screws, and wire mesh for use in reinforced concrete and fencing. Demand for our steel wire is driven primarily by spending in the construction and infrastructure industries. We have benefited from strong fixed asset investment and construction growth as the PRC has rapidly grown increasingly urbanized and invested in modernizing its infrastructure.
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We sell our products to a number of distribution companies that transport our wire to nearby wire processors. Our products are manufactured on an on-demand basis, and we usually collect payment in advance. Sales prices are set at the market price for wire on a daily basis. Our customers generally prepay for their orders, and the final price may be adjusted to the market price on the day of pick up. This allows us to maintain a low inventory of both wire and billet and protects us from exposure to commodity price volatility. In order to increase sales and be competitive in the market, we occasionally offer discounted wholesale prices to customers at our discretion. Our sales efforts are directed toward developing long-term relationships with customers who are able to purchase in large quantities.
Our production facilities are located at a 197,500 square meter property in Xingtai, Hebei Province . Our production facilities include a steel rolling mill, the unique feature of which is that two rolling lines are arranged in a "Y"-layout, i.e., two wire drawing lines share one furnace, one coarse and intermediate rolling mill, and other supporting equipment. This particular design facilitates cost savings and higher output at a higher quality. In the third quarter of 2011, we entered into a five year operating lease for a newly constructed wire plant adjacent to our current facilities. The new facility has an area of 90,500 square meters and an annual capacity of 600,000 MT and will increase our production capacity by approximately 60%. The new facility is leased at a yearly cost of $2.2 million from Longhai Steel Group , the Company's related party. The new facility is upgraded to have the capability to produce alloy steel, cold forging steel and welding rods. These higher margin products will allow Longhai to address demand in additional markets beyond construction and infrastructure. The new facility uses more advanced technology and equipment. Our topcross 45 rolling mill's highest speed could be 120m/s, which is much faster than our competitors' 90m/s. In addition, the new line uses fan-cooling instead of the traditional water-cooling method, reducing the oxidation of our finished products. The new facility is also equipped with high speed industrial computer control system, programmable logic controller and full digital alternating current speed control system. Our corporate headquarters is located at No. 1 Jingguang Road , Neiqiu County, Xingtai City, Hebei Province , 054000, People's Republic of China , and our telephone number is (86) 319 686-1111.
All our business has been conducted in Renminbi, the official currency of China . The Renminbi is still not a free floating currency. The value of the Renminbi is subject to changes in the Chinese government's policies and depends to a large extent on China's domestic and international economic and political developments, as well as supply and demand in the local market. The Renminbi has slowly but steadily appreciated against the U.S. dollar since July 2005 .
Second Quarter Financial Performance Highlights
The following summarizes certain key financial information for the second quarter of 2012:
Revenue: Revenue decreased $5.2 million , or 3.1%, to $160.5 million for the three months ended June 30, 2012 , from $165.7 million for the same period in 2011. Gross Profit: Gross profit increased $1.2 million , or 33.3% to $4.8 million in the period ended June 30, 2012 from $3.6 million in the same period in 2011. Net Income: Net income increased $0.6 million , or 33.3%, to $2.4 million for the three months ended June 30, 2012 , from $1.8 million for the same period in 2011. Fully diluted earnings per share: Fully diluted earnings per share were $0.22 and $0.18 for the three months ended June 30, 2012 and 2011, respectively.
Results of Operations
Comparison of Three Months Ended June 30, 2012 and June 30, 2011 (Unaudited)
The following table sets forth key components of our results of operations during the three month periods ended June 30, 2012 and 2011, both in dollars and as a percentage of our revenues:
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Three Months Ended Three Months Ended 30-Jun-12 30-Jun-11 % of % of Amount Revenues Amount Revenues Net revenues $ 160,483,483 165,698,776 Cost of sales (155,720,612 ) 97.0% (162,139,025 ) 97.9% Gross profit 4,762,871 3.0% 3,559,751 2.1% General and administrative (956,224 ) 0.6% (321,022 ) 0.2% expenses Selling expense (134,884 ) 0.1% - 0.0% Income from operations 3,671,763 2.3% 3,238,729 2.0% Other income and expense (287,068 ) 0.2% (829,344 ) 0.5% Income before income tax 3,384,695 2.1% 2,409,385 1.5% Income tax expense (1,028,510 ) 0.6% (622,817 ) 0.4% Net income 2,356,185 1.5% 1,786,568 1.1% Other comprehensive income 42,747 0.0% 779,449 0.5% Comprehensive income $ 2,398,932 1.5% 2,566,017 1.5%
Net Revenues. Net revenues consist of revenue from the sale of steel wire and scrap metal. Roughly 99% of revenues are derived from wire. Our net revenues decreased to $160.5 million , or 3.1%, to 160.5 million in the three months ended June 30, 2012 from $165.7 million in the same period in 2011. The decrease was primarily attributable to a 14.9% decrease in average wire prices. The sales volume increased from 267,938 MT to 295,635 MT, representing a period over period increase of 10.3% . However, the sales volume increase was not enough to offset the decrease in average wire prices.
Cost of Sales. Our cost of sales decreased $6.4 million , or 3.9%, to $155.7 million in the three months ended June 30, 2012 , from $162.1 million in the same period in 2011. The cost of sales as a percentage of revenues decreased from 97.9% to 97.0% between the periods. Our cost of sales is largely dictated by fluctuations in steel billet prices as billet typically represents more than 95% of our cost of goods sold. Cost of goods sold per ton of wire sold decreased 13.9% period over period.
Gross Profit and Gross Margin. Our gross profit increased $1.2 million to $4.8 million in the three months ended June 30, 2012 from $3.6 million in the same period in 2011. Gross margin increased from 2.1% for the three months ended June 30, 2011 to 3.0% for the three months ended June 30, 2012 . The increase in gross margin was primarily due to the increase of the spread between billet purchase prices and wire sales prices, as billet prices decreased more than wire prices because the steel wire market was stronger in comparison to the billet market.
General and administrative expenses. Our general and administrative expenses increased $0.6 million to $0.9 million in the three months ended June 30, 2012 from $0.3 million in the same period in 2011. The increase was due to increased salary levels and new executive employed and stock option expenses to officers and an independent board director. Also during the three months ended June 30, 2012 , more capital market related expenses occurred.
Income Before Income Taxes. Our income before income taxes increased to $3.4 million in the three months ended June 30, 2012 from $2.4 million in the same period in 2011. This increase was due to an increase in our gross profit, and partially offset by the increase in our operating expenses as discussed above. In addition, we experienced lower interest expenses in association with the decreased use of bank acceptance bills.
Bank acceptance bills are common instruments used by companies in China to secure credit terms from their suppliers. These instruments feature a local bank guarantee of the payment risk, which is provided for a fee. In these arrangements, a company and a bank enter into a bank acceptance agreement pursuant to which the bank agrees to accept and pay when due the company's bills payable to the supplier. Cashing in such bank acceptance bills before they mature enables us to purchase more steel billet, our main production input, at a discount. The discounts are greater than the cost of cashing in said bank acceptance bills early.
Income Tax. Income tax increased to $1.0 million in the three months ended June 30, 2012 from $0.6 million in the same period in 2011 as we had higher taxable income.
Net Income. In the quarter ended June 30, 2012 , we generated net income of $2.4 million , compared to $1.8 million in the same period in 2011. This increase was primarily attributable to the factors discussed above.
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Comparison of Six Months Ended June 30, 2012 and June 30, 2011 (Unaudited)
Six Months Ended Six Months Ended 30-Jun-12 30-Jun-11 % of % of Amount Revenues Amount Revenues Net revenues $ 296,262,619 292,014,638 Cost of sales (285,946,421 ) 96.5% (284,508,440 ) 97.4% Gross profit 10,316,198 3.5% 7,506,198 2.6% General and administrative (1,508,185 ) 0.5% (1,110,390 ) 0.4% expenses Selling expense (400,988 ) 0.1% (5,599 ) 0.0% Other operation expense (500,337 ) 0.2% - 0.0% Income from operations 7,906,688 2.7% 6,390,209 2.2% Other income and expense (869,652 ) 0.3% (1,407,018 ) 0.5% Income before income tax 7,037,036 2.4% 4,983,191 1.7% Income tax expense (1,974,876 ) 0.7% (1,282,954 ) 0.4% Net income 5,062,160 1.7% 3,700,237 1.3% Other comprehensive income 402,245 0.1% 1,068,105 0.4% Comprehensive income $ 5,464,405 1.9% 4,768,342 1.6%
Net Revenues. Our net revenues increased $4.3 million , or 1.5%, to $296.3 million in the six months ended June30, 2012 from $292.0 million in the same period in 2011. The increase was primarily due to an increase in sales volume. The sales volume increased from 478,818 MT to 538,011 MT, representing a period over period increase of 12.4% . The increase in sales volume was partially offset by decrease in average sales price of 13.0% .
Cost of Sales. Our cost of sales increased $1.4 million , or 0.5%, to $285.9 million in the six months ended June 30, 2012 , from $284.5 million in the same period in 2011. The cost of sales as a percentage of revenues decreased from 97.4% to 96.5% between the periods. Our cost of sales is largely dictated by fluctuations in steel billet prices as billet typically represents more than 95% of our cost of goods sold. Cost of goods sold per ton of wire sold decreased 12.7% period over period.
Gross Profit and Gross Margin. Our gross profit increased $2.8 million to $10.3 million in the six months ended June 30, 2012 from $7.5 million in the same period in 2011. Gross margin improved from 2.6% for the six months ended June 30, 2011 to 3.5% for the six months ended June 30, 2012 . The increase in gross margin was primarily due to the increase of the spread between billet purchase prices and wire sales price.
General and administrative expenses. Our general and administrative expenses increased $0.4 million to $1.5 million in the six months ended June 30, 2012 , from $1.1 million in the same period in 2011. The increase was due to increased salary levels and new executive employed and stock option expenses issued to officers and independent directors. Also during the six months ended June 30, 2012 , more capital market related expenses occurred.
Selling expenses. Our selling expenses increased approximately $0.4 million to 0.4 million in the six months ended June 30, 2012 , from $5,599 in the same period in 2011. The increase was due to our plan to open up new markets in Hubei Province in China .
Other Operation expenses. In the first quarter of 2012, the leased new production line at Longhai was temporarily closed because of insufficient customer demand and a shortage of steel billet supply. $500,337 of manufacturing overhead expense during was charged to other operation expenses.
Income Before Income Taxes. Our income before income taxes increased to $7.0 million in the six months ended June 30, 2012 from $5.0 million in the same period in 2011. This increase was due to an increase in our gross profit partially offset by the increase in our operating expenses as discussed above. In addition, we experienced lower interest expenses in association with decreased use of bank acceptance bills.
Income Tax. Income tax increased to $2.0 million in the six months ended June 30, 2012 from $1.3 million in the same period in 2011 as we had higher taxable income.
Net Income. In the six months ended June 30, 2012 , we generated net income of $5.0 million , compared to $3.7 million in the same period in 2011. This increase was primarily attributable to the factors discussed above.
Liquidity and Capital Resources
As of June 30, 2012 , we had cash and cash equivalents of $18,027,281 , consisting primarily of cash on hand, demand deposits and restricted cash. The following table sets forth a summary of our cash flows for the periods indicated:
The following table sets forth a summary of our cash flows for the periods indicated:
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Cash Flows Six Months Ended June 30, 2012 2011 Net cash provided by operating activities $ 4,629,523 9,327,913 Net cash used in investing activities (89,618 ) (4,509,771 )
Net cash provided by (used in) financing activities 10,702,241 (2,233,624 ) Effect of exchange rate changes on cash
19,982 44,760 Net increase in cash and cash equivalents 15,262,128 2,629,278 Cash and cash equivalents, beginning balance 2,765,153 293,445 Cash and cash equivalents, ending balance 18,027,281 2,922,723
Operating activities
Net cash provided by operating activities was $4.6 million for the period ended June 30, 2012 , as compared to net cash provided by operating activities of $9.2 million for the same period in 2011. The decrease was mainly attributable the following factors: advances to suppliers in the six months ended June 30, 2011 increased $46.5 million as compared to the same period in 2011 as our production capacity expanded since the second production line was set up in August 2011 ; there was no advances to the related party for purchase of billets as we have been purchasing billets from unrelated third party trading companies; and our accounts payable decreased $10.5 million as a result of better control over accounts payable after introduction of electronic inventory system in July 2011 .
Investing activities
Net cash used in investing activities for the period ended June 30, 2012 was $0.09 million , compared to net cash used in investing activities of $4.5 million during the same period of 2011. This decrease in cash used in investing activities was mainly because there was no cash lending to a related party in the six months ended June 30, 2012 , compared with $3.8 million during the same period in 2011.
Financing activities
Net cash provided by financing activities for the period ended June 30, 2012 was $10.7 million , as compared to net cash used in financing activities of $2.2 million during the same period in 2011. The increase was primarily attributable to the gross proceeds of $1.2 million in the June 2012 private placement and a total amount of $14.2 million banker's acceptance and borrowing from banks, offset by a loan payment of $4.7 million in the six months ended June 30, 2012
We believe that our cash on hand and cash flows from operations will meet our present cash needs, but we may require additional cash resources to implement our expansion through the acquisition of additional facilities. If our own financial resources are insufficient to satisfy our capital requirements, we may seek to sell additional equity or debt securities or obtain additional credit facilities. The sale of additional equity securities could result in dilution to our stockholders. The incurrence of indebtedness would result in increased debt service obligations and could require us to agree to operating and financial covenants that would restrict our operations. Financing may not be available in amounts or on terms acceptable to us, if at all. Any failure by us to raise additional funds on terms favorable to us, or at all, could limit our ability to expand our business operations and could harm our overall business prospects. On July 20, 2010 , we filed a registration statement with the SEC in order to be able to issue additional common stock at a proposed maximum offer price of 20 million U.S. Dollars for the purpose of expanding our business through acquisitions and to better meet our working capital needs.
Inflation
Inflation and changing prices have not had a material effect on our business and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future. However, our management will closely monitor price changes in the steel industry and continually maintain effective cost control in operations.
Off Balance Sheet Arrangements
We do not have any off balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity or capital expenditures or capital resources that is material to an investor in our securities.
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Seasonality
Our operating results and operating cash flows have not historically been subject to seasonal variations, however, the first quarter is usually the slowest quarter because fewer projects are undertaken during and around the Chinese spring festival.
Significant Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States ("U.S. GAAP") requires our management to make assumptions, estimates and judgments that affect the amounts reported, including the notes thereto, and related disclosures of commitments and contingencies, if any. We have identified certain accounting policies that are significant to the preparation of our financial statements. These accounting policies are important for an understanding of our financial condition and results of operation. Critical accounting policies are those that are most important to the portrayal of our financial conditions and results of operations and require management's difficult, subjective, or complex judgment, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. Certain accounting estimates are particularly sensitive because of their significance to financial statements and because of the possibility that future events affecting the estimate may differ significantly from management's current judgments. We believe the following critical accounting policies involve the most significant estimates and judgments used in the preparation of our financial statements:
Revenue Recognition
Retail sales are recognized at the point of sale to customers, are recorded net of estimated returns, and exclude VAT. Wholesales to contracted customers are recognized as revenue at the time the product is shipped and title passes to the customer FOB shipping point.
Use of Estimates
The preparation of consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the amount of revenues and expenses during the reporting periods. Significant items subject to such estimates and assumptions include revenues; the allowance for doubtful receivables; recoverability of the carrying amount of inventory; fair values of financial instruments; and the assessment of deferred tax assets or liabilities. These estimates are often based on complex judgments and assumptions that management believes to be reasonable but are inherently uncertain and unpredictable. Actual results could differ from these estimates.
Accounts Receivable
Accounts receivable consists of unpaid balances due from wholesale customers. Such balances generally are cleared in the subsequent month when the wholesale customers place another order. We do not provide an allowance for doubtful accounts because we have not experienced any credit losses in collecting these amounts from whole-sale customers.
Impairment of Long-Lived Assets
We account for impairment of property and equipment and amortizable intangible assets in accordance with ASC 360, "Accounting for Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of", which requires us to evaluate a long-lived asset for recoverability when there is event or circumstance that indicate the carrying value of the asset may not be recoverable. An impairment loss is recognized when the carrying amount of a long-lived asset or asset group is not recoverable (when carrying amount exceeds the gross, undiscounted cash flows from use and disposition) and is measured as the excess of the carrying amount over the asset's (or asset group's) fair value. There was no impairment of long-lived assets for the period ended June 30, 2012 or the period ended June 30, 2011 .
Inventories
Merchandise inventories are stated at the lower of cost or market. Cost is determined on a weighted average basis and includes all expenditures incurred in bringing the goods to the point of sale and putting them in a salable condition. In assessing the ultimate realization of inventories, the management makes judgments as to future demand requirements compared to current or committed inventory levels. Our inventory requirements generally increase as our projected demand requirements or decrease due to market conditions and product life cycle changes. We estimate the demand requirements based on market conditions, sales contracts and orders in hand.
In addition, we estimate net realizable value based on intended use, current market value and inventory ageing analyses. We write down inventories for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventories and their estimated net realizable value based upon assumptions about future demand and market conditions. Historically, the actual net realizable value has been close to management's estimate.
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Comprehensive Income
We have adopted the provisions of ASC 220 "Reporting Comprehensive Income," which establishes standards for the reporting and display of comprehensive income, its components and accumulated balances in a full set of general purpose financial statements.
ASC 220 defines comprehensive income as comprised of net income and all changes to the statements of stockholders' equity, except those due to investments by stockholders, changes in paid-in capital and distributions to stockholders, including adjustments to minimum pension liabilities, accumulated foreign currency translation, and unrealized gains or losses on marketable securities. Our other comprehensive income decreased from the effect of foreign currency translation adjustments were $42,747 and $779,449 for six months ended June 30, 2012 and June 30, 2011 , and $402,245 and $1,068,105 for three months ended June 30,2012 and June 30,2011respectively and are included in the consolidated statement of operation and comprehensive income.
In June 2011 , the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update (ASU) No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This guidance improves the comparability, consistency and transparency of financial reporting and increases the prominence of items reported in other comprehensive income. The guidance provided by this update becomes effective for annual periods beginning on or after December 15, 2011 and interim and annual periods thereafter. These changes become effective for the Company on January 1, 2012 . Other than the change in presentation, management has determined that the adoption of these changes will not have a material impact on the Company's Consolidated Financial Statements.
Foreign Currency Translation/Transactions
The reporting currency of the Company is the U.S. dollar. The functional currency of the Company's PRC subsidiaries is the Renminbi (RMB). Assets and liabilities of non-U.S. subsidiaries that operate in a local currency environment, where that local currency is the functional currency, are translated into U.S. dollars at exchange rates in effect at the balance sheet date; with the resulting translation adjustments directly recorded to a separate component of accumulated other comprehensive income. Income and expense accounts are translated at average exchange rates during the period.
Transactions denominated in currencies other than the functional currency are translated into the functional currency. The resulting exchange differences are included in the determination of net income of the consolidated financial statements for the respective periods.
The balance sheet amounts at June 30, 2012 , with the exception of shareholders' equity, were translated at the exchange rate of 6.3143 RMB to the U.S. $1.00 compared to the exchange rate of 6.3585 RMB to the U.S. $1.00 at December 31, 2011 . The equity accounts were stated at their historical exchange rates. The average translation rates applied to the income and cash flow statement amounts for the six months ended June 30, 2012 and 2011 was 6.3141 RMB and RMB 6.5488 to the U.S. $1.00 , respectively.
Translation adjustments resulting from this process are included in "accumulated other comprehensive income" in the consolidated statement of stockholders' equity and were $4,522,141 and $4,119,896 as of June 30, 2012 and December 31, 2011 , respectively.
Foreign Currency Exchange Rates
All of our revenues are collected in and substantially all of our expenses are paid in Chinese RMB. We face foreign currency rate translation risks when our results are translated to U.S. dollars. The registered equity capital denominated in the functional currency is translated at the historical rate of exchange at the time of capital contribution.
The Chinese RMB was relatively stable against the U.S. dollar at approximately 8.28 RMB to the $1.00 U.S. dollar until July 21, 2005 when the Chinese currency regime was altered resulting in a 2.1% revaluation versus the U.S. dollar. This move initially had the effect of pegging the exchange rate of the RMB at 8.11 RMB per U.S. dollar. Now the RMB exchange rate is no longer linked to the U.S. dollar but rather to a basket of currencies with a 0.3% margin of fluctuation resulting in further appreciation of the RMB against the U.S. dollar. Since June 30, 2009 , the exchange rate had remained stable at 6.8307 RMB to 1.00 U.S. dollar until June 30, 2010 when the Chinese Central Bank allowed a further appreciation of the RMB by 0.43% to 6.798 RMB to 1.00 U.S. dollar . On June 30, 2012 , the RMB traded at 6.3143 to the U.S. dollar. There remains international pressure on the Chinese government to adopt an even more flexible currency policy and the exchange rate of RMB is subject to changes in China's government policies which are, to a large extent, dependent on the economic and political development both internationally and locally and the demand and supply of RMB in the domestic market. There can be no assurance that such exchange rate will continue to remain stable in the future amongst the volatility of currencies, globalization and the unstable economies in recent years. Since (i) our income and profit are denominated in RMB, and (ii) the payment of dividends, if any, will be in U.S. dollars, any decrease in the value of the RMB against other foreign currencies would adversely affect the value of the shares and dividends payable to shareholders, in foreign currency terms.
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Commodity Prices
We are generally exposed to commodity price swings. Although there is no guaranteed correlation, steel wire prices generally fluctuate with steel prices, but the differential between market prices of steel billet and steel wire also fluctuates. Although we generally hold inventory for the duration of our 24-hour production cycle, sudden changes in the market price of steel and wire may directly impact the valuation of inventory and goods in progress, which influences earnings. So long as the market price differential between billets and wire does not shrink disproportionally, rising steel prices generally work in our favor as inventory purchased at lower prices would appreciate in such a scenario, resulting in additional profits when the wire is sold.
OPERATING RISKS
Country risk Currently, the Company's revenues are primarily derived from the sale of steel wire to customers in the People's Republic of China ("PRC"). The Company hopes to expand its operations to other countries, however, such expansion has not commenced and there is no assurance that the Company will be able to achieve such expansion. Therefore, a downturn or stagnation in the economic environment of the PRC could have a material adverse effect on the Company's financial condition.
Products risk In addition to competing with other manufacturers of steel wires, the Company competes with larger PRC companies which have greater funds available for expansion, marketing, research and development and the ability to attract more qualified personnel. These PRC companies may be able to offer products at a lower price. There can be no assurance the Company will remain competitive should this occur.
Exchange risk The Company cannot guarantee that the Renminbi - U.S. Dollar exchange rate will remain steady, therefore the Company could post the same profit for two comparable periods based on Renminbi and post higher or lower profit in U.S. Dollars depending on this exchange rate. The exchange rate could fluctuate depending on changes in the political and economic environments without notice.
Political risk Currently, the PRC is in a period of growth and is openly promoting business development in order to bring more business into the PRC. Additionally, the PRC currently allows a Chinese corporation to be owned by a United States corporation. If the laws or regulations relating to ownership of a Chinese corporation are changed by the PRC government, the Company's ability to operate the PRC subsidiaries could be affected.
Interest risk The Company is exposed to interest rate risk arising from short-term variable rate borrowings from time to time. The Company's future interest expense will fluctuate in line with any change in borrowing rates. The Company does not have any derivative financial instruments as of June 30, 2011 and believes its exposure to interest rate risk is not material.
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4kids
all jmo
10/5/07 -- there are no coincidences here ...
oh and like many other longs .. not selling at this level --
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