10-K 1 chinaindustrial10k123112.htm chinaindustrial10k123112.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549



FORM 10-K
 


 (Mark One)                                                       

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

For the fiscal year ended December 31, 2012
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ___________to __________

Commission file number 333-172135

CHINA INDUSTRIAL STEEL INC.
(Exact name of registrant as specified in its charter)

Maryland
 
27-1847645
State or other jurisdiction of
Incorporation or organization
 
(I.R.S. Employer
Identification No.)


 
110 Wall Street, 11th Floor, New York, NY
 
 
10005
(Address of principal executive offices)
 
(Zip Code)
                                                                                                                                         
Registrant’s telephone number, including area code: (646) 328 1502

Securities registered pursuant to Section 12(b) of the Act: None
 
Securities registered pursuant to section 12(g) of the Act:
 
Common Stock, par value $0.0001
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.          o Yes                x No
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.     o Yes                 x No
 
Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections.
 
 
 

 
 
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.   x Yes   ¨ 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 such shorter period that the registrant was required to submit and post such files).    x  Yes  ¨  No
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   x
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer  ¨  
Accelerated filer ¨
Non-accelerated filer    x  (Do not check if a smaller reporting company) 
Smaller reporting company ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). o Yes x No

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter.
 
Note.—If a determination as to whether a particular person or entity is an affiliate cannot be made without involving unreasonable effort and expense, the aggregate market value of the common stock held by non-affiliates may be calculated on the basis of assumptions reasonable under the circumstances, provided that the assumptions are set forth in this Form.
 
As of June 30, 2012, there had been no trading in the registrant’s common equity.
 
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
 
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
 
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    ¨ Yes  ¨ No
 
The number of shares of common stock outstanding as of March 29, 2013 is 73,620,391.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
List hereunder the following documents if incorporated by reference and the Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is incorporated: (1) Any annual report to security holders; (2) Any proxy or information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or (c) under the Securities Act of 1933. The listed documents should be clearly described for identification purposes (e.g., annual report to security holders for fiscal year ended December 24, 1980).
 
 
 

 
 
Table of Contents
 
  
 
Page
     
PART I
     
Item 1.
4
     
Item 1A.
16
     
Item 1B.
29
     
Item 2.
29
     
Item 3.
29
     
Item 4.
29
     
PART II
     
Item 5.
30
     
Item 6.
31
     
Item 7.
32
     
Item 7A.
44
     
Item 8.
44
     
Item 9.
45
     
Item 9A.
45
     
Item 9B.
46
     
PART III
     
Item 10.
47
     
Item 11.
50
     
Item 12.
52
     
Item 13.
53
     
Item 14.
56
     
PART IV
   
57
Item 15.
 

 
Cautionary Statement Regarding Forward Looking Statements
 
The discussion contained in this Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the United States Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the United States Securities Exchange Act of 1934, as amended, or the Exchange Act. Any statements about our expectations, beliefs, plans, objectives, assumptions or future events or performance are not historical facts and may be forward-looking. These statements are often, but not always, made through the use of words or phrases like “anticipate,” “estimate,” “plans,” “projects,” “continuing,” “ongoing,” “target,” “expects,” “management believes,” “we believe,” “we intend,” “we may,” “we will,” “we should,” “we seek,” “we plan,” the negative of those terms, and similar words or phrases.     We base these forward-looking statements on our expectations, assumptions, estimates and projections about our business and the industry in which we operate as of the date of this Form 10-K. These forward-looking statements are subject to a number of risks and uncertainties that cannot be predicted, quantified or controlled and that could cause actual results to differ materially from those set forth in, contemplated by, or underlying the forward-looking statements. Statements in this Form 10-K describe factors, among others, that could contribute to or cause these differences. Actual results may vary materially from those anticipated, estimated, projected or expected should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect. Because the factors discussed in this Form 10-K could cause actual results or outcomes to differ materially from those expressed in any forward-looking statement made by us or on our behalf, you should not place undue reliance on any such forward-looking statement. New factors emerge from time to time, and it is not possible for us to predict which will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statement. Except as required by law, we undertake no obligation to publicly revise our forward-looking statements to reflect events or circumstances that arise after the date of this Form 10-K or the date of documents incorporated by reference herein that include forward-looking statements.
 
PART I
 
Item 1. 
Business
 
Except as otherwise indicated by the context, references in this Annual Report to “we”, “us”, “our” or the “Company” are to the consolidated businesses of China Industrial Steel Inc.. and its wholly-owned direct and indirect subsidiaries and variable interest entity (“VIE”), except that references to “our Common Stock”, “our shares of Common Stock” or “our capital stock” or similar terms shall refer to the common stock, par value $0.0001 per share, of China Industrial Steel Inc., a Maryland corporation (“CIS” or the “Registrant”).  “China” or “PRC” refers to the People’s Republic of China.  References to “RMB” refer to the Chinese Renminbi, the currency of the primary economic environment in which the Company operates.
  
Business Overview
 
China Industrial Steel Inc. (“CIS”) is a holding company that, through its wholly-owned Chinese subsidiary and its VIE, produces and sells steel plate, bar/wire and billet in China. The Company currently has an aggregate of 2.3 million metric tons of steel making capacity and 2 million metric tons of steel rolling production capacity (including steel plate and steel wire/bar production) in the facilities on approximately 1,000 acres in Handan city in Hebei province, PRC.
 
The Company serves various industries and produces a variety of steel products, including steel billet, steel plate, and steel wire/bar.  Our products are typically used in construction, equipment manufacturing and infrastructure projects. Steel billet is also occasionally sold to end users to develop into plates and bars.
 
Our principal executive offices are located at 110 Wall Street – 11th Floor, New York, NY, 10005 and our U.S. telephone number is (646) 328-1502 and the telephone number at our production facility in the PRC is (86)-310-5919498.
 
Corporate History
 
CIS was incorporated on January 27, 2010 under the laws of the State of Maryland. On February 5, 2010, CIS formed a wholly-owned subsidiary, Northern Steel Inc. (“Northern”), under the laws of the State of Colorado to facilitate the Company’s operations in China.
 
On July 15, 2010, Northern formed its wholly owned foreign enterprise in Handan city, Hebei province, China, Nuosen (Handan) Trading Co., Ltd (“Nuosen”), under the laws of China. Nuosen is a management company to manage operations in China.
 
Handan Hongri Metallurgy Co., Ltd. (“Hongri”) is a Chinese company located in Handan city, Hebei province, China. Hongri was incorporated under the Chinese laws and the approval of Commerce Bureau of Handan Municipal Government on March 7, 2007, with a registered capital of RMB 90,489,999 (approximately $12 million at historical exchange rate). Hongri is primarily engaged in the business of manufacturing and selling steel plate, steel wire/bar and steel billet for domestic customers and certain related parties.
 
 
Hebei Wu’an Yuanbaoshan Industry Group Co., Ltd (“YBS Group”) is an enterprise incorporated in Hebei province, China. YBS Group owns 70% equity interest of Hongri.
 
Fakei Investment (Hong Kong) Ltd (“Fakei”) is an enterprise incorporated in Hong Kong. Fakei owns 30% equity interest of Hongri.
 
On August 1, 2010, CIS, through Northern and its wholly owned foreign enterprise, Nuosen, entered into an Entrusted Management Agreement, an Exclusive Option Agreement, and a Covenants Agreement (collectively, the “Entrusted Agreements”) with Hongri and shareholders of Hongri, YBS Group and Fakei. The effect of the Entrusted Agreements is to cede control of management and economic benefits of Hongri to Nuosen. As consideration, CIS issued 44,083,529 restricted shares of its common stock, par value $0.0001, to Karen Prudente, a nominee and trustee for the shareholders of YBS Group entering into the Entrusted Agreements with Nuosen. CIS also issued 17,493,463 restricted shares of its common stock to the shareholders of Fakei in consideration of Fakei entering into the Entrusted Agreements with Nuosen.
 
The Entrusted Agreements empower CIS, through Northern and Nuosen, with the ability to control and substantially influence Hongri’s daily operations and financial affairs, appoint its senior executives and approve all matters requiring shareholders’ approval. As a result of these Entrusted Agreements, which obligate CIS to absorb a majority of expected losses of Hongri and enable CIS to receive a majority of expected residual returns from Hongri and because CIS has the power to direct the activities of Hongri that most significantly impact Hongri’s economic performance. CIS, through its wholly-owned subsidiaries, accounts for Hongri as its VIE under ASC 810-10-05-8A. Accordingly, CIS consolidates Hongri’s operating results, assets and liabilities.
 
On August 10, 2010, Mr. Shenghong Liu, the Chairman of the Board of Directors and one of the shareholders of YBS Group and several other shareholders of YBS Group (each of them, a “Purchaser”) entered into a series of Call Option Agreements (collectively, the “Call Option Agreements”), with the majority shareholder, Karen Prudente, pursuant to which they are entitled to purchase up to 100% of the issued and outstanding shares from Karen Prudente at a price of $0.0001 per 100 shares for a period of five years as outlined in the Call Option Agreements: the option may be exercised, in whole or in part, in accordance with the following schedule: 34% of the option shares subject to the option shall vest and become exercisable on January 1, 2012; 33% of the option shares subject to the option shall vest and become exercisable on January 1, 2013 and 33% of the option shares subject to the option shall vest and become exercisable on January 1, 2014. The shareholders have not exercised the option as of the date of this report. According to the above mentioned Call Option Agreements, Karen Prudente would transfer all restricted shares of the Company’s common stock that she received to the shareholders of YBS Group subject to the terms and conditions thereunder and entrust the shareholders of YBS Group with her voting rights in the Company. 
 
For accounting purposes, the above transactions were accounted for in a manner similar to a reverse merger or recapitalization, since the former equity shareholders of Hongri now effectively control a majority of CIS’ common stock immediately following the transactions. Consequently, the assets and liabilities and historical operations reflected in the consolidated financial statements prior to the transactions are those of Hongri and are recorded at the historical cost of Hongri, and the consolidated financial statements after completion of the transactions include the assets and liabilities of CIS, Northern, Nuosen, and Hongri (collectively, the “Company”), historical operations of Hongri, and operations of CIS, Northern, Nuosen and Hongri from the date of the transaction.
 
 
Corporate Structure
 
The following diagram sets forth the current corporate structure of the Company:
 
 
 
* Hebei Wu’an Yuanbaoshan Industry Group Co., Ltd. and Fakei Investment (Hongkong) Limited own 44,083,529 and 17,493,463, respectively, of our shares.
  
 
None of CIS, Northern and Nuosen has any operations or plans to have any operations in the future other than acting as a holding company and management company for Hongri and raising capital for its operations. However, we reserve the right to change our operating plans regarding CIS, Northern and Nuosen.
 
Our Business
 
The Company currently has an aggregate of 2.3 million metric tons of steel making capacity and 2 million metric tons of steel rolling production capacity, including steel plate and steel wire/bar. It operates from its facilities on approximately 1,000 acres in Handan cty in Hebei province. Hebei is one of China’s leading steel producing provinces, and steel production is a significant component of the regional economy.  The Company’s business model relies on a lean infrastructure with a strong focus on production.  Functions outside of manufacturing are outsourced to third parties, including related parties, enabling us to remain profitable in a highly competitive market.
 
The Company serves various industries and produces a variety of steel products including: steel billet, steel plate and steel bar/wire. While the vast majority of our sales are made to distributors and traders, our products are typically used in construction, equipment manufacturing, and infrastructure projects.  Steel billet is also occasionally sold to end users to develop into plates and bars.
 
Manufacturing Process
 
Steel is an alloy consisting mostly of iron, with carbon content between 0.2% and 2.1% by weight, depending on the grade.  Carbon is the most cost-effective alloying material for iron, but various other alloying elements are also used such, as manganese, chromium, vanadium, and tungsten.  These elements act as a hardening agent for the steel and by varying the amount and form (i.e., solute, precipitate) of these alloying elements in the steel, manufacturers can control certain qualities such as the hardness, ductility, and tensile strength of the resulting steel.
 
Making steel is essentially a three-phase process as illustrated in the following diagram.  We possess one steel-making production line and three steel-rolling production line.
 
 
 
 
 
There are two processes in the Company’s production. The first production process is steel making, which transforms iron to steel for further fabrication. At this stage, impurities such as sulfur, phosphorus, and excess carbon are removed from the raw iron, and alloying elements such as manganese, nickel, chromium and vanadium are added to produce specific types of steel. Upon completion of the process, the iron becomes steel billet, a cast semi-finished product, which can then be formed into steel coil, medium plate or bar.  The Company completed construction of steel production phase II in 2009. Total steel-making capacity was increased to 2.3 million tons in 2009 from 1.3 million tons in 2008. Total production of steel-making to total capacity utilization rate was approximately 55%, 67%, 47% and 90% in 2012, 2011, 2010 and 2009, respectively.
 
The second production process is called steel rolling, which uses hot rolling technology to produce steel plate and bar/wire using the end products of our first production process.  The facilities produce thin, flat sheets that are used in metalworking, and can be cut and bent into a variety of different shapes.  The Company’s medium plate line produce carbon element structural armor plate, high quality carbon element structural armor plate, low alloy structural armor plate, shipbuilding armor plate, boiler armor plate, pressure vessel plate, automotive frame plate, automotive frame plate and pipeline steel. The second plate production line was added in 2009. Steel plate production capacity was increased to 1,400,000 tons per year in 2009 from 600,000 tons per year in 2008. In addition, the construction of a new 600,000 ton steel bar production line was completed in 2009 and was further modified to produce steel wire in 2011. Total annual steel rolling capacity including steel plate and steel bar/wire production is 2 million tons. Total production of steel rolling to total capacity utilization rate was approximately 55%, 49%, 44% and 58% in 2012, 2011, 2010 and 2009, respectively.
 
The Company added a new 600,000 ton steel wire production line and commenced production in January 2013. The Company is currently seeking capital to supplement the funding of further expansion and diversifying of production and processing capacity to adapt to market demand.   
 
Products
 
Products are typically categorized as low-end (long products such as pipes, tubes, wires and rods) and high end (flat products such as hot-rolled steel or cold-rolled steel strips). The Company produces a limited number of high-end steel products which are used in a broad variety of manufacturing and industrial applications.  Each application requires specific criteria in order to optimize the end product.  The Company works carefully with its customers and distributors to determine the proper makeup and form of the steel that will satisfy their needs.
 
Following is an overview of the products that the Company currently manufactures.
 
Steel Billet
 
Steel billet is the basic material for many steel-based products.  Made by molding molten liquid, and are later exposed to extremely low temperatures to allow the metal to take shape and solidify in chemical structure. The temperature manipulates the metal’s physical properties, and tones its strength and durability. Steel billet has distinct characteristics as compared with already furnished steel bar and products. Steel billet has a specific grain structure, which enables the metal to be processed more intricately.  The Company has one steel billet production line, which can produce 2.3 million tons per year.
 
Hot Rolled Steel Plate
 
Steel plate is made by hot-rolling steel from either semi-finished slabs or directly from steel billet into rectangular shapes or coils. The Company’s facilities can produce steel plate from a variety of steel in several different strength grades.
 
Hot Rolled Steel Bar (including high-speed wire)

Steel bar is commonly used as a tensioning device in reinforced concrete and reinforced masonry structures holding the concrete in compression, and given ridges or buildings for better mechanical anchoring into the concrete. Steel bar is a kind of building material with is used most. The Company has one steel bar production line, which can produce 0.6 million tons steel bar or 0.4 million tons high-speed wires per year.

Reinforcing Steel
 
Reinforced concrete was created based on the principle that by adding a material to concrete it would be sounder structurally.  Steel is the best material for reinforcing concrete because the properties of expansion for both steel and concrete are approximately the same; that is, under normal conditions, they will expand and contract at an almost equal rate. For this reason, reinforcing steel is widely used in the construction industry.
 
 
However, because the quality of reinforcing steel has direct effect on a construction project’s quality and safety, the China National Development and Reform Commission limits the number of production permits for reinforcing steel to qualified manufacturers. The Company is one of only two permitted steel makers in Handan city.
 
Pricing Model
 
The Company generally sets prices for its customers on a month by month basis.  Pricing is adjusted continually based on an evaluation of local steel market prices.
 
Industry Overview
 
China is the world’s largest steel producing country, responsible for over one-third of the global supply of steel. Steel production has been, and continues to be an integral part of China’s economic growth.  Historically, much of China’s steel production was tagged for export to more industrial nations such as the United States.  As with many other low value-added, labor-intensive sectors, China was successful in establishing a prominent position in the global steel market by pegging its currency, providing cheap labor through state-subsidized operations, and ignoring the impact of its manufacturers’ emission on the environment.  Privately run manufacturers were further subsidized through value added tax rebates on steel exports.
 
While these tactics served the nation’s economy well, during the past decade, several trends were established which have caused the government to revise its policies.  First, on the domestic front, as China continues to build infrastructure and move toward a consumer-driven economy, domestic demand for steel has grown substantially.  Conversely, because China focused the vast majority of its resources on being the low-cost provider, its development of high precision/ high technology products and modern manufacturing facilities lagged other industry participants.
 
As China increases its presence on the world stage, its policies with regard to worker’s rights and environmental impact are increasingly garnering comment from the rest of the world.  Further, as the effects of the global financial crisis maintain a stranglehold on most of the world’s “modern” economies, China faces increasing pressure to eliminate some of the subsidies and artificial restraints implemented by the central government.
 
 
Recent Government Initiatives
 
In its efforts to maximize economic growth and minimize global criticism, the Chinese government has taken several measures to modify its fragmented steel industry.
 
With an estimated 1,000 mills throughout the country, China’s steel manufacturing sector was initially dominated by state-owned enterprises.  However, the substantial demand and potential for profit resulted in numerous private steel makers, some of which grew to a sizable scale but with many smaller independent facilities.  In an effort to eliminate obsolete and inefficient producers, in May of 2010, the central government established a detailed set of guidelines with regard to the operation of existing plants including energy usage, plant emissions and production levels.  The guidelines also prohibit local governments from approving projects that increase steel production capacity before the end of 2012. More specifically, the guidelines propose new capacity levels for iron-making and steel-making projects, and do not apply to steel processing projects. Accordingly, since we do not have any investments in new or expanded iron-making or steel-making projects, these guidelines are anticipated to have no impact on our business development.  
 
While this is seen by some as an attempt to appease the international community and facilitate the modernization of China’s steel industry, the PRC has had only limited success with previous attempts to implement policy to curb expansion in this sector.  This is largely a result of the nature of China’s steel industry, where about half of the steel production capacity is privately controlled.  Provincial governments have not been aggressive in enforcing the new guidelines as steel production provides substantial economic benefit to regional communities, in the way of tax revenue and job creation.
 
These policies have also been undermined by the success of the country’s overall stimulus efforts.  The government’s direct investment in infrastructure has resulted in the startup of numerous projects, many of which rely on a ready supply of steel suitable for all levels of construction.
 
However, more recently, the PRC government implemented broad, temporary shutdowns in particular geographic markets, including Hebei.  While unpopular with manufacturers in the short run, it did have several positive effects.  It reduced steel supply, thus strengthening pricing, while decreasing demand for raw materials, specifically weakening the pricing strength of leading iron ore suppliers.  Smaller firms that were unable to sustain their operation through the shutdowns were closed.
 
Government Regulation
 
According to the Decision regarding Investment System Reform, promulgated by the State Council, on July 16, 2004, the Foreign Invested Project Approval Administration Interim Regulations, promulgated by the State Development and Reform Commission on October 9, 2004, and Hebei Province Foreign Invested Project Approval Administration Interim Regulations, promulgated by the Development and Reform Commission of Hebei province on November 19, 2004, foreign invested projects of encouraged and permitted items with total investment of no more than  $50 million shall be approved by the Development and Reform Department at municipal level, and total investment of no more than $100 million at provincial level.

On May 4, 2010, the State Development and Reform Commission issued the Circular Concerning Lowering the Approval Level of Foreign Investment Projects, foreign invested projects of encouraged and permitted items with total investment no more than $300 million can be approved by provincial authority.
 
According to the Foreign Investment Industry Guide Catalogue, promulgated by the State Development and Reform Commission and the Ministry of Commerce, revised in 2004 and 2007, steel-making and steel-rolling, the main business of the Company, are permitted items.
 
On March 5, 2007, 600,000 tons medium-thickness steel plate project of the Company was approved by the Development and Reform Commission of Wu’an city. The Development and Reform Commission of Wu’an city also approved the application of the Company to add steel-making into its business scope on April 17, 2009.
 
Environmental Regulation Compliance
 
The Company takes its environmental responsibilities very seriously and works to minimize the impact of each of itsfacilities on the environment.  Before starting each of its operations or any other relevant construction project, it must secure approval from the Environment Protection Bureau of Hebei province.  It must also secure a final approval once construction is completed before the operation commences.
 
The Company anticipates the cost to comply with environmental regulations to be approximately $850,000, which would entail primarily management expenses.
 
 
All PRC enterprises in the iron and steel industry are required to obtain from various PRC governmental authorities certain permits and licenses, including, without limitation, a business license, a pollution emission license and a National Industrial Product Manufacture License and filing and approval for the production capacity of fixed asset investments. If the Company does not comply with these environmental regulations, or any failure by the Company to obtain or renew the filings, licenses, permits and approvals may have an adverse effect on the operations of the Company’s business. Further, the Company's consolidated business and operating results could be materially and adversely affected if its operating subsidiaries were required to increase expenditures to comply with any new environmental regulations affecting their operations.
 
The Company is also required to conduct an environmental impact assessment and file such assessment with the local government, as well as to obtain the approval of construction project environment protection completion acceptance from Environmental Protection Bureau of Hebei province for the production lines. The Company intends to obtain and apply for the environmental impact assessment and application for construction project environment protection completion acceptance for its production lines. Any failure by the Company to make the filing and obtain the approval for environmental impact assessment may subject the Company to a fine of approximately RMB 50,000 to RMB 200,000 and any failure by the Company to obtain the approval of construction project environment protection completion acceptance may subject the Company to halt the operation or production and a fine up to RMB 100,000, and as a result may have a material adverse effect on the Company’s production and business.
 
Currently, the Management is not aware of any investigations, prosecutions, disputes, claims or other proceedings in respect of environmental protection and our cold-rolled mills produce no impermissible emissions.  The pickling process is outsourced to a local company which is wholly-responsible for any failure to comply with applicable law.
 
Market Demand
 
China’s steel industrial sector is facing over capacity and high debt to equity ratio issues. The domestic market demand for steel fell in 2012 as investment in infrastructure and industrial production slowed down. During 2012, the prices of both raw material and finished steel products moved towards to lower points. According to Association of Chinese Steel Industry, steel manufactures Chinese comprehensive price index of steel products (“CSPI”), an index combining various price of steel products and an economic indicator of market demand for steel products, was decreasing continuously from the beginning of 2012. On December 31, 2012, CSPI was 105.31, a decrease of 13% compared to 120.45 on December 31, 2011.

However, the Chinese steel industry continues to experience solid fundamental trends and favorable supply and demand dynamics. In addition to the overall improvement in China’s economy, the increased demand for steel results from several trends within the overall economy:
 
China’s real estate sector has been very instrumental in the growth of domestic steel demand. In 2012, the investment in real estate increased 14.9% compared to 2011 and housing sales increased 1.8% compared to 2011. While housing sales have weakened currently, the real estate sector and its growth will continuously generate demand to steel industrial since China is still in early phase of urbanization.
 
China’s auto sales continue to increase, despite the financial crisis, due to improving consumer confidence as well as the purchase tax reduction and higher auto replacement subsidy introduced by the government.
 
China’s total steel production for year 2013 is projected at 750 million tons, while the growth rate is expected to be 4.7%, higher than the 3.6% seen in 2012. Steel exports for 2012 were 55.8 million tons, compared to 48.91 million tons in 2011.  For the first two months of year 2013, China’s total production was 158 million tons, an increase of 14.2% in volume compared to the same period of 2012. 
 
Competitive Environment
 
World-renown steel producers such as Shanghai Baosteel Group and Magang Group Holding Company Limited concentrate on the production of crude steel and hot-rolled steel from iron ore imported from Brazil and Australia. Hot-rolled steel coils produced by these steelmakers are then supplied as raw materials to high precision steel manufacturers, such as the Company, for further cold processing to meet specific market demand.
 
Within the regional Handan area, there are currently more than 40 steel manufacturers. The Company is one of the major steel manufacturers in Wu’an city, Hebei province. The local steel manufacturers can be characterized into five groups, as follows.
 
Industry Leaders -- These firms incorporate advanced production technologies and sophisticated management teams.  Regional manufacturers in this division include Handan Iron and Steel Group Co., Ltd, Xin Xing Ductile Iron Pipe Co., Ltd, and Tian Tie Group, each of which has substantial production capacity.
 
High End Producers -- Companies in this group integrate iron making, steel making and rolling, to produce high-end products including, billet, hot rolled plate, and hot rolled strips, and have strong production capacity.  High end producers include the Company, Wen Feng Iron and Steel Co., Ltd., and Zongheng Iron and Steel Co., Ltd.
 
 
Mid-Level “Country” Producers -- These firms produce low-end billet, steel and iron.  They have ample capacity, however the quality of their products are relatively low. Companies in this group include Puyang Iron and Steel Co., Ltd. and Dongshan metallurgy Industry Co., Ltd.
 
Independent/Private Producers – These enterprises tend to be small and low tech, and include iron-smelting, rebar, round bar steel, ribbon steel and section steel, such as Wen An Iron and Steel Co., Ltd and Wu An Bao Feng Iron and Steel Co., Ltd
 
Proprietary/Specialized There is only one specialized manufacturer in Handan – Xinxing Ductile Pipes co., Ltdwhich produces ductile iron pipe and ductile iron fittings.
 
The Company mainly competes with other high-end producers within its local market. The management believes that the Company is well positioned within the sector to sustain considerable growth going forward.  Following is a brief discussion of our strengths within the overall sector and its regional market.
 
Hebei province is the biggest iron and steel manufacturing province in China, accounting for an estimated 60% of the PRCs total production capacity, and within the province, Handan and Wu'an (where our facilities are located) are the most important regions.  Management believes there are numerous advantages to be gained as a result of being headquartered in Hebei.
 
“Brand Name” Recognition – Hebei is associated with steel production, and as such attracts customers, management, labor and financing resources interested in the sector.
 
Competitive Cluster – Steel manufacturers and related companies located in Hebei are quick to hear about new strategies and innovations of their counterparts, in addition to getting feedback on their own products.
 
Strong Alliances Related Parties – A common shareholder has resulted in us developing an excellent working relationship with YBS Group, one of biggest iron makers in local market.
 
Specifically within the Company's market -- ultra-thin cold-rolled precision steel, the other regional manufacturer is Qinghuangdao Longteng Precision Strip Co., Limited, or Longteng. However, Longteng’s production capabilities are currently for cold-rolled steel with widths of approximately 400 mm, whereas our mills can provide widths of 1000 mm to 1400 mm (with a 1450 mm line in planning).  Consequently, Longteng’s products are largely sold in different segments and are not considered by management to be direct competition.
 
The Company utilizes product performance and pricing as its principal methods of competition.
 
Regarding production management, Hongri, as a non-state owned enterprise, has flexibility in its production and the management of production as compared to national enterprises. Generally, national steel companies manufacture their products on standard models. Hongri, however, develops, designs and manufactures products based on orders from our customers. Moreover, as Hongri offers various types of products, it can better satisfy the needs of our customers while also increasing the output of our products. The negative factors pertaining to its product performance is that it may encounter a higher level of difficulty in production coordination along with an increase in production costs due to its diverse product performance. However, Hongri diversified products also enable it to price high enough to absorb the increase in such costs.
 
Regarding pricing, Hongri has flexibility in pricing as a non-state owned enterprise, enabling us to adjust prices to adapt to market demands. The positive aspect of its pricing flexibility is that adjustments to pricing to meet market demands can increase the gross profit rate of products in good market conditions, while retaining customers using pricing advantages and favorable payment terms in bad market conditions. The negative aspect of Hongri’s pricing flexibility is that the increase of gross profit rates in good market conditions may result in the loss of customers, and favorable payment terms may increase financial costs to Hongri in bad market conditions for steel.
 
 
Raw Materials and Suppliers
 
The primary raw materials necessary for production of steel are iron ore and coal. Several larger steel manufacturers have vertically integrated their business to include a mining component within their operation.  The Company does not have any internal coal or iron mine resources, opting instead to purchase those raw materials from third parties with whom it has established relationships.  The Company’s raw materials are readily available in the market as there are more than twenty molten iron producers from which the Company can get its raw materials from.
 
For year ended December 31, 2012, 57% of the total purchase of the Company was from Hongrong Iron and Steel Co., Ltd. (“Hongrong”), part of the YBS Group, and 31% of the total purchase was from an unrelated party. For the year ended December 31, 2011 and 2010, the purchase from Hongrong was 98% and 94% of the total purchases, respectively. No purchase from other vendors was over 5% in 2011 and 2010. 

Sales and Marketing
 
The Company sold its products to various customers located in China. During 2012 and 2011, top ten customers accounted for 55.7% and 60.17% of total sales, respectively.

While the Company’s margins may be lowered by selling directly to the customers, this strategy requires a comparatively lower investment in overhead expenses (i.e., training, marketing and salaries) but will require the Company to take the market risk when there is a lack of demand. 
 
Dependence on One or a Few Customers
 
For the year ended December 31, 2012, there were two (2) major customers that accounted for approximately 20% and 18% of the Company’s total sales, respectively. For the year ended December 31, 2011, there were two (2) major customers that accounted for approximately 21% and 19% of the Company’s total sales, respectively. For the year ended December 31, 2010, there were two (2) major customers that accounted for approximately 18% and 10% of the Company’s total sales, respectively. 

The following table lists the Company’s top ten customers in 2012 and 2011.

   
Customers
 
2012
   
2011
 
1
 
Wu'an Yinli Materials Trade Co., Ltd.
   
20.49
%
   
18.89
%
2
 
Wu'an Junfa Materials Trade Co., Ltd.
   
18.05
%
   
21.29
%
3
 
Hebei Fushan Iron & Steel Trade Co., Ltd.
   
4.99
%
   
1.83
%
4
 
Tangshan Xindong Trade Co., Ltd.
   
2.58
%
   
*
 
5
 
Taian Zhiwei Trade Co., Ltd.
   
1.95
%
   
*
 
6
 
Wu'an Puxing Trade Co., Ltd.
   
1.69
%
   
*
 
7
 
Wu’an Hongbao Trade Co., Ltd.
   
1.53
%
   
*
 
8
 
Shanghai Jiali International Trading, Ltd
   
1.53
%
   
1.32
 %
9
 
Hebei Huachi Iron Steel Trade Co., Ltd
   
1.53
 %
   
 
10
 
Taian Dongfang Hengxin Materials Co., Ltd
   
1.36
%
   
*
 
   
Jizhong Energy Group International Materials Co., Ltd.
   
*
%
   
5.69
   
Hebei Wu'an Yuanbaoshan Industry Group Ltd.
   
*
%
   
2.53
%
   
Tanshan Xingyu Metal Trading Co., Ltd.
   
*
%
   
2.42
 %
   
Henan Rongtong Industrial Co., Ltd.
   
*
%
   
2.24
%
   
Handan Gangfeng Materials Co., Ltd.
   
*
%
   
2.11
 %
   
Shanghai Huachangyuan Industrial Investment Co., Ltd.
   
*
%
   
1.85
%
         
55.70
%
   
60.17
%

* Not in top ten list
 
The nature of China’s steel industry and the regional demand for high quality, cold-rolled steel, result in us having to do very little formal marketing.  The majority of new orders come from current customers reducing imports and new customers who are referred by trading agents or existing customers.  The company transacts a small portion of its sales directly to customers via the internet; however these orders are not consistent.  Looking forward, the Company is evaluating the feasibility of establishing an in-house distribution center to facilitate direct sales to certain end-users.
 
 
Manufacturing Facilities
 
Total steelmaking capacity of the Company was increased to 2.3 million metric tons in 2009 from 1.3 million tons in 2008. Total production of steelmaking to total capacity utilization rate was approximately 55%, 67%, 47% and 90% in 2012, 2011, 2010 and 2009, respectively. In addition to steel-making capacity, the Company has 2 million metric tons of steel-rolling capacities; 1.4 million metric tons in steel plate production and 0.6 million metric tons in steel bar/wire production. Total production of steel rolling to total capacity utilization rate was approximately 55%, 49%, 44% and 58% in 2012, 2011, 2010 and 2009, respectively. The Company added a new 600,000 ton steel wire production line and commenced production in January 2013.
 
   
Annual Capacity
   
Output (Tons)
 
Productions
 
(Tons)
   
2009
   
2010
   
2011
   
2012
 
Steel Making
     
2,300,000
     
1,323,345
     
1,069,783
     
1,543,032
     
1,268,460
 
                                           
Steel-Rolling
Plate Production
   
1,400,000
     
911,631
     
835,794
     
774,876
     
652,732
 
 
Bar Production (including steel wires production)
   
600,000
             
48,780
     
196,186
     
452,657
 
Cumulative Steel Rolling Production
     
2,000,000
     
911,631
     
884,574
     
971,062
     
1,105,389
 
 
Quality Control
 
The Company’s facilities conform to system standard GB/t 19001-2008/ISO 9001:2008.  The Company processes products in strict accordance with standard testing and substandard products are disposed of in strict accordance with the procedures to prevent the unintended use of unqualified products to ensure final product quality.
 
All key personnel regularly undergo further training to improve their skills to monitor the production process and maintain superior quality control.
 
Employees
 
As of March 29, 2013, Hongri employed a staff of 1,621, all of whom are full-time employees. The largest group is the production staff, as illustrated in the following table.
 
Employees breakdown
 
Department
 
Number of Employees
 
Steel Workshop
    154  
Continuous casting workshop
    218  
Power workshop
    157  
Electrical & Control workshop
    33  
Automation workshop
    10  
Oxygen making workshop
    58  
Back office
    128  
Control Laboratory
    32  
Quality Inspection Department
    27  
Security Department
    17  
Dispatch Department
    46  
Financial Department
    7  
Warehouse
    38  
Equipment management Department
    5  
Administrative Department
    35  
Machine repair workshop
    116  
Steel plate making workshop
    313  
Steel bar making workshop
    227  
Total Employees
    1621  
 
 
Hongri maintains good relations with its employees.
 
Hongri is required to contribute a portion of its employees' total salaries to the Chinese government's social insurance funds, including medical insurance and unemployment insurance and to purchase job injuries insurance for employees, in accordance with relevant regulations. The government's social insurance funds account for 10% of employees' total salaries, while job injuries insurance premiums are about RMB 50 (approximately US$7) per person. Hongri expects the amount of its contribution to the government's social insurance funds and the cost related to job injuries insurance to increase in the future as it expands its workforce and operations.

Item 1A. 
Risk Factors

This investment has a high degree of risk. Before you invest you should carefully consider the risks and uncertainties described below and the other information in this prospectus. If any of the following risks actually occur, our business, operating results and financial condition could be harmed and the value of our stock could go down. This means you could lose all or a part of your investment.
 
RISKS RELATED TO OUR BUSINESS
 
Steel consumption is cyclical and worldwide overcapacity in the steel industry and the availability of alternative products has resulted in intense competition, which may have an adverse effect on our profitability and cash flow.
 
Steel consumption is highly cyclical and generally follows general economic and industrial conditions both worldwide and in various smaller geographic areas. The steel industry has historically been characterized by excess world supply. This has led to substantial price decreases during periods of economic weakness, which have not been offset by commensurate price increases during periods of economic strength. Substitute materials are increasingly available for many steel products, which may further reduce demand for steel. Additional overcapacity or the use of alternative products could have a material adverse effect upon our results of operations.
 
Rapidly growing demand and supply in China and other developing economies may result in additional excess worldwide capacity and falling steel prices, which could adversely impact our results.
 
Over the last several years steel consumption in China and other developing economies such as India has increased at a rapid pace. Steel companies have responded by developing plans to rapidly increase steel production capability in these countries and entered into long-term contracts with iron ore suppliers in Australia and Brazil. Steel production, especially in China, has been expanding rapidly and could be in excess of Chinese demand depending on continuing growth rates. Because China is now the largest worldwide steel producer, any significant excess in Chinese capacity could have a major impact on domestic and international steel trade and prices.
 
The business of Hongri, our subsidiary, will suffer if it cannot obtain, maintain or renew necessary filings, approvals, permits or licenses.
 
All PRC enterprises in the iron and steel industry are required to obtain from various PRC governmental authorities certain permits and licenses, including, without limitation, a business license, a pollution emission license and a National Industrial Product Manufacture License and filing and approval for the production capacity of fixed asset investments.
 
These filings, approvals, permits and licenses are subject to periodic renewal and/or reassessment by the relevant PRC government authorities, and the standards of compliance required in relation thereto may from time to time be subject to change. Hongri intends to obtain and apply for renewal and/or reassessment of such filings, approvals, permits and licenses when required by applicable laws. However, we cannot assure you that Hongri can obtain, maintain or renew the filings, approvals, permits and licenses or accomplish the reassessment of such permits and licenses in a timely manner. Any changes in compliance standards, or any new laws or regulations that may prohibit or render it more restrictive for us to conduct Hongri's business or increase its compliance costs may adversely affect our operations or profitability. Any failure by Hongri to obtain, maintain or renew the filings, licenses, permits and approvals may have an adverse effect on the operation of Hongri's business.  
 
Hongri is also required to conduct an environmental impact assessment and file such assessment with the local government, as well as to obtain the approval of construction project environment protection completion acceptance from Environmental Protection Bureau of Hebei Province for the production lines. Hongri intends to obtain and apply for the environmental impact assessment and application for construction project environment protection completion acceptance for its production lines. We cannot assure you that Hongri can obtain the requisite approval for the environmental impact assessment and construction project environment protection completion acceptance in a timely manner.
 
 
Any failure by Hongri to make the filing and obtain the approval for environmental impact assessment may subject Hongri to a fine of approximately RMB 50,000 to RMB 200,000 and any failure by Hongri to obtain the approval of construction project environment protection completion acceptance may subject Hongri to halt the operation or production and a fine up to RMB 100,000, and as a result may have a material adverse effect on Hongri's production and business.
 
Environmental compliance and remediation could result in substantially increased capital requirements and operating costs.
 
Our operating subsidiary, Hongri, is subject to numerous Chinese provincial and local laws and regulations relating to the protection of the environment. These laws continue to evolve and are becoming increasingly stringent. The ultimate impact of complying with such laws and regulations is not always clearly known or determinable because regulations under some of these laws have not yet been promulgated or are undergoing revision. Our consolidated business and operating results could be materially and adversely affected if our operating subsidiaries were required to increase expenditures to comply with any new environmental regulations affecting its operations.
 
We may require additional capital in the future and we cannot assure that capital will be available on reasonable terms, if at all, or on terms that would not cause substantial dilution to stockholdings.
 
The development of high quality precision steel requires substantial funds. Sourcing external capital funds for product development and requisite capital expenditures are key factors that have and may in the future constrain our growth, production capability and profitability. To achieve the next phase of our corporate growth, increased production capacity, successful product development and additional external capital will be necessary. There can be no assurance that such capital will be available in sufficient amounts or on terms acceptable to us, if at all. Any sale of a substantial number of additional shares of common stock or securities convertible into common stock will cause dilution to the holders of our common stock and could also cause the market price of our common stock to decline.
 
Because we have entered into a significant number of related party transactions through the course of our routine business operations, there is a risk that we may not be able to control the valuation of such transactions, which could then adversely impact our profitability.
 
Hongri is 70% owned by YBS Group, who is a majority shareholder of some other steel production related companies, mainly Hongrong, Wu'an Baoye Coke Industrial Co. Ltd. (“Baoye”), Wu'an Yuanbaoshan Cement Plant, Wu'an Yuanbaoshan Ore Treatment Plant, Wu'an Yuanbaoshan Industrial Group Go. Ltd - Gas Station and Wu’an Yejin Iron Co. Ltd.  In the course of our normal business operations, Hongri has purchased raw materials and supplies from these companies and made advances to or owed cash to these companies in respect of these purchases. Hongri has also engaged in sales of its products to the YBS Group. Because such related party transactions may not always be completed at arm’s-length due to their nature, we may not be able to control the valuation of such transactions and as a result, there is a risk that the value of such related party transactions exceeds market value, which could ultimately impact our profitability.
  
We face significant competition from competitors who have greater resources than we do, and we may not have the resources necessary to successfully compete with them.
 
There are many manufacturers of steel products in China.  Our business is in an industry that is becoming increasingly competitive and capital intensive, and competition comes from manufacturers located in China as well as from international competition. Our competitors may have financial resources, staff and facilities substantially greater than ours and we may be at a competitive disadvantage compared with larger companies.
  
We are dependent on our Chinese manufacturing operations to generate our income and profits, and the deterioration of any current favorable local conditions may make it difficult or prohibitive to continue to operate or expand in China.
 
Our manufacturing operations are located in China and could be affected by, among other things:
 
 
·
economic and political instability in China, including problems related to labor unrest;
 
·
lack of developed infrastructure;
 
·
variances in payment cycles;
 
·
currency fluctuations;
 
·
employment and severance taxes;
 
·
compliance with local laws and regulatory requirements;
 
Moreover, inadequate development or maintenance of infrastructure in China, including adequate power and water supplies, transportation, raw materials availability or the deterioration in the general political, economic or social environment could make it difficult, more expensive and possibly prohibitive to continue to operate or expand our facilities in China.
 
 
We may not be able to pass on to customers the increases in the costs of our raw materials, particularly crude steel.
 
We require substantial amounts of raw materials in our business, principally iron ore. Any substantial increases in the cost of iron ore could adversely affect our financial condition and results of operations. The availability and price of iron ore depends on a number of factors outside our control, including general economic conditions, domestic and international supply and tariffs. Increased domestic and worldwide demand for iron ore has had and will continue to have the effect of increasing the prices that we pay for these raw materials, thereby increasing our cost of goods sold. Generally, there is a potential time lag between changes in prices under our purchase contracts and the point when we can implement a corresponding change under our sales contracts with our customers. As a result, we can be exposed to fluctuations in the price of raw materials, since, during the time lag period, we may have to temporarily bear the additional cost of the change under our purchase contracts, which could have a material adverse effect on our profitability. If raw material prices were to increase significantly without a commensurate increase in the market value of our products, our financial condition and results of operations would be adversely affected.
 
Although we are dependent on a steady flow of raw materials for our operations, we do not have in place long-term supply agreements for all of our material requirements.
 
A substantial portion of our raw material requirements is met by Hongrong, a related party, however, we do not currently have long-term supply contracts with any particular supplier, including Northern,  to assure a continued supply of the raw materials we need in our operations. While we maintain good relationships with our suppliers, the supply of raw materials may nevertheless be interrupted on account of events outside our control, which will negatively impact our operations.
 
The loss of any key executive or our failure to attract and retain key personnel could adversely affect our future performance, strategic plans and other objectives.
 
The loss or failure to attract and retain key personnel could significantly impede our future performance, including product development, strategic plans, marketing and other objectives. Our success depends to a substantial extent not only on the ability and experience of our senior management, but particularly upon our Chairman, Mr. Shenghong Liu, our Chief Engineer and Plant Manager, Mr. Rutai Pan, and our Chief Financial Officer, Mr. Xiaolong Zhou. We do not currently have in place key man life insurance for these executive officers. To the extent that the services of these officers would be unavailable to us, we would be required to recruit other persons to perform the duties performed by them. We may be unable to employ other qualified persons with the appropriate background and expertise to replace these officers and directors on terms suitable to us.  
 
We may not be able to retain, recruit and train adequate management and production personnel. We rely heavily on those personnel to help develop and execute our business plans and strategies, and if we lose such personnel, it would reduce our ability to operate effectively.
 
Our continued operations are dependent upon our ability to identify and recruit adequate management and production personnel in China. We require trained graduates of varying levels and experience and a flexible work force of semi-skilled operators. Many of our current employees come from the more remote regions of China as they are attracted by the wage differential and prospects afforded by our operations. With the economic growth currently being experienced in China, competition for qualified personnel is substantial, and there can be no guarantee that a favorable employment climate will continue and that wage rates we must offer to attract qualified personnel will enable us to remain competitive internationally. The inability to attract such personnel or the increased cost of doing so could reduce our competitive advantage relative to other precision steel producers, reducing or eliminating our growth in revenues and profits.    
 
We are subject to risks associated with changing technology and manufacturing techniques, which could place us at a competitive disadvantage.
 
The successful implementation of our business strategy requires our products and services meet customers’ needs. Our designs and products are characterized by stringent performance and specification requirements that mandate a high degree of manufacturing and engineering expertise. We believe that our customers rigorously evaluate our services and products on the basis of a number of factors, including, but not limited to:
 
 
·
quality;
 
·
price competitiveness;
 
·
technical expertise and development capability;
 
·
innovation;
 
·
reliability and timeliness of delivery;
 
·
product design capability;
 
·
operational flexibility;
 
·
customer service; and
 
·
overall management.
  
 
Our success depends on our ability to continue to meet our customers’ changing requirements and specifications with respect to these and other criteria. There can be no assurance that we will be able to address technological advances or introduce new designs or products that may be necessary to remain competitive within the precision steel industry.
 
We depend upon independent distributors for a significant portion of our sales revenue, and we cannot be certain that sales to these distributors will continue. If sales to these distributors do not continue, then our sales may decline and our business may be negatively impacted.
 
We currently supply our steel products in the Chinese domestic market. For the year ended December 31, 2012, there were two (2) major customers that accounted for approximately 20% and 18% of the Company’s total sales, respectively.  For the year ended December 31, 2011, there were two (2) major customers that accounted for approximately 40% of the Company’s total sales, 21% and 19%, respectively. For the year ended December 31, 2010, two customers accounted for 18% and 10% of sales, respectively. We do not enter into long-term contracts with our customers and therefore cannot be certain that sales to these customers will continue. The loss of any of our largest customers would likely have a material negative impact on our sales revenues and business.
  
Defects in our products could impair our ability to sell products or could result in litigation and other significant costs.
 
Detection of any significant defects in our precision steel products may result in, among other things, delay in time-to-market, loss of market acceptance and sales of its products, diversion of development resources, injury to our reputation, litigation or fines, or increased costs to correct such defects. Defects could harm our reputation, which could result in significant costs and could impair our ability to sell our products. The costs we may incur in correcting any product defects may be substantial and could decrease our profit margins.
 
Failure to optimize our manufacturing potential and cost structure could materially increase our overhead, causing a decline in our margins and profitability.
 
We strive to utilize the manufacturing capacity of our facilities fully but may not do so on a consistent basis. Our factory utilization is dependent on our success in, among other things:
 
 
·
accurately forecasting demand;
 
·
predicting volatility;
 
·
timing volume sales to our customers;
 
·
balancing our productive resources with product mix; and
 
·
planning manufacturing services for new or other products that we intend to produce.
  
Demand for contract manufacturing of these products may not be as high as we expect, and we may fail to realize the expected benefit from our investment in our manufacturing facilities. Our profitability and operating results are also dependent upon a variety of other factors, including, but not limited to:
 
 
·
utilization rates of manufacturing lines;
 
·
downtime due to product changeover;
 
·
impurities in raw materials causing shutdowns; and
 
·
maintenance of contaminant-free operations.
 
Failure to optimize our manufacturing potential and cost structure could materially and adversely affect our business and operating results.
 
Moreover, our cost structure is subject to fluctuations from inflationary pressures in China and specific geographic regions where we conduct business. China is currently experiencing dramatic growth in its economy. This growth may lead to continued pressure on wages and salaries that may exceed our budget and adversely affect our operating results.
 
Our production facilities are subject to risks of power shortages and risks of halts in production due to government action, which may adversely affect our ability to meet our customers’ needs and reduce our revenues.
 
Many cities and provinces in China have suffered serious power shortages since 2004. Many of the regional grids do not have sufficient power generating capacity to fully satisfy the increased demand for electricity driven by continual economic growth and persistent hot weather. Local governments have occasionally required local factories to temporarily shut down their operations or reduce their daily operational hours in order to reduce local power consumption levels.
 
 
In September 2010, the Company was forced to stop production with all other local steel manufacturers in order to fulfill the quota of “energy-saving and emission-production” by the local government.  There is a risk that our operations may be affected by those administrative measures at another time in the future, thereby causing material production disruption and delay in delivery schedule. In such event, our business, results of operation and financial conditions could be materially adversely affected.

We do have a back-up power generation system in the event natural power outages should occur.
 
Unexpected equipment failures may lead to production curtailments or shutdowns.
 
Interruptions in our production capabilities will adversely affect our production costs, products available for sales and earnings for the affected period. In addition to equipment failures, our facilities are also subject to the risk of catastrophic loss due to unanticipated events such as fires, explosions or violent weather conditions. Our manufacturing processes are dependent upon critical pieces of equipment, such as our various cold-rolling mills, as well as electrical equipment, such as transformers, and this equipment may, on occasion, be out of service as a result of unanticipated failures. We have experienced and may in the future experience material plant shutdowns or periods of reduced production as a result of such equipment failures.
 
We do not currently maintain property damage or business interruption insurance.  If our production facilities were destroyed or significantly damaged as a result of fire or some other natural disaster, it could have a material impact on our operations.
 
All of our products are currently manufactured at our existing facilities located in Handan city in Hebei province. Firefighting and disaster relief or assistance in China may not be as developed as in Western countries. We do not maintain property damage insurance covering our inventories and equipment. We do not maintain business interruption insurance. Material damage to, or the loss of, our production facilities due to fire, severe weather, flood or other act of God or cause, even if insured, could have a material adverse effect on our financial condition, results of operations, business and prospects.

Our holding company structure may limit the payment of dividends.
 
We have no direct business operations, other than our ownership of our subsidiary.  While we have no current intention of paying dividends, should we decide in the future to do so, as a holding company, our ability to pay dividends and meet other obligations depends upon the receipt of dividends or other payments from our operating subsidiary and/or other holdings and investments.  In addition, our operating subsidiaries, from time to time, may be subject to restrictions on their ability to make distributions to us, including as a result of restrictive covenants in loan agreements, restrictions on the conversion of local currency into U.S. dollars or other hard currency and other regulatory restrictions as discussed below.  If future dividends are paid in RMB, fluctuations in the exchange rate for the conversion of RMB into U.S. dollars may reduce the amount received by U.S. stockholders upon conversion of the dividend payment into U.S. dollars.
 
Chinese regulations currently permit the payment of dividends only out of accumulated profits as determined in accordance with Chinese accounting standards and regulations.  Our subsidiaries in China are also required to set aside a portion of their after tax profits according to Chinese accounting standards and regulations to fund certain reserve funds. Currently, our subsidiaries in China are the only sources of revenues or investment holdings for the payment of dividends.  If they do not accumulate sufficient profits under Chinese accounting standards and regulations to first fund certain reserve funds as required by Chinese accounting standards, we will be unable to pay any dividends.
 
We may be exposed to liabilities under the Foreign Corrupt Practices Act, and any determination that we violated the Foreign Corrupt Practices Act could have a material adverse effect on our business.
 
We are subject to the Foreign Corrupt Practice Act, or FCPA, and other laws that prohibit improper payments or offers of payments to foreign governments and their officials and political parties by U.S. persons and issuers as defined by the statute for the purpose of obtaining or retaining business. We have operations, agreements with third parties and make sales in China, which may experience corruption. Our activities in China create the risk of unauthorized payments or offers of payments by one of the employees, consultants, sales agents or distributors of our company, because these parties are not always subject to our control. It is our policy to implement safeguards to discourage these practices by our employees. Also, our existing safeguards and any future improvements may prove to be less than effective, and the employees, consultants, sales agents or distributors of our Company may engage in conduct for which we might be held responsible. Violations of the FCPA may result in severe criminal or civil sanctions, and we may be subject to other liabilities, which could negatively affect our business, operating results and financial condition. In addition, the government may seek to hold our Company liable for successor liability FCPA violations committed by companies in which we invest or that we acquire.
  
 
RISKS RELATED TO DOING BUSINESS IN CHINA
 
Adverse changes in political and economic policies of the PRC government could impede the overall economic growth of China, which could reduce the demand for our products and damage our business.
 
We currently conduct substantially all of our operations and generate all of our revenue in China. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. The PRC economy differs from the economies of most developed countries in many respects, including:
 
 
·
a higher level of government involvement;
 
·
an early stage of development of the market-oriented sector of the economy;
 
·
a rapid growth rate;
 
·
a higher level of control over foreign exchange; and
 
·
the allocation of resources.
 
As the PRC economy has been transitioning from a planned economy to a more market-oriented economy, the PRC government has implemented various measures to encourage economic growth and guide the allocation of resources. While these measures may benefit the overall PRC economy, they may also have a negative effect on us.
 
Although the PRC government has in recent years implemented measures emphasizing the utilization of market forces for economic reform, the PRC government continues to exercise significant control over economic growth in China through the allocation of resources, controlling the payment of foreign currency-denominated obligations, setting monetary policy and imposing policies that impact particular industries or companies in different ways.
 
Any adverse change in economic conditions or government policies in China could have a material adverse effect on the overall economic growth in China, which in turn could lead to a reduction in demand for our services and consequently have a material adverse effect on our business and prospects.
 
Uncertainties with respect to the PRC legal system could limit the legal protections available to you and us.
 
We conduct substantially all of our business through our operating subsidiaries in the PRC. Our operating subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to foreign-invested enterprises. The PRC legal system is based on written statutes, and prior court decisions may be cited for reference but have limited precedential value. Since 1979, a series of new PRC laws and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since the PRC legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involve uncertainties, which may limit legal protections available to you and us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. In addition, all of our executive officers and all of our directors are residents of China and not of the United States, and substantially all the assets of these persons are located outside the United States. As a result, it could be difficult for investors to affect service of process in the United States or to enforce a judgment obtained in the United States against our Chinese operations and subsidiaries.
 
If we are found to have failed to comply with applicable laws, we may incur additional expenditures or be subject to significant fines and penalties.
 
Our operations are subject to PRC laws and regulations applicable to us. However, many PRC laws and regulations are uncertain in their scope, and the implementation of such laws and regulations in different localities could have significant differences. In certain instances, local implementation rules and/or the actual implementation are not necessarily consistent with the regulations at the national level. Although we strive to comply with all the applicable PRC laws and regulations, we cannot assure you that the relevant PRC government authorities will not later determine that we have not been in compliance with certain laws or regulations.
 
In addition, our facilities and products are subject to many laws and regulations. Our failure to comply with these and other applicable laws and regulations in China could subject us to administrative penalties and injunctive relief, as well as civil remedies, including fines, injunctions and recalls of our products. It is possible that changes to such laws or more rigorous enforcement of such laws or with respect to our current or past practices could have a material adverse effect on our business, operating results and financial condition. Further, additional environmental, health or safety issues relating to matters that are not currently known to management may result in unanticipated liabilities and expenditures.
 
 
The PRC government exerts substantial influence over the manner in which we must conduct our business activities.
 
The PRC government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property and other matters. We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of the jurisdictions in which we operate may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations.
 
Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof and could require us to divest ourselves of any interest we then hold in Chinese properties or joint ventures.
 
Restrictions on currency exchange may limit our ability to receive and use our sales effectively.
 
The majority of our revenues will be settled in RMB and any future restrictions on currency exchanges may limit our ability to use revenue generated in RMB to fund any future business activities outside China or to make dividend or other payments in U.S. dollars. Although the Chinese government introduced regulations in 1996 to allow greater convertibility of the RMB for current account transactions, significant restrictions still remain, including primarily the restriction that foreign-invested enterprises may only buy, sell or remit foreign currencies after providing valid commercial documents, at those banks in China authorized to conduct foreign exchange business. In addition, conversion of RMB for capital account items, including direct investment and loans, is subject to governmental approval in China, and companies are required to open and maintain separate foreign exchange accounts for capital account items. We cannot be certain that the Chinese regulatory authorities will not impose more stringent restrictions on the convertibility of the RMB.
  
Fluctuations in exchange rates could adversely affect our business and the value of our securities.
 
The value of our common stock will be indirectly affected by the foreign exchange rate between the U.S. dollar and RMB and between those currencies and other currencies in which our revenues may be denominated. Appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue that will be exchanged into U.S. dollars, as well as earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.
 
Since July 2005, the RMB is no longer pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future PRC authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.
 
Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies.
 
Currently, some of our raw materials and equipment are imported. In the event that the U.S. dollars appreciate against RMB, our costs will increase. If we cannot pass the resulting increased cost to our customers, our profitability and operating results will suffer.
 
Restrictions under PRC law on our PRC subsidiaries’ ability to make dividends and other distributions could materially and adversely affect our ability to grow, make investments or acquisitions that could benefit our business, pay dividends to you, and otherwise fund and conduct our business.
 
Substantially all of our revenues are earned by our PRC subsidiary. However, PRC regulations restrict the ability of our PRC subsidiary to make dividends and other payments to its offshore parent company. PRC legal restrictions permit payments of dividends by our PRC subsidiary only out of their accumulated after-tax profits, if any, determined in accordance with PRC accounting standards and regulations. Our PRC subsidiary is also required under PRC laws and regulations to allocate at least 10% of its annual after-tax profits determined in accordance with PRC generally accepted accounting principles to a statutory general reserve fund until the amounts in said fund reaches 50% of our registered capital. Allocations to these statutory reserve funds can only be used for specific purposes and are not transferable to us in the form of loans, advances, or cash dividends. Any limitations on the ability of our PRC subsidiary to transfer funds to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends and otherwise fund and conduct our business.
 
 
You may have difficulty enforcing judgments against us.
 
We are a Maryland holding company and most of our assets are located outside of the United States. Almost all of our operations are conducted in the PRC. In addition, most of our directors and officers are nationals and residents of countries other than the United States. A substantial portion of the assets of these persons is located outside the United States. As a result, it may be difficult for you to effect service of process within the United States upon these persons. It may also be difficult for you to enforce in U.S. courts judgments on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors, most of whom are not residents in the United States and the substantial majority of whose assets are located outside of the United States. In addition, there is uncertainty as to whether the courts of the PRC would recognize or enforce judgments of U.S. courts. Although the recognition and enforcement of foreign judgments are generally provided for under the PRC Civil Procedures Law, courts in China may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based on treaties between China and the country where the judgment is made or on reciprocity between jurisdictions. China does not have any treaties or other arrangements that provide for the reciprocal recognition and enforcement of foreign judgments with the United States. In addition, according to the PRC Civil Procedures Law, courts in the PRC will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates basic principles of PRC law or national sovereignty, security or the public interest. So it is uncertain whether a PRC court would enforce a judgment rendered by a court in the United States.
 
PRC State Administration of Foreign Exchange ("SAFE") regulations regarding offshore financing activities by PRC residents which may increase the administrative burden we face. The failure by our shareholders who are PRC residents to make any required applications and filings pursuant to such regulations may prevent us from being able to distribute profits and could expose us and our PRC resident shareholders to liability under PRC law.
 
SAFE, issued a public notice ("SAFE #75") effective from November 1, 2005, which requires registration with SAFE by the PRC resident shareholders of any offshore special purpose company. Without registration, the PRC subsidiary entity cannot remit any of its profits out of the PRC as dividends or otherwise.
 
In October 2005, SAFE issued a public notice, the Notice on Relevant Issues in the Foreign Exchange Control over Financing and Return Investment Through Special Purpose Companies by Residents Inside China, or the SAFE notice, which requires PRC residents, including both legal persons and natural persons, to register with the competent local SAFE branch before establishing or controlling any company outside of China, referred to as an "offshore special purpose company," for the purpose of overseas equity financing involving onshore assets or equity interests held by them. In addition, any PRC resident that is the shareholder of an offshore special purpose company is required to amend its SAFE registration with the local SAFE branch with respect to that offshore special purpose company in connection with any increase or decrease of capital, transfer of shares, merger, division, equity investment or creation of any security interest over any assets located in China. Moreover, if the offshore special purpose company was established and owned the onshore assets or equity interests before the implementation date of the SAFE notice, a retroactive SAFE registration is required to have been completed before March 31, 2006. If any PRC shareholder of any offshore special purpose company fails to make the required SAFE registration and amendment, the PRC subsidiaries of that offshore special purpose company may be prohibited from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to the offshore special purpose company. Moreover, failure to comply with the SAFE registration and amendment requirements described above could result in liability under PRC laws for evasion of applicable foreign exchange restrictions.
 
Our current beneficial owners and/or prospective shareholders may fall within the ambit of the SAFE notice and be required to register with the local SAFE branch as required under the SAFE notice. If so required, and if such beneficial owners fail to timely register their SAFE registrations pursuant to the SAFE notice, or if future shareholders and/or beneficial owners of our company who are PRC residents fail to comply with the registration procedures set forth in the SAFE notice, this may subject such shareholders, beneficial owners and/or our PRC subsidiaries to fines and legal sanctions and even criminal liabilities under the PRC Foreign Exchange Administrative Regulations promulgated January 29, 1996, as amended, and may also limit our ability to contribute additional capitals, limit our PRC subsidiaries’ ability to distribute dividends to our company, or otherwise adversely affect our business.
 
Under the New Enterprise Income Tax Law, we may be classified as a “resident enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders.
 
On March 16, 2007, the National People’s Congress of China passed the EIT Law and on November 28, 2007, the State Council of China passed its implementing rules, both of which took effect on January 1, 2008. Under the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. The implementing rules of the EIT Law define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise.
 
 
On April 22, 2009, the State Administration of Taxation issued the Notice Concerning Relevant Issues Regarding Cognizance of Chinese Investment Controlled Enterprises Incorporated Offshore as Resident Enterprises pursuant to Criteria of de facto Management Bodies, or the Notice, further interpreting the application of the EIT Law and its implementation against non-Chinese enterprise or group controlled offshore entities. Pursuant to the Notice, an enterprise incorporated in an offshore jurisdiction and controlled by a Chinese enterprise or group will be classified as a “domestically incorporated resident enterprise” if (i) its senior management in charge of daily operations reside or perform their duties mainly in China; (ii) its financial or personnel decisions are made or approved by bodies or persons in China; (iii) its substantial assets and properties, accounting books, corporate chops, board and shareholder minutes are kept in China; and (iv) at least half of its directors with voting rights or senior management often resident in China. A resident enterprise would be subject to an enterprise income tax rate of 25% on its worldwide income and its non-PRC stockholders would be subject to a withholding tax at a rate of 10% when dividends are paid to such non-PRC stockholders. However, it remains unclear as to whether the Notice is applicable to an offshore enterprise incorporated by a Chinese natural person. Nor are detailed measures on enforcement of PRC tax against non-domestically incorporated resident enterprises are available. Therefore, it is unclear how tax authorities will determine tax residency based on the facts of each case.
 
We may be deemed to be a resident enterprise by Chinese tax authorities. If the PRC tax authorities determine that we are a “resident enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations. In our case, this would mean that income such as interest on financing proceeds and non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Second, although under the EIT Law and its implementing rules dividends paid to us from our PRC subsidiary would qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes. Finally, it is possible that future guidance issued with respect to the new “resident enterprise” classification could result in a situation in which a 10% withholding tax is imposed on dividends we pay to our non-PRC stockholders and with respect to gains derived by our non-PRC stockholders from transferring our shares. We are actively monitoring the possibility of “resident enterprise” treatment for the 2010 tax year and are evaluating appropriate organizational changes to avoid this treatment, to the extent possible.
 
If we were treated as a “resident enterprise” by PRC tax authorities, we would be subject to taxation in both the U.S. and China, and our PRC tax may not be creditable against our U.S. tax.
  
We face uncertainty from China’s Circular on Strengthening the Administration of Enterprise Income Tax on Non-Resident Enterprises' Share Transfer, or Circular 698, that was released in December 2009 with retroactive effect from January 1, 2008.
 
The Chinese State Administration of Taxation released a circular on December 15, 2009 that addresses the transfer of shares by nonresident companies, generally referred to as Circular 698. Circular 698, which is effective retroactively to January 1, 2008, may have a significant impact on many companies that use offshore holding companies to invest in China. Circular 698, which provides parties with a short period of time to comply with its requirements, indirectly taxes foreign companies on gains derived from the indirect sale of a Chinese company. Where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise by selling the shares in an offshore holding company, and the latter is located in a country or jurisdiction where the effective tax burden is less than 12.5% or where the offshore income of his, her, or its residents is not taxable, the foreign investor is required to provide the tax authority in charge of that Chinese resident enterprise with the relevant information within 30 days of the transfers. Moreover, where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise through an abuse of form of organization and there are no reasonable commercial purposes such that the corporate income tax liability is avoided, the PRC tax authority will have the power to re-assess the nature of the equity transfer in accordance with PRC’s “substance-over-form” principle and deny the existence of the offshore holding company that is used for tax planning purposes. There is uncertainty as to the application of Circular 698. For example, while the term "indirectly transfer" is not defined, it is understood that the relevant PRC tax authorities have jurisdiction regarding requests for information over a wide range of foreign entities having no direct contact with China. It is also unclear, in the event that an offshore holding company is treated as a domestically incorporated resident enterprise, whether Circular 698 would still be applicable to transfer of shares in such offshore holding company. Moreover, the relevant authority has not yet promulgated any formal provisions or formally declared or stated how to calculate the effective tax in the country or jurisdiction and to what extent and the process of the disclosure to the tax authority in charge of that Chinese resident enterprise. In addition, there are not any formal declarations with regard to how to decide “abuse of form of organization” and “reasonable commercial purpose,” which can be utilized by us to balance if our Company complies with the Circular 698. If Circular 698 is determined to be applicable to us based on the facts and circumstances around such share transfers, we may become at risk of being taxed under Circular 698 and we may be required to expend valuable resources to comply with Circular 698 or to establish that we should not be taxed under Circular 698, which could have a material adverse effect on our financial condition and results of operations.
 
Because our funds are held in banks in the PRC that do not provide insurance, the failure of any bank in which we deposit our funds could affect our ability to continue in business.
 
Banks and other financial institutions in the PRC do not provide insurance for funds held on deposit. A significant portion of our assets are in the form of cash deposited with banks in the PRC, and in the event of a bank failure, we may not have access to our funds on deposit. Depending upon the amount of money we maintain in a bank that fails, our inability to have access to our cash could impair our operations, and, if we are not able to access funds to pay our suppliers, employees and other creditors, we may be unable to continue in business.
 
 
RISKS RELATED TO THE MARKET FOR OUR STOCK
 
The market price for shares of our common stock could be volatile and could decline.
 
The market price for the shares of our common stock may fluctuate in response to a number of factors, many of which are beyond our control. In some cases, these fluctuations may be unrelated to our operating performance. Many companies with Chinese operations have experienced dramatic volatility in the market prices of their common stock. We believe that a number of factors, both within and outside of our control, could cause the price of our common stock to fluctuate, perhaps substantially. Factors such as the following could have a significant adverse impact on the market price of our common stock:
 
 
·
our ability to obtain additional financing and, if available, the terms and conditions of the financing;
 
·
our financial position and results of operations;
 
·
period-to-period fluctuations in our operating results;
 
·
changes in estimates of our performance by any securities analysts;
 
·
substantial sales of our common stock pursuant to Rule 144 or otherwise;
 
·
new regulatory requirements and changes in the existing regulatory environment;
 
·
the issuance of new equity securities in a future offering;
 
·
changes in interest rates; and
 
·
general economic, monetary and other national conditions, particularly in the U.S. and China.
  
Securities class action litigation is often instituted against companies following periods of volatility in their stock price. This type of litigation could result in substantial costs to us and divert our management’s attention and resources. Moreover, securities markets may from time to time experience significant price and volume fluctuations for reasons unrelated to operating performance of particular companies. For example, in July 2008, the securities markets in the United States, China and other jurisdictions experienced the largest decline in share prices since September 2001. These market fluctuations may adversely affect the price of our common stock and other interests in our company at a time when you want to sell your interest in us.
 
We may be required to raise additional financing by issuing new securities with terms or rights superior to those of our shares of common stock, which could adversely affect the market price of our shares of common stock.
 
We may require additional financing to fund future operations, develop and exploit existing and new products and to expand into new markets. We may not be able to obtain financing on favorable terms, if at all. If we raise additional funds by issuing equity securities, the percentage ownership of our current shareholders will be reduced, and the holders of the new equity securities may have rights superior to those of the holders of shares of common stock, which could adversely affect the market price and the voting power of shares of our common stock. If we raise additional funds by issuing debt securities, the holders of these debt securities would similarly have some rights senior to those of the holders of shares of common stock, and the terms of these debt securities could impose restrictions on operations and create a significant interest expense for us.
 
We do not intend to pay dividends for the foreseeable future.
 
For the foreseeable future, we intend to retain any earnings to finance the development and expansion of our business, and we do not anticipate paying any cash dividends on our common stock. Accordingly, investors must be prepared to rely on sales of their common stock after price appreciation to earn an investment return, which may never occur. Investors seeking cash dividends should not purchase our common stock. Any determination to pay dividends in the future will be made at the discretion of our Board of Directors and will depend on our results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law and other factors our board deems relevant.
 
 
RISKS RELATED TO OWNERSHIP OF OUR COMMON STOCK
 
The PRC government may determine that Entrusted Agreements are not in compliance with applicable PRC laws, rules and regulations, thereby rendering the Entrusted Agreements unenforceable and resulting in the deconsolidation of our VIE structure.
 
We manage and operate Hongri, our operating entity, through Nuosen (Handan) Trading Co. Ltd. (“Nuosen”) pursuant to the rights its holds under the Entrusted Agreements.  By virtue of the Entrusted Agreements, Hongri is a variable interest entity (“VIE”).  Almost all economic benefits and risks arising from Hongri’s operations are transferred to Nuosen under the Entrusted Agreements.  Details of the Entrusted Agreements are set out in “The Company – Corporate History”.
 
There are risks involved with the operation of our business in reliance on the Entrusted Agreements, including the risk that the Entrusted Agreements may be determined by PRC regulators or courts to be unenforceable, thereby resulting in the de-consolidation of our VIE structure. If the Entrusted Agreements were for any reason determined to be in breach of any existing or future PRC laws or regulations, the relevant regulatory authorities would have broad discretion in dealing with such breach, including:
 
 
·
imposing economic penalties;
 
·
discontinuing or restricting the operations of Nuosen or Hongri;
 
·
imposing conditions or requirements with respect to the Entrusted Agreements with which Nuosen or Hongri may not be able to comply;
 
·
requiring the Company to restructure the relevant ownership structure or operations;
 
·
taking other regulatory or enforcement actions that could adversely affect our  business; and
 
·
revoking the business licenses and/or the licenses or certificates of Hongri, and/or voiding the Entrusted Agreements.
  
Any of these actions could adversely affect our ability to manage, operate and gain the financial benefits of Hongri, which would have a material adverse impact on our business, financial condition and results of operations.
 
Our ability to manage and operate Hongri under the Entrusted Agreements may not be as effective as direct ownership, which may result in the potential non-performance by Hongri under the Entrusted Agreements.
 
We conduct our business in the PRC and generate virtually all of our revenues through the Entrusted Agreements. We depend on Hongri to hold and maintain contracts with our customers.  Our plans for future growth are based substantially on growing the operations of Hongri. However, the Entrusted Agreements may not be as effective in providing us with control over Hongri as direct ownership.
 
Neither CIS nor Nuosen has any ownership interest in Hongri, nor do we have business assets or revenue streams other than through our Entrusted Agreements with Hongri. Although we believe that the Entrusted Agreements are valid, binding and enforceable under current Chinese laws and regulations, these contractual arrangements may not be as effective in providing us with control over Hongri as direct ownership of Hongri would be. In addition, Hongri may breach the contractual arrangements. For example, Hongri may decide not to perform under the Entrusted Agreements by not making contractual payments to Nuosen, and consequently to CIS, in accordance with the existing contractual arrangements. In the event of any such breach, we may have to (i) incur substantial costs and resources to enforce such arrangements, and (ii) rely on legal remedies under PRC law, which we cannot be sure would be always effective in light of uncertainties in the Chinese legal system.
 
Therefore, if we are unable to effectively control Hongri, it may have an adverse effect on our ability to achieve our business objectives and grow our revenues.
 
 
As the Entrusted Agreements are governed by PRC law, we would be required to rely on PRC law to enforce our rights and remedies under them; PRC law may not provide us with the same rights and remedies as are available in contractual disputes governed by the law of other jurisdictions.
 
The Entrusted Agreements are governed by the PRC law and provide for the resolution of disputes through arbitral proceedings pursuant to PRC law. If Hongri or its shareholders fail to perform the obligations under the Entrusted Agreements, we would be required to resort to legal remedies available under PRC law, including seeking specific performance or injunctive relief, or claiming damages. We cannot ensure that such remedies would provide us with effective means of causing Hongri to meet its obligations, or recovering any losses or damages as a result of non-performance. Further, the legal environment in China is not as developed as in other jurisdictions. Uncertainties in the application of various laws, rules, regulations or policies in the PRC legal system could limit our ability to enforce the Entrusted Agreements and protect our interests.
 
Two of our stockholders control us through their position and stock ownership and their interest may differ from other stockholders.
 
On August 1, 2010, we issued 44,083,529 restricted shares of our common stock, par value $0.0001, to Karen Prudente,  nominee and trustee for YBS Group, for YBS Group entering into the Entrusted Agreements. As such, Ms. Prudente has the right to vote on each of the shareholders of YBS Group’s behalf all of their voting rights with respect to their shares of the Company. In addition, we issued 17,493,463 restricted shares of our common stock to Fakei for Fakei entering into the Entrusted Agreements. These shares were issued in reliance upon the exemptions set forth in Section 4(2) of the Securities Act of 1933, as amended, on the basis that they were issued under circumstances not involving a public offering.
 
Upon exercise of the call option agreement entered into on August 1, 2010, by and between Karen Prudente and the YBS Group, Karen Prudente will transfer all restricted shares of our common stock that she received to the shareholders of YBS Group subject to the terms and conditions thereunder and entrust the shareholders of YBS Group with her voting rights in the Company. Accordingly, YBS Group beneficially owns 60% of our common stock through their holdings of Karen Prudente’s shares. Fakei beneficially owns 24% of our common stock.
 
Prior to the exercise of the call option, Karen Prudente and Fakei will be able to influence the outcome of stockholder votes. Upon the occurrence of an exercise of the call option, both YBS Group and Fakei will be able to influence the outcome of stockholder votes on various matters, including the election of directors and extraordinary corporate transactions such as business combinations. Their interests may differ from that of other stockholders.
  
We are not likely to pay cash dividends in the foreseeable future.
 
We intend to retain any future earnings for use in the operation and expansion of Hongri's business. We do not expect to pay any cash dividends in the foreseeable future but will review this policy as circumstances dictate. Should we decide in the future to do so, as a holding company, our ability to pay dividends and meet other obligations depends upon the receipt of dividends or other payments from our operating subsidiaries. In addition, our operating subsidiaries, from time to time, may be subject to restrictions on their ability to make distributions to us, including restrictions on the conversion of local currency into U.S. dollars or other hard currency and other regulatory restrictions.
 
There is currently no trading market for our common stock.
 
Our common stock is not quoted on any exchange or inter-dealer quotation system. There is no trading market for our common stock and our common stock may never be included for trading on any stock exchange or through any quotation system (including, without limitation, the NASDAQ Stock Market and the FINRA over-the-counter Bulletin Board). You may not be able to sell your shares due to the absence of a trading market.
 
Our common stock may be also subject to the "penny stock" rules to the extent that its price is below $5.00, which rules require delivery of a schedule explaining the penny stock market and the associated risks before any sale. These requirements may further limit your ability to sell your shares.
 
Our common stock is illiquid and subject to price volatility unrelated to our operations.
 
If a market for our common stock does develop, its market price could fluctuate substantially due to a variety of factors, including market perception of our ability to achieve our planned growth, quarterly operating results of other companies in the same industry, trading volume in our common stock, changes in general conditions in the economy and the financial markets or other developments affecting us or our competitors. In addition, the stock market itself is subject to extreme price and volume fluctuations. This volatility has had a significant effect on the market price of securities issued by many companies for reasons unrelated to their operating performance and could have the same effect on our common stock.
 
 
We are authorized to issue "blank check" preferred stock, which, if issued without stockholders approval, may adversely affect the rights of holders of our common stock.
 
We are authorized to issue 20,000,000 shares of preferred stock, of which 10,000,000 shares have been designated as Series A Preferred Stock. As of March 29, 2013 there are no shares of Series A Preferred Stock issued and outstanding. The Board of Directors is authorized under our Articles of Amendment to provide for the issuance of additional shares of preferred stock by resolution, and to fix the designation, powers, preferences and rights of the shares of each such series and the qualifications, limitations or restrictions thereof without any further vote or action by the stockholders. Any shares of preferred stock so issued are likely to have priority over the common stock with respect to dividend or liquidation rights. In the event of issuance, the preferred stock could be utilized, under certain circumstances, as a method of discouraging, delaying or preventing a change in control, which could have the effect of discouraging bids for our company and thereby prevent stockholders from receiving the maximum value for their shares. We have no present intention to issue any shares of its preferred stock in order to discourage or delay a change of control. However, there can be no assurance that preferred stock will not be issued at some time in the future. 
  
Our shares may become subject to the U.S. “Penny Stock” Rules and investors who purchase our shares may have difficulty re-selling their shares as the liquidity of the market for our shares may be adversely affected by the impact of the “Penny Stock” Rules.
 
Our stock may become subject to U.S. "Penny Stock" rules, which may make the stock more difficult to trade on the open market. Our common shares are expected to trade on the OTCBB. A "penny stock" is generally defined by regulations of the U.S. Securities and Exchange Commission ("SEC") as an equity security with a market price of less than US$5.00 per share. However, an equity security with a market price under US$5.00 will not be considered a penny stock if it fits within any of the following exceptions:
 
 
(i)
the equity security is listed on a national securities exchange;
 
(ii)
the issuer of the equity security has been in continuous operation for less than three years, and either has (a) net tangible assets of at least US$5,000,000, or (b) average annual revenue of at least US$6,000,000; or
 
(iii)
the issuer of the equity security has been in continuous operation for more than three years, and has net tangible assets of at least US$2,000,000.
 
If an investor buys or sells a penny stock, SEC regulations require that the investor receive, prior to the transaction, a disclosure explaining the penny stock market and associated risks. Furthermore, trading in our common stock is currently subject to Rule 15g-9 of the Exchange Act, which relates to non-NASDAQ and non-exchange listed securities. Under this rule, broker/dealers who recommend our securities to persons other than established customers and accredited investors must make a special written suitability determination for the purchaser and receive the purchaser's written agreement to a transaction prior to sale. Securities are exempt from this rule if their market price is at least $5.00 per share.
  
The anticipated low price of our common stock has a negative effect on the amount and percentage of transaction costs paid by individual shareholders. The low price of our common stock also limits our ability to raise additional capital by issuing additional shares. There are several reasons for these effects. First, the internal policies of certain institutional investors prohibit the purchase of low-priced stocks. Second, many brokerage houses do not permit low-priced stocks to be used as collateral for margin accounts or to be purchased on margin. Third, some brokerage house policies and practices tend to discourage individual brokers from dealing in low-priced stocks. Finally, broker's commissions on low-priced stocks usually represent a higher percentage of the stock price than commissions on higher priced stocks. As a result, our shareholders may pay transaction costs that are a higher percentage of their total share value than if our share price were substantially higher.
 
The issuance of shares through our stock compensation plans may dilute the value of existing stockholders and may affect the market price of our stock.
 
Although we do not have an option or other equity-based incentive plan at present, in the future we may use stock options, stock grants and other equity-based incentives, to provide motivation and compensation to our officers, employees and key independent consultants. The award of any such incentives will result in an immediate and potentially substantial dilution to our existing stockholders and could result in a decline in the value of our stock price. The exercise of these options and the sale of the underlying shares of common stock and the sale of stock issued pursuant to stock grants may have an adverse effect upon the price of our stock.
 
Standards for compliance with Section 404 of the Sarbanes-Oxley Act of 2002, as amended, are uncertain, and if we fail to comply in a timely manner, our business could be harmed and our stock price could decline.
 
Recently, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which became effective on July 21, 2010, has amended Section 404 of the Sarbanes-Oxley Act of 2002 (the “Act”). The rules adopted by the SEC pursuant to the Act require an annual assessment of our internal control over financial reporting. The standards that must be met for management to assess the internal control over financial reporting as effective are new and complex, and require significant documentation, testing and possible remediation to meet the detailed standards. We may encounter problems or delays in completing activities necessary to make an assessment of our internal control over financial reporting. Pursuant to the amended Act, as neither a “large accelerated filer” nor an “accelerated filer”, we are exempt from the requirements of Section 404(b) of the Act to obtain an auditor’s report on management’s assessment of the effectiveness of the Company’s internal control over financial reporting.
 
 
A large number of shares will be eligible for future sale and may depress our stock price.
 
We may be required, under terms of future financing arrangements, to offer a large number of common shares to the public, or to register for sale by future private investors a large number of shares sold in private sales to them.
 
Sales of substantial amounts of common stock, or a perception that such sales could occur, could adversely affect the market price of our common stock and could impair our ability to raise capital through the sale of our equity securities, either of which would decrease the value of any earlier investment in our common stock.

Item 1B. 
Unresolved Staff Comments
 
 None.
 
Item 2. 
Properties
 
DESCRIPTION OF PROPERTY
 
All land in the PRC is owned by the government and cannot be sold to any individual or entity. Instead, the government grants landholders a "land use right" after a purchase price for such "land use right" is paid to the government. The "land use right" allows the holder the right to use the land for a specified long-term period of time and enjoys all the incidents of ownership of the land. The following are the details regarding Hongri’s land use rights with regard to the land that it uses in its business.
 
In November 2007, the Company entered into a lease agreement with YBS Group to lease the manufacturing building of Plate-Rolling I. The annual lease payment is $565,350 (RMB 3,522,211) commencing on January 1, 2008. The lease is set to expire on December 31, 2017. The present value of the total lease payments at inception was $3,822,806 (RMB 23,816,623 at the current exchange rate), which was calculated with a discount rate of 7.83%, a PRC long term borrowing rate in December 2007.
 
In November 2007, the Company entered into a lease agreement with Hongrong, a related party, to lease the manufacturing building of Steel-Making I. The annual lease payment is $194,322 (RMB 1,210,716) commencing on January 1, 2008. The lease is set to expire on December 31, 2017. The present value of the total lease payments at inception was $1,314,042 (RMB 8,186,666 at the current exchange rate), which was calculated with a discount rate of 7.83%, a PRC long term borrowing rate in December 2007.
 
In November 2009, the Company entered into a lease agreement with YBS Group to lease the manufacturing building of Steel-Making II. The annual lease payment is $17,250 (RMB 107,469) commencing on January 1, 2010. The lease is set to expire on December 31, 2019. The present value of the total lease payments at inception was $127,316 (RMB 793,198 at the current exchange rate), which was calculated with a discount rate of 5.94%, a PRC long term borrowing rate in December 2009.
 
In November 2009, the Company entered into a lease agreement with Hongrong to lease the manufacturing building of Bar-Rolling III. The annual lease payment is $121,747 (RMB 758,503) commencing on January 1, 2010. The lease is set to expire on December 31, 2019. The present value of the total lease payments at inception was $898,624 (RMB 5,598,552 at the current exchange rate), which was calculated with a discount rate of 5.94%, a PRC long term borrowing rate in December 2009.
 
Item 3. 
Legal Proceedings
 
We are not a party to any pending legal proceeding, nor is our property the subject of a pending legal proceeding, that is not in the ordinary course of business or otherwise material to the financial condition of our business. None of our directors, officers or affiliates is involved in a proceeding adverse to our business or has a material interest adverse to our business.
 
Item 4. 
Mine Safety disclosures
 
Not Applicable.
 
 
PART II
 
 
Item 5. 
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Market for Common Equity and Related Stockholder Matters
 
Our common stock is currently quoted on the OTCQB under the symbol “CDNN”. Because we are quoted on the OTCQB, our securities may be less liquid, receive less coverage by security analysts and news media, and generate lower prices than might otherwise be obtained if they were listed on a national securities exchange.

The following table sets forth the high and low bid quotations for our common stock as reported on the OTCQB for the periods indicated.

   
High
   
Low
 
Fiscal 2012
  $       $    
                 
First Quarter*
    -       -  
Second Quarter*
    -       -  
Third Quarter
    4.50       1.50  
Fourth Quarter
    1.50       0.60  
 
* There were no tradings of our common stock in the first and second quarters of 2012.

Holders
 
As of March 29, 2013, there were 73,542,058 shares of our common stock issued and outstanding, and there were approximately 52 holders of record of our common stock.
 
Dividends
  
We have not declared or paid any cash dividends on our common stock during either of our last two fiscal years. The payment of dividends, if any, is at the discretion of the Board of Directors and is contingent on the Company's revenues and earnings, capital requirements, financial conditions. We currently intend to retain all earnings, if any, for use in business operations. Accordingly, we do not anticipate declaring any dividends in the near future.
 
The PRC's national currency, RMB, is not a freely convertible currency. For an explanation of how this may restrict our ability to declare dividends on our common stock, please refer to the risk factors in the section entitled “Risk Factors – Risks Related to Doing Business in China.”
 
Securities Authorized for Issuance under Equity Compensation Plans
 
As of December 31, 2012, we do not have any securities authorized for issuance under any equity compensation plans and we do not have any equity compensation plans.

Penny Stock Regulations
 
Our common stock may be subject to regulations prescribed by the SEC relating to "penny stocks." The SEC has adopted regulations that generally define a penny stock to be any equity security that has a market price (as defined in such regulations) of less than $5 per share, subject to certain exceptions. These regulations impose additional sales practice requirements on broker-dealers who sell penny stocks to persons other than established customers and accredited investors (generally institutions with assets in excess of $5,000,000 and individuals with a net worth in excess of $1,000,000 or annual income exceeding $200,000 (individually) or $300,000 (jointly with their spouse). For transactions covered by these rules,  other than exempt transactions, involving a penny stock, the rules require the delivery, prior to the transaction, of a risk disclosure document mandated by the SEC relating to the penny stock market, that: (a) contains a description of the nature and level of risk in the market for penny stocks in both public offerings and secondary trading; (b) contains a description of the broker's or dealer's duties to the customer and of the rights and remedies available to the customer with respect to a violation to such duties or other requirements of Securities' laws; (c) contains a brief, clear, narrative description of a dealer market, including bid and ask prices for penny stocks and the significance of the spread between the bid and ask price; (d) contains a toll-free telephone number for inquiries on disciplinary actions; (e) defines significant terms in the disclosure document or in the conduct of trading in penny stocks; and (f) contains such other information and is in such form, including language, type, size and format, as the Securities and Exchange Commission shall require by rule or regulation. The broker-dealer also must provide, prior to effecting any transaction in a penny stock, the customer with: (a) bid and offer quotations for the penny stock; (b) the compensation of the broker-dealer and its salesperson in the transaction; (c) the number of shares to which such bid and ask prices apply, or other comparable information relating to the depth and liquidity of the market for such stock; and (d) monthly account statements showing the market value of each penny stock held in the customer's account. In addition, the penny stock rules require that prior to a transaction in a penny stock not otherwise exempt from those rules; the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser's written acknowledgment of the receipt of a risk disclosure statement, a written agreement to transactions involving penny stocks, and a signed and dated copy of a suitably written statement.
 
 
The broker-dealer also must disclose the commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and, if the broker-dealer is the sole market-maker, the broker-dealer must disclose this fact and the broker dealer's presumed control over the market. Finally, monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks.
 
Legal remedies, which may be available to the investor, are as follows:
 
 
If penny stocks are sold in violation of the investor's rights listed above, or other federal or state securities laws, the investor may be able to cancel his purchase and get his money back.
 
 
If the stocks are sold in a fraudulent manner, the investor may be able to sue the persons and firms that caused the fraud for damages.
 
 
 If the investor has signed an arbitration agreement, however, s/he may have to pursue a claim through arbitration.
 
If the person purchasing the securities is someone other than an accredited investor or an established customer of the broker-dealer, the broker-dealer must also approve the potential customer's account by obtaining information concerning the customer's financial situation, investment experience and investment objectives. The broker-dealer must also make a determination whether the transaction is suitable for the customer and whether the customer has sufficient knowledge and experience in financial matters to be reasonably expected to be capable of evaluating the risk of transactions in such securities. Accordingly, the SEC's rules may limit the number of potential purchasers of the shares of our common stock and stockholders may have difficulty selling their securities. 
 
Recent Sales of Unregistered Securities
 
On April 30, 2012, our board of directors resolved to issue 50,000 restricted shares of our common stock to Xiaolong Zhou, the CFO of the Company, and 28,333 restricted shares to Frank Pena, a director of the Company, as consideration for their services.
 
Item 6. 
Selected Financial Data
 
SELECTED FINANCIAL DATA

The following selected financial data were derived from the audited consolidated financial statements for the years ended December 31, 2012, 2011, 2010, 2009, and 2008. Such financial data should be read in conjunction with the consolidated financial statements and the notes to the consolidated financial statements filed with the Form 10K and with the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below.

Selected Consolidated Income Statements Data

   
2012
   
2011
   
2010
   
2009
   
2008
 
Net Revenues
  $ 649,318,792     $ 823,107,042     $ 573,666,684     $ 556,754,960     $ 359,057,857  
Gross profit
  $ 14,856,116     $ 61,461,008     $ 37,812,187     $ 62,136,779     $ 33,217,202  
Income from operations
  $ 11,483,281     $ 58,960,631     $ 35,279,926     $ 61,260,199     $ 32,134,803  
Net income
  $ 5,934,990     $ 45,801,476     $ 25,770,440     $ 58,160,977     $ 27,848,080  
Earnings per share - basic and diluted
  $ 0.08     $ 0.62     $ 0.39     $ 0.94     $ 0.45  
Weighted average shares outstanding - basic and diluted
    73,594,852       73,351,698       66,308,038       61,576,992       61,576,992  
Selected Consolidated Balance Sheets Data
                                       
Current assets
  $ 246,177,716     $ 143,326,333     $ 109,999,314     $ 101,114,893     $ 131,164,157  
Total assets
  $ 443,864,161     $ 337,266,685     $ 299,511,009     $ 295,919,596     $ 242,571,451  
Current liabilities
  $ 241,751,172     $ 92,596,081     $ 99,854,735     $ 120,901,452     $ 136,574,269  
Long term liabilities
  $ 6,757,390     $ 57,348,648     $ 66,280,378     $ 75,087,441     $ 64,902,579  


Item 7. 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion should be read in conjunction with our financial statements and notes thereto included in this report.

On August 1, 2010, CIS, through Northern and its wholly owned foreign enterprise, Nuosen, entered into the Entrusted Agreements with Hongri and shareholders of Hongri, YBS Group and Fakei. The effect of the Entrusted Agreements is to cede control of management and economic benefits of Hongri to Nuosen. As a consideration, CIS issued 44,083,529 restricted shares of its common stock, par value $0.0001, to Karen Prudente, a nominee and trustee for YBS Group for entering into the Entrusted Agreements with Nuosen. CIS also issued 17,493,463 restricted shares of its common stock to Fakei in consideration for Fakei entering into the Entrusted Management Agreement with Nuosen.

The Entrusted Agreements empower CIS, through Northern and Nuosen, with the ability to control and substantially influence Hongri’s daily operations and financial affairs, appoint its senior executives and approve all matters requiring shareholders’ approval. As a result of these entrusted agreements, which obligate CIS to absorb a majority of expected losses of Hongri and enable CIS to receive a majority of expected residual returns from Hongri and because CIS has the power to direct the activities of Hongri that most significantly impact Hongri’s economic performance, CIS, through its wholly-owned subsidiaries, accounts for Hongri as its VIE under Accounting Standards Codification (“ASC”) subtopic 810-10-05-8, “Consolidation of VIEs”. Accordingly, CIS consolidates Hongri’s operating results, assets and liabilities. The management of the Company currently intends reinvest all of the income of Hongri for strategic expansion purpose for the foreseeable future.

For accounting purposes, the above transactions were accounted for in a manner similar to a reverse merger or recapitalization, since the former equity shareholders of Hongri now effectively control a majority of CIS’ common stock immediately following the transactions. Consequently, the assets and liabilities and historical operations reflected in the consolidated financial statements prior to the transactions are those of Hongri and are recorded at the historical cost of Hongri. The consolidated financial statements after completion of the transactions include the assets and liabilities of CIS, Northern, Nuosen, and Hongri (collectively, CIS or the “Company”), historical operations of Hongri, and operations of CIS, Northern, Nuosen and Hongri from the date of the transaction. The 44,083,529 restricted shares of common stock issued to Karen Prudente and 17,493,463 restricted shares of common stock issued to Fakei were presented as of the beginning of the first period presented in the accompanying consolidated financial statements.

CIS through Hongri, its operating company in China, produces and sells steel plates, steel wires and steel billets. The Company currently operates from its headquarters on approximately 1,000 acres in Handan city, Hebei province, China. Most of the Company’s products are sold domestically in China.

The Company completed construction of steel production phase II in 2009, which increased steelmaking capacity to 2.3 million metric tons in 2009 from 1.3 million tons in 2008. Production of steelmaking to its capacity utilization rate was approximately 55%, 67% and 47% in 2012, 2011 and 2010, respectively. The decrease in capacity utilization rate in 2012 resulted from lack of market demand for steel products during 2012.

In addition to steelmaking capacity, the Company currently has 2 million metric tons of steel rolling production capacity (including steel plate and steel wire/bar production). Production of steel rolling to its capacity utilization rate was approximately 55%, 49% and 44% in 2012, 2011 and 2010, respectively. The decrease in capacity utilization rate in 2012 resulted from lack of market demand for steel products during 2012. The Company added a new 600,000 ton steel wire production line and commenced production in January 2013.

The Company subcontracted Hongrong, a related party, to process molten iron prior to February 2010. Beginning from February 2010, the Company terminated the subcontracting relationship with Hongrong and began purchasing processed molten iron from Hongrong at the prevailing market price on the local iron market, in accordance with a supply agreement. This change had no material impact on the Company’s gross profit margin since the subcontracting fees paid was commensurate with the gross profit of manufacturing molten iron in the local market. The Company purchased $318,369,059 (786,354 metric tons) molten iron, $659,998,838 (1,445,304 metric tons) molten iron, and $431,329,226 (1,080,737 metric tons) of molten iron from Hongrong, respectively in 2012, 2011 and 2010.
 
 
There are many factors of our business which are impacted by prevailing market conditions, specifically, a change in the raw material and energy price will influence the Company’s inventory levels and purchasing and selling decisions which will, ultimately, impact the Company’s realized gross margin. The Company’s management make operational decisions in response to the market and, as such, will change as market conditions change. The Company does not -undertake any hedging strategies to mitigate the fluctuation of market price. Therefore, the fluctuation of commodity price will have a direct impact on the Company’s operation through the price change in local steel market.

During 2012, the prices of both raw material and finished steel products moved downwards. According to Association of Chinese Steel Industry, steel manufactures Chinese comprehensive price index of steel products (“CSPI”), an index combining prices of various steel products and an economic indicator of market demand for steel products, was decreasing continuously since the beginning of 2012. On December 31, 2012, the CSPI was 105.31, a decrease of 13% compared to 120.45 on December 31, 2011. In the meantime, according to IndexMundi, the average monthly price of iron ore was $128.87 per dry metric ton on December 31, 2012, a decrease of 6% compared to $136.46 per dry metric ton at December 31, 2011. Though the price of iron ore, coking coal and other materials decreased in the same period, the extent of decrease in raw material was less than the decrease in the price of steel products. The combination of the unparalleled decrease in selling price of steel products, excessive steel production capacities and lack of demand for steel products in Chinese domestic market, had a direct negative impact on steel-making manufacturers. Many Chinese steel manufacturers incurred losses in 2012. The Company incurred loss in the third quarter of 2012. However, the Company still made a profit in 2012 by adjusting the production of certain types of steel products in accordance with the change in market conditions.

Looking forward, the index of both prices of steel products and iron ore rebounded in the beginning of 2013. CSPI was 111.12 at February 28, 2013, an increase of 6% compared to 105.31 on December 31, 2012. In the same period, the iron ore average price on IndexMundi increased 20% to $154.64 in February 2013 from $128.87 per dry metric ton at December 31, 2012. The rapid increase in the price of raw materials will have a negative impact on our operations in 2013. The recovery of the Chinese steel market is still uncertain and will largely depend on the new Chinese government and its new economic development policies and expected recovery of the world economy.

Results of Operations for the Years Ended December 31, 2012 and 2011

Comparison of Revenue for the Years Ended December 31, 2012 and 2011

   
2012
   
2011
 
 Products
 
Revenue
   
Quantity (Ton)
   
Revenue
   
Quantity (Ton)
 
Steel plates
  $ 335,591,348       658,425     $ 474,946,204       768,374  
Steel wires / bars
    236,557,650       453,595       120,870,983       197,070  
Steel billets
    64,888,724       121,559       209,657,073       368,544  
Byproducts and others
    12,281,070       -       17,632,782       -  
Products Total
  $ 649,318,792       1,233,579     $ 823,107,042       1,333,988  
 
Total sales in 2012 were $649,318,792, a decrease of $173,788,250, or 21% compared to $823,107,042 in 2011. Of the decreased revenue, approximately $117 million, or 68% of the decrease was due to a decrease in average sales price of steel products; $51 million, or 29% of the decrease was due to decrease in selling quantity of steel products and $5 million, or 3% was due to decrease in the revenue of byproducts.

Revenue from steel plates was $335,591,348 in 2012, a decrease of $139,354,856, or 29% compared to $474,946,204 in 2011. The Company sold 658,425 tons of steel plates in 2012, a decrease of 109,949 tons or 14%, compared to 768,374 tons in 2011. The Company reduced its production of steel plates in 2012 due to lower sales price and lack of market demand. The average unit sales price of steel plates was approximately $510 per ton in 2012, a decrease of $108 per ton, or 17%, from $618 in 2011.

In 2011, the Company modified its steel bar production line to produce steel wires to adapt to the market demand. Production of steel wires helped the Company alleviate the negative market impact to a certain extent in 2012. In 2012, revenue from steel wires was $236,557,650, an increase of $115,686,667, or 96%, compared to $120,870,983 in 2011. The Company sold 453,595 metric tons of steel wires, an increase of 256,525 metric tons, or 130%, compared to 197,070 in 2011. However, the increase in sales of steel wires was offset by the decrease in the unit sales price. The average unit sales price of steel wires was approximately $522 per ton in 2012, a decrease of $91 per ton, or 15%, from $613 per ton in 2011.

Revenue from steel billets was $64,888,724 in 2012, a decrease of $144,768,349, or 69%, compared to $209,657,073 in 2011. The Company sold 121,559 metric tons of steel billets in 2012, a decrease of 246,985 metric tons, or 67%, compared to 368,544 metric tons in 2011. The average unit sales price of steel billets was approximately $534 per ton in 2012, a decrease of $35 per ton, or 6%, from $569 in 2011. Steel billets are semi-finished products that can be used to produce steel plates, steel bars and steel wires with further processing, or they can be sold directly in the market. The Company sold less steel billets in 2012, which was attributable to lower customer demand caused by the depressed market conditions.
 
 
Byproducts and others consist of the reselling of offcuts of steel plates, steel drop, oxygen gas and others. Byproducts and other sales were $12,281,070 in 2012, a decrease of $5,351,712, or 30%, compared to $17,632,782 in 2011. The Company does not sell byproduct in its regular daily sales activities. The selling of byproducts depends on the market condition as byproducts may be reused as raw materials in our production.

Comparison of Cost of Revenue for the Years Ended December 31, 2012 and 2011
 
Costs of Revenue
 
2012
   
2011
 
Steel plates
  $ 343,339,636     $ 460,188,852  
Steel wires / bars
    229,958,766       107,931,190  
Steel billets
    59,719,198       192,353,711  
Byproducts and others
    1,445,076       1,172,281  
Total Cost of Revenue
  $ 634,462,676     $ 761,646,034  
                 
Gross Profit Margin
    2012       2011  
Steel plates
    -2.31 %     3.11 %
Steel wires / bars
    2.79 %     10.71 %
Steel billets
    7.97 %     8.25 %
Total Gross Profit Margin
    2.29 %     7.47 %
 
Cost of revenue totaled $634,462,676 in 2012, a decrease of $127,183,358, or 17%, compared to $761,646,034 in 2011. Of the decreased cost of revenue, approximately $73 million, or 58%, of the decrease was due to the decrease in unit raw material price, $54 million, or 43%, of the decrease was due to decrease in production quantities.

The Company does not buy any commodity products to hedge the fluctuation of market price. However, the fluctuation of commodity price will have a direct impact on our operations. The average cost of revenue of steel plates was approximately $521 per ton in 2012, a decrease of $78 per ton, or 13%, from $599 in 2011. The average cost of revenue of steel wires was approximately $507 per ton in 2012, a decrease of $41, or 7%, compared to $548 in 2011. The average cost of revenue of steel billets was $491 per metric ton, a decrease of $31, or 6%, compared to $522 per metric ton in 2011. The Company actively manages the production volume and the type of steel products manufactured to maximize net profit or reduce the loss in response to the fluctuations in market conditions.

Comparison of Operating Expenses for the Years Ended December 31, 2012 and 2011

Selling, General and Administrative expenses consist of allowance for bad debts, selling expenses, professional service fees and other general and administrative expenses. Total operating expenses were $3,372,835 in 2012, an increase of $872,458, or 35%, compared to $2,500,377 in 2011. Operating expenses – non related parties was $2,225,060 in 2012, an increase of $529,224, or 31%, compared to $1,695,836 in 2011. The increase in operating expenses – non related parties was mainly attributable to $879,040 allowance for impairment of advance to suppliers, which was offset by $281,817 decrease in allowance for doubtful accounts receivable. The Company made an allowance for potentially forfeited advances to suppliers based on aging commenced from 2012.  The Company incurred $567,282 professional service and consulting fees in 2012, an increase of $121,160, compared to 446,122 in 2011. Included in the 2012 professional fees, there was $117,499 cost of stock issued to the CFO and a director in 2012. The Company expects that professional service fees will increase continually as a result of the Company’s effort to be listed in the US security market.
 
 
The operating expenses – related parties were $1,147,775 in 2012, an increase of $343,234, or 43%, compared to $804,541 in 2011. The operating expenses – related parties represented service fees charged by YBS Group. YBS Group owns 70% of the equity interest of Hongri. It provides various services to its subsidiaries, including market and industrial information, public relationship, various government agents’ relationship, coordination of recycling of byproducts among the subsidiaries and executive officers’ salaries. YBS group charged a service fee based on expenses and fixed service fees. Commencing in 2010, YBS Group charged Hongri a fixed service fee of 0.1% of Hongri’s annual revenue. Service fees consisted of management salaries, trainings, consultations, common areas charges and other fees. The management believes that 0.1% of revenue is reasonable. The Company estimated that service fee would be similar or marginally higher than current charged fees if the services had provided by third parties. In addition to the fixed service fee, YBS Group will charge itemized services and expenses to the Company if they are incurred. Among the services fees in 2012, $510,744 was an itemized charge in connection with the refinancing of the $16 million loan from Raiffeisen Bank. Executive officers’ salaries were stand-alone expenses. Such expenses were $63,408 and $61,880 for financial years 2012 and 2011, respectively.

Comparison of Other Expenses for the Years Ended December 31, 2012 and 2011

Other expenses consist of interest expense and interest income. Total net other expenses were $4,162,351 in 2012, a decrease of $1,564,365, or 27% compared to $5,726,716 in 2011. Interest expense for bank borrowings was $2,855,244 in 2012, an increase of $1,349,904, or 90%, compared to $1,505,340 in 2011. The increase of interest expense for bank loan borrowings resulted from the increase in short-term bank loan borrowings and in increase in interest rate. The weighted average short term loan balance consisting of financial institution and related party loans was $31,241,243 and $18,308,766 in 2012 and 2011, respectively. The weighted average interest rate for short term loan was 8.34% and 8.11% in 2012 and 2011, respectively. Other interest expense in connection with the related party loans was $1,705,435 in 2012 and $4,405,934 in 2011. The decrease in interest expense – related parties resulted from a repayment of $58,582,991 in equipment loans – related parties in 2012.

Comparison of Income Tax for the Years Ended December 31, 2012 and 2011

The provision for income tax was $1,385,940 in 2012 and $7,432,439 in 2011. The incurred provision for income tax was foreign income tax and paid to the Chinese tax authority. The current standard corporation income tax rate is 25% in PRC. Hongri applied for foreign investment enterprise exemption, and the application was approved by the local tax authority in 2007. Hongri was entitled to a tax holiday of full (100%) income tax exemption starting from the first profitable year of 2008 through 2009 and then a 50% reduction in income tax for additional three (3) years commencing 2010. The reduced income tax rate is 12.5% for the years ended December 31, 2010, 2011 and 2012. Due to certain expenses were not recognized by PRC tax authority, the effective tax rate was 18.9% for 2012. Management believes that the realization of the benefits from these expenses appears uncertain due to the complicated application and approval procedures regulated by Chinese tax authority. Accordingly, a full deferred tax asset valuation allowance has been provided and no deferred tax asset benefit has been recorded.

Comparison of Net Income for the Years Ended December 31, 2012 and 2011

Net income was $5,934,990 in 2012, a decrease of $39,866,486, or 87%, compared to the net income of $45,801,476 in 2011. The decrease of net income was attributable to the decrease in sales price of the Company’s products as discussed above. The average sales price per ton decreased by 15%, 5 percentage points (150%) higher than 10% decrease in average cost of sales per ton. The decreased net income was also due to decrease in sales volume resulted from lack of market demand.

Results of Operations for the Years Ended December 31, 2011 and 2010

Comparison of Revenue for the Years Ended December 31, 2011 and 2010

    2011     2010  
Products
 
Revenue
   
Quantity (Ton)
   
Revenue
   
Quantity (Ton)
 
Steel plates
  $ 474,946,204       768,374     $ 439,719,098       835,795  
Steel bars
    934,581       1,653       26,101,538       48,780  
Steel wires
    119,936,402       195,417       -       -  
Steel billets
    209,657,073       368,544       100,568,635       195,214  
Byproducts
    17,632,782       -       7,277,413       -  
Products Total
  $ 823,107,042       1,333,988     $ 573,666,684       1,079,789  
 
 
Total sales for the years ended December 31, 2011 were $823,107,042, an increase of $249,440,358, or 43%, compared to $573,666,684 in 2010. Of the increased revenues, approximately $28.6 million, or 11% of the increase was due to an increase in total selling quantity excluding steel wires; $119.9 million, 48% of the increase was generated from the recently introduced sale of steel wires; $90.5 million, or 37% of the increase was attributable to an increase in sales price; and $10.4 million, or 4% of the increase was from increased sales of byproducts.

Revenue from steel plates was $474,946,204 in 2011, an increase of $35,227,106, or 8% compared to $439,719,098 in 2010. The Company sold 768,374 tons of steel plates in 2011, a decrease of 67,421 ton or 8%, compared to 835,795 tons in 2010. The Company reduced its production of steel plates in the fourth quarter of 2011 due to lack of market demand. The increase in steel plates was mainly attributable to an increase in the unit sales prices. The average sales price of steel plates was approximately $618 per ton during 2011, an increase of $92 per ton, or 17%, from $520 in 2010. The increase of selling prices of our products resulted from an increase of raw material prices. The price of iron ore was rising consistently from mid-2009 and increased the price of steel products.

Production of steel bars started in 2010. The Company sold 1,653 and 48,780 tons of steel bars in 2011 and 2010, respectively. The Company temporarily stopped manufacturing steel bars in 2011 due to lack of demand and low market price of steel bars. The Company turned steel bar production line to produce steel wires to adapt to the market demand. During 2011, the Company sold 195,417 metric tons of steel wire, which generated $119,936,402 of revenue.

Revenue from steel billets was $209,657,073 in 2011, an increase of $109,088,438, or 108% compared to $100,568,635 in 2010. The increase in revenue from steel billets was attributable to the increase in both sales quantity and sales price. The Company sold 368,544 tons of steel billets in 2011, an increase of 173,330 tons, or 89%, compared to 195,214 tons in 2010. Steel billets are semi-finished products that can be used to produce steel plates, steel bars and steel wires with further processing, or they can be sold directly in the market. The Company sold more steel billets in 2011 than in 2010, which was mainly attributable to a relative higher customer demand and a higher profit margin compared to the sales of steel plates and steel bars in 2011. The average sales price of steel billets was approximately $569 per ton during 2011, an increase of $54 per ton, or 10%, from $515 in 2010. The increase in sales price of steel billets also resulted from the rising iron ore prices.

Byproducts consist of the reselling of offcuts of steel plates, steel drop, oxygen gas and etc. Byproducts sales were $17,632,782 in 2011, an increase of $10,355,369, or 142%, compared to $7,277,413 in 2010. The Company does not sell its byproduct in its regular daily sales activities. The selling of byproducts depends on the market condition as byproducts may be reused as raw materials in our production.

Comparison of Cost of Revenue for the Years Ended December 31, 2011 and 2010
 
Costs of Revenue
 
2011
   
2010
 
Steel plates
  $ 460,188,852     $ 416,440,083  
Steel bars
    929,289       26,868,918  
Steel wires
    107,001,901       -  
Steel billets
    192,353,711       92,545,496  
Others
    1,172,281       -  
Total Cost of Revenue
  $ 761,646,034     $ 535,854,497  
 
Gross Profit Margin
  2011     2010  
Steel plates
    3.11 %     5.29 %
Steel bars
    0.57 %     -2.94 %
Steel wires
    10.78 %     -  
Steel billets
    8.25 %     7.98 %
Total Gross Profit Margin
    7.47 %     6.59 %
 
Cost of revenue totaled $761,646,034 for the year ended December 31, 2011, an increase of 225,791,537, or 42% compared to $535,854,497 in 2010. Of the increased cost of revenue, approximately $95.0 million or 42% of the increase was due to the increase in raw material price; $22.6 million, or 10% of the increase was attributable to the increase in production quantity; $107.0 million, or 47% of the increase was due to the increase in new product of steel wires; and $1.2 million, or 1% of the increase was due to the increase of other costs.
 
 
The Company does not buy any commodity products to hedge the fluctuation of market price. However, the fluctuation of commodity price will have a direct impact on our operation through the price changes in the local steel market. The average cost of revenue of steel plates was approximately $599 per ton 2011, an increase of $101 per ton, or 20%, from $498 in 2010. The average cost of revenue of steel bars was approximately $562 per ton in 2011, an increase of $11, or 2%, from $551 per ton in 2010. The average cost of revenue of steel wires was approximately $548 per ton in 2011. Average cost of revenue of steel billets was $522 per ton in 2011, an increase of $48 per ton, or 10%, from $474 in 2010. The new products – steel wire has higher gross profit rate than the gross profit rate of other our products, which helped improvement of our gross profit margin. The Company actively manages the production volume and type of steel products manufactured to maximize our net profit in response to the fluctuations in market conditions.

Comparison of Operating Expenses for the Years Ended December 31, 2011 and 2010

Selling, General and Administrative expenses consist of allowance for bad debts, selling expenses, professional service fees and other general and administrative expenses. Total operating expenses were $2,500,377 in 2011, a decrease of 31,884, or (1)%, compared to $2,532,261 in 2010. Operating expenses – non related parties were $1,695,836 in 2011, a decrease of $267,390, or -14%, compared to $1,963,226 in 2010. The decrease in operating expenses – non related parties were mainly attributable to $762,873 reduction in professional service and consulting fees in connection with the Company’s effort to be a listed in the US security market. The Company incurred $446,122 professional service and consulting fees in 2011, such fees were $1,208,995 in 2010. The Company expects that professional service fees will increase continually as a result of the Company’s effort to be listed in the US security market. The operating expenses – related parties were $804,541 in 2011, an increase of $235,506, or 41%, compared to $569,035 in 2010. The operating expenses – related parties represented service fees charged by YBS Group. YBS Group is the parent company. It provides various services to its subsidiary companies, such as market and industrial information, public relationship, various government agents’ relationship, coordination of recycling of byproducts among the subsidiaries and executive officers’ salaries. YBS Group charges a service fee based on its expenses and services and allocates to its subsidiary companies proportionally. The amount charged to each subsidiary varies each year. Commencing on 2010, YBS Group began changing a fee of 0.1% of annual revenue of Hongri. Management believes that 0.1% of annual revenue is reasonable and the cost would be similar or only marginally higher if the services had provided by the third parties.

Comparison of Other Expenses for the Year Ended December 31, 2011 and 2010

Other expenses consist of interest expense, gain or loss on disposal of fixed assets and interest income. Total net other expenses were $5,726,716 in 2011, an increase of $672,407, or 13%, compared to $5,054,309 in 2010. Interest expense for bank borrowings was $1,505,340 and $353,815 in 2011 and 2010, respectively. The increase of interest expense for bank borrowings mainly resulted from the increase in short-term bank loan borrowings. Other interest expense in connection with the related party loans was $4,405,934 and $4,719,552 in 2011 and 2010, respectively.

Comparison of Income Tax for the Years Ended December 31, 2011 and 2010

The provision for income tax of $7,432,439 and $4,455,177 for 2011 and 2010, respectively and arose from foreign income tax incurred and or paid to the Chinese tax authority. Hongri is subject to a PRC 25% standard enterprise income tax. Hongri applied for foreign investment enterprise exemption, and the application was approved by the local tax authority in 2007. Hongri was entitled to a tax holiday of full (100%) income tax exemption starting from the first profitable year of 2008 through 2009 and then a 50% reduction in income tax for additional three (3) years commencing 2010. The reduced income tax rate is 12.5% for the years ended December 31, 2010, 2011 and 2012.

Comparison of Net Income for the Years Ended December 31, 2011 and 2010

Net income totaled $45,801,476 in 2011, an increase of $20,031,036, or 78%, compared to the net income of $25,770,440 in 2010. The increase of net income was attributable primarily to the increase of revenue and decrease in selling, general and administrative expenses offset by the increase of other expenses as discussed above.

Liquidity and Capital Resources

The Company incurred losses in the third quarter of 2012. However, the Company still had net income of $5,934,990 in 2012. The Company’s decision to modify steel bar production line to produce steel wires to adapt to the market demand in 2011 helped the Company to alleviate some the negative market impact in 2012. The revenue from steel wires increased 96% in 2012. The revenue from steel wires accounted 36% of total revenue in 2012.
 
 
The cash flow generated from our operations can support our daily operations currently. Nevertheless, it may not be enough to support our operation in the future if the deterioration of steel market continues. The Company is facing rigorous challenges in 2013, including unfavorable steel industry cycles, unforeseeable recovery of world economy and uncertainty of political environment resulting from change of leadership in China. All those factors may continue have a negative impact on our operations and cash flows. It is difficult to predict and mitigate these unfavorable trends. Management will continuously monitor these negative factors and determine the production based on the demand of market, cash on hand and available credit facilitates.

In addition, the Company plans to add a new value added production line to adapt the market demand. To implement this expansion strategy, we may require external financial sources to support the capital investment. Management believes that our available cash will not be sufficient to fund our expansion requirements and therefore, the Company will look for external sources such as debt or equity financings. However, there is no assurance that any such required funds from external sources will be available on attractive terms or that they will not have a significant dilutive effect on the Company’s existing stockholders. If such required funds from outside sources are limited, or not available, the Company will adjust its expansion plan accordingly.

Relevant PRC statutory laws and regulations restrict certain payments, such as dividends, loans or advances, from the Companies’ registered capital. Such restricted capital amounted to approximate $14,799,000 as of December 31, 2012 and 2011. The Company is also required to allocate a portion of its after-tax profits to the statutory reserve. Annual appropriations to the statutory reserve are required to be at least 10% of the enterprise’s after-tax net income determined under Chinese GAAP. When the surplus reserves account balance is equal to or greater than 50% of the Company’s paid-in capital, no further allocation to the surplus reserve account is required. The Company’s surplus reserve is over 50% of the paid-in capital and does not need more surplus reserve in the future. As of December 2012 and 2011, the Company’s reserved fund totaled $6,530,869. In addition, our ability to use revenue generated in RMB to fund any future business activities outside of China or to make dividend or other payments in U.S. dollars is limited due to the regulations of PRC’s currency exchange. We cannot be certain that the Chinese regulatory authorities will not impose more stringent restrictions on the convertibility of the RMB in the future.

The Company currently intends to retain all earnings, if any, for use in its business operations. We have no plan to repurchase our common stock, nor declare any dividends in the near future.

The Company will have obligations to pay expenses in US dollars in connection with its status as a public company listed in the US security market, including audit, legal, contracted CFO and other SEC filing related service fees. These service fees are usually wired to the Company’s US bank account or paid to vendors directly from China as satisfying such obligations, which is allowed under the current PRC regulations. Other than these service fees, the Company has no significant obligations outside the PRC currently. The Company had cash of $1,710,887 and $1,737,495 as of December 31, 2012 and 2011, respectively. Most of the Company’s funds are kept in financial institutions in China, which do not provide insurance for deposits.

It has been the intent of the management to accelerate repayments of equipment loans, which were due to the related parties. During 2012, the Company repaid $42,037,885 equipment loans to YBS Group by offsetting its advances to related parties; the Company repaid $16,545,106 equipment loans to Hongrong by offsetting its advances to related parties in 2012. The remaining equipment loan balance to YBS group is $3,972,871.

The Company’s advances to related parties were $183,797,203 as of December 31, 2012, an increase of $106,380,918, or 137%, compared to $77,416,285 at December 31, 2011. The increase in advances to related parties resulted mainly from advance to Hongrong, the Company’s major molten iron supplier. The Company uses Hongrong as its primary molten iron supplier. It will reduce the transportation cost and steel making cost since Hongrong is located nearby Hongri. Hongrong has a new blast furnace ready for production and to guarantee the Company has enough molten iron supply, the Company advanced funds to Hongrong in order to ensure that at least 3 months of current volume demand is available for immediate use in Hongrong’s blast furnace. The balance of advances to Hongong approximated four months of cost of sales at the current production level. The accumulation of advance to Hongrong was due to that Hongrong’s new blast furnace is in its testing stage. The quality of molten iron was not stable and some of its molten iron could not be used in Hongri’s steel making process. As long as the technical issues of Hongrong’s new blast furnace are resolved, the purchase from Hongrong will be normalized and advance to Hongrong is expected to be reduced. However, in the event that the technical issues of Hongrong’s new blast furnace cannot be resolved, or the demand to Hongri’s steel products is lower, or there are further price reductions on raw materials already purchased, the assets advanced to Hongrong could be impaired and/or the gross profit margin may be negatively impacted. At the end of March 2013, the Company is still working on the improvement of the new blast furnance.

During 2012, the Company purchased total of $349,903,920 molten iron and steel iron, utility and spare parts from Hongrong. During 2011, the Company purchased total of $666,764,895 molten iron, scrap steel and supplies from Hongrong. During 2010, the Company purchased $431,329,226 of molten iron from Hongrong. The purchase form Hongrong in 2012 was lower than 2011, resulted from construction of Hongrong’s new blast furnace in 2012.
 
 
The Company’s accounts payable were $92,228,161 at December 31, 2012, an increase of $69,132,334, compared $23,095,827 at December 31, 2011. The increase in accounts payable resulted from increased payable balance to two new major steel pig iron suppliers of the Company. The payable to each such supplier amounted $52,569,091 and $16,539,706 in 2012. There was no such payable in 2011. The accounts payable balance is interest free and the Company has no specific terms of accounts payable with these vendors. The Company will pay these payables from cash generated from its operation currently. If the deterioration of steel market continues and the sales prices further decrease, the Company’s ability to pay these payables from its operation would be very limited. The Company may look for a debt or equity financing, if needed after taking into consideration the impact of the advances to related parties, the advances from customers and current debt requirements.

Advance from customers was $77,275,327 at December 31, 2012, an increase of $64,017,840, compared to $13,257,487 at December 31, 2011. The sales prices of steel products are fluctuated daily. Timing of buying and selling is one of the keys for profit. In order to ensure availability of the Company’s products in the event that the prices of steel products are going up, the customers will deposit certain amount of money in the Company’s account. During 2012, two new major customers increased approximately $40.1 million deposit in the Company’s account. These deposits are short term in nature and are interest free. If the deterioration of steel market continues and the sales prices are further decreased, some of the customers may recall their deposits. If it happens, it will have negative impact on Company’s cash flows and the Company may look for a debt or equity financing if needed after taking into consideration the impact of the advances to related parties, accounts payable and current debt requirements.
 
Net cash provided by operating activities was $65,538,117 in 2012. Net cash used in operation activities was $2,983,884 in 2011. The increase in net cash provided by operating activities in 2012 was mainly due to the adjustments as a result of changes in working capital components offset by the decrease of $39,866,486 in net income. The changes in working capital components primarily contributing to the increase in cash flow provided in operating activities were: (i) a decrease in accounts receivable ($11,574,308 decrease in 2012 and 8,019,652 increase in 2011), (ii) an increase in accounts payable ($68,044,123 increase in 2012 and $27,991,152 decrease in 2011), (iii) an increase in advances from customers ($63,091,486 increase in 2012 and $10,155,614 decrease in 2011), (iv) above major increase adjustments offset by a major decrease adjustment, an increase in advance to related parties ($104,287,340 increase in 2012 and $29,898,852 decrease in 2011).

Net cash used in investing activities was $27,524,933 and $9,860,311, respectively, in 2012 and 2011. Those expenditures were primarily related to the construction of steel wire production lines and replacement, or modification of current production lines equipment.

Net cash used in financing activities was $38,063,957 in 2012. During 2012, the Company repaid total of $76,089,600 and renewed and borrowed total of $63,408,000 from Raiffeisen Bank pursuant to a revolving loan agreement (the “Amendment Agreement II”) with Raiffeisen Bank International AG Beijing Branch (“Raiffeisen”) signed on June 28, 2011 and amended on July 23, 2012 and September 18, 2012 subsequently. The Amendment Loan Agreement II provides for a revolving credit facility in an aggregate principal amount of $16,051,000 (RMB 100,000,000) which shall be used as working capital only and could not exceed 180 days. The Company repaid total of $11,714,628 and renewed and borrowed $11,714,628 from credit Union and private party. The Company acquired a letter of credit loan from ICBC bank in the amount of $3,836,184. During 2012, the Company repaid equipment loans of $42,037,885 to YBS group, a related party and $16,545,106 to Hongrong. The Company received $2,672,647 short term loan from related parties and repaid $3,623,767 to related parties. The Company made $317,040 deposit to bank as additional collateral for bank notes payable. The Company paid $595,830 to related parties for obligation under capital lease in 2012. During 2012, the Company provided 100% credit guarantee to two major customers for them to get bank loans. These two customers then advanced $31,620,470 (RMB 197,000,000 translated at December 31, 2012 exchange rate) cash receipt from the bank to the Company as a prepayment for the goods (customer financing).
 
Net cash provided by financing activities was $10,287,419 in 2011. On June 28, 2011, Hongri entered into a revolving loan agreement (the “Agreement”) with Raiffeisen Bank International AG Beijing Branch (“Raiffeisen”). The Agreement provides for a revolving credit facility in an aggregate principal amount of RMB 180,000,000 ($28,602,000) which shall be used as working capital. On August 24, 2011, Hongri deposited RMB 15,000,000 ($2,320,500) into Raiffeisen to execute the revolving loan agreement, which was recorded as restricted cash. On August 31, 2011, the Company received the first borrowing RMB 180,000,000 ($28,602,000) which was due by February 27, 2012. During 2011, the Company repaid RMB 57,000,000 ($8,817,900) to Credit Union and acquired same amount $8,817,900 from Credit Union. During 2011, the Company made an additional RMB 7,000,000 ($1,082,900) deposit to a bank as additional collateral to bank notes payable. The Company also received $310,951 from private placement closed on January 28, 2011 (“PP1”) and private placement closed on February 7, 2011 (“PP2”). PP1and PP2 sold total of 2,580,022 units to 45 accredited investors with total proceeds of $3,873,047 and net proceeds of $3,486,192 after commission payment of $386,855. ($3,175,241 received in 2010, 310,951 received in 2011). The Company repaid $17,264,520 short term loan from a related party and acquired $15,237,950 short term loans from two related parties in 2011. The employee loan $722,360 was paid off in 2011. Repayment to equipment loans – related parties was $11,257,129 and repayment to obligation under capital lease – related parties was $540,646 in 2011.
 
 
Short-term Borrowings

Bank Notes Payable

The bank notes payable do not carry a stated interest rate, but carry a specific due date usually within six months. These notes are negotiable documents issued by financial institutions on the Company’s behalf to vendors. These notes can either be endorsed by the vendor to other third parties as payment, or prior to becoming due, they can factor these notes to other financial institutions. These notes are short-term in nature, as such; the Company does not calculate imputed interest with respect to them. These notes are collateralized by the Company’s restricted bank deposits. The Company has to maintain 100% or 50% of the balance of the bank notes payable to ensure future credit availability.

Bank Loans Payable

Bank loans at December 31, 2012 and December 31, 2011 consisted of the following:
 
     
2012
   
2011
 
To Credit Union
             
  Interest at 6.10%, payable March 29, 2012
(a)
  $ -     $ 3,019,100  
  Interest at 13.12%, payable  September 19, 2012
(b)
    -       3,019,100  
  Interest at 11.40%, payable September 24, 2013
(c)
    3,049,690       -  
  Interest at 7.28%, payable April 7, 2013
(d)
    3,049,690       -  
To Raiffeisen Bank International AG Beijing Branch
                 
  Interest at 7.93%, due by February 27, 2012
(e)
    -       28,602,000  
  Interest at 7.31%, due varied from January to February 2013
(f)
    16,051,000       -  
To a ICBC Letter of Credit Loan
                 
  Interest at 0%, payable May 16, 2013
(g)
    3,884,342       -  
Total Short Term Bank Loans
    $ 26,034,722     $ 34,640,200  
 
 
(a) On September 30, 2011, the Company received a $3,019,100 (RMB 19,000,000 translated at December 31, 2011 exchange rate) short-term borrowing from Credit Union. The loan was a “working capital” loan that bore interest at 6.10% per annum and was repaid on March 23, 2012.
 
 
(b) On September 22, 2011, the Company received a $3,019,100 (RMB 19,000,000 translated at December 31, 2011 exchange rate) short-term borrowing from Credit Union. The loan was a “working capital” loan that bore interest at 13.12% per annum and was repaid on September 19, 2012.
 
 
(c) On March 26, 2012, the Company received a $3,049,690 (RMB 19,000,000 translated at December 31, 2012 exchange rate) short-term borrowing from Credit Union. The loan bore interest at 7.93% per annum and was repaid on September 25, 2012. Upon repayment, the Company borrowed a new $3,049,690 (RMB 19,000,000 translated at December 31, 2012 exchange rate) loan on September 25, 2012. The loan is a “working capital” loan that bears interest at 11.40% per annum and due on September 24, 2013. The loan is secured by the equipment of Hongrong, a related party.

 
 (d) On October 8, 2012 the Company received a $3,049,690 (RMB 19,000,000 translated at December 31, 2012 exchange rate) short-term borrowing from Credit Union. The loan was a “working capital” loan that bears interest at 7.28% per annum and is due by April 7, 2013. The loan is secured by the equipment of Hongrong, a related party.
 
 
 
 (e) On June 28, 2011, Hongri entered into a revolving loan agreement (the “Agreement”) with Raiffeisen Bank International AG Beijing Branch (“Raiffeisen”). The Agreement provides for a revolving credit facility in an aggregate principal amount of   $28,602,000 (RMB 180,000,000 translated at December 31, 2011 exchange rate) which used as working capital. Each borrowing could not exceed 180 days or days the Bank agreed during the Agreement period.
 
On August 24, 2011, Hongri deposited $2,383,500 (RMB 15,000,000 translated at December 31, 2011 exchange rate) into Raiffeisen to execute the revolving loan agreement, which was recorded as restricted cash. On August 31, 2011, the Company received the first borrowing $28,602,000 (RMB 180,000,000) which was due by February 27, 2012. The Company repaid its outstanding balance as of February 24, 2012.  Upon the repayment, the Company acquired the second borrowing in the total amount of $28,602,000 (RMB 180,000,000) from Raiffeisen Bank. The second borrowing was due by varied date from July to August 2012. The Company repaid $28,602,000 in July and August 2012.

 
(f) On July 23, 2012, Hongri entered into an amendment agreement (the “Amendment Agreement I”) with Raiffeisen Bank International AG Beijing Branch (“Raiffeisen”). The Amendment Agreement provided for a revolving credit facility in an aggregate principal amount of $19,261,200 (RMB 120,000,000 translated at December 31, 2012 exchange rate) which used as working capital only. Each borrowing could not exceed 180 days or days the Bank agreed during the Amendment Agreement period.

On September 18, 2012, Hongri entered into a second amendment agreement (the “Amendment Agreement II”) with Raiffeisen Bank International AG Beijing Branch (“Raiffeisen”). The Amendment Agreement II provides for a revolving credit facility in an aggregate principal amount of $16,051,000 (RMB 100,000,000 translated at December 31, 2012 exchange rate) which is used as working capital only. Each borrowing could not exceed 180 days or days the Bank agreed during the Amendment Agreement period. The Amendment Agreement II is to be terminated on January 31, 2014.

During July 2012, the Company borrowed total of $3,210,000 (RMB 20,000,000 translated at December 31, 2012 exchange rate) and repaid all borrowed amount by the end of September 2012.

During August 2012, the Company borrowed total of $16,051,000 (RMB 100,000,000 translated at December 31, 2012 exchange rate) and repaid all borrowed amount by the end of September 2012. Upon repayment, the Company borrowed separately total of $16,051,000 (RMB 100,000,000 translated at December 31, 2012 exchange rate). The loans bear interest rate of 7.31% per annual and are due varied from January 29, 2013 to February 28, 2013. The total amount of $16,051,000 (RMB 100,000,000 translated at December 31, 2012 exchange rate) has been renewed and will be due varied from July 22 to August 2, 2013.

Pursuant to the Amendment Agreement II, borrowings will bear interest at 130.6% of the benchmark rates of similar loans published by the People’s Bank of China. Current benchmark interest rate for a six months loan is 5.6% revised on July 6, 2012. The borrowing interest is 7.31% currently. The interest is calculated on the daily basis and shall be paid on the 20th of the last month of each quarter. The borrowings are secured substantially by the following: all machinery and equipment of Hongri acquired before 2012. The net value of these machinery and equipment is approximately $159 million as of December 31, 2012, a security deposit of $1,605,100 (RMB 10,000,000) into the Raiffeisen bank as a collateral; corporate guaranty from Hebei Wu’an Yuanbaoshan Industry Group Co., Ltd. (“YBS group”), a majority shareholder of Hongri; and personal guaranty from Mr. Beifang Liu, Chairman of YBS group and Mr. Shenghong Liu, Chairman and Chief Executive Officer of the Company.

 
(g) On December 4, 2012, the Company borrowed a $3,884,342 (RMB 24,200,000 translated at December 31, 2012 exchange rate) short-term collateral loan from Industrial and Commercial Bank of China (“ICBC”). The loan is collaterated by a letter of credit in the same amount held by the Company, which is recorded as other assets in the balance sheet. The collateral loan is interest free and due by Mary 16, 2013.
 
 
Short Term Loan Payable – Related Party
 
On June 28, 2012, the Company borrowed $160,510 (RMB 1,000,000) from Mr. Beifang Liu, director of the Company, and $642,040 (RMB 4,000,000) from Mr. Maisheng Liu, brother of the CEO of the Company. These payables are interest free and due on demand.
 
The weighted average short term loan balance consisting of financial institution and private loans and Binchang Liu, Beifang Liu and Maisheng Liu loans was $31,241,243 and $18,308,766 for the years ended December 31, 2012 and 2011, respectively. The weighted average interest rate for short term loan was 8.34% and 8.11% for 2012 and 2011, respectively.
 
Customer Financing

During 2012, the Company provided 100% credit guarantee to two major customers for them to get bank loans. These two customers then advanced cash receipt from the bank to the Company as a prepayment for the goods. The credit guarantee amounted to $31,620,470 (RMB 197,000,000 translated at December 31, 2012 exchange rate). The loans will be due in August 2013 but can be renewed upon mutual agreement.
 
Critical Accounting Policies and Estimates

In Note 2 to our audited consolidated financial statements for the years ended December 31, 2012 and 2011 included in the Form 10K, the Company discusses those accounting policies that are considered to be significant in determining the results of operations and its financial position. The Company believes that the accounting principles utilized by it conform to accounting principles generally accepted in the United States of America (U.S. GAAP). The Company applies the following critical accounting policies related to revenue recognition in the preparation of its financial statements.
 
Use of Estimates

In preparing the consolidated financial statements in conformity with U.S. GAAP, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the consolidated financial statements, as well as the reported amounts of revenues and expenses during the reporting year. Significant estimates, required by management, include bad debt allowance, recoverability of long-lived assets and the valuation of inventories. Actual results could differ from those estimates.

Revenue Recognition

The recognize revenue from the sales of products. The Company recognizes revenues under FAS ASC Topic 605 “Revenue Recognition”. Revenue is recognized when all of the following have occurred: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been rendered, (iii) the price is fixed or determinable, and (iv) the ability to collect is reasonably assured. These criteria are generally satisfied at the time of delivery for sales when risk of loss and title passes to the customer. Revenue is reported net of all value added taxes. Other income is recognized when it is earned. The Company does not routinely permit customers to return products and historically, customer returns have been immaterial. The Company will replace the original product with a similar product if the customer is not satisfied with the quality of product.
 
 
Fair Value of Financial Instruments

The Company’s financial instruments consist of bank notes receivable, accounts receivable, net, advances to suppliers, VAT tax recoverable, advance to related parties, current portion of equipment loan payables, short term loan payable – related party, accrued liabilities, bank notes payable, accounts payable, accrued liabilities, tax payables, advances from customers, and accounts payable - related parties.  The fair value of these financial instruments approximate their carrying amounts reported in the balance sheets due to their short-term maturity or by comparison to other instruments with similar terms.

Foreign Currency Translation

The Company’s financial information is presented in U.S. dollars. The functional currency of the US parent company and US subsidiaries is the US dollar. The functional currency of the Company’s subsidiaries in the PRC is the RMB. Subsidiary transactions, which are denominated in currencies other than RMB, are translated into RMB at the exchange rate quoted by the People’s Bank of China prevailing at the dates of the transactions. Exchange gains and losses resulting from transactions denominated in a currency other than the RMB are included in statements of income as foreign currency transaction gain or loss.
 
The consolidated financial statements of the Company have been translated into U.S. dollars in accordance with ASC 830, “Foreign Currency Matters”. The financial information is first prepared in RMB and then is translated into U.S. dollars at period-end exchange rates for assets and liabilities and average exchange rates for revenue and expenses. Capital accounts are translated at their historical exchange rates when the capital transactions occurred. The effects of foreign currency translation adjustments are included as a component of accumulated other comprehensive income (loss) in stockholders’ equity.

Segment Information

ASC 280-10, “Disclosure About Segments of and Enterprise and Related Information”, requires entity-wide disclosures about the products and services an entity provides, the material countries in which it holds assets and reports revenues and its major customers. The Company operates in a single segment and will evaluate additional segment disclosure requirements as it expands its operations.
 
Off-Balance Sheet Arrangements

During 2012, the Company provided 100% credit guarantee to two major customers for them to get bank loans. These two customers then advanced cash receipt from the bank to the Company as a prepayment for the goods. The credit guarantee amounted to $31,620,470 (RMB 197,000,000 translated at December 31, 2012 exchange rate). The loans will be due in August 2013 but can be renewed upon mutual agreement.

Contractual Obligations

At December 31, 2012, our significant contractual obligations were as follows:

   
Less than
One Year
   
One to
Three Years
   
Three to
Five Years
   
More Than
Five Years
   
Total
 
Long Term Debts
  $ 2,884,919     $ 1,087,952     $ -     $ -     $ 3,972,871  
Capital Leases
    648,893       1,448,686       1,676,252       2,544,500       6,318,331  
Interest on Capital Leases
    480,029       809,158       581,593       2,338,363       4,209,143  
Interest on Equipment loans
    198,644       54,398       -       -       253,042  
 Total
  $ 4,212,485     $ 3,400,194     $ 2,257,845     $ 4,882,863     $ 14,753,387  
 
 
Item 7A. 
Quantitative and Qualitative Disclosures About Market Risk
 
Foreign Exchange Risk

While our reporting currency is the US dollar, almost all of our consolidated revenues and consolidated costs and expenses are denominated in RMB. All of our assets are denominated in RMB except for some cash and cash equivalents and accounts receivables. As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange rate between US dollar and RMB. If the RMB depreciates against the US dollar, the value of our RMB revenues, net income and assets as expressed in our US dollar financial statements will decline.  If the RMB appreciates against the US dollar, the value of our RMB revenues, net income and assets as expressed in US dollars will increase. We have not entered into any hedging transactions in an effort to reduce our exposure to foreign exchange risk.

Inflation Risk

According to the National Bureau of Statistics of China, the change in Consumer Price Index in China was 3.3% , 5.4% and 3.0 % in 2010, 2011 and 2012 respectively. In recent years, the PRC has not experienced significant inflation, and thus inflation has not had a material impact on our results of operations. Although we are generally able to pass along minor incremental cost inflation to our customers, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of gross margin and selling and distribution, general and administrative expenses as a percentage of net revenues if the selling prices of our products do not increase to cope with these increased costs.

Higher Interest Rate Risk

The Company may borrow more loans from bank in addition to other source of fund to support its expansion. We are exposed to higher interest rate risk arising from short-term borrowings. The interest rate in China is higher than that of in the US. The interest rate may go higher under the pressure of inflation. Our future interest expense will fluctuate in line with changes of borrowing rates.

Item 8. 
Financial Statements and Supplementary Data
 
 
 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the Board of Directors and Stockholders of
China Industrial Steel, Inc. and subsidiaries

We have audited the accompanying consolidated balance sheets of China Industrial Steel, Inc. and subsidiaries (the “Company”) as of December 31, 2012 and 2011, and the related consolidated statements of income and comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2012. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2012 and 2011, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America.


/s/Friedman LLP

New York, NY
April 1, 2013
 
 
 
CHINA INDUSTRIAL STEEL INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (IN US DOLLARS)
 
   
December 31,
   
December 31,
 
   
2012
   
2011
 
ASSETS
           
 Current Assets:
           
 Cash
  $ 1,710,887     $ 1,737,495  
 Bank notes receivable
    979,111       2,342,186  
 Accounts receivables, net
    9,639,396       20,862,269  
 Inventories, net
    11,585,277       16,139,936  
 Advances to suppliers, net
    2,372,693       3,215,680  
 VAT recoverable
    32,208,807       21,612,482  
 Advances to related parties
    183,797,203       77,416,285  
 Other current assets
    3,884,342       -  
     Total Current Assets
    246,177,716       143,326,333  
                 
 Machinery and Equipment, Net
    101,450,993       84,410,398  
 Machinery and Equipment - acquired from related parties, Net
    85,471,360       98,514,249  
Total Machinery and Equipment, Net
    186,922,353       182,924,647  
                 
                 
 Other Assets:
               
 Restricted cash
    5,778,360       5,402,600  
 Land use rights and buildings under capital leases
    4,985,732       5,613,105  
     Total Other Assets
    10,764,092       11,015,705  
                 
 TOTAL ASSETS
  $ 443,864,161     $ 337,266,685  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
 Current Liabilities:
               
 Accounts payable
  $ 92,228,161     $ 23,095,827  
 Accounts payable - related parties
    1,833,558       184,447  
 Accrued liabilities
    3,123,315       2,622,224  
 Taxes payables
    2,427       1,868,886  
 Bank loans payable
    26,034,722       34,640,200  
 Bank notes payable
    5,296,830       3,019,100  
 Equipment loan payable - related parties - current
    2,884,919       11,562,752  
 Current obligations under capital leases - related parties - current
    648,893       597,258  
 Short term loan payable - related party
    802,550       1,747,900  
 Customer financing
    31,620,470       -  
 Advances from customers
    77,275,327       13,257,487  
     Total Current Liabilities
    241,751,172       92,596,081  
                 
 Long Term Liabilities:
               
 Equipment loan payables - related parties - non current
    1,087,952       51,093,694  
 Obligation under capital leases - related parties - non current
    5,669,438       6,254,954  
     Total Long Term Liabilities
    6,757,390       57,348,648  
                 
 TOTAL LIABILITIES
    248,508,562       149,944,729  
                 
Commitments and Contingencies
               
                 
Stockholders' Equity:
               
Series A Convertible Preferred Stock, $0.0001 par value, 10,000,000 shares authorized, none issued and outstanding
    -       -  
Blank Check Preferred Stock, $0.0001 par value, 10,000,000 shares authorized, none issued and outstanding
    -       -  
Common stock, $0.0001 par value, 980,000,000 authorized, 73,620,391 and 73,542,058 issued and outstanding at December 31, 2012 and 2011, respectively
    7,362       7,354  
Paid-in capital
    16,417,235       16,299,744  
Statutory reserves
    6,530,869       6,530,869  
Retained earnings
    156,124,507       150,189,517  
Accumulated other comprehensive income
    16,275,626       14,294,472  
Total Stockholders' Equity
    195,355,599       187,321,956  
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 443,864,161     $ 337,266,685  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
CHINA INDUSTRIAL STEEL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (IN US DOLLARS)
FOR THE YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010
 
   
2012
   
2011
   
2010
 
Revenues
                 
Sales to customers
  $ 623,373,273     $ 796,011,478     $ 546,489,212  
Sales to related parties
    25,945,519       27,095,564       27,177,472  
    Total Revenues
    649,318,792       823,107,042       573,666,684  
                         
Cost of Revenue
                       
Cost of Revenue - non-related parties
    304,795,870       92,311,499       76,627,193  
Cost of Revenue - related parties
    329,666,806       669,334,535       459,227,304  
  Total Cost of Revenue
    634,462,676       761,646,034       535,854,497  
                         
Gross Profit
    14,856,116       61,461,008       37,812,187  
                         
Selling and General and Administrative Expenses
                       
Selling and General and Administrative Expenses - non-related parties
    2,225,060       1,695,836       1,963,226  
Selling and General and Administrative Expenses - related parties
    1,147,775       804,541       569,035  
Total Selling and General and Administrative Expenses
    3,372,835       2,500,377       2,532,261  
                         
Income From Operations
    11,483,281       58,960,631       35,279,926  
                         
Other Income (Expenses)
                       
Interest income
    194,673       67,303       19,058  
Interest expense - bank and private borrowings
    (2,855,244 )     (1,505,340 )     (353,815 )
Interest expense - related parties
    (1,705,435 )     (4,405,934 )     (4,719,552 )
Other income
    203,655       117,255       -  
    Total Other Income (Expenses)
    (4,162,351 )     (5,726,716 )     (5,054,309 )
                         
Income from operation before income tax
    7,320,930       53,233,915       30,225,617  
Provision for income tax
    1,385,940       7,432,439       4,455,177  
Net Income
    5,934,990       45,801,476       25,770,440  
                         
Earnings Per Share - Basic and Diluted
  $ 0.08     $ 0.62     $ 0.39  
Weighted Average Shares Outstanding - Basic and Diluted
    73,594,852       73,351,698       66,308,038  
                         
Other Comprehensive Income:
                       
Foreign currency translation gain
    1,981,154       7,753,060       4,122,803  
Comprehensive Income
  $ 7,916,144     $ 53,554,536     $ 29,893,243  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
CHINA INDUSTRIAL STEEL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (IN US DOLLARS)
FOR THE YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010
 
   
Preferred Stock
   
Common Stock
   
Stock to be
   
Additional Paid-In
   
Statutory
   
Retained
    Accumulated
Other
Comprehensive
     
   
Shares
   
Amount
   
Shares
   
Amount
   
Issued
   
Capital
   
Reserves
   
Earnings
   
Income
   
Total
 
Balance as of  December 31, 2009
    -     $ -       61,576,992     $ 6,158     $ -     $ 12,357,466     $ 6,530,869     $ 78,617,601     $ 2,418,609     $ 99,930,703  
Effect of recapitalization
    -       -       -       -       -       (691 )     -       -       -       (691 )
Common stock issued
    -       -       9,385,044       938       -       376,462       -       -       -       377,400  
Stock to be issued
    -       -       -       -       3,175,241       -       -       -       -       3,175,241  
Net income
    -       -       -       -       -       -       -       25,770,440       -       25,770,440  
Foreign currency translation adjustment
    -       -       -       -       -       -       -       -       4,122,803       4,122,803  
Balance as of December 31, 2010
    -       -       70,962,036       7,096       3,175,241       12,733,237       6,530,869       104,388,041       6,541,412       133,375,896  
Stock issued - private placement
    -       -       2,580,022       258       (3,175,241 )     3,485,934       -       -       -       310,951  
Additional paid in capital from Fakei
    -       -       -       -       -       80,573       -       -       -       80,573  
Net income
    -       -       -       -       -       -       -       45,801,476       -       45,801,476  
Foreign currency translation adjustment
    -       -       -       -       -       -       -       -       7,753,060       7,753,060  
Balance as of December 31, 2011
    -       -       73,542,058       7,354       -       16,299,744       6,530,869       150,189,517       14,294,472       187,321,956  
Stock issued for compensation
                    78,333       8               117,491                               117,499  
Net income
    -       -       -       -       -       -       -       5,934,990       -       5,934,990  
Foreign currency translation adjustment
    -       -       -       -       -       -       -       -       1,981,154       1,981,154  
Balance as of December 31, 2012
    -     $ -       73,620,391     $ 7,362     $ -     $ 16,417,235     $ 6,530,869     $ 156,124,507     $ 16,275,626