UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended: September 30, 2012

or

o 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)

1-646-328-1502

(Registrant’s telephone number, including area code)

____________________________

 (Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  

Yes x  No o

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).   

Yes x  No o

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	o		Accelerated filer	o
Non-accelerated filer	x	(Do not check if a smaller reporting company)	Smaller reporting company	o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  

Yes o  No x

APPLICABLE ONLY TO ISSUERS 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 Sections 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 o  No o

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 73,620,391 shares of common stock are issued and outstanding as of November 9, 2012.

TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS	F-1
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	4
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	14
ITEM 4. CONTROLS AND PROCEDURES	15
PART II – OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS	16
ITEM 1A. RISK FACTORS	16
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	16
ITEM 3. DEFAULTS UPON SENIOR SECURITIES	16
ITEM 4. MINE SAFETY DISCLOSURES	16
ITEM 5. OTHER INFORMATION	16
ITEM 6. EXHIBITS	17
SIGNATURES	18

PART I – FINANCIAL INFORMATION

Forward Looking Statements

This quarterly report contains forward-looking statements that relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may”, “should”, “expects”, “plans”, “anticipates”, “believes”, “estimates”, “predicts”, “potential” or “continue” or the negative of these terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors, that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Except as required by applicable law, including the securities laws of the United States, we do not intend to update any of the forward-looking statements to conform these statements to actual results.

Our unaudited financial statements are stated in United States Dollars (US$) and are prepared in accordance with United States Generally Accepted Accounting Principles. The following discussion should be read in conjunction with our financial statements and the related notes that appear elsewhere in this quarterly report. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward looking statements.

In this quarterly report, unless otherwise specified, all dollar amounts are expressed in United States dollars. All references to “common shares” refer to the common shares in our capital stock.

As used in this quarterly report, the terms "we", "us", "our", and "CIS" mean China Industrial Steel Inc., unless the context clearly requires otherwise.

3

ITEM 1. FINANCIAL STATEMENTS.

CHINA INDUSTRIAL STEEL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (IN US DOLLARS)
(UNAUDITED)
	September 30,		December 31,
	2012		2011
ASSETS
Current Assets:
Cash	$	1,100,439	$	1,737,495
Bank notes receivable		225,955		2,342,186
Accounts receivables, net		6,079,850		20,862,269
Inventories, net		9,790,159		16,139,936
Advances to suppliers, net		2,639,108		3,215,680
VAT and other taxes recoverable		29,747,838		21,612,482
Advances to related parties		176,815,708		77,416,285
Total Current Assets		226,399,057		143,326,333
Machinery and Equipment, Net		96,868,009		84,410,398
Machinery and Equipment - acquired from related parties, Net		88,388,646		98,514,249
Total Machinery and Equipment, Net		185,256,655		182,924,647
Other Assets:
Restricted cash		3,500,420		5,402,600
Land use rights and buildings under capital leases		5,111,815		5,613,105
Total Other Assets		8,612,235		11,015,705
TOTAL ASSETS	$	420,267,947	$	337,266,685
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable	$	96,776,076	$	23,095,827
Accounts payable - related parties		10,181,676		184,447
Accrued liabilities		2,418,914		2,622,224
Taxes payables		17,729		1,868,886
Bank and private loans payable		20,191,059		34,640,200
Bank notes payable		3,023,090		3,019,100
Equipment loan payable - related parties		3,938,219		11,562,752
Current obligations under capital leases - related parties		631,937		597,258
Short term loan payable - related party		795,550		1,747,900
Advances from customers		86,023,316		13,257,487
Total Current Liabilities		223,997,566		92,596,081
Long Term Liabilities:
Equipment loan payables - related parties		-		51,093,694
Obligation under capital leases - related parties		5,780,795		6,254,954
Total Long Term Liabilities		5,780,795		57,348,648
TOTAL LIABILITIES		229,778,361		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 September 30, 2012 and December 31, 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		152,995,798		150,189,517
Accumulated other comprehensive income		14,538,322		14,294,472
Total Stockholders' Equity		190,489,586		187,321,956
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	420,267,947	$	337,266,685

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

F-1

CHINA INDUSTRIAL STEEL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATION AND COMPREHENSIVE INCOME (LOSS) (IN US DOLLARS)
(UNAUDITED)
	Three Months Ended September 30,						Nine Months Ended September 30,
	2012			2011			2012			2011
Revenues
Sales to customers	$	162,539,814		$	222,596,275		$	475,334,300		$	605,634,960
Sales to related parties		7,010,402			3,359,561			16,816,933			24,644,993
Total Revenues		169,550,216			225,955,836			492,151,233			630,279,953
Cost of Revenue
Cost of Revenue - non-related parties		72,622,372			24,541,195			197,528,829			73,393,963
Cost of Revenue - related parties		99,305,592			177,943,910			283,719,169			508,579,448
Total Cost of Revenue		171,927,964			202,485,105			481,247,998			581,973,411
Gross Profit		(2,377,748	)		23,470,731			10,903,235			48,306,542
Selling and General and Administrative Expenses
Selling and General and Administrative Expenses - non-related parties		579,364			620,093			1,940,420			1,479,380
Selling and General and Administrative Expenses - related parties		165,787			225,951			1,048,696			629,402
Total Selling and General and Administrative Expenses		745,151			846,044			2,989,116			2,108,782
(Loss) Income From Operations		(3,122,899	)		22,624,687			7,914,119			46,197,760
Other Income (Expenses)
Interest income		137,276			47,132			191,885			55,675
Interest expense - bank and private borrowings		(584,983	)		(222,538	)		(2,451,068	)		(797,134	)
Interest expense - related parties		(177,674	)		(1,206,802	)		(1,464,263	)		(3,405,577	)
Total Other Income (Expenses)		(625,381	)		(1,382,208	)		(3,723,446	)		(4,147,036	)
(Loss) income from operation before income tax		(3,748,280	)		21,242,479			4,190,673			42,050,724
Provision for income tax		-			2,887,528			1,384,392			5,858,792
Net (Loss) Income		(3,748,280	)		18,354,951			2,806,281			36,191,932
Earnings Per Share - Basic and Diluted	$	(0.05	)	$	0.25		$	0.04		$	0.49
Weighted Average Shares Outstanding - Basic and Diluted		73,620,391			73,542,058			73,585,924			73,287,782
Other Comprehensive Income (Loss):
Foreign currency translation (loss) gain		2,042,302			2,196,174			243,850			5,209,554
Comprehensive Income (Loss)	$	(1,705,978	)	$	20,551,125		$	3,050,131		$	41,401,486

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

F-2

CHINA INDUSTRIAL STEEL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN US DOLLARS)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2012 AND 2011
(UNAUDITED)
	2012			2011
Cash Flows from Operating Activities:
Net Income	$	2,806,281		$	36,191,932
Adjustments to Reconcile Net Income to  Net Cash Provided by Operating Activities:
(Reduction) provision for allowance for doubtful accounts receivable		(225,900	)		169,458
Provision for allowance for forfeited advances to suppliers		860,201			-
Depreciation		18,870,122			17,487,162
Amortization of land use rights and buildings under capital leases		505,063			493,745
Common stock issued for services		117,499			-
Changes in operating assets and liabilities:
Decrease in accounts receivables		14,929,348			385,528
Decrease in accounts receivables - related party		-			6,177,200
Decrease (increase) in bank notes receivable		2,104,142			(3,033,993	)
Decrease in inventories		6,325,459			258,854
(Increase) decrease in advances to suppliers		(281,797	)		773,806
Increase in VAT and other taxes recoverable		(8,048,709	)		(3,122,829	)
Increase in advances to related parties		(140,477,692	)		(42,777,788	)
Increase (decrease) in accounts payable		73,122,036			(5,499,546	)
Increase (decrease) in accounts payable - related parties		474,397			(4,412,958	)
Decrease in accrued liabilities		(205,294	)		(1,617,300	)
Increase (decrease) in advances from customers		72,227,077			(11,718,295	)
(Decrease) increase in taxes payables		(1,840,346	)		2,206,469
Net Cash Provided by (Used in) Operating Activities		41,261,887			(8,038,555	)
Cash Flows from Investing Activities:
Capital expenditures		(11,493,538	)		(12,578,737	)
Net Cash Used in Investing Activities		(11,493,538	)		(12,578,737	)
Cash Flows from Financing Activities
Proceeds from bank and private loans		68,701,153			33,665,740
Repayment of bank loans		(83,092,220	)		(5,868,340	)
Proceeds from short term loan - related parties		2,663,374			-
Repayment of short term loan - related parties		(3,611,194	)		(3,721,763	)
Repayment of equipment loans - related party		(16,487,701	)		-
Payment of obligation under capital lease - related parties		(445,322	)		(404,776	)
Deposit of restricted cash		1,895,640			(5,250,620	)
Repayment of employee loans		-			(721,099	)
Proceeds from private placement		-			310,951
Net Cash (Used in) provided by Financing Activities		(30,376,270	)		18,010,093
Effect of Exchange Rate Changes on Cash		(29,135	)		103,134
Net Decrease in Cash and Cash Equivalents		(637,056	)		(2,504,065	)
Cash - Beginning of the Period		1,737,495			4,061,412
Cash - End of the Period	$	1,100,439		$	1,557,347
Supplemental Cash Flow Information:
Interest Paid	$	3,880,343		$	4,583,018
Income taxes	$	2,986,552		$	3,723,192
Supplemental Schedule of Non-Cash Investing Activities:
Repayment of equipment loan payable - related party offset by previous advances to the same related party	$	(41,892,031	)	$	-
Construction in progree paid by related party	$	9,450,961		$	-

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

F-3

CHINA INDUSTRIAL STEEL INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.   Organization and Basis of Presentation

Organization

China Industrial Steel inc. (“CIS”) was incorporated 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 at Handan City, Hebei Province, China. Hongri was incorporated under the Chinese laws on March 7, 2007 with registered capital of Reminbi (“RMB”) 90,489,999 (approximately $12 million US dollars). Hongri is primarily engaged in the business of manufacturing and selling steel plate, steel bars, steel wires and steel billets for domestic customers and certain related parties.

Hebei Wu’an Yuanbaoshan Industry Group Co., Ltd (“YBS Group”) is an enterprise incorporated and existing within the territory of 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 Entrusted Management Agreement, Exclusive Option Agreement, and 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 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 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 for 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 Variable Interest Entity (“VIE”) under ASC 810-10-05-8A. Accordingly, CIS consolidates Hongri’s operating results, assets and liabilities.

On August 10, 2010, Mr. Liu Shenghong, 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”) have entered into call option agreements, (collectively, the “Call Option Agreements”), with the major 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. 34% of the Option Shares became exercisable after December 31, 2011. The shareholders did not exercise these Option Shares 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.

F-4

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 own 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, CIS or the “Company”), historical operations of Hongri, and operations of CIS, Northern, Nuosen and Hongri from the date of the transaction.

CIS through Hongri, its operating company in China, produces and sells steel plates, steel bars, steel wires and steel billets. The Company currently has an aggregate production capacity of 2.3 million metric tons of steel per year from its headquarters on approximately 1,000 acres in Handan City, Hebei Province, China. Most of the Company’s products are domestically sold in China.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of the Company. All significant intercompany balances and transactions have been eliminated in consolidation.

The condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) and reflect all adjustments (consisting of normal recurring adjustments unless otherwise indicated) which, in the opinion of management, are necessary for a fair presentation of the results for the interim periods presented.

Certain information in footnote disclosures normally included in the financial statements prepared in conformity with accounting principles generally accepted in the United States of America has been condensed or omitted pursuant to such principles and the financial results for the periods presented may not be indicative of the full year’s results. The Company believes the disclosures are adequate to make the information presented not misleading.

These financial statements should be read in conjunction with the Company’s audited financial statements and notes thereto for the year ended December 31, 2011 included in the Company’s Annual Report on Form 10K filed in March 2012.

2.   Summary of Significant Accounting Policies

There have been no material changes during 2012 in the Companies’ significant accounting policies to these previously disclosed in the 2011 annual report.  Only those policies considered to be most important to the reader have been disclosed in the quarterly Form 10-Q.

Advances from Customers

Customer advances consist of amounts received from customers relating to the sales of the Company’s steel products. The Company recognizes these funds as a current liability until the revenue can be recognized.

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.

F-5

The unaudited 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.

The foreign exchange rates used in the translation were as follows:

	Three Months Ended				Nine Months Ended				Year Ended
	September 30,				September 30,				December 31,
	2012		2011		2012		2011		2011
RMB/US$ exchange rate	$	0.1591	$	0.1568	$	0.1591	$	0.1568	$	0.1589
Average RMB/US$ exchange rate		0.1575		0.1558		0.1580		0.1544		0.1547

The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into U.S. dollars at the rates used in translation.

Cash flows from the Company’s operations are calculated based upon the local currencies using the average translation rate. As a result, amounts related to assets and liabilities reported on the statements of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheets.

Net Income Per Share

Basic net income per share is computed on the basis of the weighted average number of common shares outstanding during the period.

Diluted net income per share is computed similarly to basic net income per share except that it includes the dilutive securities (warrants) outstanding and potential dilution that could occur if dilutive securities were converted. Such securities (2,580,022 warrants at $4.50 per share and 1,000 warrants at $2.00 per share), had an anti-dilutive effect and, as such, were excluded from the calculation for all periods presented.

Risks and Uncertainties

The operations of the Company are located in the PRC. Accordingly, the Company’s business and financial condition may be influenced by the political, economic, and legal environments in the PRC, as well as by the general state of the PRC economy. The Company’s operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environment and foreign currency exchange. The Company’s results may be adversely affected by changes in the political, regulatory and social conditions in the PRC, and by changes in governmental policies or interpretations with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation. The current management team (specifically the CEO) of the Company and the majority owner of the Company through YBS are also the majority owners of the controlled variable interest entity in the PRC, Handan Hongri Metallurgy Co. Ltd. (“Hongri”). The US parent company (or CIS) only controls Hongri through certain agreements which obligated CIS to absorb a majority of expected losses of Hongri or  enabled CIS  to receive a majority residual returns from Hongri and granted CIS the power to direct the activities of Hongri that most significantly impact Hongri’s economic performance. As such, there is a risk that the majority shareholders of the Company and, or Hongri could cancel these agreements. If such action was to be taken, the Company would no longer retain control of Hongri, the operating subsidiary. Although the Company has not experienced losses from these risks and believes that they are in compliance with existing laws and regulations including the organization and structure disclosed in Note 1, this may not be indicative of future results. In addition, the management of CIS currently intends to either reinvest or retain all of the income generated by Hongri for strategic expansion purposes and operations into the foreseeable future.

F-6

The Company has significant exposure to the fluctuation of raw materials and energy. The Company does not enter into any commodity contracts or other financial derivatives to hedge these risks.  In addition, the Company is subject to the cyclical nature of the steel industry and the current economic and political environment as it relates to steel production in China. There are many factors of the business which are impacted by prevailing market conditions, specifically, a change in the raw material and energy product pricing environment, rise or decline, will influence our inventory levels, purchasing decisions and will, ultimately, all have an impact on the Company’s gross profit and operating results. Excessive steel production capacities, lack of demand for steel products and higher iron ore, coking coal and material costs are major challenges that can occur within the Chinese steel industry and have begun to be encountered by the Company. In addition, a significant portion of the Company’s assets have been advanced to a related party supplier (see Note 11). These advances have been or are expected to be used by the related party to purchase raw materials for production of molten iron, which is a major raw material of the Company, equivalent to approximately 100 days of cost of sales of the Company currently. To the extent the demand is actually lower, or there are further price reductions on raw materials already purchased, the gross profit margin and results of operations may be negatively impacted. 

The Company provides credit in the normal course of business. Management continues to take appropriate actions to perform ongoing business and credit reviews of customers to reduce exposure to new and recurring customers who have been deemed to pose a high credit risk based on their commercial credit reports, the Company’s collection history, and perception of the risk posed by their geographic location. Concentration of credit risk with respect to accounts receivable is limited because a large number of geographically diverse customers make up the Company’s customer base. In addition, our customers may advance or deposit cash with the Company in order to obtain future order fulfillment preference.  Such advances increased to $86 million at September 30, 2012.  Should steel pricing further decrease or demand further deteriorate for any reason, such advances may need to be repaid to the applicable customer.  Through the date of filing there have been no requests for repayment.  However, this may not be indicative of future results.

The Company is potentially exposed to risks of losses that may result from business interruptions, injury to others (including employees) and damage to property. These losses may be uninsured, especially due to the fact that the Company’s operations are in China, where business insurance is not readily available. As of September 30, 2012, the Company has not experienced any uninsured losses from injury to others or other losses.

The Company incurred losses of $3,748,280 in the three months ended September 30, 2012. The cash flow generated from the Company’s operations can support the Company’s daily operations currently. However, it may not be enough to support the operations in the future if there is a continuous significant deterioration in the Chinese steel market. The Company is facing rigorous challenges in the remainder of 2012 and the coming 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 have a negative impact on the Company’s future results of operations and cash flows which could be difficult to predict and mitigate.

Recent Accounting Pronouncements

There were no new pronouncements that would have a material impact on the financial position of the Company.

3. Bank Notes Receivable

Bank notes receivable are highly liquid negotiable instruments issued by banks in the PRC on behalf of Hongri’s customers.  These notes typically have maturities between one to six months.  With these bank notes, The Company can: (a) redeem the notes for face value at maturity, (b) endorse the notes to the Company’s vendors as a form of payment instrument at full value, or (c) factor the notes to a bank.  In the event that the Company factors these notes to a bank, it will record as interest expense the difference between cash received and the face value of the note. The Company believes all of the notes are fully realizable.

F-7

4. Accounts Receivable

Accounts receivable at September 30, 2012 and December 31, 2011 consisted of the following:

	2012			2011
Accounts receivable	$	6,374,909		$	21,383,735
Allowance for doubtful accounts		(295,059	)		(521,466	)
Accounts receivable, net	$	6,079,850		$	20,862,269

5. Inventories

Inventories at September 30, 2012 and December 31, 2011 consisted of the following:

	2012		2011
Raw materials	$	22,441	$	172,372
Finished products		4,567,544		12,004,416
Spare parts		5,200,174		3,963,148
Total	$	9,790,159	$	16,139,936

6. Machinery and Equipment, Net

Machinery and equipment stated at cost less accumulated depreciation at September 30, 2012 and December 31, 2011 consisted of the following:

	2012			2011
Machinery and equipment	$	252,698,401		$	246,906,365
Auxiliary facilities		3,032,426			3,028,424
Transportation equipment		565,245			552,288
Office equipment		42,675			34,087
Electronic equipment		58,190			36,741
Subtotal		256,396,937			250,557,905
Accumulated depreciation		(89,618,874	)		(70,520,287	)
Construction in progress		18,478,592			2,887,029
Total	$	185,256,655		$	182,924,647

Construction in progress is related to the expanding of steel wires production capacity. 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 the negative market impact in 2012. Total estimated cost for expansion of steel wires capacity is approximately $32 million. The Company believes that facilities to produce steel plate are not impaired though the production was reduced in the current quarter.  Management will continuously monitor the market situation and may add additional equipment to enable current plate production line to produce other steel products based on the demand of market, cash on hand and available credit facilitates in the future.

F-8

7. Restricted Cash

Restricted cash consisted of the following at September 30, 2012 and December 31, 2011.

	2012		2011
Bank deposit as part of collateral to bank notes payable	$	1,909,320	$	3,019,100
Bank deposit as part of collateral to working capital loan		1,591,100		2,383,500
Total	$	3,500,420	$	5,402,600

Restricted cash represents required cash deposits by the bank as a part of collateral to bank notes payable and working capital loan (see Note 9). The Company has to maintain 100% or 50% of the balance of the bank notes payable to ensure future credit availability. The Company earns interest at a variable rate per month on this restricted cash.

8.   Obligations Under Capital Leases – Related Parties

The Company accounts for its related party leases with YBS and its affiliates as capital leases under ASC 840 because YBS has the ability to extend the length of the terms of all of the leases whenever they see fit. Therefore, the leases meet the requirement for capitalization of assets as the term is expected to be greater than 75% of the useful life of the asset. Typically, the terms of the lease are based on YBS’s costs. The value of the capitalized assets have been calculated to be the present value of all lease payments over the stated term using the Company’s bank borrowing rates. Should YBS extend any of the leases, the Company will re-calculate the value of the capitalized lease based on the renewed terms and record an additional asset upon the occurrence.

In December 2007, the Company entered into a lease agreement with YBS Group to lease 956 mu (approximately 157.5 acres) of land as its manufacturing site. The rent for the first three years was waived per lease agreement. The annual lease payment is RMB 1,434,450 (approximately $228,235) which commenced in 2011. The average lease payment is RMB 1,291,005 (approximately $205,412) per annum. The lease is set to expire on December 31, 2037. The present value of the total lease payments at inception was RMB 12,703,147 (approximately $2,021,198 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 YBS Group to lease the manufacturing building of Plate-Rolling I. The annual lease payment is RMB 3,522,211 (approximately $560,419) 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 RMB 23,816,623 (approximately $3,789,463 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 RMB 1,210,716 (approximately $192,637) 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 RMB 8,186,666 (approximately $1,302,580 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 RMB 107,469 (approximately $17,099) 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 RMB 793,198 (approximately $126,206 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 RMB 758,503 (approximately $120,685) 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 RMB 5,598,552 (approximately $890,786 at the current exchange rate), which was calculated with a discount rate of 5.94%, a PRC long term borrowing rate in December 2009.

F-9

As of September 30, 2012, future minimum rental payments applicable to the above non-cancelable capital leases with remaining terms in excess of one year were as follows:

September 30,	Capital Leases
2013	$	1,119,075
2014		1,119,075
2015		1,119,075
2016		1,119,075
2017		1,119,075
Thereafter		5,120,045
Total minimum lease payments		10,715,420
Less amount representing interest		(4,302,688	)
Present value of net minimum lease payments		6,412,732
Less current obligations		(631,937	)
Long-term obligations	$	5,780,795

9.   Bank Notes, Bank Loan Payable, Private Loan and Short Term Loan Payable – Related Party

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% of the balance of the bank notes payable to ensure future credit availability.

Bank and Private Loan Payable

Bank and private loans at September 30, 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)		3,023,090		-
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)		15,911,000		-
To a Private Loan
Interest at 10.50%, payable January 10, 2013	(d)		1,256,969		-
Total Short Term Bank Loans		$	20,191,059	$	34,640,200

(a) On September 30, 2011, the Company received a RMB 19,000,000 ($3,019,100, 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 RMB 19,000,000 ($3,019,100 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.

F-10

(c) On March 26, 2012, the Company received a RMB 19,000,000 ($3,023,090) 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 RMB 19,000,000 ($3,023,090) 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.

Total value of equipment secured for above mentioned bank loans is RMB 70,967,104 ($11,292,576).

(d) On January 20, 2012, the Company received a RMB 7,900,000 ($1,256,969) short-term borrowing from a private lender. The loan bears interest of 10.50% per annum and is due on January 10, 2013.

(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   RMB 180,000,000 (approximately $28,602,000 translated at the rate of December 31, 2011) 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 RMB 15,000,000 ($2,383,500, 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 RMB 180,000,000 ($28,602,000) 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 RMB 180,000,000 from Raiffeisen Bank. The second borrowing was due by varied from July to August 2012. On June 27, 2012, the Company repaid RMB 60,000,000 ($9,478,200, translated at the average rate of the nine months ended September 30, 2012). The remaining balance of RMB 120,000,000 ($18,956,400, translated at the average rate of the nine months ended September 30, 2012) was repaid in July (RMB 50,000,000) and August (RMB 70,000,000).

(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 RMB 120,000,000 (approximately $19,093,200, translated at the rate of September 30, 2012) 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 RMB 100,000,000 (approximately $15,911,000, translated at the rate of September 30, 2012) 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 August 2012, the Company borrowed total of RMB 100,000,000 ($15,797,000, translated at the average rate of the nine months ended September 30, 2012) and repaid all borrowed amount by the end of September 2012. Upon repayment, the Company borrowed separately total of RMB 100,000,000 ($15,911,000, translated at the rate of September 30, 2012). The loans bear interest rate of 7.31% per annual and are due varied from January 29, 2013 to February 28, 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; a security deposit of RMB 10,000,000 (approximately $1,591,100) 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.

F-11

Short Term Loan Payable – Related Party

During 2011, the Company borrowed RMB 11,000,000 from Mr. Maisheng Liu, a senior manager of the Company. During the six months ended June 30, 2012, the Company borrowed additional RMB 11,860,000 from Mr. Maisheng Liu and returned total of RMB 22,860,000 ($3,611,194) to Mr. Liu.

On June 28, 2012, the Company borrowed RMB 1,000,000 ($159,110) from Mr. Beifang Liu, director of the Company, and RMB 4,000,000 ($636,440) 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 $24,051,181 and $9,020,513 for the nine months ended September 30, 2012 and 2011, respectively. The weighted average interest rate for short term loan was 8.77% and 8.32% for the nine months ended September 30, 2012 and 2011, respectively.

10.   Taxes Payable

Tax payables at September 30, 2012 and December 31, 2011 consisted of:

	2012		2011
PRC corporation income tax	$	-	$	1,602,160
Other taxes payable		17,729		266,726
Total	$	17,729	$	1,868,886

See Note 13.

11.   Related Party Transactions

Hongri is 70% owned by YBS Group,a major shareholder of some other steel production related companies, mainly Hongrong Iron and Steel Co. Ltd. (“Hongrong”), Wu'an Baoye Coke Industrial Co. Ltd.(“Baoye”), Wu'an Yuanbaoshan Cement Plant (“Cement Plant”), Wu'an Yuanbaoshan Ore Treatment Plant (“Ore Treatment”), Wu'an Yuanbaoshan Industrial Group Go. Ltd - Gas Station and Wu’an Yeijin Iron Co. Ltd. (“Yeijin”). During the routine business process, Hongri purchases raw materials and supplies from these companies and advances to / or owes cash to these companies.

The relationships and the nature of related party transactions are summarized as follow:

Name of Related Party	Owned by YBS and its major shareholders			Relationship  to Hongri	Nature of Transactions
Hebei Wu'an Yuanbaoshan Industrial Group Co. Ltd. (“YBS Group”)	Self			70% parent	Services, information and public relationship, and coordination
Wu'an Yuanbaoshan Industrial Group Co. Ltd - Gas Station		100	%	Affiliated company	Supplier of gas
Wu'an Hongrong Iron & Steel Co. Ltd (“Hongrong”)		67	%	Affiliated company	Supplier of molten iron
Wu'an Baoye Coke Industrial Co. Ltd. (“Baoye”)		49	%	Affiliated company	Supplier of coke
Wu'an Yuanbaoshan Cement Plant		36	%	Affiliated company	Supplier of cement
Wu'an Yuanbaoshan Ore Treatment Plant		33	%	Affiliated company	Supplier of granular
Wu’an Yeijin Iron Co. Ltd		31	%	Affiliated company	Supplier of iron

F-12

Consolidation is required when an entity holds a controlling interest in another entity (often in the form of control through voting interests) or if the entity meets the requirements of a variable interest entity (“VIE”). The Company has no direct control of the affiliated companies, noted above, through voting interests. However, because the Company has a variable interest in some of these affiliated companies via the supply relationships noted above (i.e. implied relationships), the Company is required to determine whether such affiliates are VIE’s and, if so, whether the Company is the primary beneficiary so that consolidation must occur. A VIE has the following characteristics in accordance with ASC 810-10-15-14:  insufficient equity investment at risk; equity lacking decision-making rights; equity with nonsubstantive voting rights; lacking the obligation to absorb an entity’s expected losses and lacking the right to receive an entity’s expected residual returns. The Company’s analysis concluded that such affiliates were not VIE’s because none of these characteristics are present.

As of September 30, 2012 and December 31, 2011 advances to related parties and accounts payable - related parties consisted of:

Advances to Related Parties
Name of related parties	2012		2011
YBS Group	$	-	$	21,075,317
Hongrong		176,653,491		56,340,968
Cement Plant		162,217		-
Total Advances to Related Parties	$	176,815,708	$	77,416,285

Accounts Payable - Related Parties
Name of related parties	2012			2011
YBS Group	$	(9,562,720	)	$	-
Baoye		(615,803	)		(56,447	)
Ore Treatment		(3,153	)		(3,149	)
Cement Plant		-			(124,851	)
Total Accounts Payable - Related Parties	$	(10,181,676	)	$	(184,447	)

The balance of advances to YBS group, a parent company, was $0 and $21,075,317 as of September 30, 2012 and December 31, 2011, respectively. YBS Group is a parent company. It provides various services to the subsidiary companies, such as market and industrial information, public relationship, various government agents’ relationship, coordination the production and purchase for subsidiaries and so on. Advances to YBS Group were in connection with the purchase of iron and supplementary materials used in Hongrong’s production, a motlen iron supplier of Hongri. The balance of advance to YBS Group will be returned or credited for YBS Group’s other services provided to the Company.

YBS group charged a service fee based on applicable itemized expenses and fixed service fee. Commencing in 2010, YBS Group charged 0.1% of current year revenue of Hongri as a fixed service fee. Service fees consisted of management salaries, training, consultations, common areas charges and other fees. Management believes that 0.1% of revenue is a reasonable charge method. The Company estimated that this service fee would be similar or marginally higher if the same services had been provided by third parties. In addition to the fixed service fee, the Company will charge itemized services and expenses to the Company if such service and expenses are incurred. The services fees were $165,787 and $225,953 for the three months ended September 30, 2012 and 2011, respectively, and $1,023,655 and $629,403 for the nine months ended September 30, 2012 and 2011, respectively. Among the nine months services fees ended September 30, 2012, $560,254 was an itemized expense in connection with the refinancing of RMB 180 million loan from Raiffeisen Bank. Executive officers’ salaries were stand-alone expenses. Such expenses were $15,911 and $15,580 for the three months ended September 30, 2012 and 2011, respectively, and $47,531 and $46,229 for the nine months ended September 30, 2012 and 2011, respectively.

During nine months ended September 30, 2012, the Company repaid its $41,892,031 equipment loans to YBS group by offsetting its previous and current advanced fund to YBS group. In the same period, the Company also repaid $16,487,701 equipment loan to Hongrong by offsetting its current advanced fund to Hongrong.

F-13

Purchases from related parties

Hongri purchased raw materials from the above-mentioned related parties and had advances and accounts payable to these related parties in the routine business operations. It is a common practice in China that a vendor or supplier requires an advance payment before the shipment of merchandise. Company advance to the related parties enable these related parties to pay partial amounts in advance to their vendors or suppliers. Most of these advances related to the purchase of raw material and other supplies in routine business and were short term in nature. These advances are interest free. The Company is in favor of 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 more 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 Hongrong, the Company’s major molten iron supplier, was $176,653,491 and $56,340,968 as of September 30, 2012 and December 31, 2011, respectively.

Accounts payable to related parties represents an unsettled amount in the normal course of business. These payables were short term in nature. Total payable to related parties was $10,181,676 and $184,447 as of September 30, 2012 and December 31, 2011, respectively. Among accounts payable – related parties, $9,450,961 to YBS group was related to the equipment the Company received during nine months ended September 30, 2012. The received equipment was included in the construction in progress as of September 30, 2012.

For the three months ended September 30, 2012, the Company purchased $95,602,827 (246,092 metric tons) molten iron and steel iron and $1,708,558 utility and other materials from Hongrong. For the nine months ended September 30, 2012, the Company purchased $269,643,744 (649,844 metric tons) molten iron and steel iron and $14,586,473 utility and other materials from Hongrong. During the three and nine months ended September 30, 2011, the Company purchased $176,488,138 (388,479 metric tons) and $506,574,339 (1,102,860 metric tons), respectively, of molten iron from Hongrong.

Sales to related parties

During the three and nine months ended in September 30, 2012, the Company’s sales of its products to YBS Group amounted to $4,660,167 and $8,871,871, respectively. During the three and nine months ended September 30, 2011, the Company’s sales of its products to YBS Group amounted to $1,136,271 and $17,881,628, respectively. YBS acts as a distributor of steel products for the Company and all sales are final. The only right of return is for defective steel products and the Company has not experienced any returns in the past years of operations. The steel products are picked up directly by YBS’ customers at which time the Company recognizes the sale. The Company has determined these sales should be recorded on a gross basis based on the following analysis: upon shipment all risks of ownership transfer to YBS’ customers and the Company does not bare any additional risks and YBS has all of the collection risk from its customers.

During the three and nine months ended September 30, 2012, the Company sold $343,455 and $3,833,650 steel products to Hongrong, which were used in Hongrong’s blast furnace constructions. The Company also sold $2,006,780 and $4,102,425 by-products to Hongrong for the three and nine months ended September 30, 2012, respectively, which were re-used in manufacturing of molten iron. During three and nine months ended September 30, 2011, the Company sold $578,426 and $5,118,501 steel products and $1,644,864 and $1,644,864 by-products to Hongrong, respectively.

During three and nine months ended September 30, 2012, the Company sold $0 and $8,987 steel products to Baoye.

Equipment purchased from related parties

See Note 12 Equipment Loans Payable – Related Parties.

Loan from related party

See Note 9 Bank Notes, Bank Loan Payable and Short Term Loan Payable – Related Party

F-14

Leases from related parties

See Note 8 Obligations Under Capital Lease – Related Parties

12.   Equipment Loans Payable – Related Parties

Equipment loan payables – related parties at September 30, 2012 and December 31, 2011 consisted of:

Equipment Loans Payable	2012			2011
Equipment loan - YBS Group payable	$	3,938,219		$	46,071,679
Equipment loan - Hongrong payable		-			16,584,767
Total equipment loans payable		3,938,219			62,656,446
Less: current portion		(3,938,219	)		(11,562,752	)
Long-term payable	$	-		$	51,093,694

On November 30, 2007, the Company purchased Plate-Rolling I production line and related auxiliary equipment from YBS Group at a price of RMB 191,163,559 (approximately $26,208,524 translated at the historical exchange rate), which was at cost, and carryover basis of YBS group. YBS Group provided a 10 year seller-financed loan to the Company to finance the purchase. The loan bore interest at 5% per annum, and has a fixed repayment schedule at RMB 17,973,455 (approximately $2,859,756 at the September 30, 2012 exchange rate) per annum (payable at the end of the year). On March 31, 2012 the Company repaid $16,458,861 equipment loan to YBS group by offsetting its previous advanced fund to YBS group. The remaining unpaid loan balance of $2,382,180 was paid on June 30, 2012 by offsetting its previous and current advanced fund to YBS group.

On November 30, 2009, the Company purchased Steel-Making II production line and related auxiliary equipment from YBS Group at a price of RMB 243,811,599 (approximately $35,718,399 at the historical exchange rate), which was at cost, and carryover basis of YBS Group. YBS Group provided a 10 year seller-financed loan to the Company to finance the purchase. The loan bears interest at 5% per annum, and has a fixed repayment schedule at RMB 24,380,000 (approximately $3,879,102 at September 30, 2012 exchange rate) per annum (payable at the end of the year). On June 30, 2012 the Company repaid $23,050,990equipment loan to YBS group by offsetting its previous advanced fund to YBS group. The remaining unpaid loan balance is $3,938,219.

On November 30, 2007, the Company purchased Steel-Making I production line and related auxiliary equipment from Hongrong at a price of RMB 326,028,440 ($44,698,499 translated at the historical exchange rate), which was at cost, and carryover basis of Hongrong. Hongrong provided a 10 year seller-financed loan to the Company to finance the purchase. The loan bore interest at 5% per annum, and has a fixed annual repayment schedule at RMB 30,414,021 (approximately $4,839,175 at September 30, 2012 exchange rate) per annum (payable at the end of the year). On March 31, 2012, the Company repaid the remaining $16,487,701 equipment loan balance to Hongrong by offsetting its current advanced fund to Hongrong.

For the three and nine months ended September 30, 2012, the Company recorded interest expense and paid interest totaling $49,228 and $990,368 to YBS Group, respectively. For the three and nine months ended September 30, 2011, the Company recorded interest expense and paid interest totalling $647,144 and $1,917,258 to YBS Group, respectively.

For the three and nine months ended September 30, 2012, the Company recorded interest expense and paid interest totaling $0 and $206,762 to Hongrong, respectively. For the three and nine months ended September 30, 2011, the Company recorded interest expense and paid interest totalling $262,497 and $777,684 to Hongrong, respectively.

F-15

13.   Income Tax

The provision for income tax arose from income tax incurred and or paid to the Chinese tax agent.

Hongri is subject to the PRC’s 25% standard enterprise income tax. However, in 2007, the Company applied for a foreign investment enterprise exemption, and the application was approved by the local tax authority. The Company is entitled to a tax holiday of full (100%) income tax exemption for two (2) years starting from the first profitable year of 2008 through 2009 and then a 50% reduction in income tax for additional three (3) years from the year of 2010 to 2012.

Nuosen is subject to the PRC’s 25% standard enterprise income tax.

Foreign pretax loss was $3,679,977 for the three months ended September and earnings of $21,332,060 for the three months ended September 30, 2011, respectively. Foreign pretax earnings were $4,688,782 and $42,427,479 for the nine months ended September 30, 2012 and 2011, respectively. Pretax earnings of a foreign subsidiary are subject to U.S. taxation when effectively repatriated. The Company provides income taxes on the undistributed earnings of non-U.S. subsidiaries except to the extent that such earnings are indefinitely invested outside the United States. At September 30, 2012, approximately $161,234,000 of accumulated unadjusted earnings of non-U.S. subsidiaries was indefinitely invested. At the existing U.S federal corporation income tax rate of 34%, an additional tax of $45,819,000 approximately would have to be provided if such earnings were remitted currently.

The following table reconciled the US statutory rates to the Company’s effective rate for the three and nine months ended September 30, 2012 and 2011.

	Three Months Ended September 30,						Nine Months Ended September 30,
	2012			2011			2012			2011
US statutory tax rate		34.0	%		34.0	%		34.0	%		34.0	%
Foreign income not recognized in US		-34.0	%		-34.0	%		-34.0	%		-34.0	%
China income tax rate		0.0	%		12.5	%		29.5	% *		12.5	%
Non-deductible expenses		0.0	%		1.1	%		3.5	%		1.4	%
Effective rate		0.0	%		13.6	%		33.0	%		13.9	%

*	29.5% was effective rate for the nine months ended September 30, 2012 due to loss in current quarter.
	The Company may not claim refund of tax paid in previous quarters.

CIS and Northern were incorporated in the United States and have incurred net operating losses for income tax purposes in past years and the current period. As of September 30, 2012, the Companies had loss carry forwards of approximately $1708,000 for U.S. income tax purposes available for offset against future taxable U.S. income expiring in 2030 and 2031. Management believes that the realization of the benefits from these losses appears uncertain due to the Company's limited operating history. Accordingly, a full deferred tax asset valuation allowance has been provided and no deferred tax asset benefit has been recorded. The valuation allowance as of September 30, 2012 and December 31, 2011 were approximately $581,000 and $411,000, respectively.

The Company did not have any significant temporary differences relating to deferred tax liabilities as of September 30, 2012 and December 31, 2011.

The Company files income tax returns with U.S. Federal Government and the states of Maryland and Colorado. With few exceptions, the Company is subject to U.S. federal and Maryland state income tax examinations by tax authorities for years on or after 2007 and for years on or after 2006 by Colorado tax authorities. The Company’s foreign subsidiaries also file income tax returns with the National Tax Bureau (with its branches in Handan) and other taxes and surcharges with the Local Tax Bureaus (Hubei Provincial Tax Bureau and Handan Municipal Tax Bureau). The Company is subject to tax examinations by these foreign tax authorities for years from 2007 to 2009.

F-16

The Company evaluated its tax positions, and as of September 30, 2012 and December 31, 2011. No uncertain tax position has been identified.

14.   Commitments and Contingencies

In the normal course of business, the Company is subject to contingencies, including legal proceedings and claims arising out of the normal course of businesses that relate to a wide range of matters, including among others, product liability. The Company records accruals for such contingencies based upon the assessment of the probability of occurrence and where determinable, an estimate of the liability. Management may consider many factors in making these assessments including past history, scientific evidence and the specifics of each matter.  As of September 30, 2012 and December 31, 2011, the Company had no pending litigation.

15.    Major Customers and Vendors

For the three months ended September 30, 2012 and 2011, there were two (2) and three (3) major customers that accounted for approximately 48% and 38% of the Company’s total sales, respectively. Each of major customer accounted 25% and 23% of total sales for three months ended September 30, 2012, and 14%, 14% and 10% of total sales for the three months ended September 30, 2011, respectively.

For the nine months ended September 30, 2012 and 2011, there were two (2) major customers that accounted for approximately 42% and 35% of the Company’s total sales, respectively. Each of major customer accounted 22% and 20% of total sales for nine months ended September 30, 2012, and 18% and 17% of total sales for the nine months ended September 30, 2011, respectively.

For three months ended September 30, 2012, 59% of the total Company’s purchase was from Hongrong, and 32% of the total purchase was from an unrelated party. For the comparable period of 2011, 98% of the total purchases were from Hongrong. No purchase from other vendors was over 5%.

For nine months ended September 30, 2012, 62% of the total Company’s purchase was from Hongrong, and 32% of the total purchase was from an unrelated party. For the comparable period of 2011, 98% of the total purchases were from Hongrong. No purchase from other vendors was over 5%.

16.   Major Products Lines

The Company operates in one industry segment and in one geographic region, which is the PRC. Revenues and costs of goods sold by major products for the three and nine months ended September 30, 2012 and 2011 consisted of:

	Three Months Ended September 30,				Nine Months Ended September 30,
Revenues	2012		2011		2012		2011
Steel plates	$	68,888,563	$	141,829,798	$	234,481,468	$	439,293,501
Steel bars/steel wires		79,207,594		37,654,951		184,161,945		38,583,974
Steel billets		17,691,200		41,524,991		64,758,880		137,666,819
Byproducts and others		3,762,859		4,946,096		8,748,940		14,735,659
Total Revenues	$	169,550,216	$	225,955,836	$	492,151,233	$	630,279,953

F-17

	Three Months Ended September 30,				Nine Months Ended September 30,
Costs of Revenue		2012		2011		2012		2011
Steel plates	$	74,576,323	$	132,399,026	$	241,787,579	$	421,433,705
Steel bars/steel wires		79,810,988		32,041,516		178,480,622		32,965,278
Steel billets		17,230,547		36,929,465		59,539,101		126,459,330
Others		310,106		1,115,098		1,440,696		1,115,098
Total Cost of Revenue	$	171,927,964	$	202,485,105	$	481,247,998	$	581,973,411

	Three Months Ended September 30,					Nine Months Ended September 30,
Gross Profit Margin		2012		2011			2012		2011
Steel plates		-8.26	%	6.65	%		-3.12	%	4.07	%
Steel bars/steel wires		-0.76	%	14.91	%		3.08	%	14.56	%
Steel billets		2.60	%	11.07	%		8.06	%	8.14	%
Total Gross Profit Margin		-1.40	%	10.39	%		2.22	%	7.66	%

The Company sold 146,689 and 226,997 metric tons of steel plates for the three months ended September 30, 2012 and 2011, respectively. The Company sold 443,065 and 708,731 metric tons of steel plates for the nine months ended September 30, 2012 and 2011, respectively.

The Company sold 164,331 and 55,672 metric tons of steel wires and bars for the three months ended September 30, 2012 and 2011, respectively. The Company sold 345,902 and 57,325 metric tons of steel wires and bars for the nine months ended September 30, 2012 and 2011, respectively.

The Company sold 35,957 and 69,342 metric tons of steel billets for the three months ended June 30, 2012 and 2011, respectively. The Company sold 121,559 and 235,696 metric tons of steel billets for the nine months ended September 30, 2012 and 2011, respectively.

17.   Subsequent Event

On October 8, 2012, the Company received a RMB 19,000,000 ($3,022,900) short-term borrowing from Credit Union. The loan bears interest at 7.28% per annum and will be due on April 17, 2013. The loan is secured by the equipment of Hongrong.

F-18

ITEM 2. 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, China Industrial Steel Inc. (“CIS” or the “Company”), through Northern Steel Inc. (“Northern”) and its wholly owned foreign enterprise, Nuosen (Handan) Trading Co., Ltd (“Nuosen”), entered into Entrusted Management Agreement, Exclusive Option Agreement, and Covenants Agreement (collectively, the “Entrusted Agreements”) with Handan Hongri Metallurgy Co., Ltd. (“Hongri”) and shareholders of Hongri, Hebei Wu’an Yuanbaoshan Industry Group Co., Ltd (“YBS Group”) and Fakei Investment (Hong Kong) Ltd (“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 Variable Interest Entity (“VIE”) under ASC 810-10-05-8A. 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 own 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. Annualized production of steelmaking to total capacity utilization rate was approximately 61% and 64% for the three months ended September 30, 2012 and 2011, respectively. Annualized production of steelmaking to total capacity utilization rate was approximately 52% and 60% for the nine months ended September 30, 2012 and 2011, respectively. The decrease in capacity utilization rate in 2012 resulted from a reduced  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 bar production). Annualized production of steel rolling to total capacity utilization rate was approximately 61% and 57% for the three months ended September 30, 2012 and 2011, respectively. Annualized production of steel rolling to total capacity utilization rate was approximately 52% and 51% for the nine months ended September 30, 2012 and 2011, respectively.

Due to the nature of its business, the Company has significant exposure to the fluctuation of raw materials and energy prices as part of its normal operations. There are many factors of our business which are impacted by prevailing market conditions, specifically, a change in the raw material and energy pricing environment will influence our inventory levels and purchasing decisions which will, ultimately, impact our realized gross margin. The Company’s management operational decisions are a direct 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 our operation through the price change in local steel market.

4

The Company subcontracted Wu'an Hongrong Iron & Steel Co. Ltd (“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 our gross profit margin since the subcontracting fees paid was commensurate with the gross profit of manufacturing molten iron in the local market.

For the three months ended September 30, 2012, 59% of the Company’s total purchase was from Hongrong, and 32% of the total purchase was from an unrelated party. For the comparable period of 2011, 98% of the total purchases were from Hongrong. No purchase from other vendors was over 5%. For the nine months ended September 30, 2012, 62% of the Company’s total purchase was from Hongrong, and 32% of the total purchase was from an unrelated party. For the comparable period of 2011, 98% of the total purchases were from Hongrong. No purchase from other vendors was over 5%. The decrease in purchase form Hongrong was mainly due to the maintenance of the blast furnace and construction of a new blast furnace in Hongrong.  It is expected that once the blast furnace is completed by late November, the purchases from Hongrong will increase and the third party purchases will decrease.

For the three months ended September 30, 2012 and 2011, there were two (2) and three (3) major customers that accounted for approximately 48% and 38% of the Company’s total sales, respectively. Each of major customer accounted 25% and 23% of total sales for three months ended September 30, 2012, and 14%, 14% and 10% of total sales for the three months ended September 30, 2011, respectively.

For the nine months ended September 30, 2012 and 2011, there were two (2) major customers that accounted for approximately 42% and 35% of the Company’s total sales, respectively. Each of major customer accounted 22% and 20% of total sales for nine months ended September 30, 2012, and 18% and 17% of total sales for the nine months ended September 30, 2011, respectively.

Excessive steel production capacities, lack of demand for steel products and higher iron ore, coking coal and material costs are major challenges that the Chinese steel industry has encountered today after more than twenty years of expansion and development in China. According to Association of Chinese Steel Industry, steel manufactures Chinese comprehensive price index of steel products (“CSPI”), an index combined various price of steel products, an economic indicator of market demand for steel products, was decreasing continuously from the beginning of 2012. At September 30, 2012, CSPI was 102.45, a decrease of 18 points compared to 120.45 at December 31, 2011; a decrease of 29.85 points compared to 132.30 at September 30, 2011. Though the price of iron ore, coking coal and other materials were decreased in the same period, the extent of decrease in raw material was less than the decrease in the price of steel products. Many Chinese steel manufacturers incurred losses in 2012. It was estimated by the “Association of Chinese Steel Industry” that 45% of steel manufacturers were experiencing losses during the nine months ended September 30, 2012. This loss percentage increased 11 points from 34% estimated for the six months ended June 30, 2012. The recovery of the Chinese steel market is still uncertain and will largely depend on the expected new Chinese government and its new economic development policy and bounce-back of the world economy.

During the three and nine months ended September 30, 2012, the decrease in sales price was greater than the decrease in cost of production had a material negative impact on the Company’s operation results. The Company incurred losses for the three months ended September 30, 2012. If the deterioration of steel market continues, the Company may have further losses in the remainder of 2012.

Results of Operations for the Three Months Ended September 30, 2012 and 2011

Comparison of Revenue for the Three Months Ended September 30, 2012 and 2011

	2012				2011
Products	Revenue		Quantity (Ton)		Revenue		Quantity (Ton)
Steel plates	$	68,888,563		146,689	$	141,829,798		226,997
Steel wires / bars		79,207,594		164,331		37,654,951		55,672
Steel billets		17,691,200		35,957		41,524,991		69,342
Byproducts and others		3,762,859		-		4,946,096		-
Products Total	$	169,550,216		346,977	$	225,955,836		352,011

Total sales for the three months ended September 30, 2012 were $169,550,216, a decrease of $56,405,620, or 25%, compared to $225,955,836 in the comparable period in 2011. Of the decreased revenues, approximately $59 million, or 104% of the decrease was due to a decrease in average sales price of steel products; 2% of the decrease was due to a decrease in the revenue of byproducts and other income; the decrease in revenue was offset by a 6% increase in revenue resulted from increase in steel wires/bars sales quantities offset by the decrease in selling quantity of steel plates and steel billets.

5

Revenue from steel plates was $68,888,563 in 2012, a decrease of $72,941,235, or 51% compared to $141,829,798 in 2011. The Company sold 146,689 tons of steel plates in 2012, a decrease of 80,308 ton or 35%, compared to 226,997 tons in 2011. The Company reduced its production of steel plates in the reporting period of 2012 due to lower sales price and lack of market demand. The average unit sales price of steel plates was approximately $470 per ton during the three months ended September 30, 2012, a decrease of $155 per ton, or 25%, from $625 in 2011.

In 2011, the Company modified steel bar production line to produce steel wires to adapt to the market demand. Production of steel wires helped the Company to alleviate the negative market impact to certain extent in 2012. During three months ended September 30, 2012, revenue from steel wires was $79,207,594, an increase of 41,552,643, or 110%, compared to 37,654,951 in the comparable period of 2011. The Company sold 164,331 metric tons of steel wires, an increase of 108,659 metric tons, or 195%, compared to 55,672 in the same period in 2011. However, the increase of sales was offset by the decrease in the sales price. The average unit sales price of steel wires was approximately $482 per ton during the three months ended September 30, 2012, a decrease of $194 per ton, or 29%, from $676 in the comparable period in 2011.

Revenue from steel billets was $17,691,200 in the three months ended September 30, 2012, a decrease of $23,833,791, or 57%, compared to $41,524,991 in the comparable period of 2011. The Company sold 35,957 metric tons of steel billets in the three months ended September 30, 2012, a decrease of 33,385 metric tons, or 48%, compared to 69,342 metric tons in the comparable period in 2011. The average unit sales price of steel billets was approximately $492 per ton during the three months ended September 30, 2012, a decrease of $107 per ton, or 18%, from $599 in the three months ended September 30, 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 the three months ended September 30, 2012, which was mainly attributable to lower sales price and relative lower customer demand caused by the down market condition.

Byproducts and others consist of the reselling of offcuts of steel plates, steel drop and oxygen gas. and others. Byproducts and others sales were $3,762,859 in the three months ended September 30, 2012, a decrease of $1,183,237, or 24%, compared to $4,946,096 in the comparable period of 2011. 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 Three Months Ended September 30, 2012 and 2011

Costs of Revenue	2012		2011
Steel plates	$	74,576,323	$	132,399,026
Steel wires / bars		79,810,988		32,041,516
Steel billets		17,230,547		36,929,465
Byproducts and others		310,106		1,115,098
Total Cost of Revenue	$	171,927,964	$	202,485,105

Gross Profit Margin	2012		2011
Steel plates	-8.26	%	6.65	%
Steel wires / bars	-0.76	%	14.91	%
Steel billets	2.60	%	11.07	%
Total Gross Profit Margin	-1.40	%	10.39	%

Cost of revenue totaled $171,927,964 for the three months ended September 30, 2012, a decrease of $30,557,141, or 15% compared to $202,485,105 in the comparable period of 2011. Of the decreased cost of revenue, approximately $28 million or 91% of the decrease was due to the decrease in raw material price, $2 million, or 7% of the decrease was due to decrease in production quantities and remaining 2% of the decrease was due to decrease in byproducts and others.

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 $508 per ton in the three months ended September 30, 2012, a decrease of $75 per ton, or 13%, from $583 in the comparable period of 2011. The average cost of revenue of steel wires was approximately $486 per ton in the three months ended September 30, 2012, a decrease of $90, or 16%, compared to $576 in the comparable period of 2011. The average cost of revenue of steel billets was $479 per metric ton, a decrease of $54, or 10%, compared to $533 per metric ton in the comparable period of 2011. The Company actively manages the production volume and type of steel products manufactured to maximize net profit or reduce the loss in response to the fluctuations in market conditions.

6

Comparison of Operating Expenses for the Three Months Ended September 30, 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 $745,151 in the three months ended September 30, 2012, a decrease of 100,893, or 12%, compared to $846,044 in the comparable period of 2011. Operating expenses – non related parties was $579,364 in the three months ended September 30, 2012, a decrease of $40,729, or 7%, compared to $620,093 in the comparable period of 2011. The decrease in operating expenses – non related parties was mainly attributable to $232,000 decrease in financing costs in connection with the Raiffeisen Bank loan, offset by the increase in allowance for impairment of advance to suppliers and business taxes. The Company made an allowance for potentially forfeited advances to suppliers based on aging commenced from the quarter ended March 31, 2012. The Company incurred $62,250 professional service and consulting fees in the three months ended September 30, 2012, a decrease of 4,580 or 7% as compared to $66,830 in the comparable period of 2011. The Company expects that professional service fees will increase as a result of the Company being listed in the US security market.

The operating expenses – related parties were $165,787 in the three months ended September 30, 2012, a decrease of $60,164, or 27%, compared to $225,951 in the comparable period of 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 subsidiary companies, 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 countable expenses and fixed service fee. Commencing in 2010, YBS Group charged Hongri as a fixed service fee of 0.1% of Hongri’s revenue. Service fees consisted of management salaries, trainings, consultations, common area charges and other fees. The management believes that 0.1% of revenue is a reasonable charge method and 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 such service and expenses incurred. Executive officers’ salaries were stand-alone expenses. Such expenses were $15,911 and $15,580 for the three months ended September 30, 2012 and 2011, respectively.

Comparison of Other Expenses for the Three Months Ended September 30, 2012 and 2011

Other expenses consist of interest expense and interest income. Total net other expenses were $625,381 in the three months ended September 30, 2012, compared to $1,382,208 in the comparable period of 2011. Interest expense for bank and private borrowings was $652,059 and $222,538 in the three months ended September 30, 2012 and 2011, respectively. The increase of interest expense for bank borrowings mainly resulted from the increase in short-term bank and private loan borrowings and in increase in interest rate. During the three months ended September 30, 2012, the average loan balance outstanding was approximately $8,888,000 and the average loan interest rate was 8.72%. During the comparable period of 2011, the average loan balance outstanding was approximately $4,268,000 and the average loan interest was 8.41%. Other interest expense in connection with the related party loans was $177,674 and $1,206,802 in the three months ended September 30, 2012 and 2011, respectively. The decrease in interest expense – related parties resulted from repayments of equipment loans – related parties in 2012.

Comparison of Income Tax for the Three Months Ended September 30, 2012 and 2011

The provision for income tax of $0 and $2,887,528 for the three months ended September 30, 2012 and 2011, respectively and arose from foreign income tax incurred and or paid to the Chinese tax authority. The Standard corporation income tax rate is 25% currently 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. The Company incurred loss from its operation during the three months ended September 30, 2012. Management believes that the realization of the benefits from these losses 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 Three Months Ended September 30, 2012 and 2011

The Company incurred losses of $3,748,280 from its operations in the three months ended September 30, 2012, compared to the net income of $18,354,951 in the comparable period of 2011. The decrease of net income was attributable primarily to decrease in sales price of the Company’s products as discussed above. The average sales price per ton decreased in 24%, a 10 percentage higher than 14% of the decrease in average cost of sales per ton.

7

Results of Operations for the Nine Months Ended September 30, 2012 and 2011

Comparison of Revenue for the Nine Months Ended September 30, 2012 and 2011

	2012				2011
Products	Revenue		Quantity (Ton)		Revenue		Quantity (Ton)
Steel plates	$	234,481,468		443,065	$	439,293,501		708,731
Steel wires / bars		184,161,945		345,902		38,583,974		57,325
Steel billets		64,758,880		121,559		137,666,819		235,696
Byproducts and others		8,748,940		-		14,735,659		-
Products Total	$	492,151,233		910,526	$	630,279,953		1,001,752

Total sales for the nine months ended September 30, 2012 were $492,151,233, a decrease of $138,128,720, or 22%, compared to $630,279,953 in the nine months ended September 30, 2011. Of the decreased revenues, approximately $95 million or 69% of the decrease was due to decrease in average sales price; $37 million or 27% was due to decrease in selling quantity of steel plates and steel billets off set by increase of new steel wire product; the remaining decrease was related to byproducts and others.

Revenue from steel plates was $234,481,468 in the nine months ended September 30, 2012, a decrease of $204,812,033, or 47% compared to $439,293,501 in the nine months ended September 30, 2011. The Company sold 443,065 tons of steel plates in the nine months ended September 30, 2012, a decrease of 265,666 tons or 37%, compared to 708,731 tons in the comparable period of 2011. The Company reduced its production of steel plates in the nine months ended September 30, 2012 due to lack of market demand. The average unit sales price of steel plates was approximately $529 per ton during the nine months ended September 30, 2012, a decrease of $91 per ton, or 15%, from $620 in the nine months ended September 30, 2011.

In 2011, the Company modified steel bar production line to produce steel wires to adapt to the market demand. Production of steel wires helped the Company to alleviate the negative market impact to certain extent in 2012. During nine months ended September 30, 2012, the Company sold 345,902 metric tons of steel wires and bars, which generated $184,161,945 of revenue. In the comparable period of 2011, the Company sold 57,325 metric tons of steel wires and bars with revenue of $38,583,974. Other than $929,023 steel bars revenue, there was no steel wires production in the first six months of 2011. During three months ended September 30, 2012, revenue from steel wires was $79,207,594, an increase of 41,552,643, or 110%, compared to 37,654,951 in the comparable period of 2011.

Revenue from steel billets was $64,758,880 in the nine months ended September 30, 2012, a decrease of 72,907,939, or 53%, compared to $137,666,819 in the comparable period of 2011. The Company sold 121,559 metric tons of steel billets in the nine months ended September 30, 2012, a decrease of 114,137 tons, or 48%, compared to 235,696 metric tons in the comparable period of 2011. Steel billets are semi-finished products that can be used to produce steel plates or steel bars and steel wires with further processing, or they can be sold directly in the market. The Company sold fewer steel billets in the nine months ended September 30, 2012, which was mainly attributable to a relative lower customer demand and down market condition.

Byproducts consist of the reselling of offcuts of steel plates, steel drop and oxygen gas. Byproducts and others income were $8,748,940 in the nine months ended September 30, 2012, a decrease of $5,986,719, or 41%, compared to $14,735,659 in the comparable period of 2011. 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 Nine Months Ended September 30, 2012 and 2011

Costs of Revenue	2012		2011
Steel plates	$	241,787,579	$	421,433,705
Steel wires / bars		178,480,622		32,965,278
Steel billets		59,539,101		126,459,330
Byproducts and others		1,440,696		1,115,098
Total Cost of Revenue	$	481,247,998	$	581,973,411

Gross Profit Margin	2012		2011
Steel plates	-3.12	%	4.07	%
Steel wires / bars	3.08	%	14.56	%
Steel billets	8.06	%	8.14	%
Total Gross Profit Margin	2.22	%	7.66	%

8

Cost of revenue totaled $481,247,998 for the nine months ended September 30, 2012, a decrease of $100,725,413, or 17% compared to $581,973,411 in the comparable period of 2011. Of the decreased cost of revenue, approximately $48 million or 47% of the decrease was due to the decrease in unit cost of sales; approximately $53 million, or 53% of the decrease was due to decrease in production quantities of steel plates and steel billets, offset by the increase of steel wires.

The Company does not buy any commodity products to hedge the fluctuation of market price. However, the fluctuation of commodity prices 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 $546 per ton in the nine months ended September 30, 2012, a decrease of $49 per ton, or 8%, from $595 in the comparable period of 2011. The average cost of revenue of steel billets was $490 per ton in the nine months ended September 30, 2012, a decrease of $47, or 9%, from $537 in the comparable period of 2011. The average cost of revenue of steel wires/bars was approximately $516 per ton in the nine months ended September 30, 2012, a decrease of $59, or 10%, from $575 in the comparable period of 2011. There was no sale of steel wires during the six months ended June 30, 2011. The Company actively manages the production volume and type of steel products manufactured to maximize net profit in response to the fluctuations in market conditions.

Comparison of Operating Expenses for the Nine Months Ended September 30, 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 $2,989,116 in the nine months ended September 30, 2012, an increase of 880,334, or 42%, compared to $2,108,782 in the comparable period of 2011. Operating expenses – non related parties was $1,940,420 in the nine months ended September 30, 2012, an increase of $461,040, or 31%, compared to $1,479,380 in the comparable period of 2011. The increase in operating expenses – non related parties was mainly attributable to $860,201 increase in allowance for impairment of advance to suppliers, which was offset by $57,218 decrease in allowance for doubtful accounts receivable. The Company made an allowance for potentially forfeited advances to suppliers based on aging commenced from of the quarter ended March 31, 2012. The Company incurred $492,015 professional service and consulting fees in the nine months ended September 30, 2012, such fees were $374,308 in the comparable period of 2011. 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 $1,048,696 in the nine months ended September 30, 2012, an increase of $419,294, or 67%, compared to $629,402 in the comparable period of 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 subsidiary companies, 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 countable expenses and fixed service fee. 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 such service and expenses incurred. Among the services fees in the nine months ended September 30, 2012, $560,254 was an itemized charge in connection with the refinancing of the RMB 180 million loan from Raiffeisen Bank. Executive officers’ salaries were stand-alone expenses. Such expenses were $47,531 and $46,229 for the nine months ended September 30, 2012 and 2011, respectively.

Comparison of Other Expenses for the Nine Months Ended September 30, 2012 and 2011

Other expenses consist of interest expense and interest income. Total net other expenses were $3,723,446 in the nine months ended September 30, 2012, compared to $4,147,036 in the comparable period of 2011. Interest expense for bank and private borrowings was $2,518,114 in the nine months ended September 30, 2012, an increase of $1,720,980, or 216%, compared to $797,134 in the comparable period of 2011. The increase of interest expense for bank and private loan borrowings mainly resulted from the increase in short-term bank and private loan borrowings and in increase in interest rate. During the nine months ended September 30, 2012, the average loan balance outstanding was approximately $24,051,000 and the average loan interest rate was 8.77%. During the comparable period of 2011, the average loan balance outstanding was approximately $9,020,513 and the average loan interest was 8.32%. Other interest expense in connection with the related party loans was $1,464,263 and $3,405,577 in the nine months ended September 30, 2012 and 2011, respectively. The decrease in interest expense – related parties resulted from repayments of equipment loans – related parties in 2012.

9

Comparison of Income Tax for the Nine Months Ended September 30, 2012 and 2011

The provision for income tax of $1,384,392 and $5,858,792 for the nine months ended September 30, 2012 and 2011, respectively and arose from foreign income tax incurred and or paid to the Chinese tax authority. The Standard corporation income tax rate is 25% currently 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. The Company incurred loss from its operation during the three months ended September 30, 2012. The losses in the three months ended September 30, 2012 brought effective tax rates to 29.5% for the nine months ended September 30, 2012. Management believes that the realization of the benefits from these losses 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 Nine Months Ended September 30, 2012 and 2011

Net income totaled $2,806,281 in the nine months ended September 30, 2012, a decrease of $33,385,651, or 92%, compared to the net income of $36,191,932 in the comparable period of 2011. The Company incurred losses of $3,748,280 from its operations in the nine months ended September 30, 2012, compared to the net income of $18,354,951 in the comparable period of 2011. The decrease of net income was attributable primarily to decrease in sales price of the Company’s products as discussed above. The average sales price per ton decreased in 14%, 5 percentage higher than 9% of the decrease in average cost of sales per ton.

Liquidity and Capital Resources

The Company incurred losses of $3,748,280 in the three months ended September 30, 2012. However, the Company still had positive cash inflow from operating approximately $6.4 million during the three months ended September 30, 2012, and $41.3 million for the nine months ended September 30, 2012. The Company’s decision to modify steel bar production line to produce steel wires to adapt to the market demand in 2011helped the Company to alleviate some the negative market impact in 2012. During the three months ended September 30, 2012, the revenue from steel wires increased 110% compared to the comparable period of 2011. The revenue from steel wires accounted 47% of total revenue in the three months ended September 30, 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 continuous. The Company is facing rigorous challenges in the remainder of 2012 and the coming 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 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 production line to produce a coated steel product, known as Galvalume, which is primarily used in the automotive and home appliance industries. To implement this expansion strategy, it is estimated that we will require at least $80 million. 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, then 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 $15,244,000 as of September 30, 2012. 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. As of September 30, 2012, 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.

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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 $1,100,439 and $1,737,495 as of September 30, 2012 and December 31, 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 the nine months ended September 30, 2012, the Company repaid $41,892,031 equipment loans to YBS Group by offsetting its advances to related parties in previous year; the Company repaid $16,487,701 equipment loans to Hongrong by offsetting its advances to related parties in current year. The remaining equipment loan balance is $3,938,219.

The Company’s advances to related parties were $176,815,708 as of September 30, 2012, an increase of $99,399,423, or 128%, 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 is in favor of 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 more 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 funace.   The advance to Hongrong was $176,653,491 as of September 30, 2012, an increase of $120,312,523 compared $56,340,968 at December 31, 2011. Most of these advances related to the purchase of raw materials and other supplies in routine business and were short term in nature. The balance of advances to Hongong approximated 100 days of cost of sales  at the current production level. To the extent the demand is actually lower, or there are further price reductions on raw materials already purchased, the gross profit margin, results of operations and cash flow may be negatively impacted.

The Company’s accounts payable were $96,776,076 at September 30, 2012, an increase of 73,680,249, compared $23,095,827 at December 31, 2011. The increase in accounts payable resulted mainly from increased payable balance to one new major pig iron supplier of the Company. The payable to such supplier amounted $73,659,103 and $0 at September 30, 2012 and December 31, 2011, respectively. The accounts payable balance is interest free and the Company has no specific terms of accounts payable with this vendor. The Company will pay this payable from cash generated from its operation currently. If the deterioration of steel market continues and the sales prices are further decreased, the Company’s ability to pay these payables from its operation is limited. The Company may require additional funding from external source, either debt or equity financing.  We cannot be sure funding will be available on reasonable terms when we require funding.

Advance from customers was $86,023,316 at September 30, 2012, an increase of $72,765,829, 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 get the Company’s products with priority whenever the price of steel products are going up, the customer will deposit certain amount of money in Company’s account. During nine months ended September 30, 2012, two major customers increased approximately $48.4 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 customer may recall their deposits. If it happens, it will have negative impact on Company’s cash flows. The Company may require additional funding from external source, either debt or equity financing.  We cannot be sure funding will be available on reasonable terms when we require funding.

Net cash provided by operating activities was $41,261,887 in the nine months ended September 30, 2012. Net cash used in operation activities was $8,038,555 in the nine months ended September 30, 2011. The increase in net cash provided by operating activities in 2012 was mainly due to the following factors: A $33,385,651 negative change in net income ($2,806,281 in 2012 and $36,191,932 in 2011). A $14,543,820 positive change in accounts receivable ($14,929,348 decrease in accounts receivable in 2012, $385,528 decrease in accounts receivable in 2011) resulted from more subsequent collections in 2012. A $6,177,200 negative change in accounts receivable from related parties ($0 in accounts receivable – related parties in 2012, $6,177,200 increase in 2011) resulted from no accounts receivable from related parties in 2012. A $5,138,135 positive change in bank notes receivable ($2,104,142 decrease in 2012 and $3,033,993 increase in 2011) resulted from reduced amount of bank notes receivable in 2012. A $6,066,605 positive change in inventories ($6,325,459 decrease in inventories in 2012; $258,854 decrease in inventories in 2011) resulted from the Company purchasing molten iron from Hongrong, a related party, beginning from February 2010 instead of outsourcing the production and consequently reduced related inventories. A $97,699,904 negative change in advances to related parties ($140,477,692 increase in advance to related parties in 2012 and $42,777,788 increase in advance to related parties in 2011) resulted from the Company’s expectation for increasing demand of molten iron from Hongrong in the remaining of 2012. A $78,621,582 positive change in accounts payable ($73,122,036 increase in accounts payable in 2012; $5,499,546 decrease in accounts payable in 2011) resulted from the Company purchased 32% of its total purchase from a third party vendor, a pig iron supplier during the nine months ended September 30, 2012. A $4,887,355 positive change in accounts payable to related parties ($474,397 increase in 2012; $4,412,958 decrease in 2011) resulted from less accounts payables to related parties paid off in 2012 than in 2011. A $1,412,006 positive change in accrued expenses ($205,294 decrease in 2012; $1,617,300 decrease in 2011) resulted from more paid off and less accrued in 2011 than in 2012. A $83,945,372 positive change in advances from customers ($72,227,077 increase in 2012; $11,718,295 decrease in 2011) resulted from two major customer’s increased prepayments.

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Net cash used in investing activities was $11,493,538 and $12,578,737, respectively, in the nine months ended September 30, 2012 and 2011. Those expenditures were primarily related to the steel wire production line and replacement, or modification of current production lines equipment.

Net cash used in financing activities was 30,376,270 in the nine months ended September 30, 2012. During the nine months ended September 30, 2012, the Company repaid total of $72,666,200 and renewed and borrowed total of $60,028,600 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 RMB 100,000,000 ($15,911,000) which shall be used as working capital only and could not exceed 180 days. The Company repaid total of $10,426,020 and renewed and borrowed total of $7,424,590 from credit Union. During nine months ended September 30, 2012, the Company repaid equipment loans of $16,487,701 to Hongrong. The Company received $2,663,374 short term loan from related parties and repaid $3,611,194 to related parties. The Company received $1,895,640 deposit returned by bank as collateral for bank notes payable. The Company paid $445,322 to related parties for obligation under capital lease in 2012.

Net cash provided by financing activities was 18,010,093 in the nine months ended September 30, 2011. On June 28, 2011, Hongri entered into a loan agreement (the “Loan Agreement”) with Raiffeisen Bank International AG Beijing Branch (“Raiffeisen”). The Loan Agreement provides for a revolving credit facility in an aggregate principal amount of RMB 180,000,000 which shall be used as working capital. On August 24, 2011, Hongri received RMB 180,000,000 ($27,797,400) on August 31, 2011. The Company also received $310,951 from private placement closed on January 28, 2011 (“PP1”) and private placement closed on February 7, 2011 (“PP2”).  In the nine months ended September 30, 2011, the Company paid $2,934,170 deposit to a bank as collateral to bank notes payable and $2,316,450 to Raiffeisen bank as a security deposit of bank loan. The Company also repaid $3,721,763 related party loan, $721,099 employee loan and $404,776 to related parties for obligation under capital lease.

Short-term Borrowings

Bank and Private Loan Payable

Bank and private loans at September 30, 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)		3,023,090		-
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)		15,911,000		-
To a Private Loan
Interest at 10.50%, payable January 10, 2013	(d)		1,256,969		-
Total Short Term Bank Loans		$	20,191,059	$	34,640,200

(a) On September 30, 2011, the Company received a RMB 19,000,000 ($3,019,100, 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 RMB 19,000,000 ($3,019,100 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 RMB 19,000,000 ($3,023,090) 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 RMB 19,000,000 ($3,023,090) 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.

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The total value of the collateral for the above mentioned bank loans is RMB 70,967,104 ($11,292,576).

(d) On January 20, 2012, the Company received a RMB 7,900,000 ($1,256,969) short-term borrowing from a private lender. The loan bears interest of 10.50% per annum and is due on January 10, 2013.

(e) On June 28, 2011, Hongri entered into the Loan Agreement with Raiffeisen. The Loan Agreement provides for a revolving credit facility in an aggregate principal amount of   RMB 180,000,000 (approximately $28,602,000 translated at the rate of December 31, 2011) 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 RMB 15,000,000 ($2,383,500, 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 RMB 180,000,000 ($28,602,000) 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 RMB 180,000,000 from Raiffeisen Bank. The second borrowing was due by varied from July to August 2012. On June 27, 2012, the Company repaid RMB 60,000,000 ($9,478,200, translated at the average rate of the nine months ended September 30, 2012). The remaining balance of RMB 120,000,000 ($18,956,400, translated at the average rate of the nine months ended September 30, 2012) was repaid in July (RMB 50,000,000) and August (RMB 70,000,000).

(f) On July 23, 2012, Hongri entered into an amendment agreement (the “Amendment Agreement I”) with Raiffeisen. The Amendment Agreement I provided for a revolving credit facility in an aggregate principal amount of RMB 120,000,000 (approximately $19,093,200, translated at the rate of September 30, 2012) 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 the Amendment Agreement II with Raiffeisen. The Amendment Agreement II provides for a revolving credit facility in an aggregate principal amount of RMB 100,000,000 (approximately $15,911,000, translated at the rate of September 30, 2012) 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 August 2012, the Company borrowed total of RMB 100,000,000 ($15,797,000, translated at the average rate of the nine months ended September 30, 2012) and repaid all borrowed amount by the end of September 2012. Upon repayment, the Company borrowed separately total of RMB 100,000,000 ($15,911,000, translated at the rate of September 30, 2012). The loans bear interest rate of 7.31% per annual and are due varied from January 29, 2013 to February 28, 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; a security deposit of RMB 10,000,000 (approximately $1,591,100) 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.

On October 8, 2012, the Company received a RMB 19,000,000 ($3,022,900) short-term borrowing from Credit Union. The loan bears interest at 7.28% per annum and will be due on April 17, 2013. The loan is secured by the equipment of Hongrong.

Short Term Loan Payable – Related Party

During 2011, the Company borrowed RMB 11,000,000 from a related party, Mr. Maisheng Liu, a senior manager of the Company. During the nine months ended September 30, 2012, the Company borrowed additional RMB 11,860,000 from Mr. Maisheng Liu and returned total of RMB 22,860,000 ($3,611,194) to Mr. Liu.

On June 28, 2012, the Company borrowed RMB 1,000,000 ($159,110) from Mr. Beifang Liu, director of the Company, and RMB 4,000,000 ($636,440) 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 $24,051,181 and $9,020,513 for the nine months ended September 30, 2012 and 2011, respectively. The weighted average interest rate for short term loan was 8.77% and 8.32% for the nine months ended September 30, 2012 and 2011, respectively.

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Critical Accounting Policies and Estimates

In Note 2 to our audited consolidated financial statements for the years ended December 31, 2011 and 2010 included in the Form 10-K filed on March 29, 2012, 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).

Off-Balance Sheet Arrangements

The Company has not entered into any off-balance sheet financing arrangements and has not established any special purpose entities. The Company has not guaranteed any debt or commitments of other entities or entered into any options on non-financial assets.

Contractual Obligations

At September 30, 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	$	3,938,219	$	-	$	-	$	-	$	3,938,219
Capital Leases		631,937		1,410,809		1,632,398		2,737,588		6,412,732
Interest on Capital Leases		487,139		827,341		605,752		2,382,456		4,302,688
Interest on Equipment loans		196,911		-		-		-		196,911
	$	5,254,206	$	2,238,150	$	2,238,150	$	5,120,044	$	14,850,550

ITEM 3. 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 -0.7%, 3.3% and 5.4% in 2009, 2010 and 2011 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.

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ITEM 4. CONTROLS AND PROCEDURES.

Disclosure Controls and Procedures

As required by paragraph (b) of Rules 13a-15 or 15d-15 under the Exchange Act, our management, with the participation of our principal executive and principal financial officer evaluated our company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of the end of the period covered by this report on Form 10-Q. Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our company's reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in our company's reports filed under the Exchange Act is accumulated and communicated to our principal executive officer and our principal accounting officer, as appropriate, to allow timely decisions regarding required disclosure. Based on their evaluation, management concluded that as of the period covered by this quarterly report on Form 10-Q, these disclosure controls and procedures were not effective.

Plan for Remediation of Material Weaknesses

As financial conditions permit, we plan to take the following actions to improve our internal control over financial reporting, including actions to remediate those material weaknesses identified.

1. Recruit qualified staff for internal control positions and develop a suitable internal control system. to provide effective oversight of our internal control over financial reporting.

2. Conduct an equity level risk assessment by the end of this year.

3. Look to engage the services of qualified consultants with China GAAP, U.S. GAAP and SEC reporting experience to support our financial reporting and SOX compliance requirements, including assistance with the following:

o   Remediating identified material weaknesses;

o   Monitoring our internal control over financial reporting on an ongoing basis;

o   Managing our period-end financial closing and reporting processes; and

o   Identifying and resolving non-routine or complex accounting matters.

Our management will continue to monitor and evaluate the effectiveness of its disclosure controls and procedures, as well as its internal control over financial reporting, on an ongoing basis, and is committed to taking further action and implementing additional improvements, as necessary and as funds allow.  However, our management cannot guarantee that the measures taken or any future measures will remediate the material weaknesses identified or that any additional material weaknesses or significant deficiencies will not arise in the future due to a failure to implement and maintain adequate internal control.

Changes in Internal Control over Financial Reporting

During the period ended September 30, 2011, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.

Certifications

Certifications with respect to disclosure controls and procedures and internal control over financial reporting under Rules 13a-14(a) or 15d-14(a) of the Exchange Act are attached to this quarterly report on Form 10-Q.

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PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

None.

ITEM 1A. RISK FACTORS.

Information about risk factors for the three months ended September 30, 2012, does not differ materially from that set forth in Part I, Item 1A of the Company’s 2011 Annual Report on Form 10-K.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION.

None.

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ITEM 6. EXHIBITS.

Exhibits required by Item 601 of Regulation S-K:

Exhibit Index

3.1	Articles of Incorporation filed with the Secretary of State of the State of Maryland on January 27, 2010 (1)
3.2	Bylaws of the Company (3)
10.1	Financial Advisory Agreement, dated 8, 2008, entered into between the Company and Friedland Capital Inc. (2)
10.2	Entrusted Management Agreement, by and among Fakei, YBS Group, Hongri Metallurgy and Nuosen (1)
10.3	Exclusive Option Agreement, by and among Nuosen, Fakei, YBS Group and Hongri Metallurgy (2)
10.4	Covenant Letter (2)
10.5	Call Option Agreement (2)
10.6	Molten Iron Purchase Contract (1)
21.1	List of subsidiaries (1)
31.1	Certification of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
31.2	Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
32.1	Certification of the Principal Executive Officer pursuant to U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
32.2	Certification of the Principal Financial Officer pursuant to U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
101.INS	XBRL Instance Document**
101.SCH	XBRL Taxonomy Extension Schema**
101.CAL	XBRL Taxonomy Extension Calculation Linkbase**
101.DEF	XBRL Taxonomy Extension Definition Linkbase**
101.LAB	XBRL Taxonomy Extension Label Linkbase**
101.PRE	XBRL Extension Presentation Linkbase**

(1)  Previously filed with the Registration Statement on Form S-1 (File No. 333-172135) filed with the Securities and Exchange Commission on February 9, 2011 and incorporated by reference herein.

(2)  Previously filed with the Registration Statement on Form S-1/A filed with the Securities and Exchange Commission on May 6, 2011, and incorporated by reference herein.

(3)  Previously filed with the Registration Statement on Form S-1/A filed with the Securities and Exchange Commission on September 22, 2011, and incorporated by reference herein.

* Filed herewith.

** Attached as Exhibit 101 to this report are the following financial statements from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2012 formatted in XBRL (eXtensible Business Reporting Language):  (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Cash Flows, and (iv) related notes to these financial statements tagged as blocks of text.  The XBRL-related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall not be deemed “filed” or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, and is not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liabilities of those sections.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	CHINA INDUSTRIAL STEEL INC.
Dated:  November 14, 2012	By:	/s/ Liu Shenghong
		Liu Shenghong
		Chief Executive Officer and Chairman
		(Chief Executive Officer)
	By:	/s/ Xiaolong Zhou
		Xiaolong Zhou
		Chief Financial Officer
		(Principal Accounting and Financial Officer)

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