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


FORM 10-K
 

 (Mark One)                                                        

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

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

For the transition period from ___________to __________

Commission file number 333-172135

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

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


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

Securities registered pursuant to Section 12(b) of the Act: None
 
Securities registered pursuant to section 12(g) of the Act:
 
Common Stock, par value $ 0.0001
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.           o Yes                 x No
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.      o Yes                  x No
 
Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections.
 
 
 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   x Yes   ¨ No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x   Yes   ¨   No
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer   ¨   
Accelerated filer ¨
Non-accelerated filer    x   (Do not check if a smaller reporting company) 
Smaller reporting company ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  o Yes x No

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter.
 
Note.—If a determination as to whether a particular person or entity is an affiliate cannot be made without involving unreasonable effort and expense, the aggregate market value of the common stock held by non-affiliates may be calculated on the basis of assumptions reasonable under the circumstances, provided that the assumptions are set forth in this Form.
 
As of June 30, 2012, there had been no trading in the registrant’s common equity.
 
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
 
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
 
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    ¨ Yes   ¨ No
 
The number of shares of common stock outstanding as of March 29 , 2013 is 73,620,391.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
List hereunder the following documents if incorporated by reference and the Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is incorporated: (1) Any annual report to security holders; (2) Any proxy or information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or (c) under the Securities Act of 1933. The listed documents should be clearly described for identification purposes (e.g., annual report to security holders for fiscal year ended December 24, 1980).
 
 
 
 
 
Table of Contents
 
  
 
Page
     
PART I
     
Item 1.
4
     
Item 1A.
16
     
Item 1B.
29
     
Item 2.
29
     
Item 3.
29
     
Item 4.
29
     
PART II
     
Item 5.
30
     
Item 6.
31
     
Item 7.
32
     
Item 7A.
44
     
Item 8.
44
     
Item 9.
45
     
Item 9A.
45
     
Item 9B.
46
     
PART III
     
Item 10.
47
     
Item 11.
50
     
Item 12.
52
     
Item 13.
53
     
Item 14.
56
     
PART IV
   
57
Item 15.
 

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

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

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

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

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

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

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

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

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

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

Item 1A. 
Risk Factors

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

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

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

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

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

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

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

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

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

Selected Consolidated Income Statements Data

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


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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Liquidity and Capital Resources

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

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

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

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

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

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

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

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

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

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

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

Bank Notes Payable

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

Bank Loans Payable

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

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

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

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

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

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

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

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

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

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

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

Revenue Recognition

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

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

Foreign Currency Translation

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

Segment Information

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

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

Contractual Obligations

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

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

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

Inflation Risk

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

Higher Interest Rate Risk

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

Item 8. 
Financial Statements and Supplementary Data
 
 
 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



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

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


/s/Friedman LLP

New York, NY
April 1, 2013
 
 
 
CH INA INDUSTRIAL STEEL INC . AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (IN US DOLLARS)
 
   
December 31,
   
December 31,
 
   
2012
   
2011
 
ASSETS
           
 Current Assets:
           
 Cash
  $ 1,710,887     $ 1,737,495  
 Bank notes receivable
    979,111       2,342,186  
 Accounts receivables, net
    9,639,396       20,862,269  
 Inventories, net
    11,585,277       16,139,936  
 Advances to suppliers, net
    2,372,693       3,215,680  
 VAT recoverable
    32,208,807       21,612,482  
 Advances to related parties
    183,797,203       77,416,285  
 Other current assets
    3,884,342       -  
     Total Current Assets
    246,177,716       143,326,333  
                 
 Machinery and Equipment, Net
    101,450,993       84,410,398  
 Machinery and Equipment - acquired from related parties, Net
    85,471,360       98,514,249  
Total Machinery and Equipment, Net
    186,922,353       182,924,647  
                 
                 
 Other Assets:
               
 Restricted cash
    5,778,360       5,402,600  
 Land use rights and buildings under capital leases
    4,985,732       5,613,105  
     Total Other Assets
    10,764,092       11,015,705  
                 
 TOTAL ASSETS
  $ 443,864,161     $ 337,266,685  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
 Current Liabilities:
               
 Accounts payable
  $ 92,228,161     $ 23,095,827  
 Accounts payable - related parties
    1,833,558       184,447  
 Accrued liabilities
    3,123,315       2,622,224  
 Taxes payables
    2,427       1,868,886  
 Bank loans payable
    26,034,722       34,640,200  
 Bank notes payable
    5,296,830       3,019,100  
 Equipment loan payable - related parties - current
    2,884,919       11,562,752  
 Current obligations under capital leases - related parties - current
    648,893       597,258  
 Short term loan payable - related party
    802,550       1,747,900  
 Customer financing
    31,620,470       -  
 Advances from customers
    77,275,327       13,257,487  
     Total Current Liabilities
    241,751,172       92,596,081  
                 
 Long Term Liabilities:
               
 Equipment loan payables - related parties - non current
    1,087,952       51,093,694  
 Obligation under capital leases - related parties - non current
    5,669,438       6,254,954  
     Total Long Term Liabilities
    6,757,390       57,348,648  
                 
 TOTAL LIABILITIES
    248,508,562       149,944,729  
                 
Commitments and Contingencies
               
                 
Stockholders' Equity:
               
Series A Convertible Preferred Stock, $0.0001 par value, 10,000,000 shares authorized, none issued and outstanding
    -       -  
Blank Check Preferred Stock, $0.0001 par value, 10,000,000 shares authorized, none issued and outstanding
    -       -  
Common stock, $0.0001 par value, 980,000,000 authorized, 73,620,391 and 73,542,058 issued and outstanding at December 31, 2012 and 2011, respectively
    7,362       7,354  
Paid-in capital
    16,417,235       16,299,744  
Statutory reserves
    6,530,869       6,530,869  
Retained earnings
    156,124,507       150,189,517  
Accumulated other comprehensive income
    16,275,626       14,294,472  
Total Stockholders' Equity
    195,355,599       187,321,956  
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 443,864,161     $ 337,266,685  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
CHINA INDUSTRIAL STEEL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (IN US DOLLARS)
FOR THE YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010
 
   
2012
   
2011
   
2010
 
Revenues
                 
Sales to customers
  $ 623,373,273     $ 796,011,478     $ 546,489,212  
Sales to related parties
    25,945,519       27,095,564       27,177,472  
    Total Revenues
    649,318,792       823,107,042       573,666,684  
                         
Cost of Revenue
                       
Cost of Revenue - non-related parties
    304,795,870       92,311,499       76,627,193  
Cost of Revenue - related parties
    329,666,806       669,334,535       459,227,304  
  Total Cost of Revenue
    634,462,676       761,646,034       535,854,497  
                         
Gross Profit
    14,856,116       61,461,008       37,812,187  
                         
Selling and General and Administrative Expenses
                       
Selling and General and Administrative Expenses - non-related parties
    2,225,060       1,695,836       1,963,226  
Selling and General and Administrative Expenses - related parties
    1,147,775       804,541       569,035  
Total Selling and General and Administrative Expenses
    3,372,835       2,500,377       2,532,261  
                         
Income From Operations
    11,483,281       58,960,631       35,279,926  
                         
Other Income (Expenses)
                       
Interest income
    194,673       67,303       19,058  
Interest expense - bank and private borrowings
    (2,855,244 )     (1,505,340 )     (353,815 )
Interest expense - related parties
    (1,705,435 )     (4,405,934 )     (4,719,552 )
Other income
    203,655       117,255       -  
    Total Other Income (Expenses)
    (4,162,351 )     (5,726,716 )     (5,054,309 )
                         
Income from operation before income tax
    7,320,930       53,233,915       30,225,617  
Provision for income tax
    1,385,940       7,432,439       4,455,177  
Net Income
    5,934,990       45,801,476       25,770,440  
                         
Earnings Per Share - Basic and Diluted
  $ 0.08     $ 0.62     $ 0.39  
Weighted Average Shares Outstanding - Basic and Diluted
    73,594,852       73,351,698       66,308,038  
                         
Other Comprehensive Income:
                       
Foreign currency translation gain
    1,981,154       7,753,060       4,122,803  
Comprehensive Income
  $ 7,916,144     $ 53,554,536     $ 29,893,243  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
CHINA INDUSTRIAL STEEL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (IN US DOLLARS)
FOR THE YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010
 
   
Preferred Stock
   
Common Stock
   
Stock to be
   
Additional Paid-In
   
Statutory
   
Retained
    Accumulated
Other
Comprehensive
     
   
Shares
   
Amount
   
Shares
   
Amount
   
Issued
   
Capital
   
Reserves
   
Earnings
   
Income
   
Total
 
Balance as of  December 31, 2009
    -     $ -       61,576,992     $ 6,158     $ -     $ 12,357,466     $ 6,530,869     $ 78,617,601     $ 2,418,609     $ 99,930,703  
Effect of recapitalization
    -       -       -       -       -       (691 )     -       -       -       (691 )
Common stock issued
    -       -       9,385,044       938       -       376,462       -       -       -       377,400  
Stock to be issued
    -       -       -       -       3,175,241       -       -       -       -       3,175,241  
Net income
    -       -       -       -       -       -       -       25,770,440       -       25,770,440  
Foreign currency translation adjustment
    -       -       -       -       -       -       -       -       4,122,803       4,122,803  
Balance as of December 31, 2010
    -       -       70,962,036       7,096       3,175,241       12,733,237       6,530,869       104,388,041       6,541,412       133,375,896  
Stock issued - private placement
    -       -       2,580,022       258       (3,175,241 )     3,485,934       -       -       -       310,951  
Additional paid in capital from Fakei
    -       -       -       -       -       80,573       -       -       -       80,573  
Net income
    -       -       -       -       -       -       -       45,801,476       -       45,801,476  
Foreign currency translation adjustment
    -       -       -       -       -       -       -       -       7,753,060       7,753,060  
Balance as of December 31, 2011
    -       -       73,542,058       7,354       -       16,299,744       6,530,869       150,189,517       14,294,472       187,321,956  
Stock issued for compensation
                    78,333       8               117,491                               117,499  
Net income
    -       -       -       -       -       -       -       5,934,990       -       5,934,990  
Foreign currency translation adjustment
    -       -       -       -       -       -       -       -       1,981,154       1,981,154  
Balance as of December 31, 2012
    -     $ -       73,620,391     $ 7,362     $ -     $ 16,417,235     $ 6,530,869     $ 156,124,507     $ 16,275,626     $ 195,355,599  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
CHINA INDUSTRIAL STEEL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (IN US DOLLARS)
FOR THE YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010
 
   
2012
   
2011
   
2010
 
                   
Cash Flows from Operating Activities:
                 
Net Income
  $ 5,934,990     $ 45,801,476     $ 25,770,440  
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:
         
 (Reduction) provision for allowance for doubtful accounts receivable
    (281,817 )     72,229       172,859  
 Allowance for doubtful advances to suppliers
    879,040       -       -  
 Depreciation
    25,407,234       23,673,076       21,510,507  
 Amortization of land use rights and buildings under capital leases
    675,763       659,478       629,807  
 Common stock issued for services
    117,499       -       375,491  
 Capitalized interest for lease obligation
            -       170,863  
 Gain on disposal of fixed assets
    -       (116,873 )     -  
 Changes in operating assets and liabilities:
                       
    Decrease (increase) in accounts receivables
    11,574,308       (8,019,652 )     (4,442,271 )
    Decrease (increase) in accounts receivables - related party
    -       17,661,321       (17,298,276 )
    Decrease (increase) in bank notes receivable
    1,369,613       (1,139,582 )     746,880  
    Decrease (increase) in inventories
    4,659,695       (2,257,850 )     12,592,542  
    (Increase) decrease in advances to suppliers
    (14,326 )     1,625,894       10,695,413  
    Increase in VAT recoverable
    (10,248,686 )     (7,728,655 )     (4,216,534 )
    Increase in other current assets
    (3,836,184 )     -       -  
    Increase in advances to related parties
    (104,287,340 )     (29,898,852 )     (2,095,811 )
    Increase (decrease) in accounts payable
    68,044,123       (27,991,152 )     (33,902,095 )
    Increase (decrease) in accounts payable - related parties
    1,626,820       (4,420,675 )     (5,834,431 )
    Increase (decrease) in accrued liabilities
    468,639       (1,545,150 )     2,270,186  
    Increase (decrease) in bank notes payable
    2,219,280       (154,700 )     -  
    Increase (decrease) in advances from customers
    63,091,486       (10,155,614 )     6,195,617  
    (Decrease) increase  in taxes payables
    (1,862,020 )     951,397       (1,076,550 )
Net Cash Provided by (Used in) Operating Activities
    65,538,117       (2,983,884 )     12,264,637  
                         
Cash Flows from Investing Activities:
                       
Cash acquired from recapitalization
    -       -       1,278  
Cash received on disposal of fixed assets
    -       180,999       -  
Capital expenditures
    (27,524,933 )     (10,041,310 )     (10,470,663 )
Net Cash Used in Investing Activities
    (27,524,933 )     (9,860,311 )     (10,469,385 )
                         
Cash Flows from Financing Activities
                       
Proceeds from bank loans
    78,958,812       36,663,900       8,636,640  
Repayment of bank loans
    (87,804,228 )     (8,817,900 )     (2,878,880 )
Proceeds from short term loan - related parties
    2,672,647       15,237,950       2,083,134  
Repayment of short term loan - related parties
    (3,623,767 )     (17,264,520 )     -  
Proceeds from customer financing
    31,228,440       -       -  
Proceeds from stock to be issued
    -       -       3,175,241  
Proceeds from stock issued
    -       -       1,910  
Repayment of equipment loans - related party
    (58,582,991 )     (11,257,129 )     (11,025,728 )
Payment of obligation under capital lease - related parties
    (595,830 )     (540,646 )     (454,415 )
Deposit of restricted cash
    (317,040 )     (3,403,400 )     -  
Repayment of employee loans
    -       (722,360 )     -  
Additional paid in capital - Fakei
    -       80,573       -  
Proceeds from private placement
    -       310,951       -  
Net Cash (Used in) provided by Financing Activities
    (38,063,957 )     10,287,419       (462,098 )
                         
Effect of Exchange Rate Changes on Cash
    24,165       232,859       203,728  
Net (Decrease) Increase in Cash and Cash Equivalents
    (26,608 )     (2,323,917 )     1,536,882  
Cash - Beginning of the Period
    1,737,495       4,061,412       2,524,530  
                         
Cash - End of the Period
  $ 1,710,887     $ 1,737,495     $ 4,061,412  
                         
Supplemental Cash Flow Information:
                       
Interest Paid
  $ 4,596,895     $ 6,183,958     $ 4,772,075  
Income taxes
  $ 2,988,100     $ 6,597,605     $ 3,687,851  
                         
Supplemental Schedule of Non-Cash Investing Activities:
                       
 Obligation payable to seller of assets acquired
  $       $ 6,518,297     $ -  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
CHINA INDUSTRIAL STEEL INC. AND SUBSIDIARIES
NOTES TO 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 at historical exchange rate). 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 in Hebei province, China. YBS Group owns 70% equity interest of Hongri.
 
Fakei Investment (Hong Kong) Ltd (“Fakei”) is an enterprise incorporated in Hong Kong. Fakei owns 30% equity interest of Hongri.

On August 1, 2010, CIS, through Northern and its wholly owned foreign enterprise, Nuosen, entered into 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. Shenghong Liu, the Chairman of the Board of Directors and one of the shareholders of YBS Group and several other shareholders of YBS Group (each of them, a “Purchaser”) 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.
 

For accounting purposes, the above transactions were accounted for in a manner similar to a reverse merger or recapitalization, since the former equity shareholders of Hongri now effectively control a majority of CIS’ common stock immediately following the transactions. Consequently, the assets and liabilities and historical operations reflected in the consolidated financial statements prior to the transactions are those of Hongri and are recorded at the historical cost of Hongri, and the consolidated financial statements after completion of the transactions include the assets and liabilities of CIS, Northern, Nuosen, and Hongri (collectively, 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 of 2.3 million metric tons steel making production capacity and 2 million metric tons of steel rolling production capacity 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 consolidated financial statements have been prepared in order to present the financial position and results of operations in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and are expressed in U.S. dollars. The consolidated financial statements include the historical operations of Hongri.

2.  
S ummary of Significant Accounting Policies

Use of Estimates

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

Fair Value of Financial Instruments

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

The Company evaluated the fair value of the equipment loans payable – related parties, net of current portion at December 31, 2012 and 2011, and determined that the book value of equipment loans payable approximated the fair market value based on information available as of December 31, 2012 and 2011.

Accounts Receivable

Accounts receivable consists of balances due from customers for the sale of the Company’s steel products. Accounts receivable is recorded at the net realizable value consisting of the carrying amount less an allowance for uncollectible amounts.
 

The Company estimates the valuation allowance for anticipated uncollectible receivable balances after taking into consideration industry experience, the current economic climate and facts and circumstances specific to the applicable customer. Account balances are written-off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.

Inventories

Inventories are stated at the lower of cost, as determined on a weighted average basis, or market. Costs of inventories include the purchase price and related manufacturing costs incurred in bringing the products to their present location and condition. Market value is determined by reference to selling prices or to management’s estimates based on prevailing market conditions. Management writes down the inventories to market value if it is below cost and also regularly evaluates the composition of its inventories to identify slow-moving and obsolete inventories to determine if a valuation allowance is required.

Advances to Suppliers and Related Parties

In order to ensure a steady supply of raw materials, the Company is required from time to time to make cash advances when placing its purchase orders. Management regularly evaluates the balance of advances and will record a reserve if necessary. 

See Note 11 for advances to related parties in the normal course of business.

Machinery and Equipment and Construction In Progress

Machinery and equipment are stated at cost less accumulated depreciation. The cost of an asset comprises its purchase price and any directly attributable costs of bringing the asset to its present working condition and location for its intended use.

Depreciation is computed on a straight-line basis over the estimated useful lives of the related assets. The estimated useful lives for significant machinery and equipment are as follows:

Machinery and equipment
10 years
Auxiliary facilities
10 years
Transportation equipment
5 years
Office equipment
3 - 5 years
Electronic equipment
3 - 5 years

Repairs and maintenance costs are normally charged to the statement of operations in the year in which they are incurred. In situations where it can be clearly demonstrated that the expenditure has resulted in an increase in the future economic benefits expected to be obtained from the use of the asset, the expenditure is capitalized as an additional cost of the asset.

Construction in progress includes direct costs of construction or acquisition of equipment and design fees incurred. Capitalization of these costs ceases and the construction in progress is transferred to plant and equipment when substantially all the activities necessary to prepare the assets for their intended use are completed. No depreciation is provided until it is completed and ready for its intended use.

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.

Revenue Recognition

Revenue is recognized when all of the following have occurred: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the price is fixed or determinable, and (iv) the ability to collect is reasonably assured. These criteria are generally satisfied by the Company at the time of delivery, which is the point when risk of loss and title passes to the customer. Revenue is reported net of all value added taxes. The Company does not routinely permit customers to return products and historically, customer returns have been immaterial.
 

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

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

   
2012
   
2011
   
2010
 
RMB/US$ exchange rate at period end
    0.1605       0.1589       0.1515  
                         
Average RMB/US$ exchange rate for the period
    0.1585       0.1547       0.1477  
 
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.
 
Value Added Tax

The Provisional Regulations of the People’s Republic of China Concerning Value Added Tax (“VAT”) promulgated by the State Council came into effect on January 1, 1994. Under these regulations and the Implementing Rules of the Provisional Regulations of the People’s Republic of China concerning Value Added Tax, VAT is imposed on goods sold or imported into the PRC and on processing, repair and replacement services provided within the PRC.

VAT payable in the PRC is charged on an aggregated basis at a rate of 13% or 17% (depending on the type of goods involved) on the full price collected for the goods sold but excluding any amount paid in respect of VAT included in the price.  Certain offshore and overseas sales are not subject to VAT tax.

The Company reports revenues and costs net of the PRC’s value added tax for all periods presented in the statements of operations.

Shipping Costs

Shipping costs include shipping and handling costs. Shipping costs are expensed as incurred. The freight-in costs are included in the cost of revenue. The freight-out costs are usually incurred by the customers and, as such, there were no significant shipping costs for the years ended December 31, 2012, 2011 and 2010.

Advertising

Advertising is expensed as incurred and is included in selling expenses. The Company did not incur significant advertising expenses for the years ended December 31, 2012, 2011 and 2010.
 

Comprehensive Income (Loss)

Comprehensive income (loss) is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. Accumulated other comprehensive income (loss) arose from changes in foreign currency exchange rates.

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, 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.

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 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 the Chinese steel industry can occur 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 to purchase raw materials for production of molten iron, which is a major raw material of the Company, equivalent to four months  of cost of sales of the Company currently. In the event that the steel products market demand is lower, or there are further price reductions on raw materials already purchased, such asset could be impaired and/or the gross profit margin 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.

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 December 31, 2012, the Company has not experienced any uninsured losses from injury to others or other losses.
 
Recent Accounting Pronouncements

In December 2011, the FASB issued ASU No. 2011-11, Topic 210 - Balance Sheet: Disclosures about Offsetting Assets and Liabilities (“ASU 2011-11”). ASU 2011-11 requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. ASU 2011-11 will be effective for fiscal years beginning on or after January 1, 2013, with retrospective application for all comparable periods presented. The Company does not expect the adoption of this guidance to have a material effect on the Company’s consolidated financial statements.

In February 2013, the FASB issued ASU 2013-02, Topic 220 – Comprehensive Income: Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (“ASU 2013-02”).  ASU 2013-02 changes the presentation requirements of significant reclassifications out of accumulated other comprehensive income in their entirety and their corresponding effect on net income. For other significant amounts that are not required to be reclassified in their entirety, the standard requires the company to cross-reference to related footnote disclosures. ASU 2013-02 became effective for the company on January 1, 2013. The Company does not expect the adoption of this guidance to have a material effect on the Company’s consolidated financial statements.

In March 2013, the FASB issued ASU 2013-05 Topic 830 – Foreign Currency Matters (“ASU 2013-05”).  ASU 2013-05 resolves the diversity in practice about whether Subtopic 810-10, Consolidation—Overall, or Subtopic 830-30, ASU 2013-05 applies to the release of the cumulative translation adjustment into net income when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business (other than a sale of in substance real estate or conveyance of oil and gas mineral rights) within a foreign entity. In addition, the amendments in this Update resolve the diversity in practice for the treatment of business combinations achieved in stages (sometimes also referred to as step acquisitions) involving a foreign entity.  ASU 2013-02 became effective for the company prospectively for fiscal years (and interim reporting periods within those years) beginning after December 15, 2013.  The Company does not expect the adoption of this guidance to have a material effect on the Company’s consolidated financial statements.
 
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.
 

4.
Accounts Receivable

Accounts receivable at December 31, 2012 and 2011 consisted of the following:
 
   
2012
   
2011
 
Accounts receivable
  $ 9,880,791     $ 21,383,735  
Allowance for doubtful accounts
    (241,395 )     (521,466 )
Accounts receivable, net
  $ 9,639,396     $ 20,862,269  

5.
Inventories

Inventories at December 31, 2012 and 2011 consisted of the following:
 
   
2012
   
2011
 
Raw materials
  $ 405,113     $ 172,372  
Finished products
    5,919,991       12,004,416  
Spare parts
    5,260,173       3,963,148  
Total
  $ 11,585,277     $ 16,139,936  
 
6.
Machinery and Equipment, Net

Machinery and equipment stated at cost less accumulated depreciation at December 31, 2012 and 2011 consisted of the following:
 
   
2012
   
2011
 
Machinery and equipment
  $ 262,788,674     $ 246,906,365  
Auxiliary facilities
    3,059,109       3,028,424  
Transportation equipment
    570,219       552,288  
Office equipment
    43,428       34,087  
Electronic equipment
    58,702       36,741  
Subtotal
    266,520,132       250,557,905  
Accumulated depreciation
    (96,960,996 )     (70,520,287 )
Construction in progress
    17,363,217       2,887,029  
Total
  $ 186,922,353     $ 182,924,647  
 
Construction in progress is related to a new 600,000 metric tons of steel wires production capacity. The new steel wires production line commenced production in January 2013. The Company believes that facilities to produce steel plate are not impaired though the quantity of production would be adjusted down or up in response to the demand of steel market.
 

7.
Restricted Cash

Restricted cash at December 31, 2012 and 2011 consisted of the following:
 
   
2012
   
2011
 
Bank deposit as part of collateral to bank notes payable
  $ 4,173,260     $ 3,019,100  
Bank deposit as part of collateral to working capital loan
    1,605,100       2,383,500  
Total
  $ 5,778,360     $ 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 “Leases” because YBS has the ability to extend the length of the terms of all 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 and structured without significant built in profit. The value of the capitalized assets has 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 $230,244 (RMB 1,434,450) which commenced in 2011. The average lease payment is $207,219 (RMB 1,291,005) per annum. The lease is set to expire on December 31, 2037. The present value of the total lease payments at inception was $2,038,982 (RMB 12,703,147 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 $565,350 (RMB 3,522,211) commencing on January 1, 2008. The lease is set to expire on December 31, 2017. The present value of the total lease payments at inception was $3,822,806 (RMB 23,816,623 at the current exchange rate), which was calculated with a discount rate of 7.83%, a PRC long term borrowing rate in December 2007.

In November 2007, the Company entered into a lease agreement with Hongrong, a related party, to lease the manufacturing building of Steel-Making I. The annual lease payment is $194,322 (RMB 1,210,716) commencing on January 1, 2008. The lease is set to expire on December 31, 2017. The present value of the total lease payments at inception was $1,314,042 (RMB 8,186,666 at the current exchange rate), which was calculated with a discount rate of 7.83%, a PRC long term borrowing rate in December 2007.

In November 2009, the Company entered into a lease agreement with YBS Group to lease the manufacturing building of Steel-Making II. The annual lease payment is $17,250 (RMB 107,469) commencing on January 1, 2010. The lease is set to expire on December 31, 2019. The present value of the total lease payments at inception was $127,316 (RMB 793,198 at the current exchange rate), which was calculated with a discount rate of 5.94%, a PRC long term borrowing rate in December 2009.

In November 2009, the Company entered into a lease agreement with Hongrong to lease the manufacturing building of Bar-Rolling III. The annual lease payment is $121,747 (RMB 758,503) commencing on January 1, 2010. The lease is set to expire on December 31, 2019. The present value of the total lease payments at inception was $898,624 (RMB 5,598,552 at the current exchange rate), which was calculated with a discount rate of 5.94%, a PRC long term borrowing rate in December 2009.
 

As of December 31, 2012, future minimum rental payments applicable to the above non-cancelable capital leases with remaining terms in excess of one year were as follows:

December 31,
 
Capital Leases
 
2013
  $ 1,128,922  
2014
    1,128,922  
2015
    1,128,922  
2016
    1,128,922  
2017
    1,128,922  
Thereafter
    4,882,864  
  Total minimum lease payments
    10,527,474  
Less amount representing interest
    (4,209,143 )
  Present value of net minimum lease payments
    6,318,331  
Less current obligations
    (648,893 )
  Long-term obligations
  $ 5,669,438  
 
9.  
Bank Notes, Bank Loan Payable, Short Term Loan Payable – Related Party and Customer Financing

Bank Notes Payable

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

Bank Loans Payable

Bank loans at December 31, 2012 and December 31, 2011 consisted of the following:

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

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

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

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

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

During August 2012, the Company borrowed total of $16,051,000 (RMB 100,000,000 translated at December 31, 2012 exchange rate) and repaid all borrowed amount by the end of September 2012.

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

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

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

Customer financing

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

10.  
Taxes Payable

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

   
2012
   
2011
 
PRC corporation income tax
  $ -     $ 1,602,160  
Other taxes payable
    2,427       266,726  
Total
  $ 2,427     $ 1,868,886  
 
See Note 15.

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

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 December 31, 2012 and 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
    183,633,559       56,340,968  
Cement Plant
    163,644       -  
Total Advances to Related Parties
  $ 183,797,203     $ 77,416,285  
 
Accounts Payable - Related Parties
           
             
Name of related parties
 
2012
   
2011
 
Baoye
  $ (1,830,377 )   $ (56,447 )
Ore Treatment
    (3,181 )     (3,149 )
Cement Plant
    -       (124,851 )
Total Accounts Payable - Related Parties
  $ (1,833,558 )   $ (184,447 )
 
 
The balance of advances to YBS group was $0 and $21,075,317 as of December 31, 2012 and 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 of 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 total services fees were $1,147,775, $804,541 and $569,035 for 2012, 2011 and 2010, respectively. Among the 2012 services fees, $510,744 was an itemized expense in connection with the refinancing of $16 million loan from Raiffeisen Bank. Executive officers’ salaries were stand-alone expenses. Such expenses were $63,408, $61,880 and $59,096 for 2012, 2011 and 2010, respectively.

In 2012, the Company repaid its $42,037,885 equipment loans to YBS group by offsetting its previous and current advanced fund to YBS group. In the same period, the Company repaid $16,545,106 equipment loan to Hongrong by offsetting its current advanced fund to Hongrong.

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. The Company’s advances to the related parties enable these related parties to pay partial amounts in advance to their vendors or suppliers. 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 in its testing stage. If the Hongrong’s new blast furnace is in full production, it will  guarantee the Company has enough molten iron supplies.Expected that Hongrong’s new blast furnace would be in operation in fourth quarter of 2012, the Company advanced more funds to Hongrong in order to ensure that Hongri will have continuously molten iron supply. The balance of advances to Hongrong was $183,633,559 and $56,340,968 as of December 31, 2012 and 2011, respectively. The amount advanced to Hongrong approximated to purchase of four months molten iron used in production.
 
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 $1,833,558 and $184,447 as of December 31, 2012 and 2011, respectively.

In 2012, the Company purchased $318,369,059 (786,354 metric tons) molten iron, $30,453,078 utility and $1,081,783 spare parts from Hongrong. During 2011, the Company purchased $659,998,838 (1,445,304 metric tons) molten iron, $5,659,111 (21,400 metric tons) scrap steel and $1,106,946 supplies from Hongrong. During 2010, the Company purchased $431,329,226 (1,080,737 metric tons) of molten iron from Hongrong.

The Company purchased coke – raw material and electricity from Baoye. Such purchase was $1,512,598, $0 and $2,927,689 in 2012, 2011 and 2010, respectively.

Sales to related parties

The Company’s sales of its products to YBS Group were $15,802,957, $20,344,781 and $26,854,226 in 2012, 2011 and 2010 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.
 
 
Company sold $4,191,682, 6,750,783 and $0 steel products to Hongrong in 2012, 2011 and 2010, respectively. Hongrong used these steel products in Hongrong’s blast furnace constructions. The Company also sold $5,950,879 by-products, which were re-used in manufacturing of molten iron to Hongrong in 2012.

During 2010, the Company sold $323,246 its 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

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 December 31, 2012 and 2011 consisted of:

Equipment Loans Payable
 
2012
   
2011
 
             
Equipment loan - YBS Group payable
  $ 3,972,871     $ 46,071,679  
Equipment loan - Hongrong payable
    -       16,584,767  
Total equipment loans payable
    3,972,871       62,656,446  
Less: current portion
    (2,884,919 )     (11,562,752 )
Long-term payable
  $ 1,087,952     $ 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 $26,208,524 (RMB 191,163,559 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 bears interest at 5% per annum, and has a fixed repayment schedule at $2,884,919 (RMB 17,973,455 at the December 31, 2012 exchange rate) per annum (payable at the end of the year). During 2012, the Company repaid $14,983,023 (RMB 94,518,192 translated at the 2012 average rate) equipment loan to YBS group by offsetting its previous advanced fund to YBS group. The remaining unpaid loan balance was $3,972,871 (RMB 24,751,549 translated at the December 31, 2012 exchange rate).

On November 30, 2009, the Company purchased Steel-Making II production line and related auxiliary equipment from YBS Group at a price of $35,718,399 (RMB 243,811,599 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 had a fixed repayment schedule at $3,913,233 (RMB 24,380,000 at the December 31, 2012 exchange rate) per annum (payable at the end of the year). During 2012, the Company repaid remaining balance of $27,054,862 (RMB 170,671,599 at the 2012 average exchange rate) in full by offsetting its previous advanced fund to YBS group.
 

On November 30, 2007, the Company purchased Steel-Making I production line and related auxiliary equipment from Hongrong at a price of $44,698,499 (RMB 326,028,440 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 had a fixed annual repayment schedule at $4,881,755 (RMB 30,414,021 at  the December 31, 2012 exchange rate) per annum (payable at the end of the year). On March 31, 2012, the Company repaid the remaining $16,545,106 (RMB 104,372,354 at the 2012 average rate) by offsetting its current advanced fund to Hongrong.

Interest paid to YBS group for equipment loans was $1,040,676, $2,570,300, and $2,767,527 in 2012, 2011 and 2010, respectively.

Interest paid to Hongrong for equipment loan was $206,814, $1,042,573, and $1,220,335 in 2012, 2011 and 2010, respectively.

13.  
Statutory Reserves

The Company is 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 an enterprise’s after-tax net income determined under Chinese GAAP. When the surplus reserves account balance is equal to or greater than 50% of the Company’s paid-in capital, no further allocation to the surplus reserve account is required.

The statutory surplus reserve fund is non-distributable other than during liquidation and can be used to fund previous years’ losses, if any, and may be utilized for business expansion or converted into share capital by issuing new shares to existing shareholders in proportion to their shareholding or by increasing the par value of shares currently held by them, provided that the remaining statutory surplus reserve balance after such issue is not less than 25% of the registered capital.

If the accumulated balance of the Company’s statutory reserve is not enough to make up for the losses of the Company of the previous year, the current years’ profit shall first be used for making up the losses before the statutory reserve is drawn. As of December 31, 2012, the statutory reserves amounted to $6,530,869.

14.  
Stockholders’ Equity

The Company is authorized to issue 980,000,000 shares of common stock with par value at $0.0001 per share.  The common stock has voting rights, dividend rights and liquidation rights (after debt and other liabilities of the Company). The Company is also authorized to issue 10,000,000 shares of Series A Convertible Preferred Stock with par value at $0.0001 per share. The Series A Convertible Preferred Stock ranked junior to any other series of Blank Check Preferred Stock but senior to any other equity securities of the Company. Series A Convertible Preferred Stock has $10 liquidation amount for each share outstanding and has no dividend and voting rights. In addition, the Company is authorized to issue 10,000,000 shares of Blank Check Preferred Stock with par value at $0.0001 per share.

On July 1, 2010, the Company had approved a resolution to issue 25,000 shares of common stock to its director, Mr. Frank Pena for a consideration of $0.0001 per share; to issue 25,000 shares of common stock to its Chief Financial Officer Mr. Xiaolong Zhou for a consideration of $0.0001 per share; to issue 10, 000 shares to Mr. Mark Cohen for a consideration of $0.0001 per share. The shares issued to Mr. Frank Pena, Mr. Xiaolong Zhou and Mr. Mark Cohen were valued at $1,000, $1,000 and $400, respectively, which were based on the fair value of the services provided. The fair value was determined to be more reliable than the equity interests due to the early status in the Company’s lifecycle. The fair value was capitalized in the accompanying balance sheet and expensed in the statement of operation in 2010, the period the services received.

On July 1, 2010, the Company approved the resolution to execute the Corporate Finance Advisory Service Agreement with Friedland Capital USA Inc. (“Friedland”). Pursuant to the terms of the Agreement, the Company issued 9,325,044 shares of common stock to the designees of Friedland for a consideration totaled $1,902. The shares issued to Friedland were valued at $375,000 in total, which was based on the fair value of the services provided by Friedland. This fair value was determined to be more reliable than the equity interests due to the early status in the Company’s lifecycle. The fair value was capitalized in the accompanying balance sheet and expensed in the statement of operation in 2010, the period the Friedland fulfilled its services.
 

During the third quarter of 2010, the Company commenced a private placement to sell up to 2,580,022 shares of its common stock and warrants at a price of $1.50 per share. Each share consists of 1 share of common stock and a warrant to purchase 1 share of common stock at a price of $4.50 per share. The warrant has a term of 3 years. As of December 31, 2010, the Company had 29 accredited investors subscribed for a total of 2,352,023 units and for total of $3,528,046 of proceeds that had been prepaid. In addition, the Company has recorded $352,805 as commissions offsetting the subscriptions received. On January 28, 2011, the Company closed the private placement with 44 accredited investors purchasing 2,579,022 shares for total proceeds of $3,868,547.

On February 7, 2011, the Company consummated another private placement and sold additional 1,000 of its common stock and warrants to one (1) accredited investors at the price of $4.50 and received proceeds of $4,500. Each selling share comprises one share of Company’s common stock and one three-year warrant to purchase one share of Company’s common stock at $2.00 per share and additional one three-year warrant to purchase one share of Company’s common stock at $4.50 per share. Subsequent to the closing the private placement, the Company issued 1,000 shares of common stocks, 1,000 shares of $2.00 warrants and 1,000 shares of $4.50 warrants to the investor.

In conjunction with January 28, 2011 and February 7, 2011 private placements, the Company granted three year warrants to the investors for the purchase of 2,580,022 shares of the Company’s common stock at an exercise price of $4.50 and for the purchase of 1,000 shares of the Company’s common stock at an exercise price of $2.00. These warrants have no cash settlement provision, registration rights and do not include any price protection features. The exercise of the warrants will result in restricted shares under the SEC rule 144.

The relative fair value of warrants were valued at $1,090,303 by using “Black-Scholes Model” and the proceeds were   allocated and recorded based on the relative fair value of the warrants and the common stock. The assumption used in “Black-Scholes Model” calculations ware: volatility 99.05%; risk free interest rate 0.96% and 1.28%; and expected term of three years.

On April 30, 2012, the Board of Directors made a resolution to issue total of 78,333 shares of the Company’s common stock, par value $0.0001 per share (the “Shares”), to certain officer and director for their services to the Company. The share was valued at $1.50 per share based on the price of previous closed major private placement.

Following was a summary of the warrants as of December 31, 2012 and 2011:
 
2011
 
Date of Issuance
   
Number of Warrants
   
Weighted Average Exercise Price
   
Weighted Remaining Life in Years
 
Outstanding, December 31, 2010
    -       -     $ -        
$4.50 warrants
 
January 28, 2011
      2,579,022       4.50       2.07  
$4.50 warrants
 
February 7, 2011
      1,000       4.50       2.10  
$2.00 warrants
 
February 7, 2011
      1,000       2.00       2.10  
Outstanding, December 31, 2011
            2,581,022     $ 4.50       2.07  
 
2012
 
Date of Issuance
   
Number of Warrants
   
Weighted Average Exercise Price
   
Weighted Remaining Life in Years
 
$4.50 warrants
 
January 28, 2011
      2,579,022       4.50       1.07  
$4.50 warrants
 
February 7, 2011
      1,000       4.50       1.10  
$2.00 warrants
 
February 7, 2011
      1,000       2.00       1.10  
Outstanding, December 31, 2012
            2,581,022     $ 4.50       1.07  
 

15.  
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 earnings were $7,893,739, $53,649,225 and $30,225,617, in 2012, 2011 and 2010, 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 December 31, 2012, approximately $164,437,000 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 $46,972,000 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 2012, 2011 and 2010.

   
2012
   
2011
   
2010
 
                   
US statutory tax rate
    34.0 %     34.0 %     34.0 %
Foreign income not recognized in US
    -34.0 %     -34.0 %     -34.0 %
China income tax rate
    12.5 %     12.5 %     12.5 %
Non-deductible expenses *
    6.4 %     1.5 %     2.2 %
Effective rate
    18.9 %     14.0 %     14.7 %
 
*  
Non-deductible expenses consists of:
 
   
a, 4.74% US GAAP adjustments not recognized by PRC tax authority;
 
   
b, 1.37% US operation loss;
 
   
c, 0.26% WOFE loss;
 
   
d, 0.05% loss not recognized by PRC tax authority.
 
 
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 December 31, 2012, the Companies had loss carry forwards of approximately $1,782,000 for U.S. income tax purposes available for offset against future taxable U.S. income expiring in 2031 and 2032. 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 December 31, 2012 and December 31, 2011 were approximately $606,000 and $411,000, respectively.

The Company did not have any significant temporary differences relating to deferred tax liabilities as of December 31, 2012 and 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 2008 and for years on or after 2007 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 (Hebei Provincial Tax Bureau and Handan Municipal Tax Bureau). The Company is subject to tax examinations by these foreign tax authorities for years from 2008 to 2012.

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

16.  
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.

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

17.  
 Major Customers and Vendors

For the year ended December 31, 2012, there were two (2) major customers that accounted for approximately 20% and 18% of the Company’s total sales, respectively. For the year ended December 31, 2011, there were two (2) major customers that accounted for approximately 21% and 19% of the Company’s total sales, respectively. For the year ended December 31, 2010, there were two (2) major customers that accounted for approximately 18% and 10% of the Company’s total sales, respectively.

For year ended December 31, 2012, 57% of the total Company’s purchase was from Hongrong, and 31% of the total purchase was from an unrelated party. For the year ended December 31, 2011 and 2010, the purchase from Hongrong was 98% and 94% of the total purchases, respectively. No purchase from other vendors was over 5% in 2011 and 2010.

18.  
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 year ended December 31, 2012, 2011 and 2010 consisted of:

Revenues
 
2012
   
2011
   
2010
 
Steel plates
  $ 335,591,348     $ 474,946,204     $ 439,719,098  
Steel bars/steel wires
    236,557,650       120,870,983       26,101,538  
Steel billets
    64,888,724       209,657,073       100,568,635  
Byproducts and others
    12,281,070       17,632,782       7,277,413  
Total Revenues
  $ 649,318,792     $ 823,107,042     $ 573,666,684  
 
Costs of Revenue
  2012     2011     2010  
Steel plates
  $ 343,339,636     $ 460,188,852     $ 416,440,083  
Steel bars/steel wires
    229,958,766       107,931,190       26,868,918  
Steel billets
    59,719,198       192,353,711       92,545,496  
Others
    1,445,076       1,172,281          
Total Cost of Revenue
  $ 634,462,676     $ 761,646,034     $ 535,854,497  
 
Gross Profit Margin
  2012     2011     2012  
Steel plates
    -2.31 %     3.11 %     5.29 %
Steel bars/steel wires
    2.79 %     10.71 %     -2.94 %
Steel billets
    7.97 %     8.25 %     7.98 %
Total Gross Profit Margin
    2.29 %     7.47 %     6.59 %
 
The Company sold 658,425, 768,374 and 835,795 metric tons of steel plates for the year ended December 31, 2012, 2011 and 2010, respectively.

The Company sold 453,595, 197,070 and 48,780 metric tons of steel wire/bars for the year ended December 31, 2012, 2011 and 2010, respectively.

The Company sold 121,559, 368,544 and 195,214 metric tons of steel billets for year ended December 31, 2012, 2011 and 2010, respectively.
 

19.    Condensed Unaudited Parent Company Financial Information

Basis of Presentation

China Industrial Steel Inc. (“CIS”) was incorporated January 27, 2010 under the laws of the State of Maryland. The Company is a holding Company to develop business opportunities in the People’s Republic of China (“PRC”).

The condensed parent company financial statements have been prepared using the same accounting principles and policies described in the notes to the condensed consolidated financial statements. Refer to the condensed consolidated financial statements and notes presented above for additional information and disclosures with respect to condensed parent company only financial statements.

The Investment in subsidiaries was determined using the equity method of accounting. Relevant PRC statutory laws and regulations restrict certain payments, such as dividends, loans or advances, from the Companies’ registered capital. Such restricted capital approximates $14,799,000 as of December 31, 2012 and 2011. The Company is also required to allocate a portion of its after-tax profits to the statutory reserve. Annual appropriations to the statutory reserve are required to be at least 10% of an 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 December 31, 2012 and 2011, such reserved fund totaled $6,530,869. In addition, the Company’s ability to use revenue generated in RMB to fund any future business activities outside China or to make dividend or other payments in U.S. dollars is limited due to the regulations of PRC’s currency exchange. It is not certain that the Chinese regulatory authorities will not impose more stringent restrictions on the convertibility of the RMB in the future.

CHINA INDUSTRIAL STEEL INC.
PARENT COMPANY
CONDENSED BALANCE SHEETS (IN US DOLLARS)
AS OF DECEMBER 31, 2012 AND 2011
   
   
2012
   
2011
 
ASSETS
           
 Current Assets:
           
 Cash and cash equivalents
  $ 7,285     $ 76,318  
 Total Current Assets
    7,285       76,318  
 Investment in subsidiaries
    195,957,121       187,468,138  
 TOTAL ASSETS
  $ 195,964,406     $ 187,544,456  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
 Current Liabilities:
               
 Accrued liabilities
  $ 17,451     $ -  
 Due to YBS group, a related party
    591,356       222,500  
 Total Current Liabilities
    608,807       222,500  
 TOTAL LIABILITIES
    608,807       222,500  
                 
Commitments and Contingencies
               
                 
Stockholders' Equity:
               
Series A Convertible Preferred Stock, $0.0001 par value, 10,000,000 shares authorized, none issued and outstanding
    -       -  
Blank Check Preferred Stock, $0.0001 par value, 10,000,000 shares authorized, none issued and outstanding
    -       -  
Common stock, $0.0001 par value, 980,000,000 authorized, 73,620,391 and 73,542,058 issued and outstanding at December 31, 2012 and 2011, respectively
    7,362       7,354  
 Paid-in capital
    16,417,235       16,299,744  
 Retained earnings
    162,655,376       156,720,386  
 Accumulated other comprehensive income
    16,275,626       14,294,472  
Total Stockholders' Equity
    195,355,599       187,321,956  
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 195,964,406     $ 187,544,456  


CHINA INDUSTRIAL STEEL INC.
PARENT COMPANY
CONDENSED STATEMENTS OF OPERATIONS (IN US DOLLARS)
FOR THE YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010
                   
   
2012
   
2011
   
2010
 
Revenues
  $ -     $ -     $ -  
Cost of Revenue
    -       -       -  
Gross Profit
    -       -       -  
                         
Professional fees
    540,334       388,109       784,242  
Other General and Administrative expenses
    32,355       27,066       10,109  
                         
Loss from operation before income tax
    (572,689 )     (415,175 )     (794,351 )
Provision for income tax
    -       -       -  
Equity income from subsidiary
    6,507,679       46,216,651       26,564,791  
Net Income
  $ 5,934,990     $ 45,801,476     $ 25,770,440  
                         
Other Comprehensive Income:
                       
Foreign currency translation gain
    1,981,154       7,754,573       4,122,803  
Other Comprehensive Income
  $ 7,916,144     $ 53,556,049     $ 29,893,243  


CHINA INDUSTRIAL STEEL INC.
PARENT COMPANY
CONDENSED STATEMENTS OF CASH FLOWS (IN US DOLLARS)
FOR THE YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010
                   
   
2012
   
2011
   
2010
 
Cash Flows from Operating Activities:
                 
Net Income
  $ 5,934,990     $ 45,801,476     $ 25,770,440  
Adjustments to Reconcile Net Income to
Net Cash Provided by Operating Activities:
                       
 Equity income from subsidiaries
    (6,507,679 )     (46,216,651 )     (26,564,791 )
 Issuance of shares in consideration for services
    117,499       -       375,491  
 Increase (decrease) in accrued liabilities
    17,451       (538,804 )     538,804  
Net Cash (Used in) Provided by Operating Activities
    (437,739 )     (953,979 )     119,944  
                         
Cash Flows from Investing Activities:
                       
Investment in subsidiary
    -       -       (2,800,100 )
Net Cash Used in Investing Activities
    -       -       (2,800,100 )
                         
Cash Flows from Financing Activities
                       
Investment in subsidiary
    (150 )     (149 )     -  
Proceeds from YBS group
    368,856       222,500       -  
Proceeds from stock issued
    -       -       1,910  
Proceeds from private placement
    -       310,951       3,175,241  
Net Cash Provided by Financing Activities
    368,706       533,302       3,177,151  
                         
Net (Decrease) Increase in Cash and Cash Equivalents
    (69,033 )     (420,677 )     496,995  
Cash and Cash Equivalents - Beginning of Year
    76,318       496,995       -  
Cash and Cash Equivalents - End of Year
  $ 7,285     $ 76,318     $ 496,995  


20.  
Unaudited Quarterly Financial Data

Year 2012
 
First
Quarter
   
Second
Quarter
   
Third
Quarter
   
Fourth
Quarter
 
Net Sales
  $ 177,028,648     $ 145,572,369     $ 169,550,216       157,167,559  
Gross profit
    8,824,083       4,456,900       (2,377,748 )     3,952,881  
Net income (loss)
    4,706,044       1,848,517       (3,748,280 )     3,128,709  
Earnings (loss) per common share
                               
  Basic and diluted
  $ 0.06     $ 0.03     $ (0.05 )   $ 0.04  
 
Year 2011
   
First
Quarter
     
Second
Quarter
     
Third
Quarter
     
Fourth
Quarter
 
Net Sales
  $ 187,524,816     $ 216,799,301     $ 225,955,836       192,827,089  
Gross profit
    10,426,543       14,409,268       23,470,731       13,154,466  
Net income
    7,132,774       10,704,209       18,354,949       9,609,544  
Earnings per common share
                               
  Basic and diluted
  $ 0.10     $ 0.15     $ 0.25     $ 0.13  
 
Year 2010
   
First
Quarter
     
Second
Quarter
     
Third
Quarter
     
Fourth
Quarter
 
Net Sales
  $ 119,167,163     $ 141,378,635     $ 109,201,658       203,919,228  
Gross profit
    9,420,194       8,928,053       6,719,421       12,744,519  
Net income
    6,783,946       6,258,235       2,763,261       9,964,998  
Earnings per common share
                               
  Basic and diluted
  $ 0.11     $ 0.10     $ 0.04     $ 0.14  
 
21.    Subsequent Events

The Company repaid its revolving loan $16,051,000 (RMB 100,000,000 translated at December 31, 2012 exchange rate) borrowed from Raiffeisen Bank in January 2013. The Company then acquired a second borrowing in the amount of $16,051,000 (RMB 100,000,000 translated at December 31, 2012 exchange rate) from Raiffeisen Bank. The new borrowing bears interest of 7.31% per annual and is due varied from July 22 to August 2, 2013.

In February 2013, the Company borrowed a $1,540,896 (RMB 9,600,000 translated at December 31, 2012 exchange rate) short-term collateral loan from Industrial and Commercial Bank of China (“ICBC”). The loan is collaterated by a letter of credit in the same amount held by the Company. The collateral loan is interest free and due by August 15, 2013.
 
 
Item 9. 
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
 
None.
 
Item 9A. 
Controls and Procedures
 
Disclosure Controls and Procedures

The Company is not required to provide a report of management’s assessment regarding internal control due to a transition period established by rules of the Securities and Exchange Commission for newly public companies.  However, our management, with the participation of our principal executive and principal financial officer began the process of evaluating 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-K. 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 annual report on Form 10-K, these disclosure controls and procedures were not effective, as a result of the material weaknesses identified in our internal control over financial reporting. These material weaknesses are discussed in “Management’s Report on Internal Control over Financial Reporting” below.  Our management considers our internal control over financial reporting to be an integral part of our disclosure controls and procedures.
 
Management’s Report on Internal Control over Financial Reporting
 
The Company’s management is responsible for establishing and maintaining adequate internal control over our financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act.   The Company’s management is also required to assess and report on the effectiveness of the Company’s internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”).    Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of the Company’s financial reporting for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes policies and procedures that: (i) pertain to maintaining records that in reasonable detail accurately and fairly reflect the Company’s transactions; (ii) provide reasonable assurance that transactions are recorded as necessary for preparation of the Company’s financial statements and that receipts and expenditures of company assets are made in accordance with management authorization; and (iii) provide reasonable assurance that unauthorized acquisition, use or disposition of company assets that could have a material effect on our financial statements would be prevented or detected on a timely basis.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.

The Company initiated evaluation work and identified some material weaknesses. During the fourth quarter of 2012, our management, under the supervision of Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our entity-level control,  include the control environment, risk assessment, information and communication, monitoring, financial close and reporting, and IT general controls. Our management also evaluated the design and operating effectiveness of our internal control over financial reporting in the areas of inventory and cost accounting as additional assessment. Based on our initial assessment, our management, including the Chief Executive Officer and Chief Financial Officer, concluded that our internal control over financial reporting was not effective as of December 31, 2012.
 
 
Specifically, our management identified certain matters involving internal control and our operations that it considered to be material weaknesses.  As defined in the Exchange Act, a material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the registrant's annual or interim financial statements will not be prevented or detected on a timely basis.  The material weaknesses identified by our management as of December 31, 2012, are described below:

1. We lacked sufficiently-trained personnel to provide for adequate segregation of duties within the accounting system and effective oversight of controls over access, change, data, and security management.  Because this control deficiency, and the related segregation of duties constraints, is pervasive in nature and impacts all significant accounts, our management believes this deficiency rises to the level of material weakness.

2. We have substantial related party transactions and have no audit committee to supervise those transactions. There is an absence of expertise in the management and staff in maintaining effective internal control, due to our recent transition from a private company to a public company. Our management believes that the pervasive nature of this control deficiency impact all significant accounts and disclosures and rise to the level of material weakness.
 
The above material weaknesses are identified based on the management’s evaluation to date. Material weakness other than discussed above may be identified with further evaluations.
 
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.
Further review and assess the weakness on current internal control over financial reporting system and identify possible improvements at our abilities.
3.
Step by step to establish a suitable internal control system within the Company in accordance with the SOX compliance requirements. We may look for outside help, including engage the service of qualified consultant with Chinese GAAP, US GAAP and SEC reporting experiences.
4.
Continuing on job trainings to all accounting staffs and other related staffs
 
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
 
As an initial step, the Company added three new accounting staff; each of them will focus on the function of sales, purchase and cost separately during 2012. The Company also hired a local consultant to help in establishing accounting and reporting policy within the Company. In March 2012, the Company hired a new bilingual (Chinese and English) controller, who has the ability to learn US GAAP.
 
Item 9B.
Other Information
 
 None.
 
 
PART III
 
 
Item 10.
Directors, Executive Officers and Corporate Governance
 
The following are our officers and directors as of March 29 , 2013. Most of our officers and directors are residents of the PRC and, therefore, it may be difficult for investors to effect service of process within the US upon them or to enforce judgments against them obtained from the US courts.
 
The following table sets forth certain information concerning our directors and executive officers:
 
Name
 
Age
 
Position
Shenghong Liu
 
52
 
Chairman of Board, Chief Executive Officer and Chief Operating Officer
Xiaolong Zhou
 
61
 
Chief Financial Officer
Rutai Pan
 
51
 
Chief Engineer and Manager, Plant Operations
Frank J. Pena
 
54
 
Director
Beifang Liu
 
76
 
Director
Fengye Liu
 
57
 
Director
Jinghe Liu
 
59
 
Director
 
Biographies

Shenghong Liu, Mr. Liu, our Chief Executive Officer and Chief Operating Officer, and Chairman of the Board of Directors, brings 20 years of expertise in ferrous metallurgy to the Company.  He has been serving as Chairman of the Board of Directors since August 2010, and became a director after the execution of the Entrustment Agreements. He has been with the Company (and/or its parent the Yuanbaoshan Group) since 1988, where he first served as the Deputy Plant Chief, then was promoted to Deputy General Manager of the Yuanbaoshan Group in 1993, where he helped increase the company’s assets from 10 million RMB to 150 million.  From 1999 to 2007, he served as the Group General Manager, where he was instrumental in increasing sales to 4.8 billion RMB, with profits of 500 million RMB.  In 2007 he became Chairman and General Manager of, Hongri.  Mr. Liu, graduated from Hebei Tangshan Project Technology Institute in 1987.
 
Xiaolong Zhou, Mr. Zhou was appointed as our Chief Financial Officer in February 2010. He had been a senior accountant in Liss Okou Goldstein Okun and Tancer CPA'S P.C. in Great Neck, New York for the prior nine years. He is a certified public accountant, registered in the state of New York, a member of American Institute of Certified Public Accountants, and a member of New York State Society of Certified Public Accountants. Mr. Zhou obtained an M.B.A. in accountancy degree from Baruch College of CUNY and an M.A. in economics degree from City College of CUNY. He obtained a B.A. in economics degree from Fudan University, Shanghai, China.
 
Rutai Pan, Mr. Pan joined the Yuanbaoshan Industry Group as Production Chief of the cement division in 1983.  In 1989 he joined the Company as Deputy Director of Production, a position he held for 10 years.  From 2000 to 2006, he served as Factory Manager of the Company’s iron to steel production facility.  In 2007 he was promoted to his current position as Chief Engineer and Manager of the Company, where he has been extremely instrumental in increasing the efficiency of the operation and reducing the energy consumption.
  
Frank J. Pena, our director since March 2010, has spent over 27 years in the financial services arena primarily in banking, brokerage and consulting. Mr. Pena has worked on hundreds of transactions in the real estate and distressed asset arena totaling over $1.5 billion as well as raising significant equity and debt capital for both public and private companies.  From January 2000 to the present day, Mr. Pena has been the Principal of Winthorp Capital Group, a boutique advisory firm that works with public and private companies in raising equity and debt capital.  Prior to forming Winthorp Capital Group, Mr. Pena was the Director of Sales & Marketing for the Breen Capital Group from May 1996 to December 1999.  From October 1988 until May 1996, Mr. Pena was a Vice President of First Fidelity Bank (subsequently acquired by First Union National Bank and today known as Wachovia Bank), where he was pivotal in creating First Fidelity's Municipal Tax Lien business. Mr. Pena has a BS degree from Kean University in Management Science. Mr. Pena is fluent in English and Spanish.
 
Beifang Lie, our director since August 2010, after the execution of the Entrustment Agreements, joined the YBS Group as General Manger in 1989, In 1999 he Joined the company as President, a position he held for 11 years. From 2007 till now, he served as member of Board of Directors of Hongri. He has more than 25 years of management experience in iron industries.
   
 
Fengye Liu, our director since August 2010, after the execution of the Entrustment Agreements, is a   junior college level, party member, acted as the president of the Economics and Trade Company of YBS Group from 1978 to 1995. She also served as the president of YIN SHENG Economics and Trade Company of Wu’an City from 1996 to 2006. Since 2007, Mrs. Liu has held a post of member of the board of Hongri. Enthusiastic and decisive, she is one of the best in our Group, who participated in many substantial jobs and won a reputation for us.
 
Jinghe Liu, our director since August 2010, after the execution of the Entrustment Agreements, is a junior college level, party member, is the vice president of Hongri. He served in military from 1974 to 1978. From 1983 to 1989, he acted as the manager of the Secondary Cement in Wu’an City and as the manager of the First Cement Factory of YBS Group from 1990 to 1999. Since 2000, he has been the Vice President of YBS Group. The 20 years professional history ensured him having more practical experiences, which covers market positioning and market model of steel and iron industry. Possessing abundant experiences and updated concepts, he is precisely one of the talents our enterprise needs for healthy development.
 
The directors will serve until our next annual meeting, or until their successors are duly elected and qualified. The officers serve at the pleasure of the Board.
 
When evaluating candidates for election to the Board, the Company seeks candidates with certain qualities that it believes are important, including integrity, an objective perspective, good judgment, leadership skills. Our directors are highly educated and have diverse backgrounds and talents and extensive track records of success in what we believe are highly relevant positions. Each of them has contributed to the mix of skills, core competencies and qualifications of the Board.
 
The Board does not have a specific diversity policy, but considers diversity of race, ethnicity, gender, age, cultural background and professional experiences in evaluating candidates for Board membership. Diversity is important because a variety of points of view contribute to a more effective decision-making process.
 
None of our directors currently hold or held any directorships during the past five years in other reporting companies.
 
Presently, only one directors, Frank J. Pena is an “independent director” under the Corporate Governance Rules of the NASDAQ Stock Market, Inc., Rule 5605(a)(2).
 
There are no family relationships among our directors or officers other than disclosed below:

Beifang Liu is the father of Shenghong Liu, our Chairman, Chief Executive Officer and Chief Operating Officer.
 
To our knowledge, during the last ten years, none of our directors and executive officers (including those of our subsidiaries) has:
 
●
Had a bankruptcy petition filed by or against any business of which such person was a general partner or executive officer either at the time of the bankruptcy or within two years prior to that time.
 
●
Been convicted in a criminal proceeding or been subject to a pending criminal proceeding, excluding traffic violations and other minor offenses.
 
●
Been subject to any order, judgment or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction, permanently or temporarily enjoining, barring, suspending or otherwise limiting his involvement in any type of business, securities or banking activities.
 
●
Been found by a court of competent jurisdiction (in a civil action), the SEC, or the Commodities Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended or vacated.
 
●
Been the subject to, or a party to, any sanction or order, not subsequently reverse, suspended or vacated, of any self-regulatory organization, any registered entity, or any equivalent exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member.  
 
 
  Audit Committee Financial Expert
 
Currently, the Company only has one independent director and does not have audit committee. Our Board of Directors currently acts as our audit committee and has not made a determination as to whether any member of our board is an audit committee financial expert. Accordingly, as of the date hereof, the Company does not have an audit committee financial expert. However, upon the establishment of an audit committee, the board will determine whether any of the directors qualify as an audit committee financial expert.
 
Audit Committee
 
We have not yet appointed an audit committee.  We do, however, recognize the importance of good corporate governance and intend to appoint an audit committee comprised entirely of independent directors, including at least one financial expert as soon as practicable.
 
Compensation Committee
 
We do not presently have a compensation committee. Our Board of Directors currently acts as our compensation committee.
 
Nominating Committee
 
We do not presently have a nominating committee. Our Board of Directors currently acts as our nominating committee.
 
Board Leadership Structure
 
Shenghong Liu is our chairman. At the advice of other members of the management or the Board, Mr. Liu calls meetings of Board of Directors when necessary. The Board believes that the Company's Chief Executive Officer is best situated to serve as chairman of the Board because she is the director most familiar with our business and industry and the director most capable of identifying strategic priorities and executing our business strategy. In addition, having a single leader eliminates the potential for confusion and provides clear leadership for the Company. We believe that this leadership structure has served the Company well.
 
The Board’s Role in Risk Oversight
 
Risk is an integral part of the Board's deliberations throughout the year. The Board oversees and reviews an assessment prepared by management of the critical risks facing the Company, their relative magnitude and management’s actions to mitigate these risks.
 
Code of Ethics
 
We have not yet adopted a corporate code of ethics. The Company’s Board of Directors is considering establishing a code of ethics to deter wrongdoing and promote honest and ethical conduct; provide full, fair, accurate, timely and understandable disclosure in public reports; comply with applicable laws; ensure prompt internal reporting of code violations; and provide accountability for adherence to the code.
 
 
Board Meetings
 
The Board of Directors met one time and did not act by unanimous written consent during the fiscal year of 2012.
 
Section 16(a) Beneficial Ownership Reporting Compliance
 
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our executive officers and directors and persons who own more than 10% of a registered class of our equity securities to file with the Securities and Exchange Commission initial statements of beneficial ownership, reports of changes in ownership and annual reports concerning their ownership of the our common stock and other equity securities, on Form 3, 4 and 5 respectively. Executive officers, directors and greater than 10% shareholders are required by the Securities and Exchange Commission regulations to furnish our company with copies of all Section 16(a) reports they file.

Based solely on our review of the copies of such reports received by us, and on written representations by our officers and directors regarding their compliance with the applicable reporting requirements under Section 16(a) of the Exchange Act, we believe that, with respect to the fiscal year ended December 31, 2012, our officers and directors, and all of the persons known to us to own more than 10% of our common stock, filed all required reports on a timely basis. 
 
Item 11.
Executive Compensation
 
Compensation Discussion and Analysis
 
We presently pay compensation to our Chief Executive Officer, Shenghong Liu, and our Chief Financial Officer,  Xiaolong Zhou, and our Chief Engineer and Manager, Plant Operations, Rutai Pan. We do not presently have a compensation committee. Our Board of Directors currently acts as our compensation committee. The Board of Directors has extensive executive level experience in other companies and brings a perspective of reasonableness to compensation matters with our Company. In addition, the Board of Directors compares executive compensation practices of similar companies at similar stages of development. For example, the compensation to executive officers in China varies depending on the size, profitability, development stage, and location of the company. Generally, compensation to executive officers in China ranges from RMB100,000 to over RMB1,000,000 per annum.  As we are a relatively young company in the PRC, the compensation to our named executive officers is comparable to other young companies because like other young companies, we have not yet developed our executive compensation arrangements. We intend to develop our compensation arrangements as the Company develops and our resources expand.
 
The objectives of our compensation program are as follows:
 
●
Reward performance that drives substantial increases in shareholder value, as evidenced through both future operating profits and increased market price of our common shares; and
●
Attract, hire and retain well-qualified executives.
  
Specific salary and bonus levels, as well as the amount and timing of equity incentive grants, are determined informally and judgmentally, on an individual-case basis, taking into consideration each executive's unique talents and experience as they relate to our needs. Currently, none of our executives have entered into written employment agreements with the Company. However, executive compensation is paid or granted pursuant to each executive's compensation arrangement or understanding with the Company. Currently, in consideration for Shenghong Liu’s, Xiaolong Zhou’s, and Pan Ruitai’s services to the Company as Chief Executive Officer and Chief Operating Officer, Chief Financial Officer, and Chief Engineer and Manager, Plant Operations, respectively, Messrs. Liu, Zhou, and Pan are entitled to receive an annual salary of approximately $31,704, $65,000, and $31,704, respectively. The terms of Messrs. Liu’s, Zhou’s, and Pan’s employment with the Company shall continue on a year-to-year basis unless terminated by the other party. Compensation adjustments are made occasionally based on changes in an executive's level of responsibility or on changed local and specific executive employment market conditions.
   
Risk Management Considerations
 
In response to the ongoing global economic recession in 2012, the board considered the incentives under our executive compensation program and whether they introduced or encouraged excessive risk taking or other behaviors by our executives that could have a negative impact on our business. The board determined that our executive compensation program provides an appropriate balance of incentives and that it does not encourage our executives to take excessive risks or otherwise create risks that are reasonably likely to have a material adverse effect on us.
 
 
Summary Compensation Table
 
The following table summarizes the annual compensation paid to our named executive officers for the three years ended December 31, 2012, 2011, and 2010:
 
Name and Principal Position
 
Year
 
Salary
($)
   
Bonus
($)
   
Stock
Awards
($)
   
Option
Awards
($)
   
All Other
Comp
($)
   
Total
($)
 
Shenghong Liu (1)
 
2012
   
31,704
     
-
     
-
     
-
     
-
     
31,704
 
Chairman, Chief Executive Officer and
 
2011
   
30,940
     
-
     
-
     
-
     
-
     
30,940
 
Chief Operating Officer
 
2010
   
29,548
 
   
-
     
-
     
-
     
-
     
29,548
 
                                                 
                                                     
Xiaolong Zhou
 
2012
   
65,000
             
75,000
                     
140,000
 
Chief Financial Officer
 
2011
   
65,000
     
-
     
-
     
-
     
-
     
65,000
 
   
2010
   
48,750
     
-
     
-
     
-
     
-
     
48,750
 
                                                     
                                                     
Rutai Pan (2)
 
2012
   
31,704
                                     
31,704
 
Chief Engineer and Manager,
 
2011
   
30,940
     
-
     
-
     
-
     
-
     
30,940
 
Plant Operations
 
2010
   
29,548
 
   
-
     
-
     
-
     
-
     
29,548
 
 
(1)  
During 2012, 2011 and 2010, Mr. Shenghong Liu received RMB 200,000 per annum. However, the difference in the amounts reflected in the Summary Compensation Table for 2012, 2011 and 2010 is due to changes in exchange rates.
(2)  
During 2012, 2011 and 2010, Mr. Rutai Pan received RMB 200,000 per annum. However, the difference in the amounts reflected in the Summary Compensation Table for 2012, 2011 and 2010 is due to changes in exchange rates.
 
Please see the assumptions relating to the valuation of our stock option awards which are contained in Notes to audited Financial Statements included in this Report.
 
Stock Option Grants Under Our Stock Option Plans
 
During 2012, there were no stock option awards granted to our executive officers under our stock option plans. 
 
Outstanding Equity Awards at 2012 Fiscal Year End
 
There were no option exercises or options outstanding as of the end of the fiscal year ending December 31, 2012.
 
 
Employment Agreements
 
There are currently no employment agreements with any officers or directors.
 
Director Compensation
 
In 2012, Frank Pena received $8,000 cash ($1,000 per month commencing May 2012) as compensation. He also received 28,333 common shares (valued at $42,500) as compensation in 2012. None of our other named executive officers receive any compensation for their work at Hongri.
 
We have not had compensation arrangements in place for members of our Board of Directors and have not finalized any plan to compensate directors in the future for their services as directors.  We may develop a compensation plan for our independent directors in order to attract qualified persons and to retain them.  We expect that the compensation arrangements may be comprised of a combination of cash and/or equity awards.
 
Notwithstanding the foregoing, generally, we pay no compensation to the directors for serving as a director. There are no other elements of compensation paid to our directors but it is expected that in the future, we may create a remuneration and expense reimbursement plan.

Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
The following table sets forth certain information with respect to the beneficial ownership of our common stock as of March 29 , 2013 by (i) any person or group with more than 5% of our voting securities, (ii) each director, (iii) each executive officer and (iv) all executive officers and directors as a group.
 
Title of Class
 
Name and
Address of
Beneficial Owner
 
Common Stock Beneficially Owned (1)
   
Percent of
Common Stock (2)
 
Common Stock  
 
Shenghong Liu, Chief Executive Officer and Chairman of the Board of Directors (3)
Address: No.1055, Guzheng Village, Yetao Town, Wu'an City, Hebei Province, PRC 056304
   
1,819,321
     
2.47
%
   
                   
Common Stock
 
Beifang Liu, Director
Address: No.603, Guzheng Village, Yetao Town, Wu'an City, Hebei Province, PRC 056304
   
37,086,143
     
50.37
%
                     
Common Stock  
 
Xiaolong Zhou, Chief Financial Officer
Address: 85-19 54th Ave, Elmhurst, NY 11373
   
75,000
     
*
 
                     
Common Stock 
 
Rutai Pan, Chief Engineer and Manager, Plant Operations
Address: No.347, Guzheng Village, Yetao Town, Wu'an City, Hebei Province, PRC 056304
   
0
     
0
 
   
                   
Common Stock  
 
Frank J. Pena, Director
Address: 1590 HORSESHOE DRIVE
MANASQUAN, NJ, 08736
   
53,333
     
*
 
   
                   
Common Stock  
 
Fengye Liu, Director
Address: No.1054, Guzheng Village, Yetao Town, Wu'an City, Hebei Province, PRC 056304
   
1,259,530
     
1.71
%
   
                   
Common Stock  
 
Jinghe Liu, Director
Address: No.580, Guzheng Village, Yetao Town, Wu'an City, Hebei Province, PRC 056304
   
559,751
     
*
 
                     
Common Stock
 
Fakei Investment Ltd. (4)
Address: Flat/RM 808, 8/F, Yusung Boon Bldg, 107-111 Des Voeux Rd. Central, HK
   
17,493,463
     
23.76
%
                     
Common Stock
 
All Directors and Officers of the Company as a group (7 persons)
   
40,853,078
     
55.49
%
 
*Less than 1% of the outstanding common stock.
 
 
 
(1)
As of March 29 , 2 013, none of the beneficial owners listed in the table holds any option, warrant or other right to acquire any shares of our common within 60 days.
     
 
(2)
As of March 29 , 2013 , we had 73,620,391 outstanding shares of common stock outstanding. Because none of the beneficial owners listed in the table holds any option, warrant or other right to acquire any shares of our common within 60 days of the date of this prospectus, the calculation of percentage of class held by each owner does not include any such shares.
     
 
(3)
Shenghong Liu, our Chief Executive Officer, Chairman of Board of Directors and a shareholder of YBS Group, and several other shareholders of YBS Group entered into the Call Option Agreements, with Karen Prudente, the nominee and trustee of YBS Group, pursuant to which they are entitled to purchase up to 100% of the issued and outstanding shares of Karen Prudente at a price of $0.0001 per 100 shares for a period of five years as defined 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. Karen Prudente exercises the sole voting power with respect to the shares held in the name of Shenghong Liu, but disclaims beneficial ownership of such shares.
     
 
(4)
Weiru Liu is the Authorized Representative of Fakei, and has the sole voting and dispositive power over the securities held for the account of Fakei.
 
Item 13.
Certain Relationships and Related Transactions, and Director Independence
 
Hongri is 70% owned by YBS Group, a majority shareholder of some other steel production related companies, mainly Hongrong, 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
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
 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

As of December 31, 2012 and 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
   
183,633,559
     
56,340,968
 
Cement Plant
   
163,644
     
-
 
Total Advances to Related Parties
 
$
183,797,203
   
$
77,416,285
 
 
Accounts Payable - Related Parties
           
             
Name of related parties
 
2012
   
2011
 
Baoye
 
$
(1,830,377
)
 
$
(56,447
)
Ore Treatment
   
(3,181
)
   
(3,149
)
Cement Plant
   
-
     
(124,851
)
Total Accounts Payable - Related Parties
 
$
(1,833,558
)
 
$
(184,447
)

The balance of advances to YBS Group was $0 and $21,075,317 as of December 31, 2012 and 2011, respectively. YBS Group is a parent company that provides various services to its subsidiaries, such as market and industrial information, public relationship, various government agents’ relationship, coordination of the production and purchase for subsidiaries. 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 annual 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 be charged itemized services and expenses if such service and expenses are incurred. The total services fees were $1,147,775, $804,541 and $569,035 for 2012, 2011 and 2010, respectively. Among the 2012 services fees, $510,744 was an itemized expense in connection with the refinancing of $16 million loan from Raiffeisen Bank. Executive officers’ salaries were stand-alone expenses. Such expenses were $63,408, $61,880 and $59,096 for 2012, 2011 and 2010, respectively.

In 2012, the Company repaid its $42,037,885 equipment loans to YBS group by offsetting its previous and current advanced fund to YBS Group. In the same period, the Company repaid $16,545,106 equipment loan to Hongrong by offsetting its current advanced fund to Hongrong.

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. The Company’s advances to the related parties enable these related parties to pay partial amounts in advance to their vendors or suppliers. 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 in its testing stage. If the Hongrong’s new blast furnace is in full production, it will  guarantee the Company has enough molten iron supplies. Expected that Hongrong’s new blast furnace would be in operation in fourth quarter of 2012, the Company advanced more funds to Hongrong in order to ensure that Hongri will have continuously molten iron supply. The balance of advances to Hongrong was $183,633,559 and $56,340,968 as of December 31, 2012 and 2011, respectively. The amount advanced to Hongrong approximated to purchase of four months molten iron used in production.
 
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 $1,833,558 and $184,447 as of December 31, 2012 and 2011, respectively.

In 2012, the Company purchased $318,369,059 (786,354 metric tons) molten iron, $30,453,078 utility and $1,081,783 spare parts from Hongrong. During 2011, the Company purchased $659,998,838 (1,445,304 metric tons) molten iron, $5,659,111 (21,400 metric tons) scrap steel and $1,106,946 supplies from Hongrong. During 2010, the Company purchased $431,329,226 (1,080,737 metric tons) of molten iron from Hongrong.

The Company purchased coke – raw material and electricity from Baoye. Such purchase was $1,512,598, $0 and $2,927,689 in 2012, 2011 and 2010, respectively.

Sales to related parties

The Company’s sales of its products to YBS Group were $15,802,957, $20,344,781 and $26,854,226 in 2012, 2011 and 2010 respectively. YBS Group 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 Group’ 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 Group’ customers and the Company does not bare any additional risks and YBS Group has all of the collection risk from its customers.
 
Company sold $4,191,682, 6,750,783 and $0 steel products to Hongrong in 2012, 2011 and 2010, respectively. Hongrong used these steel products in Hongrong’s blast furnace constructions. The Company also sold $5,950,879 by-products, which were re-used in manufacturing of molten iron to Hongrong in 2012.

During 2010, the Company sold $323,246 its steel products to Baoye.
 

Equipment purchased from related parties

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

Equipment Loans Payable
 
2012
   
2011
 
             
Equipment loan - YBS Group payable
 
$
3,972,871
   
$
46,071,679
 
Equipment loan - Hongrong payable
   
-
     
16,584,767
 
Total equipment loans payable
   
3,972,871
     
62,656,446
 
Less: current portion
   
(2,884,919
)
   
(11,562,752
)
Long-term payable
 
$
1,087,952
   
$
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 $26,208,524 (RMB 191,163,559 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 bears interest at 5% per annum, and has a fixed repayment schedule at $2,884,919 (RMB 17,973,455 at the December 31, 2012 exchange rate) per annum (payable at the end of the year). During 2012, the Company repaid $14,983,023 (RMB 94,518,192 translated at the 2012 average rate) equipment loan to YBS group by offsetting its previous advanced fund to YBS group. The remaining unpaid loan balance was $3,972,871 (RMB 24,751,549 translated at the December 31, 2012 exchange rate).

On November 30, 2009, the Company purchased Steel-Making II production line and related auxiliary equipment from YBS Group at a price of $35,718,399 (RMB 243,811,599 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 had a fixed repayment schedule at $3,913,233 (RMB 24,380,000 at the December 31, 2012 exchange rate) per annum (payable at the end of the year). During 2012, the Company repaid remaining balance of $27,054,862 (RMB 170,671,599 at the 2012 average exchange rate) in full by offsetting its previous advanced fund to YBS group.

On November 30, 2007, the Company purchased Steel-Making I production line and related auxiliary equipment from Hongrong at a price of $44,698,499 (RMB 326,028,440 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 had a fixed annual repayment schedule at $4,881,755 (RMB 30,414,021 at  the December 31, 2012 exchange rate) per annum (payable at the end of the year). On March 31, 2012, the Company repaid the remaining $16,545,106 (RMB 104,372,354 at the 2012 average rate) by offsetting its current advanced fund to Hongrong.

Interest paid to YBS group for equipment loans was $1,040,676, $2,570,300, and $2,767,527 in 2012, 2011 and 2010, respectively.

Interest paid to Hongrong for equipment loan was $206,814, $1,042,573, and $1,220,335 in 2012, 2011 and 2010, respectively.

Loans from related party

On June 28, 2012, the Company borrowed $160,510 (RMB 1,000,000) from Mr. Beifang Liu, director of the Company, and $642,040 (RMB 4,000,000) from Mr. Maisheng Liu, brother of the CEO of the Company. These payables are interest free and due on demand.
 
The weighted average short term loan balance consisting of financial institution and private loans and Binchang Liu, Beifang Liu and Maisheng Liu loans was $31,241,243 and $18,308,766 for the years ended December 31, 2012 and 2011, respectively. The weighted average interest rate for short term loan was 8.34% and 8.11% for 2012 and 2011, respectively.
 
 
Leases from related parties

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 $230,244 (RMB 1,434,450) which commenced in 2011. The average lease payment is $207,219 (RMB 1,291,005) per annum. The lease is set to expire on December 31, 2037. The present value of the total lease payments at inception was $2,038,982 (RMB 12,703,147 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 $565,350 (RMB 3,522,211) commencing on January 1, 2008. The lease is set to expire on December 31, 2017. The present value of the total lease payments at inception was $3,822,806 (RMB 23,816,623 at the current exchange rate), which was calculated with a discount rate of 7.83%, a PRC long term borrowing rate in December 2007.

In November 2007, the Company entered into a lease agreement with Hongrong, a related party, to lease the manufacturing building of Steel-Making I. The annual lease payment is $194,322 (RMB 1,210,716) commencing on January 1, 2008. The lease is set to expire on December 31, 2017. The present value of the total lease payments at inception was $1,314,042 (RMB 8,186,666 at the current exchange rate), which was calculated with a discount rate of 7.83%, a PRC long term borrowing rate in December 2007.

In November 2009, the Company entered into a lease agreement with YBS Group to lease the manufacturing building of Steel-Making II. The annual lease payment is $17,250 (RMB 107,469) commencing on January 1, 2010. The lease is set to expire on December 31, 2019. The present value of the total lease payments at inception was $127,316 (RMB 793,198 at the current exchange rate), which was calculated with a discount rate of 5.94%, a PRC long term borrowing rate in December 2009.

In November 2009, the Company entered into a lease agreement with Hongrong to lease the manufacturing building of Bar-Rolling III. The annual lease payment is $121,747 (RMB 758,503) commencing on January 1, 2010. The lease is set to expire on December 31, 2019. The present value of the total lease payments at inception was $898,624 (RMB 5,598,552 at the current exchange rate), which was calculated with a discount rate of 5.94%, a PRC long term borrowing rate in December 2009.

As of December 31, 2012, future minimum rental payments applicable to the above non-cancelable capital leases with remaining terms in excess of one year were as follows:

December 31,
 
Capital Leases
 
2013
 
$
1,128,922
 
2014
   
1,128,922
 
2015
   
1,128,922
 
2016
   
1,128,922
 
2017
   
1,128,922
 
Thereafter
   
4,882,864
 
  Total minimum lease payments
   
10,527,474
 
Less amount representing interest
   
(4,209,143
)
  Present value of net minimum lease payments
   
6,318,331
 
Less current obligations
   
(648,893
)
  Long-term obligations
 
$
5,669,438
 
 
Item 14.
Principal Accounting Fees and Services
 
We were billed by Friedman LLP, an independent public accounting firm, for the following professional services they performed for us during fiscal years ended December 31, 2012 and 2011 as set forth in the table below:
 
   
Fiscal year ended December 31,
 
   
2012
   
2011
 
Audit fees
  $ 262,850     $ 279,093  
Audit-related fees
            -  
Tax fees
            -  
All other fees
            -  
Total
  $       $ 279,093  
 
The Board of Directors pre-approves all audit and non-audit services performed by the Company's auditor and the fees to be paid in connection with such services.
 
 
PART IV
 
Item 15.
Exhibits, Financial Statement Schedules
 
Exhibit No.
 
   
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 and Nuosen (1)
   
10.3
Exclusive Option Agreement, by and among Nuosen, Fakei, YBS Group and Hongri  (2)
   
10.4
Covenant Letter (2)
   
10.5
Call Option Agreement (2)
   
10.6 
   
10.7
   
10.8
   
10.9
   
10.10
   
10.11 Sales Agreement dated November 21, 2012
   
21.1
List of subsidiaries (1)
   
31.1
   
31.2
   
32.1
   
32.2
   
101.INS
XBRL Instance Document
   
101.SCH
XBRL Schema Document
   
101.CAL
XBRL Calculation Linkbase Document
   
101.DEF
XBRL Definition Linkbase Document
   
101.LAB
XBRL Label Linkbase Document
   
101.PRE
XBRL Presentation Linkbase Document
 
(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.
 
 
SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
CHINA INDUSTRIAL STEEL INC.
 
       
Date:  April 1, 2013  
By:  
/s/ Shenghong Liu
 
 
Shenghong Liu
Chairman of Board , Chief Executive Officer and Chief Operating Officer (Principal Executive Officer)
   
Date:  April 1, 2013   By:   /s/ Xiaolong Zhou  
  Xiaolong Zhou
Chief Financial Officer
(Principal Financial and Accounting Officer)
   
 
In accordance with the Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
 
Name
 
Title
 
Date
 
/s/ Shenghong Liu
 
Chairman of Board , Chief Executive Officer and Chief Operating Officer
 
April 1, 2013   
Shenghong Liu
       
 
/s/Frank J. Pena
 
Director
 
April 1, 2013  
Frank J. Pena
       
 
/s/ Beifang Liu
 
Director
 
April 1, 2013 
Beifang Liu
       
 
/s/ Fengye Liu
 
 
Director
 

April 1, 2013
Fengye Liu        
 
/s/ Jinghe Liu
 
 
Director
 

April 1, 2013
  Jinghe Liu        
         
         
 
 
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