ITEM 1. BUSINESS.
Overview
Our company was initially incorporated as “American Construction Company” (“ACC”) on August 5, 2002 in the State of Nevada for the purpose of commencing a business of general construction contracting.
On October 14, 2004, ACC, Northwest Steel Company, a wholly-owned Nevada subsidiary of ACC (“Merger Sub”), and General Steel Investment Co., Ltd., a British Virgin Islands company (“General Steel Investment”) entered into an Agreement and Plan of Merger pursuant to which ACC acquired General Steel Investment, and its 70% ownership in its subsidiary Tianjin Daqiuzhuang Metal Sheet Co., Ltd., a PRC company of limited liability (“Daqiuzhuang Metal”) in exchange for shares of ACC’s common stock.
Effective March 7, 2005, ACC changed its name to “General Steel Holdings, Inc.”
Daqiuzhuang Metal started its operation in 1988 and was corporatized under its current form on August 18, 2000 in Jinghai County, Tianjin City, Hebei Province, China. Daqiuzhuang Metal is a Sino-foreign joint venture with an operating term that will expire on June 24, 2024, at which point we expect to file a request for an extension of the term permitted under the then applicable laws. General Steel owns approximately 70% of the share capital of Daqiuzhuang Metal. On May 16, 2004, General Steel Investment purchased approximately 70% equity interest in Daqiuzhuang Metal for the amount of 55.45 million RMB or approximately $6,709,450. Daqiuzhuang Metal received a new business license certifying the new ownership structure as a Chinese Foreign Joint Venture on June 25, 2004.
Daqiuzhuang Metal’s core business is the manufacturing of high quality hot-rolled carbon and silicon steel sheets which are mainly used in the production of tractors, agricultural vehicles, shipping containers and in other specialty markets. Daqiuzhuang Metal uses a traditional rolling mill production sequence, such as heating, rolling, cutting, annealing, and flattening to process slabs into steel sheets. The sheet sizes are approximately 2,000 mm (length) x 1,000 mm (width) x 0.75 to 2.0 mm (thickness). Limited size adjustments can be made to meet order requirements. “Qiu Steel” is the registered name for our products.
Daqiuzhuang Metal currently has ten steel sheet production lines processing approximately 400,000 tons of 0.75-2.0 mm hot-rolled carbon steel sheets per year, maintaining an approximately 50% market share of all hot-rolled steel sheets used in the production of agricultural vehicles in China, out of which 150,000 tons of production capacity were added since mid-March 2006.
Marketing and Customers
Hot rolled carbon and silicon steel sheets are semi-finished products. We sell our products primarily to distributors, service centers, or manufacturers. Our products are primarily used by domestic manufacturers of economy agricultural vehicles: small, motorized, 3-wheel vehicles with a payload from 1,650 to 4,400 lbs. (750 to 2,000 kgs), retailing between 1,200 and 1,800 USD (10,000 - 15,000 RMB).
These inexpensive agriculture vehicles are targeted to the low income farming populations in the rural areas of China. International non-government organizations estimate that approximately 80% of China’s population of 1.3 billion people is comprised of low-income rural farmers.
Based on the production and sales figures supplied by our customers producing economy agricultural vehicles, we estimates that we supply approximately 50% of this industry’s nationwide demand for hot-rolled steel products.
Our marketing efforts are mainly directed toward those customers who have exacting requirements for on-time delivery, customer support and product quality. We believe that our enhanced product quality and delivery capabilities, and our emphasis on customer support and product planning, are critical factors in our ability to serve this segment of the market.
Our revenue is dependent, in large part, on significant contracts from a limited number of customers. During the fiscal year ended December 31, 2006 approximately 30 % of sales were to five customers and approximately 6% of sales were to one customer. During the fiscal year ended December 31, 2005 approximately 37% of sales were to five customers and approximately 9% of sales were to one customer. During the fiscal year ended December 31, 2004 approximately 47% of sales were to five customers and approximately 23% of sales were to one customer. We believe that revenue derived from current and future large customers will continue to represent a significant portion of our total revenue.
We currently sell our products through the following thirty-five distributors:
Upon inception of business, each distributor pays between 100,000 RMB and 1,000,000 RMB, that is, approximately $12,820 and $128,200 deposit to us. Distributors must submit a monthly sales plan for each calendar year. Distributors are required to have a minimum annual order requirement of between 1,000 tons and 5,000 tons. Distributors who do not meet this quota are penalized based on a certain percentage of the difference between the minimum requirement and their actual sales. Thus far, we have not experienced such a problem with any of our distributors and hence did not have to enforce any penalty.
Since April 2006 when we began offering the credit terms to our main customers with whom we have a well-established business relationship. We have not had any delinquent accounts. For customers to whom credit terms are not extended, we require full payment upon or prior to delivery. All customers must place orders 30 days prior to requested delivery.
ABOUT OUR PRODUCTS
Principal Products
We produce hot rolled carbon and silicon steel sheets. Hot rolling is a process in which steel slabs are reduced in thickness. The slabs are first reheated and then passed through rolls in a hot mill to reduce their thickness. The sizes of sheets are roughly 2,000 mm (width) x 1,000 mm (length) x 0.75 to 2.0 mm (thickness). Limited size adjustments are possible to meet specific order requirements.
We believe our product is thinner, lighter and more durable than our competitors. Through our production process, we are able to roll our sheets to a minimum thickness of 0.75 mm while maintaining even durability throughout the surface area. This level of thinness makes our sheets suitable substitutes for sheets produced with more expensive cold-rolled technology. This gives us an advantage in pricing our product. We are able to price our product slightly above the market price for traditional hot-rolled sheets and below the market price for cold-rolled sheets.
“Qiu Steel” is the registered trademark under which our Company sells its products. Our logo has been registered with the China National Trademark Bureau under No. 586433. “Qiu Steel” is registered under the GB 912-89 national quality standard, and certified under the National Quality Assurance program.
Our Company was awarded the “Excellent Quality Product” award by the Tianjin Products Technical Quality Assurance Bureau in 2001, and the “Famous Trade Mark Award” by the Tianjin Commerce Bureau in 2002.
From to 2006, our overall sales volume increased by 68% from 203,422 tons in 2005 to 341,702 tons in 2006.
Raw Materials
We mainly purchase two types of raw materials from our suppliers, namely, slabs and steel strip. We purchase raw materials from several local steel manufacturers and distributors including but not limited to Tianjin Rong Steel Co., Ltd., Tianjin Ren Ai Steel Co., Ltd., Tianjin Hengying Commercial Trading Co., Ltd., etc.
Employees
As of December 31, 2006, we had 1,250 employees on a full time basis. As of December 31, 2005, we had 900 employees on a full time basis. The increase in number of employees from 2005 to 2006 is largely due to the addition of our four new production lines and additional employees necessary to operate them.
ABOUT OUR RECENT STRATEGIC ALLIANCE
In 2005, we signed a joint venture agreement (the “Joint Venture Agreement”) with Baotou Iron and Steel Group (“Baotou Steel”) to form Baotou Steel - General Steel Special Steel Joint Venture Company Limited, a limited liability company formed under the laws of the People’s Republic of China (the “Joint Venture Company”). The Joint Venture Company has not been launched and is not operational yet.
This contemplated transaction is not considered a business combination as defined under Article 11 of Regulation S-X. The revenue producing activity for the new entity will be different from that of the existing companies. New high-end special steel products will be produced and marketed to new customers. In order to produce these new products, the new entity will build new facilities on the land to be contributed by Baotou Steel. It will take some equipment to be contributed by Baotou Steel, which are to be substantially modified, and add a 100-ton electric furnace and a refiner to create a new production line. A new sales force will be built to identify and target new customers. The new entity will not carry the names of either of its future owners.
This contemplated transaction is not considered as a business acquisition through a non-monetary exchange under EITF 98-3 because it does not meet the relevant definition thereunder. The assets to be contributed do not include systems, standards, protocols, conventions and rules that act to define the process necessary for normal, self-sustaining operations, such as (i) strategic management processes, (ii) operational processes, and (iii) resource management processes. The assets to be contributed do not include the ability to obtain access to the customers that purchase the outputs of the assets to be contributed. Additionally, while the newly formed entity will receive certain tangible assets, it will be a start-up company. It will need to attract and retain talent to install/modify/acquire equipment, manage operations, as well as to manufacture, market and sell products to newly identified customers. The assets to be contributed by Baotou Steel are insignificant compared to the total assets of Baotou Steel. Baotou Steel will continue to operate at its historical levels even assuming the consummation of the contemplated transaction. The respective future owners who will contribute certain assets to the new entity will continue to operate as separate entities. They will not reduce or transfer any of their respective workforces as a result of this transaction. They will continue to operate their existing businesses at their historical levels.
The Joint Venture is contemplated to be implemented in three stages. The total investment in the Joint Venture Company may be up to US$30,000,000, with an anticipated registered capital of approximately US$24,000,000. The total investment in the first stage is contemplated to be $5,000,000. Pursuant to the Joint Venture Agreement, Baotou Steel will contribute land, existing equipment and materials whereas General Steel Investment and Daqiuzhuang Metal will each contribute cash capital to the Joint Venture Company. The completion of this transaction is subject to the provision of both General Steel Investment and Daqiuzhuang Metal by Baotou Steel of relevant financial statements and an independent appraisal of the assets to be contributed to the Joint Venture Company, which as of the end of 2006 have not been produced thus far. In addition, China’s State Assets Supervision and Administration Committee will need to assign an independent appraisal firm to perform an appraisal of the assets contributed by Baotou Steel. At the end of 2006, we were still waiting for the Chinese government to appoint an appraisal firm to complete the appraisal and the evaluation process of the joint venture project. As a result, as of the end of 2006, we are not in a position to determine the amount of cash capital General Steel Investment and Daqiuzhuang Metal will be required to contribute to the Joint Venture Company. As of the end of 2006, we are working to encourage relevant parties to provide the requisite documentation and initiate the needed procedures.
ITEM 1A.
ITEM 1A. Risk Factors.
Risks related to our business
We face substantial competition which, among other things, may lead to price pressure and adversely affect our sales.
In the sale of flat rolled carbon steel and silicon steel, we compete with other market players on the basis of product quality, responsiveness to customer needs and price. There are two types of steel and iron companies in China: State Owned Enterprises (“SOEs”), and privately owned companies.
Criteria for our customers include:
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Quality;
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Price/cost competitiveness;
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System and product performance;
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Reliability and timeliness of delivery;
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New product and technology development capability;
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Excellence and flexibility in operations;
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Degree of global and local presence;
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Effectiveness of customer service; and
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Overall management capability.
We compete with both SOEs and privately owned steel manufacturers. While we believe that our price and quality are superior to other manufacturers, many of our competitors are better capitalized, more experienced, and have deeper ties in the Chinese marketplace. We consider there to be three major competitors of similar size, production capability and product line in the market place: Tianjin No. 1 Rolling Steel Plant, Tianjin Yinze Metal Sheet Plant and Tangshan Fengrun Metal Sheet Plant. In addition, with China’s entry into the World Trade Organization and China’s agreements to lift many of the barriers to foreign competition, we believe that competition will increase in the agricultural equipment market in China as a whole with the entry of foreign companies into this market. This may limit our opportunities for growth, lead to price pressure and reduce our profitability. We may not be able to compete favorably and this increased competition may harm our business, our business prospects and results of operations.
Our limited operating history may not serve as an adequate basis to judge our future prospects and results of operations.
Our limited operating history may not provide a meaningful basis on which to evaluate our business. Although our revenues have grown rapidly since inception, we might not be able to maintain our profitability or we may incur net losses in the future. We expect that our operating expenses will increase as we expand. Any significant failure to realize anticipated revenue growth could result in significant operating losses. We will continue to encounter risks and difficulties frequently experienced by companies at a similar stage of development, including our potential failure to:
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Implement our business model and strategy and adapt and modify them as needed;
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Increase awareness of our brands, protect our reputation and develop customer loyalty;
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Manage our expanding operations and service offerings, including the integration of any future acquisitions;
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Maintain adequate control of our expenses;
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Anticipate and adapt to changing conditions in the agricultural equipment markets in which we operate as well as the impact of any changes in government regulation; and
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Anticipate mergers and acquisitions involving our competitors, technological developments and other significant competitive and market dynamics.
Our business, business prospects and results of operations will be affected if we are not successful in addressing any or all of these risks and difficulties.
Our inability to fund our capital expenditure requirements may adversely affect our growth and profitability.
Our continued growth is dependent upon our ability to raise additional capital from outside sources. We believe that in order to grow our company further, we intend to seize opportunities in Chinese SOEs’ privatization and set up strategic joint ventures with these SOEs. That will require us to obtain additional financing through capital markets. In the future we may be unable to obtain the necessary financing on a timely basis and on favorable terms, and our failure to do so may weaken our financial position, reduce our competitiveness, limit our growth and reduce our profitability. Our ability to obtain acceptable financing at any given time may depend on a number of factors, including:
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Our financial condition and results of operations,
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The condition of the PRC economy and the agricultural equipment industry in the PRC, and
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Conditions in relevant financial markets in the U.S., the PRC and elsewhere in the world.
We may not be able to effectively control and manage our growth.
If our business and markets grow and develop, it will be necessary for us to finance and manage such an expansion in an orderly fashion. This growth will lead to an increase in the responsibilities of existing personnel, the hiring of additional personnel and expansion of our scope of operations. It is possible that we may not be able to obtain the required financing under terms that are acceptable to us or hire additional personnel to meet the needs of our expansion.
Our business, revenues and profitability are dependent on a limited number of large customers.
Our revenue is dependent, in large part, on significant contracts with a limited number of large customers. For the year 2006, approximately 28% of our sales were to five customers. We believe that revenue derived from our current and future large customers will continue to represent a significant portion of our total revenue. Our inability to continue to secure and maintain a sufficient number of large contracts or the loss of, or significant reduction in purchases by, one or more of our major customers would have the effect of reducing our revenues and profitability.
Moreover, our success will depend in part upon our ability to obtain orders from new customers, as well as the financial condition and success of our customers and general economic conditions in China.
We may not be able to pass on to customers the increases in the costs of our raw materials, particularly iron and steel.
The major raw materials that we purchase for production are steel slabs and strip steel. The price and availability of these raw materials are subject to market conditions affecting supply and demand. Our financial condition or results of operations may be impaired by further increases in raw material costs to the extent we are unable to pass those increases to our customers. In addition, if these materials are not available on a timely basis or at all, we may not be able to produce our products and our sales may decline.
The price of steel may decline due to an overproduction by the Chinese steel companies.
According to the survey conducted by China Iron and Steel Association, there are more than 1,500 steel companies in China. Among those, only 15 companies have over 5 million tons of production capacity. Each steel company has its own production plan. The Chinese government posted a new guidance on steel industry to encourage consolidation within the fragmented steel sector to mitigate problems of low-end repetitive production and inefficient use of resources. The current situation of overproduction may not be solved by these measures posted by the Chinese government. If the current state of overproduction continues, our products shipments could decline, our inventory could build up and eventually we may be required to decrease our sales price, which may eventually decrease our profitability.
Because we are a holding company with substantially all of our operations conducted through our subsidiaries, our performance will be affected by the performance of such subsidiaries.
We have no operations independent of those of Daqiuzhuang Metal, and our principal assets are our investments in Daqiuzhuang Metal. As a result, we are dependent upon the performance of Daqiuzhuang Metal and we will be subject to the financial, business and other factors affecting Daqiuzhuang Metal as well as general economic and financial conditions. As substantially all of our operations are and will be conducted through our subsidiaries, we will be dependent on the cash flow of our subsidiaries to meet our obligations.
Because virtually all of our assets are and will be held by operating subsidiaries, the claims of our stockholders will be structurally subordinate to all existing and future liabilities and obligations, and trade payables of such subsidiaries. In the event of our bankruptcy, liquidation or reorganization, our assets and those of our subsidiaries will be available to satisfy the claims of our stockholders only after all of the our and our subsidiaries’ liabilities and obligations have been paid in full.
We depend on acquiring companies to fulfill our growth plan
An important element of our planned growth strategy is the pursuit and acquisitions of other businesses that increase our existing production capacity. However, integrating businesses involves a number of special risks, including the possibility that management may be distracted from regular business concerns by the need to integrate operations, unforeseen difficulties in integrating operations and systems, problems relating to assimilating and retaining employees of the acquisition, challenges in retaining customers, and potential adverse short-term effects on operation results. If we are unable to successfully complete and integrate strategic acquisitions in a timely manner, our growth strategy may be adversely impacted.
We depend on bank financing for our working capital needs.
We have various financing facilities amounting to approximately US$30.3 million, of which all are due on demand or within one year. So far, we have not experienced any difficulties in repaying such financing facilities. However, we may in the future encounter difficulties to repay or refinance such loans on time and may face severe difficulties in our operations and financial position.
We rely on Yu, Zuo Sheng for important business leadership
We depend, to a large extent, on the abilities and operations of our current management team. However, we have a particular reliance upon Yu, Zuo Sheng, our chairman and chief executive officer, for the redirection of our business and leadership in our growth effort. The loss of the services of Yu, Zuo Sheng, for any reason, may have a material adverse effect on our business and prospects. We cannot be guarantee that Yu, Zuo Sheng will continue to be available to us, or that we will be able to find a suitable replacement for Yu, Zuo Sheng on a timely basis.
Risks Related to Operating Our Business in China
We face the risk that changes in the policies of the Chinese government could have significant impact upon the business we may be able to conduct in China and the profitability of such business.
The economy of China is at a transition from a planned economy to a market oriented economy subject to five-year and annual plans adopted by the government that set down national economic development goals. Policies of the Chinese government can have significant effects on the economic conditions of China. The Chinese government has confirmed that economic development will follow a model of market economy under socialism. Under this direction, we believe that the PRC will continue to strengthen its economic and trading relationships with foreign countries and business development in China will follow market forces. While we believe that this trend will continue, there can be no assurance that such will be the case. A change in policies by the Chinese government could adversely affect our interests by, among other factors: changes in laws, regulations or the interpretation thereof; confiscatory taxation; restrictions on currency conversion, imports or sources of supplies; or the expropriation or nationalization of private enterprises. Although the Chinese government has been pursuing economic reform policies for approximately two decades, the Chinese government may significantly alter such policies, especially in the event of a change in leadership, social or political disruption, or other circumstances affecting China’s political, economic and social life.
The PRC laws and regulations governing our current business operations and contractual arrangements are uncertain, and if we are found to be in violation, we could be subject to sanctions. In addition, any changes in such PRC laws and regulations may have a material and adverse effect on our business.
There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including but not limited to the laws and regulations governing our business, or the enforcement and performance of our arrangements with customers in the event of the imposition of statutory liens, death, bankruptcy and criminal proceedings. Our subsidiaries and we are considered foreign persons or foreign funded enterprises under PRC laws, and as a result, we are required to comply with PRC laws and regulations. These laws and regulations are relatively new and may be subject to future changes, and their official interpretation and enforcement may involve substantial uncertainty. The effectiveness of newly enacted laws, regulations or amendments may be delayed, resulting in detrimental reliance by foreign investors. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively. In addition, the PRC authorities retain broad discretion in dealing with violations of laws and regulations, including levying fines, revoking business licenses and requiring actions necessary for compliance. In particular, licenses, permits and beneficial treatments issued or granted to us by relevant governmental bodies may be revoked at a later time under contrary findings of higher regulatory bodies. We cannot predict what effect the interpretation of existing or new PRC laws or regulations may have on our businesses. Such restructuring may not be effective or result in similar or other difficulties. We may be
subject to sanctions, including fines, and could be required to restructure our operations. As a result of these substantial uncertainties, there is a risk that we may be found in violation of any current or future PRC laws or regulations.
A slowdown or other adverse developments in the PRC economy may materially and adversely affect our customers, demand for our services and our business.
All of our operations are conducted in the PRC and all of our revenues are generated from sales to businesses operating in the PRC. Although the PRC economy has grown significantly in recent years, such growth may not continue. We do not know how sensitive we are to a slowdown in economic growth or other adverse changes in the PRC economy which may affect demand for agricultural equipment. A slowdown in overall economic growth, an economic downturn or recession or other adverse economic developments in the PRC may materially reduce the demand for our products and in turn reduce our results of operations and our productivity.
In China, farmers are key consumers for agricultural vehicles. The consumption is closely related to the economic developments in different regions and areas. With the continuous development of rural economy in central and western China, there is increasing demand for agricultural vehicles. In addition, the implementation of the “Go West” strategy and China’s entry into the World Trade Organization have prodded the government to increase investment in the agricultural sector in central and western China. China’s western areas will become a high growth market for agricultural vehicles. However the new government policies may as well bring competition to this market. More steel companies may turn their focus to the agricultural sector which will increase the supply of steel products used for agricultural vehicles. This new competition may force us to lower our product price or reduce the production volume.
Inflation in China could negatively affect our profitability and growth.
While the Chinese economy has experienced rapid growth, such growth has been uneven among various sectors of the economy and in different geographical areas of the country. Rapid economic growth can lead to growth in the money supply and rising inflation. If prices for our products rise at a rate that is insufficient to compensate for the rise in the costs of supplies, it may have an adverse effect on profitability. In order to control inflation in the past, the Chinese government has imposed controls on bank credits, limits on loans for fixed assets and restrictions on state bank lending. Such an austerity policy can lead to a slowing of economic growth. In October 2004, the People’s Bank of China, China’s central bank, raised interest rates for the first time in nearly a decade and indicated in a statement that the measure was prompted by inflationary concerns in the Chinese economy. Repeated increases in interest rates by the central bank will likely slow economic activity in China which could, in turn, materially increase our costs and also reduce demand for our products.
If relations between the United States and China worsen, our stock price may decrease and we may experience difficulties accessing the U.S. capital markets.
At various times during recent years, the United States and China have had disagreements over political and economic issues. Controversies may arise in the future between these two countries. Any political or trade controversies between the United States and China could impact the market price of our common stock and our ability to access US capital markets.
The Chinese Government could change its policies toward private enterprises, which could result in the total loss of our investments in China.
Our business is subject to political and economic uncertainties in China and may be adversely affected by its political, economic and social developments. Over the past several years, the Chinese Government has pursued economic reform policies including the encouragement of private economic activity and greater economic decentralization. The Chinese Government may not continue to pursue these policies or may alter them to our detriment from time to time. Conducting our business might become more difficult or costly due to changes in policies, laws and regulations, or in their interpretation or the
imposition of confiscatory taxation, restrictions on currency conversion, restrictions or prohibitions on dividend payments to stockholders, devaluations of currency or the nationalization or other expropriation of private enterprises. In addition, nationalization or expropriation could result in the total loss of our investments in China.
Our business, results of operations and overall profitability are linked to the economic, political and social conditions in China.
All of our business, assets and operations are located in China. The economy of China differs from the economies of most developed countries in many respects, including government involvement, level of development, growth rate, control of foreign exchange, and allocation of resources. The economy of China has been transitioning from a planned economy to a more market-oriented economy. Although the Chinese Government has implemented measures recently emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets and the establishment of sound corporate governance in business enterprises, a substantial portion of productive assets in China is still owned by the Chinese Government. In addition, the Chinese Government continues to play a significant role in regulating industry by imposing industrial policies. It also exercises significant control over China’s economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. Therefore, the Chinese Government’s involvement in the economy may affect our business operations, results of operations and our financial condition.
Governmental control of currency conversion may cause the value of your investment in our common stock to decrease.
The PRC government imposes controls on the convertibility of Renminbi into foreign currencies and, in certain cases, the remittance of currency out of the PRC. We receive substantially all of our revenues in Renminbi, which is currently not a freely convertible currency. Shortages in the availability of foreign currency may restrict our ability to remit sufficient foreign currency to pay dividends, or otherwise satisfy foreign currency denominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from the transaction, can be made in foreign currencies without prior approval from the PRC State Administration of Foreign Exchange by complying with certain procedural requirements. However, approval from appropriate governmental authorities is required where Renminbi is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of bank loans denominated in foreign currencies.
The PRC government may also at its discretion restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay certain of our expenses as they come due.
The fluctuation of the Renminbi may cause the value of your investment in our common stock to decrease.
The value of the Renminbi against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in the PRC’s political and economic conditions. As we rely entirely on revenues earned in the PRC, our cash flows, revenues and financial condition will be affected by any significant revaluation of the Renminbi. For example, to the extent that we need to convert U.S. dollars we receive from an offering of our securities into Renminbi for our operations, if the Renminbi appreciates against the U.S. dollar, the Renminbi equivalent of the US dollar we convert would be reduced. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of making payments for dividends on our common shares or for other business purposes and the U.S. dollar appreciates against the Renminbi, the U.S. dollar equivalent of the Renminbi we convert would be reduced. To date, however, we have not engaged in transactions of either type. In addition, the depreciation of significant U.S. dollar
denominated assets could result in a charge to our income statement and a reduction in the value of these assets.
Since 1994 the PRC has pegged the value of the Renminbi to the U.S. dollar. We do not believe that this policy has affected our business. However, there have been indications that the PRC government may be reconsidering its monetary policy in light of the overall devaluation of the U.S. dollar against the Euro and other currencies during the last two years. In July 2005, the PRC government revalued the Renminbi by 2.1% against the U.S. dollar, moving from Renminbi 8.28 to Renminbi 8.11 per dollar. Because of the pegging of the Renminbi to the U.S. dollar is loosened, we anticipate that the value of the Renminbi will appreciate against the dollar with the consequences discussed above.
We are subject to environmental and safety regulations, which may increase our compliance costs and reduce our overall profitability.
We are subject to the requirements of environmental and occupational safety and health laws and regulations in China. We may incur substantial costs or liabilities in connection with these requirements. Additionally, these regulations may become stricter, which will increase our costs of compliance in a manner that could reduce our overall profitability. The capital requirements and other expenditures that may be necessary to comply with environmental requirements could increase and become a significant expense linked to the conduct of our business.
Because the Chinese legal system is not fully developed, our legal protections may be limited.
The PRC legal system is based upon written statutes. Prior court decisions may be cited for reference but are not binding on subsequent cases and have limited value as precedents. Since 1979, the PRC legislative bodies have promulgated laws and regulations dealing with economic matters such as foreign investment, corporate organization and governance, commerce, taxation and trade. However, the PRC has not developed a fully integrated legal system and the array of new laws and regulations may not be sufficient to cover all aspects of economic activities in the PRC. In particular, because these laws and regulations are relatively new, and because of the limited volume of published decisions and their non-binding nature, the interpretation and enforcement of these laws and regulations involve uncertainties. In addition, published government policies and internal rules may have retroactive effects and, in some cases, the policies and rules are not published at all. As a result, we may be unaware of our violation of these policies and rules until some time later. The laws of the PRC govern our contractual arrangements with our affiliated entities. The enforcement of these contracts and the interpretation of the laws governing these relationships are subject to uncertainty. For the above reasons, legal compliance in China may be more difficult or expensive.
Risks Related to Our Common Stock
Our officers, directors and affiliates control us through their positions and stock ownership and their interests may differ from other stockholders.
Our officers, directors and affiliates beneficially own approximately 96% of our common stock. Mr. Yu, Zuo Sheng our major shareholder, beneficially owns approximately 76.5% of our common stock. Mr. Yu can effectively control us and his interests may differ from other stockholders.
Because our principal assets are located outside of the United States and all of our directors and officers reside outside of the United States, it may be difficult for you to enforce your rights based on U.S. federal securities laws against us and our officers and directors in the U.S. or enforce U.S. court judgments against us or them in the PRC.
All our directors reside outside of the United States. In addition, Daqiuzhuang, our operating subsidiary, is located in China and substantially all of its assets are located outside of the United States. It may therefore be difficult for investors in the United States to enforce their legal rights based on the civil
liability provisions of the U.S. federal securities laws against us in the courts of either the U.S. and the PRC and, even if civil judgments are obtained in U.S. courts, to enforce such judgments in PRC courts. Further, it is unclear if extradition treaties now in effect between the United States and the PRC would permit effective enforcement against us or our officers and directors of criminal penalties under the U.S. federal securities laws or otherwise.
We have never paid cash dividends and are not likely to do so in the foreseeable future.
We currently intend to retain any future earnings for use in the operation and expansion of our business. We do not expect to pay any cash dividends in the foreseeable future but will review this policy as circumstances dictate.
There is only a limited trading market for our common stock.
Our common stock is now listed on the over-the-counter Bulletin Board. There is currently limited trading market for our common stock and we do not know if any trading market will ever develop. You may be unable to sell your shares due to the absence of a trading market.
In addition, broker-dealers who recommend our common stock to people who are not established customers or qualifying investors must follow special sales procedures, including getting the purchaser’s written consent prior to the sale. We are currently subject to the “penny stock” rules promulgated under the Securities Exchange Act of 1934. During the period(s) that our stock trades below $5.00 per share, as it currently does, trading in our common stock is subject to the requirements of the “penny stock” rules. These rules require additional disclosure by broker dealers in connection with any trades generally involving any non-NASDAQ equity security that has a market price of less than $5.00 per share, subject to certain exceptions. Such rules require the delivery, before any “penny stock” transaction, of a disclosure schedule explaining the penny stock market and the risks associated therewith, and impose various sales practice requirements on broker dealers who sell penny stocks to persons other than established customers and accredited investors (generally institutions). For these types of transactions, the broker-dealer must determine the suitability of the penny stock for the purchaser and receive the purchaser’s written consent to the transaction before sale. The additional burdens imposed upon broker dealers by such requirements may discourage broker-dealers from effecting transactions in our common stock affected. As a consequence, the market liquidity of General Steel’s common stock could be severely limited by these regulatory requirements.
Our common stock is subject to price volatility unrelated to our operations.
The market price of our common stock 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 steel makers, trading volume in our common stock, changes in general conditions in the economy and the financial markets or other developments affecting our competitors or us.
In addition, the stock market 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.
ITEM 1B.
ITEM 1B. Unresolved Staff Comments.
None
ITEM 2.
ITEM 2. Properties.
Our manufacturing sites and the office buildings are located in the Jinghai county, about 20 miles (45 kilometers) southwest of the Tianjin city center. The sites are situated on a total of 17.81 acres (7.21 hectares) of land and resides within 320,390 sq. ft. (29,667 sq. m.) of building space.
Under Chinese law, all land in the PRC is owned by the government, which grants a “land use right” to an individual or entity 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 enjoy all the ownership incidents to the land. We are the registered owner of the land use rights for the parcels of land identified in the chart below.
Our production equipment includes the following:
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
Not applicable.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR GENERAL STEEL HOLDINGS INC.’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Our common stock is listed on the OTC Bulletin Board with the ticker symbol "GSHO." Information regarding the high and low sales prices for the common stock for each quarter of the last two years is as follows:
As of March 23, 2007, there were approximately 42 holders of record of our common stock. We are seeking the listing of our shares of common stock on the American Stock Exchange (the “AMEX”). The listing application has been submitted to AMEX.
Dividend Policy
Our board of directors currently does not intend to declare dividends or make any other distributions to our shareholders. Any determination to pay dividends in the future will be at our board’s discretion and will depend upon our results of operations, financial condition and prospects as well as other factors deemed relevant by our board of directors.
ITEM 6.
ITEM 6. Selected Financial Data.
SUMMARY OF OPERATIONS
(USD in thousands, except the ratio amount)
FINANCIAL DATA
(USD in thousands, except the ratio amount)
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
Forward-Looking Statements:
The following discussion of the financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes thereto. The following discussion contains forward-looking statements. General Steel Holdings, Inc. is referred to herein as “we” or “our.” The words or phrases “would be,” “will allow,” “expect to”, “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” or similar expressions are intended to identify forward-looking statements. Such statements include those concerning our expected financial performance, our corporate strategy and operational plans. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of risks and uncertainties, including: (a) those risks and uncertainties related to general economic conditions in China, including regulatory factors that may affect such economic conditions; (b) whether we are able to manage our planned growth efficiently and operate profitable operations, including whether our management will be able to identify, hire, train, retain, motivate and manage required personnel or that management will be able to successfully manage and exploit existing and potential market opportunities; (c) whether we are able to generate sufficient revenues or obtain financing to sustain and grow our operations; and (d) whether we are able to successfully fulfill our primary requirements for cash which are explained below under “Liquidity and Capital Resources. Unless otherwise required by applicable law, we do not undertake, and we specifically disclaim any obligation, to update any forward-looking statements to reflect occurrences, developments, unanticipated events or circumstances after the date of such statement.
Overview
Following the acquisition of ownership in General Steel Investment Co., Ltd. in October 2004, we have shifted our main business focus to general steel products and steel manufacturing. As our core-operating unit, Tianjin Daqiuzhuang Metal Sheet Co., Ltd. (“Daqiuzhuang Metal”) started its operation in 1988. Daqiuzhuang Metal ‘s core business is the manufacturing of high quality hot-rolled carbon and silicon steel sheets which are mainly used in the production of tractors, agricultural vehicles, shipping containers and in other specialty markets.
Daqiuzhuang Metal uses a traditional rolling mill production sequence, such as heating, rolling, cutting, annealing, and flattening to process slabs into steel sheets. The sheet sizes are approximately 2,000 mm (length) x 1,000 mm (width) x 0.75 to 2.0 mm (thickness). Limited size adjustments can be made to meet order requirements. “Qiu Steel” is the registered name for our products.
Daqiuzhuang Metal currently has ten steel sheet production lines processing approximately 400,000 tons of 0.75-2.0 mm hot-rolled carbon steel sheets per year, maintaining an approximately 50% market share of all hot-rolled steel sheets used in the production of agricultural vehicles in China, out of which 150,000 tons of production capacity were added since mid-March 2006.
In we expanded the number of our distributors from 19 to 35 and established 3 regional sales offices: Nanjing city in Jiangsu province, Shenyang city in Liaoning province, and Shanghai.
In 2006, we invested heavily in our operations. We added four new production lines increasing our capacity by 150,000 tons. The higher costs associated with the start up of these lines and bringing them to full capacity negatively impacted our earnings.
Due to higher rates of waste, only 88.5% of products produced from the new lines were rated “A” quality, compared to 92.29% of the products produced from the established lines. This resulted in a selling price differential of $33.96 per ton. In other words, the products produced from the new lines overall sold for $33.96 less than the products produced from the established lines. Based on the new lines produced 123,390.34 tons, this resulted in a $4,190,336 effective difference. The chart below illustrates this.
Selling Price Differences between Products Produced on (old) Lines 1-6 and (new) Lines 1-7
Likewise, owing to overall start up inefficiencies a cost differential also existed between products produced on the two lines. Products produced on the new lines were $9.03 per ton more expensive to produce than products produced on the established lines. Since the new lines produced 123,390.34 tons, this resulted in a $1,114,215 cost differential. The chart below illustrates this.
Production Cost Differences between Products Produced on (old) Lines 1-6 and (new) Lines 1-7
To this we also must include additional costs for worker training, $188,355, and setting up new regional sales offices, $42,713.
The combination of the above mentioned four factors $4,190,336 + $1,114,215 + $188,355 + $42,713 results in $5,535,619 negative impact to Daqiuzhuang Metals income.
We have a 30% minority share holder in our company. After taking out minority shareholders interest, the net impact on our income was $3,874,933..
If the new production lines had produced at the same efficiency and yield, in terms of producing the same percentage of product of “A” quality and production efficiency, as the old lines, our earnings would have been $4,908,141, which was $3,874,933 higher than the $1,033,208, we reported.
By the end of the fourth quarter, we believe the new lines are operating at a level equal to the efficiencies of our established lines. This puts us in a very strong position to begin 2007.
Joint Venture
On September 28, 2005, We signed a joint venture agreement (the “Joint Venture Agreement”) with Baotou Iron and Steel Group (“Baotou Steel”), to form Baotou Steel - General Steel Special Steel Joint Venture Company Limited, a limited liability company formed under the laws of the People's Republic of China (the “Joint Venture Company”). As of December 31, 2006, the Joint Venture Company has not been launched and is not operational yet.
This contemplated transaction is not considered a business combination as defined under Article 11 of Regulation S-X. The revenue producing activity for the new entity will be different from that of the existing companies. New high-end special steel products will be produced and marketed to new customers. In order to produce these new products, the new entity will build new facilities on the land to be contributed by Baotou Steel. It will take some equipment to be contributed by Baotou Steel, which are to be substantially modified, and add a 100-ton electric furnace and a refiner to create a new production line. A new sales force will be built to identify and target new customers. The new entity will not carry the names of either of its future owners.
This contemplated transaction is not considered as a business acquisition through a non-monetary exchange under EITF 98-3 because it does not meet the relevant definition thereunder. The assets to be contributed do not include systems, standards, protocols, conventions and rules that act to define the process necessary for normal, self-sustaining operations, such as (i) strategic management processes, (ii) operational processes, and (iii) resource management processes. The assets to be contributed do not include the ability to obtain access to the customers that purchase the outputs of the assets to be contributed. Additionally, while the newly formed entity will receive certain tangible assets, it will be a start-up company. It will need to attract and retain talent to install/modify/acquire equipment, manage operations, as well as to manufacture, market and sell products to newly identified customers. The assets to be contributed by Baotou Steel are insignificant compared to the total assets of Baotou Steel. Baotou Steel will continue to operate at its historical levels even assuming the consummation of the contemplated transaction. The respective future owners who will contribute certain assets to the new entity will continue to operate as separate entities. They will not reduce or transfer any of their respective workforces as a result of this transaction. They will continue to operate their existing businesses at their historical levels.
The Joint Venture is contemplated to be implemented in three stages. The total investment in the Joint Venture Company may be up to US$ 30,000,000, with an anticipated registered capital of approximately US$ 24,000,000. The initial investment in the first stage is projected to be $5,000,000. Pursuant to the Joint Venture Agreement, Baotou Steel will contribute land, existing equipment and materials whereas General Steel Investment and Daqiuzhuang Metal will each contribute cash capital to the Joint Venture Company. The completion of this transaction is subject to the provision to both General Steel Investment and Daqiuzhuang Metal by Baotou Steel of relevant financial statements and an independent appraisal of the assets to be contributed to the Joint Venture Company, which have not been produced thus far. In addition, China’s State Assets Supervision and Administration Committee will need to assign an independent appraisal firm to perform an appraisal of the assets contributed by Baotou Steel. As of December 31, 2006, we are still waiting for the Chinese government to appoint an appraisal firm to complete the appraisal and the evaluation process of the joint venture project. As a result, as of December 31, 2006, we are not in a position to determine the amount of cash capital General Steel Investment and Daqiuzhuang Metal will be required to contribute to the Joint Venture Company. We are working to encourage relevant parties to provide the requisite documentation and initiate the needed procedures.
Trends
Industry Consolidation:
In 2006, the domestic steel industry continued to remain fragmented and competitive. However, we began to see encouraging results of the central government’s plan to bring about consolidation in the industry.
-
Slowing annual growth rate: For the second consecutive year, the annual growth rate in crude steel production declined (see chart below):
-
Large SOE mergers: Laiwu Steel Corporation and Jinan Iron and Steel Group merged (the sixth and seventh largest domestic producers), and Anshan Iron and Steel Group merged with Benxi Iron and Steel Group (the second and fifth largest in the domestic market).
-
Closures: The central government announced targeted closure of blast furnaces of less than 200cbm and converters of 200 tonne or below - representing an elimination of 55 million tons of capacity by 2010.
-
Fixed asset investment down: Fixed asset investment in the steel and iron industry dropped 2.5% from 2006 to 2005 - the first time in 5 years.
Overall, we see the central government’s effort is beginning to gain traction to bring consolidation and reduce the number of producers in the market. We have foreseen this trend, have formed relationship with targeted steel companies and are now in a position to capitalize on this consolidation trend.
Western China Development:
In the central government’s 11th Five-year Economic Development Plan for 2006 - 2010, China’s western region is prioritized for targeted economic and infrastructure development.
Raw Material Costs:
We anticipate in 2007 that the cost of imported iron ore will continue to be a driver in the price of crude rolled steel. Crude steel is a primary input material used in making our product. China must import 60% of the iron ore it uses. Because the domestic industry is so fragmented, no cohesive bargaining leverage exists to negotiate better terms with the main foreign iron ore suppliers: Rio Tinto, CVRD, & BHP Billiton. In developed countries with a consolidated steel industry profile, the collective bargaining leverage of the dominant players results in lower prices.
Export Subsidies for Steel Products:
Complaints from other countries about China’s export subsidy program for selected steel products violating its World Trade Organization commitments appeared often, especially in the fourth quarter, in the international media throughout the year. Many countries have called for China to eliminate these subsidies. We do not export our product. We will not be directly affected in our ability to sell our product by any government decision whether to end or continue these export subsidies for steel products.
Operating Results
Summary:
Below is a summary of changes to our principal financial indicators for the year. An explanation of the reasons for the changes follows:
Net sales from operations increased from $89.7 million in 2005 to $139.5 million in 2006, a 55% increase.
Gross profit decreased from $8.6 million in 2005 to $4.2 million in 2006 million. In the same period gross profit margin decreased from 9.6% in 2005 to 3.0% in 2006, representing a 6% decrease.
Overall cost of sales increased to $135.3 million in 2006, from $81.2 million in 2005, a 67% increase.
Selling, general and administrative expenses were $2.4 million for 2006, compared to $2.8 million for the same period of 2005, a 12.9% decrease.
Interest expense was $2.07million for the fiscal year ended December 31, 2006, a 20% increase compared to $1.72 million in 2005.
Cash balance including restricted cash amounted to $11.1 million and $11.4 million as of December 31, 2006 and 2005.
Accounts receivable were $17.1 million as of December 31, 2006 compared to $993,417 at December 31, 2005.
Net sales and gross profit
Fiscal year ended December 31, 2006 compared to Fiscal year ended December 31,
Net sales from operations increased from $89.7 million in 2005 to $139.5 million in 2006, a 55% increase. This increase is a result from a combination of factors, including:
·
increase in our production volume with our four new productions lines with a total capacity of 150,000 tons annually,
·
increase in the number of distributors from 19 to 35;
·
establishment of 3 new regional sales offices in Nanjing city in Jiangsu province, Shenyang city in Liaoning province and Shanghai municipality;
·
increase in demand for light agricultural vehicles brought about by the central government’s effort to raise rural income.
As part of the central government’s 11th Five-year plan for Economic Development 2006 - 2010, the government has initiated a number of programs to aid rural farmers and increase their incomes. These programs are varied and include, but are not limited to, such things as tax relief packages and consumer-durable subsidies. The central government targets rural incomes to rise between five and ten percent annually from 2006 through 2010. We know from our own understanding of the market, that rural transportation asset growth closely mirrors rural income growth. In other words, when rural income begins to rise, one of the first items purchased by a rural household is a small agricultural vehicle - the product for which our hot-rolled steel sheets are used to make. We believe the force of this macro-economic government policy to raise rural income levels will continue to be a positive driver in the demand for our product.
Shipments: Shipment volume increased from 203,422 tons in 2005 to 341,702 tons in 2006, a 68% increase. In addition to the reasons cited above, this rise is also attributable to the fact that we instituted in the second quarter a credit system for our best customers. This allowed them to more easily purchase large quantities of product at a single time. Have larger quantities of inventory on hand made it easier for them to sell larger quantities.
Gross profit decreased from $8.6 million in 2005 to $4.2 million in 2006 million. In the same period gross profit margin decreased from 9.6% in 2005 to 3.0% in 2006, representing a 6% decrease.
With the establishment of our four new production lines in April and their associated start up costs discussed above, our gross margins were under the greatest pressure in the 2nd and 3rd quarters. It was not until the fourth quarter when our promotional pricing period ended and an upswing in overall domestic pricing came about that we were able to see a margin recovery.
The inching downward of market steel prices for the first three quarters of the year put continuing pressure on our margins. We were able to offset much of the decline by obtaining greater efficiencies in our original production lines. However, the start-up costs of the new lines negatively impacted margins.
We must also point out that during April through December, the pilot phase of our new operating lines, we initiated a promotional pricing strategy whereby we offered our product to new customers at a price favorable to prevailing market rate. We did this to attract new distributors (we expanded from 19 to 35 distributors), to gain market share in new areas and to support new sales in our 3 newly established regional sales offices. Additionally, because of our dominant size in the market, the power of our pricing effect helped to put pressure on smaller and less efficient producers and drive them out of the market.
Although we were under strong margin pressure for most of the year, both from general market steel prices and our own new lines start-up costs, we managed to protect our net income from severe damage by pursuing five key actions,
a)
Production increase: By starting the operation of four new production lines, by sheer volume of a 68% increase in product produced, we were able to offset in large part the drop in price.
b)
Credit policy: In April we initiated a credit policy for our main customers which allow them to more easily buy larger quantities of our product at a time.
c)
Pre-payment of raw materials: Throughout the year we pursued a strategy to purchase our raw materials in bulk by pre-paying for them. We did this at the times of the year we believed the prices to be at their lowest. This allowed us to lock-in low and secure pricing for raw materials for a longer period of time than we could otherwise do by purchasing more frequently in small quantities. We were able to pursue this cost saving action because of long-standing and favorable relationships with our financing partners. We will continue to view this action as a viable option in 2007. Because of our size and long operating history, we do not believe that our competitors are in a position to also pursue this strategy.
d)
Improved finished product scrap usage: Throughout the year we collected the large remnants after the cutting process for standard sized sheets. We cut these remnants and sold them as smaller than standard size sheets. As the sale price for our product is higher than sale price of scrap, we were able to earn additional income.
e)
Improved production efficiency: In early 2006 we began purchasing our raw materials in the form of steel strip coils instead of 6-meter long slabs. This change improved our production efficiency in two ways: First, the amount of raw material scrap was reduced. We could cut strips from the coil to the exact size needed to feed through our hot rolling mill, thus only creating a small amount of scrap at the end of each coil. Previously, each 6-meter slab had to be cut, generating scrap from each slab. Secondly, steel strip in coil form is thinner than steel in slab form. By starting with a thinner piece of steel, we need only put it through the rollers four times to get the desired thickness, rather than five times when using crude steel in slab form. This change decreased our processing time by 20%.
Fiscal year ended December 31, 2005 compared to Fiscal year ended December 31,
Net sales for the year ended December 31, 2005 were $89.7 million compared to $87.8 million in 2004, representing a 2% increase. Shipments for year ended December 31, 2005 climbed 7% to 203,422 tons from 190,936 tons due to overall increase in productivity and market development. Average selling price per ton including sale of scrap for the years ended December 30, 2005 and 2004 has increased to $479 from $460. The price of our finished products climbed to its peak around $730 in April 2005 and slowly dropped throughout the rest of the year. The overall average selling price in 2005 was still higher than 2004 as a result of good market demand for our steel products. In summary, the main reasons for the increase in sales revenue are due to an increase in selling price and an increase in shipment volume of steel products.
Gross profit for the years ended December 31, 2005 was $8.6 million, an increase of 38% or $2.4 million from $6.2 million for the same period last year. Gross profit margin increased to 9.6% from 7.1% for the years ended December 31, and 2004. This increase in gross profit margin is mainly due to the increase in both sales volume and selling price outpacing the increase in raw materials price. Since April 2005, the price of steel products has been decreasing globally due to the overall increase in steel supply. We have to adjust our products’ prices in order to stay competitive in this market. The management thinks that the pressure on the selling price will be mitigated in 2006 as a result of steel industry consolidation and overall increase in demand.
Cost of sales
Fiscal year ended December 31, 2006 compare to Fiscal year ended December 31,
Cost of sales principally consists of the cost of raw materials, labor, utilities, manufacturing costs, manufacturing related depreciation and other fixed costs. Overall cost of sales increased to $135.3 million in 2006, from $81.2 million in 2005, a 67% increase. Cost of sales as a percentage of sales increased from 90.4% in 2005 to 97% in 2006, a 6.6% increase. Average cost per ton was $396 for 2006 compared to $399 in 2005. This cost of sales per ton decrease can be traced to the cost savings achieved through our bulk purchasing of raw materials and overall down turn in pricing in the domestic steel market.
Fiscal year ended December 31, 2005 compared to Fiscal year ended December 31,
Overall cost of sales slightly decreased to $81.2 million for the years ended December 31, 2005 from $81.6 million for 2004. Cost of sales as percentage of sales decreased from 92.9% to 90.4%. Average cost per ton was $399 and $427, respectively for the years ended December 31, 2005 and 2004. Even though the sales volume went up by 7% in 2005 compared to 2004, the decrease in cost of sales was due primarily to the cheaper raw material prices and increase in work efficiency for the years ended December 31, 2005 compared to 2004.
Selling, General and Administrative Expenses
Fiscal year ended December 31, 2006 compare to Fiscal year ended December 31,
Selling, general and administrative expenses were $2.4 million for 2006, compared to $2.8 million for the same period of 2005, a 12.9% decrease. A large component of the decrease was due to the reclassification of packaging expense back to cost of sales.
Fiscal year ended December 31, 2005 compared to Fiscal year ended December 31,
Selling, general and administrative expenses, such as executive compensation, office expenses, legal and accounting charges, travel charges, and various taxes were $2.8 million for the year ended December 31, 2005. It represented a 20% increase from $2.3 million for the year ended December 31, 2004. A large component of the increase came from the legal and accounting expenses and investor and public relations charges for the public listed company.
Other income (expense)
Fiscal year ended December 31, 2006 compared to Fiscal year ended December 31,
Interest expense was $2.07 million for the fiscal year ended December 31, 2006, a 20% increase compared to $1.72 million in 2005. This increase was because the outstanding bank loans increased to $30.3 million from $27.1 million as of December 31, 2006 and 2005, respectively. This increase in debt borrowing was mainly used for financing our bulk purchases of raw materials and our credit program to our main customers.
Fiscal year ended December 31, 2005 compared to Fiscal year ended December 31,
Other income (expense) for the year ended December 31, 2005 consisted mainly of finance charges and interest income. Interest expense was $1.7 million for the year ended December 31, 2005 representing a $0.3 million year-over-year increase. Outstanding bank loans increased to $27.1 million from $25.7 million as of December 31, 2005 and 2004, respectively. This increase in debt borrowing is mainly driven by management’s decision to increase the working capital for the current operation.
Income taxes
Fiscal year ended December 31, 2006 compared to Fiscal year ended December 31,
We did not carry on any business and did not maintain any branch office in the United States during the years ended December 31, 2006 and 2005. Therefore, no provision for withholding or U.S. federal income taxes or tax benefits on our undistributed earnings and/or losses has been made.
Pursuant to the relevant laws and regulations in the People’s Republic of China, Daqiuzhuang Metal, as a Sino-foreign joint venture in the People’s Republic of China, is entitled to an exemption from the PRC enterprise income tax for two years commencing from its first profitable year. We are approved for this tax benefit and are exempt from income tax for the years ended December 31, 2005 and 2006. We are entitled to a 50% income tax reduction for the years ended December 31, 2007, 2008 and 2009.
Fiscal year ended December 31, 2005 compared to Fiscal year ended December 31
We did not carry on any business and did not maintain a branch office in the United States during the years ended December 31, 2005 and 2004. Therefore, no provision for withholding or U.S. federal income taxes or tax benefits on the undistributed earnings and/or losses of the Company has been made.
Pursuant to the relevant laws and regulations in the People’s Republic of China, Daqiuzhuang Metal, as a Sino-foreign joint venture in the People’s Republic of China, is entitled to an exemption from the PRC enterprise income tax for two years commencing from its first profitable year. We have been approved for this tax benefit and will be exempt from income tax for the years ended December 31, 2005 and 2006 and 50% income tax reduction for the years ended December 31, 2007, 2008 and 2009.
We have been accruing the income tax every quarter as required by the local tax administrative agencies. Having obtained the approval notice from local tax administrative agency by the end of March 2006, we have decided to reverse the accruals for 2005 income taxes and add them back to the net income.
Liquidity and capital resources
Due to the strong market demand for our products, we increased production capacity by adding four new production lines. We plan to maintain a higher-than-average debt to equity ratio to better position itself in this fast growing market. The bank loans are considered short term for the purpose of the preparation of the financial statements because they are renewable with the banks every year. Due to the recent joint venture agreement with Baotou Iron and Steel (Group) Co., Ltd., we are reserving cash for the first 30% of its capital contribution, approximately $3.7 million, which needs to be paid when the business license for the
joint venture is issued. Cash balance including restricted cash amounted to $11.1 million and $11.4 million as of December 31, 2006 and 2005.
Accounts Receivable
Accounts receivable were $17.1 million as of December 31, 2006 compared to $993,417 at December 31, 2005. This increase in accounts receivable is mainly due to a change in the company’s collection approach. Starting in the second quarter of 2006, we have gone with a different collection methodology. We implemented a credit sales program for our main customers with whom we have a long-standing business relationship. We now have four new production lines in operation. The management is now taking measures to secure the existing customer base and attract new customers. One of the approaches is to extend credit sales to our major customers and distributors as incentives for buying our products. Extending credit to our major customers and distributors is also in line with a growing industrial trend in this competitive market.
We recognize the revenue when we ship out products and passed the titles of the products to our customers and distributors. We have increased production capacity since April this year. To enhance sales, we extended short-term credit to our customers and distributors with good reputations and long-term business relationships. We have not experienced any bad debt in these accounts. Also we review our accounts receivable on a regular basis to determine if the bad debt allowance is adequate and we adjust the allowance amount if needed. We believe the accounts receivable are collectible. Never-the-less, to be conservative and prudent in our management practice, as of December 31, 2006, we have decided to reserve $137,132 for bad debts based on our reasonable estimate.
Operating activities
Fiscal year ended December 31, 2006 compared to Fiscal year ended December 31,
Net cash used in operating activities for the fiscal year ended December 31, 2006 was $0.9 million compared to $10.0 million provided by operating activities in 2005. This change was mainly due to an increase in accounts receivable and offset by a decrease in advances on inventory purchases. Accounts receivable increased by $15.9 million compared to December 31, 2005. The increase is due to the credit sales we extended to our major customers and distributors as incentives starting from the second quarter of 2006. As the new production lines are now in full operation, approximately 13,000 tons of additional products are now being produced monthly.
Fiscal year ended December 31, 2005 compared to Fiscal year ended December 31,
Net cash provided by operating activities for the years ended December 31, 2005 was $10.0 million compared with $6.9 million used in operating activities for 2004. Our net income before minority interest was $4.1 million for the year ended December 31, 2005, a $2.7 million or 198% increase compared with the previous year. More customer deposits, less inventory and less advances on inventory purchases became the major factors of this increase in cash generated by operating activities.
Investing activities
Fiscal year ended December 31, 2006 compared to Fiscal year ended December 31,
Net cash used in investing activities was $5.9 million for the fiscal year ended December 31, 2006 compared to $7.9 million used in investing activities in the previous year. The cash has been spent on the construction of the new plant.
Fiscal year ended December 31, 2005 compared to Fiscal year ended December 31,
Net cash used in investing activities was $7.9 million for the year ended December 31, 2005 compared with $1.2 million used in investing activities for the year ended December 31, 2004. This change mainly resulted from the increase in notes receivable and equipment purchases. Our customers usually pay for our products with promissory notes issued by the banks that in turn can be used like cash by us to pay for our purchases. We were also building four more production lines next to the existing facility. This construction has been completed as of the statement date. We spent $4.2 million on construction in progress.
Financing activities
Fiscal year ended December 31, 2006 compared to Fiscal year ended December 31,
Net cash provided by financing activities was $4.7 million for the year ended December 31, 2006 compared to $0.81 million provided by investing activities of the previous year. We signed a borrowing agreement with Shenzhen Development Bank to borrow $5,064,000 in the first quarter. The proceeds were mainly used to pay for inventory purchases and the construction of the new plant.
Fiscal year ended December 31, 2005 compared to Fiscal year ended December 31,
We issued 1,176,665 shares of redeemable stock in a private placement round on September 18, 2005. The stock was issued at $1.50 per share with put rights for us to purchase the shares back at $1.95, eighteen months after the closing date. Under this private offering, we raised total of $1,765,000 which will be used to pay for the special steel joint venture with Baotou Steel. This is the main reason attributable to the net cash provided by financing activities.
Compliance with environmental laws and regulations
Based on the equipment, technologies and measures adopted, we are not considered a high-pollution factory in China. The production process does not need much water and produces only a minimal amount of chemical pollution. We use gas-fired reheat furnaces recommended by the State Environmental Protection Agency to heat raw materials and semi-finished products.
In 2005, the Daqiuzhuang County ordered an environmental clean-up campaign and required harmless waste water discharge. In order to meet these requirements, we invested $94,190 to remodel our industrial water recycling system to reduce new water consumption and industrial water discharge.
This wastewater recycling system is able to process 350 tons of wastewater daily. We can realize approximately $10,000 savings per year using this system.
As for the remodeling of gas furnace and desulphurization of discharged gas, the local government has not posted any control measures currently and we have no plans to proceed with this remodeling until such time regulations are mandated. We believe that future costs relating to environmental compliance will not have a materially adverse effect on the Company’s financial position. There is always the possibility, however, that unforeseen changes, such as new laws or enforcement policies, could result in materially adverse costs.
Impact of inflation
We are subject to commodity price risks arising from price fluctuations in the market prices of the raw materials. We have generally been able to pass on cost increases through price adjustments. However, the ability to pass on these increases depends on market conditions driven by the overall economic conditions in China. We manage our price risks through productivity improvements and cost-containment measures. We do not believe that inflation risk is material to our business or our financial position, results of operations or cash flows.
Off-balance sheet arrangements
There are currently no off-balance sheet arrangements.
Subsequent Events Concerning Our Put Option which Expired on March 1, 2007
Pursuant to a put right granted to the investors in our private placement in September 2005, the investors had the right to request us to repurchase part or all of the 1,176,665 shares of our common stock on March 1, 2007 (the “Repurchase Date”) at a per share price of $1.95 per share. If an investor elected to put the shares back to us on the Repurchase Date, the investor was required to notify us 60 days prior to the Repurchase Date. The aggregate number of shares held by investors elected not to put the shares back to us at a per share price of $1.95 is 176,665 shares.
On March 1, 2007, we received written notification from Matlin Patterson Global Opportunities Partners II L.P. and Matlin Patterson Global Opportunities Partners (Caymans) II L.P. asking us to extend the Repurchase Date until September 1, 2007, and to keep the redemption price unchanged at $1.95 per share. We agreed to this request and extended the Repurchase Date and kept the repurchase price as per their request. The aggregate number of shares held by Matlin Patterson Global Opportunities Partners II L.P. and Matlin Patterson Global Opportunities Partners (Caymans) II L.P. is 1,000,000 shares.
ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk.
Commodity Price Risk and Related Risks
In the normal course of its business, we are exposed to market risk or price fluctuations related to the purchase, production or sale of steel products over which we have little or no control. We do not use any derivative commodity instruments to manage the price risk. Our market risk strategy has generally been to obtain competitive prices for its products and allow operating results to reflect market price movements dictated by supply and demand. Based upon an assumed annual production capacity of 200,000 tons, a $1 change in the annual average price would change annual pre-tax profits by approximately $200,000.
Interest Rate Risk
At December 31, 2006, Our outstanding debts are short-term and bear interest at fixed interest rates and accordingly are not sensitive to changes in interest rates. We do not use swaps or other interest rate protection agreements to hedge this risk.
Foreign Currency Exchange Rate Risk
Our operating unit, Daqiuzhuang Metal, is located in China. The operation purchase, produce and sell all of the steel products domestically. It is subject to the foreign currency exchange rate risk due to the effects of fluctuations in the Chinese Renminbi on revenues and operating cost and existing assets or liabilities. General Steel has not generally used derivative instruments to manage this risk. A 10 percent decrease in the 2006 average Renminbi exchange rate would result in a $227,218 charge to income.
ITEM 8.
ITEM 8. Financial Statements and Supplementary Data.
The consolidated financial statements of General Steel Holdings, Inc., including consolidated balance sheets as of December 31, 2006 and 2005, and consolidated statements of income and other comprehensive income, consolidated statements of stockholders’ equity and consolidated statements of cash flows for the year ended December 31, 2006, 2005 and 2004 and notes to the consolidated financial statements, together with a report thereon of Moore Stephens Wurth Frazer and Torbet, LLP, dated March 10, 2007, are attached hereto as pages through .
ITEM 9.
ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosures.
Not applicable.
ITEM 9A.
ITEM 9A. Controls and Procedures.
Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective. There were no changes in our internal control over financial reporting during the year ended December 31, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. Other Information.
Not applicable
PART III
ITEM 10.
ITEM 10. Directors and Executive Officers and Corporate Governance.
The following table sets forth the names and ages of our current directors and executive officers, their principal offices and positions and the date each such person became our director or executive officer. Our executive officers are elected annually by the board of directors. Our directors serve one-year terms until their successors are elected. The executive officers serve terms of one year or until their death, resignation or removal by the board of directors. There are no family relationships between any of the directors and executive officers. In addition, there was no arrangement or understanding between any executive officer and any other person pursuant to which any person was selected as an executive officer.
The executive officers are all full time employees of General Steel Holdings, Inc.
The directors and executive officers of General Steel Holdings, Inc. are as follows:
In 2006, Zhao Sheng Guo became an independent director and Ross Warner became a director.
Our directors are generally elected until the next annual meeting of shareholders and until their successors are elected and qualified, or until their earlier resignation or removal. Each director’s term of office is one year.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), requires our executive officers, directors and persons who own more than 10% of our common stock to file initial reports of ownership on Form 3 and changes in ownership on Forms 4 or 5 with the SEC. Such executive officers, directors and over 10% stockholders are also required by SEC rules to furnish us with copies of all such forms they file.
Based solely on our review of the copies of such forms we have received, or written representations from certain reporting persons, we believe that, during the year ended December 31, 2006, all executive officers, directors and over 10% stockholders filed on a timely basis all reports required to be filed by them under Section 16(a) with respect to our common stock.
There were no material changes to the procedures in place for our shareholders to use to recommend nominees to our board of directors.
Audit Committee
Our Board has a separately-designated Audit Committee. Our Audit Committee consists of John Wong, Zhao, Sheng Guo and Tian, Lian Hui. Mr. John Wong is the chairman of the Audit Committee. In 2006, the audit committee met periodically and communicated frequently via email and telephone. The audit committee is scheduled to hold four meetings during fiscal year 2007 and will continue to communicate frequently via email and telephone
The primary responsibilities of the Audit Committee are to review the results of the annual audit and to discuss the financial statements, including the independent auditors' judgment about the quality of accounting principles, the reasonableness of significant judgments, the clarity of the disclosures in the financial statements. Additionally, the Audit Committee meets with our independent auditors to review the interim financial statements prior to the filing of our Quarterly Reports on Form 10-Q, recommends to the Board the independent auditors to be retained by us, oversees the independence of the independent auditors, evaluates the independent auditors' performance, receives and considers the independent auditors' comments as to controls, adequacy of staff and management performance and procedures in connection with audit and financial controls, including our system to monitor and manage business risks and legal and ethical compliance programs audit and non-audit services provided to us by our independent auditors, considers conflicts of interest involving executive officers or Board members. Our Board has determined that Mr. Wong is an "audit committee financial expert" as defined by the SEC, and that each member of the Audit Committee is independent.
None of the following ever occurred to any of our directors and officers.
(1) Any 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;
(2) Any conviction in a criminal proceeding or being subject to a pending criminal proceeding (excluding traffic violations and other minor offenses);
(3) Being 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; or
(4) Being found by a court of competent jurisdiction (in a civil action), the SEC or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended, or vacated.
Family relationships
Mr. Liu, Yu Wen is Mr. Yu, Zuo Sheng's brother in-law, Mr. Yu, Zuo Yan is Mr. Yu, Zuo Sheng's brother.
Biographical information
Mr. Yu, Zuo Sheng, President, Chief Executive Officer and Chairman, joined us in August 2000 and became a Director in August 2000. From April 1986 to February 1992, he was President of Daqiuzhuang Metal Sheet Factory, Tianjin, China. From February 1992 to December 1999, he was General Manager of Sheng Da Industrial Company, Tianjin, China. From November 1999 to March 2001, he was President and Chairman of the Board of Directors of Sheng Da Machinery Manufactory, Tianjin, China. Since February 2001, he is President and Chairman of Board of Directors of Beijing Wendlar Investment Management Group, Beijing, China. Since March 2001, he is President and Chairman of Board of Directors of Baotou Sheng Da Steel Pipe Limited, Inner Mongolia, China and Chairman of Board of Directors of Sheng Da Steel and Iron Mill, Hebei province, China. Since April 2001, he is President and Chairman of Sheng Da Industrial Park Real Estate Development Limited.
Mr. Yu graduated in 1985 from Sciences and Engineering Institute, Tianjin, China. In July 1994, he received Bachelor degree from Institute of Business Management for Officers. Mr. Yu received the title of “Senior Economist” from the Committee of Science and Technology of Tianjin City in 1994. In July 1997, he received a MBA degree from the Graduate School of Tianjin Party University. In April 2003, Mr. Yu, Zuo Sheng held a position as a member of China’s APEC (Asia Pacific Economic Co-operation) Development Council.
Mr. John Chen, Director and Chief Financial Officer. Mr. John Chen joined us in May 2004. He is the Chief Financial Officer and a Director. From August 1997 to July 2003 , he was senior accountant at Moore Stephens Wurth Frazer and Torbet, LLP, Los Angeles, California, USA. He graduated from Norman Bethune University of Medical Science, Changchun city, Jilin province, China in September 1992. He received his B.S. degree in accounting from California State Polytechnic University, Pomona, California, USA in July 1997. He received his California certified public accountant license in August 2002.
Mr. Wang, Guo Dong, Director. Mr. Wang joined us in May 2003. From January 1982 to May 2003, he was professor at Northeast University, Shenyang city, Liaoning province, China. From October to October 1978, he was the engineer of Anshan Iron and Steel Company, in Anshan city, Liaoning province, China. He received a Master’s Degree in Engineering from Beijing Iron and Steel Research Institute, Beijing, China, in September 1982. He also received a Bachelor’s Degree in Engineering from Northeast University, Shenyang city, Liaoning province, China in September 1966.
Mr. Zhao, Sheng Guo, Director. Mr. Zhao joined us in March 2003. He is a Director. From June 1995 to June 2003, he was the Chief Technical Officier of Beijing Capital Steel Plate Mill. From March 1988 to June 1995, he was chief engineer of Beijing Capital Steel Plate Mill. From March 1983 to March 1988, he was engineer of Beijing Special Steel Metal Sheet Mill. He received MBA Degree from Northeast University, Shenyang city, Liaoning province, China, in August 2001. He graduated from Beijing Steel Institute in Beijing, China in 1982. He became an independent director for us in 2006.
Mr. Han, Wen Chun, Plant Controller. Mr. Han joined us in October 2000. He is the plant controller. From June 1989 to October 2000, he was the manager of Accounting Department of Sheng Da Industrial Company.
Mr. Liu, Yu Wen, Manager of Sales and Purchase Department. Mr. Liu joined us in August 2000. He is the head of the Sales and Purchasing Department. From October 1991 to August 2000, he was office manager of Daqiuzhuang Metal Sheet Company, Daqiuzhuang, Tianjin, China. In July 1991, he graduated from Jinghai Adult High School, Tianjin, China. He is brother in-law of Mr. Yu, Zuo Sheng.
Mr. Yu, Zuo Yan, Manager of Production Department. Mr. Yu joined us in May, 2000. He is the manager of the Production Department. From July 1989 to May 2000, he was manager of the steel pipe workshop of Daqiuzhuang Steel Pipe Company. From August 1986 to May 1989, he was the technician of Daqiuzhuang Steel Pipe Company. He graduated from Tianjin Polytechnic Institute in August 1986. He is brother of Mr. Yu, Zuo Sheng.
Mr. John Wong, Director. Mr. Wong was elected as the independent director in August 2005. From June 2003 to present, he is the managing partner of Vantage & Associates. From January 2000 to March 2003, he was the director at Deloitte Touche Corporate Finance, Shanghai. From July 1998 to December 1999, he was director of Amrex Capitals. From July 1996 to June 1998, he worked as senior audit manager at Ernest & Young, Hong Kong. Mr. Wong graduated from Melbourne University in 1989. He obtained Independent Directorship Certificate in 2002.
Mr. Ross Warner, Director. Mr. Warner was elected as the independent director in August 2005 and became a director in 2006. From July 2003 to 2006, he was the Chief of Operations at OCDF. From July 2002 to June 2003, he was the country manager for English First in charge of China and Vietnam. From April 2001 to July 2002, he was the non-technical training manager at TTI-China. From July 1998 to December 2000, he worked as the consultant at Info Technology Group, Inc.-Beijing Office. Mr. Ross Warner obtained the master degree from Thunderbird graduate school.
Mr. Tian, Lian Hui, Director. Mr. Tian was elected as the independent director in December 2005. He has held the position of Chairman of COCIM since 1995. COCIM is a software company which designs and implements Office Automation Software, such as ERP system for businesses. He has been the head of the Research Institute of Ministry of Electronic Industry. Mr. Tian has also led several national projects including the design of computer information system for Baoshan Steel. Mr. Tian, 64, graduated from Northeast University with a Masters Degree in Automation Control.
Mr. Su, Xiao Gang, Manager of the Human Resources Department. Mr. Su joined us in March 2005. He is the manager of the Human Resources Department. From July 2002 to March 2005, he was the deputy general manager of Beijing Wendlar Group. From July 1998 to June 2002, he was the general manager of Tianjin Shengda Packaging Co., Ltd. He graduated from Tianjin Institute of Economic Management in 1996.
INDEMNIFICATION
Our articles of incorporation limit the liability of directors to the maximum extent permitted by Nevada law. This limitation of liability is subject to exceptions including intentional misconduct, obtaining an improper personal benefit and abdication or reckless disregard of director duties. Our articles of incorporation and bylaws provide that we may indemnify our directors, officer, employees and other agents to the fullest extent permitted by law. Our bylaws also permit us to secure insurance on behalf of any
officer, director, employee or other agent for any liability arising out of his or her actions in such capacity, regardless of whether the bylaws would permit indemnification. We currently do not have such an insurance policy.
Code of Ethics and Business Conduct
Our Code of Ethics and Business Conduct is available on our website at the following address: http://www.gshi-steel.com/gshi-steel/codeofethics.pdf. Our Code of Ethics and Business Conduct provides information:
·
To guide employees so that their business conduct is consistent with our ethical standards;
·
To improve the understanding of our ethical standards among customers, suppliers and others outside the Company.
Our Code of Ethics and Business Conduct may also be obtained free of charge by contacting Ross Warner at ross@gshi-steel.com or by phone: 86-10-5879-7346
ITEM 11.
ITEM 11. Executive Compensation.
Compensation Discussion and Analysis
General Philosophy
Our compensation philosophy is simple. At this point in our growth, we compensate our senior management, which is our CEO and CFO, and all mangers through salary only. We do not now provide a bonus program, equity compensation program, severance benefit program, retirement plan or change in control benefits program. Additionally, we do not have a compensation committee. Our compensation philosophy will likely change when we achieve Phase II of our strategic growth goals.
Current Status
No person in our company earns more than $100,000. Our CEO earns 600,000 RMB (approximately $75,342) and our CFO earns 180,000 RMB (approximately $22,603). We understand these amounts may be generally less than those paid to senior managers by other Chinese companies listed on US stock exchanges. In determining ranges for these salaries, we followed the principal that we are a developing company pursuing a goal to rapidly become a significantly larger company. As such, at this stage of development, we believe it is in our stockholders best interest to reinvest as much profit as possible back into the company. In this way we can reach our growth goal as quickly as possible.
The salary amounts for our CEO and the CFO are determined through individual negotiations: the CFO with the CEO, and the CEO with the Board of Directors. We have not used any industry benchmarking studies to determine these amounts. Their salaries are paid in full, in RMB, in monthly installments and receive the standard salary tax recording treatment. We believe the amounts of these salaries reward, to the best of our ability, our CEO and CFO for their yearly total contributions to the company.
The CEO reviews yearly the work performance of the CFO and lower level managers. In general, the CEO uses subjective criteria to evaluate the work performance. Our CEO has final decision authority on all salary amounts and adjustments, except his own, which the Board of Directors must approve.
The CFO’s salary increased 33% from 2005 to 2006. This increase is attributable to the following:
a)
A low starting salary the first year that was agreed to as trial period,
b)
A cost of living allowance increase reflecting the extremely fast increase in housing costs in Beijing where our CFO lives.
Desiring to reinvest as much profit as possible back into the company, our CEO has not taken a pay increase since 2003.
John Wong is an independent director on our board of directors and also serves as the chairman of the remuneration committee for a Singapore stock exchange listed company, CDW Holdings, Ltd. No other member of our board of directors serves on the compensation committee or similar body of a listed company.
The competition for senior management among Chinese companies listed on a US stock exchange is fierce. We compete against companies that are much larger and have greater financial resources with which to attract and retain managers. We do not try to compete for senior management with other companies on the basis compensation. Instead, we seek to attract and retain qualified candidates who embrace our vision, see the long-term potential for the company and are motivated by being pioneers in the field of State Owned Enterprise (SOE) privatization.
We spend a great deal of effort and time communicating our vision to anyone considering working for us. It is vitally important that everyone working for us be committed to our vision and understands our philosophy to grow the company. Our CEO plays an integral role in instilling this vision on an on-going basis with all our staff. Our work culture is very much like that of an entrepreneurial company characterized by high trust, high loyalty and a high personal sacrifice to current financial reward ratio.
We have been successful in recruiting and retaining senior management using our compensation philosophy. Since 2004 when the company became listed on the Nasdaq OTCBB, we have not had any staff resignations among our senior management team. We view this as a validation that we have followed the correct compensation philosophy for this stage in our company’s development.
Executive Compensation
The following table sets forth certain information concerning the compensation paid to our chief executive officer and our other most highly compensated executive officers:
The board of directors has reviewed the Compensation Discussion and Analysis and based this review recommends that it be included in the 2006 10K.
Respectfully submitted
YU, Zuo Sheng, Chairman of the Board
John Chen
WANG, Guo Dong
ZHAO, Sheng Guo
John Wong
Ross Warner
TIAN, Lian Hui
None of our directors has received any compensation for their services rendered as directors to our company during fiscal year 2006.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth certain information regarding beneficial ownership of common stock as of March 30, 2007, by:
·
Each person known to us to own beneficially more than 5%, in the aggregate, of the outstanding shares of our common stock;
·
Each of our directors;
·
Each of our Chairman and Chief Executive Officer and our other four most highly compensated executive officers; and
·
All of our executive officers and directors as a group.
The number of shares beneficially owned and the percent of shares outstanding are based on 32,444,665 shares outstanding as of March 30, 2007. Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities.
We know of no arrangements that may result in a change of control of our company.
(1) Beneficial ownership is determined in accordance with Rule 13d-3 under the Exchange Act securities and includes securities that are convertible into common stock at the owner’s option within 60 days.
(2) The information is based solely on a Schedule 13G filed with the Securities and Exchange Commission by the beneficial owner on September 30, 2005.
* indicates percentages that are below 1%.
ITEM 13.
ITEM 13. Certain Relationships and Related Transactions.
Certain Relationships and Related Transactions.
We have a cash advance to Golden Glister Holdings Limited. Golden Glister Holdings Limited is incorporated in Hong Kong and our CEO and Chairman, Yu Zuo Sheng, is the majority shareholder. The amount was advanced to Golden Glister Holdings for business operations. Golden Glister Holdings Limited has agreed to pay back the amount on a short-term basis. We had a receivable from Golden Glister Holdings Limited for $850,400 at December 31, 2006 and a payable to Golden Glister Holdings Limited for $980,000 at December 31, 2005. These receivable and payable are short term and non-interest bearing. We have received payment from Golden Glister for the receivable amount in January 2007.
Starting from January 1, 2006, we subleased a portion of our land use rights to Tianjin Jing Qiu Steel Company, a related party under common control. The total rent income of 2006 was $1,439,121.
We have four directors that are independent under the independence standards of S-K Item 407(a)(1). They are: John Wong, Wang Guo Dong, Tian Lian Hui and Zhao Sheng Guo.
ITEM 14.
ITEM 14. Principal Accounting Fees and Services.
The Board has reappointed Moore Stephens Wurth Frazer and Torbet, LLP as the Company's independent auditors for the year ended December 31, 2007.
Public Accountants' Fees
Audit fees were for professional services rendered by Moore Stephens Wurth Frazer and Torbet, LLP during 2006 and 2005 years for the audit of our annual financial statements and the review of our financial statements included in our quarterly reports form 10-Q and services that are normally provided by Moore Stephens Wurth Frazer and Torbet, LLP in the connection with the statutory and regulatory filings. Tax fees involved the preparation of our consolidated tax returns.
PART IV
ITEM 15.
ITEM 15. Exhibits, Financial Statement Schedules.
EXHIBIT NO.
DESCRIPTION
1.1
Baotou Steel - GSHI Special Steel Joint Venture Agreement dated as of September 28, 2005 by and between Baotou Iron & Steel (Group) Co., Ltd., General Steel Investment Co., Ltd. and Daqiuzhuang Metal Sheet Co., Ltd. (Incorporated by reference to the current report on Form 8-K, filed with the Commission on October 31, 2005)
2.1
Agreement and Plan of Merger dated as of October 14, 2004 by and among American Construction Company, General Steel Investment Co., Ltd. and Northwest Steel Company, a Nevada corporation (Incorporated by reference to the current report on Form 8-K/A, filed with the Commission on October 19, 2004)
3.1
Articles of Incorporation of General Steel Holdings, Inc. (Incorporated by reference to the registration statement on Form SB-2, filed with the Commission on June 6, 2003)
4.1
Subscription Agreement (Incorporated by reference to the registration statement on Form SB-2/A, filed with the Commission on September 12, 2003)
10.1
Form of Subscription Agreement (Incorporated by reference to the registration statement on Form S-1, filed with the Commission on June 23, 2006)
10.2
Form of Registration Rights Agreement (Incorporated by reference to the registration statement on Form S-1, filed with the Commission on June 23, 2006)
10.3
Form of Warrant (Incorporated by reference to the registration statement on Form S-1, filed with the Commission on June 23, 2006)
10.4
Form of Lock Box Agreement (Incorporated by reference to the registration statement on Form S-1, filed with the Commission on June 23, 2006)
10.5
English translation of the loan between Tianjin Daqiuzhuang Metal Sheet Co., Ltd. to and Yang Pu Automotive Investment Limited (Incorporated by reference to the registration statement on Form S-1, filed with the Commission on June 23, 2006)
10.6
Loan Documentation by and between Tianjin Daqiuzhuang Metal Sheet Co., Ltd. and the Agricultural Bank of China (Incorporated by reference to the registration statement on Form S-1, filed with the Commission on June 23, 2006)
21.1
List of Subsidiaries of the Registrant.*
31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.*
31.2
Certification of Principal Financial and Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.*
32.1
Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act.*
32.2
Certification of Chief Accounting Officer Pursuant to Section 906 of the Sarbanes-Oxley Act.*
* filed herewith.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
General Steel Holdings Inc.
We have audited the accompanying consolidated balance sheets of General Steel Holdings Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income and other comprehensive income, shareholders’ equity, and cash flows for each year in the three-year period ended December 31, 2006. These financial statements are the responsibility of the company’s management. 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 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 audit 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 consolidated 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 General Steel Holdings Inc. and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America.
See report of independent registered public accounting firm.
The accompanying notes are an integral part of these consolidated financial statements.
See report of independent registered public accounting firm.
The accompanying notes are an integral part of these consolidated financial statements.
See report of independent registered public accounting firm.
The accompanying notes are an integral part of these consolidated financial statements.
See report of independent registered public accounting firm.
The accompanying notes are an integral part of these consolidated financial statements.
GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
Note 1 - Background
The Company was established on August 5, 2002, and, through its subsidiary in China, engages in the manufacturing of hot rolled carbon and silicon steel sheets which are mainly used on tractors, agricultural vehicles and in other specialty markets. The Company sells its products through both retailers and wholesalers.
On October 14, 2004, American Construction Company, General Steel Investment Co., Ltd. (General Steel) and Northwest Steel Company, a Nevada corporation, entered into an Agreement and Plan of Merger (the "Agreement") pursuant to which American Construction Company acquired General Steel, and it’s 70% ownership in its subsidiary Daqiuzhuang Metal Sheet Co., Ltd. (Daqiuzhuang Metal) in exchange for shares of the Company’s common stock, of which 22,040,000 shares was a new issuance by the Company, and 7,960,000 shares are from certain shareholders of the Company, which in aggregate, constituted 96% of the total issued and outstanding shares of the Company.
Under the terms of the Agreement, General Steel will remain a 100% owned subsidiary of the Company. The transaction contemplated by the Agreement was intended to be a “tax-free" reorganization pursuant to the provisions of Section 351 and 368(a) (1) (A) of the Internal Revenue Code of 1986, as amended. The stockholders of General Steel, as of the closing date of the merger own approximately 96% of the Company's common stock outstanding as of October 15, 2004 (excluding any additional shares to be issued on outstanding options, warrants and other securities convertible into common stock).
The accounting for these transactions is identical to that resulting from a reverse-acquisition, except that no goodwill or other intangible assets is recorded. Accordingly, the financial statements of General Steel Investment Co., Ltd. are the historical financial statements of the Company, formerly the operations of Daqiuzhuang Metal Sheet Co., Ltd.
Based on the Company's Plan of Merger with General Steel Investment Co., Ltd., the Board of Directors determined to change the Registrant's fiscal year end from January 31 to December 31.
Daqiuzhuang Metal Sheet Co., Ltd. (referred to as Daqiuzhuang Metal) was established on August 18, 2000 in Jinghai county, Tianjin city, Hebei province, the People’s Republic of China (PRC). The Articles of Corporation provides for a 10 year operating term beginning on August 18, 2000 with registered capital of $ 9,583,200.
The Company is a Chinese registered limited liability company with a legal structure similar to a limited liability company organized under state laws in the United States of America. There is no discriminatory provision for the minority shareholders and the 30% shareholders will receive their distribution of retained earnings according to their ownership percentage in Daqiuzhuang Metal.
Note 2 - Restatement of financial statements
The Company restated its consolidated financial statements for 2005 and 2004 for corrections in accounting which included:
See report of independent registered public accounting firm.
GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
1.
Restating the carrying amount of redeemable stock issued in 2005 and amortizing the difference between redemption amount and fair value as interest expense over the 18 months period from issuance date using an implied interest rate in accordance with SFAS 150. The amount originally recorded as liability was discounted at an average market rate with the difference between the discounted amount and the cash received being treated as reduction in paid-in-capital and the difference between discounted amount and redemption value to be amortized over the 18 months from issuance. In addition, certain disclosures in notes 3 and 18 to the consolidated financial statements were restated to reflect the correction. The effects of this restatement are as follows:
2.
Reclassifying Advances on equipment purchases to Other Assets - non-current from current assets on the 2005 balance sheet
3.
Reclassifying certain amounts on the statements of cash flows for 2005 and 2004 as follows:
a.
Reclassified accrued interest expense accrued on mandatory redeemable stock from financing activities to operating activities
b.
Reclassified notes receivable from investing activities to operating activities since it is related to inventory sales
c.
Separated restricted cash from cash and classified restricted cash in investing activities
d.
Reclassified deposits due to sales representatives and advances on equipment purchases from operating activities to investing activities
See report of independent registered public accounting firm.
GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
4.
Restating borrowings and payments on short term loan - bank and short term notes payable on a gross basis vs. net basis as previously reported
Note 3 - Summary of significant accounting policies
Basis of presentation
The consolidated financial statements of General Steel Holdings, Inc. reflect the activities of the following subsidiaries:
The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements include the accounts of General Steel Investment Co., Ltd and Tianjin Daqiuzhuang Metal Sheet Co., Ltd (collectively the "Company"). All material intercompany transactions and balances have been eliminated in the consolidation.
Revenue recognition
The Company recognizes revenue when the goods are delivered and title has passed. Sales revenue represents the invoiced value of goods, net of a value-added tax (VAT). All of the Company’s products that are sold in the PRC are subject to a Chinese value-added tax at a rate of 17% of the gross sales price. This VAT may be offset by VAT paid by the Company on raw materials and other materials included in the cost of producing their finished product.
Foreign currency translation
The reporting currency of the Company is the US dollar. The Company uses their local currency, Renminbi (RMB), as their functional currency. Results of operations and cash flow are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate as quoted by the People’s Bank of China at the end of the period.
Translation adjustments resulting from this process are included in accumulated other comprehensive income in the statement of shareholders’ equity. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.
Translation adjustments resulting from this process are included in accumulated other comprehensive income in the consolidated statement of shareholders' equity and amounted to $677,500, $399,188 and $0 as of December 31, 2006, 2005 and 2004, respectively. The balance sheet amounts with the exception of equity at December 31, 2006 and 2005 were translated at 7.80 RMB to $1.00 USD and 8.06 RMB, respectively.
See report of independent registered public accounting firm.
GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
The equity accounts were stated at their historical rate. The average translation rates applied to income statement accounts for the years ended December 31, 2006, 2005 and 2004 were 7.96 RMB, 8.18 RMB and 8.26 RMB, respectively.
Plant and equipment, net
Plant and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets with 3% residual value. The depreciation expense for the years ended December 31, 2006, 2005 and 2004 amounted to $1,619,267, $1,053,976 and $968,332, respectively.
Estimated useful lives of the assets are as follows:
Construction in progress represents the costs incurred in connection with the construction of buildings or new additions to the Company’s plant facilities. No depreciation is provided for construction in progress until such time as the assets are completed and are placed into service.
The cost and related accumulated depreciation of assets sold or otherwise retired are eliminated from the accounts and any gain or loss is included in the statements of operations. Maintenance, repairs and minor renewals are charged directly to expenses as incurred. Major additions and betterment to buildings and equipment are capitalized.
Long-term assets of the Company are reviewed annually as to whether their carrying value has become impaired. The Company considers assets to be impaired if the carrying value exceeds the future projected cash flows from related operations. The Company also re-evaluates the periods of amortization to determine whether subsequent events and circumstances warrant revised estimates of useful lives. As of December 31, 2006, the Company expects these assets to be fully recoverable.
Plant and equipment consist of the following at December 31:
See report of independent registered public accounting firm.
GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
Use of estimates
The preparation of financial statements in conformity with generally accepted accounting principles of the United States of America requires management to make estimates and assumptions that affect the amounts reported in the combined financial statements and accompanying notes. Management believes that the estimates utilized in preparing its financial statements are reasonable and prudent. Actual results could differ from these estimates.
Cash and concentration of risk
Cash includes cash on hand and demand deposits in accounts maintained with state owned banks within the People’s Republic of China and Hong Kong. Total cash (including restricted cash balances) in these banks at December 31, 2006 and 2005, amounted to $11,058,636 and $11,446,120, respectively of which no deposits are covered by insurance. The Company has not experienced any losses in such accounts and believes it is not exposed to any risks on its cash in bank accounts.
Restricted Cash
The Company through its bank agreements is required to keep certain amounts on deposit that are subject to withdrawal restrictions and these amounts are $4,231,523 and $2,735,583 as of December 31, 2006 and 2005, respectively.
Inventories
Inventories are stated at the lower of cost or market using weighted average method. Inventories consisted of the followings at December 31,
Inventories consist of supplies, raw materials and finished goods. Raw materials consist primarily of iron and steel used in production. The cost of finished goods included direct costs of raw materials as well as direct labor used in production. Indirect production costs such as utilities and indirect labor related to production such as assembling, shipping and handling costs are also included in the cost of inventory. No work in process inventory existed at December 31, 2006 and 2005, as all inventory in process was completed and transferred to finished goods prior to the physical inventory count. The Company reviews its inventory annually for possible obsolete goods or to determine if any reserves are necessary for potential obsolescence. As of December 31, and 2005, the Company has determined that no reserves are necessary.
See report of independent registered public accounting firm.
GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
Financial instruments
Statement of Financial Accounting Standards No. 107 (SFAS 107), “Disclosures about Fair Value of Financial Instruments” requires disclosure of the fair value of financial instruments held by the Company. SFAS 107 defines the fair value of financial instruments as the amount at which the instrument could be exchanged in a current transaction between willing parties. The Company considers the carrying amount of cash, accounts receivable, other receivables, accounts payable, accrued liabilities and other payables to approximate their fair values because of the short period of time between the origination of such instruments and their expected realization and their current market rate of interest.
Intangible assets
All land in the People’s Republic of China is owned by the government and cannot be sold to any individual or company. However, the government grants the user a “land use right” (the Right) to use the land. Daqiuzhuang Metal acquired land use rights during the years ended 2000 and 2003 for a total amount of $2,870,902. The land use right is for 50 years. However, Daqiuzhuang Metal's initial business license had ten-year term. The management elected to amortize the land use rights over the ten-year business term. Daqiuzhuang Metal became a Sino Joint Venture in 2004 as discussed in note 1 and obtained a new business license for twenty years; however, the Company decided to continue amortizing the land use rights over the original ten-year business term.
As of December 31, 2006 and 2005, accumulated amortization amounted to $1,237,293 and $902,550, respectively. The costs of these rights are being amortized over ten years using the straight-line method. Total amortization expense for the years ended December 31, 2006, 2005 and 2004, amounted to $297,933, $289,938 and $287,090, respectively.
Intangible assets of the Company are reviewed annually as to whether their carrying value has become impaired. The Company considers assets to be impaired if the carrying value exceeds the future projected cash flows from related operations. The Company also re-evaluates the periods of amortization to determine whether subsequent events and circumstances warrant revised estimates of useful lives. As of December 31, 2006, the Company expects these assets to be fully recoverable.
Shares subject to mandatory redemption
The Company has adopted Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. FAS 150 established classification and measurement standards for three types of freestanding financial instruments that have characteristics of both liabilities and equity. Instruments within the scope of FAS 150 must be classified as liabilities within the Company’s Consolidated Financial Statements and be reported at settlement date value. The provisions of FAS 150 are effective for (1) instruments entered into or modified after May 31, 2003, and (2) pre-existing instruments as of July 1, 2003. In November 2003, through the issuance of FSP 150-3, the FASB indefinitely deferred the effective date of certain provisions of FAS 150, including mandatory redeemable instruments as they relate to minority interests in consolidated finite-lived entities.
See report of independent registered public accounting firm.
GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
The Company issued new redeemable stock in September, 2005. The amount is presented as a liability on balance sheet at the fair market value on the date of issuance plus accrued interest at the balance sheet date, see note 20.
Income taxes
The Company has adopted Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (SFAS 109). SFAS 109 requires the recognition of deferred income tax liabilities and assets for the expected future tax consequences of temporary differences between income tax basis and financial reporting basis of assets and liabilities. Provision for income taxes consist of taxes currently due plus deferred taxes. There are no deferred tax amounts at December 31, 2006 and 2005.
The charge for taxation is based on the results for the year as adjusted for items, which are non-assessable or disallowed. It is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date.
Deferred tax is accounted for using the balance sheet liability method in respect of temporary differences arising from differences between the carrying amount of assets and liabilities in the financial statements and the corresponding tax basis used in the computation of assessable tax profit.
In principle, deferred tax liabilities are recognized for all taxable temporary differences, and deferred tax assets are recognized to the extent that it is probably that taxable profit will be available against which deductible temporary differences can be utilized.
Deferred tax is calculated at the tax rates that are expected to apply to the period when the asset is realized or the liability is settled. Deferred tax is charged or credited in the income statement, except when it related to items credited or charged directly to equity, in which case the deferred tax is also dealt with in equity.
Deferred tax assets and liabilities are offset when they relate to income taxes levied by the same taxation authority and the Company intends to settle its current tax assets and liabilities on a net basis.
Under the Income Tax Laws of PRC, the Company is generally subject to an income tax at an effective rate of 33% (30% state income taxes plus 3% local income taxes) on income reported in the statutory financial statements after appropriate tax adjustments, unless the enterprise is located in a specially designated region where it allows foreign enterprises a two-year income tax exemption and a 50% income tax reduction for the following three years.
The Company’s subsidiary, Daqiuzhuang Metal Sheet Co., Ltd., became a Chinese Sino-foreign joint venture at the time of the merger on October 14, 2004 and it became eligible to receive tax benefit. The Company is exempt from income taxes for the years ended December 31ô2005 and 2006 and 50% income tax reduction for the years ended December 31, 2007, and 2009.
See report of independent registered public accounting firm.
GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
The provision for income taxes for the period ended December 31 consisted of the following:
The following table reconciles the U.S. statutory rates to the Company’s effective tax rate for the years ended December 31:
The estimated tax savings for the years ended December 31, 2006 and 2005 amounted to $604,553 and $1,056,377, respectively. The net effect on earnings per share had the income tax been applied would decrease earnings per share from $0.033 to $0.027 and $0.09 to 0.06 for the years ended December 31, 2006 and 2005, respectively.
Value Added Tax
Enterprises or individuals who sell commodities, engage in repair and maintenance or import and export goods in the PRC are subject to a value added tax in accordance with Chinese laws. The value added tax standard rate is 17% of the gross sales price. A credit is available whereby VAT paid on the purchases of semi-finished products or raw materials used in the production of the Company’s finished products can be used to offset the VAT due on sales of the finished product.
Taxes payable consisted of the following:
See report of independent registered public accounting firm.
GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
Recently issued accounting pronouncements
In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments” (“FAS 155”), which amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“FAS 133”) and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“FAS 140”). FAS 155 provides guidance to simplify the accounting for certain hybrid instruments by permitting fair value remeasurement for any hybrid financial instrument that contains an embedded derivative, as well as, clarifies that beneficial interests in securitized financial assets are subject to FAS 133. In addition, FAS 155 eliminates a restriction on the passive derivative instruments that a qualifying special-purpose entity may hold under FAS 140. FAS 155 is effective for all financial instruments acquired, issued or subject to a new basis occurring after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The adoption of SFAS No. 155 is not expected to have a material effect on the Company’s financial position or results of operations.
In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets” (“FAS 156”), which amends SFAS No. 140. FAS 156 specifically provides guidance addressing the recognition and measurement of separately recognized servicing assets and liabilities, common with mortgage securitization activities, and provides an approach to simplify efforts to obtain hedge accounting treatment. FAS 156 is effective for all separately recognized servicing assets and liabilities acquired or issued after the beginning of an entity’s fiscal year that begins after September 15, 2006, with early adoption being permitted. The adoption of SFAS No. 156 is not expected to have a material effect on the Company’s financial position or results of operations.
In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with FAS 109, “Accounting for Income Taxes”. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The requirements of FIN 48 are effective for our fiscal year beginning January 1, 2007. The adoption of this interpretation is not expected to have a material effect on the Company’s financial position or results of operations.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements," which addresses the measurement of fair value by companies when they are required to use a fair value measure for recognition or disclosure purposes under GAAP. SFAS No. 157 provides a common definition of fair value to be used throughout GAAP which is intended to make the measurement of fair value more consistent and comparable and improve disclosures about those measures. SFAS No. 157 will be effective for an entity's financial statements issued for fiscal years beginning after November 15, 2007.
The Company is currently evaluating the effect SFAS No. 157 will have on its consolidated financial position, liquidity, or results of operations.
See report of independent registered public accounting firm.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans−−an amendment of FASB Statements No. 87, 88, 106, and 132(R)". One objective of this standard is to make it easier for investors, employees, retirees and other parties to understand and assess an employer's financial position and its ability to fulfill the obligations under its benefit plans. SFAS No. 158 requires employers to fully recognize in their financial statements the obligations associated with single−employer defined benefit pension plans, retiree healthcare plans, and other postretirement plans. SFAS No. 158 requires an employer to fully recognize in its statement of financial position the overfunded or under funded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. This Statement also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. SFAS No. 158 requires an entity to recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost pursuant to SFAS No. 87. This Statement requires an entity to disclose in the notes to financial statements additional information about certain effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset or obligation. Management does not currently believe adoption will have a material impact on the Company's financial position or results of operations.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year presentation. These reclassifications have no effect on net income or cash flows.
Note 5 - Earnings Per Share
The Company reports earnings per share in accordance with the provisions of SFAS No. 128, "Earnings Per Share." SFAS No. 128 requires presentation of basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic earnings per share is computed by dividing income available to common stockholders by the weighted average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock.
Under SFAS 150 "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity", entities that have issued mandatory redeemable shares of common stock or entered into forward contracts that require physical settlement by repurchase of a fixed number of the issuer’s equity shares of common stock in exchange for cash shall exclude the common shares that are to be redeemed or repurchased in calculating basic and diluted earnings per share. Thus the 1,176,665 shares described in note 18 have been excluded from the earnings per share calculation.
See report of independent registered public accounting firm.
GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
The weighted average number of shares used to calculate EPS for the years ended December 31, 2006 (31,250,000), 2005 (31,250,000) and 2004 (30,259,644) reflect only the shares outstanding for those periods.
Note 6 - Supplemental disclosure of cash flow information
Interest paid amounted to $2,065,237, $1,785,558 and $1,463,385 for the years ended December 31, 2006, 2005 and 2004, respectively.
Income tax payments amounted to $0, $490,431 and $489,800 for the years ended December 31, 2006, 2005 and 2004, respectively.
Note 7 - Accounts receivable and allowance for doubtful accounts
The Company conducts its business operations in the People’s Republic of China. Account receivables include trade accounts due from the customers. Management believes that the trade accounts are fully collectible as these amounts are being collected throughout the year. Also, management reviews its accounts receivable on a regular basis to determine if the bad debt allowance is adequate and adjusts the allowance when necessary. The allowance for doubtful accounts as of December 31, 2006 and December 31, 2005 amounted to $137,132 and $1,371, respectively.
Schedule of valuation and qualifying accounts:
Note 8 - Notes receivable
Notes receivable represents trade accounts receivable due from various customers where the customers’ bank has guaranteed the payment of the receivable. This amount is non-interest bearing and is normally paid within three to six months. The Company has the ability to submit their request for payment to the customer’s bank earlier than the scheduled payment date. However, the Company will incur an interest charge and a processing fee when they submit the payment request early. The Company had $537,946 and $4,960 outstanding as of December 31, 2006 and 2005, respectively.
Note 9 - Prepaid Expenses
Prepaid expenses at December 31, 2006 and 2005 consisted of the followings:
See report of independent registered public accounting firm.
GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
The Company rented a dormitory for its employees during 2006. The rent is for ten years starting on January 1, 2006 at $11,301 per quarter or $45,205 per year. The Company's prepayment at December 31, 2006 amounted to $271,675.
The Company also entered into another rental agreement on July 21, 2005 to rent the land use right for its manufacture expansion. The total amount of the rental is RMB 8,067,400 for a period of 50 years starting on September 1, 2005. The Company’s prepayment at December 31, 2006 and 2005 amounted to $515,345 and $427,331, respectively.
Note 10 - Advances on inventory purchases
Advances on inventory purchases are monies deposited or advanced to outside vendors or related parties on future inventory purchases. Due to the high shortage of steel in China, most of the Company’s vendors require a certain amount of money to be deposited with them as a guarantee that the Company will receive their purchases on a timely basis.
This amount is refundable and bears no interest. The Company has a legal binding contract with their vendors for the guarantee deposit, which is to be returned to the Company at the end of the contract. The inventory is normally delivered within one month after the monies has been advanced. The total outstanding amount was $2,318,344 and $10,716,293 as of December 31, 2006 and 2005, respectively.
Note 11 - Related party transactions
The Company has a cash advance to Golden Glister Holdings Limited. Golden Glister Holdings Limited is incorporated in the territory of the British Virgin Islands which our president Yu Zuo Sheng is the majority shareholder. The amount was advanced to Golden Glister Holdings Limited for business operations. Golden Glister Holdings Limited has agreed to pay back the amount on a short term basis. The Company had a receivable from Golden Glister for $850,400 at December 31, 2006 and a payable to Golden Glister for $980,000 at December 31, 2005. The receivable and payable are short term and non interest bearing. The Company has received payment from Golden Glister for the receivable amount in January 2007.
Starting from January 1, 2006, the Company subleased a portion of its land use rights to Tianjin Jing Qiu Steel Company, a related party under common control. The total rent income for was $1,439,121.
The Company’s short term loan of $5,128,000 from Shenzhen Development Bank is personally guaranteed by Yu Zuo Sheng, CEO and majority holder of the Company.
See report of independent registered public accounting firm.
GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
Note 12 - Short term loans - bank
Short term loans - bank represent amounts due to various banks which are due on demand or normally within one year. These loans can be renewed with the banks. The Company had a total of $30,284,686 and $27,118,800 short term bank loans with various banks as of December 31, 2006 and 2005, respectively and consisted of the following:
See report of independent registered public accounting firm.
GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
Note 13 - Short term notes payable
Short-term notes payable are lines of credit extended by the banks. When purchasing raw materials, the Company often issues a short term note payable to the vendor. This short term note payable is guaranteed by the bank for its complete face value. The banks usually require the Company to deposit a certain amount of cash at the bank as a guarantee deposit which is classified on the balance sheet as restricted cash.
The Company has the following short term notes payable outstanding as of December 31:
Total interest expense for the years ended December 31, 2006, 2005 and 2004 on all debt amounted to $2,065,237, $1,719,351 and $1,463,385, respectively. Capitalized interest amounted to $186,432 and $57,844 for the years ended December 31,2006 and 2005, respectively.
Note 14 - Customer deposits
Customer deposits represent amounts advanced by customers on product orders. The product normally is shipped within six months after receipt of the advance payment and the related sale is recognized in accordance with the Company’s revenue recognition policy. As of December 31, 2006 and 2005, customer deposits amounted to $1,093,602 and $1,276,536, respectively.
Note 15 - Deposits due to sales representatives
The Company has entered into agreements with various entities to act as the Company’s exclusive sales agent in a specified area. These exclusive sales agents must meet certain criteria and are required to deposit a certain amount of money with the Company. In return the sales agents receive exclusive sales rights to a specified area and discounted prices on products they order. These deposits bear no interest and are required to be returned to the sales agent once the agreement has been terminated. The Company had $2,051,200 and $1,261,080 in deposits due to sales representatives outstanding as of December 31, 2006 and 2005, respectively.
See report of independent registered public accounting firm.
GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
Note 16 - Major customers and suppliers
The Company has 5 major customers which represent approximately 30% and 37% of the Company’s total sales for the years ended December 31, 2006 and 2005 respectively. Five Customers accounted for 62% and 51% of total accounts receivable as of December 31, 2006 and 2005, respectively.
For the years ended December 31, 2006 and 2005, the Company purchases approximately 82% and 85%, respectively, of their raw materials from four major suppliers. There are no accounts payable due to these vendors at December 31, 2006 and 2005.
Note 17 - Minority interest
Minority interest represents the outside shareholders’ 30% interest in Tianjin Daqiuzhuang Metal Sheet Co., Ltd.
Note 18 - Other expenses and income, net
Other income and expense for the years ended December 31 consist of the following:
Rental income totaling $1,439,121 for 2006 represents land use right subleased to a related party for one year as discussed in note 11.
Note 19 - Private offering of redeemable stock
The Company has offered an aggregate of 3,333,333 shares of Common Stock par value $0.001 in a private placement to investors at a purchase price of $1.50 per share. On September 18, 2005, the Company entered into a subscription agreement with certain investors to sell a total of 1,176,665 shares of common stock at $1.50 per share. In addition, two warrants are attached to each share of common stock and each warrant gives the warrant holder the right to purchase an additional share of common stock or a total of 2,353,330 of common stock in the future. The warrants can be exercised on the second anniversary date at $2.50 per share and on the third anniversary date at $5.00 per share. The number of shares attached to the warrants will be adjusted due to dividends and changes in the capital stock structure changes. At the option of the investors the Company maybe required to repurchase the 1,176,665 shares of common stock 18 months after the closing date at a per share price of $1.95.
Under this private offering, the Company raised a total of $1,765,000 and received net proceeds of $1,606,151 net of $158,849 of commissions paid.
See report of independent registered public accounting firm.
GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
In accordance with Accounting Principles Board Opinion No. 14, the Company determined the fair value of the detachable warrants issued with redeemable stock using the Black-Scholes option pricing model under the following assumptions: risk free interest rate of 3.85%, dividend yield of 0% and volatility of 11%. The estimated value of the warrants is zero.
In accordance with SFAS 150, the Company has recorded this stock issuance as a liability in the financial statements due to the mandatory redemption provision. The shares are recorded at fair market value on the date of issuance, which is the net cash proceeds, plus any accrued interest up to December 31, 2005. The difference between the net proceeds, $1,606,151, and the redemption amount, $2,294,497, which is $688,346, will be accrued and amortized as interest expense over an 18 month period beginning in October 2005 and ending in March 2007. The following table reconciles the December 31, 2005 carrying amount as follows:
As of December 31, 2006 and 2005, $114,718 and $573,622 are the remaining amount left to be accrued and amortized through March 2007.
Note 21 - Retirement plan
Regulations in the People’s Republic of China require the Company to contribute to a defined contribution retirement plan for all employees. All Joint Venture employees are entitled to a retirement pension amount calculated based upon their salary at their date of retirement and their length of service in accordance with a government managed pension plan. The PRC government is responsible for the pension liability to the retired staff.
The Company became a foreign joint venture entity in the year of 2004. For the year ended December 31, 2005, it was the first year the Company was required to make contributions to the state retirement plan at 20% of the employees’ monthly salary. Employees are required to contribute 7% of their salary to the plan. Total pension expense incurred by the Company amounted to $346,385, $236,730 and $0 for the years ended December 31, 2006, 2005 and 2004, respectively.
Note 22- Statutory reserves
The laws and regulations of the People’s Republic of China require that before a Sino-foreign cooperative joint venture enterprise distributes profits to its partners, it must first satisfy all tax liabilities, provide for losses in previous years, and make allocations, in proportions determined at the discretion of the board of directors, after the statutory reserve.
See report of independent registered public accounting firm.
GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
The statutory reserves include surplus reserve fund, common welfare fund, and the enterprise fund. Daqiuzhuang Metal, the Company's operating subsidiary in China, did not become a Sino Joint Venture until 2004; therefore, no reserve was made in 2003.
Surplus reserve fund
The Company is required to transfer 10% of its net income, as determined in accordance with the PRC accounting rules and regulations, to a statutory surplus reserve fund until such reserve balance reaches 50% of the Company’s registered capital.
The transfer to this reserve must be made before distribution of any dividend to shareholders. For the years ended December 31, 2006 and 2005, the Company transferred $266,257 and $685,959, representing 10% of the year’s net income determined in accordance with PRC accounting rules and regulations, to this reserve. The 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 the shares currently held by them, provided that the remaining reserve balance after such issue is not less than 25% of the registered capital.
Note 23 - Joint venture agreement with Baotou Steel
On September 28, 2005, General Steel Investment Co., Ltd., a wholly owned subsidiary of General Steel Holdings, Inc., entered into a certain Baotou-GSHI Special Steel Joint Venture Agreement (the "Agreement") with Daqiuzhuang Metal Sheet Co., Ltd., and Baotou Iron and Steel (Group) Co., Ltd., a limited liability company formed under the laws of the People's Republic of China (the "Baotou Steel"). The name of the joint venture will be Baotou Steel-General Steel Special Steel Joint Venture Company Limited.
The Joint Venture Company will be located at Kundulun District, Baotou City, Inner Mongolia, China. The stated purposes of the Joint Venture Company are, among others, to produce and sell special steel and to improve the product quality and the production capacity and competitiveness by adopting advanced technology in the production of steel products. The Joint Venture Company shall have a capacity of producing 600,000 of specialty steel products a year.
The registered capital of the joint venture will be approximately $24,000,000. The products of the joint venture will be sold in the Chinese market and abroad. The ownership will be comprised of the following:
See report of independent registered public accounting firm.
GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
Baotou Steel shall contribute land, existing equipment and materials at an estimated value of approximately $12,000,000 which will be contributed to the joint venture at the date of the approval of Joint Venture or issuance of the business license. The value of the assets to be contributed by Baotou Steel will be stated at fair market value. General Steel Investment Co., Ltd. will contribute approximately $7,500,000 of cash and Daqiuzhuang Metal will contribute approximately $5,000,000 cash. These contributions will be required to be made on the following payment schedule 30% of their capital contribution within 30 days of the date of approval of the Joint Venture; 30% of their capital contribution within 3 months of the date of approval of the Joint Venture; and 40% of their capital contribution within 6 months of the date of approval of the Joint Venture. The Company will use the consolidation method to account for the joint venture.
These contributed assets will be used to commence a new operation. The joint venture will purchase a 100-tonne electric furnace and a refiner furnace to produce high quality specialty steel using advanced technology. This type of specialty steel has not been previously produced by Baotou Steel. This advanced technology has not been previously utilized by Baotou Steel. This new joint venture will aim to enter into a new market segment of high-end specialty steel.
Upon the commencement of the joint venture, the rights of the minority shareholders of Daqiuzhuang Metal Sheet Co. Ltd. will be limited to receiving a distribution of profits from the joint venture; the minority shareholders will not have any voting rights.
As of December 31, 2006, the Company has not received the approval of the Baotou Steel Joint Venture and it is still under government review and maybe subject to further industry sector review by the relevant authorities in China in view of the sensitive nature of the steel industry. The management at this point is uncertain if and when the government approval will be granted. Currently none of the operations of Baotou Steel is consolidated into the Company’s financial statements as there is no ownership or control relationship between the Company and Baotou Steel at this time.
Note 24 - Subsequent events
Issuance of shares to Aurelius Consulting Group, Inc.
On February 12, 2007, the Company issued to Aurelius Consulting Group, Inc., (known to us as RedChip Companies, Inc.) 18,000 shares of restricted Reg. F.D. (Rule 144) stock as a portion of their compensation for investor relations services rendered.
Investors Electing Not to Exercise Put Option
Pursuant to a put right granted to the investors in the September 2005 private placement, described in the “About Our Recent Private Placement” section of this report, the investors had the right to request us to repurchase part or all of the 1,176,665 shares of our common stock on March 1, 2007 (the “Repurchase Date”) at a per share price of $1.95 per share. If an investor elected to put the shares back to us on the Repurchase Date, the investor was required to notify us 60 days prior to the Repurchase Date. This date was January 1, 2007. The following investors elected not to put the shares back to us at a per share price of $1.95.
See report of independent registered public accounting firm.
GENERAL STEEL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
Investors Electing to Extend Put Option to US
Pursuant to a put right granted to the investors in the September 2005 private placement, described in the “About Our Recent Private Placement” section of this report, On March 1, 2007, we received written notification from Matlin Patterson Global Opportunities Partners II L.P. (3) and Matlin Patterson Global Opportunities Partners (Caymans) II L.P. (3) asking us to extend the Date of Repurchase from March 1, 2007, until September 1, 2007, and to keep the redemption price unchanged at $1.95 per share. We agreed to this request and extended the Date of Repurchase and repurchase price as per their request. The number of shares held by Matlin Patterson Global Opportunities Partners II L.P. (3) and Matlin Patterson Global Opportunities Partners (Caymans) II L.P. (3) is listed below
See report of independent registered public accounting firm.
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.
GENERAL STEEL HOLDINGS, INC.
By: /s/ Zuo Sheng Yu
Name: YU Zuo Sheng
Title: Chief Executive Officer and Chairman
Date: April 2, 2007
Pursuant to the requirements of the Securities 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.
SIGNATURE
TITLE
DATE
/s/ Zuo Sheng Yu
President and Chief Executive Officer
April 2, 2007
YU Zuo Sheng
/s/ Chen John
Director and Chief Financial Officer
April 2, 2007
CHEN John
/s/ Zhao Sheng Guo
Director
April 2, 2007
ZHAO Sheng Guo
/s/ Tian Lian Hui
Director
April 2, 2007
TIAN Lian Hui
/s/ Warner Ross
Director
April 2, 2007
WARNER, Ross
/s/ Wong John
Director
April 2, 2007
WONG, John
/s/ Wang Guo Dong
Director
April 2, 2007
WANG, Guo Dong