**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM10-Q**

 

**(MarkOne)**

 

**x**** Quarterly Report pursuantto Section 13 or 15(d) of the Securities Exchange Act of 1934**

 

**For the quarterly period endedSeptember 30, 2007**

 

**or**

 

**o**** Transition Report Pursuantto Section 13 or 15(d) of the Securities Exchange Act of 1934**

 

**For the transition periodfrom             to**

 

**Commissionfile number 000-23039**

 

**CHINAPRECISION STEEL, INC.**

(Exactname of registrant as specified in charter)

 

| **Delaware**                                   | **14-1623047**                    |
|------------------------------------------------|-----------------------------------|
| (State  or other jurisdictionof incorporation) | (IRS  EmployerIdentification No.) |

 

**8thFloor, Teda Building, 87 Wing Lok Street, Sheungwan**

**HongKong, The People’s Republic of China**

(Addressof principal executive offices)

 

**+852-2543-8223**

Registrant’stelephone number, including area code:

 

 

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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

 

Yes x No o

 

Indicate by check mark whetherthe registrant is a large accelerated filer, an accelerated filer or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o    Accelerated filer o      Non-acceleratedfiler x

 

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

 

Yes o No x

 

As of November 6, 2007,there were 45,896,288 shares of the Company’s common stock outstanding.

 

 

----

 

**China Precision Steel, Inc.**

**Index to Quarterly Report**

**on Form 10-Q**

 

**Quarter Ended September 30, 2007**

 

**Part I - Financial Information**

 
| Item 1.                         | Financial Statements                                                                                                                                                              |   |
|---------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                            |                                                                                                                                                                              |   |
|                            | Condensed  Consolidated Balance Sheets at September 30, 2007 (unaudited) and June 30,  2007 (audited)                                                                             |   |
|                            |                                                                                                                                                                              |   |
|                            | Unaudited  Condensed Consolidated Statements of Operations for the three months  ended September 30, 2007 and 2006                                                           |   |
|                            |                                                                                                                                                                              |   |
|                            | Unaudited Condensed  Consolidated Statements of Cash Flows for the three months ended September  30, 2007 and 2006                                                           |   |
|                            |                                                                                                                                                                              |   |
|                            | Condensed  Consolidated Statements of Changes in Stockholders’ Equity for the year ended  June 30, 2007 (audited) and the three months ended September 30, 2007  (unaudited) |   |
|                            |                                                                                                                                                                              |   |
|                            | Notes  to Condensed Consolidated Financial Statements                                                                                                                        |   |
|                            |                                                                                                                                                                              |   |
| Item  2.                        | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                                       |   |
|                            |                                                                                                                                                                              |   |
| Item  3.                        | Quantitative  and Qualitative Disclosures About Market Risk                                                                                                                       |   |
|                            |                                                                                                                                                                              |   |
| Item 4.                         | Controls and  Procedures                                                                                                                                                          |   |
|                            |                                                                                                                                                                              |   |
| **Part II - Other Information** |                                                                                                                                                                              |
|                            |                                                                                                                                                                              |   |
| Item 1.                         | Legal Proceedings                                                                                                                                                                 |   |
|                            |                                                                                                                                                                              |   |
| Item 1A.                        | Risk Factors                                                                                                                                                                      |   |
|                            |                                                                                                                                                                              |   |
| Item  2.                        | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                                                      |   |
|                            |                                                                                                                                                                              |   |
| Item  3.                        | Defaults Upon  Senior Securities                                                                                                                                                  |   |
|                            |                                                                                                                                                                              |   |
| Item  4.                        | Submission of  Matters to a Vote of Security Holders                                                                                                                              |   |
|                            |                                                                                                                                                                              |   |
| Item 5.                         | Other Information                                                                                                                                                                 |   |
|                            |                                                                                                                                                                              |   |
| Item 6.                         | Exhibits                                                                                                                                                                          |   |
|                            |                                                                                                                                                                              |   |
| Signatures                      |                                                                                                                                                                              |   |

 

2

----

 

**Item 1.Financial Statements.**

 

**China Precision Steel, Inc. and Subsidiaries**

**Condensed Consolidated Balance Sheets**

 
| ** **                                                                                                                                                                                                                                                    | ** ** | **(Unaudited)**        | ** **   | ** **        | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|--------------|-------------------|------------|
| ** **                                                                                                                                                                                                                                                    | ** ** | **September 30,** | ** **   | **June 30,** | ** ** |
| ** **                                                                                                                                                                                                                                                    | ** ** | **2007**               | ** **   | **2007**          | ** ** |
|                                                                                                                                                                                                                                                          |       |                   |         |              |       |
| **Assets**                                                                                                                                                                                                                                                    |       |                   |         |              |       |
|                                                                                                                                                                                                                                                          |       |                   |         |              |       |
| **Current assets**                                                                                                                                                                                                                                            |       |                   |         |              |       |
| Cash and equivalents                                                                                                                                                                                                                                          |       | $                      | 6,049,792.00 |              | $          | 5,504,862 |   |
| Accounts receivable                                                                                                                                                                                                                                           |       |                   |         |              |       |
| Trade, net of allowances of $908,008 and  $273,461 at September 30, and June 30, 2007, respectively                                                                                                                                                           |       | 14,103,862             |         | 8,242,044         |       |
| Bank acceptance notes                                                                                                                                                                                                                                         |       | 14,862,667             |         |              |       |
| Other                                                                                                                                                                                                                                                         |       | 19,362                 |         | 85,708            |       |
| Inventory                                                                                                                                                                                                                                                     |       | 7,827,785              |         | 15,723,704        |       |
| Deposits                                                                                                                                                                                                                                                      |       | —                 |         | 82,758            |       |
| Prepaid expenses                                                                                                                                                                                                                                              |       | 14,702                 |         | —            |       |
| Advances to suppliers, net of allowance of  $2,305,637 and $3,502,184 at September 30, and June 30, 2007, respectively                                                                                                                                        |       | 11,521,415             |         | 11,699,918        |       |
|                                                                                                                                                                                                                                                          |       |                   |         |              |       |
| **Total current assets**                                                                                                                                                                                                                                      |       | 54,399,585             |         | 41,338,994        |       |
|                                                                                                                                                                                                                                                          |       |                   |         |              |       |
| **Property and equipment**                                                                                                                                                                                                                                    |       |                   |         |              |       |
| Land use rights                                                                                                                                                                                                                                               |       | 1,475,342              |         | 1,124,583         |       |
| Property and equipment, net                                                                                                                                                                                                                                   |       | 29,290,837             |         | 29,238,227        |       |
| Construction-in-progress                                                                                                                                                                                                                                      |       | 10,846,113             |         | 10,355,763        |       |
|                                                                                                                                                                                                                                                          |       |                   |         |              |       |
|                                                                                                                                                                                                                                                          |       | 41,612,292             |         | 40,718,573        |       |
|                                                                                                                                                                                                                                                          |       |                   |         |              |       |
| **Goodwill**                                                                                                                                                                                                                                                  |       | 99,999                 |         | 99,999            |       |
|                                                                                                                                                                                                                                                          |       |                   |         |              |       |
| **Total assets**                                                                                                                                                                                                                                              |       | $                      | 96,111,876   |              | $          | 82,157,566 |   |
|                                                                                                                                                                                                                                                          |       |                   |         |              |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                                                                                |       |                   |         |              |       |
|                                                                                                                                                                                                                                                          |       |                   |         |              |       |
| **Current liabilities**                                                                                                                                                                                                                                       |       |                   |         |              |       |
| Accounts payable and accrued liabilities                                                                                                                                                                                                                      |       | $                      | 3,537,985.00 |              | $          | 4,855,932 |   |
| Advances from customers                                                                                                                                                                                                                                       |       | 8,286,100              |         | 1,720,812         |       |
| Other taxes payables                                                                                                                                                                                                                                          |       | 2,054,814              |         | 816,553           |       |
| Current income taxes payable                                                                                                                                                                                                                                  |       | 2,197,655              |         | 1,892,866         |       |
| Deferred income taxes payable                                                                                                                                                                                                                                 |       | 1,791,265              |         | 1,064,028         |       |
| Amounts due to directors                                                                                                                                                                                                                                      |       | 845,523                |         | 408,620           |       |
| Current portion of long-term debt                                                                                                                                                                                                                             |       | —                 |         | 6,163,445         |       |
| Notes payable                                                                                                                                                                                                                                                 |       | 16,490,833             |         | 9,842,520         |       |
|                                                                                                                                                                                                                                                          |       |                   |         |              |       |
| **Total current liabilities**                                                                                                                                                                                                                                 |       | 35,204,175             |         | 26,764,776        |       |
|                                                                                                                                                                                                                                                          |       |                   |         |              |       |
| **Long-term debt, net of current portion  shown above**                                                                                                                                                                                                       |       | 6,008,889              |         | 6,878,714         |       |
|                                                                                                                                                                                                                                                          |       |                   |         |              |       |
| **Stockholders’ equity:**                                                                                                                                                                                                                                |       |                   |         |              |       |
| Preferred stock: $0.001 per value,  8,000,000 shares authorized, no shares outstanding at September 30, and June  30, 2007 Ordinary stock: $0.001 par value, 62,000,000 shares authorized,  37,378,143 issued and outstanding September 30, and June 30, 2007 |       | 37,378                 |         | 37,378            |       |
| Additional paid-in capital                                                                                                                                                                                                                                    |       | 31,867,063             |         | 31,867,063        |       |
| Accumulated other comprehensive income                                                                                                                                                                                                                        |       | 3,085,407              |         | 2,192,160         |       |
| Retained earnings                                                                                                                                                                                                                                             |       | 19,908,964             |         | 17,008,238        |       |
|                                                                                                                                                                                                                                                          |       |                   |         |              |       |
| **Total stockholders’ equity**                                                                                                                                                                                                                           |       | 54,898,812             |         | 51,104,839        |       |
|                                                                                                                                                                                                                                                          |       |                   |         |              |       |
| **Amounts due from directors**                                                                                                                                                                                                                                |       | —                 |         | (2,590,763        | )          |
|                                                                                                                                                                                                                                                          |       |                   |         |              |       |
| **Total liabilities and stockholders’ equity**                                                                                                                                                                                                           |       | $                      | 96,111,876   |              | $          | 82,157,566 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

3

----

 

**China Precision Steel, Inc. and Subsidiaries**

**Condensed Consolidated Statements of Operations**

**For the Three Months Ended September 30. 2007 and 2006**

**(Unaudited)**

 
| ** **                                                   | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|--------------------------------------------------------------|------------|------------|------------|------------|------------|
|                                                         |       |       |       |       |       |
| **Revenues**                                                 |       |       |       |       |       |
| Sales revenues                                               |       | $          | 25,312,698 |       | $          | 10,503,348 |   |
| Cost of goods sold                                           |       | 20,245,135 |       | 6,800,098  |       |
|                                                         |       |       |       |       |       |
| **Gross profit**                                             |       | 5,067,563  |       | 3,703,250  |       |
|                                                         |       |       |       |       |       |
| **Operating expenses**                                       |       |       |       |       |       |
| Selling expenses                                             |       | 100,705    |       | 39,697     |       |
| Administrative expenses                                      |       | 486,377    |       | 186,188    |       |
| Provision for bad debts                                      |       | 625,998    |       | —     |       |
| Depreciation and amortization expense                        |       | 13,632     |       | 10,417     |       |
|                                                         |       |       |       |       |       |
| **Total operating expenses**                                 |       | 1,226,712  |       | 236,302    |       |
|                                                         |       |       |       |       |       |
| **Income from continuing operations**                        |       | 3,840,851  |       | 3,466,948  |       |
|                                                         |       |       |       |       |       |
| **Other income (expense)**                                   |       |       |       |       |       |
| Other revenues                                               |       | 9,155      |       | —     |       |
| Interest and finance costs                                   |       | (442,141   | )          | (203,339   | )          |
|                                                         |       |       |       |       |       |
| **Total other income (expense)**                             |       | (432,986   | )          | (203,339   | )          |
|                                                         |       |       |       |       |       |
| **Net income from continuing operations before  income tax** |       | 3,407,865  |       | 3,263,609  |       |
|                                                         |       |       |       |       |       |
| **Provision for (benefit from) income tax**                  |       |       |       |       |       |
| Current                                                      |       | (182,977   | )          | 929,370    |       |
| Deferred                                                     |       | 690,116    |       | (475,009   | )          |
|                                                         |       |       |       |       |       |
| Total income tax expense                                     |       | 507,139    |       | 454,361    |       |
|                                                         |       |       |       |       |       |
| **Net income before discontinued operations**                |       | 2,900,726  |       | 2,809,248  |       |
|                                                         |       |       |       |       |       |
| **Net income from discontinued operations**                  |       | —     |       | 155,072    |       |
|                                                         |       |       |       |       |       |
| **Net income**                                               |       | $          | 2,900,726  |       | $          | 2,964,320 |   |
|                                                         |       |       |       |       |       |
| **Basic earnings per share**                                 |       |       |       |       |       |
| From continuing operations                                   |       | $          | 0.08       |       | $          | 0.11 |   |
| From discontinued operations                                 |       | $          | —     |       | $          | 0.01 |   |
| Total                                                        |       | $          | 0.08       |       | $          | 0.12 |   |
|                                                         |       |       |       |       |       |
| **Basic weighted average shares outstanding**                |       | 37,378,143 |       | 24,283,725 |       |
|                                                         |       |       |       |       |       |
| **Diluted earnings per share**                               |       |       |       |       |       |
| From continuing operations                                   |       | $          | 0.08       |       | $          | 0.11 |   |
| From discontinued operations                                 |       | $          | —     |       | $          | 0.01 |   |
| Total                                                        |       | $          | 0.08       |       | $          | 0.12 |   |
|                                                         |       |       |       |       |       |
| **Diluted weighted average shares outstanding**              |       | 38,397,325 |       | 24,283,725 |       |
|                                                         |       |       |       |       |       |
| **The Components of comprehensive income:**                  |       |       |       |       |       |
| Net income                                                   |       | $          | 2,900,726  |       | $          | 2,964,320 |   |
| Foreign currency translation adjustment                      |       | 893,247    |       | 745,583    |       |
|                                                         |       |       |       |       |       |
| **Comprehensive income**                                     |       | $          | 3,793,973  |       | $          | 3,709,903 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

4

----

 

**China Precision Steel, Inc. and Subsidiaries**

**Condensed Consolidated Statements of Cash Flows**

**For the Three Months Ended September 30, 2007and 2006**

**(Unaudited)**

 
| ** **                                                                                      | ** ** | **2007**    | ** ** | **2006**   | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-------------|------------|------------|------------|
|                                                                                            |       |        |       |       |       |
| **Cash flows from operating activities**                                                        |       |        |       |       |       |
| **Net Income**                                                                                  |       | $           | 2,900,726  |       | $          | 2,964,320 |   |
| **Adjustments to reconcile net income to net  cash provided by (used in) operating activities** |       |        |       |       |       |
| Depreciation                                                                                    |       | 493,613     |       | 260,892    |       |
| Less income from discontinued operations -  OraLabs, Inc                                        |       | —      |       | (155,072   | )          |
| Provision for doubtful accounts                                                                 |       | 625,998     |       | —     |       |
| **Net changes in assets and liabilities:**                                                      |       |        |       |       |       |
| Accounts receivable, net                                                                        |       | (21,208,354 | )          | 981,606    |       |
| Inventories                                                                                     |       | 8,039,005   |       | (8,236,768 | )          |
| Advances to suppliers                                                                           |       | 284,972     |       | (4,506,824 | )          |
| Deposits                                                                                        |       | 82,758      |       | (196,233   | )          |
| Prepayments                                                                                     |       | (14,702     | )          | —     |       |
| Accounts payable and accrued expenses                                                           |       | (1,362,136  | )          | 10,805,570 |       |
| Advances from customers                                                                         |       | 6,549,629   |       | 2,976,867  |       |
| Deferred income taxes                                                                           |       | 690,166     |       | (475,009   | )          |
| Current income taxes                                                                            |       | (182,977    | )          | 929,370    |       |
| Taxes payable                                                                                   |       | 1,826,668   |       | 139,996    |       |
|                                                                                            |       |        |       |       |       |
| **Net cash (used in) provided by operating  activities**                                        |       | (1,274,634  | )          | 5,488,715  |       |
|                                                                                            |       |        |       |       |       |
| **Cash flows from investing activities**                                                        |       |        |       |       |       |
| Purchases of fixed assets including  construction in progress                                   |       | (1,016,793  | )          | (5,230,112 | )          |
|                                                                                            |       |        |       |       |       |
| **Net cash (used in) investing activities**                                                     |       | (1,016,793  | )          | (5,230,112 | )          |
|                                                                                            |       |        |       |       |       |
| **Cash flows from financing activities**                                                        |       |        |       |       |       |
| Advances from directors, net                                                                    |       | 2,946,615   |       | (3,894,566 | )          |
| Notes payable proceeds                                                                          |       | 16,490,833  |       | 4,233,252  |       |
| Repayments of notes payable                                                                     |       | (17,084,041 | )          | —     |       |
|                                                                                            |       |        |       |       |       |
| **Net cash provided by financing activities**                                                   |       | 2,353,407   |       | 338,686    |       |
|                                                                                            |       |        |       |       |       |
| **Effect of exchange rate**                                                                     |       | 482,950     |       | 97,772     |       |
|                                                                                            |       |        |       |       |       |
| **Net increase in cash**                                                                        |       | 544,530     |       | 695,061    |       |
|                                                                                            |       |        |       |       |       |
| **Cash and cash equivalents, beginning of  year**                                               |       | 5,504,862   |       | 186,955    |       |
|                                                                                            |       |        |       |       |       |
| **Cash and cash equivalents, end of year**                                                      |       | $           | 6,049,392  |       | $          | 882,016 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

5

----

 

**China Precision Steel, Inc. and Subsidiaries**

**Condensed Consolidated Statements of Changes inStockholders’ Equity**

**For the Year Ended June 30, 2007 and the Three Months Ended September30, 2007**

**(Unaudited)**

** **
| ** **                                               | ** ** | ** **               | ** ** | ** **  | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** **             | ** ** | ** ** | ** ** |
|----------------------------------------------------------|------------|--------------------------|------------|-------------|------------|-------------------|------------|-----------------|------------|------------------------|------------|------------|------------|
| ** **                                               | ** ** | ** **               | ** ** | ** **  | ** ** | **Additional**    | ** ** | **Other**       | ** ** | ** **             | ** ** | **Total**  | ** ** |
| ** **                                               | ** ** | **Ordinary Shares** | ** ** | **Paid-in** | ** ** | **Comprehensive** | ** ** | **Retained**    | ** ** | **Stockholders’** | ** ** |
| ** **                                               | ** ** | **Share**                | ** ** | **Amount**  | ** ** | **Capital**       | ** ** | **Income**      | ** ** | **Earnings**           | ** ** | **Equity** | ** ** |
| Balance at June  30, 2006                                |       | 24,283,725               |       | 24,284      |       | 1,375,716         |       | 745,583         |       | 9,535,577              |       | 11,681,160 |       |
|                                                     |       |                     |       |        |       |              |       |            |       |                   |       |       |       |
| Sale of common  stock                                    |       | 7,451,665                |       | 7,451       |       | 22,347,543        |       | —          |       | —                 |       | 22,354,994 |       |
| Syndication fees                                         |       | —                   |       | —      |       | (3,028,116        | )          | —          |       | —                 |       | (3,028,116 | )          |
| Stock issued for  syndication fees                       |       | 2,798,191                |       | 2,798       |       | (2,798            | )          | —          |       | —                 |       | —     |       |
| Anti-dilution  rights stock                              |       | 827,962                  |       | 828         |       | (828              | )          | —          |       | —                 |       | —     |       |
| Conversion of  debt to stock                             |       | 2,016,600                |       | 2,017       |       | 6,773,759         |       |            |       |                   |       | 6,775,776  |       |
| Warrants issued  for consulting                          |       | —                   |       | —      |       | 447,993           |       | —          |       | —                 |       | 447,993    |       |
| Capital  contribution from waiver of dividend            |       | —                   |       | —      |       | 3,953,794         |       |            |       |                   |       | 3,953,794  |       |
| Foreign currency  translation adjustment                 |       | —                   |       | —      |       | —            |       | 1,446,577       |       | —                 |       | 1,446,577  |       |
| Net income                                               |       | —                   |       | —      |       | —            |       | —          |       | 8,304,109              |       | 8,304,109  |       |
| Less discontinued  operations sold to former shareholder |       | —                   |       | —      |       | —            |       | —          |       | (831,448               | )          | (831,448   | )          |
|                                                     |       |                     |       |        |       |              |       |            |       |                   |       |       |       |
| Balance at June  30, 2007                                |       | 37,378,143               |       | 37,378      |       | 31,867,063        |       | 2,192,160       |       | 17,008,238             |       | 51,104,839 |       |
|                                                     |       |                     |       |        |       |              |       |            |       |                   |       |       |       |
| Foreign currency  translation adjustment                 |       |                     |       |        |       |              |       | 893,247         |       |                   |       | 893,247    |       |
| Net income                                               |       |                     |       |        |       |              |       |            |       | 2,900,726              |       | 2,900,726  |       |
|                                                     |       |                     |       |        |       |              |       |            |       |                   |       |       |       |
| Balance at  September 30, 2007                           |       | 37,378,143               |       | $           | 37,378     |              | $          | 31,867,063      |       | $                      | 3,085,407  |       | $          | 19,908,964 |   | $ | 54,898,812 |   |
|                                                          |            |                          |            |             |            |                   |            |                 |            |                        |            |            |            |  |  |  |  |  |

 

The accompanying notes are an integral part of these financialstatements.

 

6

----

 

**China Precision Steel, Inc.**

Notes to the Condensed Consolidated FinancialStatements

 

****1.   Descriptionof Business****

 

OnDecember 28, 2006, China Precision Steel, Inc. (the “Company” or “we”) underits former name, Oralabs Holding Corp., issued 25,363,002 shares of its commonstock in exchange for 100% of the registered capital of Partner SuccessHoldings Limited, a British Virgin Islands Business Company (“PSHL”) pursuantto a Stock Exchange Agreement, dated March 31, 2006. Subsequent to the closingof that transaction, on December 28, 2006, the Company redeemed 3,629,350shares of its common stock in exchange for all of the common stock of Oralabs,Inc., a wholly-owned operating subsidiary. The Company issued 100,000 shares ofits common stock to Oralabs, Inc. in exchange for $450,690, and receivedadditional cash payments in the aggregate amount of $108,107 in payment of anestimated $558,797 tax liability to be incurred by the Company in connectionwith the spin off of OraLabs, Inc. and the supplement payment received. TheCompany then changed its name to China Precision Steel, Inc.

 

Thesetransactions were treated for financial reporting purposes as arecapitalization, with prior OraLabs, Inc. operating activities reflected onthe statements of operations as income (loss) from discontinued operations. The$558,797 estimated tax liability incurred in connection with the spin off of OraLabs,Inc. was treated as a transaction cost for financial reporting purposes and wastreated as a reduction in additional paid in capital to the extent of theadditional cash received which was also $558,797.

 

PSHL,registered on April 30, 2002 in the Territory of the British Virgin Islands,had registered capital of $50,000 as of June 30, 2006 and 2005. It has threewholly-owned subsidiaries, Shanghai Chengtong Precision Strip Company Limited (“Chengtong”),Shanghai Tuorong Precision Strip Co., Limited (“Tuorong”), and BlessfordInternational Limited (“Blessford”).

 

Inthe year ended June 30, 2007, we added three indirect subsidiaries to ourcorporate structure. On April 9, 2007, we purchased Shanghai Tuorong PrecisionStrip, Limited, or Tuorong, through PSHL. The sole activity of Tuorong is theownership of a land use right with respect to facilities utilized by Chengtong.On April 10, 2007, PSHL purchased for $100,000 Blessford International Limited,a British Virgin Islands company. Blessford International Limited does notconduct any business, but it owns a single subsidiary, Shanghai Blessford AlloyCompany Limited, that is a wholly-foreign owned enterprise chartered in China.We intend to hold Blessford International Limited as a shell subsidiary thatmay be used in the future to facilitate optimization of the tax structure ofthe Group’s activities.

 

Chengtongwas registered on July 2, 2002 in Shanghai, in the People’s Republic of China (“PRC”)with a registered capital of $3,220,000 and a defined period of existence of 50years from July 2, 2002 to July 1, 2052. Chengtong was classified as aSino-foreign joint venture enterprise with limited liabilities. On August 22,2005, the authorized registered capital was increased to $15,220,000. Pursuantto the document issued by the District Council to Xuhang Town Council on June28, 2004, the equity transfers from China Chengtong Metal Group Limited andEastreal Holdings Company Limited to PSHL was approved and the transformationof Chengtong from a Sino-foreign joint investment enterprise to a whollyforeign owned enterprise (WFOE) was granted.

 

Asused herein, the “Group” refers to the Company, PSHL and Chengtong, Tuorong andBlessford on a consolidated basis.

 

TheCompany’s principal activities are conducted through its principal subsidiary,Chengtong. Chengtong, is a niche precision steel processing company principallyengaged in the manufacture and sales of cold-rolled and hot-rolled precisionsteel products and plates for down stream applications in the automobileindustry (components and spare parts), kitchen tools and functional parts ofelectrical appliances. Raw materials, hot-rolled de-scaled (pickled) steelcoils, will go through certain cold reduction processing

 

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proceduresto give steel rolls and plates in different cuts and thickness for deliveriesin accordance with customers’ specifications. Specialty precision steel offers specificcontrol of thickness, shape, width, surface finish and other special qualityfeatures that compliment the emerging need for highly engineered end useapplications. Precision steel pertains to the precision of measurements andtolerances of the above factors, especially thickness tolerance.

 

****2.    Basis of Preparation of Financial Statements****

 

Theaccompanying unaudited condensed consolidated financial statements have beenprepared in accordance with generally accepted accounting principles for interimfinancial information and with the instructions to Form 10-Q. Accordingly, theydo not include all of the information and footnotes required by generallyaccepted accounting principles for complete financial statements and relatednotes. The accompanying unaudited condensed consolidated financial statementsand related notes should be read in conjunction with the audited consolidatedfinancial statements of the Company and notes thereto for the year ended June30, 2007.

 

Inthe opinion of management, the accompanying unaudited condensed consolidatedfinancial statements contain all adjustments (which include only normalrecurring adjustments) necessary to present fairly the balance sheets of ChinaPrecision Steel, Inc. and subsidiaries as of September 30, 2007 and June 30,2007 and the results of their operations for the three months ended September30, 2007 and 2006, and cash flows for the three months ended September 30, 2007and 2006. The results of operations for the three months ended September 30, 2007and 2006 are not necessarily indicative of the results to be expected for theentire year.

 

****3.  **** ****Summaryof Significant Accounting Policies****

 

Thefollowing is a summary of significant accounting policies:

 

****Cashand Equivalents -****The**** ****Company considers all highlyliquid debt instruments purchased with maturity period of three months or lessto be cash equivalents. The carrying amounts reported in the accompanyingconsolidated balance sheet for cash and cash equivalents approximate their fairvalue.

 

****AccountsReceivable -****TheCompany provides an allowance for doubtful accounts equal to the estimateduncollectible amounts. It is reasonably possible that the Company’s estimate ofthe allowance will change. At September 30, 2007 and June 30, 2006, the Companyhad $908,008 and $273,461 of allowances for doubtful accounts, respectively.

 

****Inventory- ****Inventoryis stated at the lower of cost or market. Cost is determined using the weightedaverage method. Market value represents the estimated selling price in the ordinarycourse of business less the estimated costs necessary to complete the sale.

 

Thecost of inventories comprises all costs of purchases, costs of conversion andother costs incurred in bringing the inventories to their present location andcondition. The costs of conversion of inventories include fixed and variableproduction overheads, taking into account the stage of completion.

 

****Advancesto Suppliers -****Inorder to insure a steady supply of raw materials, the Company is required fromtime to time to make cash advances when placing its purchase orders. Cashadvances are shown net of allowances for unrecoverable advances of $2,305,637and $3,502,184 at September 30, 2007 and June 30, 2007 respectively.

 

****Property,Plant and Equipment -****Property, plant and equipment are stated at cost less accumulateddepreciation. The cost of an asset comprises its purchase price and anydirectly attributable costs of bringing the asset to its present workingcondition and location for its intended use.

 

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Depreciationis computed on a straight-line basis over the estimated useful lives of therelated assets for financial reporting purposes. The estimated useful lives forsignificant property and equipment are as follows:

 
| Buildings         |   | 25 years |
|-------------------|--------|----------|
| Office  equipment |   | 5 years  |
| Motor  vehicles   |   | 5 years  |
| Machineries       |   | 10 years |

 

Repairsand maintenance costs are normally charged to the statement of operations inthe year in which they are incurred. In situations where it can be clearlydemonstrated that the expenditure has resulted in an increase in the futureeconomic benefits expected to be obtained from the use of the asset, theexpenditure is capitalized as an additional cost of the asset.

 

Property,plant and equipment are evaluated annually for any impairment in value. Wherethe recoverable amount of any property and equipment is determined to havedeclined below its carrying amount, the carrying amount is reduced to reflectthe decline in value. There were no property and equipment impairmentsrecognized during the years ended June 30, 2007 and 2006 .

 

****CapitalizedInterest -****The Company capitalizes interest cost on borrowings incurred during the newconstruction or upgrade of qualified assets. Capitalized interest is added tothe cost of the underlying assets and is amortized over the useful lives of theassets. During the three months ended September 30, 2007 and 2006, the Companycapitalized $0 and $192,767, respectively, of interest toconstruction-in-progress.

 

****Construction-in-Progress**** - Properties currently under development areaccounted for as construction-in-progress. Construction-in-progress is recordedat acquisition cost, including land rights cost, development expenditure,professional fees and the interest expenses capitalized during the course ofconstruction for the purpose of financing the project. Upon completion andreadiness for use of the project, the cost of construction-in-progress is to betransferred to properties held for sale.

 

Construction-in-progressis valued at the lower of cost or market. Management evaluates the market valueof its properties on a quarterly basis by comparing selling prices of itsproperties with those of other equivalent properties in the vicinity offered byother developers reduced by anticipated selling costs and associated taxes. Inthe case of construction-in-progress, management takes into consideration theestimated cost to complete the project when making the lower of cost or marketcalculation.

 

****ContingentLiabilities and Contingent Assets**** ****-**** A contingentliability is a possible obligation that arises from past events and whoseexistence will only be confirmed by the occurrence or non-occurrence of one ormore uncertain future events not wholly within the control of the Company. Itcan also be a present obligation arising from past events that is notrecognized because it is not probable that outflow of economic resources willbe required or the amount of obligation cannot be measured reliably.

 

Acontingent liability is not recognized but is disclosed in the notes to thefinancial statements. When a change in the probability of an outflow occurs sothat outflow is probable, they will then be recognized as a provision.

 

Acontingent asset is a possible asset that arises from past events and whoseexistence will be confirmed only by the occurrence or non-occurrence of one ormore uncertain events not wholly within the control of the Company.

 

Contingentassets are not recognized but are disclosed in the notes to the financialstatements when an inflow of economic benefits is probable. When inflow isvirtually certain, an asset is recognized.

 

9

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****Advancesfrom customers**** ****-****Revenue from the sale of goods or services is recognized at the time that goodsare delivered or services are rendered. Receipts in advance for goods to bedelivered or services to be rendered in the subsequent year are carried forwardas deferred revenue.

 

****RevenueRecognition - ****Revenue from the sale of goods and services is recognized on thetransfer of risks and rewards of ownership, which generally coincides with thetime when the goods are delivered to customers and the title has passed andservices have been rendered and invoiced. Revenue is reported net of all VAT taxes.Other income is recognized when it is earned.

 

****ForeignCurrencies**** -The Company’s principal country of operations is in the PRC. The financialposition and results of operations of the Company are determined using thelocal currency (“Renminbi” or “Yuan”) as the functional currency. The resultsof operations denominated in foreign currency are translated at the averagerate of exchange during the reporting period. Assets and liabilitiesdenominated in foreign currencies at the balance sheet date are translated atthe market rate of exchange ruling at that date. The registered equity capitaldenominated in the functional currency is translated at the historical rate ofexchange at the time of capital contribution. All translation adjustmentsresulting from the translation of the financial statements into the reportingcurrency (“US Dollars”) are dealt with as an exchange fluctuation reserve inshareholders’ equity.

 

****Taxation-****Taxationon overseas profits has been calculated on the estimated assessable profits forthe year at the rates of taxation prevailing in the country in which theCompany operates.

 

Provisionfor the PRC enterprise income tax is calculated at the prevailing rate based onthe estimated assessable profits less available tax relief for losses broughtforward****.****The Company does not accrue taxeson unremitted earnings from foreign operations as it is the Company’s intentionto invest these earnings in the foreign operations indefinitely****.****

 

**Enterpriseincome tax**

 

Underthe Provisional Regulations of the People’s Republic of China Concerning IncomeTax on Enterprises promulgated by the State Council which came into effect onJanuary 1, 1994, income tax is payable by enterprises at a rate of 33% of theirtaxable income. Preferential tax treatment may, however, be granted pursuant toany law or regulations from time to time promulgated by the State Council.Specialty state companies’ enterprise income tax rate was reduced to 27%. TheGroup is currently enjoying a 50% reduction in the statutory rates due to theclassification of Chengtong as a “Wholly Foreign Owned Enterprise”. Thisreduced rate applies to the fiscal years ended June 30, 2007, 2008, and 2009.Subsequent to June 30, 2009, Chengtong will be subject to enterprise incometaxes at the prevailing statutory rates. The Enterprise Income Tax Law waspassed on March 16, 2007, and becomes effective on January 1, 2008. The new lawintroduces fundamental changes to the Chinese tax system for both domestic andforeign-owned entities. A new unified general income tax of 25% will beapplicable to enterprises in China. Entities subject to a “tax holiday” priorto January 1, 2008, are expected to be able to retain the benefits of thereduced rates for the remaining term.

 

Deferredtax assets and liabilities are recognized for the future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases. Deferred taxassets, including tax loss and credit carry forwards, and liabilities aremeasured using enacted tax rates expected to apply to taxable income in theyears in which those temporary differences are expected to be recovered orsettled. The effect on deferred tax assets and liabilities of a change in tax ratesis recognized in income in the period that includes the enactment date.Deferred income tax expense represents the change during the period in thedeferred tax assets and deferred tax liabilities. The components of thedeferred tax assets and liabilities are individually classified as current andnon-current based on their characteristics. Deferred tax assets are reduced bya valuation allowance when, in the

 

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opinionof management, it is more likely than not that some portion or all of thedeferred tax assets will not be realized.

 

In2006, the Financial Accounting Standards Board (FASB) issued FIN 48, whichclarifies the application of SFAS 109 by defining a criterion that anindividual income tax position must meet for any part of the benefit of thatposition to be recognized in an enterprise’s financial statements and providesguidance on measurement, derecognition, classification, accounting for interestand penalties, accounting in interim periods, disclosure and transition. Inaccordance with the transition provisions, the Company adopted FIN 48 effectiveJanuary 1, 2007.

 

TheCompany recognizes that virtually all tax positions in the PRC are not free ofsome degree of uncertainty due to tax law and policy changes by the state.However, the Company cannot reasonably quantify political risk factors and thusmust depend on guidance issued by current state officials.

 

Basedon all known facts and circumstances and current tax law, the Company believesthat the total amount of unrecognized tax benefits as of June 30, 2007, is notmaterial to its results of operations, financial condition or cash flows. The Companyalso believes that the total amount of unrecognized tax benefits as of June 30,2007, if recognized, would not have a material effect on its effective taxrate. The Company further believes that there are no tax positions for which itis reasonably possible, based on current Chinese tax law and policy, that theunrecognized tax benefits will significantly increase or decrease over the next12 months producing, individually or in the aggregate, a material effect on theCompany’s results of operations, financial condition or cash flows.

 

**Valueadded tax**

 

TheProvisional Regulations of the People’s Republic of China Concerning ValueAdded Tax promulgated by the State Council came into effect on January 1, 1994.Under these regulations and the Implementing Rules of the ProvisionalRegulations of the People’s Republic of China Concerning Value Added Tax, valueadded tax is imposed on goods sold in or imported into the PRC and onprocessing, repair and replacement services provided within the PRC.

 

Valueadded tax payable in the PRC is charged on an aggregated basis at a rate of 13%or 17% (depending on the type of goods involved) on the full price collectedfor the goods sold or, in the case of taxable services provided, at a rate of17% on the charges for the taxable services provided, but excluding, in respectof both goods and services, any amount paid in respect of value added taxincluded in the price or charges, and less any deductible value added taxalready paid by the taxpayer on purchases of goods and services in the samefinancial year.

 

****RetirementBenefit Costs****- According to the PRC regulations on pension, Chengtong contributes to a definedcontribution retirement scheme organized by municipal government in theprovince in which Chengtong was registered and all qualified employees areeligible to participate in the scheme. Contributions to the scheme arecalculated at 23.5% of the employees’ salaries above a fixed threshold amountand the employees contribute 2% to 8%, while Chengtong contributes the balancecontribution of 21.5%% to 15.5%. The Group has no other material obligation forthe payment of retirement benefits beyond the annual contributions under thisscheme.

 

Forthe three months ended September 30, 2007 and 2006 the Company’s pension costcharged to the statements of operations under the plan amounted to $60,599 and$34,698, respectively, all of which have been paid to the State Pension Fund.

 

****FairValue of Financial Instruments -****The carrying amounts of certain financialinstruments, including cash, accounts receivable, other receivables, accountspayable, accrued expenses, and other payables approximate their fair values asat September 30, 2007 and June 30, 2007 because of the relatively short-termmaturity of these instruments.

 

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****Adjustments****- In theopinion of management, all adjustments that are necessary for a fairpresentation for the periods presented have been reflected as required byRegulation S-X, Rule 10-01. All such adjustments are of a normal, recurringnature.

 

****Useof Estimates**** ****-****The preparation of financial statements in accordance with generally acceptedaccounting principles require management to make estimates and assumptions thataffect reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements and reportedamounts of revenues and expenses during the reporting period. Actual resultscould differ from those estimates.

 

****Reclassifications-****Certainreclassifications have been made to the prior years’ financial statements toconform to the current year presentation. These reclassifications had no effecton previously reported results of operations or retained earnings.

 

****RecentAccounting Pronouncements**** -

 

TheFinancial Accounting Standards Board recently issued the following standardswhich the Company reviewed to determine the potential impact on our financialstatements upon adoption.

 

InJune 2006, the FASB issued FASB Interpretation No. 48, Accounting forUncertainty in Income Taxes—an Interpretation of FASB Statement No. 109 (“FIN 48”).FIN 48 provides guidance for recognizing and measuring uncertain tax positions,as defined in SFAS 109, Accounting for Income Taxes. FIN 48 prescribes athreshold condition that a tax position must meet for any of the benefit of theuncertain tax position to be recognized in the financial statements. Guidanceis also provided regarding de-recognition, classification and disclosure ofthese uncertain tax positions. FIN 48 iseffective for fiscal years beginningafter December 15, 2006. The adoption of FIN 48 did not have a materialimpact on our financial position, results of operations or cash flows.

 

InSeptember 2006, the FASB issued Statement No. 157, “Fair ValueMeasurements” (“SFAS No. 157”). SFAS No. 157 addresses howcompanies should measure fair value when they are required to use a fair valuemeasure for recognition or disclosure purposes under generally acceptedaccounting principles. SFAS No. 157 defines fair value, establishes aframework for measuring fair value and expands the required disclosures aboutfair value measurements. SFAS No. 157 is effective for fiscal yearsbeginning after November 15, 2007, with earlier adoption permitted.Management is assessing the impact of the adoption of SFAS No. 157.

 

InSeptember 2006, the FASB issued Statement No. 158, “Employers’ Accountingfor Defined Benefit Pension and Other Postretirement Plans” (“SFAS No. 158”),an amendment of FASB Statements No. 87, 88, 106 and 132(R).SFAS No. 158 requires (a) recognition of the funded status(measured as the difference between the fair value of the plan assets and thebenefit obligation) of a benefit plan as an asset or liability in the employer’sstatement of financial position, (b) measurement of the funded status asof the employer’s fiscal year-end with limited exceptions, and(c) recognition of changes in the funded status in the year in which thechanges occur through comprehensive income. The requirement to recognize thefunded status of a benefit plan and the disclosure requirements are effectiveas of the end of the fiscal year ending after December 15, 2006. Therequirement to measure the plan assets and benefit obligations as of the dateof the employer’s fiscal year-end statement of financial position is effectivefor fiscal years ending after December 15, 2008. SFAS No. 158has no current applicability to the Company’s financial statements.

 

InSeptember 2006, the Securities and Exchange Commission issued Staff AccountingBulletin No. 108 (“SAB No. 108”). SAB No. 108addresses how the effects of prior year uncorrected misstatements should beconsidered when quantifying misstatements in current year financial statements.SAB No. 108 requires companies to quantify misstatements using abalance sheet and income statement approach and to evaluate whether eitherapproach results in quantifying an error that is material in light of relevantquantitative and

 

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qualitativefactors. When the effect of initial adoption is material, companies will recordthe effect as a cumulative effect adjustment to beginning of year retainedearnings and disclose the nature and amount of each individual error beingcorrected in the cumulative adjustment. Complying with the requirements of SABNo. 108 had no impact on the Company’s financial statements.

 

InFebruary 2007, the FASB issued Statement No. 159, “The Fair Value Optionfor Financial Assets and Financial Liabilities” (“SFAS No. 159”), anamendment of FASB Statement No. 115. SFAS No. 159 addresses howcompanies should measure many financial instruments and certain other items atfair value. The objective is to mitigate volatility in reported earnings causedby measuring related assets and liabilities differently without having to applycomplex hedge accounting provisions. SFAS No. 159 is effective forfiscal years beginning after November 15, 2007, with earlier adoptionpermitted. Management is assessing the impact of the adoption ofSFAS No. 159.

 

****4.  Concentrationsof Business and Credit Risk****

 

Chengtongprovides credit in the normal course of business. Chengtong performs ongoingcredit evaluations of its customers and clients and maintains allowances fordoubtful accounts based on factors surrounding the credit risk of specificcustomers and clients, historical trends, and other information. Trade accountsreceivable totaled $8,242,044 and $13,399,003 as of June 30, 2007 and 2006,respectively.

 

Chengtong’slist of customers whose purchases exceeded 10% of total sales during the threemonths ended September 30, 2007 and 2006 were as follows:

 
| ****Customers****                         | **** **** | ****September 30,  2007**** | **** **** | ****% to  sales**** | **** **** | ****September 30,  2006**** | **** **** | ****% to  sales**** | **** **** |
|-------------------------------------------|----------------|-----------------------------|----------------|--------------------------|----------------|-----------------------------|----------------|--------------------------|----------------|
| Shanghai Ruixuefeng Metals Co., Limited   |           | —                      |           | —                   |           | 3,888,986                   |           | 37                       |           |
| Shanghai Changshuo Steel Company, Ltd     |           | 8,648,752                   |           | 34                       |           | —                      |           | —                   |           |
| Shanghi Shengdejia Metal Products Limited |           | 3,288,926                   |           | 13                       |           | —                      |           | —                   |           |
| Hangzhou Relian Company Limited           |           | —                      |           | —                   |           | 1,285,775                   |           | 12                       |           |
| Sinosteel Company Limited                 |           | —                      |           | —                   |           | 1,082,329                   |           | 10                       |           |

 

****5.  **** ****Inventories****

 

Asof September 30, 2007 and June 30, 2007 inventory consisted of the following:

 
| ** **       | ** ** | **September 30,  2007** | ** ** | **June 30,  2007** | ** ** |
|------------------|------------|------------------------------|------------|-------------------------|------------|
| Raw materials    |       | $                            | 5,735,871  |                    | $          | 13,026,530 |   |
| Work in progress |       | 724,962                      |       | —                  |       |
| Finished goods   |       | 1,366,952                    |       | 2,697,174               |       |
|             |       | $                            | 7,827,785  |                    | $          | 15,723,704 |   |

 

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****6.  **** ****Property,Plant and Equipment****

 

Property,plant and equipment, stated at cost less accumulated depreciation, consisted ofthe following:

 
| **** ****                 | **** **** | ****September 30,  2007**** | **** **** | ****June 30,  2007**** | **** **** |
|--------------------------------|----------------|----------------------------------|----------------|-----------------------------|----------------|
| Plant and machinery            |           | $                                | 21,473,439     |                        | $              | 21,087,245 |   |
| Buildings                      |           | 11,542,987                       |           | 11,361,207                  |           |
| Motor vehicles                 |           | 316,445                          |           | 283,534                     |           |
| Office equipment               |           | 89,444                           |           | 85,560                      |           |
|                           |           | 33,422,315                       |           | 32,817,546                  |           |
| Less: Accumulated depreciation |           | (4,131,478                       | )              | (3,579,319                  | )              |
|                           |           | $                                | 29,290,837     |                        | $              | 29,238,227 |   |

 

Depreciationexpense related to manufacturing is included as a component of cost of goodssold. During the three months ended September 30, 2007 and 2006, depreciationtotaling $477,980 and $250,475, respectively, was included as a component ofcost of goods sold.

 

****7.  Construction-In-Progress****

 

Asof September 30, 2007 and June 30, 2007, construction-in-progress consisted ofthe following:

 
| **** ****                            | **** **** | ****September 30,  2007**** | **** **** | ****June 30,  2007**** | **** **** |
|-------------------------------------------|----------------|----------------------------------|----------------|-----------------------------|----------------|
| Construction costs of plant and machinery |           | $                                | 10,846,113     |                        | $              | 10,355,763 |   |
|                                      |           | $                                | 10,846,113     |                        | $              | 10,355,763 |   |

 

Construction-in-progressrepresents construction and installations of the new plant and machinery andadministration and factory buildings.

 

****8.  **** ****Advancesfrom Customers****

 

Advancesfrom customers represent advance cash receipts from new customers and for whichgoods have not been delivered as of the balance sheets dates. Advances fromcustomers for goods to be delivered or services to be rendered in thesubsequent year are carried forward as deferred revenue. As of September 30,2007 and June 30, 2007, there were advances from customers of $8,286,100 and $1,720,812,respectively.

 

****9.  **** ****Transactionswith Related Parties****

 

Amountsdue to (from) directors as of September 30, 2007 and June 30, 2007 are asfollows:

 
| **Name**       | ** ** | **September 30, 2007** | ** ** | **June 30, 2007** | ** ** |
|----------------|------------|----------------------------------|------------|-----------------------------|------------|
| Wo Hing Li     |       | $                                | 434,365    |                        | $          | (2,590,763 | ) |
| Hai Sheng Chen |       | 411,158                          |       | 408,620                     |       |
|           |       | $                                | 845,523    |                        | $          | (2,182,143 | ) |

 

Amountsdue are unsecured, non-interest bearing and have no fixed repayment terms.

 

WoHing Li, a director and the President of the Company, executed an agreementwith the Company and certain other parties, dated as of February 13, 2007, asamended (the “Debt Conversion Agreement”), such that, upon the occurrence ofthe transfer to Chengtong of Tuorong, he contributed $3,953,794 as additionalpaid in capital to the Company and agreed to convert current debt outstandingand payable to him of $6,775,776 into shares of the Company’s common stock at aprice of $3.36 per share. This transaction was completed on May 19, 2007. WhenChengtong acquired Tuorong, Tuorong had a preexisting receivable from Wo HingLi, and the Group offset remaining amounts owed to Wo Hing Li against thisreceivable.

 

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****10.  Short-TermLoans****

 

Short-termloans consisted of the following:

 
| ** **                                                                                                                                                                                                                 | ** ** | **September 30,  2007** | ** ** | **June 30,  2007** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-------------------------|------------|
| Bank loan dated September 22, 2005, due  December 31, 2007 with a interest rate of 15% over the standard market rate  set by the People’s Bank of China for Renminbi loans, secured by land,  buildings and machinery |       | $                            | —     |                    | $          | 9,842,520 |   |
|                                                                                                                                                                                                                       |       |                         |       |                    |       |   |   |
| Bank loan dated August 1, 2007, due in one  year with a interest rate of SIBOR plus 3%                                                                                                                                     |       | 5,344,166                    |       | —                  |       |
|                                                                                                                                                                                                                       |       |                         |       |                    |       |
| Bank loan dated August 1, 2007, due in one  year with a interest rate of 13% over the standard market rate set by the  People’s Bank of China for Renminbi loans, secured by land, buildings, plant  and machinery    |       | 2,666,667                    |       | —                  |       |
|                                                                                                                                                                                                                       |       |                         |       |                    |       |
| Bank loan dated July 26, 2007, due in one  year with a interest rate of 15% over the standard market rate set by the  People’s Bank of China for Renminbi loans, secured by land, buildings, plant  and machinery     |       | 8,480,000                    |       | —                  |       |
|                                                                                                                                                                                                                       |       |                         |       |                    |       |
|                                                                                                                                                                                                                       |       | $                            | 16,490,833 |                    | $          | 9,842,520 |   |

 

****11.  Long-TermDebts - Secured****

 
| ** **                                                                                                                                                                                                                     | ** ** | **September 30,  2007** | ** ** | **June 30,  2007** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-------------------------|------------|
| Long-term debts:                                                                                                                                                                                                               |       |                         |       |                    |       |
|                                                                                                                                                                                                                           |       |                         |       |                    |       |
| Bank loan dated October 14, 2004, due July  31, 2007, at an interest rate of 3% over the 10% of the standard market rate  set by the People’s Bank of China for Renminbi loans, secured by land,  buildings and machinery |       | $                            | —     |                    | $          | 6,163,445 |   |
|                                                                                                                                                                                                                           |       |                         |       |                    |       |   |   |
| Bank loan dated September 22, 2005, due  August 31, 2009, at an interest rate of 15% the standard market rate set by  the People’s Bank of China for Renminbi loans, secured by land, buildings and  machinery            |       | 6,008,889                    |       | 6,878,714               |       |
|                                                                                                                                                                                                                           |       |                         |       |                    |       |
| Total long-term debt                                                                                                                                                                                                           |       | 6,008,889                    |       | 13,042,159              |       |
| Less: Current portion of long-term debts                                                                                                                                                                                       |       | —                       |       | 6,163,445               |       |
|                                                                                                                                                                                                                           |       |                         |       |                    |       |
| Long-term debts                                                                                                                                                                                                                |       | $                            | 6,008,889  |                    | $          | 6,878,714 |   |

 

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Maturitieson long-term debt for each of the next five years and thereafter are asfollows:

 
| 2008           |   | $         | —    |   |
|----------------|--------|-----------|-----------|--------|
| 2009           |   | 6,008,889 |      |
| 2010           |   | —    |      |
| 2011           |   | —    |      |
| 2012           |   | —    |      |
| 2013 and after |   | —    |      |
|           |   | $         | 6,008,889 |   |

 

****12.  IncomeTax****

 

ForEIT reporting purposes, the Company reports income and expenses on a tax basisand is required to compute a 10% salvage value when computing depreciationexpense. For financial reporting purposes, the Company reports income andexpenses on the accrual basis and does not take into account a 10% salvagevalue when computing depreciation expense.

 

Noaccrual for deferred taxes was required for the fiscal year ended June 30, 2005as the Group benefited from Chengtong’s 100% tax holiday during the two fiscalyears ended June 30, 2006 and all material timing differences would reversewithin one year with the exception of depreciation which resulted in a smalldeferred tax asset which was deemed to be immaterial by the Company and was notrecorded at that time.

 

Asof June 30, 2006, Chengtong had utilized all of its 100% tax holiday, thereforeany timing differences reversing within the next three years would be taxed at50% of the statutory rate of 27%. Therefore, it was necessary for the Group torecord a deferred income tax liability and offsetting deferred income taxexpense of $1,535,203 as of June 30, 2006.

 

Thetax holiday resulted in tax savings as follows:

 
| ** **        | ** ** | **Three months ended  September 30,** | ** ** |
|-------------------|------------|------------------------------------------------------|------------|
| ** **        | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| Tax savings       |       | $                                                    | 545,720    |   | $ | 454,361 |   |
|              |       |                                                 |       |   |   |
| Benefit per share |       |                                                 |       |   |   |
| Basic             |       | $                                                    | .01        |   | $ | .02 |   |
| Diluted           |       | $                                                    | .01        |   | $ | .02 |   |

 

Significantcomponents of the Group’s deferred tax assets and liabilities as of September30, 2007 and June 30, 2007 are as follows:

 
| **Deferred tax assets:**                                       | ** ** | **September 30,  2007** | ** ** | **June 30,  2007** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------------|------------|-------------------------|------------|
|                                                                     |       |                         |       |                    |       |
| Book depreciation in excess of tax  depreciation                         |       | $                            | 43,460     |                    | $          | 39,918 |   |
|                                                                     |       |                         |       |                    |       |
| Deferred tax liability                                                   |       |                         |       |                    |       |
|                                                                     |       |                         |       |                    |       |
| Timing differences resulting form cash  basis reporting for tax purposes |       | (1,834,725                   | )          | (1,103,946              | )          |
|                                                                     |       |                         |       |                    |       |
| Net deferred income tax (liability)                                      |       | $                            | (1,791,265 | )                       | $          | (1,064,028 | ) |

 

16

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Areconciliation of the provision for income taxes with amounts determined by theU.S. federal income tax rate to income before income taxes is as follows.

 
| ** **                                         | ** ** | **Three months ended  September 30,** | ** ** |
|----------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                         | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| Computed tax at the federal statutory rate  of 34% |       | $                                                    | 1,158,674  |   | $ | 1,109,627 |   |
| Less adjustment to EIT statutory rate of 27%       |       | (238,550                                             | )          | (228,453 | ) |
| Tax effect of US losses not deductible in  PRC     |       | 132,735                                              |       | 27,548 |   |
| Benefit of tax holiday                             |       | (545,720                                             | )          | (454,361 | ) |
|                                               |       |                                                 |       |   |   |
| Income tax expense per books                       |       | $                                                    | 507,139    |   | $ | 454,361 |   |
|                                                    |            |                                                      |            |  |  |  |  |  |

 

17

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****13.  BlessfordInternational, Limited****

 

OnApril 10, 2007, the Company purchased for $100,000 Blessford InternationalLimited, a British Virgin Islands company. Blessford International Limited doesnot conduct any business, but it owns a single subsidiary, Shanghai BlessfordAlloy Company Limited, that is a wholly-foreign owned enterprise chartered inChina. The purchase price was allocated $1 to cash and $99,999 to goodwill.

 

****14.  Equity****

 

Inconnection with the Private Placement, on February 22, 2007, the Companyissued warrants to the placement agents to purchase an aggregateof 1,300,059 shares of Common Stock as partial compensation for servicesrendered in connection with the Private Placement.

 

OnFebruary 22, 2007, the Company issued warrants to purchase up to 100,000 sharesof Common Stock to the Company’s investor relations consultants valued at$447,993.

 

Informationwith respect to stock warrants outstanding are as follows:

 
| **Exercise Price** | ** ** | **Outstanding  June 30, 2007** | ** ** | **Granted** | ** ** | **Expired or  Exercised** | ** ** | **Outstanding  September 30,  2007** | ** ** | **Expiration Date** | ** ** |
|-------------------------|------------|------------------------------------------|------------|-------------|------------|--------------------------------|------------|-------------------------------------------|------------|--------------------------|------------|
| $                       | 3.00       |                                     | 1,300,059  |        | -0-        |                           | -0-        |                                      | 1,300,059  |                     | 02/22/2011 |   |
| $                       | 3.60       |                                     | 100,000    |        | -0-        |                           | -0-        |                                      | 100,000    |                     | 02/22/2010 |   |

 

18

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TheCompany entered into an agreement with a financial advisor to act as theexclusive financial advisor with respect to certain of  the Company’sprivate placement offerings. The agreement called for cash fees equal to (10%of) of the gross proceeds of the first $25 million and eight percent (8%) of thegross proceeds of the other $25 million thereafter received from the sale ofsecurities. In respect of any capital raised in excess of $50 million orfollowing the consummation of the offering of $50 million contemplated, theCompany would pay in cash a fee equal to nine percent (9%) of the grossproceeds after the first $50 million has been raised.

 

Afterthe closing of any applicable offering, the Company will issue to the advisorwarrants to purchase shares equivalent to eight and one half percent (8.5%) ofthe securities issued at the closing share price in the Offering. The Warrantswill be exercisable into the same class of common stock as issued as part ofthe Offering, have a strike price equal to 100% of the Company’s common stockon the closing date of the Offering and have a term of 3 years. In the eventthat warrants are issued as part of the offering, the terms and conditions ofthe Warrants shall be the same as investor warrants.

 

Pursuantto the terms of this agreement and in connection with the private placementoffering of February 22, 2007 the advisor was paid 10% of the proceeds of and1,300,059 shares of common stock were issued. These fees were treated assyndication costs and charged against additional paid-in capital.

 

****15.  EarningsPer Share****

 

SFAS128 requires a reconciliation of the numerator and denominator of the basic anddiluted earnings per share (EPS) computations.

 

Forthe three months ended September 30, 2007, dilutive shares include outstandingwarrants to purchase 1,300,059 shares of common stock at an exercise price of$3.00 and warrants to purchase 100,000 shares at an exercise price of $3.60.

 

Thefollowing reconciles the components of the EPS computation:

 
| ** **                                           | ** ** | **Income**      | ** ** | **Shares**        | ** ** | **Per Share** | ** ** |
|------------------------------------------------------|------------|-----------------|------------|-------------------|------------|--------------------|------------|
| ** **                                           | ** ** | **(Numerator)** | ** ** | **(Denominator)** | ** ** | **Amount**         | ** ** |
| For the three months ended September 30,  2007:      |       |            |       |              |       |               |       |
| Net income                                           |       | $               | 2,900,726  |              |       |               |       |   |
| Less Net income from discontinued  operations        |       | $               | -0-        |              |       |               |       |   |
| Basic EPS income available to common  shareholders   |       | $               | 2,900,726  |              | 37,378,143 |               | $          | 0.08 |   |
| Effect of dilutive securities:                       |       |            |       |              |       |               |       |
| Warrants                                             |       | —          |       | 1,019,182         |       |               |       |
| Diluted EPS income available to common  shareholders |       | $               | 2,900,726  |              | 38,397,325 |               | $          | 0.08 |   |
|                                                 |       |            |       |              |       |               |       |
| For the three months ended September 30,  2006:      |       |            |       |              |       |               |       |
| Net income                                           |       | $               | 2,964,320  |              |       |               |       |   |
| Less net income from discontinued  operations        |       | $               | (155,072   | )                 |       |               |       |   |
| Basic EPS income available to common  shareholders   |       | $               | 2,809,248  |              | 24,283,725 |               | $          | 0.11 |   |
| Effect of dilutive securities:                       |       |            |       |              |       |               |       |
| Warrants                                             |       | —          |       | —            |       |               |       |
| Diluted EPS income available to common shareholders  |       | $               | 2,809,248  |              | 24,283,725 |               | $          | 0.11 |   |

 

19

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****16.  DiscontinuedOperations****

 

Theoperations of Oralabs Inc prior to December 28, 2006 are shown in the financialstatements as income from discontinued operations as these operations weretransferred to a former shareholder in exchange for the redemption of hiscommon stock. The consolidated financial statements have been reclassified toconform to discontinued operations presentation for all historical periodspresented.

 

Summarizedselected financial information for discontinued operations for the three monthsended September 30, 2007, and 2006 is as follows:

 
| ** **                          | ** **     | **Three months ended:** | ** **     |
|-------------------------------------|----------------|-----------------------------------|----------------|
| **** ****                      | **** **** | ****September 30,****        | **** **** | ****September 30,**** | **** **** |
| **** ****                      | **** **** | ****2007****                      | **** **** | ****2006**** | **** **** |
|                                |           |                              |           |   |   |
| Revenues                            |           | $                                 | -0-            |   | $ | 4,386,000 |   |
| Income before tax                   |           | -0-                               |           | 244,000 |   |
| Income taxes                        |           | -0-                               |           | 89,000 |   |
| Income from discontinued operations |           | $                                 | -0-            |   | $ | 155,000 |   |

 

Asof September 30, 2007, there were no assets or liabilities associated withOraLabs, Inc.

 

****17.  Commitments****

 

Asof September 30, 2007, the Company had $4,270,236, in commitments for capitalexpenditures for contractual commitments of the construction projects relatedto expansion of Chengtong’s production facilities.

 

****18.**** ****Subsequentevents****

 

Pursuantto Section 5.1 of the Stock Purchase Agreement, dated February 16, 2007, theCompany agreed to reserve for issuance to investors in the private placement anaggregate of 2,000,000 shares of Common Stock if the Company’s net income forthe fiscal year ending June 30, 2007 was less than US$10.4 million, as setforth in the Company’s audited financial statements as filed with the SEC inthe Company’s Annual Report on Form 10-K for the fiscal year ended June 30,2007. As the Company’s net income as set forth in its audited financialstatements for the year ended June 30, 2007 was less than US$10.4 million, theCompany was required to issue the 2,000,000 shares of Common Stock to suchinvestors.  Such issuance was effected onOctober 15, 2007.

 

Inconjunction with the Company’s final audit of the Tuorong acquisition, certainpost-closing adjustments were required. In light of such adjustments andconsistent with the purposes and intentions of the Debt Reduction Agreement,dated February 13, 2007, as amended February 20, 2007, it was determined that771,060 shares of the Company’s Common Stock issued to directors pursuant tosuch Agreement would be required to be cancelled in order to eliminate the$2,590,763 reflected on the June 30, 2007 audited financial statements asamounts due from directors.  Suchcancellation was effected on November 8, 2007.

 

The net effect of these transactionson earnings per share had they been retroactively applied to these auditedfinancial statements would have been a reduction in basic and diluted earningsper share of $(0.01).

 

On November 1,2007, the Company entered into a Subscription Agreement (the “Agreement”) withthe buyers named therein (the “Investors” and each individually as an“Investor”) pursuant to which the Company agreed to issue and sell in aregistered direct offering (the “Offering”) an aggregate of 7,100,000 shares ofits common stock (“Common Stock”) at a price of $6.75 per share (the “PurchasePrice”) and an aggregate of 1,420,000 warrants to purchase shares of its CommonStock (“Warrants” and, together with the Common Stock, the “Securities”).  The Warrants have an exercise price of $8.45per share.  The Warrants may not beexercised prior to May 6, 2008.  TheSecurities (including the shares issuable upon exercise of the Warrants) areregistered under the Securities Act of 1933, as amended (the “Act”), pursuantto the Company’s existing effective shelf Registration Statement on FormS-3.  In connection with the offer andsale of the Securities, the Company filed on November 1, 2007, a RegistrationStatement on Form S-3 pursuant to Rule 462(b) promulgated under the Act toregister an additional $10 million of its securities relating to its shelfRegistration Statement.

 

On October 31,2007, in connection with the Agreement, the Company entered into a PlacementAgency Agreement (the “Placement Agreement”) with Roth Capital Partners, LLC,(“Roth Capital”) pursuant to which Roth Capital agreed to act as placementagent for the Company in connection with the Offering.  

 

The Companyclosed the Offering on November 6, 2007 (the “Closing Date”). The net proceedsof the offering were approximately $44 million, after deducting underwritingcommissions and discounts and other fees and expenses relating to theoffering.  The Company intends to use thenet proceeds for repayment of certain existing bank debt in the amount ofapproximately $22 million, capital expenditures related to the completion ofthe second reverse rolling mill and annealing furnace and construction of thethird reverse rolling mill and related capital expenditures in the amount ofapproximately $18 million, and the balance for general corporate purposes.

 

On the ClosingDate, pursuant to the Placement Agreement and in connection with the completionof the Offering, Roth Capital received an amount in cash equal to 7.0% of thegross proceeds of the Offering and warrants to purchase an amount of CommonStock equal to 3.0% of the total number of shares of Common Stock sold in theOffering (the “Placement Warrants”), or 225,600 shares of Common Stock.  Such Placement Warrants have an exerciseprice per share of 120% of the closing price per share of the Company’s CommonStock on the Closing Date, or $7.38, and are not exercisable prior to May 6,2008.  Thereafter, the Placement Warrantsare exercisable at any time until the third anniversary of the date of issue. 

 

On November 12,20007, at the Annual Meeting of the Company’s shareholders, the Company’sshareholders approved the reincorporation of the Company in the state ofDelaware.  The reincorporation waseffected on November 16, 2007 through a merger with and into the Company’swholly-owned subsidiary.

 

20

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****ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATION****

 

**ThisQuarterly Report on Form 10-Q contains statements that constitute “forwardlooking statements” within the meaning of Section 21E of the SecuritiesExchange Act of 1934, as amended, and Section 27A of the Securities Act of1933, as amended. The words “may,” “will,” “expect,” “anticipate,” “continue,” “estimate,”“project,” “intend,” and similar expressions are intended to identifyforward-looking statements. These statements appear in a number of places inthis document and include statements regarding the intent, belief orexpectation of the Company, its directors or its officers with respect toevents, conditions, and financial trends that may affect the Company’s futureplans of operations, business strategy, operating results, and financialposition. Persons reviewing this Quarterly Report on Form 10-Q are cautionedthat any forward-looking statements are not guarantees of future performanceand are subject to risks and uncertainties and that actual results may differmaterially from those included within the forward-looking statements as aresult of various factors. More information on these risks and uncertainties,many of which are beyond the Company’s control, is set forth under Part II,Item 1A, “Risk Factors,” in this Quarterly Report.**

 

**Whilethese forward-looking statements, and any assumptions upon which they arebased, are made in good faith and reflect the Company’s current judgmentregarding the direction of its business, actual results will almost alwaysvary, sometimes materially, from any estimates, predictions, projections,assumptions or other future performance suggested herein. The Companyundertakes no responsibility or obligation to update publicly theseforward-looking statements, but may do so in the future in written or oralstatements. Investors should take note of any future statements made by or onbehalf the Company.**

 

Thefollowing discussion should be read in conjunction with our unauditedconsolidated financial statements and the related notes that appear in Part I,Item 1, “Financial Statements,” of this Quarterly Report. Our unauditedconsolidated financial statements are stated in United States Dollars and areprepared in accordance with United States Generally Accepted AccountingPrinciples. The following discussion and analysis covers the Company’sconsolidated financial condition at September 30, 2007 (unaudited) and June 30,2007, the end of its prior fiscal year, and its unaudited consolidated resultsof operation for the three month periods ended September 30, 2007 and 2006.

 

****Introduction****

 

Management’sdiscussion and analysis of financial condition and results of operations isintended to help provide an understanding of China Precision Steel, Inc. andour subsidiaries’ (together, the “Group”) financial condition, changes infinancial condition and results of operations. This discussion is organized asfollows.

 

•               ****Overview of theCompany’s Business**** - This section provides a general description of the Group’s business,as well as recent developments that have either occurred during the threemonths ended September 30, 2007 and are important in understanding the resultsof operations and financial condition or disclose known trends.

 

•               ****Results ofOperations**** -This section provides an analysis of our results of operations for the threemonths ended September 30, 2007. This discussion includes a brief descriptionof significant transactions and events that have an impact on the comparabilityof the results being analyzed.

 

•               ****Liquidity andCapital Resources**** - This section provides an analysis of the Group’s cash flows for thethree months ended September 30, 2007. Included in this section is a discussionof the Group’s outstanding debt and the financial capacity available to fundthe Group’s future commitments and obligations.

 

****OVERVIEW OF THE COMPANY’S BUSINESS****

 

Weare a niche and high value-added steel processing company principally engagedin the manufacture and sale of high precision cold-rolled steel products, inthe provision of heat treatment and in the cutting of medium and high-carbonhot-rolled steel strips. We use commodity steel to create a specialty premiumsteel intended to yield above-average industry gross margins. Specialtyprecision steel pertains to the precision of measurements and tolerances ofthickness, shape, width, surface finish and other special quality features ofhighly-engineered end-use applications.

 

Weproduce and sell precision ultra-thin and high strength cold-rolled steelproducts ranging from 7.5 mm to 0.03 mm. We also provide heat treatment andcutting of medium and high-carbon hot-rolled steel strips not exceeding 7.5 mmfineness. Our process puts hot-rolled de-scaled (pickled) steel coils through acold-rolling mill, utilizing our patented systems and high technology reductionprocessing procedures, to make steel coils and sheets in customized thicknessesaccording to customer specifications. Currently, our specialty precisionproducts are mainly used in the manufacture of automobile parts and components,plane friction discs, appliances, food packaging materials, saw blades, textileneedles, microelectronics, and packing containers.

 

21

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Weconduct our operations principally in China through our wholly-owned operatingsubsidiary, Shanghai Chengtong Precision Strip Co., Limited, or Chengtong,which, in turn, is a wholly owned subsidiary of our direct subsidiary, PartnerSuccess Holdings Limited, or PSHL. Most of our sales are made domestically inChina; however, during fiscal 2007, we began exporting ourcold-rolled steel products to Indonesia and the Philippines and, to a lesserextent, Nigeria and Thailand. We intend to expand into additionaloverseas markets in the future, subject to suitable market conditions andfavorable regulatory controls.

 

Overthe course of the past two years, we have begun to alter our product mix tomeet market demands in our primary market, China, as well as to expand intooverseas markets. We continue to focus on the production of higher marginproducts, although we have increased production of certain of our lower marginproducts due to market demand. These changes in our strategy have createdincreased capital requirements as we have sought to construct additionalrolling mills to accommodate our planned growth. In addition, our workforce hasincreased and, in particular, we have faced a growing need for experiencedexecutive and technical staff.

 

Ourmarket is highly competitive, although we have focused on a niche market thatwe consider allows us to compete effectively as we continue to grow ourbusiness. We face significant competition for raw materials, especially crudesteel, and our financial results may be impacted by changes in the marketprices for these materials. Given our size, we do not have the ability toinfluence the prices at which we must purchase raw materials. However, the natureof our products enable us to pass on all or part of the price fluctuations inraw materials to our customers.

 

Inthe year ended June 30, 2007, we added three indirect subsidiaries to ourcorporate structure. On April 9, 2007, we purchased Shanghai Tuorong PrecisionStrip, Limited, or Tuorong, through PSHL. The sole activity of Tuorong is theownership of a land use right with respect to facilities leased to Chengtong.On April 10, 2007, PSHL purchased for nominal consideration BlessfordInternational Limited, a British Virgin Islands company. BlessfordInternational Limited does not conduct any business, but it owns a singlesubsidiary, Shanghai Blessford Alloy Company Limited, that is a wholly-foreignowned enterprise chartered in China. We intend to hold Blessford InternationalLimited as a shell subsidiary that may be used in the future to facilitateoptimization of the structure of the Group’s activities.

 

****RESULTS OF OPERATIONS****

 

****Three Months Ended September 30, 2007 versus Three MonthsEnded September 30, 2006****

 

Netincome before tax increased by $144,256, or 4.4%, period-on-period to$3,407,865 for the three months ended September 30, 2007 from $3,263,609 forthe three months ended September 30, 2006 and gross profit increased by$1,364,313, or 36.8%, period-on-period.

 

****GrossProfit****

 

Grossprofits in absolute terms increased by $1,364,313, or 36.8%, period-on-periodto $5,067,563 for the three months ended September 30, 2007 from $3,703,250 forthe three months ended September 30, 2006, while gross profit margin decreasedto 20.0% for the three months ended September 30, 2007 from 35.3% for the threemonths ended September 30, 2006. The increase in gross profits is mainlyattributable to a 140.9% period-on-period increase in sales revenues inrelation to a 197.7% period-on-period increase in cost of sales. The decreasein gross profit margin principally resulted from a change in sales mix over thethree months ended September 30, 2007, which produced increased sales of lowermargin products in the high-carbon cold-rolled steel product line and anincrease in the cost of sales due to higher depreciation costs associated withthe addition of a second mill.

 

****Sales Revenues.****Sales volume increased by 18,824 metric tons,or 191%, period-on-period to 28,683 metric tons for the three months endedSeptember 30, 2007 from 9,859 tons for the three months ended September 30,2006.  As a result, sales revenuesincreased by $14,809,350, or 141%, period-on-period to $25,312,698 for the threemonths ended September 30, 2007 from $10,503,348 for the three months endedSeptember 30, 2006. We believe that the increases in sales and sales revenuesare a direct result of increases in our capacity and the building of our brandin China among users of precision steel products.

 

Averagecost of production per ton increased to $706 for the three months endedSeptember 30, 2007 compared to an average cost of production per ton of $690for the three months ended September 30, 2006, representing an increase of $16per ton, or 2.0%, period-on-period. The new 1400 mm cold-roll mill becameoperational at the beginning of October 2006, and it will likely take two tothree years for the mill to reach its maximum production capacity.

 

****Salesby Product Line********.****A break-down of our sales by product line forthe three months ended September 30, 2007 and 2006 is as follows:

 

22

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| **** ****                | **** **** | ****2007****             | ** **     | ****2006****        | ** **     | ****Period-on-period****     | ** **     |
|-------------------------------|----------------|--------------------------|----------------|---------------------|----------------|------------------------------|----------------|
| ****Product category**** | **** **** | ****Quantity  (tons)**** | **** **** | ****$******Amount** | **** **** | ****% of sales**** | **** **** | ****Quantity  (tons)**** | **** **** | ****$******Amount** | **** **** | ****% of  sales**** | **** **** | ****Qty.  Variance**** | **** **** |
|                          |           |                     |           |                |           |                         |           |   |   |   |   |   |   |   |   |
| Low carbon cold-rolled        |           | 14,321                   |           | 8,455,500           |           | 34                           |           | 6,182 |   | 3,668,242 |   | 35 |   | 8,139 |   |
| Low carbon hard rolled        |           | 2,387                    |           | 1,531,850           |           | 6                            |           | — |   | — |   | — |   | 2,387 |   |
| High-carbon cold-rolled       |           | 8,936                    |           | 13,637,161          |           | 54                           |           | 1,208 |   | 4,840,658 |   | 47 |   | 7,728 |   |
| High-carbon hot-rolled        |           | 1,897                    |           | 1,355,408           |           | 5                            |           | 2,378 |   | 1,809,410 |   | 17 |   | (481 | ) |
| Sales of Scrap Metal          |           |                     |           | 258,774             |           | 1                            |           | — |   | 155,182 |   | 1 |   |   |   |
| Subcontracting income         |           | 1,142                    |           | 73,945              |           | —                       |           | 91 |   | 29,856 |   | — |   | 1,051 |   |
| Total                         |           | 28,683                   |           | 25,312,698          |           | 100                          | %              | 9,859 |   | 10,503,348 |   | 100 |   | 18,824 |   |

 

Therewere various changes in the break-down of sales among our product lines overthe three months ended September 30, 2007 as we are now operating an additionalmill and are in the process of developing new markets. High-carbon hot-rolledsteel products only accounted for 6% of the current sales mix at an averageselling price of $715 per ton for the three months ended September 30, 2007compared to 17% of the sales mix at an average selling price per ton of $761for the three months ended September 30, 2006. The lower priced low-carboncold-rolled steel products accounted for 36% of the current sales mix at anaverage selling price of $590 per ton for the three months ended September 30,2007 compared to $3,668,242 or 35% of the sales mix at an average selling priceper ton of $593 for the three months ended September 30, 2006. Low carbonhard-rolled steel, which was not sold during the three months ended September30, 2006, accounted for $1,531,850, or 6%, of the current sales mix at anaverage selling price of $689 per ton for the three months ended September 30,2007.

 

Westrive to find an appropriate sales mix that provides us with the stability andcash flows of the low-carbon cold-rolled steel products along with the highermargin provided by high-carbon cold-rolled products. Management continues totake appropriate action to optimize our product mix without adversely affectingoverall sales volume. Management believes that there are high barriers to entryin the Chinese domestic precision steel industry and that our uniquecapabilities give us a competitive advantage to grow sales of higher marginproducts.

 
| ****Average selling prices**** | **** **** | ****2007**** | **** **** | ****2006**** | **** **** | ****Variance**** | ** ** |
|------------------------------------------|----------------|--------------|----------------|--------------|----------------|------------------|------------|
| **** ****                           | **** **** | ****$****    | **** **** | ****$****    | ** **     | ****$****        | ** ** | ****%**** | ** ** |
| Low-carbon cold-rolled                   |           | 590          |           | 593          |           | (3               | )          | (1 | )% |
| Low-carbon hard rolled                   |           | 642          |           | —       |           | 642              |       | 100 | % |
| High-carbon cold-rolled                  |           | 1,526        |           | 4,007        |           | (2,481           | )          | (42 | )% |
| High-carbon hot-rolled                   |           | 714          |           | 761          |           | (47              | )          | (6 | )% |
| Subcontracting income                    |           | 64           |           | 327          |           | (263             | )          | (80 | )% |

 

Theaverage unit selling price per ton generated decreased to $883 per ton for thethree months ended September 30, 2007 compared to the corresponding period in2006 of $1,065, representing a decrease of $183, or 17.2%,period-on-period. This decrease was due to a non-repeated order for a highlyspecialized type of high-carbon cold-rolled steel in the three months endedSeptember 30, 2006 which favorably impacted average price for this product lineand overall margins and an increase in sales volume of lower margin products inthe high-carbon cold-rolled steel product line as we are operating anadditional mill and developing new markets. Sales of high-carbon cold-rolledsteel products have increased by 7,728 metric tons or 640% period-on-period to8,936 metric tons for the three months ended September 30, 2007 compared to1,208 metric tons for the three months ended September 30, 2006. While thevolume increased of high-carbon cold-rolled steel increased, the average salesprice declined $2,481, or 62%, to $1,526 in the three months ended September30, 2007 as compared to an average selling of $4,007 in the three months endedSeptember 30, 2006. This product accounted for $13,637,161, or 54%, of thetotal sales mix for the three months ended September 30, 2007 compared to$4,840,658, or 47%, of the sales mix for the three months ended September 30,2006.

 

****SalesBreakdown by Major Customer.****

 
| **** ****                                             | **** **** | ****September 30****  | **** **** |
|------------------------------------------------------------|----------------|-----------------------|----------------|
| ****Customers****                                          | **** **** | ****2007 ($)**** | **** **** | ****% to sales**** | **** **** | ****2006 ($)**** | **** **** | ****% to sales**** | **** **** |
|                                                       |           |                  |           |   |   |   |   |   |   |
| Shanghai Changshuo Steel Company Ltd                       |           | 8,648,752             |           | 34 |   | — | * | — | * |
| Shanghai  Shengdejia Metal Products Limited                |           | 3,288,926             |           | 13 |   | — | * | — | * |
| Beijing  Beimo Aircraft Material Technology Ltd Co         |           | 1,746,538             |           | 7 |   |   |   |   |   |
| Hangzhou Relian Company Limited                            |           | 1,393,982             |           | 6 |   | 1,285,775 |   | 12 |   |
| Shangdong  Province Boxing County Longhua Material Limited |           | 1,277,358             |           | 5 |   |   |   |   |   |
| Shanghai Ruixuefeng Metals Co. Ltd                         |           | —                | *              | — | * | 3,888,986 |   | 37 |   |
| China Railway Materials Shanghai Company                   |           | —                | *              | — | * | — | * | — | * |
| Sinosteel Company Limited                                  |           | —                | *              | — | * | 1,082,329 |   | 10 |   |
| Shanghai BaoGang XinBao Industrial Co., Ltd                |           | —                | *              | — | * | 481,307 |   | 5 |   |
| Shanghai Xin Zhong Da Trading Co. Limited                  |           | —                | *              | — | * | 286,997 |   | 3 |   |
|                                                       |           | 16,355,556            |           | 65 |   | 7,025,394 |   | 67 |   |
| Others                                                     |           | 8,957,142             |           | 35 |   | 3,477,954 |   | 33 |   |
| ****Total****                                              |           | 25,312,698            |           | 100 |   | 10,503,348 |   | 100 |   |

** **

****

*** Not major customers forthe relevant years**

 

23

****

**

 

Salesrevenues generated from the top five major customers as a percentage of totalsales decreased to 65% for the three months ended September 30, 2007 ascompared to 67% for the three months ended September 30, 2006. With theexception of Hangzhou Relian Company Limited, the top five major customers weredifferent period-on-period. The change in customer mix reflects our shift inproduct focus during the course of the period.

 

****Costof Sales****

 
| **** ****              | **** **** | ****2007**** | **** **** | ****2006**** | **** **** | ****Variance**** | ** ** |
|-----------------------------|----------------|--------------|----------------|--------------|----------------|------------------|------------|
| ** **                  | ** **     | **$**        | ** **     | **$**        | ** **     | **$**            | ** ** | **%** | ** ** |
| ****Cost of sales****       |           |         |           |         |           |             |       |   |   |
| - Raw materials             |           | 18,487,907   |           | 5,717,139    |           | 12,770,768       |       | 223 |   |
| - Direct labor              |           | 176,906      |           | 151,925      |           | 24,981           |       | 16 |   |
| - Factory overhead          |           | 1,580,322    |           | 931,034      |           | 649,288          |       | 70 |   |
|                        |           | 20,245,135   |           | 6,800,098    |           | 13,445,037       |       | 198 |   |
|                        |           |         |           |         |           |             |       |   |   |
| ****Cost per units sold**** |           |         |           |         |           |             |       |   |   |
| Total units sold            |           | 28,683       |           | 9,859        |           | 18,824           |       | 191 |   |
| Average cost per unit sold  |           | 706          |           | 690          |           | 16               |       | 2 |   |

 

Costof sales increased by $13,445,037 or 198% period-on-period to $20,245,135 for thethree months ended September 30, 2007 from $6,800,098 for the three monthsended September 30, 2006. Cost of sales represented 80% of sales revenues forthe three months ended September 30, 2007 compared to 64.7% for the threemonths ended September 30, 2006. Average cost per ton sold increased by $16, or2%, period-on-period to $706 per ton for the three months ended September 30,2007 from $690 per ton for the three months ended September 30, 2006.Meanwhile, the average selling price per ton decreased by $183 per ton, or17.2%, period-on-period to $883 per ton for the three months ended September30, 2007 from $1,065 per ton for the three months ended September 30, 2006.

 

Theraw materials cost component relative to sales revenues increased to 73% forthe three months ended September 30, 2007 compared to 54% for the three monthsended September 30, 2006. This was attributable to increases in the averagepurchase price of raw materials per unit produced by $65, or 11%,period-on-period to $645 for the three months ended September 30, 2007 comparedto $580 for the three months ended September 30, 2006. Management believes thatincreases in the purchase price of raw materials were due to the excess ofdemand over supply of raw materials due to significant increases ininfrastructure projects in China.

 

Managementbelieves that the increase in cost of sales is represented by the combinedeffect of:

 

•                  significant increases in sales of low-carboncold-rolled steel to 14,321 metric tons (compared to 6,182 metric tons for thethree months ended September 30, 2006) was generated at an average sellingprice of $634 per ton (compared to $593 for the three months ended September30, 2006) for the three months ended September 30, 2007;

 

•                  sales of 8,936 metric tons of high-carboncold-rolled steel (compared to 1,208 metric tons for the three months endedSeptember 30, 2006) generated at an average selling price of $1,639 per ton(compared to $4,007 per ton for the three months ended September 30, 2006) forthe three months ended September 30, 2007; and

 

•                  sales of 2,387 metric tons of low-carbonhard-rolled steel at (compared to none for the three months ended September 30,2006) generated at an average selling price of $689 per ton for the threemonths ended September 30, 2007.

 

Thecost of raw materials consumed increased by $12,770,768, or 223%,period-on-period to $18,487,907 for the three months ended September 30, 2007from $5,717,139 for the three months ended September 30, 2006. This increasewas mainly attributable to increases in sales volume by 18,824 metric tons, or191%, period-on-period to 28,683 metric tons for the three months endedSeptember 30, 2007 from 9,859 metric tons for the three months ended September30, 2006 resulting in higher input of raw materials utilized in production.Average unit cost of raw materials per unit produced increased by $65 per ton,or 11%, period-on-period to $645 per ton for the three months ended September30, 2007 from $580 per ton for the three months ended September 30, 2006.

 

Manufacturingoverhead costs increased by $649,288, or 70%, period-on-period to $1,580,322for the three months ended September 30, 2007 from $931,034 for the threemonths ended September 30, 2006. The increase was mainly attributable to thecombined effect of an increase in depreciation by $227,505, or 91%,period-on-period to $477,980 for the three months ended September 30, 2007 from$250,475 for the three months ended September 30, 2006, an increase inutilities by $220,851, or 175%, period-on-period to $346,994 for the threemonths ended September 30, 2007 from $126,143 for the three months endedSeptember 30, 2006, and an increase in consumables by $259,281, or 113%,period-on-period to $488,238 for the three months ended September 30, 2007 from$228,957 for the three months ended September 30, 2006.

 

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****Expenses****

 

*****SellingExpenses*****.Selling expenses increased by $61,008, or 154%, period-on-period, to $100,705for the three months ended September 30, 2007 compared to the correspondingperiod in 2006 of $39,697. The increase was mainly attributable to increases intransportation, which rose by 697% period-on-period, due to our increaseddelivery charges of precision steel resulting from a broader customer base,including exports, as well as an increase in the frequency of deliveries. Inresponse to these rising costs, Chengtong has adopted a policy of requiring allnew customers to provide for transportation and delivery of goods.

 

*****AdministrativeExpenses*********.******** ****Administrative expenses increased by $300,189,or 161%, period-on-period, to $486,377 for the three months ended September 30,2007 compared to the comparable period in 2006. This increase was chiefly dueto increases in the amortization of intangible assets, listing fees relating tothe Company’s admission to the NASDAQ Capital Market, and salaries and wages.Increases in salaries and wages were principally due to increases in theaverage number of Chengtong staff.

 

*****FinanceCosts*****.Net finance cost increased 117% period-on-period as a result of increases intotal interest expense by $238,802 for 2007 compared to $203,339 for 2006.

 

****LIQUIDITY AND CAPITAL RESOURCES****

 

Ourbusiness is capital intensive and requires substantial expenditures for, amongother things, the purchase and maintenance of equipment used in our operations.Our short-term and long-term liquidity needs arise primarily from capitalexpenditures, working capital requirements and principal and interest paymentsrelated to our outstanding indebtedness. We have met these liquidityrequirements with cash provided by operations, equity financing, and bank debt.

 

**Currentassets**. Currentassets increased significantly by $13,060,591, or 32%, period-on-period to$54,399,585 as of September 30, 2007 from $41,338,994 as of June 30, 2007principally as a result of increases in cash and equivalents by $544,930, or10%, period-on-period, accounts receivable by $20,658,139, or 248%, period-on-period offset by a decline ininventories of $7,895,919, or 50%, period-on-period. We also raised grossproceeds of $22,354,995 in February of 2007 through the private sale of ourcommon stock.

 

**Currentliabilities**.Current liabilities increased by $8,948,018, or 34%, period-on-period to$35,204,175 as of September 30, 2007 from $26,256,157 as of June 30, 2007. Theincrease was due to increases in advances from customers, tax payables,provision for taxation and amounts due to directors and was mitigated bydecreases in accounts payable.

 

Asof September 30, 2007, we had $16,490,833 in short term bank debt. We expect torefinance such debt during the current year, but we cannot assure you that wewill be able to do so on terms favorable to the Company or at all.

 

**CapitalExpenditures**.**  **Duringthe three months ended September 30, 2007, we invested $1,016,793 in property,production plants and equipment. We believe these capital investments increaseour capacity, expand our product line, and reduce risks related to occupancycosts, thereby creating new opportunities to grow sales and control expenses.

 

Duringthe current year, we expect to make additional investments in a new hydrogenannealing furnace and a new 1700mm cold roll mill at our facilities in JiaDing. We estimate that these investments could total up to $18 million. Weintend to fund these investments through a combination of funds fromoperations, working capital, bank debt and the sale of debt and/or equitysecurities. The actual combination of sources of funds will be dependant uponmarket conditions at the time of implementation.

 

****OFF-BALANCE SHEET ARRANGEMENTS****

 

Forthe three months ended September 30, 2007, we did not have any off-balancesheet arrangements.

 

****CONTRACTUAL OBLIGATIONS****

 
| **** ****              | **** **** | ****Payments Due By Period**** | **** **** |
|-----------------------------|----------------|-----------------------------------------------|----------------|
| ****(in thousands)**** | **** **** | ****Total****                                 | **** **** | ****Fiscal Year  2008**** | **** **** | ****Fiscal  Years  2009-2010**** | **** **** | ****Fiscal  Years  2011-2012**** | **** **** | ****Fiscal Year  2013 and  Beyond**** | **** **** |
| Contractual obligations:    |           |                                          |           |   |   |   |   |   |   |   |   |
| Debt Obligations            |           | $                                             | 24,296,761     |   | $ | 17,810,101 |   | $ | 6,486,600 |   | $ | — |   | $ | — |   |
| Construction Commitments    |           | 4,270,236                                     |           | 4,270,236 |   | — |   | — |   | — |   |
|                        |           | $                                             | 28,566,997     |   | $ | 22,080,337 |   | $ | 6,486,600 |   | $ | — |   | $ | — |   |

 

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****BankDebt****

 

Bankand other loans decreased by $384,957 or 1.7% period-on-period to $22,499,722as of September 30, 2007 from $22,884,679 as of June 30, 2007. The decrease wasattributable to the partial payoff of outstanding loans.

 

****Short-term bank loans****

 

Thecurrent portion of long-term debt decreased by $6,163,445, or 100%, from$6,163,445 at June 30, 2007 to none at September 30, 2007.

 

HaiSheng Chen, an officer and director of the Company, provided an unsecured loanto Chengtong in 2003 with a maximum drawdown of $656,168 (RMB 5,000,000) forbusiness development purposes. The loan is interest free and has no fixed termsof repayment. No further drawdown on this loan was made during the year, and asof September 30, 2007, $447,600 (RMB 3,357,000) remained outstanding.

 

****Long-term bank loans****

 

Long-termbank loans decreased by $7,033,270, or 54%, period-on-period to $6,008,889 asof September 30, 2007 compared to $13,042,159 as of June 30, 2007.

 

****LandUse Rights****

 

Tuoronghas agreed to purchase a land use right from the Shanghai Labor and EconomicDevelopment Council with respect to a 20-acre parcel for a lease term of 50years at a cost of $472,441. Additionally, Chengtong has agreed to purchase aland use right from the Shanghai Labor and Economic Development Council withrespect to a 27.4-acre parcel for a lease period of 50 years at a cost of$497,795. In connection with the aforementioned land use rights, Tuorongentered into a Compensation Agreement with the Shanghai Municipal Housing, Landand Resource Management Bureau to pay an aggregate amount of $831,680.

 

****Inflation****

 

Webelieve that inflation has not had a material effect on our results of operations.We generally manufacture our products to match orders from our customers. Dueto the specialized nature of our products, we are able to purchase rawmaterials based upon customer orders. This operating model allows us toeffectively pass along fluctuations in the price of raw materials to ourcustomers. For commonly used raw materials, we purchase larger quantities whenwe believe prices are likely to increase in the short term in order to minimizethe impact of any such price increase.

 

****CRITICAL ACCOUNTING POLICIES AND ESTIMATES****

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States requires our management to makeassumptions, estimates and judgments that affect the amounts reported in thefinancial statements, including the notes thereto, and related disclosures ofcommitments and contingencies, if any. We consider our critical accountingpolicies to be those that require the more significant judgments and estimatesin the preparation of financial statements, including the following:

 

•               **FunctionalCurrency and Translating Financial Statements** — The consolidated financial statements havebeen prepared in accordance with accounting principles generally accepted inthe United States of America. Our functional currency is Chinese Renminbi;however, the accompanying consolidated financial statements have been expressedin USD. The consolidated balance sheets have been translated into USD at theexchange rates prevailing at each balance sheet date. The consolidatedstatements of operations and cash flows have been translated using theweighted-average exchange rates prevailing during the periods of eachstatement.

 

•               **Advances toSuppliers and from Customers**- As is common practice in China, Chengtong will often make advancepayments to its suppliers for materials, or receive advance payments from itscustomers. In some cases, the same party may be both a supplier to, andcustomer of, Chengtong. In such cases, Chengtong may make an advance to a thirdparty as supplier and receive an advance from the same party as a customer.Chengtong’s practice is to offset such amounts against each other. We haveestablished an allowance for doubtful accounts as a reserve against advancesmade to suppliers to the extent that the related goods are not received withinninety (90) days of the advance. 

 

•               **Other Policies** - Other accounting policies used by theCompany are set forth in the notes accompanying our financial statements.

 

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****RECENT ACCOUNTING PRONOUNCEMENTS****

 

InJune 2006, the FASB issued FASB Interpretation No. 48, Accounting forUncertainty in Income Taxes—an Interpretation of FASB Statement No. 109 (“FIN48”). FIN 48 provides guidance for recognizing and measuring uncertain taxpositions, as defined in SFAS 109, Accounting for Income Taxes. FIN 48prescribes a threshold condition that a tax position must meet for any of thebenefit of the uncertain tax position to be recognized in the financialstatements. Guidance is also provided regarding de-recognition, classificationand disclosure of these uncertain tax positions. FIN 48 is effective for fiscalyears beginning after December 15, 2006. The adoption of FIN 48 did not have amaterial impact on our financial position, results of operations or cash flows.

 

InSeptember 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (“SFASNo. 157”). SFAS No. 157 addresses how companies should measure fair value whenthey are required to use a fair value measure for recognition or disclosurepurposes under generally accepted accounting principles. SFAS No. 157 definesfair value, establishes a framework for measuring fair value and expands therequired disclosures about fair value measurements. SFAS No. 157 is effectivefor fiscal years beginning after November 15, 2007, with earlier adoptionpermitted. Management is assessing the impact of the adoption of SFAS No. 157.

 

InSeptember 2006, the FASB issued Statement No. 158, “Employers’ Accounting forDefined Benefit Pension and Other Postretirement Plans” (“SFAS No. 158”), anamendment of FASB Statements No. 87, 88, 106 and 132(R). SFAS No. 158 requires(a) recognition of the funded status (measured as the difference between thefair value of the plan assets and the benefit obligation) of a benefit plan asan asset or liability in the employer’s statement of financial position, (b)measurement of the funded status as of the employer’s fiscal year-end withlimited exceptions, and (c) recognition of changes in the funded status in theyear in which the changes occur through comprehensive income. The requirementto recognize the funded status of a benefit plan and the disclosurerequirements are effective as of the end of the fiscal year ending afterDecember 15, 2006. The requirement to measure the plan assets and benefitobligations as of the date of the employer’s fiscal year-end statement offinancial position is effective for fiscal years ending after December 15,2008. SFAS No. 158 has no current applicability to the Company’s financialstatements.

 

InSeptember 2006, the Securities and Exchange Commission issued Staff AccountingBulletin No. 108 (“SAB No. 108”). SAB No. 108 addresses how the effects ofprior year uncorrected misstatements should be considered when quantifyingmisstatements in current year financial statements. SAB No. 108 requirescompanies to quantify misstatements using a balance sheet and income statementapproach and to evaluate whether either approach results in quantifying anerror that is material in light of relevant quantitative and qualitativefactors. When the effect of initial adoption is material, companies will recordthe effect as a cumulative effect adjustment to beginning of year retainedearnings and disclose the nature and amount of each individual error beingcorrected in the cumulative adjustment. Complying with the requirements of SABNo. 108 had no impact on the Company’s financial statements.

 

InFebruary 2007, the FASB issued Statement No. 159, “The Fair Value Option forFinancial Assets and Financial Liabilities” (“SFAS No. 159”), an amendment ofFASB Statement No. 115. SFAS No. 159 addresses how companies should measuremany financial instruments and certain other items at fair value. The objectiveis to mitigate volatility in reported earnings caused by measuring relatedassets and liabilities differently without having to apply complex hedgeaccounting provisions. SFAS No. 159 is effective for fiscal years beginningafter November 15, 2007, with earlier adoption permitted. Management isassessing the impact of the adoption of SFAS No. 159.

 

****ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK****

 

Wehave exposure to several types of market risk: changes in foreign currencyexchange rates, interest rates and commodity prices. We neither hold nor issuefinancial instruments for trading purposes nor do we make use of derivativeinstruments to hedge the risks discussed below.

 

Thefollowing sections provide quantitative information on our exposure to marketrisks. Our use of sensitivity analyses are inherently limited in estimatingactual losses in fair value that can occur from changes in market conditions.

 

****ForeignCurrency Exchange Rates****

 

TheGroup collects revenues from operations principally in the Chinese Renminbi.Except for limited exports to Thailand and the Philippines, all of our localsales revenues are collected in and substantially all of its expenses are paidin the Chinese Renminbi. We face foreign currency rate translation risk whenChengtong’s results are translated to U.S. Dollars, as well as foreign currencyrate transaction risk with respect to sales outside of China and with respectto financial instruments denominated in foreign currencies. Our results ofoperations denominated in foreign currency are translated at the average rateof exchange during the reporting period. Assets and liabilities denominated inforeign currencies at the balance sheet date are translated at the market rateof exchange ruling at that date. The registered equity capital denominated inthe functional currency is translated at the historical rate of exchange at thetime of capital contribution.

 

TheChinese Renminbi had remained stable against the U.S. Dollar at approximately8.28 Yuan to 1.00 U.S. Dollar for several years and it was not until July 21,2005 that the Chinese currency regime was altered, with a 2.1% revaluationversus the United States Dollar. This move initially valued the Renminbi at8.11 per United States Dollar. In addition, the Renminbi is no longer linked tothe U.S. currency but rather to a basket of currencies with a 0.3% margin offluctuation. However, there remains international pressure on the Chinesegovernment to adopt an even more flexible currency policy and as ofSeptember 30, 2007 the exchange rate was 7.5 Yuan to 1.00 U.S. Dollar. Theexchange rate of Renminbi is subject to changes in China’s government policieswhich are, to a large extent, dependent on the economic and politicaldevelopment both internationally and locally and the demand and supply ofRenminbi in the domestic market. There can be no assurance that such exchangerate will continue to remain stable in the future amongst the volatility ofcurrencies, globalization and the unstable economies in recent years. Since (i)our income and profit are mainly denominated in Renminbi, and (ii) the paymentof dividends will be in U.S. dollars, if any, any exchange fluctuation of theRenminbi against other foreign currencies would adversely affect the value ofthe shares and dividends payable to shareholders, in foreign currency terms.

 

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AtSeptember 30, 2007, the Group’s outstanding financial instruments with foreigncurrency exchange rate risk exposure had an aggregate fair value of $5.2 million(including the Group’s non-U.S. dollar denominated debt). The potentialincrease in the fair values of these instruments resulting from a 10% adversechange in quoted foreign currency exchange rates would be approximately $0.52million at September 30, 2007.

 

****InterestRates****

 

TheGroup is subject to interest rate risk on its non-derivative financialinstruments. The Group does not hedge its interest rate risk. AtSeptember 30, 2007, the Group’s total bank debt outstanding was$22,499,722, all of which was interest-bearing. Substantially all of the bankdebt was floating-rate debt with interest rates which vary with changes in thestandard rate set by the People’s Bank of China. A change in the interest rateor yield of fixed rate debt will only impact the fair value of such debt, whilea change in the interest rate of floating rate, or variable rate, debt willimpact interest expense as well as the amount of cash required to service suchdebt. To the extent interest rates increase, we will be liable for higherinterest payments to its lenders. For the current financial year, annualinterest on loans is anticipated to be approximately $1.8 million. The impactof a 1% increase in interest rates will increase interest expense byapproximately $240,000. As our short-term borrowings mature, it will berequired to either repay or refinance these borrowings. An increase inshort-term interest rates at the time that we seek to refinance short-termborrowings may increase the cost of borrowings, which may adversely affect ourearnings and cash available for distribution to its shareholders.

 

AtSeptember 30, 2007, the aggregate fair value of the Group’s financialinstruments with exposure to interest rate risk was approximately $23 million.The potential change in fair value for these financial instruments from anadverse 10% change in quoted interest rates across all maturities, oftenreferred to as a parallel shift in the yield curve, would be approximately $0.1million at September 30, 2007.

 

****CommodityPrices****

 

Thesteel coils and other raw materials used by Chengtong, require large amounts ofraw materials - iron ore or other iron containing material, steel scrap, cokeand coal - as well as large amounts of energy to produce. Additionally,Chengtong also uses large amounts of energy in its operations. Over the lastseveral years, prices for raw materials and energy, in particular natural gasand oil, have increased significantly. In many cases these price increases havebeen at a greater percentage than price increases for the sale of steelproducts.

 

TheGroup has no open derivative commodity instruments as of June 30, 2007 anddoes not currently hedge its exposure to price fluctuations in the rawmaterials and energy required for the manufacture of its products.

 

**Item 4.**   **Controlsand Procedures.**

 

(a) **Disclosure Controls and Procedures**. An evaluation wasperformed, under the supervision and with the participation of Companymanagement, including the Chief Executive Officer (CEO) and the Chief FinancialOfficer (CFO), of the effectiveness of the design and operation of theCompany’s disclosure controls and procedures (as defined in Rules 13a-14(c) and15d-14(c) under the Exchange Act). Based on that evaluation, management,including the CEO and CFO, has concluded that, as of September 30, 2007, theCompany’s disclosure controls and procedures were adequate to ensure thatinformation required to be disclosed in reports that the Company files orsubmits under the Exchange Act has been recorded, processed, summarized andreported in accordance with the rules and forms of the SEC.

 

However,management also concluded that, although no significant deficiencies ormaterial weaknesses were found, additional controls and procedures wererequired to improve the recordkeeping systems at Chengtong to ensure timely andeffective reporting of information. In addition, management also concluded thatadditional financial personnel were required, particularly at the executivelevel, with experience with U.S. public companies and an appropriate level ofknowledge, experience and training in the application of generally acceptedaccounting principles in the United States. 

 

To addressthese concerns, we have recently engaged an outside management consultant whowill review the Company’s overall financial and accounting systems, with arecommendation to document and implement an accounting manual that willstrengthen and improve the systems of controls, reconciliations, procedures,books and records. In addition, we have initiated a search for a seniorfinancial executive with experience with U.S. GAAP and U.S. public companyreporting and compliance obligations. Further resources will be added to the accounting department that iscurrently understaffed.

 

We do notconsider that the deficiencies and weaknesses that we have identifiedjeopardize the quality of our financial statements for the period under reviewor for prior periods. 

 

(b) **Changes in Internal Control over Financial Reporting**. Therewere no changes in our internal controls over financial reporting (as such termis defined in Rules 13a-15(f) and 15(d)-15(f) under the Exchange Act) duringthe period under review that materially affected, or are reasonably likely tomaterial affect, our internal control over financial reporting.

 

This QuarterlyReport does not include a report of management’s assessment regarding internalcontrol over financial reporting or an attestation report by our registeredpublic accounting firm due to a transition period established by the rules ofthe SEC. 

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**Part II - Other Information**

 

**Item 1.**   **LegalProceedings.**

 

As of the date of thisQuarterly Report, there is no pending litigation against the Company nor wasthere any litigation initiated by the Company.

 

**Item 1A. Risk Factors.**

 

****We operate in a highly competitive environment in which thereare numerous factors which can influence our business, financial position orresults of operations and which can also cause the market value of our commonstock to decline. Many of these factors are beyond our control and therefore,are difficult to predict. The following section sets forth what we believe tobe the principal risks that could affect us, our business or our industry, andwhich could result in a material adverse impact on our financial results orcause the market price of our common stock to fluctuate or decline.****

 

****RisksRelating to the Company’s Business****

 

****Steel consumption is cyclical and worldwide overcapacity inthe steel industry and the availability of alternative products has resulted inintense competition, which may have an adverse effect on our profitability andcash flow.****

 

Steelconsumption is highly cyclical and generally follows general economic andindustrial conditions both worldwide and in various smaller geographic areas.The steel industry has historically been characterized by excess world supply.This has led to substantial price decreases during periods of economicweakness, which have not been offset by commensurate price increases duringperiods of economic strength. Substitute materials are increasingly availablefor many steel products, which may further reduce demand for steel. Additionalovercapacity or the use of alternative products could have a material adverseeffect upon our results of operations.

 

****Rapidly growing demand and supply in China and otherdeveloping economies may result in additional excess worldwide capacity andfalling steel prices, which could adversely impact our results.****

 

Overthe last several years steel consumption in China and other developingeconomies such as India has increased at a rapid pace. Steel companies haveresponded by developing plans to rapidly increase steel production capabilityin these countries and entered into long-term contracts with iron ore suppliersin Australia and Brazil. Steel production, especially in China, has beenexpanding rapidly and could be in excess of Chinese demand depending oncontinuing growth rates. Because China is now the largest worldwide steelproducer, any significant excess in Chinese capacity could have a major impacton domestic and international steel trade and prices.

 

****Environmental compliance and remediation could result insubstantially increased capital requirements and operating costs.****

 

Ouroperating subsidiary, Chengtong, is subject to numerous Chinese provincial andlocal laws and regulations relating to the protection of the environment. Theselaws continue to evolve and are becoming increasingly stringent. The ultimateimpact of complying with such laws and regulations is not always clearly knownor determinable because regulations under some of these laws have not yet beenpromulgated or are undergoing revision. Our consolidated business and operatingresults could be materially and adversely affected if Chengtong were requiredto increase expenditures to comply with any new environmental regulationsaffecting its operations.

 

****We may require additional capital in the future and we cannotassure that capital will be available on reasonable terms, if at all, or onterms that would not cause substantial dilution to stockholdings.****

 

Thedevelopment of high quality specialty precision steel requires substantialfunds. Sourcing external capital funds for product development and requisitecapital expenditures are key factors that have and may in the future constrainour growth, production capability and profitability. To achieve the next phaseof our corporate growth, increased production capacity, successful productdevelopment and additional external capital will be necessary. There can be noassurance that such capital will be available in sufficient amounts or on termsacceptable to us, if at all. Any sale of a substantial number of additionalshares of common stock or securities convertible into common stock will causedilution to the holders of our common stock and could also cause the marketprice of our common stock to decline.

 

****We face significant competition from competitors who havegreater resources than we do, and we may not have the resources necessary tosuccessfully compete with them.****

 

Weare one of a few manufacturers of specialty precision steel products in China.Differences in the type and nature of the specialty precision steel products inChina’s steel industry are relatively small, and, coupled with intensecompetition from international and local

 

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suppliers, to a limited extent, consumers’demand can be price sensitive. Competitors may increase their market sharethrough pricing strategies that adversely impact our business. Our business isin an industry that is becoming increasingly competitive and capital intensive,and competition comes from manufacturers located in China as well as frominternational competition. Our competitors may have financial resources, staffand facilities substantially greater than ours and we may be at a competitivedisadvantage compared with larger companies.

 

****We produce a limited number of products and may not be ableto respond quickly to significant changes in the market or new market entrants.****

 

Cold-rolledspecialty precision steel is a relatively new industry in China; Chinesemanufacturers of durable goods previously relied solely on imports from Japan,Korea, the European Union and the United States. We believe the average qualityand standards of products of China’s high precision steel industry lags behindthe international norm. During the last three years, we have developed anationally recognizable brand, however, we are not yet an internationally recognizablebrand for our specialty steel products. Although we offer more than 40 highprecision steel products, there are many other specialty precision steelproducts of similar nature in the market, even though none currently competedirectly with our products. If there are significant changes in market demandsand/or competitive forces, we may not be able to change our product mix oradapt our production equipment quickly enough to meet customers’ needs. Undersuch circumstances, our narrow band of precision steel products and/or newmarket entrants may negatively impact our financial performance.

 

****Increased imports of steel products into China couldnegatively affect domestic steel prices and demand levels and reduceprofitability of domestic*******producers*******,including Chengtong.****

 

ThroughJune 2007, China’s total production of cold-rolled steel sheets increasedapproximately 54% over the comparable period in 2006. However, domesticproduction continues to be insufficient to meet demand. As a result, Chinacontinues to import a significant portion of its steel products. Foreigncompetitors may have lower labor costs, and are often owned, controlled orsubsidized by their governments, which allows their production and pricingdecisions to be influenced by political and economic policy considerations aswell as prevailing market conditions. Import levels may also be impacted bydecisions of government agencies, under trade laws. Increases in future levelsof imported steel could negatively impact future market prices and demandlevels for our precision steel products.

 

****We are dependent on our Chinese manufacturing operations togenerate the majority of our income and profits, and the deterioration of anycurrent favorable local conditions may make it difficult or prohibitive tocontinue to operate or expand in China.****

 

Ourcurrent manufacturing operations are located in China, our administrativeoffices are in Hong Kong and we have additional establishments in the BritishVirgin Islands. The geographical distances between these facilities create anumber of logistical and communications challenges, including time differencesand differences in the cultures in each location, which makes communication andeffective cooperation more difficult.  In addition, because of the locationof the manufacturing facilities in China, our operations in China could beaffected by, among other things:

 

•                  economic and political instability in China,including problems related to labor unrest,

 

•                  lack of developed infrastructure,

 

•                  variances in payment cycles,

 

•                  currency fluctuations,

 

•                  overlapping taxes and multiple taxationissues,

 

•                  employment and severance taxes,

 

•                  compliance with local laws and regulatoryrequirements,

 

•                  greater difficulty in collecting accountsreceivable, and

 

•                  the burdens of cost and compliance with avariety of foreign laws.

 

Moreover,inadequate development or maintenance of infrastructure in China, including adequatepower and water supplies, transportation, raw materials availability or thedeterioration in the general political, economic or social environment couldmake it difficult, more expensive and possibly prohibitive to continue tooperate or expand our facilities in China.

 

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****Our operations are international and we are subject tosignificant worldwide political, economic, legal and other uncertainties thatmay make it difficult or costly to collect amounts owed to us or to conductoperations should materials needed from certain places be unavailable for anindefinite or extended period of time.****

 

Wehave subsidiaries in the British Virgin Islands and China. We manufacture allof our products in China and substantially all of the net book value of ourtotal fixed assets is located there. However, we sell our products to customersoutside of China as well as domestically. As a result, we have receivables fromand goods in transit to locations outside of China. Protectionist tradelegislation in the United States or other countries, such as a change in exportor import legislation, tariff or duty structures, or other trade policies,could adversely affect our ability to sell products in these markets, or evento purchase raw materials or equipment from foreign suppliers. Moreover, we aresubject to a variety of United States laws and regulations, changes to whichmay affect our ability to transact business with certain customers or incertain product categories.

 

InChina, Chengtong is subject to numerous national, provincial and localgovernmental regulations, all of which can limit our ability to react to marketpressures in a timely or effective way, thus causing us to lose business ormiss opportunities to expand our business. These include, among others,regulations governing:

 

•                  environmental and waste management,

 

•                  our relationship with our employees,including: wage and hour requirements, working and safety conditions,citizenship requirements, work permits and travel restrictions,

 

•                  property ownership and use in connection withour leased facilities in China, and

 

•                  import restrictions, currency restrictionsand restrictions on the volume of domestic sales.

 

****The end-use markets for certain of our products are highlycompetitive and customers are willing to accept substitutes for our productswhich could reduce our results of operations.****

 

Buyersof certain cold-rolled steel products are in highly competitive markets.Cold-rolled precision steel competes with other materials, such as aluminum,plastics, composite materials and glass, among others, for industrial andcommercial applications. Customers have demonstrated a willingness tosubstitute other materials for cold-rolled steel. The willingness of ourcustomers to accept substitutes for cold-rolled steel products could have amaterial adverse effect on our financial results.

 

****We may not be able to pass on to customers the increases inthe costs of our raw materials, particularly crude steel********.****

 

Werequire substantial amounts of raw materials in our business, consistingprincipally of steel slabs and strip steel. Any substantial increases in thecost of crude steel could adversely affect our financial condition and resultsof operations. The availability and price of crude steel depends on a number offactors outside our control, including general economic conditions, domesticand international supply and tariffs. Increased domestic and worldwide demandfor crude steel has had and will continue to have the effect of increasing theprices that we pay for these raw materials, thereby increasing our cost of sales.Generally, there is a potential time lag between changes in prices under ourpurchase contracts and the point when we can implement a corresponding changeunder our sales contracts with our customers. As a result, we can be exposed tofluctuations in the price of raw materials, since, during the time lag period,we may have to temporarily bear the additional cost of the change under ourpurchase contracts, which could have a material adverse effect on ourprofitability. If raw material prices were to increase significantly without acommensurate increase in the market value of our products, our financialcondition and results of operations would be adversely affected.

 

****Although we are dependent on a steady flow of raw materialsfor our operations, we do not have in place long-term supply agreements for allof our material requirements.****

 

Werely on several suppliers to provide us with the raw materials used in ouroperations, although a substantial portion of our raw material requirements ismet by BaoSteel Trading Co., Ltd. We do not currently have long-term supplycontracts with any particular supplier, including BaoSteel Trading Co., Ltd.,to assure a continued supply of the raw materials we need. While we maintaingood relationships with these suppliers, the supply of raw materials maynevertheless be interrupted on account of events outside our control, whichwill negatively impact our operations.

 

****We have substantial indebtedness with floating interest ratesand the cost of our borrowings may increase.****

 

Weare subject to interest rate risk on our non-derivative financial instruments.We do not hedge our interest rate risk. At September 30, 2007, our total bankdebt outstanding was $22,499,722, all of which was interest-bearing.Substantially all of the bank debt was floating-rate debt with interest rateswhich vary with changes in the standard rate set by the People’s Bank of China.A change in

 

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the interest rate or yield of fixed rate debtwill only impact the fair value of such debt, while a change in the interestrate of floating rate, or variable rate, debt will impact interest expense aswell as the amount of cash required to service such debt. To the extentinterest rates increase, we will be liable for higher interest payments to itslenders. For the current financial year, annual interest on loans isanticipated to be approximately $1.8 million. The impact of a 1% increase ininterest rates will increase interest expense by approximately $240,000. As ourshort-term borrowings mature, we will be required to either repay or refinancethese borrowings. An increase in short-term interest rates at the time that weseek to refinance short-term borrowings may increase the cost of borrowings,which may adversely affect our earnings and cash available for distribution toour stockholders.

 

AtSeptember 30, 2007, the aggregate fair value of our financial instruments withexposure to interest rate risk was approximately $23 million. The potentialchange in fair value for these financial instruments from an adverse 10% changein quoted interest rates across all maturities, often referred to as a parallelshift in the yield curve, would be approximately $0.1 million at September 30,2007.

 

****The loss of any key executive or our failure to attract andretain key personnel could adversely affect our future performance, strategicplans and other objectives.****

 

Theloss or failure to attract and retain key personnel could significantly impedeour future performance, including product development, strategic plans,marketing and other objectives. Our success depends to a substantial extent notonly on the ability and experience of our senior management, but particularlyupon our Chairman, Wo Hing Li; the General Manager of Chengtong, Hai ShengChen; and Chief Financial Officer, Leada Tak Tai Li. We do not currently havein place key man life insurance on Wo Hing Li, Hai Sheng Chen or Leada Tak TaiLi. To the extent that the services of these officers and directors would beunavailable to us, we would be required to recruit other persons to perform theduties performed by Wo Hing Li, Hai Sheng Chen and Leada Tak Tai Li. We may beunable to employ other qualified persons with the appropriate background andexpertise to replace these officers and directors on terms suitable to us.

 

****We may not be able to retain, recruit and train adequatemanagement and production personnel. We rely heavily on those personnel to helpdevelop and execute our business plans and strategies, and if we lose suchpersonnel, it would reduce our ability to operate effectively.****

 

Ourcontinued operations are dependent upon our ability to identify and recruitadequate management and production personnel in China. We require trainedgraduates of varying levels and experience and a flexible work force ofsemi-skilled operators. Many of our current employees come from the more remoteregions of China as they are attracted by the wage differential and prospectsafforded by Shanghai and our operations. With the economic growth currentlybeing experienced in China, competition for qualified personnel is substantial,and there can be no guarantee that a favorable employment climate will continueand that wage rates we must offer to attract qualified personnel will enable usto remain competitive internationally. The inability to attract such personnelor the increased cost of doing so could reduce our competitive advantagerelative to other precision steel producers, reducing or eliminating our growthin revenues and profits.

 

****We may not be able to protect adequately our intellectualproperty from infringement or unauthorized use by third parties.****

 

Exceptfor a patent on the Environment-Conscious Mill Bearing with Inner CircularLubrication, we have no patents or licenses that protect our intellectualproperty. Unauthorized parties may attempt to copy aspects of our processes andknow-how or to obtain and use information that we regard as proprietary.Policing unauthorized use of our processes and know-how is difficult. Our experienced keyengineers and management staff are extensively involved in all facets ofresearch, design, craftwork, styling and development of the specialty precisionproducts. Potential risks on the divulgence of skills and the development ofnew products increase should these employees resign, as we rely heavily onthem. Chengtong has elected to protect internally developed know-how andproduction processes (such as system pressure, cleanliness of the lubrication,temperature control, appropriate allocation of oil supply and retrieving, whichare vital in providing a radical solution to the difficulties associated withlubricating rolling mills’ backing bearing) by requiring all key personnel(production engineers and management staff) to sign non-disclosure andconfidentiality contracts. However, this means of protecting our proprietaryrights may not be adequate. In addition, the laws of some foreign countries donot protect our proprietary rights as extensively as do U.S. laws. Our failureto protect adequately our proprietary rights may allow third parties toduplicate our products, production processes or develop functionally equivalentor superior technology. In addition, our competitors may independently developsimilar technologies or design around our proprietary intellectual property.

 

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****We are subject to risks associated with changing technologyand manufacturing techniques, which could place us at a competitivedisadvantage.****

 

Thesuccessful implementation of our business strategy requires us to continuouslyevolve our existing products and services and introduce new products andservices to meet customers’ needs. Our designs and products are characterizedby stringent performance and specification requirements that mandate a highdegree of manufacturing and engineering expertise. We believe that ourcustomers rigorously evaluate our services and products on the basis of anumber of factors, including, but not limited to:

 

•                  quality,

 

•                  price competitiveness,

 

•                  technical expertise and developmentcapability,

 

•                  innovation,

 

•                  reliability and timeliness of delivery,

 

•                  product design capability,

 

•                  operational flexibility,

 

•                  customer service, and

 

•                  overall management.

 

Oursuccess depends on our ability to continue to meet our customers’ changingrequirements and specifications with respect to these and other criteria. Therecan be no assurance that we will be able to address technological advances orintroduce new designs or products that may be necessary to remain competitivewithin the precision steel industry.

 

****We depend upon our largest customers for a significantportion of our sales revenue, and we cannot be certain that sales to thesecustomers will continue. If sales to these customers do not continue, then oursales may decline and our business may be negatively impacted.****

 

Wecurrently supply high precision steel products to 12 major customers in theChinese domestic market. For the three months ended September 30, 2007 and2006, sales revenues generated from the top five major customers amounted to 65%and 67% of total sales revenues, respectively; sales to the largest singlecustomer for the same periods amounted to 34% and 37% of total sales revenues,respectively. We do not enter into long-term contracts with our customers, andtherefore cannot be certain that sales to these customers will continue. Theloss of any of our largest customers would likely have a material negativeimpact on our sales revenues and business.

 

****Defects in our products could impair our ability to sellproducts or could result in litigation and other significant costs.****

 

Detectionof any significant defects in our precision steel products may result in, amongother things, delay in time-to-market, loss of market acceptance and sales ofits products, diversion of development resources, injury to our reputation,litigation or fines, or increased costs to correct such defects. Defects couldharm our reputation, which could result in significant costs and could impairour ability to sell our products. The costs we may incur in correcting anyproduct defects may be substantial and could decrease our profit margins.

 

****Failure to optimize our manufacturing potential and coststructure could materially increase our overhead, causing a decline in ourmargins and profitability.****

 

Westrive to utilize the manufacturing capacity of our facilities fully but maynot do so on a consistent basis. Our factory utilization is dependent on oursuccess in, among other things:

 

•                  accurately forecasting demand,

 

•                  predicting volatility,

 

•                  timing volume sales to our customers,

 

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•                  balancing our productive resources withproduct mix, and

 

•                  planning manufacturing services for new orother products that we intend to produce.

 

Demandfor contract manufacturing of these products may not be as high as we expect,and we may fail to realize the expected benefit from our investment in ourmanufacturing facilities. Our profitability and operating results are alsodependent upon a variety of other factors, including, but not limited to:

 

•                  utilization rates of manufacturing lines,

 

•                  downtime due to product changeover,

 

•                  impurities in raw materials causingshutdowns, and

 

•                  maintenance of contaminant-free operations.

 

Failureto optimize our manufacturing potential and cost structure could materially andadversely affect our business and operating results.

 

Moreover,our cost structure is subject to fluctuations from inflationary pressures inChina and other geographic regions where we conduct business. China iscurrently experiencing dramatic growth in its economy. This growth may lead tocontinued pressure on wages and salaries that may exceed our budget andadversely affect our operating results.

 

****Our production facilities are subject to risks of powershortages which may adversely affect our ability to meet our customers’ needsand reduce our revenues.****

 

Manycities and provinces in China have suffered serious power shortages since thesecond quarter of 2004. Many of the regional grids do not have sufficient powergenerating capacity to fully satisfy the increased demand for electricitydriven by continual economic growth and persistent hot weather. Localgovernments have occasionally required local factories to temporarily shut downtheir operations or reduce their daily operational hours in order to reducelocal power consumption levels. To date, our operations have not been affectedby those administrative measures. However, there is a risk that our operationsmay be affected by those administrative measures in the future, thereby causingmaterial production disruption and delay in delivery schedule. In such event,our business, results of operation and financial conditions could be materiallyadversely affected. We do not have any back-up power generation system.Although we have not experienced any power outages in the past, we may beadversely affected by power outages in the future.

 

****Unexpected equipment failures may lead to productioncurtailments or shutdowns.****

 

Interruptionsin our production capabilities will adversely affect our production costs,products available for sales and earnings for the affected period. In additionto equipment failures, our facilities are also subject to the risk of catastrophicloss due to unanticipated events such as fires, explosions or violent weatherconditions. Our manufacturing processes are dependent upon critical pieces ofequipment, such as our various cold-rolling mills, as well as electricalequipment, such as transformers, and this equipment may, on occasion, be out ofservice as a result of unanticipated failures. We have experienced and may inthe future experience material plant shutdowns or periods of reduced productionas a result of such equipment failures.

 

****Our insurance may not be adequate if our productionfacilities were destroyed or significantly damaged as a result of fire or someother natural disaster.****

 

Allof our products are currently manufactured at our existing facilities locatedin the Jiading District in Shanghai, China. Fire fighting and disaster reliefor assistance in China may not be as developed as in Western countries. Whilewe maintain property damage insurance aggregating approximately $18.5 millioncovering our raw materials, finished goods, equipment and buildings and another$10.5 million insurance against equipment breakdown, we do not maintainbusiness interruption insurance. Material damage to, or the loss of, ourproduction facilities due to fire, severe weather, flood or other act of God orcause, even if insured, could have a material adverse effect on our financialcondition, results of operations, business and prospects.

 

****Our limited operating history may not serve as an adequatebasis to judge our future prospects and results of operations.****

 

Ourlimited operating history may not provide a meaningful basis on which toevaluate our business. Although our revenues have grown rapidly sinceinception, we might not be able to maintain our profitability or we may incurnet losses in the future. We expect that our operating expenses will increaseas we expand. Any significant failure to realize anticipated revenue growthcould result in significant

 

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operating losses. We will continue to encounterrisks and difficulties frequently experienced by companies at a similar stageof development, including our potential failure to:

 

•                  Implement our business model and strategy andadapt and modify them as needed;

 

•                  Manage our expanding operations and productofferings;

 

•                  Maintain adequate control of our expenses;

 

•                  Anticipate and adapt to changing conditionsin the precision steel markets in which we operate as well as the impact of anychanges in government regulation; and

 

•                  Anticipate mergers and acquisitions involvingour competitors, technological developments and other significant competitiveand market dynamics.

 

Ourbusiness, business prospects and results of operations will be affected if weare not successful in addressing any or all of these risks and difficulties.

 

****Failure to comply with the U.S. Foreign Corrupt Practices Actcould subject us to penalties and other adverse consequences.****

 

Weare subject to the U.S. Foreign Corrupt Practices Act, which generallyprohibits United States companies from engaging in bribery or other prohibitedpayments to foreign officials for the purpose of obtaining or retainingbusiness. In addition, we are required to maintain records that accurately andfairly represent our transactions and have an adequate system of internalaccounting controls. Foreign companies, including some that may compete withus, are not subject to these prohibitions, and therefore may have a competitiveadvantage over us. Corruption, extortion, bribery, pay-offs, theft and otherfraudulent practices occur from time-to-time in the PRC, and our executiveofficers and employees have not been subject to the U.S. Foreign CorruptPractices Act prior to the completion of the Stock Exchange Agreement inDecember 2006. We can make no assurance that our employees or other agents willnot engage in such conduct for which we might be held responsible. If ouremployees or other agents are found to have engaged in such practices, we couldsuffer severe penalties and other consequences that may have a material adverseeffect on our business, financial condition and results of operations.

 

****You may experience difficulties in effecting service of legalprocess, enforcing foreign judgments or bringing original actions in Chinabased upon U.S. laws, including the federal securities laws or other foreignlaws against us or our management.****

 

Substantiallyall of our current operations are conducted in China. Moreover, all but one ofour directors and all of our officers are nationals and residents of China orHong Kong. All or substantially all of the assets of these persons are locatedoutside the United States. As a result, it may not be possible to effectservice of process within the United States or elsewhere outside of China orHong Kong upon these persons. In addition, uncertainty exists as to whether thecourts of China or Hong Kong would recognize or enforce judgments of U.S.courts obtained against us or our officers and/or directors predicated upon thecivil liability provisions of the securities law of the United States or anystate thereof, or be competent to hear original actions brought in China orHong Kong against us or such persons predicated upon the securities laws of theUnited States or any state thereof.

 

****RisksRelating to China****

 

****We face significant risks if the Chinese government changesits policies, laws, regulations, tax structure or its current interpretationsof its laws, rules and regulations relating to our operations in China.****

 

Chengtong’smanufacturing facility is located in Shanghai, China. As of September 30, 2007,substantially all of our assets are located in China and, except for a smallvolume of exports, all of our sales revenues are generated in China. Ourresults of operations, financial state of affairs and future growth are, to asignificant degree, subject to China’s economic, political and legal developmentand related uncertainties. Our operations and results could be materiallyaffected by a number of factors, including, but not limited to:

 

•                  changes in policies by the Chinese governmentresulting in changes in laws or regulations or the interpretation of laws orregulations, 

 

•                  confiscatory taxation,

 

•                  freezes on commercial bank lending,

 

•                  changes in employment restrictions,

 

•                  restrictions on imports and sources ofsupply,

 

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•                  import duties,

 

•                  corruption,

 

•                  currency revaluation, and

 

•                  the expropriation of private enterprise.

 

Overthe past several years, the Chinese government has pursued economic reform policiesincluding the encouragement of private economic activities and greater economicdecentralization. If the Chinese government does not continue to pursue itspresent policies that encourage foreign investment and operations in China, orif these policies are either not successful or are significantly altered, thenour business could be adversely affected. Chengtong could even be subject tothe risk of nationalization, which could result in the total loss of ourstockholders’ investment. Following the Chinese government’s policy ofprivatizing many state-owned enterprises, the Chinese government has attemptedto augment its revenues through increased tax collection. Continued efforts toincrease tax revenues could result in increased taxation expenses beingincurred by us. Economic development may be limited as well by the impositionof austerity measures intended to reduce inflation, the inadequate developmentof infrastructure and the potential unavailability of adequate power and watersupplies, transportation and communications.

 

****Chinese laws and regulations governing our current businessoperations are sometimes vague and uncertain. Any changes in such Chinese lawsand regulations may have a material and adverse effect on our business.****

 

China’slegal system is a civil law system based on written statutes, in which systemdecided legal cases have little value as precedents unlike the common lawsystem prevalent in the United States. There are substantial uncertaintiesregarding the interpretation and application of Chinese 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 theevent of the imposition of statutory liens, death, bankruptcy and criminalproceedings. The Chinese government has been developing a comprehensive systemof commercial laws, and considerable progress has been made in introducing lawsand regulations dealing with economic matters such as foreign investment, corporateorganization and governance, commerce, taxation and trade. However, becausethese laws and regulations are relatively new, and because of the limitedvolume of published cases and judicial interpretation and their lack of forceas precedents, interpretation and enforcement of these laws and regulationsinvolve significant uncertainties. New laws and regulations that affectexisting and proposed future businesses may also be applied retroactively. Weare considered a foreign person or foreign funded enterprise under Chineselaws, and as a result, we are required to comply with Chinese laws andregulations. We cannot predict what effect the interpretation of existing ornew Chinese laws or regulations may have on our businesses. If the relevantauthorities find us in violation of Chinese laws or regulations, they wouldhave broad discretion in dealing with such a violation, including, withoutlimitation:

 

•                  levying fines;

 

•                  revoking our business and other licenses;

 

•                  requiring that we restructure our ownershipor operations; and

 

•                  requiring that we discontinue any portion orall of our business.

 

****Our business, results of operations and overall profitabilityare linked to the economic, political and social conditions in China.****

 

Substantiallyall of our business, assets and operations are located in China. The economy ofChina differs from the economies of most developed countries in many respects,including government involvement, level of development, growth rate, control offoreign exchange, and allocation of resources. The economy of China has beentransitioning from a planned economy to a more market-oriented economy.Although the Chinese government has implemented measures recently emphasizingthe utilization of market forces for economic reform, the reduction of stateownership of productive assets and the establishment of sound corporategovernance in business enterprises, a substantial portion of productive assetsin China is still owned by the Chinese government. In addition, the Chinesegovernment continues to play a significant role in regulating industry byimposing industrial policies. It also exercises significant control overChina’s economic growth through the allocation of resources, controllingpayment of foreign currency-denominated obligations, setting monetary policyand providing preferential treatment to particular industries or companies.Therefore, the Chinese government’s involvement in the economy may affect ourbusiness operations, results of operations and our financial condition.

 

 

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****A slowdown or other adverse developments in the Chineseeconomy may materially and adversely affect our customers, demand for ourservices and our business.****

 

Allof our operations are conducted in China and substantially all of our revenuesare generated from sales to businesses operating in China. Although the Chineseeconomy 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 otheradverse changes in Chinese economy which may affect demand for precision steelproducts. A slowdown in overall economic growth, an economic downturn orrecession or other adverse economic developments in China may materially reducethe demand for our products and in turn reduce our results of operations andour productivity.

 

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****Inflation in China could negatively affect our profitabilityand growth.****

 

Whilethe Chinese economy has experienced rapid growth, such growth has been unevenamong various sectors of the economy and in different geographical areas of thecountry. Rapid economic growth can lead to growth in the money supply andrising inflation. If prices for our products rise at a rate that isinsufficient to compensate for the rise in the costs of raw materials, it mayhave an adverse effect on our profitability. In order to control inflation inthe past, the Chinese government has imposed controls on bank credits, limitson loans for fixed assets and restrictions on state bank lending. Such anausterity policy can lead to a slowing of economic growth. In October 2004, thePeople’s Bank of China, China’s central bank, raised interest rates for thefirst time in nearly a decade and indicated in a statement that the measure wasprompted by inflationary concerns in the Chinese economy. Repeated increases ininterest rates by the central bank will likely slow economic activity in Chinawhich could, in turn, materially increase our costs and also reduce demand forour products.

 

****Controversies affecting China’s trade with the United Statescould depress our stock price.****

 

WhileChina has been granted permanent most favored nation trade status in the UnitedStates through its entry into the World Trade Organization, controversies andtrade disagreements between the United States and China may arise that have amaterial adverse effect upon our stock price. Political or trade frictionbetween the United States and China, whether or not actually affecting itsbusiness, could also materially and adversely affect the prevailing marketprice of our common stock.

 

****We may have difficulty establishing adequate management,legal and financial controls in China, which could impair our planningprocesses and make it difficult to provide accurate reports of our operatingresults.****

 

Chinahistorically has not followed Western style management and financial reportingconcepts and practices, and its access to modern banking, computer and othercontrol systems has been limited.  We may have difficulty in hiring andretaining a sufficient number of qualified employees to work in China in theseareas. As a result of these factors, we may experience difficulty inestablishing management, legal and financial controls, collecting financialdata and preparing financial statements, books of account and corporate recordsand instituting business practices that meet Western standards, making itdifficult for management to forecast its needs and to present the results ofour operations accurately at all times.

 

****Imposition of trade barriers and taxes may reduce our abilityto do business internationally, and the resulting loss of revenue could harmour profitability.****

 

Wemay experience barriers to conducting business and trade in our targetedemerging markets in the form of delayed customs clearances, customs duties andtariffs. In addition, we may be subject to repatriation taxes levied upon theexchange of income from local currency into foreign currency, substantial taxesof profits, revenues, assets and payroll, as well as value-added tax. Themarkets in which we plan to operate may impose onerous and unpredictableduties, tariffs and taxes on our business and products, and there can be noassurance that this will not reduce the level of sales that we achieve in suchmarkets, which would reduce our revenues and profits.

 

****There can be no guarantee that China will comply with themembership requirements of the World Trade Organization, which could leave ussubject to retaliatory actions by other governments and reduce our ability tosell our products internationally.****

 

Chinahas agreed that foreign companies will be allowed to import most products intoany part of China.  In the sensitive area of intellectual property rights,China has agreed to implement the trade-related intellectual property agreementof the Uruguay Round. There can be no assurances that China will implement anyor all of the requirements of its membership in the World Trade Organization ina timely manner, if at all.  If China does not fulfill its obligations tothe World Trade Organization, we may be subject to retaliatory actions by thegovernments of the countries into which we sell our products, which couldrender our products less attractive, thus reducing our revenues and profits.

 

****Our labor costs are likely to increase as a result of changesin Chinese labor laws.****

 

Wehave recently experienced an increase in the cost of labor. Recent changes inChinese labor laws that are effective January 1, 2008 are likely to increasecosts further and impose restrictions on our relationship with our employees.There can be no assurance that the labor laws will not change further or thattheir interpretation and implementation will vary, which may have a materialadverse effect upon our business and results of operations.

 

****We currently receive preferential tax treatment under Chineselaw which will expire in 2008 and may negatively impact our profitability.****

 

Priorto the adoption of the PRC Enterprise Income Tax Law on March 16, 2007 (the“EIT Law”), Chinese income tax law provided that any foreign-investedenterprise engaged in manufacturing and scheduled to operate for not less than10 years was entitled to receive an exemption from the entire centralgovernment income tax for the two years beginning with its first profitable yearand receive a 50% reduced income tax in the third through fifth years. As awholly foreign owned enterprise, Chengtong has been entitled to suchpreferential tax treatment. The full tax exemption for the enterprise incometax expired on December 31, 2005 and the one-half reduction on the enterpriseprofit tax to 13.5% will expire on December 31, 2008. After such tax holidays,our profits will be subject to the full tax rate of 25%, effective as of January1, 2008 in accordance with the EIT Law passed in 2007. If we are unable toincrease gross income by an amount greater than that needed to offset the lossof this preferential tax treatment, such a condition could have a materialadverse effect on the results of its operations.

 

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Underthe EIT Law, a uniform tax rate of 25.0% has been adopted for all enterprises(including foreign-invested enterprises) and several tax incentives enjoyed byforeign-invested enterprises have been cancelled. However, for foreign-investedenterprises established before the promulgation of the EIT Law, a five-yeartransition period is provided during which reduced rates will apply butgradually be phased out. Since the PRC government has not announcedimplementation measures for the transitional policy with regards to suchpreferential tax rates, we cannot reasonably estimate the financial impact ofthe new tax law to us at this time. Further, any future increase in the enterpriseincome tax rate applicable to us or other adverse tax treatments would have amaterial adverse effect on our results of operations and financial condition.

 

****Fluctuations in exchange rates of the Renminbi, or RMB, couldadversely affect the value of and dividends, if any, payable on shares of ourcommon stock or otherwise impact our operations and profitability.****

 

Wecollect revenue from operations principally in the Chinese Renminbi. Except forrecent exports to Nigeria, Thailand, Indonesia and the Philippines, all of ourlocal sales revenues are collected in and substantially all of its expenses arepaid in the Chinese Renminbi. We face foreign currency rate translation riskwhen Chengtong’s results are translated to U.S. Dollars, as well as foreign currencyrate transaction risk with respect to sales outside of China and with respectto financial instruments denominated in foreign currencies. The results ofoperations denominated in foreign currency are translated at the average rateof exchange during the reporting period. Assets and liabilities denominated inforeign currencies at the balance sheet date are translated at the market rateof exchange ruling at that date. The registered equity capital denominated inthe functional currency is translated at the historical rate of exchange at thetime of capital contribution.

 

TheChinese Renminbi remained stable against the U.S. Dollar at approximately 8.28RMB to 1.00 U.S. Dollar for several years until July 21, 2005 when the Chinesecurrency regime was altered, with a 2.1% revaluation versus the U.S. Dollar.This move initially valued the Renminbi at 8.11 per U.S. Dollar. The Renminbiis no longer linked to the U.S. currency but rather to a basket of currencieswith a 0.3% margin of fluctuation. However, there remains internationalpressure on the Chinese government to adopt an even more flexible currencypolicy. As of September 28, 2007, the exchange rate was 7.49 RMB to 1.00 U.S.Dollar. The exchange rate of Renminbi is subject to changes in China’s governmentpolicies which are, to a large extent, dependent on the economic and politicaldevelopment both internationally and locally and the demand and supply ofRenminbi in the domestic market. There can be no assurance that such exchangerate will continue to remain stable in the future amongst the volatility ofcurrencies, globalization and the unstable economies in recent years.

 

Since(i) our income and profit are mainly denominated in Renminbi, and (ii) thepayment of dividends, if any, will be in U.S. Dollars, any exchange fluctuationof the Renminbi against other foreign currencies would adversely affect thevalue of the shares and dividends payable to shareholders, in foreign currencyterms. For example, to the extent that we need to convert U.S. Dollars wereceive from an offering of our securities into Renminbi for our operations, ifthe Renminbi appreciates against the U.S. Dollar, the Renminbi equivalent ofthe US Dollar we convert would be reduced. Conversely, if we decide to convertour Renminbi into U.S. Dollars for the purpose of making payments for dividendson our common stock or for other business purposes and the U.S. Dollarappreciates against the Renminbi, the U.S. Dollar equivalent of the Renminbi weconvert would be reduced. In addition, appreciation of the Renminbi could makeour products more expensive relative to those of our competitors or increaseour profitability in U.S. Dollar terms.

 

AtSeptember 30, 2007, our outstanding financial instruments with foreign currencyexchange rate risk exposure had an aggregate fair value of $5.2 million(including our non-U.S. Dollar denominated debt). The potential increase in thefair values of these instruments resulting from a 10% adverse change in quotedforeign currency exchange rates would be approximately $0.52 million atSeptember 30, 2007.

 

****The ability of our Chinese operating subsidiary to paycertain foreign currency obligations, including dividends, may be restricteddue to foreign exchange control regulations of China.****

 

Theability of Chengtong to pay dividends may be restricted due to the foreignexchange control policies and availability of cash balances. Sincesubstantially all of our operations are conducted in China and a majority ofour revenues are generated in China, a significant portion of our revenueearned and currency received are denominated in Renminbi.

 

TheChinese government imposes controls on the convertibility of Renminbi intoforeign currencies and, in certain cases, the remittance of currency out ofChina. Renminbi is currently not a freely convertible currency. Shortages inthe availability of foreign currency may restrict our ability to remitsufficient foreign currency to pay dividends, if any, on our common stock orotherwise satisfy foreign currency denominated obligations. Under existingChinese foreign exchange regulations, payments of current account items,including profit distributions, interest payments and expenditures from thetransaction, can be made in foreign currencies without prior approval from theState Administration of Foreign Exchange by complying with certain proceduralrequirements. However, approval from appropriate governmental

 

39

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**

 

authorities is required where Renminbi is tobe converted into foreign currency and remitted out of China to pay capitalexpenses such as the repayment of bank loans denominated in foreign currencies.

 

TheChinese government may also at its discretion restrict access in the future toforeign currencies for current account transactions. If the foreign exchangecontrol system prevents us from obtaining sufficient foreign currency tosatisfy our currency demands, we may not be able to pay certain of our expensesas they come due.

 

****RisksRelating to Our Common Stock****

 

****The market price for shares of our common stock could bevolatile and could decline.****

 

Ourcommon stock is listed on The NASDAQ Capital Market under the symbol “CPSL.”The market price for the shares of our common stock may fluctuate in responseto a number of factors, many of which are beyond our control. In some cases,these fluctuations may be unrelated to our operating performance. Manycompanies with Chinese operations have experienced dramatic volatility in themarket prices of their common stock. We believe that a number of factors, bothwithin and outside of our control, could cause the price of our common stock tofluctuate, perhaps substantially. Factors such as the following could have asignificant adverse impact on the market price of our common stock:

 

•                  our ability to obtain additional financingand, if available, the terms and conditions of the financing;

 

•                  our financial position and results ofoperations;

 

•                  period-to-period fluctuations in ouroperating results;

 

•                  changes in estimates of our performance byany securities analysts;

 

•                  substantial sales of our common stockpursuant to Rule 144 or otherwise;

 

•                  new regulatory requirements and changes inthe existing regulatory environment;

 

•                  the issuance of new equity securities in afuture offering;

 

•                  changes in interest rates; and

 

•                  general economic, monetary and other nationalconditions, particularly in the U.S. and China.

 

****The trading market in our common stock is limited andilliquid and may cause volatility in the market price.****

 

Asof September 2007, 37.4% or 13,964,883 shares, of our issued and outstandingcommon stock was not owned by affiliates, of which 10,338,729 were unrestrictedand free to trade. The market price for our common stock is subject tovolatility and holders of common stock may be unable to resell their shares ator near their original purchase price or at any price. In the absence of anactive trading market:

 

•                  investors may have difficulty buying andselling;

 

•                  market visibility for our common stock may belimited; and

 

•                  a lack of visibility for our common stock mayhave a depressive effect on the market for our common stock.

 

****Shares eligible for future sale may adversely affect themarket price of our common stock, as the future sale of a substantial amount ofoutstanding stock in the public marketplace could reduce the price of ourcommon stock.****

 

Fromtime to time, certain of our stockholders may be eligible to sell all or someof their shares of common stock by means of ordinary brokerage transactions inthe open market, pursuant to Rule 144 promulgated under the Securities Act,subject to certain limitations or otherwise. In general, pursuant to Rule 144,a stockholder (or stockholders whose shares are aggregated) who has satisfied aone-year holding period may, under certain circumstances, sell within anythree-month period a number of securities which does not exceed the greater of1% of the then outstanding shares of common stock or the average weekly tradingvolume of the class during the four calendar weeks prior to such sale. Rule 144also permits, under certain circumstances, the sale of securities, without anylimitations, by a non-affiliate of our company that has satisfied a two-yearholding period. Any substantial sale of common stock pursuant to Rule 144 orpursuant to a resale prospectus may have an adverse effect on the market priceof our common stock.

 

40

****

**

 

****One stockholder, who is our Chief Executive Officer,exercises significant control over matters requiring shareholder approval.****

 

WoHing Li, our Chief Executive Officer, had voting power as of September 30, 2007equal to approximately 59.2% of our voting securities. As a result, Wo Hing Li,through such stock ownership, exercises significant control over all mattersrequiring shareholder approval, including the election of directors andapproval of significant corporate transactions. This concentration of ownershipin Wo Hing Li may also have the effect of delaying or preventing a change incontrol or other transactions that may otherwise be viewed as beneficialby shareholders other than Wo Hing Li.

 

****We may be required to raise additional financing by issuingnew securities with terms or rights superior to those of our shares of commonstock, which could adversely affect the market price of our shares of commonstock.****

 

Wemay require additional financing to fund future operations, develop and exploitexisting and new products and to expand into new markets. We may not be able toobtain financing on favorable terms, if at all. If we raise additional funds byissuing equity securities, the percentage ownership of our current shareholderswill be reduced, and the holders of the new equity securities may have rightssuperior to those of the holders of shares of common stock, which couldadversely affect the market price and the voting power of shares of our commonstock. If we raise additional funds by issuing debt securities, the holders ofthese debt securities would similarly have some rights senior to those of theholders of shares of common stock, and the terms of these debt securities couldimpose restrictions on operations and create a significant interest expense forus.

 

****We may incur significant costs to ensure compliance with U.S.corporate governance and accounting requirements.****

 

Wemay incur significant costs associated with our public company reportingrequirements, costs associated with applicable corporate governancerequirements, including requirements under the Sarbanes-Oxley Act of 2002 andother rules implemented by the SEC and requirements in connection with thelisting of our common stock on The NASDAQ Capital Market. We expect all ofthese applicable rules and regulations to increase our legal and financialcompliance costs and to make some activities more time-consuming and costly. Wealso expect that these applicable rules and regulations may make it moredifficult and more expensive for us to obtain director and officer liabilityinsurance and we may be required to accept reduced policy limits and coverageor incur substantially higher costs to obtain the same or similar coverage. Asa result, it may be more difficult for us to attract and retain qualifiedindividuals to serve on our board of directors or as executive officers.

 

****Our officers and directors have limited experience with theregulatory requirements for U.S. public companies, which could impair ourability to satisfy public company filing requirements and could increase oursecurities compliance costs.****

 

Allof our officers and most of our directors do not have any prior experience asofficers and directors of a U.S. publicly traded company, or in complying withthe regulatory requirements applicable to a U.S. public company. As a result,we could have difficulty satisfying the regulatory requirements applicable toU.S. public companies, which could adversely affect the market for our commonstock. At present, we rely upon outside experts to advise us on mattersrelating to financial accounting and public company reporting. While we believethat it will be possible to satisfy our public company reporting requirementsthrough the use of third party experts, our general and administrative costswill remain higher until we have developed or acquired internal expertise inthese matters

 

****Standards for compliance with Section 404 of theSarbanes-Oxley Act of 2002 are uncertain, and if we fail to comply in a timelymanner, our business could be harmed and our stock price could decline.****

 

Rulesadopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002require annual assessment of our internal control over financial reporting, andattestation of our assessment by our independent registered public accountants.The standards that must be met for management to assess the internal controlover financial reporting as effective are complex, and require significantdocumentation, testing and possible remediation to meet the detailed standardsand impose significant additional expenses on us. We may encounter problems ordelays in completing activities necessary to make an assessment of our internalcontrol over financial reporting. In addition, the attestation process requiredof our independent registered public accountants is new, and we may encounterproblems or delays in completing the implementation of any requestedimprovements and receiving an attestation of our assessment by our independentregistered public accountants. If we cannot assess our internal control overfinancial reporting as effective, or our independent registered publicaccountants are unable to provide an unqualified attestation report on suchassessment, investor confidence and share value may be negatively impacted.

 

****We do not foresee paying cash dividends in the foreseeablefuture.****

 

Wehave not paid cash dividends on our stock, and we do not plan to pay cashdividends on our stock in the foreseeable future.

 

41

****

**

 

**Item 2.**   **UnregisteredSales of Equity Securities and Use of Proceeds**

 

None.

 

**Item 3.**   **DefaultsUpon Senior Securities**

 

None.

 

**Item 4.**   **Submissionof Matters to a Vote of Security Holders**

 

 None.

 

**Item 5.**   **OtherInformation**

 

(a)  None.

 

(b)   None.

 

**Item 6.**   **Exhibits**

 

(a)   Exhibits requiredto be filed are listed below. Certain of the following exhibits are herebyincorporated by reference pursuant to Rule 12(b)-32, as promulgated under theSecurities and Exchange Act of 1934, as amended, from the reports noted below:

 
| **Exhibit No.** | ** ** | **Exhibit:**                                                                                                                                                                      |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                              |
| 2.1             |       | Certificate of Ownership  and Merger                                                                                                                                              |
|            |       |                                                                                                                                                                              |
| 2.2             |       | Agreement and Plan of  Merger                                                                                                                                                     |
|            |       |                                                                                                                                                                              |
| 3.1             |       | Certificate of  Incorporation                                                                                                                                                     |
|            |       |                                                                                                                                                                              |
| 3.2             |       | Bylaws                                                                                                                                                                            |
|            |       |                                                                                                                                                                              |
| 4.1             |       | Specimen Certificate for  Common Stock (incorporated herein by reference to the Company’s Form 10-Q for  the quarterly period ended December 31, 2006)                       |
|            |       |                                                                                                                                                                              |
| 4.2             |       | Form of Warrant  (incorporated herein by reference to the Company’s Form 8-K, dated February  16, 2007, Exhibit 4.1)                                                         |
|            |       |                                                                                                                                                                              |
| 4.3             |       | Warrant, dated February  22, 2007, to Belmont Capital Group Limited (incorporated herein by reference  to the Company’s Form 8-K, dated February 16, 2007, Exhibit 4.2)      |
|            |       |                                                                                                                                                                              |
| 4.4             |       | Warrant,  dated February 22, 2007, to CCG Elite Investor Relations (incorporated  herein by reference to the Company’s Form 8-K, dated February 16, 2007,  Exhibit 4.3) |
|            |       |                                                                                                                                                                              |
| 21              |       | List of Subsidiaries of  the Company (incorporated herein by reference to the Company’s Form 10-Q for  the quarterly period ended December 31, 2006)                         |
|            |       |                                                                                                                                                                              |
| 23              |       | Consent of Murrell, Hall,  McIntosh & Co. PLLP                                                                                                                                |
|            |       |                                                                                                                                                                              |
| 31(i).1         |       | Certification of President  pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act                                                                                   |
|            |       |                                                                                                                                                                              |
| 31(i).2         |       | Certification of Chief  Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities  Exchange Act                                                                    |
|            |       |                                                                                                                                                                              |
| 32              |       | Certification of President  and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                 |

 

42

****

**

 

SIGNATURES

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the Registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 

 
| ** **                    | **CHINA  PRECISION STEEL, INC.** |
|-------------------------------|----------------------------------|
|                          |                             |   |
|                          |                             |   |
| Date: November 19,  2007 | By:                              |   | /s/ Wo Hing  Li |   |
|                          |                             | Wo Hing Li |
|                          |                             | President |

 

43

****

**

 

EXHIBITINDEX

 
| **Exhibit No.** | ** ** | **Exhibits**                                                                                                                                                                       |
|-----------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                               |
| 2.1             |       | Certificate of Ownership  and Merger                                                                                                                                               |
|            |       |                                                                                                                                                                               |
| 2.2             |       | Agreement and Plan of  Merger                                                                                                                                                      |
|            |       |                                                                                                                                                                               |
| 3.1             |       | Certificate of  Incorporation                                                                                                                                                      |
|            |       |                                                                                                                                                                               |
| 3.2             |       | Bylaws                                                                                                                                                                             |
|            |       |                                                                                                                                                                               |
| 4.1             |       | Specimen Certificate for  Common Stock (incorporated herein by reference to the Company’s Form 10-Q for  the quarterly period ended December 31, 2006)                        |
|            |       |                                                                                                                                                                               |
| 4.2             |       | Form of Warrant  (incorporated herein by reference to the Company’s Form 8-K, dated February  16, 2007, Exhibit 4.1)                                                          |
|            |       |                                                                                                                                                                               |
| 4.3             |       | Warrant, dated February  22, 2007, to Belmont Capital Group Limited (incorporated herein by reference  to the Company’s Form 8-K, dated February 16, 2007, Exhibit 4.2)       |
|            |       |                                                                                                                                                                               |
| 4.4             |       | Warrant, dated    February 22, 2007, to CCG Elite Investor Relations (incorporated herein by  reference to the Company’s Form 8-K, dated February 16, 2007, Exhibit 4.3) |
|            |       |                                                                                                                                                                               |
| 21              |       | List of Subsidiaries of  the Company (incorporated herein by reference to the Company’s Form 10-Q for  the quarterly period ended December 31, 2006)                          |
|            |       |                                                                                                                                                                               |
| 23              |       | Consent of Murrell, Hall,  McIntosh & Co. PLLP                                                                                                                                 |
|            |       |                                                                                                                                                                               |
| 31(i).1         |       | Certification of President  pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act                                                                                    |
|            |       |                                                                                                                                                                               |
| 31(i).2         |       | Certification of Chief  Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities  Exchange Act                                                                     |
|            |       |                                                                                                                                                                               |
| 32              |       | Certification of President  and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                  |

 

44

****