**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

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

 

**For the quarterly period ended December 31,2007**

 

**or**

 

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

 

**For the transition periodfrom             to**

 

**Commission file number 000-23039**

 

**CHINAPRECISION STEEL, INC.**

(Exact name of registrant as specified in charter)

 

| **Delaware**                                     | ** ** | **14-1623047**                      |
|--------------------------------------------------|------------|-------------------------------------|
| (State or other jurisdiction   of incorporation) |       | (IRS Employer   Identification No.) |

 

**8th Floor, Teda Building, 87 Wing Lok Street, Sheungwan**

**Hong Kong, The People’s Republic of China**

(Address of principal executive offices)

 

**+852-2543-8223**

Registrant’s telephone number, including area code:

 

 

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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 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 February 14,2008, 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 December 31, 2007**

 

**Part I - Financial Information**

 
| Item  1.                             | Financial  Statements                                                                                                                                                                   |   |
|--------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                 |                                                                                                                                                                                    |   |
|                                 | Condensed  Consolidated Balance Sheets at, December 31, 2007 (unaudited) and  June 30, 2007 (audited)                                                                         |   |
|                                 |                                                                                                                                                                                    |   |
|                                 | Unaudited  Condensed Consolidated Statements of Operations for the three and six  months ended December 31, 2007 and 2006                                                     |   |
|                                 |                                                                                                                                                                                    |   |
|                                 | Unaudited Condensed  Consolidated Statements of Cash Flows for the six months ended  December 31, 2007 and 2006                                                               |   |
|                                 |                                                                                                                                                                                    |   |
|                                 | Condensed Consolidated Statements of  Changes in Stockholders’ Equity for the year ended June 30, 2007  (audited) and the six months ended December 31, 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                           |                                                                                                                                                                                    |   |

 

----

 

**Item 1. Financial Statements.**

 

**China Precision Steel, Inc. andSubsidiaries**

**Condensed Consolidated Balance Sheets**

** **
| ** **                                                                                                                                                | ** ** | ** ** | ** ** | **(Unaudited)**       | ** **  | ** **        | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------|-------------|-------------------|------------|
| ** **                                                                                                                                                | ** ** | ** ** | ** ** | **December 31,** | ** **  | **June 30,** | ** ** |
| ** **                                                                                                                                                | ** ** | **Notes**  | ** ** | **2007**              | ** **  | **2007**          | ** ** |
|                                                                                                                                                      |       |       |       |                  |        |              |       |
| **Assets**                                                                                                                                                |       |       |       |                  |        |              |       |
| ** **                                                                                                                                                |       |       |       |                  |        |              |       |
| **Current assets**                                                                                                                                        |       |       |       |                  |        |              |       |
| Cash and equivalents                                                                                                                                      |       |       |       | $                     | 40,205,111  |              | $          | 5,504,862 |   |
| Accounts receivable                                                                                                                                       |       |       |       |                  |        |              |       |
| Trade, net of allowances of $955,086 and  $273,461 at December 31, and June 30, 2007, respectively                                              |       |       |       | 19,888,272            |        | 8,242,044         |       |
| Bank acceptance notes                                                                                                                                     |       |       |       | 15,383,562            |        | —            |       |
| Other                                                                                                                                                     |       |       |       | 469,925               |        | 85,708            |       |
| Inventories                                                                                                                                               |       | 5          |       | 10,671,635            |        | 15,723,704        |       |
| Deposits                                                                                                                                                  |       |       |       | 68,493                |        | 82,758            |       |
| Prepaid expenses                                                                                                                                          |       |       |       | 326,065               |        | —            |       |
| Advances to suppliers, net of allowance of  $2,368,805 and $3,502,184 at December 31, and June 30, 2007, respectively                           |       |       |       | 10,256,715            |        | 11,699,918        |       |
|                                                                                                                                                      |       |       |       |                  |        |              |       |
| **Total current assets**                                                                                                                                  |       |       |       | 97,269,778            |        | 41,338,994        |       |
|                                                                                                                                                      |       |       |       |                  |        |              |       |
| **Property, plant and equipment**                                                                                                                         |       |       |       |                  |        |              |       |
| Land use rights                                                                                                                                           |       |       |       | 1,795,461             |        | 1,124,583         |       |
| Property and equipment, net                                                                                                                               |       | 6          |       | 32,305,573            |        | 29,238,227        |       |
| Construction-in-progress                                                                                                                                  |       | 7          |       | 11,503,835            |        | 10,355,763        |       |
|                                                                                                                                                      |       |       |       |                  |        |              |       |
|                                                                                                                                                      |       |       |       | 45,604,869            |        | 40,718,573        |       |
|                                                                                                                                                      |       |       |       |                  |        |              |       |
| **Goodwill**                                                                                                                                              |       | 13         |       | 99,999                |        | 99,999            |       |
|                                                                                                                                                      |       |       |       |                  |        |              |       |
| **Total assets**                                                                                                                                          |       |       |       | $                     | 142,974,646 |              | $          | 82,157,566 |   |
|                                                                                                                                                      |       |       |       |                  |        |              |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                            |       |       |       |                  |        |              |       |
|                                                                                                                                                      |       |       |       |                  |        |              |       |
| **Current liabilities**                                                                                                                                   |       |       |       |                  |        |              |       |
| Accounts payable and accrued liabilities                                                                                                                  |       |       |       | $                     | 6,196,315   |              | $          | 4,855,932 |   |
| Advances from customers                                                                                                                                   |       | 8          |       | 3,807,354             |        | 1,720,812         |       |
| Other taxes payables                                                                                                                                      |       |       |       | 2,946,169             |        | 716,554           |       |
| Current income taxes payable                                                                                                                              |       |       |       | 3,171,889             |        | 1,892,866         |       |
| Deferred income taxes payable                                                                                                                             |       | 12         |       | 1,981,121             |        | 1,064,028         |       |
| Amounts due to directors                                                                                                                                  |       | 9          |       | 2,543,019             |        | —            |       |
| Current portion of long-term debt                                                                                                                         |       |       |       | 3,086,758             |        | 6,163,445         |       |
| Notes payable                                                                                                                                             |       | 10         |       | 16,713,720            |        | 9,842,520         |       |
|                                                                                                                                                      |       |       |       |                  |        |              |       |
| **Total current liabilities**                                                                                                                             |       |       |       | 40,446,345            |        | 26,256,157        |       |
|                                                                                                                                                      |       |       |       |                  |        |              |       |
| **Long-term debt, net of current portion  shown above**                                                                                                   |       | 11         |       | 2,315,069             |        | 6,878,714         |       |
|                                                                                                                                                      |       |       |       |                  |        |              |       |
| **Stockholders’ equity:**                                                                                                                            |       |       |       |                  |        |              |       |
| Preferred stock: $0.001 per value,  8,000,000 shares authorized, no shares outstanding at December 31, and June 30,  2007;                      |       |       |       | —                |        | —            |       |
| Common stock: $0.001 par value, 62,000,000  shares authorized, 45,896,288 and 37,378,143 issued and outstanding  December 31, and June 30, 2007 |       |       |       | 45,896                |        | 37,378            |       |
| Additional paid-in capital                                                                                                                                |       | 14         |       | 73,701,004            |        | 31,867,063        |       |
| Accumulated other comprehensive income                                                                                                                    |       |       |       | 4,196,499             |        | 2,192,160         |       |
| Retained earnings                                                                                                                                         |       |       |       | 22,269,833            |        | 17,008,238        |       |
|                                                                                                                                                      |       |       |       |                  |        |              |       |
| **Total stockholders’ equity**                                                                                                                       |       |       |       | 100,213,232           |        | 51,104,839        |       |
|                                                                                                                                                      |       |       |       |                  |        |              |       |
| **Amounts due from directors**                                                                                                                            |       | 9          |       | —                |        | (2,082,144        | )          |
|                                                                                                                                                      |       |       |       |                  |        |              |       |
| **Total liabilities and stockholders’ equity**                                                                                                       |       |       |       | $                     | 142,974,646 |              | $          | 82,157,566 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

1

----

 

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

**Condensed Consolidated Statements of Operations**

**For the Three and Six Months Ended December 31.2007 and 2006**

**(Unaudited)**

** **
| ** **                                                   | ** ** | ** ** | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                   | ** ** | ** ** | ** ** | **December 31,**            | ** ** | **December 31,**          | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
| ** **                                                   | ** ** | **Notes**  | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                   | ** ** | ** ** | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Revenues**                                                 |       |       |       |                             |       |                           |       |   |   |   |   |
| Sales revenues                                               |       |       |       | $                                | 11,913,718 |                           | $          | 15,007,582 |   | $ | 37,226,416 |   | $ | 25,510,930 |   |
| Cost of goods sold                                           |       |       |       | 8,528,852                        |       | 11,594,852                     |       | 28,773,987 |   | 18,394,950 |   |
|                                                         |       |       |       |                             |       |                           |       |   |   |   |   |
| **Gross profit**                                             | ** ** | ** ** |       | 3,384,866                        |       | 3,412,730                      |       | 8,452,429 |   | 7,115,980 |   |
|                                                         |       |       |       |                             |       |                           |       |   |   |   |   |
| **Operating expenses**                                       |       |       |       |                             |       |                           |       |   |   |   |   |
| Selling expenses                                             |       |       |       | 180,744                          |       | 64,693                         |       | 281,449 |   | 104,390 |   |
| Administrative expenses                                      |       |       |       | 846,218                          |       | 498,737                        |       | 1,332,595 |   | 684,925 |   |
| Provision for bad debts                                      |       |       |       | 25,782                           |       | —                         |       | 651,780 |   | — |   |
| Depreciation and amortization expense                        |       |       |       | 15,798                           |       | 10,845                         |       | 29,430 |   | 21,262 |   |
|                                                         |       |       |       |                             |       |                           |       |   |   |   |   |
| **Total operating expenses**                                 | ** ** | ** ** |       | 1,068,542                        |       | 574,275                        |       | 2,295,254 |   | 810,577 |   |
|                                                         |       |       |       |                             |       |                           |       |   |   |   |   |
| **Income from continuing operations**                        |       |       |       | 2,316,324                        |       | 2,838,455                      |       | 6,157,175 |   | 6,305,403 |   |
|                                                         |       |       |       |                             |       |                           |       |   |   |   |   |
| **Other income (expense)**                                   |       |       |       |                             |       |                           |       |   |   |   |   |
| Other revenues                                               |       |       |       | 783,255                          |       | —                         |       | 792,410 |   | — |   |
| Interest and finance costs                                   |       |       |       | (316,860                         | )          | (114,743                       | )          | (759,001 | ) | (318,082 | ) |
|                                                         |       |       |       |                             |       |                           |       |   |   |   |   |
| **Total other income (expense)**                             | ** ** | ** ** |       | 466,395                          |       | (114,743                       | )          | 33,409 |   | (318,082 | ) |
|                                                         |       |       |       |                             |       |                           |       |   |   |   |   |
| **Net income from continuing operations before  income tax** |       |       |       | 2,782,719                        |       | 2,723,712                      |       | 6,190,584 |   | 5,987,321 |   |
|                                                         |       |       |       |                             |       |                           |       |   |   |   |   |
| **Provision for (benefit from) income tax**                  |       |       |       |                             |       |                           |       |   |   |   |   |
| Current                                                      |       | 12         |       | 194,873                          |       | (34,057                        | )          | 11,896 |   | 895,313 |   |
| Deferred                                                     |       | 12         |       | 226,977                          |       | 389,604                        |       | 917,093 |   | (85,405 | ) |
|                                                         |       |       |       |                             |       |                           |       |   |   |   |   |
| Total income tax expense                                     |       |       |       | 421,850                          |       | 355,547                        |       | 928,989 |   | 809,908 |   |
|                                                         |       |       |       |                             |       |                           |       |   |   |   |   |
| **Net income before discontinued operations**                |       |       |       | 2,360,869                        |       | 2,368,165                      |       | 5,261,595 |   | 5,177,413 |   |
|                                                         |       |       |       |                             |       |                           |       |   |   |   |   |
| **Net income from discontinued operations**                  |       | 16         |       | —                           |       | 519,879                        |       | — |   | 639,072 |   |
|                                                         |       |       |       |                             |       |                           |       |   |   |   |   |
| **Net income**                                               |       |       |       | $                                | 2,360,869  |                           | $          | 2,888,044 |   | $ | 5,261,595 |   | $ | 5,816,485 |   |
|                                                         |       |       |       |                             |       |                           |       |   |   |   |   |
| **Basic earnings per share**                                 |       | 15         |       |                             |       |                           |       |   |   |   |   |
| From continuing operations                                   |       |       |       | $                                | 0.05       |                           | $          | 0.09 |   | $ | 0.13 |   | $ | 0.19 |   |
| From discontinued operations                                 |       |       |       | $                                | —     |                           | $          | 0.02 |   | $ | — |   | $ | 0.03 |   |
| Total                                                        |       |       |       | $                                | 0.05       |                           | $          | 0.11 |   | $ | 0.13 |   | $ | 0.22 |   |
|                                                         |       |       |       |                             |       |                           |       |   |   |   |   |
| **Basic weighted average shares outstanding**                |       |       |       | 43,031,346                       |       | 26,981,916                     |       | 40,204,745 |   | 26,981,916 |   |
|                                                         |       |       |       |                             |       |                           |       |   |   |   |   |
| **Diluted earnings per share**                               |       | 15         |       |                             |       |                           |       |   |   |   |   |
| From continuing operations                                   |       |       |       | $                                | 0.05       |                           | $          | 0.09 |   | $ | 0.13 |   | $ | 0.19 |   |
| From discontinued operations                                 |       |       |       | $                                | —     |                           | $          | 0.02 |   | $ | — |   | $ | 0.03 |   |
| Total                                                        |       |       |       | $                                | 0.05       |                           | $          | 0.11 |   | $ | 0.13 |   | $ | 0.22 |   |
|                                                         |       |       |       |                             |       |                           |       |   |   |   |   |
| **Diluted weighted average shares outstanding**              |       |       |       | 43,639,342                       |       | 26,981,916                     |       | 40,809,437 |   | 26,981,916 |   |
|                                                         |       |       |       |                             |       |                           |       |   |   |   |   |
| **The Components of comprehensive income:**                  |       |       |       |                             |       |                           |       |   |   |   |   |
| Net income                                                   |       |       |       | $                                | 2,360,869  |                           | $          | 2,888,044 |   | $ | 5,261,595 |   | $ | 5,816,485 |   |
| Foreign currency translation adjustment                      |       |       |       | 557,213                          |       | 557,213                        |       | 2,004,339 |   | 654,985 |   |
|                                                         |       |       |       |                             |       |                           |       |   |   |   |   |
| **Comprehensive income**                                     |       |       |       | $                                | 2,918,082  |                           | $          | 3,445,257 |   | $ | 7,265,934 |   | $ | 6,471,470 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

2

----

 

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

**Condensed Consolidated Statements of Cash Flows**

**For the Six Months Ended December 31, 2007 and2006**

**(Unaudited)**

** **
| ** **                                                                                      | ** ** | **2007**    | ** ** | **2006**    | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|
|                                                                                            |       |        |       |        |       |
| **Cash flows from operating activities**                                                        |       |        |       |        |       |
| **Net Income**                                                                                  |       | $           | 5,261,595  |        | $          | 5,816,485 |   |
| **Adjustments to reconcile net income to net  cash provided by (used in) operating activities** |       |        |       |        |       |
| Depreciation                                                                                    |       | 992,570     |       | 617,405     |       |
| Less income from discontinued operations -  Oralabs, Inc                                        |       | —      |       | (639,072    | )          |
| Allowance for bad and doubtful debts                                                            |       | 651,780     |       | —      |       |
| **Net changes in assets and liabilities:**                                                      |       |        |       |        |       |
| Accounts receivable, net                                                                        |       | (27,990,004 | )          | 4,059,814   |       |
| Inventories                                                                                     |       | 5,195,155   |       | (8,207,665  | )          |
| Deposits                                                                                        |       | 15,018      |       | (3,661      | )          |
| Prepayments                                                                                     |       | (326,065    | )          | —      |       |
| Advances to suppliers                                                                           |       | 1,549,672   |       | (4,410,823  | )          |
| Accounts payable and accrued expenses                                                           |       | 1,296,194   |       | 4,622,396   |       |
| Advances from customers                                                                         |       | 2,070,883   |       | 2,919,124   |       |
| Other taxes payable                                                                             |       | 2,223,094   |       | (152,086    | )          |
| Current income taxes                                                                            |       | 1,261,798   |       | 937,307     |       |
| Deferred income taxes                                                                           |       | 907,410     |       | (85,405     | )          |
|                                                                                            |       |        |       |        |       |
| **Net cash (used in) provided by operating  activities**                                        |       | (6,890,900  | )          | 5,473,819   |       |
|                                                                                            |       |        |       |        |       |
| **Cash flows from investing activities**                                                        |       |        |       |        |       |
| Purchases of property and equipment  including construction in progress                         |       | (5,508,327  | )          | (10,212,328 | )          |
|                                                                                            |       |        |       |        |       |
| **Net cash (used in) investing activities**                                                     |       | (5,508,327  | )          | (10,212,328 | )          |
|                                                                                            |       |        |       |        |       |
| **Cash flows from financing activities**                                                        |       |        |       |        |       |
| Sale of common stock                                                                            |       | 44,433,222  |       | —      |       |
| Capital and restructuring contributions                                                         |       | —      |       | 558,797     |       |
| Advances from directors, net                                                                    |       | 2,053,348   |       | (3,237,243  | )          |
| Notes payable proceeds                                                                          |       | 16,446,667  |       | 7,748,990   |       |
| Repayments of notes payable                                                                     |       | (17,424,050 | )          | —      |       |
|                                                                                            |       |        |       |        |       |
| **Net cash provided by financing activities**                                                   |       | 45,509,187  |       | 5,070,544   |       |
|                                                                                            |       |        |       |        |       |
| **Effect of exchange rate**                                                                     |       | 1,590,289   |       | 654,985     |       |
|                                                                                            |       |        |       |        |       |
| **Net increase in cash**                                                                        |       | 34,700,249  |       | 987,020     |       |
|                                                                                            |       |        |       |        |       |
| **Cash and cash equivalents, beginning of  year**                                               |       | 5,504,862   |       | 186,955     |       |
|                                                                                            |       |        |       |        |       |
| **Cash and cash equivalents, end of year**                                                      |       | $           | 40,205,111 |        | $          | 1,173,975 |   |
|                                                                                            |       |        |       |        |       |
| **Supplemental disclosure of cash flow  information**                                           |       |        |       |        |       |
|                                                                                            |       |        |       |        |       |
| Interest paid                                                                                   |       | $           | 759,001    |        | $          | 318,082 |   |
| Taxes paid                                                                                      |       | $           | —     |        | $          | — |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

3

----

 

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

**Condensed Consolidated Statements of Changes in Stockholders’Equity**

**For the Year Ended June 30, 2007 and the Six MonthsEnded December 31, 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 |       |
|                                                     |       |                     |       |        |       |              |       |            |       |                   |       |       |       |
| Sale of common stock                                     |       | 7,100,000                |       | 7,100       |       | 44,498,650        |       | —          |       | —                 |       | 44,505,750 |       |
| Syndication fees                                         |       | —                   |       | —      |       | (72,528           | )          | —          |       | —                 |       | (72,528    | )          |
| Make good shares                                         |       | 2,000,000                |       | 2,000       |       | (2,000            | )          | —          |       | —                 |       | —     |       |
| Exercise of warrants                                     |       | 189,205                  |       | 189         |       | (189              | )          | —          |       | —                 |       | —     |       |
| Cancellation of stock                                    |       | (771,060                 | )          | (771        | )          | (2,589,992        | )          | —          |       | —                 |       | (2,590,763 | )          |
| Foreign currency translation adjustment                  |       | —                   |       | —      |       | —            |       | 2,004,339       |       | —                 |       | 2,004,339  |       |
| Net income                                               |       | —                   |       | —      |       | —            |       | —          |       | 5,261,595              |       | 5,261,595  |       |
|                                                     |       |                     |       |        |       |              |       |            |       |                   |       |       |       |
| Balance at December 31, 2007                        |       | 45,896,288               |       | $           | 45,896     |              | $          | 73,701,004      |       | $                      | 4,196,499  |       | $          | 22,269,833 |   | $ | 100,213,232 |   |
|                                                          |            |                          |            |             |            |                   |            |                 |            |                        |            |            |            |  |  |  |  |  |

 

Theaccompanying notes are an integral part of these financial statements.

 

4

----

** **

**China Precision Steel, Inc.**

Notes to the Condensed Consolidated FinancialStatements

 

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

 

On December 28,2006, China Precision Steel, Inc. (the “Company” or “we”), under ourformer name, OraLabs Holding Corp., issued 25,363,002 shares of common stock inexchange for 100% of the registered capital of Partner Success Holdings Limited(“PSHL”), a British Virgin Islands Business Company pursuant to a StockExchange Agreement, dated March 31, 2006. Subsequent to the closing ofthat 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 of itscommon 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 supplemental payment received.The Company then changed its name to China Precision Steel, Inc.

 

These transactions weretreated for financial reporting purposes as a recapitalization, with priorOraLabs, Inc. operating activities reflected on the statements ofoperations as income (loss) from discontinued operations. The $558,797estimated 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, 2007 and 2006. It has three wholly-ownedsubsidiaries, Shanghai Chengtong Precision Strip Company Limited (“Chengtong”),Shanghai Tuorong Precision Strip Co., Limited (“Tuorong”), and BlessfordInternational Limited (“Blessford”).

 

In the year ended June 30,2007, we added three indirect subsidiaries to our corporate structure. On April 9,2007, we purchased Shanghai Tuorong Precision Strip, Limited, or Tuorong,through PSHL. The sole activity of Tuorong is the ownership of a land use rightwith respect to facilities utilized by Chengtong. On April 10, 2007, PSHLpurchased for $100,000 Blessford International Limited, a British VirginIslands company. Blessford International Limited does not conduct any business,but it owns a single subsidiary, Shanghai Blessford Alloy Company Limited, thatis a wholly-foreign owned enterprise chartered in China. We intend to holdBlessford International Limited as a shell subsidiary that may be used in thefuture to facilitate optimization of the tax structure of the Group’sactivities.

 

Chengtong was registeredon 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 asa Sino-foreign joint venture enterprise with limited liabilities. On August 22,2005, the authorized registered capital was increased to $15,220,000 and on December 11,2007, the authorized registered capital was further increased to $42,440,000.Pursuant to the document issued by the District Council to Xuhang Town Councilon June 28, 2004, the equity transfers from China Chengtong Metal GroupLimited and Eastreal Holdings Company Limited to PSHL was approved and thetransformation of Chengtong from a Sino-foreign joint investment enterprise toa wholly foreign owned enterprise (WFOE) was granted.

 

As used herein, the “Group”refers to the Company, PSHL and Chengtong, Tuorong and Blessford on aconsolidated basis.

 

The Company’s principalactivities are conducted through its principal subsidiary, Chengtong. Chengtongis a niche precision steel processing company principally engaged in themanufacture and sales of cold-rolled and hot-rolled precision steel productsand plates for down-stream applications in the automobile industry (components andspare parts), kitchen tools and functional parts of electrical appliances. Rawmaterials, hot-rolled de-scaled (pickled) steel coils, will go through certaincold reduction processing procedures to give steel rolls and plates indifferent cuts and thickness for deliveries in accordance with customers’specifications. Specialty precision steel offers specific control of thickness,shape, width, surface finish and other special quality features that complimentthe emerging need for highly engineered end use applications. Precision steelpertains to the precision of measurements and tolerances of the above factors,especially thickness tolerance.

 

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

 

The accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with generally accepted accounting principles for interim financialinformation and with the instructions to Form 10-Q. Accordingly, they donot include all of the information and footnotes required by generally acceptedaccounting principles for complete financial statements and related notes. Theaccompanying unaudited condensed consolidated financial statements and relatednotes should be read in conjunction with the audited consolidated financialstatements of the Company and notes thereto for the year ended June 30,2007.

 

5

----

 

In the opinion ofmanagement, the accompanying unaudited condensed consolidated financialstatements contain all adjustments (which include only normal recurringadjustments) necessary to present fairly the balance sheets of China PrecisionSteel, Inc. and subsidiaries as of December 31, 2007 and June 30,2007 and the results of their operations for the three and six months ended December 31,2007 and 2006, and cash flows for the six months ended December 31, 2007and 2006. The results of operations for the three and six months ended December 31,2007 and 2006 are not necessarily indicative of the results to be expected forthe entire year.

 

****3.  ****  ****Summary ofSignificant Accounting Policies****

 

The following is asummary of significant accounting policies:

 

****Cash andEquivalents -****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 -****The Company provides an allowance for doubtful accounts equal to theestimated uncollectible amounts. It is reasonably possible that the Company’sestimate of the allowance will change. At December 31, 2007 and June 30,2007, the Company had $955,086 and $273,461 of allowances for doubtfulaccounts, respectively.

 

****Inventory - ****Inventory is stated at the lower of costor market. Cost is determined using the weighted average method. Market valuerepresents the estimated selling price in the ordinary course of business lessthe estimated costs necessary to complete the sale.

 

The cost of inventoriescomprises all costs of purchases, costs of conversion and other costs incurredin bringing the inventories to their present location and condition. The costsof conversion of inventories include fixed and variable production overheads,taking into account the stage of completion.

 

****Advances toSuppliers -****In order to insure a steady supply of raw materials, the Company isrequired from time to time to make cash advances when placing its purchaseorders. Cash advances are shown net of allowances for unrecoverable advances of$2,368,805 and $3,502,184 at, December 31, 2007 and June 30, 2007,respectively.

 

****Property, Plantand 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.

 

Depreciation is computedon a straight-line basis over the estimated useful lives of the related assetsfor financial reporting purposes. The estimated useful lives for significantproperty and equipment are as follows:

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

 

Repairs and maintenancecosts are normally charged to the statement of operations in the year in whichthey are incurred. In situations where it can be clearly demonstrated that theexpenditure has resulted in an increase in the future economic benefitsexpected to be obtained from the use of the asset, the expenditure iscapitalized as an additional cost of the asset.

 

Property, plant andequipment are evaluated annually for any impairment in value. Where therecoverable amount of any property and equipment is determined to have declinedbelow its carrying amount, the carrying amount is reduced to reflect thedecline in value. There were no property and equipment impairments recognizedduring 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 six months ended December 31, 2007 and 2006, the Companycapitalized $0 and $497,686, respectively, of interest toconstruction-in-progress.

 

****Construction-in-Progress**** - Properties currently under developmentare accounted for as construction-in-progress. Construction-in-progress isrecorded at acquisition cost, including land rights cost, developmentexpenditure, professional fees and the interest expenses capitalized during thecourse of construction for the purpose of financing the project. Uponcompletion and readiness for use of the project, the cost ofconstruction-in-progress is to be transferred to properties held for sale.

 

6

----

 

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 contingent liability is apossible obligation that arises from past events and whose existence will onlybe confirmed by the occurrence or non-occurrence of one or more uncertainfuture events not wholly within the control of the Company. It can also be apresent obligation arising from past events that is not recognized because itis not probable that outflow of economic resources will be required or theamount of obligation cannot be measured reliably.

 

A contingent liability isnot recognized but is disclosed in the notes to the financial statements. Whena change in the probability of an outflow occurs so that outflow is probable,the contingency is then recognized as a provision.

 

A contingent asset is apossible asset that arises from past events and whose existence will beconfirmed only by the occurrence or non-occurrence of one or more uncertainevents not wholly within the control of the Company.

 

Contingent assets are notrecognized but are disclosed in the notes to the financial statements when aninflow of economic benefits is probable. When inflow is virtually certain, anasset is recognized.

 

****Advances fromcustomers**** ****-****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 a subsequent period are carried forwardas deferred revenue.

 

****RevenueRecognition - ****Revenue from the sale of goods and services isrecognized on the transfer of risks and rewards of ownership, which generallycoincides with the time when the goods are delivered to customers and the titlehas passed and services have been rendered and invoiced. Revenue is reportednet of all VAT taxes. Other income is recognized when it is earned.

 

****Foreign Currencies**** - The Company’s principal country ofoperations is in the PRC. The financial position and results of operations ofthe Company are determined using the local currency (“Renminbi” or “Yuan”) asthe functional currency. The results of operations denominated in foreigncurrencies are translated at the average rate of exchange during the reportingperiod. Assets and liabilities denominated in foreign currencies at the balancesheet date are translated at the market rate of exchange ruling at that date.The registered equity capital denominated in the functional currency is translatedat the historical rate of exchange at the time of capital contribution. Alltranslation adjustments resulting from the translation of the financialstatements into the reporting currency (“US Dollars”) are dealt with as anexchange fluctuation reserve in shareholders’ equity.

 

****Taxation -****Taxation on overseas profits has beencalculated on the estimated assessable profits for the year at the rates oftaxation prevailing in the country in which the Company operates.

 

Provision for the PRCenterprise income tax is calculated at the prevailing rate based on theestimated 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****.****

 

**Enterprise incometax**

 

Under the ProvisionalRegulations of the People’s Republic of China Concerning Income Tax onEnterprises promulgated by the State Council which came into effect on January 1,1994, income tax is payable by enterprises at a rate of 33% of their taxableincome. Preferential tax treatment may, however, be granted pursuant to any lawor regulations from time to time promulgated by the State Council. Specialtystate companies’ enterprise income tax rate was reduced to 27%. The Group iscurrently 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, and2009. Subsequent to June 30, 2009, Chengtong will be subject to enterpriseincome taxes at the prevailing statutory rates. The Enterprise Income Tax Lawwas passed on March 16, 2007, and became effective on January 1,2008. The new law introduces fundamental changes to the Chinese tax system forboth domestic and foreign-owned entities. A new unified general income tax of25% will be applicable to enterprises in China. Entities subject to a “taxholiday” prior to January 1, 2008, are expected to be able to retain thebenefits of the reduced rates for the remaining term.

 

Deferred tax assets andliabilities are recognized for the future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases. Deferred tax assets, includingtax loss and credit carry forwards, and liabilities are measured using enactedtax rates expected to apply to taxable income in the years in which thosetemporary differences are expected to be recovered or settled. The effect ondeferred tax assets and liabilities of a change in tax rates is recognized inincome in the period that includes the enactment date. Deferred income taxexpense represents the change during the period in the deferred tax assets anddeferred tax liabilities. The components of the deferred tax assets andliabilities are 

 

7

----

 

individually classifiedas current and non-current based on their characteristics. Deferred tax assetsare reduced by a valuation allowance when, in the opinion of management, it ismore likely than not that some portion or all of the deferred tax assets willnot be realized.

 

In 2006, the FinancialAccounting Standards Board (FASB) issued FIN 48, which clarifies theapplication of SFAS 109 by defining a criterion that an individual income taxposition must meet for any part of the benefit of that position to berecognized in an enterprise’s financial statements and provides guidance onmeasurement, derecognition, classification, accounting for interest andpenalties, accounting in interim periods, disclosure and transition. Inaccordance with the transition provisions, the Company adopted FIN 48 effectiveJanuary 1, 2007.

 

The Company recognizesthat virtually all tax positions in the PRC are not free of some degree ofuncertainty due to tax law and policy changes by the State. However, theCompany cannot reasonably quantify political risk factors and thus must dependon guidance issued by current state officials.

 

Based on all known factsand circumstances and current tax law, the Company believes that the totalamounts of unrecognized tax benefits as of December 31 and June 30,2007, are not material to its results of operations, financial condition orcash flows. The Company also believes that the total amounts of unrecognizedtax benefits as of December 31 and June 30, 2007, if recognized, would nothave a material effect on its effective tax rate. The Company further believesthat there are no tax positions for which it is reasonably possible, based oncurrent Chinese tax law and policy, that the unrecognized tax benefits willsignificantly increase or decrease over the next 12 months producing,individually or in the aggregate, a material effect on the Company’s results ofoperations, financial condition or cash flows.

 

**Value added tax**

 

The ProvisionalRegulations of the People’s Republic of China Concerning Value Added Taxpromulgated 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.

 

Value added tax payablein the PRC is charged on an aggregated basis at a rate of 13% or 17% (dependingon the type of goods involved) on the full price collected for the goods soldor, in the case of taxable services provided, at a rate of 17% on the chargesfor the taxable services provided, but excluding, in respect of both goods andservices, any amount paid in respect of value added tax included in the priceor charges, and less any deductible value added tax already paid by thetaxpayer on purchases of goods and services in the same financial year.

 

****Retirement BenefitCosts**** -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.

 

For the three and sixmonths ended December 31, 2007, the Company’s pension cost charged to thestatements of operations under the plan amounted to $72,059 and $132,658,respectively, all of which have been paid to the State Pension Fund (2006:$39,466 and $74,163, respectively).

 

****Fair Value ofFinancial Instruments -****The carrying amounts of certain financial instruments,including cash, accounts receivable, other receivables, accounts payable,accrued expenses, and other payables approximate their fair values as at December 31June 30, 2007 because of the relatively short-term maturity of theseinstruments.

 

****Adjustments****- In the opinion of management, alladjustments that are necessary for a fair presentation for the periodspresented have been reflected as required by Regulation S-X, Rule 10-01.All such adjustments are of a normal, recurring nature.

 

****Use of Estimates**** ****-**** The preparation offinancial statements in accordance with generally accepted accountingprinciples require management to make estimates and assumptions that affect reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and reported amounts ofrevenues and expenses during the reporting period. Actual results could differfrom those estimates.

 

 

8

----

 

****Recent AccountingPronouncements****

 

The Financial AccountingStandards Board recently issued the following standards which the Companyreviewed to determine the potential impact on our financial statements uponadoption.

 

In September 2006,the FASB issued Statement No. 157, “Fair Value Measurements” (“SFAS No. 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. 157defines fair value, establishes a framework for measuring fair value andexpands the required disclosures about fair value measurements. SFAS No. 157is effective for fiscal years beginning after November 15, 2007, withearlier adoption permitted. Management is assessing the impact of the adoptionof SFAS No. 157.

 

In September 2006,the FASB issued Statement No. 158, “Employers’ Accounting for DefinedBenefit Pension and Other Postretirement Plans” (“SFAS No. 158”), anamendment of FASB Statements No. 87, 88, 106 and 132(R). SFAS No. 158requires (a) recognition of the funded status (measured as the differencebetween the fair value of the plan assets and the benefit obligation) of abenefit plan as an asset or liability in the employer’s statement of financialposition, (b) measurement of the funded status as of the employer’s fiscalyear-end with limited exceptions, and (c) recognition of changes in thefunded status in the year in which the changes occur through comprehensiveincome. The requirement to recognize the funded status of a benefit plan andthe disclosure requirements are effective as of the end of the fiscal yearending after December 15, 2006. The requirement to measure the plan assetsand benefit obligations as of the date of the employer’s fiscal year-endstatement of financial position is effective for fiscal years ending after December 15,2008. SFAS No. 158 has no current applicability to the Company’sfinancial statements.

 

In September 2006,the Securities and Exchange Commission issued Staff Accounting Bulletin 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. 108requires companies to quantify misstatements using a balance sheet and incomestatement approach and to evaluate whether either approach results inquantifying an error that is material in light of relevant quantitative andqualitative factors. When the effect of initial adoption is material, companieswill record the effect as a cumulative effect adjustment to beginning of yearretained earnings and disclose the nature and amount of each individual error beingcorrected in the cumulative adjustment. Complying with the requirements of SAB No. 108had no impact on the Company’s financial statements.

 

In February 2007,the FASB issued Statement No. 159, “The Fair Value Option for FinancialAssets and Financial Liabilities” (“SFAS No. 159”), an amendment ofFASB Statement No. 115. SFAS No. 159 addresses how companiesshould measure many financial instruments and certain other items at fairvalue. The objective is to mitigate volatility in reported earnings caused bymeasuring 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 of SFAS No. 159.

 

In December 2007,the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS141(R)”). SFAS 141(R) will change the accounting for businesscombinations. Under SFAS No. 141(R), an acquiring entity will be requiredto recognize all the assets acquired and liabilities assumed in a transactionat the acquisition-date fair value with limited exceptions. SFAS No. 141(R) willchange the accounting treatment and disclosure for certain specific items in abusiness combination. SFAS No. 141(R) applies prospectively tobusiness combinations for which the acquisition date is on or after thebeginning of the first annual reporting period beginning on or after December 15,2008. SFAS 141(R) will impact the Company in the event of any futureacquisition.

 

In December 2007,the FASB issued SFAS No. 160, “Non-controlling Interests in ConsolidatedFinancial Statements—an amendment of Accounting Research Bulletin No. 51”(“SFAS 160”). SFAS 160 establishes new accounting and reporting standards forthe noncontrolling interest in a subsidiary and for the deconsolidation of asubsidiary. SFAS No. 160 is effective for fiscal years beginning on orafter December 15, 2008. The Company does not believe that SFAS 160 willhave a material impact on its consolidated financial statements.

 

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

 

The Company providescredit in the normal course of business. The Company performs ongoing creditevaluations of its customers and clients and maintains allowances for doubtfulaccounts based on factors surrounding the credit risk of specific customers and

 

9

----

 

clients, historicaltrends, and other information. Trade accounts receivable totaled $19,888,272and $8,242,044 as of December 31, 

2007 and June 30,2007, respectively.

 

The Company’s list ofcustomers whose purchases exceeded 10% of total sales during the six monthsended December 31, 2007 and 2006 is as follows:

 
| ****Customers****                          | **** **** | ****December 31,  2007**** | **** **** | ****% to  sales**** | **** **** | ****December 31,  2006**** | **** **** | ****% to  sales**** | **** **** |
|--------------------------------------------|----------------|---------------------------------|----------------|--------------------------|----------------|---------------------------------|----------------|--------------------------|----------------|
| Shanghai Changshuo Steel Company, Ltd      |           | 11,076,780                      |           | 30                       |           |                            |           |                     |           |
| Shanghai Shengdejia Metal Products Limited |           | 6,492,562                       |           | 17                       |           |                            |           |                     |           |
| Shanghai Ruixuefeng Metals Co., Limited    |           |                            |           |                     |           | 9,254,127                       |           | 36                       |           |
| Sinosteel Company Limited                  |           |                            |           |                     |           | 3,219,796                       |           | 13                       |           |

 

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

 

Inventory consisted ofthe following:

 
| ** **       | ** ** | **December 31,  2007** | ** ** | **June 30,  2007** | ** ** |
|------------------|------------|-----------------------------|------------|-------------------------|------------|
| Raw materials    |       | $                           | 3,560,539  |                    | $          | 13,026,530 |   |
| Work in progress |       | 2,403,644                   |       | —                  |       |
| Finished goods   |       | 4,707,452                   |       | 2,697,174               |       |
|             |       | $                           | 10,671,635 |                    | $          | 15,723,704 |   |

 

****6.  ****  ****Property andEquipment****

 

Property and equipment,stated at cost less accumulated depreciation, consisted of the following:

 
| **** ****

**** **** | **** **** | ****December 31,  2007**** | **** **** | ****June 30,  2007**** | **** **** |
|--------------------------------|----------------|---------------------------------|----------------|-----------------------------|----------------|
| Plant and machinery            |           | $                               | 19,053,914     |                        | $              | 21,087,245 |   |
| Buildings                      |           | 17,568,240                      |           | 11,361,207                  |           |
| Motor vehicles                 |           | 345,350                         |           | 283,534                     |           |
| Office equipment               |           | 66,268                          |           | 85,560                      |           |
|                           |           | 37,033,772                      |           | 32,817,546                  |           |
| Less: Accumulated depreciation |           | (4,728,199                      | )              | (3,579,319                  | )              |
|                           |           | $                               | 32,305,573     |                        | $              | 29,238,227 |   |

 

Depreciation expenserelated to manufacturing is included as a component of cost of goods sold.During the three and six months ended December 31, 2007, depreciationtotaling $483,482 and $961,462, respectively, was included as a component ofcost of goods sold (2006: $345,669 and $596,143, respectively).

 

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

 

Construction-in-progressconsisted of the following:

 
| **** ****                            | **** **** | ****December 31,  2007**** | **** **** | ****June 30,  2007**** | **** **** |
|-------------------------------------------|----------------|---------------------------------|----------------|-----------------------------|----------------|
| Construction costs of plant and machinery |           | $                               | 11,503,835     |                        | $              | 10,355,763 |   |
|                                           |                |                                 |                |                             |                |  |  |

 

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

 

****8.  ****  ****Advances fromCustomers****

 

Advances from customersrepresent advance cash receipts from new customers and for which goods have notbeen delivered or services rendered as of the balance sheets dates. Advancesfrom customers for goods to be delivered or services to be rendered in thesubsequent period are carried forward as deferred revenue. As of December 31,2007 and June 30, 2007, there were advances from customers of $3,807,354and $1,720,812, respectively.

 

10

----

 

****9.  ****  ****Transactions withRelated Parties****

 

Amounts due to (from)directors are as follows:

 
| **Name**       | ** ** | **December 31, 2007** | ** ** | **June 30, 2007** | ** ** |
|----------------|------------|---------------------------------|------------|-----------------------------|------------|
| Wo Hing Li     |       | $                               | 2,120,596  |                        | $          | (2,590,763 | ) |
| Hai Sheng Chen |       | 422,423                         |       | 408,619                     |       |
|           |       | $                               | 2,543,019  |                        | $          | (2,182,144 | ) |

 

Amounts due areunsecured, non-interest bearing and have no fixed repayment terms.

 

Wo Hing Li, a directorand the President of the Company, executed an agreement with the Company andcertain other parties, dated as of February 13, 2007, as amended (the “DebtConversion Agreement”), such that, upon the occurrence of the transfer toChengtong of Tuorong, he contributed $3,953,794 as additional paid in capitalto the Company and agreed to convert current debt outstanding and payable tohim of $6,775,776 into shares of the Company’s common stock at a price of $3.36per share. This transaction was completed on May 19, 2007. When Chengtongacquired Tuorong, Tuorong had a preexisting receivable from Wo Hing Li, and theGroup offset remaining amounts owed to Wo Hing Li against this receivable.

 

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 wasdetermined that 771,060 shares of the Company’s Common Stock issued todirectors pursuant to such Agreement would be required to be cancelled in orderto eliminate the $2,590,763 reflected on the June 30, 2007 auditedfinancial statements as amounts due from directors.  Such cancellation was effected on November 8,2007.

 

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

 

Short-term loansconsisted of the following:

 
| ** **                                                                                                                                                                                                                                                     | ** ** | **December 31,  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 the Singapore Interbank Offered Rate (SIBOR) plus 3% (7.73% at  December 31, 2007)                                                                                          |       | 5,300,000                   |       | —                  |       |
|                                                                                                                                                                                                                                                           |       |                        |       |                    |       |
| 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 (8.24% at  December 31, 2007) |       | 2,701,391                   |       | —                  |       |
|                                                                                                                                                                                                                                                           |       |                        |       |                    |       |
| 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 (8.38% at  December 31, 2007)  |       | 8,712,329                   |       | —                  |       |
|                                                                                                                                                                                                                                                           |       |                        |       |                    |       |
|                                                                                                                                                                                                                                                           |       | $                           | 16,713,720 |                    | $          | 9,842,520 |   |

 

****Theweighted average interest rate on short-term loans at December 31, 2007was 8.15%.****

 

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

 
| ** **                                                                                                                                                                                                                                                      | ** ** | **December 31,  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 (8.38% at  December 31, 2007) |       | 5,401,827                   |       | 6,878,714               |       |
|                                                                                                                                                                                                                                                                 |            |                             |            |                         |            |  |  |

 

11

----

 
| Total long-term debt                     |   | 5,401,827 |      | 13,042,159 |   |
|------------------------------------------|--------|-----------|-----------|------------|--------|
| Less: Current portion of long-term debts |   | 3,086,758 |      | 6,163,445  |   |
|                                     |   |      |      |       |   |
| Long-term debts                          |   | $         | 2,315,069 |       | $      | 6,878,714 |   |
|                                          |        |           |           |            |        |  |  |

 

Maturities on long-termdebt for each of the next five years and thereafter are as follows:

 
| 2008           |   | $         | 3,086,758 |   |
|----------------|--------|-----------|-----------|--------|
| 2009           |   | 2,315,069 |      |
| 2010           |   |      |      |
| 2011           |   |      |      |
| 2012           |   |      |      |
| 2013 and after |   |      |      |
|           |   | $         | 5,401,827 |   |

 

****12.   IncomeTax****

 

For enterprise income taxreporting purposes, the Company reports income and expenses on a tax basis andis required to compute a 10% salvage value when computing depreciation expense.For financial reporting purposes, the Company reports income and expenses onthe accrual basis and does not take into account a 10% salvage value whencomputing depreciation expense.

 

No accrual for deferredtaxes was required for the fiscal year ended June 30, 2005 as the Groupbenefited from Chengtong’s 100% tax holiday during the two fiscal years ended June 30,2006 and all material timing differences would reverse within one year with theexception of depreciation which resulted in a small deferred tax asset whichwas deemed to be immaterial by the Company and was not recorded at that time.

 

As of June 30, 2006,Chengtong had utilized all of its 100% tax holiday, therefore any timing differencesreversing within the next three years would be taxed at 50% of the statutoryrate of 27%.

 

The tax holiday resultedin tax savings as follows:

 
| ** **        | ** ** | **Three months ended December 31,** | ** ** | **Six months ended December 31** | ** ** |
|-------------------|------------|---------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **        | ** ** | **2007**                                                | ** ** | **2006**                                             | ** ** | **2007** | ** ** | **2006** | ** ** |
| Tax savings       |       | $                                                       | 459,759    |                                                 | $          | 367,701 |   | $ | 1,005,469 |   | $ | 806,669 |   |
|              |       |                                                    |       |                                                 |       |   |   |   |   |
| Benefit per share |       |                                                    |       |                                                 |       |   |   |   |   |
| Basic             |       | $                                                       | 0.01       |                                                 | $          | 0.01 |   | $ | 0.03 |   | $ | 0.03 |   |
| Diluted           |       | $                                                       | 0.01       |                                                 | $          | 0.01 |   | $ | 0.02 |   | $ | 0.03 |   |

 

Significant components ofthe Group’s deferred tax assets and liabilities as of December 31, 2007and June 30, 2007 are as follows:

 
| **Deferred tax liabilities:**                                  | ** ** | **December 31,  2007** | ** ** | **June 30,  2007** | ** ** |
|--------------------------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
|                                                                     |       |                        |       |                    |       |
| Book depreciation in excess of tax depreciation                          |       | $                           | 86,306     |                    | $          | 39,918 |   |
|                                                                     |       |                        |       |                    |       |
| Timing differences resulting form cash basis reporting for tax  purposes |       | (2,067,427                  | )          | (1,103,946              | )          |
|                                                                     |       |                        |       |                    |       |
| Net deferred income tax (liability)                                      |       | $                           | (1,981,121 | )                       | $          | (1,064,028 | ) |

 

 

12

----

 

 

A reconciliation of theprovision for income taxes with amounts determined by the U.S. federal incometax rate to income before income taxes is as follows.

 
| ** **                                        | ** ** | **Three months ended  December 31,** | ** ** | **Six months ended  December 31,** | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                        | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| Computed tax at the federal statutory rate of 34% |       | $                                                   | 946,124    |                                              | $          | 926,062 |   | $ | 2,104,799 |   | $ | 2,035,689 |   |
| Less adjustment to EIT statutory rate of 27%      |       | (194,790                                            | )          | (190,660                                          | )          | (433,341 | ) | (419,112 | ) |
| Tax effect of US losses not deductible in PRC     |       | 130,275                                             |       | —                                            |       | 263,000 |   | — |   |
| Benefit of tax holiday                            |       | (459,759                                            | )          | (379,855                                          | )     | (1,005,469 | ) | (806,669 | ) |
|                                              |       |                                                |       |                                              |       |   |   |   |   |
| Income tax expense per books                      |       | $                                                   | 421,850    |                                              | $          | 355,547 |   | $ | 928,989 |   | $ | 809,908 |   |

 

Incometax expense (benefit) consists of:

 
| ** **                                                   | ** ** | **Three months ended  December 31,** | ** ** | **Six months ended  December 31,** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                   | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| Income tax expense (benefit) for the current year – PRC |       | $                                                   | 194,873    |                                              | $          | (34,057 | ) | $ | 11,896 |   | $ | 895,313 |   |
| Deferred income tax expense (benefit) – PRC             |       |                                                | 226,977    |                                              |       | 389,604 |   |   | 917,093 |   |   | (85,405 | ) |
| Income tax expense per books                                 |       | $                                                   | 421,850    |                                              | $          | 355,547 |   | $ | 928,989 |   | $ | 809,908 | ) |

 

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

 

On April 10, 2007,the Company purchased for $100,000 Blessford International Limited, a BritishVirgin Islands company. Blessford International Limited does not conduct anybusiness, but it owns a single subsidiary, Shanghai Blessford Alloy CompanyLimited, that is a wholly-foreign owned enterprise chartered in China. Thepurchase price was allocated $1 to cash and $99,999 to goodwill.

 

****14.  Equity****

 

In connection with aStock Purchase Agreement, dated February 16, 2007 (the “Stock PurchaseAgreement”), on February 22, 2007, the Company issued warrants to theplacement agents to purchase an aggregate of 1,300,059 shares of CommonStock as partial compensation for services rendered in connection with the PrivatePlacement.  The value of the warrants wasconsidered syndication fees and was recorded to additional paid-in capital.

 

On February 22,2007, the Company issued warrants to purchase up to 100,000 shares of CommonStock to the Company’s investor relations consultants valued at $447,993.  The value of these was considered syndicationfees in association with the Private Placement and was recorded to additionalpaid-in capital.

 

On November 6, 2007,in connection with a Subscription Agreement, dated November 1, 2007 (the “SubscriptionAgreement”), the Company issued to certain institutional accredited investorswarrants to purchase 1,420,000 shares of Common Stock valued at $5,374,748.  In connection with the transaction, RothCapital Partners, LLC, as placement agent, received warrants to purchase225,600 shares of Common Stock valued at $887,504.

 

Information with respectto stock warrants outstanding is as follows:

 
| **Exercise Price** | ** ** | **Outstanding  June 30, 2007** | ** ** | **Granted** | ** ** | **Expired or  Exercised** | ** ** | **Outstanding  December 31,  2007** | ** ** | **Expiration Date** | ** ** |
|-------------------------|------------|------------------------------------------|------------|-------------|------------|--------------------------------|------------|------------------------------------------|------------|--------------------------|------------|
| $                       | 3.00       |                                     | 1,300,059  |        | -0-        |                           | (275,000   | )                                        | 1,025,059  |                     | 02/22/2011 |   |
| $                       | 3.60       |                                     | 100,000    |        | -0-        |                           | -0-        |                                     | 100,000    |                     | 02/22/2010 |   |
| $                       | 8.45       |                                     | -0-        |        | 1,420,000  |                           | -0-        |                                     | 1,420,000  |                     | 11/06/2010 |   |
| $                       | 7.38       |                                     | -0-        |        | 225,600    |                           | -0-        |                                     | 225,600    |                     | 11/06/2010 |   |

 

Pursuantto Section 5.1 of the Stock Purchase Agreement, the Company agreed toreserve for issuance to investors in the private placement an aggregate of2,000,000 shares of Common Stock if the Company’s net income for the fiscalyear ending June 30, 2007 was less than US$10.4 million, as set forth inthe Company’s audited financial statements as filed with the SEC in the Company’sAnnual 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 financial statementsfor 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.  No additionalconsideration was received by the Company in connection with this issuance ofshares of Common Stock.

 

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 

 

13

----

 

amendedFebruary 20, 2007, it was determined that 771,060 shares of the Company’sCommon Stock issued to directors pursuant to such Agreement would be requiredto be cancelled in order to eliminate the $2,590,763 reflected on the June 30,2007 audited financial statements as amounts due from directors.  Such cancellation was effected on November 8,2007.

 

Pursuantto the Subscription Agreement, on November 6, 2007, the Company agreed toissue and sell in a registered direct offering (the “Offering”) an aggregate of7,100,000 shares of its common stock (“Common Stock”) at a price of $6.75 pershare (the “Purchase Price”) and an aggregate of 1,420,000 warrants to purchaseshares of its Common Stock (“Warrants” and, together with the Common Stock, the“Securities”).  The Warrants have anexercise price of $8.45 per share.  TheWarrants may not be exercised prior to May 6, 2008.  The Securities (including the shares issuableupon exercise of the Warrants) are registered under the Securities Act of 1933,as amended (the “Act”), pursuant to the Company’s existing effective shelfRegistration Statement on Form S-3. In connection with the offer and sale of the Securities, the Companyfiled on November 1, 2007, a Registration Statement on Form S-3pursuant to Rule 462(b) promulgated under the Act to register anadditional $10 million of its securities relating to its shelf RegistrationStatement.

 

TheCompany closed the Offering on November 6, 2007 (the “Closing Date”). Thenet proceeds of the offering were approximately $44 million, after deductingunderwriting commissions and discounts and other fees and expenses relating tothe offering.  The warrants were valuedat $5.3 million and were recorded to additional paid-in capital.  The Company intends to use the net proceedsfor repayment of certain existing bank debt in the amount of approximately $22million, capital expenditures related to the completion of the second reverserolling mill and annealing furnace and construction of the third reverserolling mill and related capital expenditures in the amount of approximately$18 million, and the balance for general corporate purposes.

 

Onthe Closing Date, pursuant to a Placement Agency Agreement entered into betweenthe Company and Roth Capital Partners LLC on October 31, 2007, RothCapital received an amount in cash equal to 7.0% of the gross proceeds of theOffering and warrants to purchase an amount of Common Stock equal to 3.0% ofthe total number of shares of Common Stock sold in the Offering (the “PlacementWarrants”), or 225,600 shares of Common Stock valued at $887,504 and wererecorded as syndication fees offsetting additional paid-in capital.  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.

 

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

 

SFAS 128 requires areconciliation of the numerator and denominator of the basic and dilutedearnings per share (EPS) computations.

 

For the six months ended December 31,2007 , dilutive shares include outstanding warrants to purchase 1,025,059shares of common stock at an exercise price of $3.00; 100,000 shares at anexercise price of $3.60; 1,420,000 shares at an exercise price of $8.45; and225,600 shares at an exercise price of $7.38. There were no dilutive sharesoutstanding at December 31, 2006.

 

The following reconcilesthe components of the EPS computation:

 
| ** **                                          | ** ** | **Income**      | ** ** | **Shares**        | ** ** | **Per Share** | ** ** |
|-----------------------------------------------------|------------|-----------------|------------|-------------------|------------|--------------------|------------|
| ** **                                          | ** ** | **(Numerator)** | ** ** | **(Denominator)** | ** ** | **Amount**         | ** ** |
| For the three months ended December 31, 2007:  |       |            |       |              |       |               |       |
| Net income                                          |       | $               | 2,360,869  |              |       |               |       |   |
| Less Net income from discontinued operations        |       | $               | —     |              |       |               |       |   |
| Basic EPS income available to common shareholders   |       | $               | 2,360,869  |              | 43,031,346 |               | $          | 0.05 |   |
| Effect of dilutive securities:                      |       |            |       |              |       |               |       |
| Warrants                                            |       |            |       | 607,996           |       |               |       |
| Diluted EPS income available to common shareholders |       | $               | 2,360,869  |              | 43,639,342 |               | $          | 0.05 |   |
|                                                |       |            |       |              |       |               |       |
| For the three months ended December 31, 2006:  |       |            |       |              |       |               |       |
| Net income                                          |       | $               | 2,888,044  |              |       |               |       |   |
| Less net income from discontinued operations        |       | $               | (519,879   | )                 |       |               |       |   |
| Basic EPS income available to common shareholders   |       | $               | 2,368,165  |              | 26,981,916 |               | $          | 0.09 |   |
| Effect of dilutive securities:                      |       |            |       |              |       |               |       |
| Warrants                                            |       |            |       | —            |       |               |       |
| Diluted EPS income available to common shareholders |       | $               | 2,368,165  |              | 26,981,916 |               | $          | 0.09 |   |

 
| ** **                                       | ** ** | **Income**      | ** ** | **Shares**        | ** ** | **Per Share** | ** ** |
|--------------------------------------------------|------------|-----------------|------------|-------------------|------------|--------------------|------------|
| ** **                                       | ** ** | **(Numerator)** | ** ** | **(Denominator)** | ** ** | **Amount**         | ** ** |
| For the six months ended December 31, 2007: |       |            |       |              |       |               |       |
| Net income                                       |       | $               | 5,261,595  |              |       |               |       |   |
| Less Net income from discontinued operations     |       | $               | —     |              |       |               |       |   |

 

14

----

 
| Basic EPS income available to common shareholders   |   | $      | 5,261,595 |    | 40,204,745 |   | $      | 0.13   |   |
|-----------------------------------------------------|--------|--------|-----------|---------|------------|--------|--------|--------|--------|
| Effect of dilutive securities:                      |   |   |      |    |       |   |   |
| Warrants                                            |   |   |      | 604,692 |       |   |   |
| Diluted EPS income available to common shareholders |   | $      | 5,261,595 |    | 40,809,437 |   | $      | 0.13   |   |
|                                                |   |   |      |    |       |   |   |
| For the six months ended December 31, 2006:    |   |   |      |    |       |   |   |
| Net income                                          |   | $      | 5,816,485 |    |       |   |   |   |
| Less net income from discontinued operations        |   | $      | (639,072  | )       |       |   |   |   |
| Basic EPS income available to common shareholders   |   | $      | 5,177,413 |    | 26,981,916 |   | $      | 0.19   |   |
| Effect of dilutive securities:                      |   |   |      |    |       |   |   |
| Warrants                                            |   |   |      | —  |       |   |   |
| Diluted EPS income available to common shareholders |   | $      | 5,177,413 |    | 26,981,916 |   | $      | 0.19   |   |

 

****16.  DiscontinuedOperations****

 

Theoperations of OraLabs Inc prior to December 28, 2006 are shown in thefinancial statements as income from discontinued operations as these operationswere transferred 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 andsix months ended December 31, 2007, and 2006 is as follows:

 
| ** **                          | ** **     | **Three months ended** | ** **     | **Six months ended** | ** **     |
|-------------------------------------|----------------|----------------------------------|----------------|--------------------------------|----------------|
| **** ****                      | **** **** | ****December 31,****        | **** **** | ****December 31****       | **** **** |
| **** ****                      | **** **** | ****2007****                     | **** **** | ****2006****                   | **** **** | ****2007 **** | **** **** | ****2006**** | **** **** |
|                                |           | **($ ‘000)**           | ** **     | **($ ‘000)**         | ** **     | **($ ‘000)** | ** ** | **($ ‘000)** |   |
| Revenues                            |           | $                                | -0-            |                           | $              | 5,019 |   | $ | -0- |   | $ | 9,404 |   |
| Income before tax                   |           | -0-                              |           | 676                            |           | -0- |   | 831 |   |
| Income taxes                        |           | -0-                              |           | 156                            |           | -0- |   | 192 |   |
| Income from discontinued operations |           | $                                | -0-            |                           | $              | 520 |   | $ | -0- |   | $ | 639 |   |

 

Asof December 31, 2007, there were no assets or liabilities associated withOraLabs, Inc.

 

****17.  Commitments****

 

Asof, December 31, 2007, the Company had $4,235,722 in commitments for capitalexpenditures for contractual commitments of the construction projects relatedto expansion of Chengtong’s production facilities.

 

****18.**** ****Other events****

 

OnNovember 12, 20007, at the Annual Meeting of the Company’s shareholders,the Company’s shareholders approved the reincorporation of the Company in thestate of Delaware.  The reincorporationwas effected on November 16, 2007 through a merger with and into theCompany’s wholly-owned subsidiary.

 

15

----

 

****ITEM 2. MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION****

 

**This QuarterlyReport on Form 10-Q contains statements that constitute “forward lookingstatements” within the meaning of Section 21E of the Securities Exchange Actof 1934, as amended, and Section 27A of the Securities Act of 1933, asamended. 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 arecautioned that any forward-looking statements are not guarantees of futureperformance and are subject to risks and uncertainties and that actual resultsmay differ materially from those included within the forward-looking statementsas a result of various factors. More information on these risks anduncertainties, many of which are beyond the Company’s control, is set forthunder Part II, Item 1A, “Risk Factors,” in this Quarterly Report.**

 

**While theseforward-looking statements, and any assumptions upon which they are based, aremade in good faith and reflect the Company’s current judgment regarding the directionof its business, actual results will almost always vary, sometimes materially,from any estimates, predictions, projections, assumptions or other futureperformance suggested herein. The Company undertakes no responsibility orobligation to update publicly these forward-looking statements, but may do soin the future in written or oral statements. Investors should take note of anyfuture statements made by or on behalf the Company.**

 

The following discussionshould be read in conjunction with our unaudited consolidated financialstatements and the related notes that appear in Part I, Item 1, “FinancialStatements,” of this Quarterly Report. Our unaudited consolidated financialstatements are stated in United States Dollars and are prepared in accordancewith United States Generally Accepted Accounting Principles. The followingdiscussion and analysis covers the Company’s consolidated financial conditionat December 31, 2007 (unaudited) and June 30, 2007, the end of itsprior fiscal year, and its unaudited consolidated results of operation for thethree and six month periods ended December 31, 2007 and 2006.

 

****Introduction****

 

Management’s discussionand analysis of financial condition and results of operations is intended tohelp provide an understanding of China Precision Steel, Inc. and oursubsidiaries’ (together, the “Group”) financial condition, changes in financialcondition and results of operations. This discussion is organized as follows.

 

·               ****Overview of theCompany’s Business**** - This section provides a general description of theGroup’s business, as well as recent developments that have either occurredduring the six months ended December 31, 2007 and are important inunderstanding the results of operations and financial condition or discloseknown trends.

 

·               ****Results ofOperations****- This section provides an analysis of our results of operations for the threeand six months ended December 31, 2007 and 2006. This discussion includesa brief description of significant transactions and events that have an impacton the comparability of the results being analyzed.

 

·               ****Liquidity andCapital Resources**** - This section provides an analysis of the Group’scash flows for the six months ended December 31, 2007 and 2006. Includedin this section is a discussion of the Group’s outstanding debt and thefinancial capacity available to fund the Group’s future commitments andobligations.

 

****OVERVIEWOF THE COMPANY’S BUSINESS****

 

We are a niche and highvalue-added steel processing company principally engaged in the manufacture andsale of high precision cold-rolled steel products, in the provision of heattreatment and in the cutting of medium and high-carbon hot-rolled steel strips.We use commodity steel to create a specialty premium steel intended to yieldabove-average industry gross margins. Specialty precision steel pertains to theprecision of measurements and tolerances of thickness, shape, width, surfacefinish and other special quality features of highly-engineered end-useapplications.

 

We produce and sellprecision ultra-thin and high strength cold-rolled steel products ranging from7.5 mm to 0.03 mm. We also provide heat treatment and cutting of medium andhigh-carbon hot-rolled steel strips not exceeding 7.5 mm fineness. Our processputs hot-rolled de-scaled (pickled) steel coils through a cold-rolling mill,utilizing our patented systems and high technology reduction processingprocedures, to make steel coils and sheets in customized thicknesses according tocustomer specifications. Currently, our specialty precision products are mainlyused in the manufacture of automobile parts and components, plane frictiondiscs, appliances, food packaging materials, saw blades, textile needles,microelectronics, and packing containers.

 

We conduct our operationsprincipally in China through our wholly-owned operating subsidiary, ShanghaiChengtong Precision Strip Co., Limited, or Chengtong, which, in turn, is awholly owned subsidiary of our direct subsidiary, Partner Success HoldingsLimited, 

 

16

----

 

or PSHL. Most of oursales are made domestically in China; however, during fiscal 2007,we began exporting our cold-rolled steel products to Indonesia and thePhilippines and, to a lesser extent, Nigeria and Thailand. We intend to expandinto additional overseas markets in the future, subject to suitable marketconditions and favorable regulatory controls.

 

Over the course of thepast two years, we have begun to alter our product mix to meet market demandsin our primary market, China, as well as to expand into overseas markets. Wecontinue to focus on the production of higher margin products, although we haveincreased production of certain of our lower margin products due to marketdemand. These changes in our strategy have created increased capitalrequirements as we have sought to construct additional rolling mills toaccommodate our planned growth. In addition, our workforce has increased and,in particular, we have faced a growing need for experienced executive andtechnical staff.

 

Our market is highlycompetitive, although we have focused on a niche market that we consider allowsus to compete effectively as we continue to grow our business. We facesignificant competition for raw materials, especially crude steel, and ourfinancial results may be impacted by changes in the market prices for thesematerials. Given our size, we do not have the ability to influence the pricesat which we must purchase raw materials. However, the nature of our productsenable us to pass on all or part of the price fluctuations in raw materials toour customers.

 

In the year ended June 30,2007, we added three indirect subsidiaries to our corporate structure. On April 9,2007, we purchased Shanghai Tuorong Precision Strip, Limited, or Tuorong,through PSHL. The sole activity of Tuorong is the ownership of a land use rightwith respect to facilities leased to Chengtong. On April 10, 2007, PSHLpurchased for nominal consideration Blessford International Limited, a BritishVirgin Islands company. Blessford International Limited does not conduct anybusiness, but it owns a single subsidiary, Shanghai Blessford Alloy CompanyLimited, that is a wholly-foreign owned enterprise chartered in China. We intendto hold Blessford International Limited as a shell subsidiary that may be usedin the future to facilitate optimization of the structure of the Group’sactivities.

 

****RESULTSOF OPERATIONS****

 

****ThreeMonths Ended December 31, 2007 Compared to Three Months Ended December 31,2006****

 

Net income before taxincreased by $59,007, or 2%, period-on-period to $2,782,719 for the threemonths ended December 31, 2007 from $2,723,712 for the three months ended December 31,2006 and gross profit decreased by $27,864, or 1%, period-on-period.

 

****Gross Profit****

 

Gross profits in absoluteterms decreased by $27,864, or 1%, period-on-period to $3,384,866 for the threemonths ended December 31, 2007 from $3,412,730 for the three months ended December 31,2006, while gross profit margin increased to 28.4% for the three months ended December 31,2007 from 23.0% for the three months ended December 31, 2006. The increase ingross profit margin principally resulted from production ofhigher quality products with more complexity and higher margins, which is also associated with longer production times and thus a lower volume.

 

****SalesRevenues.****Salesvolume decreased by 5,624 metric tons, or 28.6%, period-on-period to 14,010metric tons for the three months ended December 31, 2007 from 19,634 tonsfor the three months ended December 31, 2006.  As a result, sales revenues decreased by$3,093,864, or 20.6%, period-on-period to $11,913,718 for the three monthsended December 31, 2007 from $15,007,582 for the three months ended December 31,2006. We believe that the decreases in sales and sales revenues are a directresult of changes in our sales mix during the quarter to focus on high qualityhigh margin products, and thus less volume was produced due to the complexityand longer production times required for the higher margin products. The decrease in sales revenue was also attributed to an under provisionof VAT and sales tax during the first quarter of fiscal 2008 in the amount$1,991,671, which was accounted for in the second quarter.

 

Average cost ofproduction per ton increased to $609 for the three months ended December 31,2007 compared to an average cost of production per ton of $591 for the threemonths ended December 31, 2006, representing an increase of $18 per ton,or 3%, period-on-period. The 1400 mm cold-roll mill which became operational atthe beginning of October 2006 is now operating at approximately 50% of design capacity and will likely take two to three yearsto reach its maximum production capacity.

 

****Sales by ProductLine.****Abreak-down of our sales by product line for the three months ended December 31,2007 and 2006 is as follows:

 

17

----

 
| ** **                    | ** **     | **Three Months Ended December 31,** | ** **     | ** **                  | ** **     |
|-------------------------------|----------------|---------------------------------------------------------|----------------|-----------------------------|----------------|
| **** ****                | **** **** | ****2007****                                            | ** **     | ****2006****                | ** **     | ****Period-on-period**** | ** ** |
| ****Product category**** | **** **** | ****Quantity  (tons)****                                | **** **** | ****$  Amount**** | **** **** | ****% of sales**** | **** **** | ****Quantity  (tons)**** | **** **** | ****$****** Amount** | **** **** | ****% of  sales**** | **** **** | ****Qty.  Variance**** | **** **** |
|                          |           |                                                    |           |                        |           |   |   | ** ** |   |   |   |   |   |   |   |
| Low carbon cold-rolled        |           | 3,442                                                   |           | 2,478,690                   |           | 20.8 |   | 11,836 |   | 7,146,805 |   | 47.6 |   | (8,394 | ) |
| Low carbon hard rolled        |           | 4,897                                                   |           | 3,110,265                   |           | 26.1 |   | 1,724 |   | 18,721 |   | 0.1 |   | 3,173 |   |
| High-carbon cold-rolled       |           | 3,520                                                   |           | 3,706,176                   |           | 31.1 |   | 936 |   | 4,759,443 |   | 31.8 |   | 2,584 |   |
| High-carbon hot-rolled        |           | 1,171                                                   |           | 814,223                     |           | 6.8 |   | 5,138 |   | 3,082,613 |   | 20.5 |   | (3,967 | ) |
| Sales of Scrap Metal          |           | —                                                  |           | 391,735                     |           | 3.3 |   | — |   | — |   | — |   | — |   |
| Subcontracting income         |           | 980                                                     |           | 1,412,629                   |           | 11.9 |   | — |   | — |   | — |   | 980 |   |
| Total                         |           | 14,010                                                  |           | 11,913,718                  |           | 100.0 |   | 19,634 |   | 15,007,582 |   | 100 |   |   |   |
|                               |                |                                                         |                |                             |                |  |  |  |  |  |  |  |  |  |  |  |

 

Therewere various changes in the break-down of sales among our product lines overthe three months ended December 31, 2007 as we are now operating anadditional mill and are in the process of developing new products and new markets. High-carbonhot-rolled steel products only accounted for 6.8% of the current sales mix at an averageselling price of $695per ton for the three months ended December 31, 2007 compared to 20.5% of the sales mix at anaverage selling price per ton of $600for the three months ended December 31,2006. The lower priced low-carbon cold-rolled steel products accounted for 20.8% of the current sales mixat an average selling price of $720per ton for the three months ended December 31,2007 compared to  47.6% of the sales mixat an average selling price per ton of $604for the three months ended December 31,2006. Low carbon hard-rolled steel, which is also our exported precision steel products, was 0.1% of sales during thethree months ended December 31, 2006, accounted for $3,110,265, or 26.1%, of the currentsales mix at an average selling price of $635per ton for the three months ended December 31,2007.

 

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 and margins. Management believes that there are high barriersto entry in the Chinese domestic precision steel industry and that our uniquecapabilities give us a competitive advantage to grow sales of higher marginproducts as wecontinuously carry out R&D and strive to launch new products that couldpotentially lead to new segments and customers

 
| ** **                               | ** **     | **Three Months Ended   December 31,** | ** **     |
|------------------------------------------|----------------|-----------------------------------------------------------|----------------|
| ****Average selling prices**** | **** **** | ****2007****                                              | **** **** | ****2006**** | **** **** | ****Variance**** | ** ** |
| **** ****                           | **** **** | ****$****                                                 | ** **     | ****$**** | ** ** | ****$**** | ** ** | ****%**** | ** ** |
| Low-carbon cold-rolled                   |           | 720                                                       |           | 604 |   | 116 |   | 19.2 |   |
| Low-carbon hard rolled                   |           | 635                                                       |           | 11 |   | 624 |   | >  100 |   |
| High-carbon cold-rolled                  |           | 1,053                                                     |           | 5,085 |   | (4,032 | ) | (79.3 | ) |
| High-carbon hot-rolled                   |           | 695                                                       |           | 600 |   | 95 |   | 15.8 |   |
| Subcontracting income                    |           | 1,441                                                     |           | — |   | 1,441 |   | 100 |   |

 

Theaverage unit selling price per ton generated increased to $850per ton for the three monthsended December 31, 2007 compared to the corresponding period in 2006 of $764, representing an increaseof $86, or 11.3%, period-on-period. This increase was due to changes in our sales mix during thequarter to focus on high quality high margin products, and thus less volume wasproduced due to the complexity and longer production times required for thehigher margin products.. Sales of high-carbon cold-rolled steel productshave increased by 2,584 metric tons,or 276%, period-on-period to 3,520 metrictons for the three months ended December 31, 2007 compared to 936 metric tons for the threemonths ended December 31, 2006. While the volume of high-carboncold-rolled steel increased, the average sales price declined $4,032, or 79.3%, to $1,053 in thethree months ended December 31, 2007 as compared to an average selling of$5,085 in the threemonths ended December 31, 2006. This product accounted for $3,706,176, or31.1%, of the total sales mix for the three months ended December 31, 2007compared to $4,759,443, or 31.8%, of the sales mix for the three months ended December 31,2006.

 

18

----

 

****Sales Breakdown byMajor Customer.****

 
| **** ****                                            | **** **** | ****Three Months Ended December 31**** | **** **** |
|-----------------------------------------------------------|----------------|------------------------------------------------------------|----------------|
| ****Customers****                                         | **** **** | ****2007 ($ )****                                | **** **** | ****% to sales**** | **** **** | ****2006 ($ )**** | **** **** | ****% to sales**** | **** **** |
|                                                      |           |                                                       |           |   |   |   |   |   |   |
| Shanghai Changshuo Steel Company Ltd                      |           | 2,370,370                                                  |           | 20 |   |   | * |   | * |
| Shanghai  Shengdejia Metal Products Limited               |           | 3,181,709                                                  |           | 27 |   |   | * |   | * |
| Beijing Beimo Aircraft Material Technology  Ltd Co        |           | 85,468                                                     |           | 1 |   |   | * |   | * |
| Hangzhou Relian Company Limited                           |           | 266,970                                                    |           | 2 |   | 648,757 |   | 4 |   |
| Shangdong Province Boxing County Longhua Material Limited |           | 381,227                                                    |           | 3 |   |   | * |   | * |
| Shanghai Ruixuefeng Metals Co. Ltd                        |           |                                                       | *              |   | * | 5,365,141 |   | 36 |   |
| Nuoying International (HK) Co. Limited                    |           |                                                       | *              |   | * | 1,582,510 |   | 11 |   |
| Sinosteel Company Limited                                 |           |                                                       | *              |   | * | 2,137,467 |   | 14 |   |
| Shanghai Xin Zhong Da Trading Co. Limited                 |           |                                                       | *              |   | * | 933,762 |   | 6 |   |
|                                                      |           | 6,285,744                                                  |           | 53 |   | 10,667,637 |   | 71 |   |
| Others                                                    |           | 5,627,974                                                  |           | 47 |   | 4,339,945 |   | 29 |   |
| ****Total****                                             |           | 11,913,718                                                 |           | 100 |   | 15,007,582 |   | 100 |   |

 

----

*** Not major customers forthe relevant periods**

 

Sales revenues generatedfrom the top five major customers as a percentage of total sales decreased to53% for the three months ended December 31, 2007 as compared to 71% forthe three months ended December 31, 2006. With the exception of HangzhouRelian Company Limited, the top five major customers were differentperiod-on-period. The change in customer mix reflects our shift in productfocus during the course of the period.

 

****Cost of Sales********.****

 
| **** ****               | **** **** | ****Three Months Ended December 31,**** | **** **** |
|------------------------------|----------------|-------------------------------------------------------------|----------------|
| **** ****               | **** **** | ****2007****                                                | **** **** | ****2006**** | **** **** | ****Variance**** | ** ** |
| ** **                   | ** **     | **$**                                                       | ** **     | **$** | ** ** | **$** | ** ** | ** %** | ** ** |
| ****Cost of sales****        |           |                                                        |           |   |   |   |   |   |   |
| - Raw materials              |           | 6,362,758                                                   |           | 10,618,130 |   | (4,255,372 | ) | (40.1 | ) |
| - Direct labor               |           | 167,926                                                     |           | 184,467 |   | (16,541 | ) | (8.9 | ) |
| - Factory overhead           |           | 1,998,168                                                   |           | 792,255 |   | 1,205,913 |   | 152.2 |   |
|                         |           | 8,528,852                                                   |           | 11,594,852 |   | (3,066,000 | )  | (26.4 | ) |
|                         |           |                                                        |           |   |   |   |   |   |   |
| ****Cost per units  sold**** |           |                                                        |           |   |   |   |   | (28.6 | ) |
| Total units sold             |           | 14,010                                                      |           | 19,634 |   | (5,624 | ) |   |   |
| Average cost per unit sold   |           | 609                                                         |           | 591 |   | 18 |   | 3.0 |   |

 

Cost of sales decreasedby $3,066,000, or 26.4%, period-on-period to $8,528,852 for the three monthsended December 31, 2007 from $11,594,852 for the three months ended December 31,2006. Cost of sales represented 71.6% of sales revenues for the three monthsended December 31, 2007 compared to 77.3% for the three months ended December 31,2006. Average cost per ton sold increased by $18, or 3%, period-on-period to $609per ton for the three months ended December 31, 2007 from $591 per ton forthe three months ended December 31, 2006. Meanwhile, the average sellingprice per ton increased by $86 per ton, or 11.3%, period-on-period to $850 perton for the three months ended December 31, 2007 from $764 per ton for thethree months ended December 31, 2006.

 

The raw materials costcomponent relative to sales revenues decreased to 57.4% for the three monthsended December 31, 2007 compared to 70.7% for the three months ended December 31,2006. This was attributable to production of higher profit margin productsduring the three months ended December 31, 2007 as compared to the sameperiod in 2006.

 

Management believes thatthe decrease in cost of sales is represented by the combined effect of:

 

·                  significant decreases in sales of low-carboncold-rolled steel to 3,442 metric tons (compared to 11,836 metric tons for thethree months ended December 31, 2006) was generated at an average sellingprice of $720 per ton (compared to $604 for the three months ended December 31,2006) for the three months ended December 31, 2007;

 

·                  sales of 3,520 metric tons of high-carbon cold-rolledsteel (compared to 936 metric tons for the three months ended December 31,2006) generated at an average selling price of $1,053 per ton (compared to$5,085 per ton for the three months ended December 31, 2006) for the threemonths ended December 31, 2007; and

 

·                  sales of 4,897 metric tons of low-carbon hard-rolledsteel at (compared to 1,724 for the three months ended 

 

19

----

 

December 31,2006) generated at an average selling price of $635 per ton for the threemonths ended December 31, 2007.

 

The cost of raw materialsconsumed decreased by $4,255,372, or 40.1%, period-on-period to $6,362,758 forthe three months ended December 31, 2007 from $10,618,130 for the threemonths ended December 31, 2006. This decrease was mainly attributable todecreases in sales volume by 5,624 metric tons, or 28.6%, period-on-period to14,010 metric tons for the three months ended December 31, 2007 from19,634 metric tons for the three months ended December 31, 2006 resultingin lower input of raw materials utilized in production. Average unit cost ofraw materials per unit produced decreased by $87 per ton, or 16.1%,period-on-period to $454 per ton for the three months ended December 31,2007 from $541 per ton for the three months ended December 31, 2006.

 

Manufacturing overheadcosts increased by $1,205,913, or 152.2%, period-on-period to $1,998,168 forthe three months ended December 31, 2007 from $792,255 for the threemonths ended December 31, 2006. The increase was mainly attributable tothe combined effect of an increase in utilities by $190,792, or 147%,period-on-period to $320,736 for the three months ended December 31, 2007from $129,944 for the three months ended December 31, 2006, an increase inconsumables by $547,404, or 764%, period-on-period to $619,088 for the threemonths ended December 31, 2007 from $71,684 for the three months ended December 31,2006 and an increase in pension costs of $32,020, or 115%, period-on-period to$59,741 for the three months ended December 31, 2007, from $27,731 for thethree months ended December 31, 2006.

 

****Expenses****

 

*****SellingExpenses*****. Selling expenses increased by $116,051, or 179%, period-on-period, to$180,744 for the three months ended December 31, 2007 compared to thecorresponding period in 2006 of $64,693. The increase was mainly attributableto increases in transportation, which rose by 287% period-on-period, due to ourincreased delivery charges of precision steel resulting from a broader customerbase, especially exports where our standard contract terms are F.O.B. and we incur transportation costs to the port of shipment, plus loading costs, as well as an increase in the frequencyof deliveries.

 

*****AdministrativeExpenses*********.******** ****Administrative expenses increased by $347,981,or 69.6%, period-on-period, to $846,218 for the three months ended December 31,2007 compared to the comparable period in 2006. This increase was chiefly duetoincreases in costs associated with our NASDAQ listingand SEC compliance obligations. There were also increasesin salaries and wages which were principally due to increases in themonthly salaries of the management staff aswell as increase in averagenumber of Chengtongstaff.

 

*****FinanceCosts*****.Net finance cost increased 176% period-on-period as a result of the increase intotal interest expense by $202,117 for 2007 compared to $114,743 for 2006.

 

****SixMonths Ended December 31, 2007 Compared To Six Months Ended December 31,2006****

 

Net income before taxincreased by $203,263, or 3.4%, period-on-period to $6,190,584 for the sixmonths ended December 31, 2007 from $5,987,321 for the six months ended December 31,2006 and gross profit increased by $1,336,449, or 18.8%, period-on-period.

 

****Gross Profit****

 

Gross profits in absoluteterms increased by $1,336,449, or 18.8%, period-on-period to $8,452,429 for thesix months ended December 31, 2007 from $7,115,980 for the six monthsended December 31, 2006, while gross profit margin decreased to 22.7% forthe six months ended December 31, 2007 from 27.9% for the six months endedDecember 31, 2006. The increase in gross profits is mainly attributable toincrease in sales during the six months ended December 31, 2007. Thedecrease in gross profit margin principally resulted from a change in sales mixover the six months ended December 31, 2007, which produced increasedsales of lower margin low-carbon steel products and an increase in the cost ofsales.

 

****SalesRevenues.****Salesvolume increased by 23,885 metric tons, or 80.9%, period-on-period to 53,378metric tons for the six months ended December 31, 2007 from 29,493 tonsfor the six months ended December 31, 2006.  As a result, sales revenues increased by $11,715,486,or 45.9%, period-on-period to $37,226,416 for the six months ended December 31,2007 from $25,510,930 for the six months ended December 31, 2006. Webelieve that the increases in sales and sales revenues are a direct result ofincreases in our capacity and the continuousbuilding of our brand both inside andoutside China amongusers of precision steel products.

 

Average cost ofproduction per ton decreased to $539 for the six months ended December 31,2007 compared to an average cost of production per ton of $624 for the sixmonths ended December 31, 2006, representing an decrease of $85 per ton,or 13.6%, period-on-period. The 1400 mm cold-roll mill which became operationalin October 2006 is now operating atapproximately 50% of design capacity. Greater production capacity and more flexibility inour sales mix has resulted in a decrease in the average cost of production 

 

20

----

 

during the six monthsended December 31, 2007.

 

****Sales by ProductLine********.****A break-down of our sales by product line for the sixmonths ended December 31, 2007 and 2006 is as follows:

 
| **** ****                | **** **** | ****2007****             | ** **     | ****2006****              | ** **     | ****Period-on-period****     | ** **     |
|-------------------------------|----------------|--------------------------|----------------|---------------------------|----------------|------------------------------|----------------|
| ****Product category**** | **** **** | ****Quantity  (tons)**** | **** **** | ****$****** Amount** | **** **** | ****% of sales**** | **** **** | ****Quantity  (tons)**** | **** **** | ****$****** Amount** | **** **** | ****% of  sales**** | **** **** | ****Qty.  Variance**** | **** **** |
|                          |           |                     |           |                      |           |                         |           |   |   |   |   |   |   |   |   |
| Low carbon cold-rolled        |           | 17,762                   |           | 10,957,553                |           | 29.4                         |           | 17,819 |   | 10,813,463 |   | 42.4 |   | (57 | ) |
| Low carbon hard rolled        |           | 7,284                    |           | 4,708,053                 |           | 12.6                         |           | — |   | — |   | — |   | 7,284 |   |
| High-carbon cold-rolled       |           | 12,456                   |           | 17,372,822                |           | 46.7                         |           | 2,178 |   | 9,625,855 |   | 37.7 |   | 10,278 |   |
| High-carbon hot-rolled        |           | 5,254                    |           | 2,183,041                 |           | 5.9                          |           | 7,516 |   | 4,892,024 |   | 19.2 |   | (2,262 | ) |
| Sales of Scrap Metal          |           | —                   |           | 485,887                   |           | 1.3                          |           | — |   | — |   | — |   | — |   |
| Subcontracting income         |           | 10,622                   |           | 1,519,060                 |           | 4.1                          |           | 1,980 |   | 179,588 |   | 0.7 |   | 8,642 |   |
| Total                         |           | 53,378                   |           | 39,226,416                |           | 100.0                        |           | 29,493 |   | 25,510,930 |   | 100.0 |   |   |   |

 

Therewere various changes in the break-down of sales among our product lines overthe six months ended December 31, 2007 as we are now operating anadditional mill and are in the process of developing new markets. High-carbonhot-rolled steel products only accounted for 5.9% of the current sales mix at an averageselling price of $416per ton for the six months ended December 31, 2007 compared to 19.3% of the sales mix at anaverage selling price per ton of $651 for the six months ended December 31,2006. The lower priced low-carbon cold-rolled steel products accounted for 29.4% of the current sales mixat an average selling price of $617 per ton for the six months ended December 31,2007 compared to 42.4% of the sales mix at an average selling price per ton of$607for the sixmonths ended December 31, 2006. Low carbon hard-rolled steel, which wasnot sold during the six months ended December 31, 2006, accounted for$4,708,053, or 12.6%, of the current sales mix at an average selling price of$646per ton for thesix months ended December 31, 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 and margins. Management believes that there are high barriersto entry in the Chinese domestic precision steel industry and that our uniquecapabilities give us a competitive advantage to grow sales of higher marginproducts as wecontinuously carry out R&D and strive to launch new products that couldpotentially lead to new segments and customers.

 
| ** **                               | ** **     | **Six Months Ended  December 31,** | ** **     |
|------------------------------------------|----------------|---------------------------------------------------|----------------|
| ****Average selling prices**** | **** **** | ****2007****                                      | **** **** | ****2006**** | **** **** | ****Variance**** | ** ** |
| **** ****                           | **** **** | ****$****                                         | **** **** | ****$**** | ** ** | ****$**** | ** ** | ****%**** | ** ** |
| Low-carbon cold-rolled                   |           | 617                                               |           | 607 |   | 10 |   | 1.6 | % |
| Low-carbon hard rolled                   |           | 646                                               |           | — |   | 646 |   | 100 | % |
| High-carbon cold-rolled                  |           | 1,395                                             |           | 4,420 |   | (3,025 | ) | (68.4 | %) |
| High-carbon hot-rolled                   |           | 416                                               |           | 651 |   | 95 |   | 36.1 | % |
| Subcontracting income                    |           | 143                                               |           | 91 |   | 1,441 |   | 57 | % |

 

Theaverage unit selling price per ton generated decreased to $697per ton for the six monthsended December 31, 2007 compared to the corresponding period in 2006 of$865, representing a decrease of $168, or 19.4%, period-on-period. Thisdecrease was due to changesin the sales mix for the six months ended December 31, 2007 as compared to2006. Sales of high-carbon cold-rolled steel products have increased by 10,278 metric tons, or 472%,period-on-period to 12,456 metric tons for the six months ended December 31,2007 compared to 2,178 metric tonsfor the six months ended December 31, 2006. While the volume ofhigh-carbon cold-rolled steel increased, the average sales price declined $3,025, or 68.4%, to $1,395 in thesix months ended December 31, 2007 as compared to an average selling of $4,420 in the six months ended December 31,2006. This product accounted for $17,372,822, or 46.7%, of the total sales mixfor the six months ended December 31, 2007 compared to $9,625,855, or37.7%, of the sales mix for the six months ended December 31, 2006.

 

21

----

 

****Sales Breakdown byMajor Customer.****

**** ****
| **** ****                                            | **** **** | **** ****

****Six Months Ended December 31**** | **** **** |
|-----------------------------------------------------------|----------------|--------------------------------------------------------------------------|----------------|
| ****Customers****                                         | **** **** | ****2007 ($ )****                                              | **** **** | ****% to sales**** | **** **** | ****2006 ($ )**** | **** **** | ****% to sales**** | **** **** |
|                                                      |           |                                                                     |           |   |   |   |   |   |   |
| Shanghai Changshuo Steel Company Ltd                      |           | 11,076,780                                                               |           | 30 |   |   | * |   | * |
| Shanghai  Shengdejia Metal Products Limited               |           | 6,492,562                                                                |           | 17 |   |   | * |   | * |
| Beijing Beimo Aircraft Material Technology  Ltd Co        |           | 1,843,650                                                                |           | 5 |   |   | * |   | * |
| Hangzhou Relian Company Limited                           |           | 1,670,246                                                                |           | 4 |   | 1,934,532 |   | 7 |   |
| Shangdong Province Boxing County Longhua Material Limited |           | 1,667,100                                                                |           | 4 |   |   | * |   | * |
| Shanghai Ruixuefeng Metals Co. Ltd                        |           |                                                                     | *              |   | * | 9,254,127 |   | 36 |   |
| Nuoying International (HK) Co. Limited                    |           |                                                                     | *              |   | * | 1,708,265 |   | 7 |   |
| Sinosteel Company Limited                                 |           |                                                                     | *              |   | * | 3,219,796 |   | 13 |   |
| Shanghai Xin Zhong Da Trading Co. Limited                 |           |                                                                     | *              |   | * | 1,507,757 |   | 7 |   |
|                                                      |           | 22,750,338                                                               |           | 60 |   | 10,667,637 |   | 69 |   |
| Others                                                    |           | 14,476,078                                                               |           | 40 |   | 7,886,453 |   | 31 |   |
| ****Total****                                             |           | 37,226,416                                                               |           | 100 |   | 25,510,930 |   | 100 |   |

 

----

*** Not major customers forthe relevant periods**

 

Sales revenues generatedfrom the top five major customers as a percentage of total sales decreased to60% for the six months ended December 31, 2007 as compared to 69% for thesix months ended December 31, 2006. With the exception of Hangzhou RelianCompany Limited, the top five major customers were different period-on-period.The change in customer mix reflects our shift in product focus during thecourse of the period.

 

****Cost of Sales********.****

**** ****
| **** ****               | **** **** | ****Six Months Ended December 31,**** | **** **** |
|------------------------------|----------------|-----------------------------------------------------------|----------------|
| **** ****               | **** **** | ****2007****                                              | **** **** | ****2006**** | **** **** | ****Variance**** | ** ** |
| ** **                   | ** **     | **$**                                                     | ** **     | **$** | ** ** | **$** | ** ** | **%** | ** ** |
| ****Cost of sales****        |           |                                                      |           |   |   |   |   |   |   |
| - Raw materials              |           | 24,973,918                                                |           | 16,335,269 |   | 8,638,649 |   | 52.9 |   |
| - Direct labor               |           | 346,011                                                   |           | 336,392 |   | 9,619 |   | 2.9 |   |
| - Factory overhead           |           | 3,454,058                                                 |           | 1,723,289 |   | 1,730,769 |   | 100.4 |   |
|                         |           | 28,773,987                                                |           | 18,394,950 |   | 10,379,037 |   | 56.4 |   |
|                         |           |                                                      |           |   |   |   |   |   |   |
| ****Cost per units  sold**** |           |                                                      |           |   |   |   |   |   |   |
| Total units sold             |           | 53,378                                                    |           | 29,493 |   | 23,885 |   | 81.0 |   |
| Average cost per unit sold   |           | 539                                                       |           | 624 |   | (85 | ) | (13.6 | ) |

 

Cost of sales increasedby $10,379,037, or 56.4%, period-on-period to $28,773,987 for the six monthsended December 31, 2007 from $18,394,950 for the six months ended December 31,2006. Cost of sales represented 77.3% of sales revenues for the six monthsended December 31, 2007 compared to 72.1% for the six months ended December 31,2006. Average cost per ton sold decreased by $85, or 13.6%, period-on-period to$539 per ton for the six months ended December 31, 2007 from $624 per tonfor the six months ended December 31, 2006. Meanwhile, the average sellingprice per ton decreased by $168 per ton, or 19.4%, period-on-period to $697 perton for the six months ended December 31, 2007 from $865 per ton for thesix months ended December 31, 2006.

 

The raw materials costcomponent relative to sales revenues increased to 67.1% for the six monthsended December 31, 2007 compared to 64% for the six months ended December 31,2006. This was attributable to changes in the production mix of products withdifferent gross margins in the six months ended December 31, 2007 ascompared to the six months ended December 31, 2006.  This mix of lower margin products, primarilyproduced in the first quarter, was related to a decision by management toreduce levels of raw materials inventory to a more healthy level.

 

Management believes that theincrease in cost of sales is represented by the combined effect of:

 

·                  sales of 12,456 metric tons ofhigh-carbon cold-rolled steel (compared to 2,178 metric tons for the six monthsended December 31, 2006) generated at an average selling price of $1,395per ton (compared to $4,420 per ton for the six months ended December 31,2006) for the six months ended December 31, 2007; and

 

·                  sales of 7,284 metric tons of low-carbonhard-rolled steel (compared to none for the six months ended December 31, 

 

22

----

 

2006)generated at an average selling price of $646 per ton for the six months ended December 31,2007.

 

The cost of raw materialsconsumed increased by $8,638,649, or 52.9%, period-on-period to $24,973,918 forthe six months ended December 31, 2007 from $16,335,269 for the six monthsended December 31, 2006. This increase was mainly attributable toincreases in sales volume by 23,885 metric tons, or 81%, period-on-period to53,378 metric tons for the six months ended December 31, 2007 from 29,493metric tons for the six months ended December 31, 2006 resulting in higherinput of raw materials utilized in production. Average unit cost of rawmaterials per unit produced decreased by $86 per ton, or 15.5%,period-on-period to $468 per ton for the six months ended December 31,2007 from $554 per ton for the six months ended December 31, 2006.

 

Manufacturing overheadcosts increased by $1,730,769, or 100.4%, period-on-period to $3,454,058 forthe six months ended December 31, 2007 from $1,723,289 for the six monthsended December 31, 2006. The increase was mainly attributable to thecombined effect of an increase in depreciation by $365,665, or 61.3%,period-on-period to $961,808 for the six months ended December 31, 2007from $596,143 for the six months ended December 31, 2006, an increase inutilities by $413,956, or 161.6%, period-on-period to $670,043 for the sixmonths ended December 31, 2007 from $256,087 for the six months ended December 31,2006, and an increase in consumables by $684,404, or 181.7%, period-on-periodto $1,061,171 for the six months ended December 31, 2007 from $376,767 forthe six months ended December 31, 2006.

 

****Expenses****

 

*****SellingExpenses*****. Selling expenses increased by $177,059, or 170%, period-on-period, to$281,449 for the six months ended December 31, 2007 compared to thecorresponding period in 2006 of $104,390. The increase was mainly attributableto increases in transportation, which rose by 444% period-on-period, due to ourincreased delivery charges of precision steel resulting from a broader customerbase, especially exports where our standard contract terms are F.O.B.  and we incur transportation costs to theport of shipment, plus loading costs, as well as an increase in the frequency ofdeliveries.

 

*****AdministrativeExpenses*********.******** ****Administrative expenses increased by $647,670,or 94.6%, period-on-period, to $1,332,595 for the six months ended December 31,2007 compared to $684,925 in the comparable period in 2006. This increase waschiefly due to expenses relating to the Company’s SEC and NASDAQcompliance obligations. There were also increases in salaries and wages which wereprincipally due to increases in the monthly salaries of the management staff as well as increase in average number of Chengtongstaff.

 

*****FinanceCosts*****.Net finance cost increased 138% period-on-period as a result of increases intotal interest expense by $440,919 to $759,001 in 2007 compared to $318,082 for2006.

 

****LIQUIDITYAND CAPITAL RESOURCES****

 

Our business is capitalintensive and requires substantial expenditures for, among other things, thepurchase and maintenance of equipment used in our operations. Our short-termand long-term liquidity needs arise primarily from capital expenditures,working capital requirements and principal and interest payments related to ouroutstanding indebtedness. We have met these liquidity requirements with cashprovided by operations, equity financing, and bank debt.

 

Net cash flows used inoperating activities for the six months ended December 31, 2007 was $6,890,900as compared with $5,473,819 provided by operating activities for the six monthsended December 31, 2006, for a net decrease of $12,364,719.  This increase was due primarily to anincrease in bank acceptance notes not previously held at June 30, 2007.

 

Net cash flows used ininvesting activities for the six months ended December 31, 2007 was $5,508,327as compared with $10,212,328 for the six months ended December 31,2006.  The decrease in investing activitywas due to reduced construction during the six months ended December 31,2007 as compared to the same period in 2006.

 

Net cash flows providedby financing activities for the six months ended December 31, 2007, was$45,509,187 as compared with $5,070,544 provided by financing activities forthe six months ended December 31, 2006. The six months ended December 31,2006****reflect borrowings which were incurredfor expansion of the operations and to finance the construction-in-progress onnew facilities. Repayments on advances from directors in 2006 partially offsetthe bank borrowings. During the six months ended December 31, 2007, theCompany received $44 million in net proceeds from the sale of its equitysecurities, which will be used for repayment of certain bank debt, capitalexpenditures relating to the new facilities and working capital. Also duringthe six months ended December 31, 2007, a director cancelled stock in theamount of  $2 million which was appliedagainst amounts owed by the director at June 30, 20007.

 

**Currentassets**.Current assets increased significantly by $55,930,784, or 135%,period-on-period to $97,269,778 as of December 31, 2007 from $41,338,994as of June 30, 2007, principally as a result of increases in cash andequivalents by $34,700,249, or 630%, 

 

23

----

 

period-on-period, accountsreceivable by $11,646,228, or 141%, period-on-period, bank acceptance notes of$15,383,562, or 100%, 

period on period offsetby a decline in inventories of $5,052,069, or 32.1%, period-on-period. We alsoraised gross proceeds of $44 million in November of 2007 through theprivate sale of our equity securities.

 

**Currentliabilities**.Current liabilities increased by $14,190,188, or 54%, period-on-period to $40,446,345as of December 31, 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 current portion of long-term debt.

 

As of December 31,2007, we had $16,713,720 in short term bank debt. We expect to refinance suchdebt during the current year, but we cannot assure you that we will be able todo so on terms favorable to the Company or at all.

 

**CapitalExpenditures**.**  **Duringthe three months ended December 31, 2007, we invested $5,508,327 inproperty, production plants and equipment. We believe these capital investmentsincrease our capacity, expand our product line, and reduce risks related tooccupancy costs, thereby creating new opportunities to grow sales and controlexpenses.

 

During the current year,we expect to make additional investments in a new continuous annealing line anda new 1700mm cold roll mill at our facilities in Shanghai. We estimate thatthese investments could total up to $20 million. We intend to fund theseinvestments through a combination of funds from operations, working capital,bank debt and the recent $47.9 million financing which was completed in November 2007.The actual combination of sources of funds will be dependant upon marketconditions at the time of implementation.

 

****OFF-BALANCESHEET ARRANGEMENTS****

 

For the three and sixmonths ended December 31, 2007, we did not have any off-balance sheetarrangements.

 

****CONTRACTUALOBLIGATIONS****

 
| **** ****              | **** **** | ****At December 31, 2007  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            |           | $                                                                                  | 23,078,655     |   | $ | 20,601,531 |   | $ | 2,477,124 |   | $ | — |   | $ | — |   |
| Construction Commitments    |           | 4,270,236                                                                          |           | 4,270,236 |   | — |   | — |   | — |   |
|                        |           | $                                                                                  | 27,348,891     |   | $ | 24,871,767 |   | $ | 2,477,124 |   | $ | — |   | $ | — |   |

 

****Bank Debt****

 

Bank and other loansdecreased by $769,132, or 3.3% period-on-period to $22,115,547 as of December 31,2007 from $22,884,679 as of June 30, 2007. The decrease was attributableto the partial payoff of outstanding loans.

 

****Short-termbank loans****

 

Short-term bank loansincreased by $6,871,200 or 69.8%, period on period to $16,713,720 as of December 31,2007 compared to $9,842,520 as of June 30, 2007.

 

****Long-termbank loans****

 

The current portion oflong-term debt decreased 49.9% from $6,163,445 at June 30, 2007 to$3,086,758 at December 31, 2007.

 

Long-term portion of bankloans decreased by $4,563,645, or 66.3%, period-on-period to $2,315,069 as of December 31,2007 compared to $6,878,714 as of June 30, 2007.

 

****Land Use Rights****

 

InOctober 2004, Tuorong agreed to purchase a land use right from the ShanghaiLabor and Economic Development Council with respect to a 20-acre parcel for alease period of 50 years at a cost of $472,441. Additionally in November 2005,Chengtong agreed to purchase a land use right from the Shanghai XuhangIndustrial Development Co., Ltd. with respect to a 27.04-acre parcel for alease period of 50 years at a cost of $497,795. In November 2006, Chengtongentered into an agreement with the Shanghai Labor and Economic DevelopmentCouncil which supersedes the aforementioned Tuorong agreement to purchase atotal of 21.34-acre parcel for a lease period of 50 years at an aggregateamount of $672,126. In December 2006, Tuorong entered into a CompensationAgreement with the Shanghai Jiading Housing, Land and Resource ManagementBureau to pay an aggregate amount of $637,294 in connection to the twoaforementioned parcels.

 

24

----

 

****Inflation****

 

We believe that inflationhas not had a material effect on our results of operations. We generallymanufacture our products to match orders from our customers. Due to thespecialized nature of our products, we are able to purchase raw materials basedupon customer orders. This operating model allows us to effectively pass alongfluctuations in the price of raw materials to our customers. For commonly usedraw materials, we purchase larger quantities when we believe prices are likelyto increase in the short term in order to minimize the impact of any such priceincrease.

 

****CRITICALACCOUNTING POLICIES AND ESTIMATES****

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires our management to make assumptions,estimates and judgments that affect the amounts reported in the financialstatements, including the notes thereto, and related disclosures of commitmentsand contingencies, if any. We consider our critical accounting policies to be thosethat require the more significant judgments and estimates in the preparation offinancial statements, including the following:

 

·               **FunctionalCurrency and Translating Financial Statements** — The consolidated financial statementshave been prepared in accordance with accounting principles generally acceptedin the United States of America. Our functional currency is Chinese Renminbi; however,the accompanying consolidated financial statements have been expressed in USD.The consolidated balance sheets have been translated into USD at the exchangerates prevailing at each balance sheet date. The consolidated statements ofoperations and cash flows have been translated using the weighted-averageexchange rates prevailing during the periods of each statement.

 

·               **Advances toSuppliers and from Customers**- As is common practice in China, Chengtong will oftenmake advance payments to its suppliers for materials, or receive advancepayments from its customers. In some cases, the same party may be both asupplier to, and customer of, Chengtong. In such cases, Chengtong may make anadvance to a third party as supplier and receive an advance from the same partyas a customer. Chengtong’s practice is to offset such amounts against eachother. We have established an allowance for doubtful accounts as a reserveagainst advances made to suppliers to the extent that the related goods are notreceived within ninety (90) days of the advance.

 

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

 

****RECENTACCOUNTING PRONOUNCEMENTS****

 

InSeptember 2006, the FASB issued Statement No. 157, “Fair ValueMeasurements” (“SFAS No. 157”). SFAS No. 157 addresses how companiesshould measure fair value when they are required to use a fair value measurefor recognition or disclosure purposes under generally accepted accountingprinciples. SFAS No. 157 defines fair value, establishes a framework formeasuring fair value and expands the required disclosures about fair valuemeasurements. SFAS No. 157 is effective for fiscal years beginning after November 15,2007, with earlier adoption permitted. Management is assessing the impact ofthe adoption of SFAS No. 157.

 

InSeptember 2006, the FASB issued Statement No. 158, “Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS No. 158”),an amendment of FASB Statements No. 87, 88, 106 and 132(R). SFAS No. 158requires (a) recognition of the funded status (measured as the differencebetween the fair value of the plan assets and the benefit obligation) of abenefit plan as an asset or liability in the employer’s statement of financialposition, (b) measurement of the funded status as of the employer’s fiscalyear-end with limited exceptions, and (c) recognition of changes in thefunded status in the year in which the changes occur through comprehensiveincome. The requirement to recognize the funded status of a benefit plan andthe disclosure requirements are effective as of the end of the fiscal yearending after December 15, 2006. The requirement to measure the plan assetsand benefit obligations as of the date of the employer’s fiscal year-endstatement of financial position is effective for fiscal years ending after December 15,2008. SFAS No. 158 has no current applicability to the Company’s financialstatements.

 

25

----

 

InSeptember 2006, the Securities and Exchange Commission issued StaffAccounting Bulletin 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 a balancesheet and income statement approach and to evaluate whether either approachresults in quantifying an error that is material in light of relevantquantitative and qualitative factors. When the effect of initial adoption ismaterial, companies will record the effect as a cumulative effect adjustment tobeginning of year retained earnings and disclose the nature and amount of eachindividual error being corrected in the cumulative adjustment. Complying withthe requirements of SAB No. 108 had no impact on the Company’s financialstatements.

 

InFebruary 2007, the FASB issued Statement No. 159, “The Fair ValueOption for Financial Assets and Financial Liabilities” (“SFAS No. 159”),an amendment 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 for fiscalyears beginning after November 15, 2007, with earlier adoption permitted.Management is assessing the impact of the adoption of SFAS No. 159.

 

In December 2007,the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS141(R)”). SFAS 141(R) will change the accounting for businesscombinations. Under SFAS No. 141(R), an acquiring entity will be requiredto recognize all the assets acquired and liabilities assumed in a transactionat the acquisition-date fair value with limited exceptions. SFAS No. 141(R) willchange the accounting treatment and disclosure for certain specific items in abusiness combination. SFAS No. 141(R) applies prospectively tobusiness combinations for which the acquisition date is on or after thebeginning of the first annual reporting period beginning on or after December 15,2008. SFAS 141(R) will impact the Company in the event of any futureacquisition.

 

In December 2007,the FASB issued SFAS No. 160, “Non-controlling Interests in ConsolidatedFinancial Statements—an amendment of Accounting Research Bulletin No. 51”(“SFAS 160”). SFAS 160 establishes new accounting and reporting standards forthe noncontrolling interest in a subsidiary and for the deconsolidation of asubsidiary. SFAS No. 160 is effective for fiscal years beginning on orafter December 15, 2008. The Company does not believe that SFAS 160 willhave a material impact on its consolidated financial statements.

 

****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 estimating actuallosses in fair value that can occur from changes in market conditions.

 

****Foreign CurrencyExchange 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 of December 31,2007 the exchange rate was 7.2946 Yuan to 1.00 U.S. Dollar. The exchange rateof Renminbi is subject to changes in China’s government policies which are, toa large extent, dependent on the economic and political development bothinternationally and locally and the demand and supply of Renminbi in thedomestic market. There can be no assurance that such exchange rate willcontinue to remain stable in the future amongst the volatility of currencies,globalization and the unstable economies in recent years. Since (i) ourincome 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.

 

26

----

 

AtDecember 31, 2007, the Group’s outstanding financial instruments withforeign currency exchange rate risk exposure had an aggregate fair value of $5million (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 $0.5million at December 31, 2007.

 

****Interest Rates****

 

TheGroup is subject to interest rate risk on its non-derivative financialinstruments. The Group does not hedge its interest rate risk. At December 31,2007, the Group’s total bank debt outstanding was $22,115,547, all of which wasinterest-bearing. Substantially all of the bank debt was floating-rate debtwith interest rates which vary with changes in the standard rate set by thePeople’s Bank of China. A change in the interest rate or yield of fixed ratedebt will only impact the fair value of such debt, while a change in theinterest rate of floating rate, or variable rate, debt will impact interestexpense as well as the amount of cash required to service such debt. To theextent interest rates increase, we will be liable for higher interest paymentsto its lenders. For the current financial year, annual interest on loans isanticipated to be approximately $1.6million. The impact of a 1% increase ininterest rates will increase interest expense by approximately $220,000. As our short-termborrowings mature, it will be required to either repay or refinance theseborrowings. An increase in short-term interest rates at the time that we seekto refinance short-term borrowings may increase the cost of borrowings, whichmay adversely affect our earnings and cash available for distribution to itsshareholders.

 

AtDecember 31, 2007, the aggregate fair value of the Group’s financialinstruments with exposure to interest rate risk was approximately $22million. 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 December 31, 2007.

 

****Commodity Prices****

 

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 December 31, 2007and does 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 the Company’sdisclosure 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 December 31, 2007,the Company’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.

 

Toaddress these concerns, we have engaged an outside management consultant toreview the Company’s overall financial and accounting systems, and to documentand implement an accounting manual that will strengthen and improve the systemsof controls, reconciliations, procedures, books and records. In addition, weare continuing our search for a senior financial executive with experience withU.S. GAAP and U.S. public company reporting and compliance obligations.  Further resources will be added to theaccounting department that is currently understaffed. In January 2008, wereceived from the outside management consultants the first draft on theinternal control systems documentations which is currently being reviewed byour management.

 

Wedo not consider that the deficiencies and weaknesses that we have identifiedjeopardize the quality of our financial statements for the period under reviewor for prior periods.

 

27

----

 

(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 ExchangeAct) during the period under review that materially affected, or are reasonablylikely to material affect, our internal control over financial reporting.

 

ThisQuarterly Report does not include a report of management’s assessment regardinginternal control over financial reporting or an attestation report by ourregistered public accounting firm due to a transition period established by therules of the SEC.

 

28

----

 

**PART II - OTHER INFORMATION**

 

**ITEM 1.**   **LEGALPROCEEDINGS.**

 

As of the date of this Quarterly Report, there is nopending litigation against the Company nor was there any litigation initiatedby the Company.

 

**ITEM 1A. RISK FACTORS.**

 

****Weoperate in a highly competitive environment in which there are numerous factorswhich can influence our business, financial position or results of operationsand which can also cause the market value of our common stock to decline. Manyof these factors are beyond our control and therefore, are difficult topredict. The following section sets forth what we believe to be the principalrisks that could affect us, our business or our industry, and which couldresult in a material adverse impact on our financial results or cause themarket price of our common stock to fluctuate or decline.****

 

****Risks Relating tothe Company’s Business****

 

****Steelconsumption is cyclical and worldwide overcapacity in the steel industry andthe availability of alternative products has resulted in intense competition,which may have an adverse effect on our profitability and cash flow.****

 

Steel consumption ishighly cyclical and generally follows general economic and industrialconditions both worldwide and in various smaller geographic areas. The steelindustry has historically been characterized by excess world supply. This hasled to substantial price decreases during periods of economic weakness, whichhave not been offset by commensurate price increases during periods of economicstrength. Substitute materials are increasingly available for many steelproducts, which may further reduce demand for steel. Additional overcapacity orthe use of alternative products could have a material adverse effect upon ourresults of operations.

 

****Rapidlygrowing demand and supply in China and other developing economies may result inadditional excess worldwide capacity and falling steel prices, which couldadversely impact our results.****

 

Over the last severalyears steel consumption in China and other developing economies such as Indiahas increased at a rapid pace. Steel companies have responded by developingplans to rapidly increase steel production capability in these countries andentered into long-term contracts with iron ore suppliers in Australia andBrazil. Steel production, especially in China, has been expanding rapidly andcould be in excess of Chinese demand depending on continuing growth rates.Because China is now the largest worldwide steel producer, any significantexcess in Chinese capacity could have a major impact on domestic andinternational steel trade and prices.

 

****Environmentalcompliance and remediation could result in substantially increased capitalrequirements and operating costs.****

 

Our operating subsidiary,Chengtong, is subject to numerous Chinese provincial and local laws andregulations relating to the protection of the environment. These laws continueto evolve and are becoming increasingly stringent. The ultimate impact ofcomplying with such laws and regulations is not always clearly known or determinablebecause regulations under some of these laws have not yet been promulgated orare undergoing revision. Our consolidated business and operating results couldbe materially and adversely affected if Chengtong were required to increaseexpenditures to comply with any new environmental regulations affecting itsoperations.

 

****Wemay require additional capital in the future and we cannot assure that capitalwill be available on reasonable terms, if at all, or on terms that would notcause substantial dilution to stockholdings.****

 

The development of highquality specialty precision steel requires substantial funds. Sourcing externalcapital funds for product development and requisite capital expenditures arekey factors that have and may in the future constrain our growth, productioncapability and profitability. To achieve the next phase of our corporategrowth, increased production capacity, successful product development andadditional external capital will be necessary. There can be no assurance thatsuch capital will be available in sufficient amounts or on terms acceptable tous, if at all. Any sale of a substantial number of additional shares of commonstock or securities convertible into common stock will cause dilution to theholders of our common stock and could also cause the market price of our commonstock to decline.

 

****Weface significant competition from competitors who have greater resources thanwe do, and we may not have the resources necessary to successfully compete withthem.****

 

We are one of a fewmanufacturers of specialty precision steel products in China. Differences inthe type and nature of the specialty precision steel products in China’s steelindustry are relatively small, and, coupled with intense competition frominternational and local suppliers, to a limited extent, consumers’ demand canbe price sensitive. Competitors may increase their market share through pricingstrategies that adversely impact our business. Our business is in an industrythat is becoming increasingly competitive and capital intensive, andcompetition comes from manufacturers located in China as well as frominternational competition. Our 

 

29

----

 

competitors may havefinancial resources, staff and facilities substantially greater than ours andwe may be at a competitive disadvantage compared with larger companies.

 

****Weproduce a limited number of products and may not be able to respond quickly tosignificant changes in the market or new market entrants.****

 

Cold-rolled specialtyprecision steel is a relatively new industry in China; Chinese manufacturers ofdurable goods previously relied solely on imports from Japan, Korea, theEuropean Union and the United States. We believe the average quality andstandards of products of China’s high precision steel industry lags behind theinternational norm. During the last three years, we have developed a nationallyrecognizable 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.

 

****Increasedimports of steel products into China could negatively affect domestic steelprices and demand levels and reduce profitability of domestic*******producers*******,including Chengtong.****

 

Through June 2007,China’s total production of cold-rolled steel sheets increased approximately54% over the comparable period in 2006. However, domestic production continuesto be insufficient to meet demand. As a result, China continues to import asignificant portion of its steel products. Foreign competitors may have lowerlabor costs, and are often owned, controlled or subsidized by theirgovernments, which allows their production and pricing decisions to beinfluenced by political and economic policy considerations as well as prevailingmarket conditions. Import levels may also be impacted by decisions ofgovernment agencies, under trade laws. Increases in future levels of importedsteel could negatively impact future market prices and demand levels for ourprecision steel products.

 

****Weare dependent on our Chinese manufacturing operations to generate the majorityof our income and profits, and the deterioration of any current favorable localconditions may make it difficult or prohibitive to continue to operate orexpand in China.****

 

Our current manufacturingoperations are located in China, our administrative offices are in Hong Kongand we have additional establishments in the British Virgin Islands. Thegeographical distances between these facilities create a number of logistical andcommunications challenges, including time differences and differences in thecultures in each location, which makes communication and effective cooperationmore difficult.  In addition, because of the location of the manufacturingfacilities in China, our operations in China could be affected by, among otherthings:

 

·                  economic and political instability inChina, 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, inadequatedevelopment or maintenance of infrastructure in China, including adequate powerand 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.

 

30

----

 

****Ouroperations are international and we are subject to significant worldwidepolitical, economic, legal and other uncertainties that may make it difficultor costly to collect amounts owed to us or to conduct operations shouldmaterials needed from certain places be unavailable for an indefinite orextended period of time.****

 

We have subsidiaries inthe British Virgin Islands and China. We manufacture all of our products inChina and substantially all of the net book value of our total fixed assets islocated there. However, we sell our products to customers outside of China aswell as domestically. As a result, we have receivables from and goods intransit to locations outside of China. Protectionist trade legislation in theUnited States or other countries, such as a change in export or importlegislation, tariff or duty structures, or other trade policies, couldadversely affect our ability to sell products in these markets, or even topurchase 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.

 

In China, Chengtong issubject to numerous national, provincial and local governmental regulations,all of which can limit our ability to react to market pressures in a timely oreffective way, thus causing us to lose business or miss opportunities to expandour 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, currencyrestrictions and restrictions on the volume of domestic sales.

 

****Theend-use markets for certain of our products are highly competitive andcustomers are willing to accept substitutes for our products which could reduceour results of operations.****

 

Buyers of certaincold-rolled steel products are in highly competitive markets. Cold-rolledprecision steel competes with other materials, such as aluminum, plastics,composite materials and glass, among others, for industrial and commercialapplications. Customers have demonstrated a willingness to substitute othermaterials for cold-rolled steel. The willingness of our customers to acceptsubstitutes for cold-rolled steel products could have a material adverse effecton our financial results.

 

****Wemay not be able to pass on to customers the increases in the costs of our rawmaterials, particularly crude steel********.****

 

We require substantialamounts of raw materials in our business, consisting principally of steel slabsand strip steel. Any substantial increases in the cost of crude steel couldadversely affect our financial condition and results of operations. Theavailability and price of crude steel depends on a number of factors outsideour control, including general economic conditions, domestic and internationalsupply and tariffs. Increased domestic and worldwide demand for crude steel hashad and will continue to have the effect of increasing the prices that we payfor these raw materials, thereby increasing our cost of sales. Generally, thereis a potential time lag between changes in prices under our purchase contractsand the point when we can implement a corresponding change under our salescontracts with our customers. As a result, we can be exposed to fluctuations inthe price of raw materials, since, during the time lag period, we may have totemporarily bear the additional cost of the change under our purchasecontracts, which could have a material adverse effect on our profitability. Ifraw material prices were to increase significantly without a commensurateincrease in the market value of our products, our financial condition andresults of operations would be adversely affected.

 

****Althoughwe are dependent on a steady flow of raw materials for our operations, we donot have in place long-term supply agreements for all of our materialrequirements.****

 

We rely on severalsuppliers to provide us with the raw materials used in our operations, althougha substantial portion of our raw material requirements is met by BaoSteelTrading Co., Ltd. We do not currently have long-term supply contracts with anyparticular supplier, including BaoSteel Trading Co., Ltd., to assure acontinued supply of the raw materials we need. While we maintain good relationshipswith these suppliers, the supply of raw materials may nevertheless beinterrupted on account of events outside our control, which will negativelyimpact our operations.

 

****Wehave substantial indebtedness with floating interest rates and the cost of ourborrowings may increase.****

 

We are subject tointerest rate risk on our non-derivative financial instruments. We do not hedgeour interest rate risk. At December 31, 2007, our total bank debtoutstanding was $22.1 million, all of which was interest-bearing. Substantiallyall of the bank debt was floating-rate debt with interest rates which vary withchanges in the standard rate set by the People’s Bank of China. A change in theinterest rate or yield of fixed rate debt will only impact the fair value of suchdebt, while a change in the interest rate of floating rate, or variable rate,debt will impact interest expense as well as the amount of cash required toservice such debt. To the extent interest 

 

31

----

 

rates increase, we willbe liable for higher interest payments to its lenders. For the currentfinancial year, annual interest on loans is anticipated to be approximately $1.6million. The impact of a 1% increase in interest rates will increase interestexpense by approximately $220,000. As our short-term borrowings mature, we willbe required 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 our stockholders.

 

At December 31,2007, the aggregate fair value of our financial instruments with exposure tointerest rate risk was approximately$22 million. The potential change in fair value for these financial instrumentsfrom an adverse 10% change in quoted interest rates across all maturities,often referred to as a parallel shift in the yield curve, would beapproximately $0.1 million at December 31, 2007.

 

****Theloss of any key executive or our failure to attract and retain key personnelcould adversely affect our future performance, strategic plans and otherobjectives.****

 

The loss or failure toattract and retain key personnel could significantly impede our futureperformance, including product development, strategic plans, marketing andother objectives. Our success depends to a substantial extent not only on theability and experience of our senior management, but particularly upon ourChairman, Wo Hing Li; the General Manager of Chengtong, Hai Sheng Chen; andChief Financial Officer, Leada Tak Tai Li. We do not currently have in placekey man life insurance on Wo Hing Li, Hai Sheng Chen or Leada Tak Tai Li. Tothe 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.

 

****Wemay not be able to retain, recruit and train adequate management and productionpersonnel. We rely heavily on those personnel to help develop and execute ourbusiness plans and strategies, and if we lose such personnel, it would reduceour ability to operate effectively.****

 

Our continued operationsare dependent upon our ability to identify and recruit adequate management andproduction personnel in China. We require trained graduates of varying levelsand experience and a flexible work force of semi-skilled operators. Many of ourcurrent employees come from the more remote regions of China as they areattracted by the wage differential and prospects afforded by Shanghai and ouroperations. With the economic growth currently being experienced in China,competition for qualified personnel is substantial, and there can be noguarantee that a favorable employment climate will continue and that wage rateswe must offer to attract qualified personnel will enable us to remaincompetitive internationally. The inability to attract such personnel or theincreased cost of doing so could reduce our competitive advantage relative toother precision steel producers, reducing or eliminating our growth in revenuesand profits.

 

****Wemay not be able to protect adequately our intellectual property frominfringement or unauthorized use by third parties.****

 

Except for a patent onthe Environment-Conscious Mill Bearing with Inner Circular Lubrication, we haveno patents or licenses that protect our intellectual property. Unauthorizedparties may attempt to copy aspects of our processes and know-how or to obtainand use information that we regard as proprietary. Policing unauthorized use ofour processes and know-how is difficult. Our experienced key engineers andmanagement staff are extensively involved in all facets of research, design,craftwork, styling and development of the specialty precision products.Potential risks on the divulgence of skills and the development of new productsincrease should these employees resign, as we rely heavily on them. Chengtonghas elected to protect internally developed know-how and production processes(such as system pressure, cleanliness of the lubrication, temperature control,appropriate allocation of oil supply and retrieving, which are vital inproviding a radical solution to the difficulties associated with lubricatingrolling mills’ backing bearing) by requiring all key personnel (productionengineers and management staff) to sign non-disclosure and confidentialitycontracts. However, this means of protecting our proprietary rights may not beadequate. In addition, the laws of some foreign countries do not protect ourproprietary rights as extensively as do U.S. laws. Our failure to protectadequately our proprietary rights may allow third parties to duplicate ourproducts, production processes or develop functionally equivalent or superiortechnology. In addition, our competitors may independently develop similartechnologies or design around our proprietary intellectual property.

 

****Weare subject to risks associated with changing technology and manufacturingtechniques, which could place us at a competitive disadvantage.****

 

The successfulimplementation of our business strategy requires us to continuously evolve ourexisting products and services and introduce new products and services to meetcustomers’ needs. Our designs and products are characterized by stringentperformance and specification requirements that mandate a high degree ofmanufacturing and engineering expertise. We believe that our customersrigorously evaluate our services and products on the basis of a number offactors, including, but not limited to:

 

·                  quality,

 

32

----

 

·                  price competitiveness,

 

·                  technical expertise and developmentcapability,

 

·                  innovation,

 

·                  reliability and timeliness of delivery,

 

·                  product design capability,

 

·                  operational flexibility,

 

·                  customer service, and

 

·                  overall management.

 

Our success depends onour ability to continue to meet our customers’ changing requirements andspecifications with respect to these and other criteria. There can be noassurance that we will be able to address technological advances or introducenew designs or products that may be necessary to remain competitive within theprecision steel industry.

 

****Wedepend upon our largest customers for a significant portion of our salesrevenue, and we cannot be certain that sales to these customers will continue.If sales to these customers do not continue, then our sales may decline and ourbusiness may be negatively impacted.****

 

We currently supply highprecision steel products to 12 major customers in the Chinese domestic market.For the three months ended December 31, 2007 and 2006, sales revenuesgenerated from the top five major customers amounted to 53% and 71% of totalsales revenues, respectively; sales to the largest single customer for thesame periods amounted to 27% and 36% of total sales revenues, respectively. Wedo not enter into long-term contracts with our customers, and therefore cannotbe certain that sales to these customers will continue. The loss of any of ourlargest customers would likely have a material negative impact on our salesrevenues and business.

 

****Defectsin our products could impair our ability to sell products or could result inlitigation and other significant costs.****

 

Detection of anysignificant defects in our precision steel products may result in, among otherthings, delay in time-to-market, loss of market acceptance and sales of itsproducts, 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.

 

****Failureto optimize our manufacturing potential and cost structure could materiallyincrease our overhead, causing a decline in our margins and profitability.****

 

We strive to utilize themanufacturing capacity of our facilities fully but may not do so on aconsistent basis. Our factory utilization is dependent on our success in, amongother things:

 

·                  accurately forecasting demand,

 

·                  predicting volatility,

 

·                  timing volume sales to our customers,

 

·                  balancing our productive resources withproduct mix, and

 

·                  planning manufacturing services for newor other products that we intend to produce.

 

Demand for contractmanufacturing of these products may not be as high as we expect, and we mayfail to realize the expected benefit from our investment in our manufacturingfacilities. Our profitability and operating results are also dependent upon avariety of other factors, including, but not limited to:

 

·                  utilization rates of manufacturing lines,

 

·                  downtime due to product changeover,

 

33

----

 

·                  impurities in raw materials causingshutdowns, and

 

·                  maintenance of contaminant-freeoperations.

 

Failure to optimize ourmanufacturing potential and cost structure could materially and adverselyaffect our business and operating results.

 

Moreover, our coststructure is subject to fluctuations from inflationary pressures in China andother geographic regions where we conduct business. China is currentlyexperiencing dramatic growth in its economy. This growth may lead to continuedpressure on wages and salaries that may exceed our budget and adversely affectour operating results.

 

****Ourproduction facilities are subject to risks of power shortages which mayadversely affect our ability to meet our customers’ needs and reduce ourrevenues.****

 

Many cities and provincesin China have suffered serious power shortages since the second quarter of2004. Many of the regional grids do not have sufficient power generatingcapacity to fully satisfy the increased demand for electricity driven bycontinual economic growth and persistent hot weather. Local governments haveoccasionally required local factories to temporarily shut down their operationsor reduce their daily operational hours in order to reduce local powerconsumption levels. To date, our operations have not been affected by thoseadministrative measures. However, there is a risk that our operations may beaffected 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.

 

****Unexpectedequipment failures may lead to production curtailments or shutdowns.****

 

Interruptions in our productioncapabilities will adversely affect our production costs, products available forsales and earnings for the affected period. In addition to equipment failures,our facilities are also subject to the risk of catastrophic loss due tounanticipated events such as fires, explosions or violent weather conditions.Our manufacturing processes are dependent upon critical pieces of equipment,such as our various cold-rolling mills, as well as electrical equipment, suchas transformers, and this equipment may, on occasion, be out of service as aresult of unanticipated failures. We have experienced and may in the futureexperience material plant shutdowns or periods of reduced production as aresult of such equipment failures.

 

****Ourinsurance may not be adequate if our production facilities were destroyed orsignificantly damaged as a result of fire or some other natural disaster.****

 

All of our products arecurrently manufactured at our existing facilities located in the JiadingDistrict in Shanghai, China. Fire fighting and disaster relief or assistance inChina may not be as developed as in Western countries. While we maintainproperty damage insurance aggregating approximately $18.5 million covering ourraw materials, finished goods, equipment and buildings and another $10.5million insurance against equipment breakdown, we do not maintain businessinterruption insurance. Material damage to, or the loss of, our productionfacilities due to fire, severe weather, flood or other act of God or cause,even if insured, could have a material adverse effect on our financialcondition, results of operations, business and prospects.

 

****Ourlimited operating history may not serve as an adequate basis to judge ourfuture prospects and results of operations.****

 

Our limited operatinghistory may not provide a meaningful basis on which to evaluate our business.Although our revenues have grown rapidly since inception, we might not be ableto maintain our profitability or we may incur net losses in the future. Weexpect that our operating expenses will increase as we expand. Any significantfailure to realize anticipated revenue growth could result in significantoperating losses. We will continue to encounter risks and difficultiesfrequently experienced by companies at a similar stage of development,including our potential failure to:

 

·                  Implement our business model and strategyand adapt and modify them as needed;

 

·                  Manage our expanding operations andproduct offerings;

 

·                  Maintain adequate control of ourexpenses;

 

·                  Anticipate and adapt to changingconditions in the precision steel markets in which we operate as well as theimpact of any changes in government regulation; and

 

·                  Anticipate mergers and acquisitionsinvolving our competitors, technological developments and other significantcompetitive and market dynamics.

 

34

----

 

Our business, businessprospects and results of operations will be affected if we are not successfulin addressing any or all of these risks and difficulties.

 

****Failureto comply with the U.S. Foreign Corrupt Practices Act could subject us topenalties and other adverse consequences.****

 

We are subject to theU.S. Foreign Corrupt Practices Act, which generally prohibits United Statescompanies from engaging in bribery or other prohibited payments to foreignofficials for the purpose of obtaining or retaining business. In addition, weare required to maintain records that accurately and fairly represent ourtransactions and have an adequate system of internal accounting controls.Foreign companies, including some that may compete with us, are not subject tothese prohibitions, and therefore may have a competitive advantage over us.Corruption, extortion, bribery, pay-offs, theft and other fraudulent practicesoccur from time-to-time in the PRC, and our executive officers and employeeshave not been subject to the U.S. Foreign Corrupt Practices Act prior to thecompletion of the Stock Exchange Agreement in December 2006. We can makeno assurance that our employees or other agents will not engage in such conductfor which we might be held responsible. If our employees or other agents arefound to have engaged in such practices, we could suffer severe penalties andother consequences that may have a material adverse effect on our business,financial condition and results of operations.

 

****Youmay experience difficulties in effecting service of legal process, enforcingforeign judgments or bringing original actions in China based upon U.S. laws,including the federal securities laws or other foreign laws against us or ourmanagement.****

 

Substantially all of ourcurrent operations are conducted in China. Moreover, all but one of ourdirectors and all of our officers are nationals and residents of China or HongKong. 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.

 

****Risks Relating toChina****

 

****Weface significant risks if the Chinese government changes its policies, laws,regulations, tax structure or its current interpretations of its laws, rules andregulations relating to our operations in China.****

 

Chengtong’s manufacturingfacility is located in Shanghai, China. As of December 31, 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 legaldevelopment and related uncertainties. Our operations and results could bematerially affected 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,

 

·                  import duties,

 

·                  corruption,

 

·                  currency revaluation, and

 

·                  the expropriation of private enterprise.

 

Over the past severalyears, the Chinese government has pursued economic reform policies includingthe 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 of privatizingmany state-owned enterprises, 

 

35

----

 

the Chinese governmenthas attempted to augment its revenues through increased tax collection.Continued efforts to increase tax revenues could result in increased taxationexpenses being incurred by us. Economic development may be limited as well bythe imposition of austerity measures intended to reduce inflation, theinadequate development of infrastructure and the potential unavailability ofadequate power and water supplies, transportation and communications.

 

****Chineselaws and regulations governing our current business operations are sometimesvague and uncertain. Any changes in such Chinese laws and regulations may havea material and adverse effect on our business.****

 

China’s legal system is acivil law system based on written statutes, in which system decided legal caseshave little value as precedents unlike the common law system prevalent in theUnited States. There are substantial uncertainties regarding the interpretationand application of Chinese laws and regulations, including but not limited tothe laws and regulations governing our business, or the enforcement andperformance of our arrangements with customers in the event of the impositionof statutory liens, death, bankruptcy and criminal proceedings. The Chinesegovernment has been developing a comprehensive system of commercial laws, andconsiderable progress has been made in introducing laws and regulations dealingwith economic matters such as foreign investment, corporate organization andgovernance, commerce, taxation and trade. However, because these laws andregulations are relatively new, and because of the limited volume of publishedcases and judicial interpretation and their lack of force as precedents,interpretation and enforcement of these laws and regulations involvesignificant uncertainties. New laws and regulations that affect existing andproposed future businesses may also be applied retroactively. We are considereda foreign person or foreign funded enterprise under Chinese laws, and as aresult, we are required to comply with Chinese laws and regulations. We cannotpredict what effect the interpretation of existing or new Chinese laws orregulations may have on our businesses. If the relevant authorities find us inviolation of Chinese laws or regulations, they would have broad discretion indealing with such a violation, including, without limitation:

 

·                  levying fines;

 

·                  revoking our business and other licenses;

 

·                  requiring that we restructure ourownership or operations; and

 

·                  requiring that we discontinue any portionor all of our business.

 

****Ourbusiness, results of operations and overall profitability are linked to theeconomic, political and social conditions in China.****

 

Substantially all of ourbusiness, assets and operations are located in China. The economy of Chinadiffers 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 over China’seconomic growth through the allocation of resources, controlling payment offoreign currency-denominated obligations, setting monetary policy and providingpreferential treatment to particular industries or companies. Therefore, theChinese government’s involvement in the economy may affect our businessoperations, results of operations and our financial condition.

 

****Aslowdown or other adverse developments in the Chinese economy may materiallyand adversely affect our customers, demand for our services and our business.****

 

All of our operations areconducted in China and substantially all of our revenues are generated fromsales to businesses operating in China. Although the Chinese economy has grownsignificantly in recent years, such growth may not continue. We do not know howsensitive we are to a slowdown in economic growth or other adverse changes inChinese economy which may affect demand for precision steel products. Aslowdown in overall economic growth, an economic downturn or recession or otheradverse economic developments in China may materially reduce the demand for ourproducts and in turn reduce our results of operations and our productivity.

 

***Inflation in China could negatively affect our profitability andgrowth.***

 

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 

 

36

----

 

effecton our profitability. In order to control inflation in the past, the Chinesegovernment has imposed controls on bank credits, limits on loans for fixedassets and restrictions on state bank lending. Such an austerity policy canlead to a slowing of economic growth. In October 2004, the People’s Bankof China, China’s central bank, raised interest rates for the first time innearly a decade and indicated in a statement that the measure was prompted byinflationary concerns in the Chinese economy. Repeated increases in interestrates by the central bank will likely slow economic activity in China whichcould, in turn, materially increase our costs and also reduce demand for ourproducts.

 

****Controversiesaffecting China’s trade with the United States could 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 mayhave difficulty establishing adequate management, legal and financial controlsin China, which could impair our planning processes and make it difficult toprovide accurate reports of our operating results.****

 

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 in establishingmanagement, legal and financial controls, collecting financial data andpreparing financial statements, books of account and corporate records andinstituting business practices that meet Western standards, making it difficultfor management to forecast its needs and to present the results of ouroperations accurately at all times.

 

****Impositionof trade barriers and taxes may reduce our ability to do businessinternationally, and the resulting loss of revenue could harm ourprofitability.****

 

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.

 

****Therecan be no guarantee that China will comply with the membership requirements ofthe World Trade Organization, which could leave us subject to retaliatoryactions by other governments and reduce our ability to sell our productsinternationally.****

 

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 could renderour products less attractive, thus reducing our revenues and profits.

 

****Ourlabor costs are likely to increase as a result of changes in Chinese laborlaws.****

 

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

 

****Wecurrently receive preferential tax treatment under Chinese law which willexpire 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 profitableyear and receive a 50% reduced income tax in the third through fifth years. Asa wholly foreign owned enterprise, Chengtong has been entitled to such preferentialtax treatment. The full tax exemption for the enterprise income tax expired on December 31,2005 and the one-half reduction on the enterprise profit tax to 13.5% willexpire on December 31, 2008. After such tax holidays, our profits will besubject to the full tax rate of 25%, effective as of January 1, 2008 inaccordance with the EIT Law passed in 2007. If we are unable to increase 

 

37

----

 

grossincome by an amount greater than that needed to offset the loss of thispreferential tax treatment, such a condition could have a material adverseeffect on the results of its operations.

 

Under the EIT Law, auniform tax rate of 25.0% has been adopted for all enterprises (includingforeign-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 theenterprise income tax rate applicable to us or other adverse tax treatmentswould have a material adverse effect on our results of operations and financialcondition.

 

****Fluctuationsin exchange rates of the Renminbi, or RMB, could adversely affect the value ofand dividends, if any, payable on shares of our common stock or otherwiseimpact our operations and profitability.****

 

We collect revenue fromoperations principally in the Chinese Renminbi. Except for recent exports toNigeria, Thailand, Indonesia and the Philippines, all of our local salesrevenues are collected in and substantially all of its expenses are paid in theChinese Renminbi. We face foreign currency rate translation risk when Chengtong’sresults are translated to U.S. Dollars, as well as foreign currency ratetransaction risk with respect to sales outside of China and with respect tofinancial 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.

 

The Chinese Renminbiremained stable against the U.S. Dollar at approximately 8.28 RMB to 1.00 U.S.Dollar for several years until July 21, 2005 when the Chinese currencyregime was altered, with a 2.1% revaluation versus the U.S. Dollar. This moveinitially valued the Renminbi at 8.11 per U.S. Dollar. The Renminbi is nolonger linked to the U.S. currency but rather to a basket of currencies with a0.3% margin of fluctuation. However, there remains international pressure onthe Chinese government to adopt an even more flexible currency policy. As of December 31,2007, the exchange rate was 7.2946 RMB to 1.00 U.S. Dollar. The exchange rate ofRenminbi is subject to changes in China’s government policies which are, to alarge extent, dependent on the economic and political development bothinternationally and locally and the demand and supply of Renminbi in thedomestic market. There can be no assurance that such exchange rate willcontinue to remain stable in the future amongst the volatility of currencies,globalization and the unstable economies in recent years.

 

Since (i) our incomeand profit are mainly denominated in Renminbi, and (ii) the payment ofdividends, if any, will be in U.S. Dollars, 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.For example, to the extent that we need to convert U.S. Dollars we receive froman offering of our securities into Renminbi for our operations, if the Renminbiappreciates against the U.S. Dollar, the Renminbi equivalent of the US Dollarwe convert would be reduced. Conversely, if we decide to convert our Renminbiinto U.S. Dollars for the purpose of making payments for dividends on ourcommon stock or for other business purposes and the U.S. Dollar appreciatesagainst the Renminbi, the U.S. Dollar equivalent of the Renminbi we convertwould be reduced. In addition, appreciation of the Renminbi could make ourproducts more expensive relative to those of our competitors or increase ourprofitability in U.S. Dollar terms.

 

At December 31,2007, our outstanding financial instruments with foreign currency exchange raterisk exposure had an aggregate fair value of $5 million (including our non-U.S.Dollar denominated debt). The potential increase in the fair values of theseinstruments resulting from a 10% adverse change in quoted foreign currencyexchange rates would be approximately $0.5 million at December 31, 2007.

 

****Theability of our Chinese operating subsidiary to pay certain foreign currencyobligations, including dividends, may be restricted due to foreign exchange controlregulations of China.****

 

The ability of Chengtongto pay dividends may be restricted due to the foreign exchange control policiesand availability of cash balances. Since substantially all of our operationsare conducted in China and a majority of our revenues are generated in China, asignificant portion of our revenue earned and currency received are denominatedin Renminbi.

 

The Chinese governmentimposes controls on the convertibility of Renminbi into foreign currencies and,in certain cases, the remittance of currency out of China. Renminbi iscurrently not a freely convertible currency. Shortages in the availability offoreign currency may restrict our ability to remit sufficient foreign currencyto pay dividends, if any, on our common stock or otherwise satisfy foreigncurrency denominated obligations. Under existing Chinese foreign exchangeregulations, payments of current account items, including profit distributions,interest payments and expenditures from the transaction, can be made in foreigncurrencies without prior approval from the State Administration of ForeignExchange by complying with certain procedural requirements. 

 

38

----

 

However, approval fromappropriate governmental authorities is required where Renminbi is to beconverted into foreign currency and remitted out of China to pay capitalexpenses such as the repayment of bank loans denominated in foreign currencies.

 

The Chinese governmentmay also at its discretion restrict access in the future to foreign currenciesfor current account transactions. If the foreign exchange control systemprevents us from obtaining sufficient foreign currency to satisfy our currencydemands, we may not be able to pay certain of our expenses as they come due.

 

****Risks Relating toOur Common Stock****

 

****Themarket price for shares of our common stock could be volatile and coulddecline.****

 

Our common stock islisted on The NASDAQ Capital Market under the symbol “CPSL.” The market pricefor the shares of our common stock may fluctuate in response to a number offactors, many of which are beyond our control. In some cases, thesefluctuations may be unrelated to our operating performance. Many companies withChinese operations have experienced dramatic volatility in the market prices oftheir common stock. We believe that a number of factors, both within andoutside of our control, could cause the price of our common stock to fluctuate,perhaps substantially. Factors such as the following could have a significantadverse impact on the market price of our common stock:

 

·                  our ability to obtain additionalfinancing and, 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 performanceby any securities analysts;

 

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

 

·                  new regulatory requirements and changesin the existing regulatory environment;

 

·                  the issuance of new equity securities ina future offering;

 

·                  changes in interest rates; and

 

·                  general economic, monetary and othernational conditions, particularly in the U.S. and China.

 

****Thetrading market in our common stock is limited and illiquid and may cause volatilityin the market price.****

 

As of December 312007, 50.7% or 23,254,088 shares, of our issued and outstanding common stockwas not owned by affiliates, of which 18,519,651 were unrestricted and free totrade. The market price for our common stock is subject to volatility andholders of common stock may be unable to resell their shares at or near theiroriginal purchase price or at any price. In the absence of an active tradingmarket:

 

·                  investors may have difficulty buying andselling;

 

·                  market visibility for our common stockmay be limited; and

 

·                  a lack of visibility for our common stockmay have a depressive effect on the market for our common stock.

 

****Shareseligible for future sale may adversely affect the market price of our commonstock, as the future sale of a substantial amount of outstanding stock in thepublic marketplace could reduce the price of our common stock.****

 

From time to time,certain of our stockholders may be eligible to sell all or some of their sharesof common stock by means of ordinary brokerage transactions in the open market,pursuant to Rule 144 promulgated under the Securities Act, subject tocertain limitations or otherwise. In general, pursuant to Rule 144, astockholder (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 144or pursuant to a resale prospectus may have an adverse effect on the marketprice of our common stock.  Recent rule changesadopted by the SEC will substantially reduce the holding period for restrictedsecurities held by non-affiliates of SEC-reporting companies, such as us.  The holding period for such securities willbe reduced to six months when the rule changes become effective on February 15,2008.

 

39

----

 

****Onestockholder, who is our Chief Executive Officer, exercises significant controlover matters requiring shareholder approval.****

 

Wo Hing Li, our ChiefExecutive Officer, had voting power as of December 31, 2007 equal toapproximately 46.6% of our voting securities. As a result, Wo Hing Li, throughsuch stock ownership, exercises significant control over all matters requiringshareholder approval, including the election of directors and approval of significantcorporate transactions. This concentration of ownership in Wo Hing Li may alsohave the effect of delaying or preventing a change in control or othertransactions that may otherwise be viewed as beneficial by shareholdersother than Wo Hing Li.

 

****Wemay be required to raise additional financing by issuing new securities withterms or rights superior to those of our shares of common stock, which couldadversely affect the market price of our shares of common stock.****

 

We may require additionalfinancing to fund future operations, develop and exploit existing and newproducts and to expand into new markets. We may not be able to obtain financingon favorable terms, if at all. If we raise additional funds by issuing equitysecurities, the percentage ownership of our current shareholders will bereduced, and the holders of the new equity securities may have rights superiorto those of the holders of shares of common stock, which could adversely affectthe market price and the voting power of shares of our common stock. If weraise additional funds by issuing debt securities, the holders of these debtsecurities would similarly have some rights senior to those of the holders ofshares of common stock, and the terms of these debt securities could impose restrictionson operations and create a significant interest expense for us.

 

****Wemay incur significant costs to ensure compliance with U.S. corporate governanceand accounting requirements.****

 

We may incur significantcosts associated with our public company reporting requirements, costsassociated with applicable corporate governance requirements, includingrequirements under the Sarbanes-Oxley Act of 2002 and other rules implementedby the SEC and requirements in connection with the listing of our common stockon The NASDAQ Capital Market. We expect all of these applicable rules andregulations to increase our legal and financial compliance costs and to makesome activities more time-consuming and costly. We also expect that theseapplicable rules and regulations may make it more difficult and moreexpensive for us to obtain director and officer liability insurance and we maybe required to accept reduced policy limits and coverage or incur substantiallyhigher costs to obtain the same or similar coverage. As a result, it may bemore difficult for us to attract and retain qualified individuals to serve onour board of directors or as executive officers.

 

****Ourofficers and directors have limited experience with the regulatory requirementsfor U.S. public companies, which could impair our ability to satisfy publiccompany filing requirements and could increase our securities compliance costs.****

 

All of our officers andmost of our directors do not have any prior experience as officers anddirectors of a U.S. publicly traded company, or in complying with theregulatory requirements applicable to a U.S. public company. As a result, wecould have difficulty satisfying the regulatory requirements applicable to U.S.public companies, which could adversely affect the market for our common stock.At present, we rely upon outside experts to advise us on matters relating tofinancial accounting and public company reporting. While we believe that itwill be possible to satisfy our public company reporting requirements throughthe use of third party experts, our general and administrative costs willremain higher until we have developed or acquired internal expertise in thesematters

 

****Standardsfor compliance with Section 404 of the Sarbanes-Oxley Act of 2002 areuncertain, and if we fail to comply in a timely manner, our business could beharmed and our stock price could decline.****

 

Rules adopted by theSEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 requireannual 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.

 

****Wedo not foresee paying cash dividends in the foreseeable future.****

 

We have not paid cashdividends on our stock, and we do not plan to pay cash dividends on our stockin the foreseeable future.

 

40

----

 

**ITEM 2.**   **UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

 

Pursuantto Section 5.1 of the Stock Purchase Agreement, dated February 16,2007, the Company agreed to reserve for issuance to investors in the privateplacement an aggregate of 2,000,000 shares of Common Stock if the Company’s netincome for the fiscal year ending June 30, 2007 was less than US$10.4million, as set forth in the Company’s audited financial statements as filedwith the SEC in the Company’s Annual Report on Form 10-K for the fiscalyear ended June 30, 2007. As the Company’s net income as set forth in itsaudited financial statements for the year ended June 30, 2007 was lessthan US$10.4 million, the Company was required to issue the 2,000,000 shares ofCommon Stock to such investors.  Suchissuance was effected on October 15, 2007. No additional consideration was received by the Company in connectionwith this issuance of such shares of Common Stock.

 

Pursuantto a Placement Agency Agreement, dated October 31, 2007, between theCompany and Roth Capital Partners LLC, in connection with the registered directsale of the Company’s Common Stock and warrants, Roth Capital received, aspartial compensation for its services, 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.The net proceeds of the Offering were approximately $44 million, afterdeducting underwriting commissions and discounts and other fees and expensesrelating to the Offering.  The Companyintends to use the net proceeds for repayment of certain existing bank debt,capital expenditures related to the completion of the second reverse rollingmill and annealing furnace and construction of the third reverse rolling milland related capital expenditures in the amount of approximately $18 million,and the balance for general corporate purposes.

 

The above issuances ofsecurities was made in reliance upon exemptions from the registrationrequirements of the Securities Act of 1933 in accordance with Section 4(2) andRegulation D thereunder.

 

**ITEM 3.**   **DEFAULTSUPON SENIOR SECURITIES**

 

None.

 

**ITEM 4.**   **SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

The Company submitted matters to a vote of itssecurity holders through the solicitation of proxies. The content of thesematters may be found in the Company’s Definitive Proxy Statement issuedpursuant to Section 14(a) of the Securities Exchange Act of 1934,filed with the SEC on October 16, 2007 and incorporated herein byreference.

 

The annual meeting of the stockholders of the Companywas held November 12, 2007 at the offices of Kirkpatrick &Lockhart Preston Gates Ellis LLP, 599 Lexington Avenue, New York, NewYork.  All proposals submitted toshareholders were approved. The results of the voting were as follows:

 

**Proposal 1**: Election of Directors

 
| **Name**         | ** ** | **For**    | ** ** | **Against** | ** ** |
|------------------|------------|------------|------------|-------------|------------|
| Wo Hing Li       |       | 29,593,064 |       | 146,600     |       |
| Hai Sheng Chen   |       | 29,553,563 |       | 186,101     |       |
| Tung Kuen Tsui   |       | 29,552,862 |       | 186,802     |       |
| Che Kin Lui      |       | 29,553,365 |       | 186,299     |       |
| David Peter Wong |       | 29,553,621 |       | 186,043     |       |

 

**Proposal 2**:  Approval ofchange in state of incorporation from Colorado to Delaware by approving andadopting an Agreement and Plan of Merger providing for the merger of theCompany into its wholly-owned subsidiary, China Precision Steel, Inc., aDelaware corporation:

 
| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|------------|------------|-------------|------------|-------------|------------|
| 24,171,529 |       | 27,986      |       | 4,272       |       |

 

**Proposal 3**:  Authority toissue an undetermined number of shares of Company Common Stock, shares ofpreferred stock convertible into Company Common Stock or warrants to purchaseCompany Common Stock, in an aggregate amount of up to 11,213,443 shares ofCommon Stock, in connection with capital raising activities over the next 12months and prior to the next annual meeting of the Company’s Stockholders, at aprice and on the terms to be determined by the Company’s Board of Directors:

 

41

----

 
| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|------------|------------|-------------|------------|-------------|------------|
| 23,948,330 |       | 229,672     |       | 25,785      |       |

 

**ITEM 5.**   **OTHERINFORMATION**

 

(a)  None.

 

(b)   None.

 

**ITEM 6.**   **EXHIBITS**

 

(a)   Exhibitsrequired to be filed are listed below. Certain of the following exhibits arehereby incorporated by reference pursuant to Rule 12(b)-32, as promulgatedunder the Securities and Exchange Act of 1934, as amended, from the reportsnoted below:

 
| **Exhibit No.** | ** ** | **Exhibit:**                                                                                                                                                                                                          |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                                                                                  |
| 2.1                  |       | Certificate of Ownership and Merger (incorporated by  reference to the Company’s Form 10-Q for the quarter ended  September 30, 2007, Exhibit 2.1)                                                |
|                 |       |                                                                                                                                                                                                                  |
| 2.2                  |       | Agreement and Plan of Merger (incorporated by  reference to the Company’s Form 10-Q for the quarter ended  September 30, 2007, Exhibit 2.2)                                                       |
|                 |       |                                                                                                                                                                                                                  |
| 3.1                  |       | Certificate of Incorporation (incorporated by  reference to the Company’s Form 10-Q for the quarter ended  September 30, 2007, Exhibit 3.1)                                                       |
|                 |       |                                                                                                                                                                                                                  |
| 3.2                  |       | Bylaws (incorporated by reference to the Company’s  Form 10-Q for the quarter ended September 30, 2007,  Exhibit 3.2)                                                                             |
|                 |       |                                                                                                                                                                                                                  |
| 4.1                  |       | Specimen Certificate for Common Stock                                                                                                                                                                                 |
|                 |       |                                                                                                                                                                                                                  |
| 4.2                  |       | Form of Warrant (incorporated herein by  reference to the Company’s Form 8-K, dated February 16, 2007,  Exhibit 4.2)                                                                         |
|                 |       |                                                                                                                                                                                                                  |
| 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 4.3)                      |
|                 |       |                                                                                                                                                                                                                  |
| 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 4.4)                  |
|                 |       |                                                                                                                                                                                                                  |
| 4.5                  |       | Form of Warrant, dated November 6, 2007  (incorporated by reference to the Company’s Form 8-K, dated  November 1, 2007, Exhibit 4.5)                                                    |
|                 |       |                                                                                                                                                                                                                  |
| 4.6                  |       | Form of Placement Warrant to Roth Capital  Partners, LLC, dated November 6, 2007 (incorporated by reference to the  Company’s Form 8-K, dated November 1, 2007, Exhibit 4.6)            |
|                 |       |                                                                                                                                                                                                                  |
| 10.1                 |       | Form of Subscription Agreement, dated  November 1, 2007, among the Company and the Buyers (incorporated by  reference to the Company’s Form 8-K, dated November 1, 2007,  Exhibit 10.1) |
|                 |       |                                                                                                                                                                                                                  |
| 21                   |       | List of Subsidiaries of the Company (incorporated  herein by reference to the Company’s Form 10-K for the year ended  June 30, 2007)                                                                   |
|                 |       |                                                                                                                                                                                                                  |
| 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                                           |
|                 |       |                                                                                                                                                                                                                  |
| 99.1                 |       | Report and Certification of Inspector of Elections,  dated November 12, 2007                                                                                                                                     |

 

42

----

 

SIGNATURES

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 
| ** **                        | **CHINA PRECISION STEEL, INC.** |
|-----------------------------------|---------------------------------|
|                              |                            |   |
|                              |                            |   |
| Date: February 14, 2008 | By:                             |   /s/ Wo Hing Li |   |
|                              |                            | Wo Hing Li |
|                              |                            | President |

 

43

----

 

EXHIBIT INDEX

 
| **Exhibit No.** | ** ** | **Exhibits**                                                                                                                                                                                                          |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                                                                                  |
| 2.1                  |       | Certificate of Ownership and Merger (incorporated by  reference to the Company’s Form 10-Q for the quarter ended  September 30, 2007, Exhibit 2.1)                                                |
|                 |       |                                                                                                                                                                                                                  |
| 2.2                  |       | Agreement and Plan of Merger (incorporated by  reference to the Company’s Form 10-Q for the quarter ended  September 30, 2007, Exhibit 2.2)                                                       |
|                 |       |                                                                                                                                                                                                                  |
| 3.1                  |       | Certificate of Incorporation (incorporated by  reference to the Company’s Form 10-Q for the quarter ended  September 30, 2007, Exhibit 3.1)                                                       |
|                 |       |                                                                                                                                                                                                                  |
| 3.2                  |       | Bylaws (incorporated by reference to the Company’s  Form 10-Q for the quarter ended September 30, 2007,  Exhibit 3.2)                                                                             |
|                 |       |                                                                                                                                                                                                                  |
| 4.1                  |       | Specimen Certificate for Common Stock                                                                                                                                                                                 |
|                 |       |                                                                                                                                                                                                                  |
| 4.2                  |       | Form of Warrant (incorporated herein by  reference to the Company’s Form 8-K, dated February 16, 2007,  Exhibit 4.2)                                                                         |
|                 |       |                                                                                                                                                                                                                  |
| 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 4.3)                      |
|                 |       |                                                                                                                                                                                                                  |
| 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 4.4)                       |
|                 |       |                                                                                                                                                                                                                  |
| 4.5                  |       | Form of Warrant, dated November 6, 2007  (incorporated by reference to the Company’s Form 8-K, dated  November 1, 2007, Exhibit 4.5)                                                    |
|                 |       |                                                                                                                                                                                                                  |
| 4.6                  |       | Form of Placement Warrant to Roth Capital  Partners, LLC, dated November 6, 2007 (incorporated by reference to the  Company’s Form 8-K, dated November 1, 2007, Exhibit 4.6)            |
|                 |       |                                                                                                                                                                                                                  |
| 10.1                 |       | Form of Subscription Agreement, dated  November 1, 2007, among the Company and the Buyers (incorporated by  reference to the Company’s Form 8-K, dated November 1, 2007,  Exhibit 10.1) |
|                 |       |                                                                                                                                                                                                                  |
| 21                   |       | List of Subsidiaries of the Company (incorporated  herein by reference to the Company’s Form 10-K for the year ended  June 30, 2007)                                                                   |
|                 |       |                                                                                                                                                                                                                  |
| 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                                           |
|                 |       |                                                                                                                                                                                                                  |
| 99.1                 |       | Report and Certification of Inspector of Elections,  dated November 12, 2007                                                                                                                                     |

 

----