Table of Contents





UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10−Q




(Mark
One)




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




For the
quarterly period ended: December 31, 2008




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




For the
transition period from ____________ to _____________




Commission
File Number: 000-23039





CHINA
PRECISION STEEL, INC.


(Exact
name of registrant as specified in its charter)





Delaware
                
                14-1623047(State
      or other jurisdiction of
                  incorporation
      or organization)
                
                (I.R.S.
      Employer Identification
No.)





Room
B, 18th Floor, Teda Building


87 Wing Lok Street, Sheungwan, Hong
Kong,


People’s
Republic of China


(Address
of principal executive offices, Zip Code)




+1-852-2543-2290


(Registrant’s
telephone number, including area code)







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





Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d)
of the Exchange Act during the past 12 months (or for such shorter period that
the registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes  ̈ No
 ̈




Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See the definitions of “large accelerated
filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.





Large Accelerated Filer ̈
                Accelerated Filer ̈Non-Accelerated
      Filer   ̈
                Smaller reporting company ̈(Do not check if a smaller reporting company)





Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).  Yes o No o





The
number of shares outstanding of each of the issuer’s classes of common equity,
as of December 31, 2009 is as follows:




Class
      of Securities
                
                Shares
      OutstandingCommon
      Stock, $0.001 par value
                
                46,562,955





Table of Contents
   TABLE OF CONTENTS





PART I - FINANCIAL INFORMATION
                  2ITEM 1.
                  FINANCIAL STATEMENTS.
                  2ITEM 2.
                  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
      AND RESULTS OF OPERATIONS.
                  20ITEM 3.
                  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK.
                  35ITEM 4.
                  CONTROLS AND PROCEDURES.
                  36PART II - OTHER INFORMATION
                  37ITEM 1.
                  LEGAL PROCEEDINGS.
                  37ITEM 1A.
                  RISK FACTORS.
                  37ITEM 2.
                  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
      PROCEEDS.
                  37ITEM 3.
                  DEFAULTS UPON SENIOR SECURITIES.
                  37ITEM 4.
                  SUBMISSION OF MATTERS TO A VOTE OF SECURITY
      HOLDERS.
                  37ITEM 5.
                  OTHER INFORMATION.
                  37ITEM 6.
                  EXHIBITS.
                  37





Table of Contents




PART
I


FINANCIAL
INFORMATION




ITEM 1.
  FINANCIAL
STATEMENTS.





CHINA PRECISION STEEL, INC. AND
SUBSIDIARIES


CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS





PageCondensed
      Consolidated Balance Sheets (unaudited)
                              3Condensed Consolidated Statements
      of Operations and Comprehensive Income
    (unaudited)
                              4Condensed Consolidated Statements
      of Changes in Stockholders' Equity (unaudited)
                              5Condensed Consolidated Statements of
      Cash Flows (unaudited)
                              6Notes to Condensed Consolidated
      Financial Statements (unaudited)
                              7




2
 Table of Contents




ITEM 1. FINANCIAL STATEMENTS.





China
Precision Steel, Inc. and Subsidiaries


Condensed Consolidated Balance Sheets





(Unaudited)December 31,
                                                  
                                                  
                                                  June 30,Notes
                                                  
                                                  
                                                  2008
                                                  
                                                  
                                                  2008AssetsCurrent
      assetsCash
      and cash equivalents
                                                  
                                                  
                                                  
                                                  
                                                  $
                                                  14,763,665
                                                  
                                                  
                                                  $
                                                  18,568,842Accounts
      receivableTrade,
      net of allowance for bad and doubtful debts of $4,877,672 and
      $1,033,479 at December 31 and June 30, 2008, respectively
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  23,248,541
                                                  
                                                  
                                                  
                                                  33,783,074Bills
      receivable
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  7,634,472
                                                  
                                                  
                                                  
                                                  4,309,703Other
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  307,992
                                                  
                                                  
                                                  
                                                  571,746Inventories
                                                  
                                                  
                                                  5
                                                  
                                                  
                                                  
                                                  18,359,109
                                                  
                                                  
                                                  
                                                  17,815,087Prepaid
      expenses
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  108,410
                                                  
                                                  
                                                  
                                                  58,105Advances
      to suppliers, net of allowances of $2,534,410 and $2,522,837 at December
      31 and June 30, 2008, respectively
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  30,281,090
                                                  
                                                  
                                                  
                                                  33,027,365Total
      current assets
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  94,703,279
                                                  
                                                  
                                                  
                                                  108,133,922Property
      and equipmentProperty,
      plant and equipment, net
                                                  
                                                  
                                                  6
                                                  
                                                  
                                                  
                                                  40,646,361
                                                  
                                                  
                                                  
                                                  39,199,305Construction-in-progress
                                                  
                                                  
                                                  7
                                                  
                                                  
                                                  
                                                  25,698,608
                                                  
                                                  
                                                  
                                                  16,476,45466,344,969
                                                  
                                                  
                                                  
                                                  55,675,759Intangible
      assets, net
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  2,343,532
                                                  
                                                  
                                                  
                                                  1,625,690Goodwill
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  99,999
                                                  
                                                  
                                                  
                                                  99,999Total
      assets
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  $
                                                  163,491,779
                                                  
                                                  
                                                  $
                                                  165,535,370Liabilities
      and Stockholders' EquityCurrent
      liabilitiesAccounts
      payable and accrued liabilities
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  $
                                                  11,954,266
                                                  
                                                  
                                                  $
                                                  12,047,981Advances
      from customers
                                                  
                                                  
                                                  8
                                                  
                                                  
                                                  
                                                  4,014,580
                                                  
                                                  
                                                  
                                                  6,996,996Other
      taxes payables
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  3,566,543
                                                  
                                                  
                                                  
                                                  3,976,239Current
      income taxes payable
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  4,271,276
                                                  
                                                  
                                                  
                                                  4,742,387Short-term
      loans
                                                  
                                                  
                                                  9
                                                  
                                                  
                                                  
                                                  17,457,984
                                                  
                                                  
                                                  
                                                  17,465,799Total
      current liabilities
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  41,264,649
                                                  
                                                  
                                                  
                                                  45,229,402Stockholders'
      equity:Preferred
      stock: $0.001 per value, 8,000,000 shares authorized, no shares
      outstanding at December 31, and June 30, 2008
                                                  
                                                  
                                                  11Common
      stock: $0.001 par value, 62,000,000 shares authorized, 46,562,955 and
      46,472,955 issued and outstanding at December 31, and June 30,
      2008
                                                  
                                                  
                                                  11
                                                  
                                                  
                                                  
                                                  46,563
                                                  
                                                  
                                                  
                                                  46,473Additional
      paid-in capital
                                                  
                                                  
                                                  11
                                                  
                                                  
                                                  
                                                  75,642,383
                                                  
                                                  
                                                  
                                                  75,372,488Accumulated
      other comprehensive income
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  10,
      046,082
                                                  
                                                  
                                                  
                                                  9,295,658Retained
      earnings
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  36,492,102
                                                  
                                                  
                                                  
                                                  35,591,349Total
      stockholders' equity
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  122,227,130
                                                  
                                                  
                                                  
                                                  120,305,968Total
      liabilities and stockholders' equity
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  $
                                                  163,491,779
                                                  
                                                  
                                                  $
                                                  165,535,370





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





3
 Table of Contents





China
Precision Steel, Inc. and Subsidiaries


Condensed Consolidated Statements of Operations


For
the Three and Six Months Ended December 31. 2008 and 2007


(Unaudited)





Three Months Ended
                                
                                
                                Six Months EndedDecember 31,
                                
                                
                                December 31,
                                
                                
                                December 31,
                                
                                
                                December 31,Notes
                                
                                
                                2008
                                
                                
                                2007
                                
                                
                                2008
                                
                                
                                2007RevenuesSales
      revenue
                                
                                
                                
                                
                                $
                                17,573,959
                                
                                
                                $
                                13,228,321
                                
                                
                                $
                                42,924,378
                                
                                
                                $
                                40,415,556Cost
      of goods sold
                                
                                
                                
                                
                                
                                14,122,622
                                
                                
                                
                                8,528,852
                                
                                
                                
                                35,520,383
                                
                                
                                
                                28,773,987Gross
      profit
                                
                                
                                
                                
                                
                                3,451,337
                                
                                
                                
                                4,699,469
                                
                                
                                
                                7,403,995
                                
                                
                                
                                11,641,569Operating
      expensesSelling
      expenses
                                
                                
                                
                                
                                
                                1,122,532
                                
                                
                                
                                180,744
                                
                                
                                
                                1,333,830
                                
                                
                                
                                281,449Administrative
      expenses
                                
                                
                                
                                
                                
                                578,105
                                
                                
                                
                                846,220
                                
                                
                                
                                1,040,205
                                
                                
                                
                                1,332,596Allowance
      for bad and doubtful debts
                                
                                
                                
                                
                                
                                3,829,462
                                
                                
                                
                                25,782
                                
                                
                                
                                3,829,462
                                
                                
                                
                                651,780Depreciation
      and amortization expense
                                
                                
                                
                                
                                
                                33,318
                                
                                
                                
                                15,798
                                
                                
                                
                                59,521
                                
                                
                                
                                29,430Total
      operating expenses
                                
                                
                                
                                
                                
                                5,563,417
                                
                                
                                
                                1,068,544
                                
                                
                                
                                6,263,018
                                
                                
                                
                                2,295,255Income/(loss)
      from operations
                                
                                
                                
                                
                                
                                (2,112,080
                                )
                                
                                
                                3,630,925
                                
                                
                                
                                1,140,977
                                
                                
                                
                                9,346,314Other
      income (expense)Other
      revenues
                                
                                
                                
                                
                                
                                138,998
                                
                                
                                
                                783,255
                                
                                
                                
                                259,701
                                
                                
                                
                                792,410Interest
      and finance costs
                                
                                
                                
                                
                                
                                (320,777
                                )
                                
                                
                                (316,860
                                )
                                
                                
                                (648,182
                                )
                                
                                
                                (759,001
                                )Total
      other income (expense)
                                
                                
                                
                                
                                
                                (181,779
                                )
                                
                                
                                466,395
                                
                                
                                
                                (388,481
                                )
                                
                                
                                33,409Net
      income/(loss) from operations before income tax
                                
                                
                                
                                
                                
                                (2,293,859
                                )
                                
                                
                                4,097,320
                                
                                
                                
                                752,496
                                
                                
                                
                                9,379,723Provision
      for (benefit from) income tax
                                
                                
                                10Current
                                
                                
                                
                                
                                
                                
                                (318,878
                                )
                                
                                
                                610,869
                                
                                
                                
                                (148,257
                                )
                                
                                
                                1,116,594Deferred
                                
                                
                                
                                
                                
                                
                                —
                                
                                
                                
                                —
                                
                                
                                
                                —
                                
                                
                                
                                (1,064,028
                                )Total
      income tax expense
                                
                                
                                
                                
                                
                                
                                (318,878
                                )
                                
                                
                                610,869
                                
                                
                                
                                (148,257
                                )
                                
                                
                                52,566Net
      income/(loss)
                                
                                
                                
                                
                                
                                $
                                (1,974,981
                                )
                                
                                $
                                3,486,451
                                
                                
                                $
                                900,753
                                
                                
                                $
                                9,327,157Basic
      earnings/(loss) per share
                                
                                
                                12
                                
                                
                                $
                                (0.04
                                )
                                
                                $
                                0.08
                                
                                
                                $
                                0.02
                                
                                
                                $
                                0.23Basic
      weighted average shares outstanding
                                
                                
                                
                                
                                
                                
                                46,562,955
                                
                                
                                
                                43,031,346
                                
                                
                                
                                46,559,531
                                
                                
                                
                                40,204,745Diluted
      earnings/(loss) per share
                                
                                
                                12
                                
                                
                                $
                                (0.04
                                )
                                
                                $
                                0.08
                                
                                
                                $
                                0.02
                                
                                
                                $
                                0.23Diluted
      weighted average shares outstanding
                                
                                
                                
                                
                                
                                
                                46, 562,955
                                
                                
                                
                                43,639,342
                                
                                
                                
                                46,566,423
                                
                                
                                
                                40,809,437The
      Components of comprehensive income:Net
      income/(loss)
                                
                                
                                
                                
                                
                                $
                                (1,974,981
                                )
                                
                                $
                                3,486,451
                                
                                
                                $
                                900,753
                                
                                
                                $
                                9,327,157Foreign
      currency translation adjustment
                                
                                
                                
                                
                                
                                
                                677,905
                                
                                
                                
                                1,179,322
                                
                                
                                
                                750,424
                                
                                
                                
                                2,084,859Comprehensive
      income/(loss)
                                
                                
                                
                                
                                
                                $
                                (1,297,076
                                )
                                
                                $
                                4,665,773
                                
                                
                                $
                                1, 651,177
                                
                                
                                $
                                11,412,016





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





4
 Table of Contents





China
Precision Steel, Inc. and Subsidiaries


Condensed Consolidated Statements of Changes in Stockholders'
Equity


For
the Six Months ended December 31, 2008


and
the Year ended June 30, 2008





AccumulatedAdditional
                                                      
                                                      
                                                      Other
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      TotalOrdinary Shares
                                                      
                                                      
                                                      Paid-in
                                                      
                                                      
                                                      Comprehensive
                                                      
                                                      
                                                      Retained
                                                      
                                                      
                                                      Stockholders'Share
                                                      
                                                      
                                                      Amount
                                                      
                                                      
                                                      Capital
                                                      
                                                      
                                                      Income
                                                      
                                                      
                                                      Earnings
                                                      
                                                      
                                                      EquityBalance
      at June 30, 2007
                                                      
                                                      
                                                      37,378,141
                                                      
                                                      
                                                      $
                                                      37,378
                                                      
                                                      
                                                      $
                                                      31,867,063
                                                      
                                                      
                                                      $
                                                      2,192,160
                                                      
                                                      
                                                      $
                                                      17,008,238
                                                      
                                                      
                                                      $
                                                      51,104,839Sale
      of common stock
                                                      
                                                      
                                                      7,100,000
                                                      
                                                      
                                                      
                                                      7,100
                                                      
                                                      
                                                      
                                                      44,498,650
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      44,505,750Syndication
      fees
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      (130,468
                                                      )
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      (130,468
                                                      )Make
      good shares
                                                      
                                                      
                                                      2,000,000
                                                      
                                                      
                                                      
                                                      2,000
                                                      
                                                      
                                                      
                                                      (2,000
                                                      )
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      —Exercise
      of warrants
                                                      
                                                      
                                                      765,872
                                                      
                                                      
                                                      
                                                      766
                                                      
                                                      
                                                      
                                                      1,729,235
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      1,730,001Cancellation
      of stock
                                                      
                                                      
                                                      (771,060
                                                      )
                                                      
                                                      
                                                      (771
                                                      )
                                                      
                                                      
                                                      (2,589,992
                                                      )
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      (2,590,763
                                                      )Foreign
      currency translation adjustment
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      7,103,498
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      7,103,498Net
      income
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      18,583,111
                                                      
                                                      
                                                      
                                                      18,583,111Balance
      at June 30, 2008
                                                      
                                                      
                                                      46,472,953
                                                      
                                                      
                                                      
                                                      46,473
                                                      
                                                      
                                                      
                                                      75,372,488
                                                      
                                                      
                                                      
                                                      9,295,658
                                                      
                                                      
                                                      
                                                      35,591,349
                                                      
                                                      
                                                      
                                                      120,305,968Exercise
      of warrants
                                                      
                                                      
                                                      90,000
                                                      
                                                      
                                                      
                                                      90
                                                      
                                                      
                                                      
                                                      269,895
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      269,985Foreign
      currency translationadjustment
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      750,424
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      750,424Net
      income
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      900,753
                                                      
                                                      
                                                      
                                                      900,753Balance
      at December 31, 2008 (unaudited)
                                                      
                                                      
                                                      46,562,953
                                                      
                                                      
                                                      $
                                                      46,563
                                                      
                                                      
                                                      $
                                                      75,642,383
                                                      
                                                      
                                                      $
                                                      10, 046,082
                                                      
                                                      
                                                      $
                                                      36,492,102
                                                      
                                                      
                                                      $
                                                      121,227,130




5
 Table of Contents




China
Precision Steel, Inc. and Subsidiaries


Condensed Consolidated Statements of Cash Flows


For
the Six Months Ended December 31, 2008 and 2007


(Unaudited)





2008
                                    
                                    
                                    2007Cash
      flows from operating activitiesNet
      Income
                                    
                                    $
                                    900,753
                                    
                                    
                                    $
                                    9,327,157Adjustments
      to reconcile net income to net cash provided by operating
      activitiesDepreciation
      and amortization
                                    
                                    
                                    1,825,544
                                    
                                    
                                    
                                    992,570Allowance for bad and doubtful debts
                                    
                                    
                                    3,829,462
                                    
                                    
                                    
                                    651,780Net
      changes in assets and liabilities:Accounts
      receivable, net
                                    
                                    
                                    3,801,518
                                    
                                    
                                    
                                    (31,266,517
                                    )Inventories
                                    
                                    
                                    (461,094
                                    )
                                    
                                    
                                    5,195,155Deposits
                                    
                                    
                                    —
                                    
                                    
                                    
                                    15,018Prepaid
      expenses
                                    
                                    
                                    (50,382
                                    )
                                    
                                    
                                    (326,065
                                    )Advances
      to suppliers
                                    
                                    
                                    2,890,245
                                    
                                    
                                    
                                    1,549,672Accounts
      payable and accrued liabilities
                                    
                                    
                                    (147,831
                                    )
                                    
                                    
                                    1,296,194Advances
      from customers
                                    
                                    
                                    (3,006,670
                                    )
                                    
                                    
                                    2,070,883Other
      taxes payable
                                    
                                    
                                    (426,823
                                    )
                                    
                                    
                                    2,747,055Current
      income taxes
                                    
                                    
                                    (491,584
                                    )
                                    
                                    
                                    1,748,480Deferred
      income taxes
                                    
                                    
                                    —
                                    
                                    
                                    
                                    (1,064,028
                                    )Net
      cash provided by (used in) operating activities
                                    
                                    
                                    8,663,138
                                    
                                    
                                    
                                    (7,062,646
                                    )Cash
      flows from investing activitiesPurchases
      of property, plant and equipment including construction in
      progress
                                    
                                    
                                    (12,954,497
                                    )
                                    
                                    
                                    (5,508,327
                                    )Net
      cash (used in) investing activities
                                    
                                    
                                    (12,954,497
                                    )
                                    
                                    
                                    (5,508,327
                                    )Cash
      flows from financing activitiesExercise
      of common stock warrants
                                    
                                    
                                    269,985
                                    
                                    
                                    
                                    —Sale
      of common stock
                                    
                                    
                                    
                                    
                                    
                                    
                                    44,433,222Advances
      from/(to) directors, net
                                    
                                    
                                    —
                                    
                                    
                                    
                                    2,154,257Short-term
      loans proceeds
                                    
                                    
                                    —
                                    
                                    
                                    
                                    16,446,667Repayments
      of short-term loans
                                    
                                    
                                    (87,690
                                    )
                                    
                                    
                                    (17,424,050
                                    )Net
      cash provided by financing activities
                                    
                                    
                                    182,295
                                    
                                    
                                    
                                    45,610,096Effect
      of exchange rate
                                    
                                    
                                    303,887
                                    
                                    
                                    
                                    1,661,126Net
      (decrease)increase in cash
                                    
                                    
                                    (3,805,177
                                    )
                                    
                                    
                                    34,700,249Cash
      and cash equivalents, beginning of period
                                    
                                    
                                    18,568,842
                                    
                                    
                                    
                                    5,504,862Cash
      and cash equivalents, end of period
                                    
                                    $
                                    14,763,665
                                    
                                    
                                    $
                                    40,205,111Supplemental
      disclosure of cash flow information:Cash
      paid during the period for interest
                                    
                                    $
                                    648,182
                                    
                                    
                                    $
                                    759,001Cash
      paid during the period for income taxes
                                    
                                    $
                                    364,058
                                    
                                    
                                    $
                                    -





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




6
 Table of Contents





China
Precision Steel, Inc.


Notes to the Condensed Consolidated Financial
Statements





1.   Description
of Business





On
December 28, 2006, China Precision Steel, Inc. (the “Company” or “we”), under
our former name, OraLabs Holding Corp., issued 25,363,002 shares of common stock
in exchange for 100% of the registered capital of Partner Success Holdings
Limited (“PSHL”), a British Virgin Islands Business Company pursuant to a Stock
Exchange Agreement, dated March 31, 2006. Subsequent to the closing of that
transaction, on December 28, 2006, the Company redeemed 3,629,350 shares 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 its
common stock to OraLabs, Inc. in exchange for $450,690, and received additional
cash payments in the aggregate amount of $108,107 in payment of an estimated
$558,797 tax liability to be incurred by the Company in connection with the spin
off of OraLabs, Inc. and the supplemental payment received. The Company then
changed its name to China Precision Steel, Inc.




These
transactions were treated for financial reporting purposes as a
recapitalization, with prior OraLabs, Inc. operating activities reflected on the
statements of operations as income (loss) from discontinued operations. The
$558,797 estimated tax liability incurred in connection with the spin off of
OraLabs, Inc. was treated as a transaction cost for financial reporting purposes
and was treated as a reduction in additional paid in capital to the extent of
the additional 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 December 31, 2008 and 2007. It has three
wholly-owned subsidiaries, Shanghai Chengtong Precision Strip Company Limited
(“Chengtong”), Shanghai Tuorong Precision Strip Company Limited (“Tuorong”), and
Blessford International Limited (“Blessford”).





Chengtong
was registered on July 2, 2002 in Shanghai, People’s Republic of China (“PRC”),
with a registered capital of $3,220,000 and a defined period of existence of 50
years from July 2, 2002 to July 1, 2052. Chengtong was classified as a
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 Council on June 28, 2004, the equity transfers from China Chengtong Metal
Group Limited and Eastreal Holdings Company Limited to PSHL were approved and
the transformation of Chengtong from a Sino-foreign joint investment enterprise
to a wholly foreign owned enterprise (WFOE) was granted.





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
Company Limited, or Tuorong, through PSHL. The sole activity of Tuorong is the
ownership of a land use right with respect to facilities utilized by Chengtong.
On April 10, 2007, PSHL purchased for $100,000 Blessford International Limited,
a British Virgin Islands company. Blessford International Limited does not
conduct any business, but it owns a single subsidiary, Shanghai Blessford Alloy
Company Limited, that is a wholly-foreign owned enterprise with limited
liabilities. Shanghai Blessford was registered on February 24, 2006 in Shanghai
with a registered capital of $12,000,000 and a defined period of existence of 50
years from February 24, 2006 to February 23, 2056. On May 27, 2008, the
authorized registered capital was increased to $22,000,000. We intend to hold
Blessford International Limited as a shell subsidiary. As used herein, the
“Group” refers to the Company, PSHL, Chengtong, Tuorong, Blessford International
and Shanghai Blessford on a consolidated basis.





The
Company’s principal activities are conducted through its two operating
subsidiaries, Chengtong and Shanghai Blessford. Chengtong and Shanghai Blessford
are niche precision steel processing companies principally engaged in the
manufacture and sales of cold-rolled and hot-rolled precision steel products and
plates for downstream applications in the automobile industry (components and
spare parts), kitchen tools and functional parts of electrical appliances. Raw
materials, hot-rolled de-scaled (pickled) steel coils, will go through certain
cold reduction processing procedures to give steel rolls and plates in different
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 compliment the emerging
need for highly engineered end use applications. Precision steel pertains to the
precision of measurements and tolerances of the above factors, especially
thickness tolerance.




7
 Table of Contents




2.    
Basis of Preparation of Financial Statements





The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q. Accordingly, they
do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements and related
notes. The accompanying unaudited condensed consolidated financial statements
and related notes should be read in conjunction with the audited consolidated
financial statements of the Company and notes thereto for the year ended June
30, 2008.





In the
opinion of management, the accompanying unaudited condensed consolidated
financial statements contain all adjustments (which include only normal
recurring adjustments) necessary to present fairly the balance sheet of China
Precision Steel, Inc. and subsidiaries as of December 31, 2008 and June 30,
2008, and the results of their operations and cash flows for the three and six
months ended December 31, 2008 and 2007. The results of operations for the three
or six months ended December 31, 2008 are not necessarily indicative of the
results to be expected for the entire year ending June 30, 2009.





3.  Summary of Significant Accounting
Policies





The
following is a summary of significant accounting policies:





Cash and Cash Equivalents -TheCompany
considers all highly liquid debt instruments purchased with maturity period of
six months or less to be cash equivalents. The carrying amounts reported in the
accompanying consolidated balance sheets for cash and cash equivalents
approximate their fair value.





Accounts Receivable -The
Company provides an allowance for doubtful accounts equal to the estimated
uncollectible amounts. It is reasonably possible that the Company’s estimate of
the allowance will change. At December 31, 2008 and June 30, 2008, the Company
had $1,038,220 and $1,033,479 of allowances for doubtful accounts,
respectively.





Inventory -Inventory is
stated at the lower of cost or market. Cost is determined using the weighted
average method. Market value represents the estimated selling price in the
ordinary course of business less the estimated costs necessary to complete the
sale.





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





Advances to Suppliers -In
order to secure a steady supply of raw materials, the Company is required from
time to time to make cash advances when placing its purchase orders. Cash
advances are shown net of allowances for unrecoverable advances of $2,534,410
and $2,522,837 at December 31, 2008 and June 30, 2008,
respectively.





Intangible assets -The
Company acquired land use rights in August 2004 and December 2006 for 50 years
that expire in August 2054 and December 2056 respectively. The land use rights
are amortized over a fifty-year term. An amortization amount of approximately
$50,000 is to be recorded each year starting from the current financial year
ending June 30, 2009 for the remaining lease period.





Intangible
assets of the Company are reviewed annually to determine whether their carrying
value has become impaired, in conformity with SFAS No. 142, Goodwill and Other Intangible Assets(“SFAS No. 142”). The Company also re-evaluates the periods of
amortization to determine whether subsequent events and circumstances warrant
revised estimates of useful lives. As of December 31, 2008, the Company expects
these assets to be fully recoverable.





8
 Table of Contents


Property, Plant and Equipment -Property, plant and equipment are stated at cost less accumulated
depreciation. The cost of an asset comprises its purchase price and any directly
attributable costs of bringing the asset to its present working condition and
location for its intended use.
 
 Depreciation
is computed on a straight-line basis over the estimated useful lives of the
related assets for financial reporting purposes. The estimated useful lives for
significant property and equipment are as follows:
 Plant
      and machinery
                            
                            10 yearsBuildings
                            
                            10 yearsMotor
      vehicles
                            
                            5 yearsOffice
      equipment
                            
                            5 years
 
 Repairs
and maintenance costs are normally charged to the statement of operations in the
year in which they are incurred. In situations where it can be clearly
demonstrated that the expenditure has resulted in an increase in the future
economic benefits expected to be obtained from the use of the asset, the
expenditure is capitalized as an additional cost of the asset.
 
 Property,
plant and equipment are evaluated annually in accordance with SFAS No. 144,
“Accounting for Impairment of Long-Lived Assets and Long-Lived Assets to be
Disposed of” (“SFAS 144”) for any impairment in value. There were no property
and equipment impairments recognized during the six months ended December 31,
2008 and 2007.
 
 Impairment of Long-Lived Assets -The Company accounts for impairment of plant and equipment and
amortizable intangible assets in accordance with SFAS 144, which requires the
Company to evaluate a long-lived asset for recoverability when there is event or
circumstance that indicate the carrying value of the asset may not be
recoverable. An impairment loss is recognized when the carrying amount of a
long-lived asset or asset group is not recoverable (when carrying amount exceeds
the gross, undiscounted cash flows from use and disposition) and is measured as
the excess of the carrying amount over the asset’s (or asset group’s) fair
value.
 
 Capitalized Interest - The
Company capitalizes interest cost on borrowings incurred during the new
construction or upgrade of qualified assets. Capitalized interest is added to
the cost of the underlying assets and is amortized over the useful lives of the
assets. During the six months ended December 31, 2008 and 2007, the Company
capitalized no interest to construction-in-progress.
 
 Construction-in-Progress -
Plant and production lines currently under development are accounted for as
construction-in-progress. Construction-in-progress is recorded at acquisition
cost, including land rights cost, development expenditure, professional fees and
the interest expenses capitalized during the course of construction for the
purpose of financing the project. Upon completion and readiness for use of the
project, the cost of construction-in-progress is to be transferred to fixed
assets.
 
 Contingent Liabilities and Contingent
Assets - A
contingent liability is a possible obligation that arises from past events and
whose existence will only be confirmed by the occurrence or non-occurrence of
one or more uncertain future events not wholly within the control of the
Company. It can also be a present obligation arising from past events that is
not recognized because it is not probable that outflow of economic resources
will be required or the amount of obligation cannot be measured
reliably.
 
 A
contingent liability is not recognized but is disclosed in the notes to the
financial statements. When a 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 a possible asset that arises from past events and whose
existence will be confirmed only by the occurrence or non-occurrence of one or
more uncertain events not wholly within the control of the Company.
 
 Contingent
assets are not recognized but are disclosed in the notes to the financial
statements when an inflow of economic benefits is probable. When inflow is
virtually certain, an asset is recognized.
  9
 Table of Contents
  Advances from
Customers -
Revenue from the sale of goods or services is recognized at the time that goods
are delivered or services are rendered. Receipts in advance for goods to be
delivered or services to be rendered in a subsequent period are carried forward
as deferred revenue.
 
 Revenue Recognition
-Revenue from the sale of goods and services is recognized on the
transfer of risks and rewards of ownership, which generally coincides with the
time when the goods are delivered to customers and the title has passed and
services have been rendered and invoiced. Revenue is reported net of all VAT
taxes. Other income is recognized when it is earned.
 
 Foreign Currencies - The
Company’s principal country of operations is the PRC. The financial position and
results of operations of the Company are determined using the local currency
(“Renminbi” or “Yuan”) as the functional currency. Transactions not conducted in
Renminbi are translated into Renminbi at the exchange rates prevailing at the
times of such transactions. The results of operations denominated in foreign
currencies are translated at the average rate of exchange during the reporting
period. Assets and liabilities denominated in foreign currencies at the balance
sheet date are translated at the market rate of exchange ruling at that date.
The registered equity capital denominated in the functional currency is
translated at the historical rate of exchange at the time of capital
contribution. All translation adjustments resulting from the translation of the
financial statements into the reporting currency (“US Dollars”) are dealt with
as an exchange fluctuation reserve in shareholders’ equity.
 
 Taxation -Taxation on
overseas profits has been calculated on the estimated assessable profits for the
year at the rates of taxation prevailing in the country in which the Company
operates.
 
 United
States
 
 China
Precision Steel, Inc. is subject to United States federal income tax at a tax
rate of 34%. No provision for income taxes in the United States has been made as
China Precision Steel, Inc. had no taxable income in fiscal years 2009 and
2008.
 
 BVI
 
 PSHL and
Blessford International were incorporated in the British Virgin Islands and,
under the current laws of the British Virgin Islands, are not subject to income
taxes.
 
 PRC
 
 Provision
for the PRC enterprise income tax is calculated at the prevailing rate based on
the estimated assessable profits less available tax relief for losses brought
forward.The Company
does not accrue taxes on unremitted earnings from foreign operations as it is
the Company’s intention to invest these earnings in the foreign operations
indefinitely.
 
 Enterprise
income tax
 
 On March
16, 2007, the National People’s Congress of China passed The Enterprise Income
Tax Law (the “New EIT Law”), and on December 6, 2007, the State Council of China
passed the Implementing Rules for the EIT Law (“Implementing Rules”) which took
effect on January 1, 2008. The New EIT Law and Implementing Rules impose a
unified enterprise income tax (“EIT”) of 25% on all domestic-invested
enterprises and foreign invested entities (“FIEs”), unless they qualify under
certain limited exceptions. Therefore, nearly all FIEs are subject to the new
tax rate alongside other domestic businesses rather than benefiting from the old
FIE tax laws, and its associated preferential tax treatments, beginning January
1, 2008.
 
 Despite
these changes, the EIT Law gives the FIEs established before March 16, 2007
(“Old FIEs”) a five-year grandfather period during which they can continue to
enjoy their existing preferential tax treatments, commonly referred to as “tax
holidays”, until these holidays expire. As Old FIEs, Chengtong is currently
enjoying a 50% reduction in the 25% statutory rates that expired on December 31,
2008, Shanghai Blessford is currently enjoying a full tax exemption from the
enterprise income tax that will expire on December 31, 2009, and is entitled to
a 50% reduction for the three subsequent years expiring on December 31, 2012.
Subsequent to the expiry of their tax holidays, Chengtong and Shanghai Blessford
will be subject to enterprise income taxes at 25% or the prevailing statutory
rates. The discontinuation of any such special or preferential tax treatment or
other incentives would have an adverse effect on any organization’s business,
fiscal condition and current operations in China.
  10
 Table of Contents
  Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets, including tax loss and credit carry forwards, and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
Deferred income tax expense represents the change during the period in the
deferred tax assets and deferred tax liabilities. The components of the deferred
tax assets and liabilities are individually classified as current and
non-current based on their characteristics. Deferred tax assets are reduced by a
valuation allowance when, in the opinion of management, it is more likely than
not that some portion or all of the deferred tax assets will not be
realized.
 
 In 2006,
the Financial Accounting Standards Board (“FASB”) issued FIN 48, which clarifies
the application of SFAS No. 109 by defining a criterion that an individual
income tax position must meet for any part of the benefit of that position to be
recognized in an enterprise’s financial statements and provides guidance on
measurement, derecognition, classification, accounting for interest and
penalties, accounting in interim periods, disclosure and transition. In
accordance with the transition provisions, the Company adopted FIN 48 effective
January 1, 2007.
 
 The
Company recognizes that virtually all tax positions in the PRC are not free of
some degree of uncertainty due to tax law and policy changes by the State.
However, the Company cannot reasonably quantify political risk factors and thus
must depend on guidance issued by current State officials.
 
 Based on
all known facts and circumstances and current tax law, the Company believes that
the total amount of unrecognized tax benefits as of December 31, 2008, is not
material to its results of operations, financial condition or cash flows. The
Company also believes that the total amount of unrecognized tax benefits as of
December 31, 2008, if recognized, would not have a material effect on its
effective tax rate. The Company further believes that there are no tax positions
for which it is reasonably possible, based on current Chinese tax law and
policy, that the unrecognized tax benefits will significantly increase or
decrease over the next 12 months producing, individually or in the aggregate, a
material effect on the Company’s results of operations, financial condition or
cash flows.
 
 Value
added tax
 
 The
Provisional Regulations of the People’s Republic of China Concerning Value Added
Tax promulgated by the State Council came into effect on January 1, 1994. Under
these regulations and the Implementing Rules of the Provisional Regulations of
the People’s Republic of China Concerning Value Added Tax, value added tax is
imposed on goods sold in or imported into the PRC and on processing, repair and
replacement services provided within the PRC.
 
 Value
added tax payable in the PRC is charged on an aggregated basis at a rate of 13%
or 17% (depending on the type of goods involved) on the full price collected for
the goods sold or, in the case of taxable services provided, at a rate of 17% on
the charges for the taxable services provided, but excluding, in respect of both
goods and services, any amount paid in respect of value added tax included in
the price or charges, and less any deductible value added tax already paid by
the taxpayer on purchases of goods and services in the same financial
year.
 
 Retirement Benefit Costs -
According to the PRC regulations on pension, Chengtong and Shanghai Blessford
contribute to a defined contribution retirement scheme organized by municipal
government in the province in which Chengtong and Shanghai Blessford were
registered and all qualified employees are eligible to participate in the
scheme. Contributions to the scheme are calculated at 23.5% of the employees’
salaries above a fixed threshold amount and the employees contribute 2% to 8%,
while Chengtong and Shanghai Blessford contribute the balance contribution of
15.5%% to 21.5%. The Group has no other material obligation for the payment of
retirement benefits beyond the annual contributions under this
scheme.
  11
 Table of Contents
  For the
three and six months ended December 31, 2008, the Company’s pension cost charged
to the statements of operations under the plan amounted to $63,486 and $160,885,
respectively, all of which have been paid to the National Social Security Fund
(2007: $72,059 and $132,658, respectively).
 
 Fair Value of Financial 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 31, 2008 and June
30, 2008 because of the relatively short-term maturity of these
instruments.
 
 Use of Estimates - The preparation of financial
statements in accordance with generally accepted accounting principles requires
management to make estimates and assumptions that affect reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
 
 Recent Accounting
Pronouncements -
 
 The
Financial Accounting Standards Board (“FASB”) recently issued the following
standards which the Company reviewed to determine the potential impact on our
financial statements upon adoption.
 
 In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations” (“SFAS 141(R)”). SFAS 141(R) will change the accounting for
business combinations. Under SFAS No. 141(R), an acquiring entity will be
required to recognize all the assets acquired and liabilities assumed in a
transaction at the acquisition-date fair value with limited exceptions. SFAS
No. 141(R) will change the accounting treatment and disclosure for certain
specific items in a business combination. SFAS No. 141(R) applies
prospectively to business combinations for which the acquisition date is on or
after the beginning 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
future acquisition.
  In
December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in
Consolidated Financial Statements—an amendment of Accounting Research Bulletin
No. 51” (“SFAS 160”). SFAS 160 establishes new accounting and reporting
standards for the noncontrolling interest in a subsidiary and for the
deconsolidation of a subsidiary. SFAS No. 160 is effective for fiscal years
beginning on or after December 15, 2008. The Company does not believe that
SFAS 160 will have a material impact on its consolidated financial
statements.
  In
March 2008, the FASB issued SFAS No. 161, “Disclosures about
Derivative Instruments and Hedging Activities—an amendment of FASB Statement
No. 133” (“SFAS 161”). SFAS 161 changes the disclosure requirements for
derivative instruments and hedging activities. Entities are required to provide
enhanced disclosures about (a) how and why an entity uses derivative
instruments, (b) how derivative instruments and related hedged items are
accounted for under Statement 133 and its related interpretations, and
(c) how derivative instruments and related hedged items affect an entity’s
financial position, financial performance, and cash flows. The guidance in SFAS
161 is effective for financial statements issued for fiscal years and interim
periods beginning after November 15, 2008, with early application
encouraged. This Statement encourages, but does not require, comparative
disclosures for earlier periods at initial adoption. The adoption of SFAS No.
161 did not impact our consolidated financial statements in any material
respect.
 
 In April 2008, the FASB issued FASB
Staff Position (“FSP”) FAS 142-3, “Determination of the Useful Life of
Intangible Assets”(“FAS 142-3”), which amends the factors that should be
considered in developing renewal or extension assumptions used to determine the
useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and
Other Intangible Assets” (“SFAS No. 142”).  The intent of this FSP is
to improve the consistency between the useful life of a recognized intangible
asset under SFAS No. 142 and the period of expected cash flows used to measure
the fair value of the asset under SFAS No. 141(R), “Business Combinations,” and
other U.S. generally accepted accounting principles.  This FSP is
effective for fiscal years beginning after December 15, 2008 (the Company’s
fiscal year 2010), and interim periods within those fiscal years.  The
Company does not believe the adoption of FSP 142-3 will have a material impact
on the Company’s consolidated financial position, results of operations and cash
flows.
  12
 Table of Contents
  In May
2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted
Accounting Principles"(“SFAS 162”).  This statement identifies the
sources of accounting principles and the framework for selecting the principles
to be used in the preparation of financial statements of non-governmental
entities that are presented in conformity with US GAAP. The provisions of
SFAS162 become effective 60 days following the SEC's approval of the amendment
to AU Section 411, "The Meaning of Presents Fairly in Conformity with Generally
Accepted Accounting Principles" by the Public Company Accounting Oversight
Board.  The adoption of this statement is not expected to have a
material effect on the Company’s future reported financial position or results
of operations.
 
 In May
2008, the FASB issued FASB Statement No. 163, “Accounting for Financial Guarantee
Insurance Contracts”(FASB 163”). The new standard clarifies how FASB
Statement No. 60, “Accounting
and Reporting by Insurance Enterprises”, applies to financial guarantee
insurance contracts issued by insurance enterprises, including the recognition
and measurement of premium revenue and claim liabilities. It also requires
expanded disclosures about financial guarantee insurance contracts. FASB 163 is
effective for financial statements issued for fiscal years beginning after
December 15, 2008, and all interim periods within those fiscal years, except for
disclosures about the insurance enterprise’s risk-management activities, which
are effective the first period (including interim periods) beginning after May
23, 2008. Except for the required disclosures, earlier application is not
permitted. The standard is not applicable to this Company.
 
 In
October 2008, the FASB issued FSP FAS 157-3, “Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active”(“FAS
157-3”). This FSP clarifies the application of FASB Statement No. 157, “Fair Value Measurements”, in
a market that is not active and provides an example to illustrate key
considerations in determining the fair value of a financial asset when the
market for that financial asset is not active. FAS 157-3 was effective upon
issuance. The adoption of FAS 157-3 did not impact our consolidated financial
statements in any material respect.
 
 4.  Concentrations
of Business and Credit Risk
 
 The
Company provides credit in the normal course of business. The Company performs
ongoing credit evaluations of its customers and clients and maintains allowances
for doubtful accounts based on factors surrounding the credit risk of specific
customers and clients, historical trends, and other information. Trade accounts
receivable, net totaled $23,248,541 and $33,783,074 as of December 31, 2008 and
June 30, 2008, respectively.
 
 The
Company’s list of customers whose purchases exceeded 10% of total sales during
the six months ended December 31, 2008 and 2007 is as follows:
 
 Customers
                          
                          2008
                          
                          
                          % to
                              sales
                          
                          
                          2007
                          
                          
                          % to
                              salesSalzgitter
      Mannesmann International GMBH
                          
                          
                          13,651,071
                          
                          
                          
                          32
                          
                          
                          
                          —
                          *
                          
                          
                          —
                          *Shanghai
      Changshuo Stainless Steel Co., Ltd.
                          
                          
                          4,555,411
                          
                          
                          
                          11
                          
                          
                          
                          11,076,780
                          
                          
                          
                          27Shanghai
      Shengdejia Metal Co. Ltd.
                          
                          
                          —
                          *
                          
                          
                          —
                          *
                          
                          
                          6,492,562
                          
                          
                          
                          16
  The
Company’s list of suppliers whose sales exceeded 10% of total consumption during
the six months ended December 31, 2008 and 2007 is as follows:
 
 Suppliers
                                
                                2008
                                
                                
                                % to
                                  consumption
                                
                                
                                2007
                                
                                
                                % to
                                  consumptionBaoSteel
      Steel Products Trading Co. Ltd.
                                
                                
                                10,756,193
                                
                                
                                
                                35
                                
                                
                                
                                1,257,169
                                
                                
                                
                                7Shanghai
      Pinyun Steel Co., Ltd
                                
                                
                                6,877,828
                                
                                
                                
                                22
                                
                                
                                
                                3,262,936
                                
                                
                                
                                18Hangzhou
      Relian Company Limited
                                
                                
                                —
                                *
                                
                                
                                —
                                *
                                
                                
                                2,291,248
                                
                                
                                
                                12
  13
 Table of Contents
  5.  Inventories
 
 As of
December 31, 2008 and June 30, 2008 inventories consisted of the
following:
 
 At cost:
                                      
                                      December 31,
                                        2008
                                      
                                      
                                      June 30,
                                        2008Raw materials
                                      
                                      $
                                      6,208,271
                                      
                                      
                                      $
                                      8,376,173Work
      in progress
                                      
                                      
                                      1,866,089
                                      
                                      
                                      
                                      3,247,093Finished
      goods
                                      
                                      
                                      7,997,314
                                      
                                      
                                      
                                      3,918,801Consumable
      items
                                      
                                      
                                      2,287,435
                                      
                                      
                                      
                                      2,273,020$
                                      18,359,109
                                      
                                      
                                      $
                                      17,815,087
 
 6.  Property, Plant and
Equipment
 
 Property,
plant and equipment, stated at cost less accumulated depreciation, consisted of
the following:
 
 December 31,
                                2008
                              
                              
                              June 30,
                                2008Plant
      and machinery
                              
                              $
                              25,723,384
                              
                              
                              $
                              22,725,528Buildings
                              
                              
                              21,797,217
                              
                              
                              
                              21,685,208Motor
      vehicles
                              
                              
                              527,369
                              
                              
                              
                              379,885Office
      equipment
                              
                              
                              216,391
                              
                              
                              
                              185,16148,264,361
                              
                              
                              
                              44,975,782Less:
      Accumulated depreciation
                              
                              
                              (7,618,000
                              )
                              
                              
                              (5,776,477
                              )$
                              40,646,361
                              
                              
                              $
                              39,199,305
 
 Depreciation
expense related to manufacturing is included as a component of cost of goods
sold. During the three and six months ended December 31, 2008, depreciation
totaling $941,991 and $1,766,023, respectively, was included as a component of
cost of goods sold (2007: $483,482 and $961,462, respectively).
 
 Plant and
machinery amounting to $18,417,528 (June 30, 2008: $18,972,430) and land use
right amounting to $555,943 (June 30, 2008: $553,404) were pledged for
short-term loans totaling $17,457,984.
 
 7.  Construction-In-Progress
 
 As of
December 31, 2008 and June 30, 2008, construction-in-progress consisted of the
following:
 
 December 31,
                            2008
                          
                          
                          June 30,
                            2008Construction
      costs
                          
                          $
                          25,698,608
                          
                          
                          $
                          16,476,454
 
 Construction-in-progress
represents construction and installations of the new 1450mm cold-rolling mill at
Shanghai Blessford’s facilities.
 
 8.  Advances from
Customers
 
 Advances
from customers represent advance cash receipts from new customers and for which
goods have not been delivered or services rendered as of the balance sheets
dates. Advances from customers for goods to be delivered or services to be
rendered in the subsequent period are carried forward as deferred revenue. As of
December 31, 2008 and June 30, 2008, there were advances from customers of
$4,014,580 and $6,996,996, respectively.
  14
 Table of Contents
  9.  Short-Term
Loans
 
 Short-term
loans consisted of the following:
 
 December 31,
                        2008
                      
                      
                      June 30,
                        2008Bank
      loan dated August 1, 2008, due in one year with an interest rate of the
      Singapore Interbank Offered Rate (“SIBOR”) plus 3% (4.44% at December 31,
      2008) (Note 6)
                      
                      
                      5,300,000
                      
                      
                      
                      5,300,000Bank
      loan dated August 1, 2008, due in one year with an interest rate at 115%
      of the standard market rate set by the People’s Bank of China for Renminbi
      loans, secured by land use rights, buildings, plant and machinery (6.11%
      at December 31, 2008) (Note 6)
                      
                      
                      2,904,700
                      
                      
                      
                      2,886,952Bank
      loan dated July 26, 2008, due in one year with an interest rate at 115% of
      the standard market rate set by the People’s Bank of China for Renminbi
      loans, secured by land use rights, buildings, plant and machinery (6.11%
      at December 31, 2008) (Note 6)
                      
                      
                      9,253,284
                      
                      
                      
                      9,278,847$
                      17,457,984
                      
                      
                      $
                      17,465,799
 
 The
weighted average interest rate on short-term loans at December 31, 2008 and June
30, 2008 was 5.60% and 7.72%, respectively.
 
 The above
bank loans outstanding as at June 30, 2008 have been renewed at an interest rate
of 115% of the standard market rate set by the People’s Bank of China for
Renminbi loans and at SIBOR plus 3% for USD loans, due on July 31, 2009 and
secured by land use rights, buildings, plant and machinery.
 
 10.  Income
Taxes
 
 For
enterprise income tax reporting purposes, the Company reports income and
expenses on an accrual basis and is required to compute a 10% salvage value when
computing depreciation expense. For financial reporting purposes, the Company
reports income and expenses on the accrual basis and does not take into account
a 10% salvage value when computing depreciation expenses.
 
 The tax
holiday resulted in tax savings as follows:
 
 Three months ended December 31,
                  
                  
                  Six months ended December 312008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007Tax
      savings
                  
                  $
                  (233,193
                  )
                  
                  $
                  668,444
                  
                  
                  $
                  411,977
                  
                  
                  $
                  1,345,100Benefit
      per shareBasic
                  
                  $
                  (0.01
                  )
                  
                  $
                  0.01
                  
                  
                  $
                  0.01
                  
                  
                  $
                  0.07Diluted
                  
                  $
                  (0.01
                  )
                  
                  $
                  0.01
                  
                  
                  $
                  0.01
                  
                  
                  $
                  0.07
  15
 Table of Contents
  Significant
components of the Group’s deferred tax assets and liabilities as of December 31,
2008 and June 30, 2008 are as follows:
 
 Deferred tax assets and liabilities:
                                  
                                  December 31
                                    2008
                                  
                                  
                                  June 30,
                                    2008Book
      depreciation in excess of tax depreciation
                                  
                                  $
                                  226,107
                                  
                                  
                                  $
                                  169,962Temporary
      differences resulting from allowances
                                  
                                  
                                  1,844,343
                                  
                                  
                                  
                                  573,324Net
      deferred income tax asset
                                  
                                  $
                                  2,070,450
                                  
                                  
                                  $
                                  743,286Valuation
      allowance
                                  
                                  
                                  (2,070,450
                                  )
                                  
                                  
                                  (743,286
                                  )$
                                  —
                                  
                                  
                                  $
                                  —
  A
reconciliation of the provision for income taxes with amounts determined by the
U.S. federal income tax rate to income before income taxes is as
follows.
 
 Three months ended
                            December 31,
                          
                          
                          Six months ended
                            December 31,2008
                          
                          
                          2007
                          
                          
                          2008
                          
                          
                          2007Computed
      tax at the federal statutory rate of 34%
                          
                          $
                          (779,912
                          )
                          
                          $
                          1,393,089
                          
                          
                          $
                          255,849
                          
                          
                          $
                          3,189,106Less
      adjustment to EIT statutory rate of 25% in 2008 and 27% in
      2007
                          
                          
                          183,696
                          
                          
                          
                          (244,051
                          )
                          
                          
                          (106,772
                          )
                          
                          
                          (613,819
                          )Tax
      effect of US losses not deductible in PRC
                          
                          
                          92,894
                          
                          
                          
                          130,275
                          
                          
                          
                          147,510
                          
                          
                          
                          216,768Income
      not subject to tax
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          (330,361
                          )Deferred
      taxes
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          (1,064,028
                          )Benefit
      of tax holiday
                          
                          
                          233,193
                          
                          
                          
                          (668,444
                          )
                          
                          
                          (411,977
                          )
                          
                          
                          (1,345,100
                          )Others
                          
                          
                          (48,749
                          )
                          
                          
                          —
                          
                          
                          
                          (32,867
                          )
                          
                          
                          —Income
      tax expense per books
                          
                          $
                          (318,878
                          )
                          
                          $
                          610,689
                          
                          
                          $
                          (148,257
                          )
                          
                          $
                          52,566
 
 Income
tax expense (benefit) consists of:
 
 Three months ended
                                    December 31,
                                  
                                  Six months ended
                                    December 31,2008
                                  
                                  2007
                                  
                                  2008
                                  
                                  2007Income
      tax expense (benefit) for the current year - PRC
                                  $
                                  (318,878
                                  )
                                  
                                  $
                                  610,869
                                  
                                  
                                  $
                                  (148,257
                                  )
                                  
                                  $
                                  1,116,594Deferred
      income tax expense (benefit) - PRC
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  (1,064,028
                                  )Income
      tax expense (benefit) per books
                                  $
                                  (318,878
                                  )
                                  
                                  $
                                  610,869
                                  
                                  
                                  $
                                  (148,257
                                  )
                                  
                                  $
                                  52,566
 
 11.  Equity
 
 On
November 6, 2007, in connection with a Subscription Agreement, dated November 1,
2007 (the “Subscription Agreement”), the Company issued to certain institutional
accredited investors warrants to purchase 1,420,000 shares of Common Stock
valued at $5,374,748. In connection with the transaction, Roth Capital Partners,
LLC, as placement agent, received warrants to purchase 225,600 shares of Common
Stock valued at $887,504.
  16
 Table of Contents
  Information
with respect to stock warrants outstanding is as follows:
  Exercise
                                    Price
                                  
                                  Outstanding
                                    June 30, 2008
                                  
                                  Granted
                                  
                                  Expired or
                                    Exercised
                                  
                                  Outstanding
                                    December 31,
                                    2008
                                  
                                  Expiration Date$
                                  3.00
                                  
                                  
                                  448,392
                                  
                                  -0-
                                  
                                  
                                  (90,000
                                  )
                                  358,392
                                  
                                  February 22, 2011$
                                  3.60
                                  
                                  
                                  100,000
                                  
                                  -0-
                                  
                                  
                                  -0-
                                  
                                  100,000
                                  
                                  February 22, 2010$
                                  8.45
                                  
                                  
                                  1,420,000
                                  
                                  -0-
                                  
                                  
                                  -0-
                                  
                                  1,420,000
                                  
                                  May 5, 2013$
                                  7.38
                                  
                                  
                                  225,600
                                  
                                  -0-
                                  
                                  
                                  -0-
                                  
                                  225,600
                                  
                                  November 5, 2010
 
 Pursuant
to Section 5.1 of the Stock Purchase Agreement, the Company agreed to reserve
for issuance to investors in the private placement an aggregate of 2,000,000
shares of Common Stock if the Company’s net income for the fiscal year ended
June 30, 2007 was less than US$10.4 million, as set forth in the Company’s
audited financial statements as filed with the SEC in the Company’s Annual
Report on Form 10-K for that fiscal year. As the Company’s net income as set
forth in its audited financial statements for the year ended June 30, 2007 was
less than US$10.4 million, the Company was required to issue the 2,000,000
shares of Common Stock to such investors. Such issuance was effected on October
15, 2007. No additional consideration was received by the Company in connection
with this issuance of shares of Common Stock.
 
 In
conjunction with the Company’s final audit of the Tuorong acquisition, certain
post-closing adjustments were required. In light of such adjustments and
consistent with the purposes and intentions of the Debt Reduction Agreement,
dated February 13, 2007, as amended February 20, 2007, it was determined that
771,060 shares of the Company’s Common Stock issued to directors pursuant to
such Agreement would be required to 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.
 
 Pursuant
to the Subscription Agreement, on November 6, 2007, the Company agreed to issue
and sell in a registered direct offering (the “Offering”) an aggregate of
7,100,000 shares of its common stock (“Common Stock”) at a price of $6.75 per
share (the “Purchase Price”) and an aggregate of 1,420,000 warrants to purchase
shares of its Common Stock (“Warrants” and, together with the Common Stock, the
“Securities”). The Warrants have an exercise price of $8.45 per share. The
Warrants may not be exercised prior to May 6, 2008. The Securities (including
the shares issuable upon exercise of the Warrants) are registered under the
Securities Act of 1933, as amended (the “Act”), pursuant to the Company’s
existing effective shelf Registration Statement on Form S-3. In connection with
the offer and sale of the Securities, the Company filed on November 1, 2007, a
Registration Statement on Form S-3 pursuant to Rule 462(b) promulgated under the
Act to register an additional $10 million of its securities relating to its
shelf Registration Statement.
 
 The
Company closed the Offering on November 6, 2007 (the “Closing Date”). The net
proceeds of the offering were approximately $44 million, after deducting
underwriting commissions and discounts and other fees and expenses relating to
the offering. The warrants were valued at $5.3 million and were recorded to
additional paid-in capital. The intended usage of the net proceeds was for
repayment of certain bank debt, capital expenditure, and general corporate
purposes. During the year ended June 30, 2008, long-term bank loans of
$13,042,159 were paid off, and a progress payment of $7,016,729 was made in
relation to the third cold rolling mill. During the six months ended December
31, 2008, we invested an additional $12,954,497 in construction in progress and
property, production plants and equipment in relation to the third cold rolling
mill and expansion of the Shanghai Blessford production facilities.
 
 On the
Closing Date, pursuant to a Placement Agency Agreement entered into between the
Company and Roth Capital Partners LLC on October 31, 2007, Roth Capital received
an amount in cash equal to 7.0% of the gross proceeds of the Offering and
warrants to purchase an amount of Common Stock equal to 3.0% of the total number
of shares of Common Stock sold in the Offering (the “Placement Warrants”), or
225,600 shares of Common Stock valued at $887,504, and this amount was recorded
as syndication fees offsetting additional paid-in capital. Such Placement
Warrants have an exercise price per share of 120% of the closing price per share
of the Company’s Common Stock on the Closing Date, or $7.38, and were not
exercisable prior to May 6, 2008. Thereafter, the Placement Warrants are
exercisable at any time until the third anniversary of the date of
issue.
  17
 Table of Contents
  12.  Earnings
Per Share
 
 SFAS 128
requires a reconciliation of the numerator and denominator of the basic and
diluted earnings per share (EPS) computations.
 
 For the
six months ended December 31, 2008, dilutive shares include outstanding warrants
to purchase 358,392 shares of common stock at an exercise price of $3.00 and
warrants to purchase 100,000 shares at an exercise price of $3.60; 1,420,000
shares at an exercise price of $8.45 and 225,600 shares at an exercise price of
$7.38 were not included as their effect would have been anti-dilutive, however,
these securities could potentially dilute basic earnings per share in the
future. For the six months ended December 31, 2007, dilutive shares include
outstanding warrants to purchase 1,300,059 shares of common stock at an exercise
price of $3.00 and 100,000 shares at an exercise price of $3.60.
 
 For the
three months ended December 31, 2008, warrants to purchase 358,392 shares of
common stock at an exercise price of $3.00; 100,000 shares at an exercise price
of $3.60; 1,420,000 shares at an exercise price of $8.45 and 225,600 shares at
an exercise price of $7.38 were not included as their effect would have been
anti-dilutive, however, these securities could potentially dilute basic earnings
per share in the future.
 
 The
following reconciles the components of the EPS computation:
 
 Income(Loss)
                                
                                Shares
                                
                                Per Share(Numerator)
                                
                                (Denominator)
                                
                                AmountFor
      the three months ended December 31, 2008:Net
      income (loss)
                                
                                $
                                (1,974,981
                                )Basic
      EPS income (loss) available to common shareholders
                                
                                $
                                (1,974,981
                                )
                                46,562,955
                                
                                $
                                (0.04
                                )Effect
      of dilutive securities:Diluted
      EPS income (loss) available to common shareholders
                                
                                $
                                (1,974,981)
                                
                                46,562,955
                                
                                $
                                (0.04
                                )For
      the three months ended December 31, 2007:Net
      income
                                
                                $
                                3,486,451Basic
      EPS income available to common shareholders
                                
                                $
                                3,486,451
                                
                                43,031,346
                                
                                $
                                0.08Effect
      of dilutive securities:Warrants
                                
                                
                                
                                
                                607,996Diluted
      EPS income available to common shareholders
                                
                                $
                                3,486,451
                                
                                43,639,342
                                
                                $
                                0.08
  Income
                                                    
                                                    Shares
                                                    
                                                    Per Share(Numerator)
                                                    
                                                    (Denominator)
                                                    
                                                    AmountFor
      the six months ended December 31, 2008:Net
      income
                                                    
                                                    $
                                                    900,753Basic
      EPS income available to common shareholders
                                                    
                                                    $
                                                    900,753
                                                    
                                                    46,559,531
                                                    
                                                    $
                                                    0.02Effect
      of dilutive securities:Warrants
                                                    
                                                    
                                                    
                                                    
                                                    6,892Diluted
      EPS income available to common shareholders
                                                    
                                                    $
                                                    900,753
                                                    
                                                    46,566,423
                                                    
                                                    $
                                                    0.02For
      the six months ended December 31, 2007:Net
      income
                                                    
                                                    $
                                                    9,327,157Basic
      EPS income available to common shareholders
                                                    
                                                    $
                                                    9,327,157
                                                    
                                                    40,204,745
                                                    
                                                    $
                                                    0.23Effect
      of dilutive securities:Warrants
                                                    
                                                    
                                                    
                                                    
                                                    604,692Diluted
      EPS income available to common shareholders
                                                    
                                                    $
                                                    9,327,157
                                                    
                                                    40,809,437
                                                    
                                                    $
                                                    0.23
  18
 Table of Contents
  13.  Capital
Commitments
 
 As of
December 31, 2008, the Company had contractual commitments $917,000 for the
construction projects related to expansion of Shanghai Blessford’s production
facilities.
  19
 Table of Contents
 
 ITEM 2.
              MANAGEMENT’S DISCUSSION AND
      ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
 
 Special
Note Regarding Forward Looking Statements
 
 This
Quarterly Report on Form 10-Q, including the following “Management’s Discussion
and Analysis of Financial Condition and Results of Operations,” contains
forward-looking statements that are based on the beliefs of our management, and
involve risks and uncertainties, as well as assumptions, that, if they ever
materialize or prove incorrect, could cause actual results to differ materially
from those expressed or implied by such forward-looking
statements.  The words “believe,” “expect,” “anticipate,” “project,”
“targets,” “optimistic,” “intend,” “aim,” “will” or similar expressions are
intended to identify forward-looking statements.  All statements,
other than statements of historical fact, are statements that could be deemed
forward-looking statements, including statements regarding new and existing
products, technologies and opportunities; statements regarding market and
industry segment growth and demand and acceptance of new and existing products;
any projections of sales, earnings, revenue, margins or other financial items;
any statements of the plans, strategies and objectives of management for future
operations; any statements regarding future economic conditions or performance;
uncertainties related to conducting business in China; any statements of belief
or intention; any of the factors and risks mentioned in the “Risk Factors”
sections of the Quarter Report and our Annual Report on Form 10-K for the year
ended June 30, 2008 and subsequent SEC filings, and any statements of
assumptions underlying any of the foregoing.  All forward-looking
statements included in this report are based on information available to us on
the date of this report.  We assume no obligation and do not intend to
update these forward-looking statements, except as required by law.
 
 The
following discussion should be read in conjunction with our unaudited
consolidated financial statements and the related notes that appear in
Part I, Item 1, “Financial Statements,” of this Quarterly Report. Our
unaudited consolidated financial statements are stated in United States Dollars
and are prepared in accordance with United States Generally Accepted Accounting
Principles. The following discussion and analysis covers the Company’s
consolidated financial condition at December 31, 2008 (unaudited) and
June 30, 2008, the end of its prior fiscal year, and its unaudited
consolidated results of operation for the three and six month periods ended
December 31, 2008 and 2007.
 
 Use
of Terms
 
 Except as
otherwise indicated by the context, all references in this Quarterly Report
to
  ·
              “Blessford International” are to
      PSHL’s subsidiary Blessford International Limited, a BVI
      company;
  ·
              “Chengtong” are to PSHL’s
      subsidiary Shanghai Chengtong Precision Strip Co., Limited, a PRC
      company;
  ·
              “China” and “PRC” are to the
      People’s Republic of China.
  ·
              the “Company,” the “Group,” “we,”
      “us” or “our” are to China Precision Steel, Inc., a Delaware corporation,
      and its direct and indirect
subsidiaries;
  ·
              “Exchange Act” means the
      Securities Exchange Act of 1934, as
  amended;
  ·
              “PSHL” are to our subsidiary
      Partner Success Holdings Limited, a BVI
  company;
  ·
              “RMB” are to Renminbi, the legal
      currency of China;
  ·
              “Securities Act” are to the
      Securities Act of 1933, as
amended;
  ·
              “Shanghai Blessford” are to
      Blessford International’s subsidiary Shanghai Blessford Alloy Company
      Limited, a PRC company;
  ·
              “Tuorong” are to PSHL’s
      subsidiary Shanghai Tuorong Precision Strip Company Limited, a PRC
      company;
  ·
              “U.S.
      dollar,” “$” and “US$” are to the legal currency of the United States;
      (xi) “BVI” are to the British Virgin
Islands.
  20
 Table of Contents





Overview
of the Company’s Business




General




We are a
niche and high value-added steel processing company principally engaged in the
manufacture and sale of high precision cold-rolled steel products, in the
provision of heat treatment and in the cutting and slitting of medium and
high-carbon hot-rolled steel strips. We use commodity steel to create a high
value-added specialty premium steel. Specialty precision steel pertains to the
precision of measurements and tolerances of thickness, shape, width, surface
finish and other special quality features of highly-engineered end-use
applications.





We
produce and sell precision ultra-thin and high strength cold-rolled steel
products ranging from 7.5 mm to 0.03 mm. We also provide heat treatment and
cutting and slitting of medium and high-carbon hot-rolled steel strips not
exceeding 7.5 mm thickness. Our process puts hot-rolled de-scaled (pickled)
steel coils through a cold-rolling mill, utilizing our patented systems and high
technology reduction processing procedures, to make steel coils and sheets in
customized thicknesses according to customer specifications. Currently, our
specialty precision products are mainly used in the manufacture of automobile
parts and components, steel roofing, plane friction discs, appliances, food
packaging materials, saw blades, textile needles, and
microelectronics.





We
conduct our operations principally in China through our wholly-owned operating
subsidiaries, Chengtong and Shanghai Blessford, which are wholly owned
subsidiaries of our direct subsidiary, PSHL. Most of our sales are made
domestically in China; however, we began exporting during fiscal 2007
and our overseas market currently covers Indonesia, Thailand, the Philippines,
Nigeria and Ethiopia. We intend to further expand into additional
overseas markets in the future, subject to suitable market conditions and
favorable regulatory controls.




Corporate
History and Structure




We are a
Delaware company that became a public company in May 1997, through a reverse
merger with SSI Capital Corporation.  At that time, we changed our
name to OraLabs Holding Corp. and our principal business was the production and
sale of consumer products relating to oral care and lip care and the
distribution of nutritional supplements through our wholly-owned subsidiary,
OraLabs, Inc.  In December 2006, we merged with Partner Success
Holdings Limited, or PSHL, a British Virgin Islands business company, and
subsequently redeemed all of the shares of our outstanding common stock owned by
our former President, Gary Schlatter, in exchange for all of the issued shares
of OraLabs, Inc. As a result of the merger transaction PSHL and its subsidiary,
became our subsidiaries, and our business became the manufacture and sale of
high precision cold-rolled steel products.  Thereafter, we renamed
ourselves China Precision Steel, Inc. to reflect our continuing
operations.




Our
business is conducted principally through our PRC operating subsidiaries,
Shanghai Chengtong Precision Strip Co., Limited, or Chengtong, and Shanghai
Blessford Alloy Company Limited, or Shanghai Blessford. Both Chengtong and
Shanghai Blessford are Wholly Foreign Owned Enterprises, or WFOEs, under Chinese
law.





Our
corporate headquarters are located at 18th Floor,
Teda Building, 87 Wing Lok Street, Sheung Wan, Hong Kong, and our telephone
number is (011) 852-2543-2290.  Our agent for service of process in
the United States is Corporation Service Company, 2711 Centerville Road,
Wilmington, Delaware 19808.  Our common stock is listed on The NASDAQ
Capital Market under the symbol “CPSL.”  Although we maintain a
website at www.chinaprecisionsteelinc.com,
we do not intend that information available on our website be incorporated into
this filing.





Recent
Developments





We are
currently faced with multiple challenges. Excess capacity, low industrial
concentration and a lack of access to natural resources have long plagued
China's steel sector, and these problems have been exacerbated by the impact of
the global financial and economic crisis.





The
RMB400 billion economic stimulus package formulated jointly by the Chinese
government’s National Development and Reform Commission and the Ministry of
Industry and Information Technology in November 2008 is now planned to focus
mainly on nine pillar industries, which include steel, automobiles,
shipbuilding, petrochemicals, light industry, textiles, non-ferrous metals,
machinery, and information technology, all with serious production surpluses in
the whole industrial system.


21
 Table of Contents





Automobiles
and steel sectors have been given priority and are the two main industries out
of the nine pillars for which the government is expected to announce specific
support packages and further details. On January 14, 2009, China's State Council
approved a "rejuvenation plan" to support the steel industry, with the immediate
aim to deal with the effects of the global financial and economic crisis and to
also ease the industry's long-term structural problems. The steel industry plan
includes eliminating obsolete capacity, speeding up innovation, promoting
alliances and mergers and cutting export tariffs. The government will also
subsidize loans of about RMB15 billion to encourage technological upgrading and
product rationalization to better meet demand.





With more
specific support details yet to be announced and the global crisis and its
impact on China yet to run their full course, we expect to continue to
experience weak demands and volatilities in both domestic and international
markets for the next six months.





Second Quarter Financial Performance
Highlights





During
the second fiscal quarter of 2009, the impacts of the global crisis started to
show as demand for steel products began to slow down. There were decreases in
sales volume in most of our product lines over the three months ended December
31, 2008 as we are faced with multiple challenges and experiencing a difficult
time with the global economic downturn. Demand is weak in all of the end
segments we sell to, especially the high-carbon cold-rolled steel which are
mainly used in auto components manufacturing, due to excess capacity and high
inventory levels in the industry. Our two cold-rolling mills were fully utilized
in October and November 2008 but the utilization rate has decreased to
approximately 60% of actual capacity during December 2008 due to reduced orders
on hand.





Due to
the nature of our niche segment and high-end products, we were able to keep
quality customers and further expand international sales during the quarter, and
maintained a healthy gross margin of 19.6%. However, despite an increase in
sales volume and revenue period-on-period, we recorded an allowance for bad
and doubtful debts in the amount of $3,829,462 due to a dispute with one of
our customers over the quality of service rendered by the Company, and had a net
loss for the three months ended December 31, 2008.





While we
are experiencing a reduction in orders, especially the high-carbon cold-rolled
steel coils due to a slowdown in the auto industry, and exports to the South
East Asian markets due to the credit crisis of these countries, we continue to
negotiate new contracts with potential customers and broaden our customer base.
Management continues to take appropriate actions to perform business and credit
reviews of customers and suppliers and reduce exposure by avoiding entering into
contracts with countries or customers with high credit risks. We strive to
optimize our product mix and prioritize higher margin products in the existing
business environment with the goal to maintain overall healthy sales volume,
margins and cash positions. Management believes that there are high barriers to
entry in the Chinese domestic precision cold-rolled steel industry because of
the level of technology expertise required for operation. Although we continue
to face slowing demands and volatilities in the steel industry, the medium to
long term prospects remain highly optimistic and we believe that our unique
capabilities and know-how give us a competitive advantage to grow sales and
build a globally recognized brand as we continue to carry out R&D and expand
to new segments, customers and markets.





The
following are some financial highlights for the second quarter of
2009:




·
            Revenues:
      Our revenues were approximately $17.6 million for the second quarter of
      2009, an increase of 32.9% from the same quarter of last
    year.




·
            Gross
      Margin: Gross margin was 19.6% for the second quarter of 2009, as compared
      to 35.5% for the same period in
2007.




·
            Income/(Loss)
      from operations before tax: Loss from operations before tax was
      approximately $(2.3) million for the second quarter of 2009, as compared
      to income from operations before tax of $4.1 million of the same period
      last year.




22
 Table of Contents




·
            Net
      Income/(Loss): Net loss was approximately $2.0 million for the second
      quarter of 2009, a decrease of 156.6% from the same period of last
      year.




·
            Fully
      diluted loss per share was $0.04 for the second quarter of
      2009.




Results of Operations





The
following table sets forth key components of our results of operations for the
periods indicated, in millions of U.S. dollars and as a percentage of
revenues.




All
amounts, other than percentages, in millions of U.S. dollars




Three Months ended December 31,
                                
                                
                                Six Months ended December 31,2008
                                
                                
                                2007
                                
                                
                                2008
                                
                                
                                2007Revenues
                                
                                $
                                17,573,959
                                
                                
                                
                                100.0
                                %
                                
                                $
                                13,228,321
                                
                                
                                
                                100.0
                                %
                                
                                $
                                42,924,378
                                
                                
                                
                                100.0
                                %
                                
                                $
                                40,415,556
                                
                                
                                
                                100.00
                                %Cost
      of sales (including depreciation and amortization)
                                
                                
                                14,122,622
                                
                                
                                
                                80.4
                                %
                                
                                
                                8,528,852
                                
                                
                                
                                64.5
                                %
                                
                                
                                35,520,383
                                
                                
                                
                                82.8
                                %
                                
                                
                                28,773,987
                                
                                
                                
                                71.2
                                %Gross
      profit
                                
                                
                                3,451,337
                                
                                
                                
                                19.6
                                %
                                
                                
                                4,699,469
                                
                                
                                
                                35.5
                                %
                                
                                
                                7,403,995
                                
                                
                                
                                17.2
                                %
                                
                                
                                11,641,569
                                
                                
                                
                                28.8
                                %Selling
      and marketing
                                
                                
                                1,122,532
                                
                                
                                
                                6.4
                                %
                                
                                
                                180,744
                                
                                
                                
                                1.4
                                %
                                
                                
                                1,333,830
                                
                                
                                
                                3.1
                                %
                                
                                
                                281,449
                                
                                
                                
                                0.7
                                %Administrative
      expenses
                                
                                
                                578,105
                                
                                
                                
                                3.3
                                %
                                
                                
                                846,220
                                
                                
                                
                                6.4
                                %
                                
                                
                                1,040,205
                                
                                
                                
                                2.4
                                %
                                
                                
                                1,332,596
                                
                                
                                
                                3.3
                                %Allowance
      for bad and doubtful debts
                                
                                
                                3,829,462
                                
                                
                                
                                21.8
                                %
                                
                                
                                25,782
                                
                                
                                
                                0.2
                                %
                                
                                
                                3,829,462
                                
                                
                                
                                8.9
                                %
                                
                                
                                651,780
                                
                                
                                
                                1.6
                                %Depreciation
      and amortization
                                
                                
                                33,318
                                
                                
                                
                                0.2
                                %
                                
                                
                                15,798
                                
                                
                                
                                0.1
                                %
                                
                                
                                59,521
                                
                                
                                
                                0.1
                                %
                                
                                
                                29,430
                                
                                
                                
                                0.1
                                %Income/(loss)
      from operations
                                
                                
                                (2,112,080
                                )
                                
                                
                                (12.0
                                )%
                                
                                
                                3,630,925
                                
                                
                                
                                8.1
                                %
                                
                                
                                1,140,977
                                
                                
                                
                                2.7
                                %
                                
                                
                                9,346,314
                                
                                
                                
                                23.1
                                %Other
      income (expense)
                                
                                
                                138,998
                                
                                
                                
                                0.8
                                %
                                
                                
                                783,255
                                
                                
                                
                                5.9
                                %
                                
                                
                                259,701
                                
                                
                                
                                0.6
                                %
                                
                                
                                792,410
                                
                                
                                
                                2.0
                                %Interest
      expense, Cash
                                
                                
                                (320,777
                                )
                                
                                
                                (1.8
                                )%
                                
                                
                                (316,860
                                )
                                
                                
                                (2.4
                                )%
                                
                                
                                (648,182
                                )
                                
                                
                                (1.5
                                )%
                                
                                
                                (759,001
                                )
                                
                                
                                (1.9
                                )%Income/(loss)
      before income taxes
                                
                                
                                (2,293,859
                                )
                                
                                
                                (13.1
                                )%
                                
                                
                                4,097,320
                                
                                
                                
                                31.0
                                %
                                
                                
                                752,496
                                
                                
                                
                                1.8
                                %
                                
                                
                                9,379,723
                                
                                
                                
                                23.2
                                %Income
      taxes
                                
                                
                                (318,878
                                )
                                
                                
                                0.2
                                %
                                
                                
                                610,869
                                
                                
                                
                                4.6
                                %
                                
                                
                                (148,257
                                )
                                
                                
                                0.3
                                %
                                
                                
                                52,566
                                
                                
                                
                                0.1
                                %Net
      income/(loss)
                                
                                $
                                (1,974,981
                                )
                                
                                
                                (11.0
                                )%
                                
                                $
                                3,486,451
                                
                                
                                
                                26.4
                                %
                                
                                $
                                900,753
                                
                                
                                
                                2.1
                                %
                                
                                $
                                9,327,157
                                
                                
                                
                                23.1
                                %Basic
      earnings/(loss) per share
                                
                                $
                                (0.04
                                )
                                
                                
                                
                                
                                
                                $
                                0.08
                                
                                
                                
                                
                                
                                
                                $
                                0.02
                                
                                
                                
                                
                                
                                
                                $
                                0.23Diluted
      earnings/(loss) per share
                                
                                $
                                (0.04
                                )
                                
                                
                                
                                
                                
                                $
                                0.08
                                
                                
                                
                                
                                
                                
                                $
                                0.02
                                
                                
                                
                                
                                
                                
                                $
                                0.23




Comparison of Three Months
Ended December 31, 2008 and December 31, 2007





Sales
Revenues. Sales volume increased by 852 tons, or 6.1%, period-on-period
to 14,862 tons for the three months ended December 31, 2008 from 14,010 tons for
the three months ended December 31, 2007.  As a result, sales revenues
increased by $4,345,638, or 32.9%, period-on-period to $17,573,959 for the three
months ended December 31, 2008 from $13,228,321 for the three months ended
December 31, 2007. The increases in sales and sales revenues are a result of an
increase in volume sold during the quarter ended December 31,
2008.


23
 Table of Contents








Three Months Ended December 31,2008
                      
                      2007
                      
                      Period-on-periodProduct category
                      
                      Quantity
                        (tons)
                      
                      $  Amount
                      
                      % of sales
                      
                      Quantity
                        (tons)
                      
                      $ Amount
                      
                      % of
                        sales
                      
                      Qty.
                        VarianceLow
      carbon cold-rolled
                      
                      
                      1,834
                      
                      2,107,484
                      
                      
                      12.0
                      
                      3,442
                      
                      
                      2,791,741
                      
                      21.1
                      
                      
                      (1,608
                      )Low
      carbon hard rolled (export)
                      
                      
                      11,755
                      
                      13,238,537
                      
                      
                      75.3
                      
                      4,897
                      
                      
                      3,503,082
                      
                      26.5
                      
                      
                      6,858High-carbon
      cold-rolled
                      
                      
                      196
                      
                      168,782
                      
                      
                      1.0
                      
                      3,520
                      
                      
                      4,174,255
                      
                      31.6
                      
                      
                      (3,324
                      )High-carbon
      hot-rolled
                      
                      
                      861
                      
                      903,754
                      
                      
                      5.1
                      
                      1,171
                      
                      
                      917,057
                      
                      6.9
                      
                      
                      (310
                      )Sales
      of scrap metal
                      
                      
                      —
                      
                      1,106,292
                      
                      
                      6.3
                      
                      —
                      
                      
                      251,146
                      
                      1.9
                      
                      
                      —Subcontracting
      income
                      
                      
                      216
                      
                      49,110
                      
                      
                      0.3
                      
                      980
                      
                      
                      1,591,040
                      
                      12.0
                      
                      
                      (764
                      )Total
                      
                      
                      14,862
                      
                      17,573,959
                      
                      
                      100.0
                      
                      14,010
                      
                      
                      13,228,321
                      
                      100





Low
carbon hard-rolled steel, which is also our exported precision steel products,
accounted for 26.5% of sales during the three months ended December 31, 2007.
This was $13,238,537, or 75.3%, of the current sales mix at an average selling
price of $1,126 per ton for the three months ended December 31, 2008. This was
the result of new customers in expanded international markets, including Africa.
The low-carbon cold-rolled steel products accounted for 12.0% of the current
sales mix at an average selling price of $1,149 per ton for the three months
ended December 31, 2008 compared to 21.1% of the sales mix at an average
selling price per ton of $811 for the three months ended December 31, 2007. The
decrease is a result of reduced orders in this category. High-carbon cold-rolled
steel products accounted for 1.0% of the current sales mix at an average selling
price of $861 per ton for the three months ended December 31, 2008 compared to
31.6% of the sales mix at an average selling price per ton of $1,186 for the
three months ended December 31, 2007.  The decrease in this category
is largely attributable to the troubled Chinese auto industry with its weak
demand and excess capacity, as most of our high-carbon cold-rolled steel
products are sold to auto components manufacturers. Subcontracting income
decreased to 0.3% of the current sales mix at an average selling price of $227
for the three months ended December 31, 2008 compared to 12% of the sales mix
for the three months ended December 31, 2007 at an average selling price of
$1,624 as no new substantial orders were received during the
quarter.




Three Months Ended
                                                December 31,Average selling prices
                                              
                                              2008
                                              
                                              
                                              2007
                                              
                                              
                                              Variance$
                                              
                                              
                                              $
                                              
                                              
                                              $
                                              
                                              
                                              %Low-carbon
      cold-rolled
                                              
                                              
                                              1,149
                                              
                                              
                                              
                                              811
                                              
                                              
                                              
                                              338
                                              
                                              
                                              
                                              42Low-carbon
      hard rolled (export)
                                              
                                              
                                              1,126
                                              
                                              
                                              
                                              715
                                              
                                              
                                              
                                              411
                                              
                                              
                                              
                                              57High-carbon
      cold-rolled
                                              
                                              
                                              861
                                              
                                              
                                              
                                              1,186
                                              
                                              
                                              
                                              (325
                                              )
                                              
                                              
                                              (27
                                              )High-carbon
      hot-rolled
                                              
                                              
                                              1,050
                                              
                                              
                                              
                                              783
                                              
                                              
                                              
                                              267
                                              
                                              
                                              
                                              34Subcontracting
      income
                                              
                                              
                                              227
                                              
                                              
                                              
                                              1,624
                                              
                                              
                                              
                                              (1,397
                                              )
                                              
                                              
                                              (86
                                              )





The average unit selling price per ton
generated increased to $1,183 per ton for the three months ended December 31,
2008, compared to the corresponding period in 2007 of $944, representing an
increase of $239, or 25.3%, period-on-period. This increase was mainly due to
increases in average raw material prices period-on-period and therefore selling
prices, as well as changes in average selling prices across the product
categories. Sales of low-carbon hard-rolled steel products have increased by
6,858 tons, or 140.0%, period-on-period to 11,755 tons for the three months
ended December 31, 2008 compared to 4,897 tons for the three months ended
December 31, 2007. While the volume of low-carbon hard-rolled steel
substantially increased, the average sales price also increased $411, or 57%, to
$1,126 in the three months ended December 31, 2008, as compared to an average
selling of $715 in the three months ended December 31, 2007. This product
accounted for $13,238,537, or 75.3%, of the total sales mix for the three months
ended December 31, 2008 compared to $3,503,082, or 26.5%, of the sales mix for
the three months ended December 31, 2007.




24
 Table of Contents







Three Months Ended December 31Customers
                                        
                                        2008 ($)
                                        
                                        % to sales
                                        
                                        2007 ($)
                                        
                                        % to salesSalzgitter
      Mannesmann International GMBH
                                        
                                        
                                        11,257,852
                                        
                                        64
                                        
                                        
                                        *
                                        
                                        *Marubeni-Itochu
      Steel Inc.
                                        
                                        
                                        1,626,006
                                        
                                        9
                                        
                                        
                                        *
                                        
                                        *Shanghai
      Changshuo Stainless Steel Processing Co. Ltd.
                                        
                                        
                                        1,140,227
                                        
                                        7
                                        
                                        
                                        2,370,370
                                        
                                        18Coutinho
      and Ferrostaal GMBH
                                        
                                        
                                        351,887
                                        
                                        2
                                        
                                        
                                        *
                                        
                                        *Zhangjiagang
      Gangxing Innovative Construction Material Co., Ltd.
                                        
                                        
                                        336,980
                                        
                                        2
                                        
                                        
                                        *
                                        
                                        *Shanghai
      Shengdejia Metal Products Limited
                                        
                                        
                                        *
                                        
                                        *
                                        
                                        
                                        3,181,709
                                        
                                        24Beijing
      Beimo Aircraft Material Technology Company Limited
                                        
                                        
                                        *
                                        
                                        *
                                        
                                        
                                        85,468
                                        
                                        1Hangzhou
      Relian Company Limited
                                        
                                        
                                        *
                                        
                                        *
                                        
                                        
                                        266,970
                                        
                                        2Shangdong
      Province Boxing County Longhua Material Ltd.
                                        
                                        
                                        *
                                        
                                        *
                                        
                                        
                                        381,227
                                        
                                        314,712,952
                                        
                                        84
                                        
                                        
                                        6,285,744
                                        
                                        48Others
                                        
                                        
                                        2,861,007
                                        
                                        16
                                        
                                        
                                        6,942,577
                                        
                                        52Total
                                        
                                        
                                        17,573,959
                                        
                                        100
                                        
                                        
                                        13,228,321
                                        
                                        100







*
Not a major customer for the relevant periods




Sales revenues generated from the top
five major customers as a percentage of total sales increased to 84% for the
three months ended December 31, 2008 as compared to 48% for the three months
ended December 31, 2007. The top five major customers were different
period-on-period with the exception of Shanghai Changshuo Stainless Steel
Processing Co., Ltd.. The change in customer mix reflects our focus in
optimizing product mix to maximize margins and expansion of markets during the
course of the period.




Cost of
Sales. Cost of
sales increased by $5,593,770, or 65.6%, period-on-period to $14,122,622 for the
three months ended December 31, 2008 from $8,528,852 for the three months ended
December 31, 2007. Cost of sales represented 80.4% of sales revenues for the
three months ended December 31, 2008 compared to 64.5% for the three months
ended December 31, 2007. Average cost per ton sold increased by $341, or 56.0%,
period-on-period to $950 per ton for the three months ended December 31, 2008
from $609 per ton for the three months ended December 31, 2007. Meanwhile, the
average selling price per ton increased by $239 per ton, or 25.3%,
period-on-period to $1,183 per ton for the three months ended December 31, 2008
from $944 per ton for the three months ended December 31, 2007.





Three Months Ended December 31,2008
                                        
                                        2007
                                        
                                        Variance$
                                        
                                        $
                                        
                                        $
                                        
                                        %Cost
      of sales-
      Raw materials
                                        
                                        
                                        11,339,712
                                        
                                        6,362,758
                                        
                                        
                                        4,976,954
                                        
                                        78.2-
      Direct labor
                                        
                                        
                                        261,110
                                        
                                        167,926
                                        
                                        
                                        93,184
                                        
                                        55.5-
      Factory overhead
                                        
                                        
                                        2,521,800
                                        
                                        1,998,168
                                        
                                        
                                        523,632
                                        
                                        26.214,122,622
                                        
                                        8,528,852
                                        
                                        
                                        5,593,770
                                        
                                        65.6Cost
      per unit soldTotal
      units sold (tons)
                                        
                                        
                                        14,862
                                        
                                        14,010
                                        
                                        
                                        852
                                        
                                        6.1Average
      cost per unit sold ($/ton)
                                        
                                        
                                        950
                                        
                                        609
                                        
                                        
                                        341
                                        
                                        56.0




25
 Table of Contents





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





            a significant increase in cost of
      raw materials per unit sold of $309, or 68.0%, from $454 for the three
      months ended December 31, 2007, compared to $763 for the three months
      ended December 31, 2008;





            an increase in factory overhead
      per unit sold of $27, or 19%, from $143 for three months ended December
      31, 2007, compared to $170 for the three months ended December 31,
      2008.





The cost
of raw materials consumed increased by $4,976,954, or 78.2%, period-on-period to
$11,339,712, for the three months ended December 31, 2008 from $6,362,758 for
the three months ended December 31, 2007. This increase was due to increases in
raw material prices period-on-period.




Manufacturing
overhead costs increased by $523,632, or 26.2%, period-on-period to $2,521,800
for the three months ended December 31, 2008, from $1,998,168 for the three
months ended December 31, 2007. The increase was mainly attributable to the
combined effect of an increase in utilities of $165,380, or 52%,
period-on-period to $486,116 for the three months ended December 31, 2008 from
$320,736 for the three months ended December 31, 2007, and an increase in
depreciation allocated to cost of goods sold of $323,139, or 67%,
period-on-period to $806,621 for the three months ended December 31, 2008, from
$483,482 for the three months ended December 31, 2007.





Gross Profits and
Gross Margin. Our gross profit is equal to the difference between our
revenues and our cost of goods sold. Gross profit in absolute terms decreased by
$1,248,132, or 27%, period-on-period to $3,451,337 for the three months ended
December 31, 2008, from $4,699,469 for the three months ended December 31, 2007,
while gross profit margin decreased to 19.6% for the three months ended December
31, 2008, from 35.5% for the three months ended December 31, 2007. The decrease
in gross profit margin principally resulted from our inability to pass on all of
the higher raw material cost period-to-period to customers during a downturn in
the economy and lower sales of the higher margin products during the three
months ended December 31, 2008.




Selling
Expenses.Selling expenses
increased by $941,788, or 521.1%, period-on-period, to $1,122,532 for the three
months ended December 31, 2008 compared to the corresponding period in 2007 of
$180,744. The increase was mainly attributable to increases in sales commission
paid to export agents based on increased tonnage sold, and transportation and
custom clearing charges in relation to our expanded export sales
period-on-period. Our export precision products, the low carbon hard-rolled
steel, accounted for $13,238,537, or 75.3%, of the current sales mix for the
three months ended December 31, 2008, compared to $3,503,082, or 26.5% of sales
during the three months ended December 31, 2007.




Administrative
Expenses.  Administrative expenses
decreased by $268,115, or 31.7%, period-on-period, to $578,105 for the three
months ended December 31, 2008 compared to the comparable period in 2007. This
decrease was chiefly associated with lower SEC compliance costs and professional
fees as there was no financing activity during the quarter and as we become more
familiar with the rules and regulations as a listed company.




Income from
Operations. Income from operations before tax decreased by $5,743,005, or
158%, period-on-period to a loss of $2,112,080 for the three months ended
December 31, 2008 from $3,630,925 for the three months ended December 31,
2007, as a result of the worldwide economic downturn and slowing demands, and
the allowance for bad and doubtful debts in the amount of $3,829,462
due to a dispute over service rendered by the Company.





Other
income.  Our other income decreased $644,257, or 82.3% to
$138,998 for the three months ended December 31, 2008, from $783,255 for the
same period in 2007.  As a percentage of revenues, other income
decreased to 0.8% for the three months ended December 31, 2008 from 5.9% for the
same period in 2007.  Such percentage decrease was primarily due to
lower interest income earned during the period with a lower cash
balance.





Interest
Expense.  Total interest expense increased $3,917, or 1.2%, to
$320,777 for the three months ended December 31, 2008, from $316,860 for the
same period in 2007 due to lower loan balances offset by the effect of lower
foreign exchange rates.


26
 Table of Contents





Income
Taxes.  China Precision Steel, Inc. is subject to United States
federal income tax at a tax rate of 34%.  No provision for income
taxes in the United States has been made as China Precision Steel, Inc. had no
United States taxable income during the three months ended December 31, 2008.
Our wholly owned subsidiaries PSHL and Blessford International were incorporated
in the BVI and, under the current laws of the BVI, are not subject to income
taxes.





Our PRC
subsidiaries, Chengtong and Shanghai Blessford, enjoy certain special or
preferential tax treatments regarding foreign enterprise income tax in
accordance with the “Income Tax Law of the PRC for Enterprises with Foreign
Investment and Foreign Enterprises” and its implementing
rules.  Accordingly, our PRC subsidiaries have been entitled to tax
concessions whereby the profit for their first two financial years beginning
with the first profit-making year (after setting off tax losses carried forward
from prior years) was exempt from income tax in the PRC and the profit for each
of the subsequent three financial years is taxed at 50% of the prevailing tax
rates set by the relevant tax authorities.  However, on March 16,
2007, the PRC’s National People’s Congress passed the new Enterprise Income Tax
Law, or EIT Law, and on November 28, 2007, the State Council of China passed the
Implementing Rules for the EIT Law, or Implementing Rules, which took effect on
January 1, 2008.  The EIT Law and Implementing Rules impose a
unified EIT of 25.0% on all domestic-invested enterprises and FIEs, unless they
qualify under certain limited exceptions.  Therefore, nearly all FIEs
are subject to the new tax rate alongside other domestic businesses rather than
benefiting from the FEIT, and its associated preferential tax treatments,
beginning January 1, 2008.





Despite
these changes, the EIT Law gives existing FIEs (“Old FIEs”) a five-year
grandfather period during which they can continue to enjoy their existing
preferential tax treatments.  As Old FIEs, Chengtong has been enjoying
a 50% reduction in the 25% statutory rates that expired on December 31, 2008;
Shanghai Blessford is currently enjoying a full exemption from the enterprise
income tax that will expire on December 31, 2009, and is entitled to a 50%
reduction for the three subsequent years expiring on December 31, 2012.
Subsequent to the expiry of their respective tax holidays, Chengtong and
Shanghai Blessford will be subject to enterprise income taxes at 25% or the
prevailing statutory rates. The discontinuation of any such special or
preferential tax treatment or other incentives would have an adverse effect on
any organization’s business, fiscal condition and current operations in
China.





In
addition to the changes to the current tax structure, under the EIT Law, an
enterprise established outside of China with “de facto management bodies” within
China is considered a resident enterprise and will normally be subject to an EIT
of 25.0% on its global income.  The Implementing Rules define the term
“de facto management bodies” as “an establishment that exercises, in substance,
overall management and control over the production, business, personnel,
accounting, etc., of a Chinese enterprise.”  If the PRC tax
authorities subsequently determine that we should be classified as a resident
enterprise, then the organization’s global income will be subject to PRC income
tax of 25.0%.





For the
three months ended December 31, 2008, we recognized an income tax benefit of
$318,878, while for the same period in 2007, we recognized an income tax expense
of $610,869. The decrease in income tax expenses mainly resulted from the
reversal of provision for current income tax in relation to the bad debt written
off during the three months ended December 31, 2008.





Net
Income.Net income decreased by $5,461,432, or 156.6%,
period-on-period to a loss of $1,974,981 for the three months ended December 31,
2008, from net income of $3,486,451 for the three months ended December 31,
2007, as a result of the factors described above.





Comparison of Six Months
Ended December 31, 2008 and December 31, 2007




Gross
Profit. Gross profits in absolute terms decreased by $4,237,574, or
36.4%, period-on-period to $7,403,995 for the six months ended December 31,
2008 from $11,641,569 for the six months ended December 31, 2007, while
gross profit margin decreased to 17.2% for the six months ended
December 31, 2008 from 28.8% for the six months ended December 31,
2007, as a result of increased cost of sales across all cost components
period-on-period. The decrease in gross profit margin was also caused by two
direct sales transactions of raw materials in the amount of $2,685,419, or 11%
of sales revenues for the three months ended September 30, 2008, as a move to
lower our inventory level in view of decreasing raw material raw material
prices. Excluding the abovementioned direct raw material sales, gross profit
margin for the six months ended December 31, 2008 would have been
18.4%.


27
 Table of Contents




Sales
Revenues. Sales volume decreased by 14,301 metric tons, or 26.8%, to
39,077 metric tons for the six months ended December 31, 2008 from 53,378
metric tons for the six months ended December 31, 2007. Sales revenues
decreased by $2,508,822, or 6.2%, period-on-period to $42,924,378 for the six
months ended December 31, 2008 from $40,415,556 for the six months ended
December 31, 2007. The decreases in sales volume and sales revenues are a
result of reduced orders from customers in view of a slower economy, and the
cancellation of an export order in the first quarter ended September 30,
2008.




A
break-down of our sales by product line for the six months ended December 31,
2008 and 2007 is as follows:





Six Months Ended December 31,2008
                            
                            2007
                            
                            Period-on-periodProduct category
                            
                            Quantity
                              (tons)
                            
                            $  Amount
                            
                            % of sales
                            
                            Quantity
                              (tons)
                            
                            $ Amount
                            
                            % of
                              sales
                            
                            Qty.
                              VarianceLow
      carbon cold-rolled
                            
                            
                            12,642
                            
                            13,092,059
                            
                            
                            30.5
                            
                            17,762
                            
                            
                            11,896,272
                            
                            29.4
                            
                            
                            (5,120
                            )Low
      carbon hard rolled (export)
                            
                            
                            15,376
                            
                            17,388,885
                            
                            
                            40.5
                            
                            7,284
                            
                            
                            5,111,386
                            
                            12.6
                            
                            
                            8,092High-carbon
      cold-rolled
                            
                            
                            2,795
                            
                            3,614,759
                            
                            
                            8.4
                            
                            12,456
                            
                            
                            18,861,130
                            
                            46.7
                            
                            
                            (9,661
                            )High-carbon
      hot-rolled
                            
                            
                            2,273
                            
                            2,822,122
                            
                            
                            6.6
                            
                            5,254
                            
                            
                            2,370,060
                            
                            5.9
                            
                            
                            (2,981
                            )Sales
      of scrap metal
                            
                            
                            —
                            
                            1,277,950
                            
                            
                            3.0
                            
                            —
                            
                            
                            527,512
                            
                            1.3
                            
                            
                            —Subcontracting
      income
                            
                            
                            5,991
                            
                            4,728,603
                            
                            
                            11.0
                            
                            10,622
                            
                            
                            1,649,196
                            
                            4.1
                            
                            
                            (4,631
                            )Total
                            
                            
                            39,077
                            
                            42,924,378
                            
                            
                            100.0
                            
                            53,378
                            
                            
                            40,415,556
                            
                            100.0





There was
a general trend of slowing demands for various product categories over the six
months ended December 31, 2008 due to the global economic crisis and excess
capacity. High-carbon cold-rolled steel products only accounted for 8.4% of the
current sales mix at an average selling price of $1,293 per ton for the six
months ended December 31, 2008, compared to 46.7 % of the sales mix at an
average selling price per ton of $1,514 for the six months ended December 31,
2007. This was a result of the slowing down of the auto industry as most of the
products in this category are sold to auto components manufacturers. This
substantial decrease in sales has been offset by increases in sales of the low
carbon cold-rolled steel and low carbon hard-rolled steel during the period,
leading to a slight increase in sales revenues period-on-period. Low-carbon
cold-rolled steel products accounted for 30.5% of the current sales mix at an
average selling price of $1,036 per ton for the six months ended
December 31, 2008, compared to 29.4 % of the sales mix at an average
selling price per ton of $670 for the six months ended December 31, 2007. Low
carbon hard-rolled steel accounted for $17,388,885, or 40.5%, of the current
sales mix at an average selling price of $1,131 per ton for the six months ended
December 31, 2008.





Six Months Ended
                                      December 31,Average selling prices
                                    
                                    2008
                                    
                                    
                                    2007
                                    
                                    
                                    Variance$
                                    
                                    
                                    $
                                    
                                    
                                    $
                                    
                                    
                                    %Low-carbon
      cold-rolled
                                    
                                    
                                    1,036
                                    
                                    
                                    
                                    670
                                    
                                    
                                    
                                    366
                                    
                                    
                                    
                                    55Low-carbon
      hard rolled (export)
                                    
                                    
                                    1,131
                                    
                                    
                                    
                                    702
                                    
                                    
                                    
                                    429
                                    
                                    
                                    
                                    61High-carbon
      cold-rolled
                                    
                                    
                                    1,293
                                    
                                    
                                    
                                    1,514
                                    
                                    
                                    
                                    (221
                                    )
                                    
                                    
                                    (15
                                    )High-carbon
      hot-rolled
                                    
                                    
                                    1,242
                                    
                                    
                                    
                                    451
                                    
                                    
                                    
                                    791
                                    
                                    
                                    >100Subcontracting
      income
                                    
                                    
                                    789
                                    
                                    
                                    
                                    155
                                    
                                    
                                    
                                    634
                                    
                                    
                                    >100




The
average unit selling price per ton generated increased to $1,098 per ton for the
six months ended December 31, 2008, compared to the corresponding period in
2007 of $757, representing an increase of $341, or 45.1%, period-on-period.
This increase was mainly due to increases in average raw material prices
period-on-period and therefore selling prices, and an increase in average unit
selling price of the major products sold during the period. Sales of low-carbon
hard-rolled steel products, which accounted for $17,388,885, or 40.5%, of the
total sales mix for the six months ended December 31, 2008, increased by
8,092 metric tons, or 111.1%, period-on-period to 15,376 metric tons for the six
months ended December 31, 2008, compared to 7,284 metric tons for the six
months ended December 31, 2007. Meanwhile, the average unit selling price of
this product increased $429 to $1,131 for the six months ended December 31,
2008.


28
 Table of Contents





A
break-down of our sales by major customer for the six months ended December 31,
2008 and 2007 is as follows:





Six Months Ended December 31Customers
                                                                                                                                                                
                                                                                                                                                                2008 ($)
                                                                                                                                                                
                                                                                                                                                                % to sales
                                                                                                                                                                
                                                                                                                                                                2007 ($)
                                                                                                                                                                
                                                                                                                                                                % to salesSalzgitter
      Mannesmann International GMBH
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                13,651,071
                                                                                                                                                                
                                                                                                                                                                32
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                *
                                                                                                                                                                
                                                                                                                                                                *Shanghai
      Changshuo Stainless Steel Processing Co. Ltd.
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                4,555,411
                                                                                                                                                                
                                                                                                                                                                11
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                11,076,780
                                                                                                                                                                
                                                                                                                                                                27Jiangsu
      Sumec International Trading Co., Ltd.
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                3,217,647
                                                                                                                                                                
                                                                                                                                                                7
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                *
                                                                                                                                                                
                                                                                                                                                                *Shanghai
      Bayou Industrial Co., Ltd.
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                2,961,644
                                                                                                                                                                
                                                                                                                                                                7
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                *
                                                                                                                                                                
                                                                                                                                                                *Zhangjiagang
      Gangxing Innovative Construction Material Co., Ltd.
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                1,864,414
                                                                                                                                                                
                                                                                                                                                                4
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                *
                                                                                                                                                                
                                                                                                                                                                *Shanghai
      Shengdejia Metal Products Limited
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                *
                                                                                                                                                                
                                                                                                                                                                *
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                6,492,562
                                                                                                                                                                
                                                                                                                                                                16Beijing
      Beimo Aircraft Material Technology Company Limited
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                *
                                                                                                                                                                
                                                                                                                                                                *
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                1,843,650
                                                                                                                                                                
                                                                                                                                                                5Hangzhou
      Relian Company Limited
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                *
                                                                                                                                                                
                                                                                                                                                                *
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                1,670,246
                                                                                                                                                                
                                                                                                                                                                4Shangdong
      Province Boxing County Longhua Material Ltd.
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                *
                                                                                                                                                                
                                                                                                                                                                *
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                1,667,100
                                                                                                                                                                
                                                                                                                                                                426,250,187
                                                                                                                                                                
                                                                                                                                                                61
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                22,750,338
                                                                                                                                                                
                                                                                                                                                                56Others
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                16,674,191
                                                                                                                                                                
                                                                                                                                                                39
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                17,665,218
                                                                                                                                                                
                                                                                                                                                                44Total
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                42,924,378
                                                                                                                                                                
                                                                                                                                                                100
                                                                                                                                                                
                                                                                                                                                                
                                                                                                                                                                40,415,556
                                                                                                                                                                
                                                                                                                                                                100




*
Not a major customer for the relevant periods





Sales
revenues generated from the top five major customers as a percentage of total
sales increased to 61% for the six months ended December 31, 2008 as
compared to 56% for the six months ended December 31, 2007. With the exception
of Shanghai Changshuo Stainless Steel Processing Co. Ltd., the top five major
customers were different period-on-period. The change in customer mix reflects
our broadened customer base during the course of the period.




Cost of
Sales. Cost of
sales increased by $6,746,396, or 23.4%, period-on-period to $35,520,383 for the
six months ended December 31, 2008, from $28,773,987 for the six months
ended December 31, 2007. Cost of sales represented 82.8% of sales revenues for
the six months ended December 31, 2008 compared to 71.2% for the six months
ended December 31, 2007. Average cost of production per ton increased to $909
for the six months ended December 31, 2008 compared to an average cost of
production per ton of $539 for the six months ended December 31,
2007,  representing an increase of $370 per ton, or 68.6%,
period-on-period. Meanwhile, the average selling price per ton increased by $341
per ton, or 45.1%, period-on-period to $1,098 per ton for the six months ended
December 31, 2008, from $757 per ton for the six months ended December 31,
2007.





Six Months Ended December 31,2008
                                    
                                    2007
                                    
                                    Variance$
                                    
                                    $
                                    
                                    $
                                    
                                    %Cost
      of sales-
      Raw materials
                                    
                                    
                                    30,597,181
                                    
                                    24,973,918
                                    
                                    
                                    5,623,263
                                    
                                    22.5-
      Direct labor
                                    
                                    
                                    380,350
                                    
                                    346,011
                                    
                                    
                                    34,339
                                    
                                    9.9-
      Factory overhead
                                    
                                    
                                    4,542,852
                                    
                                    3,454,058
                                    
                                    
                                    1,088,794
                                    
                                    31.535,520,383
                                    
                                    28,773,987
                                    
                                    
                                    6,746,396
                                    
                                    23.4Cost
      per unit soldTotal
      units sold (tons)
                                    
                                    
                                    39,077
                                    
                                    53,378
                                    
                                    
                                    (14,301
                                    )
                                    (26.8
                                    )Average
      cost per unit sold ($/ton)
                                    
                                    
                                    909
                                    
                                    539
                                    
                                    
                                    370
                                    
                                    68.6




29
 Table of Contents





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





            a significant increase in cost of
      raw materials per unit sold of $315, or 67.3%, from $468 for the six
      months ended December 31, 2007 compared  to $783 for the six
      months ended December 31,
2008;






            an increase in factory overhead
      per unit sold of $51 or 78.5% from $65 for six months ended December 31,
      2007 compared to $116 for the six months ended December 31, 2008.





The cost
of raw materials consumed increased by $5,623,263, or 22.5%, period-on-period to
$30,597,181for the six months ended December 31, 2008 from $24,973,918 for
the six months ended December 31, 2007. This increase was mainly due to
increases in raw material prices period-on-period.




Manufacturing
overhead costs increased by $1,088,794, or 31.5%, period-on-period to $4,542,852
for the six months ended December 31, 2008, from $3,454,058 for the six
months ended December 31, 2007. The increase was mainly attributable to the
combined effect of an increase in depreciation of $564,740, or 58.7%,
period-on-period to $1,526,548for the six months ended December 31, 2008,
from $961,808 for the six months ended December 31, 2007, an increase in
utilities by $191,082, or 28.5%, period-on-period to $861,125 for the six months
ended December 31, 2008, from $670,043 for the six months ended December
31, 2007, and an increase in low consumables by $173,815, or 16.4%,
period-on-period to $1,234,986 for the six months ended December 31, 2008,
from $1,061,171 for the six months ended December 31, 2007.





Selling
Expenses.  Selling expenses increased by $1,052,381, or 373.9%,
period-on-period, to $1,333,830 for the six months ended December 31, 2008
compared to the corresponding period in 2007 of $281,449. The increase was
mainly attributable to increases in sales commission paid to export agents based
on increased tonnage sold, and transportation and custom clearing charges in
relation to our expanded export sales period-on-period. Our export precision
products, the low carbon hard-rolled steel, accounted for $17,388,885, or 40.5%,
of the sales mix for the six months ended December 31, 2008, compared to
$5,111,386, or 12.6% of sales during the six months ended December 31,
2007.




Administrative
Expenses. Administrative expenses
decreased by $292,391, or 21.9%, period-on-period, to $1,040,205 for the six
months ended December 31, 2008 compared to $1,332,596 in the comparable
period in 2007. This decrease was chiefly associated with lower SEC compliance
costs and professional fees as there was no financing activity during the six
months ended December 31, 2008 and as we become more familiar with the
rules and regulations as a listed company.





Income from
Operations. Income from operations before income tax decreased by
$8,205,337, or 87.8%, period-on-period to $1,140,977 for the six months ended
December 31, 2008 from $9,346,314 for the six months ended
December 31, 2007, as a result of the worldwide economic downturn and
slowing demands which have affected both sales revenue and margins. Also, the
net loss in the second quarter ended December 31, 2008 included an
allowance for bad and doubtful debts in the amount of $3,829,462 due to
a dispute over services rendered by the Company.





Other
income.  Our other income decreased $532,709, or 67.2% to
$259,701 for the six months ended December 31, 2008 from $792,410 for the same
period in 2007.  As a percentage of revenues, other income decreased
to 0.6% for the six months ended December 31, 2008 from 2.0% for the same period
in 2007. Such percentage decrease in interest income was primarily due to lower
cash balances and decrease of interest rate period-on-period.





Interest
Expense.  Total interest expense decreased $110,819, or 14.6%,
to $648,182 for the six months ended December 31, 2008, from $759,001 for the
same period in 2007 due to lower loan balances and a lower weighted average
interest rate during 2008 as compared to 2007.


30
 Table of Contents





Income
Tax. For the six
months ended December 31, 2008, we recognized income tax benefit of $148,257,
while for the same period in 2007, we recognized an income tax expense of
$52,566. The decrease in income tax expenses mainly resulted from the reversal
of provision for current income tax expense in relation to the bad debt written
off during the six months ended December 31, 2008.





Net
Income. Net income decreased by $8,426,404, or 90.3%, period-on-period to
$900,753 for the six months ended December 31, 2008, from $9,327,157 for the six
months ended December 31, 2007, as a result of the factors above.




Liquidity
and Capital Resources





General





Our
business is capital intensive and requires substantial expenditures for, among
other things, the purchase and maintenance of equipment used in our
operations.  Our short-term and long-term liquidity needs arise
primarily from capital expenditures, working capital requirements and principal
and interest payments related to our outstanding short-term loans. We have met
these liquidity requirements with cash provided by operations, equity financing,
and bank debt.As of
December 31, 2008, we had cash and cash equivalents of approximately $14.8
million.





The
following table provides detailed information about our net cash flow for all
financial statement periods presented in this report:





CASH
FLOW





Six Months Ended December 31,2008
                  
                  
                  2007Net
      cash provided by (used in) operating activities
                  
                  $
                  8,663,138
                  
                  
                  $
                  (7,062,646
                  )Net
      cash used in investing activities
                  
                  $
                  (12,954,497
                  )
                  
                  $
                  (5,508,327
                  )Net
      cash provided by financing activities
                  
                  $
                  182,295
                  
                  
                  $
                  45,610,096Net
      cash flow
                  
                  $
                  (3,805,177
                  )
                  
                  $
                  34,700,249





Operating
Activities.Net cash flows
provided by operating activities for the six months ended December 31, 2008 was
$8,663,138 as compared with $7,062,646 used in operating activities for the six
months ended December 31, 2007, for a net increase of $15,725,784. This increase
was mainly due to a substantial increase in accounts receivable, offset by
decreases in inventories and advances from customers during the six months ended
December 31, 2008.




Investing
Activities.Our main uses of cash for investing activities during the six
months ended December 31, 2008 were for purchase of property, plant and
equipment.  We believe these capital investments increase our
capacity, expand our product line, and reduce risks related to occupancy costs,
thereby creating new opportunities to grow sales and control
expenses.





Net cash
flows used in investing activities for the six months ended December 31, 2008
was $12,954,497 as compared with $5,508,327 for the six months ended December
31, 2007. The increase in investing activity was due to increased construction
during the six months ended December 31, 2008 as compared to the same period in
2007.





As of
December 31, 2008, the Company had $917,000 in commitments for capital
expenditures for contractual commitments of the construction projects related to
the new 1450mm cold-rolling mill and expansion of our production facilities. We
currently have sufficient capital resources to meet these contractual
commitments and have commenced construction of the 1450mm mill during the second
quarter of fiscal 2009.





Financing
Activities.  Net cash flows provided by financing activities
for the six months ended December 31, 2008, was $182,295 as compared with
$45,610,096 provided by financing activities for the six months ended December
31, 2007. During the six months ended December 31, 2008, the Company received
$269,985 in net proceeds from the exercise of warrants, which was partially
offset by repayment of short-term loans in the amount $87,690. The six months
ended December 31, 2007 reflect net proceeds of approximately $44 million from
an offering of the Company’s common stock, repayment and renewing of short-term
loans which offset each other, as well as advances from directors in the amount
$2,154,257.


31
 Table of Contents





On
December 30, 2008, we filed a universal shelf registration statement with the
SEC. The shelf registration, when declared effective, will permit us to issue
securities valued at up to an aggregate of $40 million. Once effective, we will
have the flexibility to issue registered securities, from time to time, in one
or more separate offerings or other transactions with the size, price and terms
to be determined at the time of issuance.  Although we do not have any
commitments or current intentions to sell securities under the registration
statement, we believe that it is prudent to have a shelf registration statement
in place to ensure financing flexibility should the need arise.





Current
Assets. Current assets decreased by $13,430,643, or 12.4%,
period-on-period to $94,703,279 as of December 31, 2008, from $108,133,922 as of
June 30, 2008, principally as a result of decreases in accounts receivable of
$10,534,533, or 31.2%, period-on-period and cash and equivalents by $3,805,177,
or 20.5%, period-on-period, offset by an increase in bills receivable of
$3,324,769, or 77.1%, period on period. The decrease in cash and cash
equivalents is mainly attributable spending on construction of the third rolling
mill during the three months ended December 31, 2008.





Current
Liabilities. Current liabilities decreased by $3,964,753, or 8.8%,
period-on-period to $41,264,649 as of December 31, 2008, from $45,229,402 as of
June 30, 2008. The decrease was mainly attributable to a decrease in advances
from customers of $2,982,416, or 42.6%, period-on-period, and a decrease in
other taxes payable of $409,696, or 10.3%, period-on-period.





As of
December 31, 2008, we had $17,457,984 in short term bank debt. This bank debt is
due in July 2009 and we expect to refinance such debt at its maturity, but we
cannot assure you that we will be able to do so on terms favorable to the
Company or at all.





Capital
Expenditures.During the three
months ended December 31, 2008, we invested $12,954,497 in property, production
plants and equipment.





Loan
Facilities




The
following table illustrates our credit facilities as of December 31, 2008,
providing the name of the lender, the amount of the facility, the date of
issuance and the maturity date:





All
amounts in U.S. dollars


Lender
                                                                
                                                                Date
      of Loan
                                                                
                                                                Maturity
      Date
                                                                
                                                                Duration
                                                                
                                                                Interest
      Rate
                                                                
                                                                Principal
      AmountRaiffeisen
                                                                  Zentralbank
      Österreich AG
                                                                
                                                                July
      23, 2008
                                                                
                                                                July
      31, 2009
                                                                
                                                                1
      year
                                                                
                                                                USD:
      SIBOR + 3%;
                                                                  RMB:
      1.13 times of the PBOC rate
                                                                
                                                                
                                                                $5,300,000;
                                                                  $2,904,700
                                                                  (RMB20,000,000)Raiffeisen
                                                                  Zentralbank
      Österreich AG
                                                                
                                                                July
      20, 2008
                                                                
                                                                July
      31, 2009
                                                                
                                                                1
      year
                                                                
                                                                1.15
      times of the PBOC rate
                                                                
                                                                
                                                                $9,253,284
                                                                  (RMB63,600,000)Total
                                                                
                                                                
                                                                
                                                                
                                                                
                                                                
                                                                
                                                                
                                                                
                                                                
                                                                $17,457,984





As of
December 31, 2008, we had $17,457,984 in short term bank debt as illustrated in
the above table. Such debt is secured by land use rights, buildings, plant and
machinery.





We
believe that our currently available working capital and the credit facilities
referred to above should be adequate to sustain our operations at our current
levels through the next twelve months.





Obligations
under Material Contracts





Below is
a table setting forth our material contractual obligations as of December 31,
2008:


32
 Table of Contents





At December 31, 2008
                      Payments Due By Period(in thousands)
                    
                    Total
                    
                    
                    Fiscal Year
                      2009
                    
                    
                    Fiscal
                      Years
                      2010-2011
                    
                    
                    Fiscal
                      Years
                      2012-2013
                    
                    
                    Fiscal Year
                      2014and
                      BeyondContractual obligations:Debt
      Obligations
                    
                    $
                    18,435,631
                    
                    
                    $
                    18,435,631
                    
                    
                    $
                    —
                    
                    
                    $
                    —
                    
                    
                    $
                    —Construction
      Commitments
                    
                    
                    917,000
                    
                    
                    
                    917,000
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —$
                    19,352,631
                    
                    
                    $
                    19,352,631
                    
                    
                    $
                    —
                    
                    
                    $
                    —
                    
                    
                    $
                    —





In
October 2004, Tuorong agreed to purchase a land use right from the Shanghai
Labor and Economic Development Council with respect to a 20-acre parcel, for a
lease 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 Xuhang
Industrial Development Co., Ltd. with respect to a 27.04-acre parcel, for a
lease period of 50 years, at a cost of $497,795. In November 2006, Chengtong
entered into an agreement with the Shanghai Labor and Economic Development
Council, which supersedes the aforementioned Tuorong agreement, to purchase a
total of 21.34-acre parcel for a lease period of 50 years at an aggregate amount
of $672,126. In December 2006, Tuorong entered into a Compensation Agreement
with the Shanghai Jiading Housing, Land and Resource Management Bureau to pay an
aggregate amount of $637,294 in connection to the two aforementioned parcels.
During the six months ended December 31, 2008, additional payment in the amount
of $717,842 has been made in relation to the abovementioned agreements and land
use right.





As of
December 31, 2008, the Company also had $917,000 in commitments for capital
expenditures for contractual commitments of the construction projects related to
expansion of Shanghai Blessford’s production facilities. We believe this capital
investment increases our capacity, expand our product line, and thereby creating
new opportunities to grow sales.





Recent
Accounting Pronouncements





In
December 2007, the FASB issued SFAS No.141 (revised 2007), “Business
Combinations” (“SFAS 141(R)”). “SFAS 141(R)” will change the accounting for
business combinations. Under SFAS No.141(R), an acquiring entity will be
required to recognize all the assets acquired and liabilities assumed in a
transaction at the acquisition-date fair value with limited exceptions. SFAS
No.141(R) will change the accounting treatment and disclosure for certain
specific items in a business combination. SFAS No.141(R) applies prospectively
to business combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after December15,
2008. SFAS 141(R) will impact the Company in the event of any future
acquisition.





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


In March
2008, the FASB issued SFAS No.161, “Disclosures about Derivative Instruments and
Hedging Activities—an amendment of FASB Statement No.133” (“SFAS 161”). SFAS 161
changes the disclosure requirements for derivative instruments and hedging
activities. Entities are required to provide enhanced disclosures about (a) how
and why an entity uses derivative instruments, (b) how derivative instruments
and related hedged items are accounted for under Statement 133 and its related
interpretations, and (c) how derivative instruments and related hedged items
affect an entity’s financial position, financial performance, and cash
flows.  The guidance in “SFAS 161” is effective for financial
statements issued for fiscal years and interim periods beginning after November
15, 2008, with early application encouraged. This Statement encourages, but does
not require, comparative disclosures for earlier periods at initial adoption.
The Company is currently assessing the impact of SFAS 161.





33
 Table of Contents




In April
2008, the FASB issued FASB Staff Position (“FSP”) FAS 142-3, “Determination of
the Useful Life of Intangible Assets”(“FAS 142-3”), which amends the factors
that should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset under SFAS No. 142,
“Goodwill and Other Intangible Assets” (“SFAS No. 142”).  The intent
of this FSP is to improve the consistency between the useful life of a
recognized intangible asset under SFAS No. 142 and the period of expected cash
flows used to measure the fair value of the asset under SFAS No. 141(R),
“Business Combinations,” and other U.S. generally accepted accounting
principles.  This FSP is effective for fiscal years beginning after
December 15, 2008 (the Company’s fiscal year 2010), and interim periods
within those fiscal years.  The Company does not believe the adoption
of FSP 142-3 will have a material impact on the Company’s consolidated financial
position, results of operations and cash flows.





In May
2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted
Accounting Principles"(“SFAS 162”).  This statement identifies the
sources of accounting principles and the framework for selecting the principles
to be used in the preparation of financial statements of non-governmental
entities that are presented in conformity with US GAAP. The provisions of SFAS
162 become effective 60 days following the SEC's approval of the amendment to AU
Section 411, "The Meaning of Presents Fairly in Conformity with Generally
Accepted Accounting Principles" by the Public Company Accounting Oversight
Board.  The adoption of this statement is not expected to have a
material effect on the Company’s future reported financial position or results
of operations.





In May
2008, the FASB issued FASB Statement No. 163, “Accounting for Financial Guarantee
Insurance Contracts” (“FASB 163”). The new standard clarifies
how FASB Statement No. 60, “Accounting and Reporting by
Insurance Enterprises”, applies to financial guarantee insurance
contracts issued by insurance enterprises, including the recognition and
measurement of premium revenue and claim liabilities. It also requires expanded
disclosures about financial guarantee insurance contracts. FASB 163 is effective
for financial statements issued for fiscal years beginning after December 15,
2008, and all interim periods within those fiscal years, except for disclosures
about the insurance enterprise’s risk-management activities, which are effective
the first period (including interim periods) beginning after May 23, 2008.
Except for the required disclosures, earlier application is not permitted. The
standard is not applicable to this Company.





In
October 2008, the FASB issued FSP FAS 157-3, “Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active” (“FASB
157-3”).This FSP
clarifies the application of FASB Statement No. 157, “Fair Value Measurements”, in
a market that is not active and provides an example to illustrate key
considerations in determining the fair value of a financial asset when the
market for that financial asset is not active. FAS 157-3 was effective upon
issuance. The adoption of FAS 157-3 did not impact our consolidated financial
statements in any material respect.





Critical
Accounting Policies




See Item
7, Management's Discussion and Analysis of Results of Operations and Financial
Condition in our Annual Report on Form 10-K for the fiscal year ended June 30,
2008, for a discussion of our critical accounting policies.





Seasonality




Our
operating results and operating cash flows historically have been subject to
seasonal variations. Our revenues are usually higher in the second half of the
year than in the first half of the year and the first quarter is usually the
slowest quarter because fewer projects are undertaken during and around the
Chinese new year holidays.





Off-Balance
Sheet Arrangements





For the
three and six months ended December 31, 2008, we did not have any off-balance
sheet arrangements.


34
 Table of Contents


ITEM 3.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK





We have
exposure to several types of market risk: changes in foreign currency exchange
rates, interest rates and commodity prices. We neither hold nor issue financial
instruments for trading purposes nor do we make use of derivative instruments to
hedge the risks discussed below.





The
following sections provide quantitative information on our exposure to market
risks. Our use of sensitivity analyses are inherently limited in estimating
actual losses in fair value that can occur from changes in market
conditions.





Foreign
Currency Exchange Rates





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





The
Chinese Renminbi had remained stable against the U.S. Dollar at approximately
8.28 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% revaluation
versus the United States Dollar. This move initially valued the Renminbi at 8.11
per United States Dollar. In addition, the Renminbi is no longer linked to the
U.S. currency but rather to a basket of currencies with a 0.3% margin of
fluctuation. However, there remains international pressure on the Chinese
government to adopt an even more flexible currency policy and as of December 31,
2008 the exchange rate was 6.823 Yuan to 1.00 U.S. Dollar. The exchange rate of
Renminbi is subject to changes in China’s government policies which are, to a
large extent, dependent on the economic and political development both
internationally and locally and the demand and supply of Renminbi in the
domestic market. There can be no assurance that such exchange rate will continue
to remain stable in the future amongst the volatility of currencies,
globalization and the unstable economies in recent years. Since (i)our income
and profit are mainly denominated in Renminbi, and (ii)the payment of dividends
will be in U.S. dollars, if any, any exchange fluctuation of the Renminbi
against other foreign currencies would adversely affect the value of the shares
and dividends payable to shareholders, in foreign currency
terms.


At
December 31, 2008, the Group’s outstanding financial instruments with foreign
currency exchange rate risk exposure had an aggregate fair value of $17 million
(including the Group’s non-U.S. dollar denominated debt). The potential increase
in the fair values of these instruments resulting from a 10% adverse change in
quoted foreign currency exchange rates would be approximately $1.7 million at
December 31, 2008.





Interest
Rates





The Group
is subject to interest rate risk on its non-derivative financial instruments.
The Group does not hedge its interest rate risk. At December 31, 2008, the
Group’s total bank debt outstanding was $17,457,984, all of which was
interest-bearing. Substantially all of the bank debt was floating-rate debt with
interest rates which vary with changes in the standard rate set by the People’s
Bank of China. A change in the interest rate or yield of fixed rate debt will
only impact the fair value of such debt, 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 to service such debt. To the extent interest rates
increase, we will be liable for higher interest payments to our lenders. For the
current financial year, annual interest on loans is anticipated to be
approximately $0.9 million. The impact of a 1% increase in interest rates will
increase interest expense by approximately $175,000. As our short-term
borrowings mature, we will be required to either repay or refinance these
borrowings. An increase in short-term interest rates at the time that we seek to
refinance short-term borrowings may increase the cost of borrowings, which may
adversely affect our earnings and cash available for distribution to its
shareholders.


35
 Table of Contents




At
December 31, 2008, the aggregate fair value of the Group’s financial instruments
with exposure to interest rate risk was approximately $17 million. The potential
change in fair value for these financial instruments from an adverse 10% change
in quoted interest rates across all maturities, often referred to as a parallel
shift in the yield curve, would be approximately $0.1 million at December 31,
2008.





Commodity
Prices





The steel
coils and other raw materials used by Chengtong, require large amounts of raw
materials - iron ore or other iron containing material, steel scrap, coke and
coal - as well as large amounts of energy to produce. Additionally, we also use
large amounts of energy in our operations. Over the last several years, prices
for raw materials and energy, in particular natural gas and oil, have increased
significantly. In many cases these price increases have been at a greater
percentage than price increases for the sale of steel products.





The Group
has no open derivative commodity instruments as of December 31, 2008 and does
not currently hedge its exposure to price fluctuations in the raw materials and
energy required for the manufacture of its products.





Inflation





Inflationary
factors such as increases in the cost of our product and overhead costs may
adversely affect our operating results.  We generally manufacture our
products to match orders from our customers. Due to the specialized nature of
our products, we are able to purchase raw materials based upon customer orders.
This operating model allows us to effectively pass along fluctuations in the
price of raw materials to our customers. For commonly used raw materials, we
purchase larger quantities when we believe prices are likely to increase in the
short term in order to minimize the impact of any such price
increase.





Although
we believe that inflation has not had a material effect on our results of
operations to date, a high rate of inflation in the future may have an adverse
effect on our ability to effectively pass along fluctuations to our customers
and our ability to maintain current levels of gross margin and selling, general
and administrative expenses as a percentage of net revenues.





ITEM
      4.
              CONTROLS AND
      PROCEDURES.





Evaluation
of Disclosure Controls and Procedures.





We
maintain disclosure controls and procedures (as defined in Rule 13a-15(e) under
the Exchange Act) that are designed to ensure that information that would be
required to be disclosed in Exchange Act reports is recorded, processed,
summarized and reported within the time period specified in the SEC’s rules and
forms, and that such information is accumulated and communicated to our
management, including to our Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow timely decisions regarding required
disclosure.





As
required by Rule 13a-15 under the Exchange Act, our management, including Wo
Hing Li, our President and Chief Executive Officer and Leada Tak Tai Li, our
Chief Financial Officer, evaluated the effectiveness of the design and operation
of our disclosure controls and procedures as of December 31, 2008. Based on that
evaluation, these executive officers concluded that as of December 31, 2008, and
as of the date that the evaluation of the effectiveness of our disclosure
controls and procedures was completed, our disclosure controls and procedures
were effective to satisfy the objectives for which they are
intended.





Changes
in Internal Control Over Financial Reporting.





During
the fiscal quarter ended December 31, 2008, there were no changes in our
internal control over financial reporting that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.


36
 Table of Contents


PART
II


OTHER
INFORMATION





ITEM
      1.
              LEGAL PROCEEDINGS.





From time
to time, we may have disputes that arise in the ordinary course of our business.
Currently, there are no legal proceedings to which we are a party, or to which
any of our property is subject, that we expect to have a material adverse effect
on our financial condition.





ITEM
      1A.
              RISK FACTORS.





There are
no material changes from the risk factors previously disclosed in Part I, Item
1A. “Risk Factors” of our Annual Report on Form 10-K for the year ended June 30,
2008, filed with the SEC on September 15, 2008.





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





There
were no unregistered sales of equity securities in the quarter ended June 30,
2008.





ITEM
      3.
              DEFAULTS UPON SENIOR
      SECURITIES.





There
were no defaults upon senior securities in the quarter ended June 30,
2008.




ITEM
      4.
              SUBMISSION OF MATTERS TO
      A VOTE OF SECURITY
HOLDERS.





No
matters were submitted to a vote of security holders in the quarter ended June
30, 2008.





ITEM
      5.
              OTHER
      INFORMATION.





None.





ITEM
      6.
              EXHIBITS.





The
following exhibits are filed as part of this report or incorporated by
reference:





Exhibit No.
              
              Description31.1
              
              Certification
      of Principal Executive Officer filed pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2
              
              Certification
      of Principal Financial Officer filed pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1
              
              Certifications
      of Principal Executive Officer furnished pursuant to 18 U.S.C. Section
      1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.32.2
              
              Certifications
      of Principal Financial Officer furnished pursuant to 18 U.S.C. Section
      1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.




37
 Table of Contents


SIGNATURES





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





Dated:
February 9, 2009





CHINA
      PRECISION STEEL, INC.By:
                /s/ Wo Hing LiWo
      Hing Li
                  Chief
      Executive Officer


38
 Table of Contents




EXHIBIT
INDEX





Exhibit No.
            
            Description31.1
            
            Certification
      of Principal Executive Officer filed pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2
            
            Certification
      of Principal Financial Officer filed pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1
            
            Certifications
      of Principal Executive Officer furnished pursuant to 18 U.S.C. Section
      1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.32.2
            
            Certifications
      of Principal Financial Officer furnished pursuant to 18 U.S.C. Section
      1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.






39