Longhai Steel Inc.

Pursuant to the VIE Agreements, the Company through its wholly-owned subsidiary, Kalington Consulting, was granted with decision making rights and power over key strategic and operational functions that would significantly impact the Longhai or the VIE’s economic performance, which includes, but is not limited to, advise, consult, manage and operate Longhai and collect and own all of the net profits of Longhai; recommend director candidates and appoint the senior executives of Longhai, approve any transactions that may materially affect the assets, liabilities, rights or operations of Longhai; and guarantee the contractual performance by Longhai of any agreements with third parties Under these agreements, the Company has the absolute and exclusive right to enjoy economic benefits similar to equity ownership through the VIE Agreements with Longhai and their shareholders.

Cost of Sales. Our cost of revenue includes direct costs to manufacture our products, including the cost of raw materials, labor, overhead, energy cost, handling charges, and other expenses associated with the manufacture and delivery of products. Our cost of sales decreased $22.9 million, or 19.8%, to $93.0 million in the three months ended September 30, 2012, from $115.9 million in the same period in 2011. The cost of sales as a percentage of revenues increased from 97.6% to 98.1% between the periods. Our cost of sales is largely dictated by fluctuations in steel billet prices as billet typically represents more than 95% of our cost of goods sold. The decrease was generally in line with the decrease in our sales revenue. Cost of goods sold per ton of wire sold decreased by 27.5 % period over period, mainly was a result of decreased billet price. The average billet price decreased from RMB3,733 per ton in the three months ended September 2011 to RMB 2,736 per ton in the same period of 2012, representing a 26.7% decrease, which explains the decrease in cost of sales.

The changes of advance to suppliers and due to related party were caused by the following changes: 1) The Company started to purchase billets from third party trading companies instead of purchasing from the related party. Funds advanced to the related party was repaid and the Company turned the advance payment to the trading companies, and 2) In August 2011, we leased a new facility with annual capacity of 600,000 MT from Longhai Steel Group, at annual cost of $2.2 million. That new facility will increase our production capacity by approximately 60%, which also requires larger amount of advance to suppliers. Advance to suppliers will remain at a higher level if our production operates at its increased capacity. Once we ramp up our production at such increased volume, we do not expect significant impact on our liquidity.

Net cash provided by financing activities for the period ended September 30, 2012 was $1.2 million, as compared to net cash used in financing activities of $2.5 million during the same period in 2011. The increase was primarily attributable to the gross proceeds of $1.2 million in the June 2012 private placement and a loan received and payment of $4.7 million in the nine months ended September 30, 2012. We also borrowed funds from a third party vendor in 2011. The annual interest rate on the borrowing in 2011 is 20% and is due on demand. The total outstanding borrowing balance was $nil and $3.6 million as of September 30, 2012 and December 31, 2011 respectively. We do not anticipate utilizing this type of funding in the future.

Inflation and changing prices have not had a material effect on our business and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future. We normally set our gross margin at fixed number regardless the price of our material. That is the spread between steel wire and steel billet. Even though steel billet and wire prices have been moving up and down as much as 30% since 2010, we still maintain the similar range of gross margins per metric ton during the same period. However, our management will closely monitor price changes in the steel industry and continually maintain effective cost control in operations.