Answers from Alloy Steel

Update: For more recent posts on AYSI, please see here, here, here, and here.

Below are shareholder questions and answers from Alloy Steel International. As I mentioned in the previous post, these questions and answers were edited and reviewed by the company, following our call.

Q: Can you offer independent verification of Arcoplate and Super Arcoplate’s superiority to other wear plates?

A: Many clients are reluctant to make testimonials. Third party testing (e.g., independent lab testing) is less meaningful in our industry as miners want to see how the product performs in their own local conditions. Client adoption demonstrates the product’s acceptance. Some of the largest mining companies in the world are using Alloy Steel’s wear plates and often end up using it in the majority of the equipment in their fleets. The best testimonial is a repeat sale.

Q: Why the departures of former CFO Alan Windus and director Alvin Tan (after one quarter, in his case)?

A: At this stage in the company’s growth, Alloy Steel needs a full time CFO and is reviewing its personnel requirements for its growth. Alan Windus was a part-time CFO. Barry Woodhouse is a full time CFO, which is the main reason he has replaced Alan Windus. Alvin Tan was a board nominee of Alan’s and the company elected to go with a clean slate.

The company is currently in the process of adding appropriately experienced board members (including an independent chairman) who have experience in the management of growing industrial companies, and have industry connections that will enable them to make introductions for the company that can lead to new client relationships.

Q: What is the status of the FINRA investigation and when do you expect it to be finished and the results made public?

A: As outlined in the recent quarterly, Alloy Steel conducted an internal investigation and provided the requested information to FINRA several months ago. The company has not received a response from FINRA yet, and has not been told if or when it will receive a response.

Q: What was the specific impact of the costs of new mill construction in this past quarter to profitability? How do you expect these costs to impact profitability going forward?

A: Costs of any new mill are carried in the balance sheet so there is no immediate impact to profitability, but to cash flow. Once commissioned, a new mill will be depreciated over its useful life. On the flip side, once a new mill is commissioned successfully, sales can commence. Subject to a decent margin, profitability then increases.

Q: Shareholder communication has been rough, at a minimum, over the past several years. Has any serious consideration been given to hiring a respectable investor relations firm to handle press releases and shareholder communication? It would at a minimum help return some confidence to shareholders and allow company executives more time to focus on what they do best, which is of course to run the company.

A: The company is reviewing the issue of shareholder communication broadly, and plans changes to increase communications in the future, including a revamp of the company’s website within the next few months.

Q: Does management care what the stock price is? If they do, why do they behave as if they don’t? If they don’t, why do they incur the considerable expense and management time associated with a public listing?

A: The company does care about the share price and is disappointed to see it so low. See the related comment below in relation to funding growth and review of strategy.

Q: What is happening in Costs of Goods Sold. AYSI’s Gross Margin has deteriorated markedly. (ii) What happened to a license agreement in Latin America (ie: sales to Vale)? (iii) Update on Indo mill as land is being acquired via installment payments.

Q: Work in progress increased from 124 th to > 1 M : does this imply we will have again record sales of > 5 M in the next quarter ? Why did work in progress increase so much ?

A: Cost of Goods Sold, W-I-P and stock-on can be a timing issue. The Gross Margin for the 9 months year to date (June 2010) was reported as 53.9% compared to 44% for the 3 month period (June 2010). In any quarter, revenue figures can be skewed by several factors including timing of shipments and customer delivery and the like.

The Company has distributor agreements in place for countries in South America. Those distributors have sold Arcoplate in South America, including to major miners who operate there.

Q: What is the capex to set up a new line ? Land expenditure versus equipment expenditure ? The 1 M investing activities: land or equipment investment ? => Idea is to get a clear idea what the company is investing its profits in … (if anyone knows about this please let me know).

A: The Company is investing some of its cash flow into firstly acquiring the Indonesian land (in monthly installments as announced) as well as further plant and equipment as appropriate.

Q: Will you need additional funds to accelerate the growth strategy of the company ?

A: The Company is reviewing its growth strategy and how to fund it. No decision as to method has been made as yet. If the company wanted to fund accelerated growth through an equity raising common sense suggests that a higher share price is required to ensure dilution is minimized.

Q: What is the growth strategy of the company ? (geographical expansion ? pricing strategy ? new products ?) = What is the main focus, main target within 1 year ?

A: The growth strategy of the company is to build credibility with large mining companies by offering a small amount of product and letting those companies see how well Alloy Steel’s wear plate performs. Selling to mining companies can be a long process, as miners generally assume that their local conditions are harsher than those anywhere else and want to see how product performs in their local area, which takes time for them to judge. Alloy Steel has successfully pursued this strategy in the United States and elsewhere, but sales results don’t follow in a linear fashion, i.e., it can take years of small deliveries of product to a particular company before they are followed by large orders once the target company has become confident in the product. Another aspect of Alloy Steel’s growth strategy is to leverage existing relationships with certain divisions of large mining company clients (e.g., the iron ore mining divisions) to introduce the product to other divisions (e.g., the uranium or copper mining divisions for example). Alloy Steel has now gained the credibility with its larger clients where it is positioned to present its product to other divisions.

Q: With the start-up of the second mill and the large backlog reported backlog, why are the total sales still below historical highs that were accomplished with a single mill?

A: Sales have grown steadily on an annual basis and for the 9 months ended 30 June 2010, reported sales are $15.7m compared to the best historical sales annual figure of $13.5m in 2008, prior to the GFC. We are dealing with new technology that has required numerous adjustments to our manufacturing process (to improve efficiencies and quality) which has led to downtime, limiting our capacity. Even with constant corrections, you can see quite clearly the increased sales effect of having a second producing mill on the current 9 month period.

We are wary of accepting large orders that we aren’t absolutely sure we can fill in a timely fashion, as committing to an order and failing to fill it on time would irreparably damage our credibility with our clients.

Q: What is the status of marketing and orders for Super Acroplate?

A: There is currently high demand for the product, but we are limited by capacity constraints.

Q: i. What is the current status of mill expansion? ii. Is the existing facility at maximum capacity?

A: i. Please see above. ii. No, please see above.

Q: Why isn’t the AYSI website used to provide updated product, marketing, and shareholder updates? This would seem to be a cost effective manner to share general information.

A: It will be, once the site has been revamped within the next few months.

Q: How many mills in Australia – in operation or being built?

A: There are currently 2 mills in production in Australia, but please note the comments above.

Q: What is the anticipated completion of the Indonesia complex – how many mills are planned?

A: We first have to complete payment for the land and then build the factory. These details will be part of the review of the growth strategy.

Q: Why were sales lower in the third quarter?

A: This may be a timing issue. In any quarter, revenue figures can be skewed by several factors including timing of shipments and customer delivery and the like.

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