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EX-32.2 - EXHIBIT 32.2 - LIHUA INTERNATIONAL INC.v320483_ex32-2.htm
EX-31.1 - EXHIBIT 31.1 - LIHUA INTERNATIONAL INC.v320483_ex31-1.htm
EX-32.1 - EXHIBIT 32.1 - LIHUA INTERNATIONAL INC.v320483_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - LIHUA INTERNATIONAL INC.v320483_ex31-2.htm

 

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 


 

xQuarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended June 30, 2012

 

or

 

¨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 000-52650

 


 

LIHUA INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

 


 

Delaware 14-1961536
(State or Other Jurisdiction of Incorporation or
Organization)
(I.R.S. Employer Identification No.)

 

Houxiang Five Star Industry District

Danyang City, Jiangsu Province, PR China 212312

(Address of Principal Executive Offices including zip code)

 

+86 51 86317399

(Registrant’s Telephone Number, Including Area Code)

 

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 preceding 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  x    No  ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every, Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x  No  ¨

 

Indicate by check mark if the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company

 

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

 

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

 

There were 30,084,883 shares of the Registrant’s Common Stock issued and outstanding on August 8, 2012.

 

 
 

 

TABLE OF CONTENTS

 

Lihua International, Inc.

Index to Form 10-Q

 

 

        Page
         
PART 1 — FINANCIAL INFORMATION   3
         
Item 1.   UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS   3
         
Item. 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS   25
         
Item 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK   40
         
Item 4.   CONTROLS AND PROCEDURES   40
         
PART II — OTHER INFORMATION   42
         
Item 1.   LEGAL PROCEEDINGS   42
         
Item 1A.   RISK FACTORS   42
         
Item 2.   UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS   42
         
Item 3.   DEFAULTS UPON SENIOR SECURITIES   42
         
Item 4.   MINE SAFETY DISCLOSURES   42
         
Item 5.   OTHER INFORMATION   42
         
Item 6.   EXHIBITS   42
         
SIGNATURES   43

 

 
 

 

PART 1 — FINANCIAL INFORMATION

 

Item 1.  UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(AMOUNTS EXPRESSED IN US DOLLARS)

 

   June 30,   December 31, 
   2012   2011 
ASSETS          
CURRENT ASSETS          
Cash and cash equivalents  $125,188,967   $105,637,627 
Accounts receivable, net   31,039,834    31,082,460 
Prepayments for raw material purchases   17,861,244    21,882,977 
Other receivables, deposits and prepayments   1,474,722    1,882,864 
Prepaid land use right – current portion   403,497    405,034 
Deferred income tax assets   19,626    200,588 
Inventories   17,764,641    15,502,246 
Total current assets   193,752,531    176,593,796 
OTHER ASSETS          
Property, plant and equipment, net   47,304,630    20,565,875 
Construction in progress   -    18,794,910 
Deposits for plant and equipment   -    3,428,082 
Prepaid land use right – long-term portion   18,632,832    18,906,280 
Intangible assets   -    170 
Total non-current assets   65,937,462    61,695,317 
Total assets  $259,689,993   $238,289,113 
           
LIABILITIES AND STOCKHOLDERS' EQUITY          
CURRENT LIABILITIES          
Accounts payable  $5,145,929   $6,066,261 
Other payables and accruals   4,966,101    6,370,833 
Income taxes payable   4,791,112    4,607,533 
Dividend payable   -    992,846 
Warrant liabilities   704,000    615,000 
Total current liabilities   15,607,142    18,652,473 
Total liabilities   15,607,142    18,652,473 
           
STOCKHOLDERS' EQUITY          
Preferred stock: $0.0001 par value, 10,000,000 shares authorized, none issued and outstanding   -    - 
Common stock, $0.0001 par value: 75,000,000 shares authorized,          
30,084,883 shares issued and 29,820,836 shares outstanding as of June 30, 2012 (December 31, 2011: 30,036,481 shares issued and 29,772,434 shares outstanding)   3,008    3,003 
Additional paid-in capital   79,090,307    78,564,128 
Treasury stock, at cost, 264,047 and 264,047 shares as of June 30, 2012 and December  31, 2011, respectively   (2,126,597)   (2,126,597)
Statutory reserves   12,136,089    10,418,476 
Retained earnings   139,573,552    116,369,487 
Accumulated other comprehensive income   15,406,492    16,408,143 
Total stockholders' equity   244,082,851    219,636,640 
Total liabilities and stockholders' equity  $259,689,993   $238,289,113 

 

See accompanying notes to condensed consolidated financial statements

 

3
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(AMOUNTS EXPRESSED IN US DOLLARS)

 

   For the Three Months Ended 
June 30,
   For the Six Months Ended
June 30,
 
   2012   2011   2012   2011 
                 
NET REVENUE  $191,007,886   $167,012,527   $360,094,153   $303,943,623 
                     
Cost of sales   (170,296,852)   (147,365,064)   (320,748,127)   (267,388,087)
                     
GROSS PROFIT   20,711,034    19,647,463    39,346,026    36,555,536 
                     
Selling expenses   (740,988)   (668,366)   (1,426,994)   (1,191,402)
General and administrative expenses   (1,834,465)   (1,339,062)   (3,932,299)   (2,912,374)
                     
Income from operations   18,135,581    17,640,035    33,986,733    32,451,760 
                     
Other income (expenses):                    
Interest income   204,694    136,941    367,830    270,046 
Interest expenses   -    (49,014)   -    (70,480)
Gain on extinguishment of warrant liabilities   -    26,531    73,291    87,255 
Change in fair value of warrants   (44,000)   1,179,151    (474,000)   2,554,252 
Other income   -    23,879    94,779    99,830 
Total other income (expenses), net   160,694    1,317,488    61,900    2,940,903 
                     
Income before income taxes   18,296,275    18,957,523    34,048,633    35,392,663 
Provision for income taxes   (4,849,609)   (4,591,447)   (9,126,955)   (8,514,601)
                     
NET INCOME  $13,446,666   $14,366,076   $24,921,678   $26,878,062 
                     
OTHER COMPREHENSIVE INCOME:                    
                     
Foreign currency translation adjustments   (1,210,053)   2,344,495    (1,001,651)   4,009,012 
                     
COMPREHENSIVE INCOME  $12,236,613   $16,710,571    23,920,027    30,887,074 
                     
Net income per share                    
Basic  $0.45   $0.48   $0.84   $0.90 
Diluted  $0.45   $0.48   $0.83   $0.89 
                     
Weighted average number of shares outstanding                    
Basic   29,820,836    29,872,934    29,810,996    29,865,896 
Diluted   30,017,985    30,111,142    30,049,336    30,200,087 

 

See accompanying notes to condensed consolidated financial statements.

 

4
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(AMOUNTS EXPRESSED IN US DOLLARS)

 

   Common Stock
Outstanding
   Additional               Accumulated
Other
     
   Number of       Paid-in   Statutory   Treasury   Retained   Comprehensive     
   Shares   Amount   Capital   Reserves   Stock   Earnings   Income   Total 
                                 
At January 1, 2012   29,772,434   $3,003   $78,564,128   $10,418,476   $(2,126,597)  $116,369,487   $16,408,143   $219,636,640 
                                         
Net income   -    -    -    -    -    24,921,678    -    24,921,678 
Foreign currency translation adjustment   -    -    -    -    -    -    (1,001,651)   (1,001,651)
Exercise of warrants   48,402    5    311,704    -    -    -    -    311,709 
Share-based payments to employees and directors   -    -    214,475    -    -    -    -    214,475 
Appropriation of statutory reserves   -    -    -    1,717,613    -    (1,717,613)   -    - 
                                         
At June  30, 2012 (Unaudited)   29,820,836   $3,008   $79,090,307   $12,136,089   $(2,126,597)  $139,573,552   $15,406,492   $244,082,851 

  

See accompanying notes to condensed consolidated financial statements.

 

5
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(AMOUNTS EXPRESSED IN US DOLLARS)

 

   Six Months Ended June  30, 
   2012   2011 
CASH FLOWS FROM OPERATING ACTIVITIES          
Net income  $24,921,678   $26,878,062 
Adjustments to reconcile net income to cash provided by operating activities:          
Depreciation and amortization   1,338,540    1,289,649 
Share-based compensation   214,475    267,074 
Gain on extinguishment of warrant liabilities   (73,291)   (87,255)
Change in fair value of warrants   474,000    (2,554,252)
Deferred income tax benefits   180,702    (19,351)
(Increase) decrease in assets:          
Accounts receivable   (75,526)   9,826,535 
Bills receivable   -    535,170 
Prepayments for raw material purchases   3,949,625    (23,343,711)
Other receivables, deposits and prepayments   402,111    (525,338)
Inventories   (2,327,659)   (1,298,889)
Increase (decrease) in liabilities:          
Accounts payable   (899,804)   2,513,027 
Other payables and accruals   (286,113)   (430,361)
Income taxes payable   201,621    (366,207)
Net cash provided by operating activities   28,020,359    12,684,153 
           
CASH FLOWS FROM INVESTING ACTIVITIES          
Purchase of property, plant and equipment   (2,274,852)   (506,313)
Addition to construction in progress   (4,650,631)   (6,120,004)
Net cash used in investing activities   (6,925,483)   (6,626,317)
           
CASH FLOWS FROM FINANCING ACTIVITIES          
Repurchase of common stock   -    (2,126,597)
Proceeds from a related party   -    140,000 
Proceeds from exercise of warrants   -    1,898,049 
Dividend paid   (992,846)   - 
Net cash used in financing activities   (992,846)   (88,548)
           
Foreign currency translation adjustment   (550,690)   2,150,410 
INCREASE IN CASH AND CASH EQUIVALENTS   19,551,340    8,119,698 
CASH AND CASH EQUIVALENTS, at the beginning of the period   105,637,627    90,609,340 
           
CASH AND CASH EQUIVALENTS, at the end of the period  $125,188,967   $98,729,038 
           
MAJOR NON-CASH TRANSACTIONS:          
Share-based compensation to employees and directors  $214,475   $267,074 
Issuance of common stock to settle warrant liabilities  $311,704   $4,895,934 
SUPPLEMENTAL DISCLOSURE INFORMATION          
Cash paid for interest  $-   $70,480 
Cash paid for income taxes  $8,744,632   $8,835,772 

 

See accompanying notes to condensed consolidated financial statements.

 

6
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

 

NOTE 1DESCRIPTION OF BUSINESS AND ORGANIZATION

 

Lihua International, Inc. (“Lihua ” or the “ Company ”) was incorporated in the State of Delaware on January 24, 2006 under the name Plastron Acquisition Corp.  On September 22, 2008, the Company changed its name from Plastron Acquisition Corp. to Lihua International, Inc. The Company conducts its business through two operating subsidiaries, Danyang Lihua Electron Co., Ltd. and Jiangsu Lihua Copper Industry Co., Ltd.

 

On September 4, 2009, the Company’s common stock began trading on the NASDAQ Capital Market under the symbol “LIWA.”

 

As of June 30, 2012, details of the subsidiaries of the Company are as follows:

 

Subsidiaries’ names  Domicile and date
of incorporation
  Paid-up capital   Effective
ownership
   Principal activities
               
Ally Profit Investments Limited
(“ Ally Profit ”)
  British Virgin Islands
March 12, 2008
  $100    100%  Holding company of other subsidiaries
                 
Lihua Holdings Limited
(“ Lihua Holdings ”)
  Hong Kong
April 17, 2008
  HK$100    100%  Holding company of other subsidiaries
                 
Danyang Lihua Electron Co., Ltd.
(“ Lihua Electron ”)
  People’s Republic of China (“PRC”)
December 30, 1999
  $10,500,000    100%  Manufacturing and sales of pure copper wire and bimetallic composite conductor wire such as copper clad aluminum (CCA) wire and enameled CCA wire
                 
Jiangsu Lihua Copper Industry Co., Ltd. (“ Lihua Copper ”)  PRC
August 31, 2007
  $46,000,000    100%  Manufacturing and sales of refined copper

 

7
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

 

NOTE 2SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Principle of consolidation

These condensed consolidated financial statements include the financial statements of Lihua International, Inc. and its subsidiaries.  All significant inter-company balances or transactions have been eliminated on consolidation.

 

Basis of preparation

These interim condensed consolidated financial statements are unaudited.  In the opinion of management, all adjustments and disclosures necessary for a fair presentation of these interim condensed consolidated financial statements, which are of a normal and recurring nature, have been included.  The results reported in the condensed consolidated financial statements for any interim periods are not necessarily indicative of the results that may be reported for the entire year. The (a) condensed consolidated balance sheet as of December 31, 2011, which was derived from audited financial statements, and (b) the unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission.  Certain information and note disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information not misleading.  These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying footnotes of the Company for the year ended December 31, 2011.

 

Use of estimates

The preparation of these financial statements in conformity with generally accepted accounting principles requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and the related disclosure of contingent assets and liabilities at the date of these financial statements and the reported amounts of revenues and expenses during the reporting period.  The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances.  Accordingly, actual results may differ from these estimates under different assumptions or conditions.

 

Cash and cash equivalents

Cash and cash equivalents consist of all cash balances and highly liquid investments with an original maturity of three months or less.  Because of the short maturity of these investments, the carrying amounts approximate their fair value.  Restricted cash is excluded from cash and cash equivalents.

 

Accounts receivable

Accounts receivable are stated at cost, net of an allowance for doubtful accounts.   The Company maintains allowances for doubtful accounts for estimated losses, if any, resulting from the failure of customers to make required payments. The Company reviews the accounts receivable on a periodic basis and makes allowances where there is doubt as to the collectibility of individual balances. In evaluating the collectibility of individual receivable balances, the Company considers many factors, including the age of the balance, the customer’s payment history, its current credit-worthiness and current economic trends.

 

8
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

 

NOTE 2SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – CONTINUED

 

Inventories

Inventories are stated at the lower of cost, determined on a weighted average basis, or market. Costs of inventories include purchase and related costs incurred in bringing the products to their present location and condition. Market value is determined by reference to selling prices after the balance sheet date or to management’s estimates based on prevailing market conditions. Management will write down the inventories to market value if it is below cost. Management also regularly evaluates the composition of its inventories to identify slow-moving and obsolete inventories to determine if a valuation allowance is required.

 

Property, plant and equipment

Property, plant and equipment are stated at cost less accumulated depreciation and accumulated impairment losses, if any. Gains or losses on disposals are reflected as gain or loss in the year of disposal. The cost of improvements that extend the life of buildings, machinery and equipment are capitalized. These capitalized costs may include structural improvements, equipment and fixtures. All ordinary repair and maintenance costs are expensed as incurred.

 

Depreciation for financial reporting purposes is provided using the straight-line method over the estimated useful lives of the assets as follows:

 

  Useful Life
  (In years)
Buildings 5-20
Machinery 5-10
Office equipment & motor vehicles 5

 

Construction in progress

Construction in progress includes direct costs of construction of buildings and equipment.  Interest incurred during the period of construction, if material, is also capitalized. Construction in progress is not depreciated until such time as the assets are completed and put into service.

 

Prepaid land use rights

Prepaid land use right represent lump sum payments for land use rights in the PRC.  The amount is expensed over the period the of land use rights of 50 years.

 

Impairment of long-lived assets

The Company reviews and evaluates its long-lived assets for impairment when events or changes in circumstances indicate that the related carrying amounts may not be recoverable. Impairment is considered to exist if the total estimated future cash flows on an undiscounted basis are less than the carrying amount of the assets, including goodwill, if any. An impairment loss is measured and recorded based on discounted estimated future cash flows. In estimating future cash flows, assets are grouped at the lowest level for which there is identifiable cash flows that are largely independent of future cash flows from other asset groups.

 

9
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

 

NOTE 2SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – CONTINUED

 

Derivative financial instruments

The Company evaluates all its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the consolidated statements of income.

 

The Company’s warrants have been classified as derivatives in accordance with the guidance provided in FASB ASC 815-40-15-7I, because they are denominated in U.S. dollars, which is different from the Company’s functional currency (Renminbi). The Company accounted for the exercise of these warrants as extinguishment of debts in accordance with ASC 815-10-40-1, “Derivatives and Hedges – Derecognition” and ASC 470-50-40, “Debt – Modification and Extinguishments – Derecognition”.

 

Revenue recognition

Revenue is recognized when the following four revenue criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectibility is reasonably assured.

 

Sales revenue is recognized net of value added tax, sales discounts and returns at the time when the merchandise is sold and delivered to the customer. Based on historical experience, management estimates that sales returns are immaterial and has not made an allowance for estimated sales returns.

 

Research and development costs

Research and development costs are expensed as incurred, and charged to general and administrative expenses. For the six months ended June 30, 2012 and 2011, research and development costs were $736,080 and $99,493, respectively. For the three months ended June 30, 2012 and 2011, research and development costs were $364,617 and $55,003, respectively.

 

Advertising costs

The Company expenses all advertising costs as incurred. The total amount of advertising costs charged to general and administrative expenses was $856 and $13,759 for the six months ended June 30, 2012 and 2011, and nil and $13,759 for the three months ended June 30, 2012 and 2011, respectively.

 

Shipping and handling costs

Substantially all costs of shipping and handling of products to customers are included in selling expenses.  Shipping and handling costs for the six months ended June 30, 2012 and 2011 were $1,152,485 and $990,014, and for the three months ended June 30, 2012 and 2011 were $585,158 and $559,257, respectively.

 

Foreign currency

The Company has its local currency, Renminbi (“RMB”), as its functional currency.  The Company’s subsidiaries maintain their books and records in their functional currency, RMB.  The consolidated financial statements of the Company are translated from RMB into United States dollars (“U.S. Dollars” or “US$” or “$”). Accordingly, assets and liabilities are translated from RMB into U.S. Dollars using the applicable exchange rates prevailing at the balance sheet dates.  Items on the statements of income and cash flows are translated at the average exchange rates during the reporting periods. Equity accounts are translated at historical rates.  Adjustments resulting from the translation of the Company’s financial statements are recorded as accumulated other comprehensive income. 

 

10
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

 

NOTE 2SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  – CONTINUED

 

Foreign currency (continued)

 

The exchange rates used to translate amounts in RMB into U.S. Dollars for the purposes of preparing the consolidated financial statements are based on the rates as published on the website of People’s Bank of China and are as follows:

 

   June 30, 2012   December 31, 2011 
Balance sheet items, except for equity accounts   US$1=RMB 6.3249    US$1=RMB 6.3009 
   Three months ended June 30, 
   2012   2011 
Items in the statements of income and cash flows   US$1=RMB 6.3074    US$1=RMB 6.5011 
   Six months ended June 30, 
   2012   2011 
Items in the statements of income and cash flows   US$1=RMB 6.3074    US$1=RMB 6.5411 

 

No representation is made that the RMB amounts could have been, or could be, converted into U.S. dollars at the above rates. The value of RMB against U.S. dollars and other currencies may fluctuate and is affected by, among other things, changes in China’s political and economic conditions. Any significant revaluation of RMB may materially affect the Company’s financial condition in terms of U.S. dollar reporting.

 

Recent accounting pronouncements

 

In May 2011, the FASB issued ASU No. 2011-04 – Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this update intend to converge requirements for how to measure fair value and for disclosing information about fair value measurements in US GAAP with International Financial Reporting Standards. For public entities, this ASU is effective for interim and annual periods beginning after December 15, 2011. The adoption of the provisions in ASU 2011-04 did not have a material impact on the Company’s consolidated financial statements.

 

In June 2011, the FASB issued ASU No. 2011-05 – Comprehensive Income (Topic 220): Presentation of Comprehensive Income. The amendments in this update require (i) that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements (the current option to present components of other comprehensive income (“OCI”) as part of the statement of changes in stockholders’ equity is eliminated) and (ii) presentation of reclassification adjustments from OCI to net income on the face of the financial statements. For public entities, the amendments in this ASU are effective for years, and interim periods within those years, beginning after December 15, 2011. The amendments in this update should be applied retrospectively. Early adoption is permitted. The adoption of the provisions in ASU 2011-05 did not have a material impact on the Company’s consolidated financial statements.

 

In September 2011, the FASB issued ASU No. 2011-08 —Intangibles —Goodwill and Other (Topic 350). The amendments in this update will allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under these amendments, an entity would not be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The amendments include a number of events and circumstances for an entity to consider in conducting the qualitative assessment. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. The adoption of the provisions in this update did not have a material impact on the Company’s consolidated financial statements.

 

11
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

 

NOTE 2SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  – CONTINUED

 

Recent accounting pronouncements (continued)

In December 2011, the FASB issued ASU No. 2011-11 —Balance Sheet (Topic 210). The objective of this update is to provide enhanced disclosures that will enable users of its financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position. This includes the effect or potential effect of rights of setoff associated with an entity’s recognized assets and recognized liabilities within the scope of this update. The amendments require enhanced disclosures by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either Section 210-20-45 or Section 815-10-45. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The Company does not expect the adoption of the provisions in this update will have a significant impact on its consolidated financial statements.

 

In December 2011, the FASB issued ASU No. 2011-12 — Comprehensive Income (Topic 220). The amendments in this update supersede certain pending paragraphs in ASU No. 2011-05, to effectively defer only those changes in ASU No. 2011-05 that relate to the presentation of reclassification adjustments out of accumulated other comprehensive income. The amendments will be temporary to allow the Board time to redeliberate the presentation requirements for reclassifications out of accumulated other comprehensive income for annual and interim financial statements for public, private, and non-profit entities. The amendments in this update are effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of the provisions in this update did not have a significant impact on the Company’s consolidated financial statements.

 

In July 2012, the FASB issued 2012-02 Intangibles — Goodwill and Other (Topic 350): The amendments in this update will allow an entity to first assess qualitative factors to determine whether it is necessary to perform a quantitative impairment test. Under these amendments, an entity would not be required to calculate the fair value of an indefinite-lived intangible asset unless the entity determines, based on a qualitative assessment first, that it is not more likely than not, the indefinite-lived intangible asset is impaired. The amendments include a number of events and circumstances for an entity to consider in conducting the qualitative assessment. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted, including for annual and interim impairment tests performed as of a date before July 27, 2012, if a public entity’s financial statements for the most recent annual or interim period have not yet been issued. The Company does not expect the adoption of the provisions in this update will have a significant impact on its consolidated financial statement.

 

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the Company’s consolidated financial statements upon adoption.

 

NOTE 3FAIR VALUE MEASUREMENTS AND FINANCIAL INSTRUMENTS

 

ASC Topic 820, Fair Value Measurement and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. This topic also establishes a fair value hierarchy, which requires classification based on observable and unobservable inputs when measuring fair value. The fair value hierarchy distinguishes between assumptions based on market data (observable inputs) and an entity’s own assumptions (unobservable inputs). The hierarchy consists of three levels:

 

¨Level one — Quoted market prices in active markets for identical assets or liabilities;
¨Level two — Inputs other than level one inputs that are either directly or indirectly observable; and
¨Level three — Unobservable inputs developed using estimates and assumptions, which are developed by the reporting entity and reflect those assumptions that a market participant would use.

 

Determining which category an asset or liability falls within the hierarchy requires significant judgment. The Company evaluates its hierarchy disclosures each quarter.

 

12
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

 

NOTE 3FAIR VALUE MEASUREMENTS AND FINANCIAL INSTRUMENTS - CONTINUED

 

Assets and liabilities measured at fair value on a recurring basis using significant observable inputs (Level 2) from January 1, 2012 to June 30, 2012 are summarized as follows:

 

   Warrant
liability (Level 2)
 
Balance at January 1, 2012  $615,000 
Change in fair value included in earnings   474,000 
Exercise of warrants   (385,000)
Balance at June 30, 2012  $704,000 

 

The Company did not identify any other non-recurring assets and liabilities that are required to be presented in the condensed consolidated balance sheets at fair value in accordance with the relevant accounting standards.

 

The carrying values of cash and cash equivalents, trade receivables and payables approximate their fair values due to the short maturities of these instruments.

 

The Company estimates the fair value of its warrants as of June 30, 2012 using the Black-Scholes option pricing model using the following assumptions:

 

   June 30, 2012   December 31, 2011 
Series A and B Warrants          
Market price of common stock:  $5.48   $4.76 
Exercise price:  $3.50   $3.50 
Remaining contractual life (years):   1.33    1.83 
Dividend yield:   -    - 
Expected volatility:   66.29%   39.58%
Risk-free interest rate:   0.24%   0.22%
Fair value – Series A and B Warrants  $644,000   $586,000 
           
Underwriter Warrants          
Market price of common stock:  $5.48   $4.76 
Exercise price:  $4.80   $4.80 
Remaining contractual life (years):   2.18    2.68 
Dividend yield:   -    - 
Expected volatility:   59.56%   36.39%
Risk-free interest rate:   0.32%   0.32%
Fair value – Underwriter Warrants  $60,000   $29,000 
           
Fair value – Total  $704,000   $615,000 

 

13
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

 

NOTE 3FAIR VALUE MEASUREMENTS AND FINANCIAL INSTRUMENTS – CONTINUED

 

During the six months ended June 30, 2012, 125,000 warrants were exercised on a cashless basis to purchase 48,402 shares of common stock. In accordance with ASC 470-50-40, “Debt – Modification and Extinguishments – Derecognition”, an aggregate gain of $73,291 was recognized.  For details, please refer to the following table.

 

Exercise date:  February 7 
Market price of common stock:  $6.44 
Exercise warrants:   125,000 
Exercise price:  $3.50 
Remaining contractual life (years):   1.73 
Dividend yield:   %
Expected volatility:   39.43%
Risk-free interest rate:   0.21%
Fair values:  $3.08 
Gain on extinguishment of warrant liabilities  $73,291 

 

NOTE 4ACCOUNTS RECEIVABLE, NET

 

Accounts receivable consisted of the following:

 

   June 30,   December 31, 
   2012   2011 
Accounts receivable  $31,039,834   $31,082,460 
Less: Allowance for doubtful debts   -    - 
           
Accounts receivable, net  $31,039,834   $31,082,460 

 

NOTE 5PREPAYMENTS FOR RAW MATERIAL PURCHASES

 

Starting from the second quarter of 2011, the Company initiated purchases of scrap copper from overseas via a third-party import-export company. Pursuant to the terms of the Company’s purchase agreements with that third-party, the Company was required to make prepayments in advance of delivery of the purchased scrap copper to the Company’s production facilities. As of June 30, 2012, such prepayments were $17,861,244.

 

14
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

 

NOTE 6OTHER RECEIVABLES, DEPOSITS AND PREPAYMENTS

 

Other receivables, deposits and prepayments consisted of the following:

 

   June 30,   December 31, 
   2012   2011 
Prepaid research and development costs  $817,020   $1,154,704 
Utility deposits   79,053    79,354 
Other prepayments   32,897    33,023 
Other receivables   59,752    24,675 
Recoverable input VAT   -    467,858 
Prepaid insurance   486,000    123,250 
Less: Allowance for valuation and doubtful debts   -    - 
           
   $1,474,722   $1,882,864 

 

In 2011, the Company signed various research and development contracts with Shanghai Electric Cable Research Institute. The service periods of the contracts varies from approximately 1.5 years to 3 years, with installment payment terms. Prepaid research and development costs as of June 30, 2012 represented aggregate installment payments made upon execution of the contracts, net of amortization in 2012 and 2011, pursuant to the terms of these contracts.

 

NOTE 7INVENTORIES

 

Inventories by major categories are summarized as follows:

 

   June 30,   December 31, 
   2012   2011 
Raw materials  $10,082,532   $9,371,850 
Work in progress   710,548    556,816 
CCA and copper wire   2,392,242    2,925,769 
Copper rod and anode   4,579,319    2,647,811 
           
   $17,764,641   $15,502,246 

 

NOTE 8INTANGIBLE ASSETS

 

   June 30,   December 31 
   2012   2011 
Computer software, cost  $11,643   $11,688 
Less: Accumulated amortization   (11,643)   (11,518)
           
   $-   $170 

 

Amortization expense for the six months ended June 30, 2012 and 2011 was $170 and $1,836, respectively. Amortization expense for the three months ended June 30, 2012 and 2011 was nil and $985, respectively.

 

15
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

 

NOTE 9PREPAID LAND USE RIGHTS

 

The Company has recorded as prepaid land use rights the lump sum payments made to acquire long-term interests to utilize the land underlying the building and production facility.  This type of arrangement is common for the use of land in the PRC.  The prepaid land use rights are expensed on the straight-line basis over the term of the land use rights of 50 years. 

 

The amounts expensed on prepaid land use right were $202,267 and $195,041 for the six months ended June 30, 2012 and 2011, and $101,132 and $98,144 for the three months ended June 30, 2012 and 2011, respectively.  The estimated expense of the prepaid land use rights over each of the next five years and thereafter will be $403,416 per annum.

 

As of June 30, 2012, prepaid land use rights included RMB32,399,100 ($5,122,468) representing payments made by Lihua Copper to a local authority to acquire a 50-year right to use a parcel of land which will be used for expansion of its manufacturing facilities. As of June 30, 2012, RMB2,399,100 ($379,310) remained unpaid and is included as other payables and accruals. Apart from the payment of $5,122,468 to the local authority, the Company also paid $5,736,192 primarily as compensation to the local communities in connection with the Company’s acquisition of these land use rights.

 

The Company has completed all the formalities in relation to the acquisition of the land use rights, except for paying the last payment of RMB2,399,910 ($379,310). Based on the Company’s understanding of the process, each year the local government allocates certain area (mu) of land to selected local manufacturers. However, the physical land use right certificates are not issued to those manufacturers until the local government receives the formal annual land quota from the state government. The Company received a land use rights certificate in November 2011 for 100 mu out of a total of 180 mu of land allocated to the Company, and management expects to receive the land use rights certificate for the remaining 80 mu by the second half of 2012. Upon receipt of the land use right certificates for the remaining 80 mu of land, the Company will pay the remaining land use right payments.

 

Based upon the local government practice, as well as the Company’s prior experience obtaining land use rights after going through the same process, management believes that the risk of losing the already allocated land use right is extremely low. In the unlikely event that the local government is unable to issue the physical land use right certificate for the remaining 80 mu of land, we believe we would have the right to receive a refund of the payment we made to the local government with respect to the land use right and, request to receive additional monies from the local government for construction costs incurred to date on the land.

 

NOTE 10PROPERTY, PLANT AND EQUIPMENT, NET

 

Property, plant and equipment, net consisted of the following:

 

   June 30,   December 31, 
   2012   2011 
Cost:          
Buildings  $32,946,186   $11,399,913 
Office equipment   382,341    383,797 
Motor vehicles   685,671    688,283 
Machinery   21,898,225    15,597,187 
           
Total cost   55,912,423    28,069,180 
Less: Accumulated depreciation   (8,607,793)   (7,503,305)
           
Net book value  $47,304,630   $20,565,875 

 

Depreciation expense was $1,136,103 and $1,092,772 for the six months ended June 30, 2012 and 2011, and $580,087 and $567,765 for the three months ended June 30, 2012 and 2011, respectively.

16
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

 

NOTE 11CONSTRUCTION IN PROGRESS

 

Construction in progress was related to the construction of the new production plant and consisted of the following:

 

   June 30,   December 31, 
   2012   2011 
Construction of equipment  $-   $2,100,659 
Construction of buildings    -    16,694,251 
           
   $-   $18,794,910 

 

NOTE 12OTHER PAYABLES AND ACCRUALS

 

Other payables and accruals consisted of the following:

 

   June 30,   December 31, 
   2012   2011 
Accrued staff costs  $557,191   $667,969 
Other taxes payable   1,264,311    1,450,360 
Construction cost payable   2,704,341    3,598,053 
Other payables (note 9)   440,258    654,451 
           
   $4,966,101   $6,370,833 

 

17
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

 

NOTE 13COMMON STOCK AND COMMON STOCK PURCHASE WARRANTS

 

During the six months ended June 30, 2012, 125,000 warrants were exercised on a cashless basis to purchase 48,402 shares of common stock, which would have been exercisable in cash for $3.50 per share.

 

Warrants issued and outstanding at June 30, 2012, and changes during the six months then ended, are as follows:

 

   Warrants Outstanding   Warrants Exercisable 
   Number of
underlying
shares
   Weighted
Average
Exercise
Price
   Average
Remaining
Contractual
Life (years)
   Number of
underlying
shares
   Weighted
Average
Exercise
Price
   Average
Remaining
Contractual
Life (years)
 
Balance, January 1, 2012   408,956   $3.59    1.89    408,956   $3.59    1.89 
Granted/Vested   -              -           
Forfeited   -              -           
Exercised   (125,000)   3.50    1.73    (125,000)   3.50    1.73 
Balance, June 30, 2012   283,956    3.63    1.42    283,956    3.63    1.42 

 

On January 24, 2011, the Board of Directors approved a one-year share repurchase program of up to $15 million of the Company’s common stock, pursuant to which the Company was authorized to repurchase its outstanding common stock from time to time, depending on market conditions, share price and other factors, on the open market or in privately negotiated transactions. Repurchased shares may be retired immediately and will resume the status of authorized but unissued shares or they may be held by the Company as treasury stock. In 2011, the Company repurchased 264,047 shares of its common stock under the share repurchase authorization at a weighted-average price of $8.05 per share for an aggregate purchase cost of $2,126,597. The share repurchase program expired on January 23, 2012.

 

NOTE 14SHARE-BASED COMPENSATION

 

Options granted to Independent Directors and Employees

 

On April 26, 2012, the Company granted options to each of its independent directors, Mr. Robert Bruce, Mr. Jonathan Serbin and Mr. Kelvin Lau to purchase 20,000 shares of the Company’s common stock at a strike price of $5.63 per share, in consideration of their services to the Company. The options vest and become exercisable in equal installments on July 14, 2012, October 14, 2012, January 14, 2013 and April 14, 2013 and will expire 10 years from the date of grant.

 

In accordance with the guidance provided in ASC Topic 718, Stock Compensation, the compensation costs associated with these options are recognized, based on the grant-date fair values of these options, over the requisite service period, or vesting period. Accordingly, the Company recognized compensation expense of $ 214,475 and $101,600 for the six and three months ended June 30, 2012, respectively. The Company recognized compensation expense of $139,949 and $57,123 for the six and three months ended June 30, 2011, respectively.

 

18
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

 

NOTE 14SHARE-BASED COMPENSATION – CONTINUED

 

Options issued and outstanding at June 30, 2012 and their movements during the six months then ended are as follows:

 

   Number of
underlying
shares
   Weighted-
Average
Exercise
Price
Per Share
   Aggregate
Intrinsic
Value (1)
   Weighted-
Average
Contractual
Life
Remaining in
Years
 
                 
Outstanding at December 31, 2011   715,000   $5.16   $213,300    9.43 
Granted   60,000    5.63         10.00 
Exercised   -                
Expired   -                
Forfeited   -                
Outstanding at June 30, 2012   775,000   $5.19   $612,900    9.00 
                     
Exercisable at June 30, 2012   190,000   $6.97   $98,400    7.86 

 

(1)The intrinsic value of the stock options at June 30, 2012 and December 31, 2011 is the amount by which the market value of the Company’s common stock of $5.48 and $4.76, as of June 30, 2012 and December 31, 2011, respectively, exceeds the exercise price of the option.

 

NOTE 15STATUTORY RESERVES

 

The Company is required to make appropriations to reserve funds, comprising the statutory surplus reserve, statutory public welfare fund and discretionary surplus reserve, based on after-tax net income determined in accordance with generally accepted accounting principles of the PRC (the “PRC GAAP”). Appropriation to the statutory surplus reserve should be at least 10% of the after tax net income determined in accordance with the PRC GAAP until the reserve is equal to 50% of the entities’ registered capital or members’ equity. Appropriations to the statutory public welfare fund are at a minimum of 5% of the after tax net income determined in accordance with PRC GAAP. Commencing on January 1, 2006, the new PRC regulations waived the requirement for appropriating retained earnings to a welfare fund. In accordance with the Chinese Company Law, the Company allocated 10% of income after taxes to the statutory surplus reserve for the six months ended June 30, 2012. For the six months ended June 30, 2012, statutory reserve activity is as follows:

 

Balance – December 31, 2011  $10,418,476 
Addition to statutory reserves   1,717,613 
Balance –June 30, 2012  $12,136,089 

 

19
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

 

NOTE 16OTHER INCOME

 

   For the Three Months
Ended June 30,
   For the Six Months
Ended June 30,
 
   2012   2011   2012   2011 
                 
Government subsidies  $-   $23,879   $95,128   $99,830 
Other   -    -    (349)   - 
                     
   $-   $23,879   $94,779   $99,830 

 

NOTE 17INCOME TAXES

 

The Company is subject to income tax on an entity basis on income arising from the tax jurisdiction in which it and its subsidiaries operate.

 

The Company’s two operating subsidiaries, Lihua Electron and Lihua Copper, are generally subject to PRC enterprise income tax (“EIT”). Both Lihua Electron and Lihua Copper are subject to an EIT rate of 25% for 2012 and 2011 under China’s Unified Enterprise Income Tax Law (“New Tax Law”).

 

The New Tax Law also imposes a 10% withholding income tax for dividends distributed by a foreign invested enterprise to its immediate holding company outside China for distribution of earnings generated after January 1, 2008. Under the New Tax Law, the distribution of earnings generated prior to January 1, 2008 is exempt from the withholding tax. As management does not anticipate that the subsidiaries in the PRC will distribute their earnings to the Company for the year ending December 31, 2012, and no dividends were distributed in the years ended December 31, 2011 and 2010, no deferred tax liability has been recognized for the undistributed earnings of these PRC subsidiaries through June 30, 2012. Total undistributed earnings of these PRC subsidiaries at June 30, 2012 was RMB1,096,594,358 ($173,377,343).

 

No provision for other overseas taxes is made as neither Lihua, Ally Profit or Lihua Holdings has any taxable income in the U.S., British Virgin Islands or Hong Kong, respectively.

 

The Company’s provision for income taxes consisted of:

 

   For the Three Months   For the Six Months 
   Ended June 30,   Ended June 30, 
   2012   2011   2012   2011 
PRC income tax:                    
Current  $4,676,545   $4,581,443   $9,133,507   $8,533,952 
Deferred   173,064    10,004    (6,552)   (19,351)
                     
   $4,849,609   $4,591,447   $9,126,955   $8,514,601 

 

20
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

 

NOTE 17INCOME TAXES – CONTINUED

 

A reconciliation of the provision for income taxes determined at the local income tax rate to the Company’s effective income tax rate is as follows:

 

   For the Three Months   For the Six Months 
   Ended June 30,   Ended June 30, 
   2012   2011   2012   2011 
                 
Pre-tax income  $18,296,275   $18,957,523   $34,048,633   $35,392,663 
                     
United States federal corporate income tax rate   34%   34%   34%   34%
Income tax computed at United States statutory
corporate income tax rate
   6,220,733    6,445,557    11,576,535    12,033,505 
Reconciling items:                    
Loss not recognized as deferred tax assets   257,658    196,876    600,187    425,909 
Non-deductible expenses (income)   81,674    (57,581)   74,444    - 
Change in fair value of warrants   14,960    (409,933)   136,241    (898,113)
Rate differential for PRC earnings   (1,724,138)   (1,645,697)   (3,267,003)   (3,055,799)
Other   (1,278)   62,225    6,551    9,099 
Effective tax expense  $4,849,609   $4,591,447   $9,126,955   $8,514,601 

 

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of deferred income tax assets are as follows:

 

   June 30,   December 31, 
   2012   2011 
Deferred income tax assets:          
Net operating loss carry forward  $4,231,319   $3,631,132 
Unrealized intercompany profit in inventory   19,626    13,142 
Accrued R&D expenses   -    187,446 
Less: Valuation allowance   (4,231,319)   (3,631,132)
           
   $19,626   $200,588 

 

As of June 30, 2012 and December 31, 2011, the Company’s U.S. entity, Lihua International, Inc., had net operating loss carry forwards of $12,445,057 and $10,679,801, respectively, available to reduce future taxable income which will expire in various years through 2030. Management believes it is more likely than not that the Company will not realize these potential tax benefits as the Company currently has no U.S. operations and is not likely to generate any operating profits in the U.S. in foreseeable future. As a result, the full amount of the valuation allowance was provided against the potential tax benefits.

 

As of June 30, 2012 and December 31, 2011, the Company has no material unrecognized tax benefits which would favorably affect the effective income tax rate in future periods and does not believe that there will be any significant increases or decreases of unrecognized tax benefits within the next twelve months. No interest or penalties relating to income tax matters have been imposed on the Company during the six months ended June 30, 2012 and 2011, and no provision for interest and penalties is deemed necessary as of June 30, 2012 and December 31, 2011.

 

21
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

 

NOTE 17INCOME TAXES – CONTINUED

 

According to the PRC Tax Administration and Collection Law, the statute of limitations is three years if the underpayment of taxes is due to computational errors made by the taxpayer or its withholding agent. The statute of limitations extends to five years under special circumstances, which are not clearly defined. In the case of a related party transaction, the statute of limitations is ten years. There is no statute of limitations in the case of tax evasion.

 

NOTE 18EARNINGS PER SHARE

 

The following table is a reconciliation of the net income and the weighted average shares used in the computation of basic and diluted earnings per share for the periods presented:

 

   For the Three Months   For the Six Months 
   Ended June 30,   Ended June 30, 
   2012   2011   2012   2011 
Income available to common shareholders:                    
- Basic and diluted  $13,446,666   $14,366,076   $24,921,678   $26,878,062 
                     
Weighted average number of shares:                    
- Basic   29,820,836    29,872,934    29,810,996    29,865,896 
- Effect of dilutive warrants and options   197,149    238,208    238,340    334,191 
- Diluted   30,017,985    30,111,142    30,049,336    30,200,087 
                     
Net income per share                    
- Basic  $0.45   $0.48   $0.84   $0.90 
- Diluted  $0.45   $0.48   $0.83   $0.89 

 

NOTE 19RELATED PARTY TRANSACTIONS

 

1.Sales

For the six months ended June 30, 2012 and 2011, sales included nil and $620,295, respectively that were made to Tianyi Telecom.  The controlling stockholders of Tianyi Telecom are related to Ms. Yaying Wang, who is the Company’s COO and one of the Company’s directors.

 

2.Loans

On May 19, 2011, Magnify Wealth Enterprise Limited (“Magnify Wealth”), a British Virgin Islands corporation and an entity affiliated with Mr. Jianhua Zhu, the Chief Executive Officer and Chairman of the Company, agreed to loan the Company up to $4 million pursuant to the terms of a demand promissory note (the “Note ”) to partially fund the Company’s previously announced $15 million stock repurchase program to make open market purchases of the Company’s common stock (the “Repurchase Program”) (See Note 13 above). While the Company’s operating subsidiaries in the PRC have substantial cash reserves available, the laws of the PRC restrict the conversion of RMB to US dollars, such that the Company has encountered difficulty funding the Repurchase Program with US dollars from cash held by its PRC subsidiaries. The Company explored possible alternative arrangements for funding the Repurchase Program in US dollars with financial institutions, but Company management determined that such alternatives would have been costly or otherwise not appropriate for the Company.

 

22
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

 

NOTE 19RELATED PARTY TRANSACTIONS - CONTINUED

 

On January 9 and March 15, 2012, in order to partially fund the 2011 special dividend payment and U.S. dollar operating expenses, upon Board approval, Magnify Wealth loaned $1 million and $0.6 million, respectively, under the Note, of which RMB6.3 million and RMB3.8 million were repaid on January 9 and March 31, 2012, respectively, in RMB, at the average rate of 6.3126 RMB per US dollars, based upon the exchange rate between US dollars and RMB as set forth by Standard Chartered Bank in Hong Kong. The loans under the Note were unsecured, payable on demand and bore interest at 2% per annum.

 

On April 6 and April 26, 2012, in order to partially fund the 2011 special dividend payment and U.S. dollar operating expenses, upon Board approval, Magnify Wealth loaned $0.5 million and $0.9 million, respectively, under the Note, of which RMB3.15 million and RMB5.65 million were repaid, respectively, in RMB, at the average rate of 6.2916 RMB per US dollars, based upon the exchange rate between US dollars and RMB as set forth by Standard Chartered Bank in Hong Kong. The loans under the Note were unsecured, payable on demand and bore interest at 2% per annum.

 

As of June 30, 2012, there was no outstanding loan under the Note.

 

NOTE 20CERTAIN RISKS AND CONCENTRATION

 

Credit risk and major customers

 

As of June 30, 2012 and December 31, 2011, substantially all of the Company’s cash including cash on hand and deposits in accounts were maintained within the PRC where there is currently no rule or regulation in place for obligatory insurance to cover bank deposits in the event of a bank’s failure. However, the Company has not experienced any such losses and believes it is not exposed to any significant risks on its cash in bank accounts.

 

For the six months ended June 30, 2012 and 2011, all of the Company’s sales arose in the PRC.  In addition, all accounts receivable as of June 30, 2012 and December 31, 2011 were due from customers located in the PRC.

 

Two customers accounted for 25.9% and 11.1% of the Company’s revenue for the six months ended June 30, 2012, respectively, and two customers accounted for 14.9% and 13.0% of the Company’s revenue for the six months ended June 30, 2011, respectively. There was no other single customer who accounted for more than 10% of the Company’s revenue for the six months ended June 30, 2012 or 2011.

 

Two customers accounted for 25.1% and 11.7% of the Company’s revenue for the three months ended June 30, 2012, respectively, and one customer accounted for 14.8% and 13.0% of the Company’s revenue for the three months ended June 30, 2011. There was no other single customer who accounted for more than 10% of the Company’s revenue for the three months ended June 30, 2012 or 2011.

 

Two customers accounted for 30.6% and 10.3% of total accounts receivable of the Company as of June 30, 2012, respectively, and one customer accounted for 33.6% of total accounts receivable of the Company as of December 31, 2011. There was no other single customer who accounted for 10% or more of the Company’s accounts receivable as of June 30, 2012 and December 31, 2011.

 

Risk arising from operations in foreign countries

 

Substantially all of the Company’s operations are conducted in China. The Company’s operations are subject to various political, economic, and other risks and uncertainties inherent in China. Among other risks, the Company’s operations are subject to the risks of restrictions on transfer of funds; export duties, quotas, and embargoes; domestic and international customs and tariffs; changing taxation policies; foreign exchange restrictions; and political conditions and governmental regulations.

 

23
 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

 

NOTE 21COMMITMENTS AND CONTINGENCIES

 

Lease commitments

 

The Company has entered into tenancy agreements for the lease of factory premises and warehousing facilities with independent parties. The Company’s commitments for minimum lease payments under these operating leases for the next five years and thereafter as of June 30, 2012 are as follows:

 

Payable within:     
- remainder of fiscal year ending December 31, 2012  $29,408 
- fiscal year ending December 31, 2013   61,345 
- fiscal year ending December 31, 2014   20,870 
      
Total  $111,623 

 

Capital commitments  – contracted but not provided for

 

   June 30,   December 31, 
   2012   2011 
         
Acquisition or construction of buildings - within one year  $-   $2,982,114 
Purchase of machinery - within one year   1,739,158    1,872,748 
Purchase of machinery - over one year   -    - 
           
   $1,739,158   $4,854,862 

 

Other commitments

During 2011, the Company signed various research and development contracts with Shanghai Electric Cable Research Institute with a total contract amount of $3 million. As of June 30, 2012, the Company has paid $2.18 million. The Company expects to pay the remaining $0.82 million within one year.

 

24
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

 

NOTE 22SEGMENT DATA AND RELATED INFORMATION

  

The Company operates in one business segment, the manufacturing and sale of refined copper rod and copper anode, as well as copper clad aluminum (CCA) wire and copper wire produced from refined copper rod. The Company also operates in only one geographical segment – China, as all of the Company’s products are sold to customers located in China and the Company’s manufacturing operations are located in China.

 

The Company’s major product categories are (1) wire manufacturing, consisting of (a) CCA fine and superfine wire, which is an electrical conductor consisting of an outer sleeve of copper that is metallurgically bonded to a solid aluminum core, and (b) copper fine and superfine wire, manufactured from recycled copper rod; (2) refined copper rod; and (3) refined copper anode, the latter two of which are fire refined from scrap copper.

 

Management evaluates performance based on several factors, of which net revenue and gross profit by product are the primary financial measures:

 

   For the Three Months   For the Six Months 
   Ended June 30,   Ended June 30, 
   2012   2011   2012   2011 
Net revenue from unaffiliated customers:                    
Copper and CCA wire  $100,397,360   $93,513,329   $190,044,806   $164,424,965 
Copper anode   70,202,817    73,499,198    133,171,370    139,518,658 
Refined copper rod   20,407,709    -    36,877,977    - 
   $191,007,886   $167,012,527   $360,094,153   $303,943,623 
                     
Gross profit:                    
Copper and CCA wire  $12,502,426   $13,833,862   $23,345,750   $24,810,315 
Copper anode   7,116,806    5,813,601    14,141,760    11,745,221 
Refined copper rod   1,091,802    -    1,858,516    - 
   $20,711,034   $19,647,463   $39,346,026   $36,555,536 

 

Item. 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS

 

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 our Annual Report on Form 10-K for the year ended December 31, 2011 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.

 

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In this report, the “Company,” “we,” “us” and “our” refer to Lihua International, Inc. and its subsidiaries.

 

OVERVIEW

 

We are principally engaged in the production of copper replacement products which include refined copper products, copper wire produced from refined scrap copper and CCA wire.

 

We manufacture and sell four major types of refined copper products and copper alternative products: copper anode, pure copper rod, pure copper wire and CCA wire. Copper anode, pure copper rod and pure copper wire products are produced from refined scrap copper utilizing our proprietary scrap copper recycling and cleaning technology and process. Currently part of the copper rod volume we produced is supplied internally as a raw material for copper wire production.

 

In the first quarter of 2009, with the completion of a 25,000 ton per annum capacity smelter, we introduced a new production process and product line which enables us to produce pure copper products from scrap copper. The new production process involves the fire refining of bulk recycled copper into high purity, low oxygen content copper rods (also known as fire-refined high-conductivity rods). We then either sell these large diameter (8mm) copper rods into a range of markets, or further process these rods into much smaller diameter (e.g., 0.03 mm) copper wire. We believe this recycled copper wire is generally a more cost effective product for our customers, compared with pure copper wire manufactured from newly mined copper. We added a second 25,000 ton per annum capacity copper smelter in July 2010, which doubled our recycled copper refining and manufacturing capacity to 50,000 tons per year. We use this second smelter to produce another new product, copper anode, which is the fundamental building block for almost all pure copper products and has a wide range of potential end market uses. In October 2011, we completed capacity efficiency improvements to our two smelters and increased annual production capacity of copper anode and copper rod to 35,000 tons and 50,000 tons, respectively. In June 2012, we started production of copper anode from two new smelters, which were constructed on our 30-acre new plant site. The two new anode smelters each have production capacities of 25,000 tons per annum. As of June 30, 2012, our scrap copper refinery capacity was approximately 135,000 tons per annum.

 

Currently we have three different CCA products: CCA fine wire, CCA magnet wire and CCA tin plated wire. CCA fine wire is the raw material for CCA magnet wire and CCA tin plated wire. In the case of CCA magnet wire, we coat the CCA fine wire with a special magnetic coating, while in the case of CCA tin plated wire, we plate the CCA fine wire with a very thin layer of tin. The value added nature of our CCA superfine wire products lies in our ability to draw down from much larger diameter CCA raw wire, and further process it to produce super fine CCA magnet wire and CCA tin plated wire, based upon our proprietary technology. As a result, CCA magnet wire and CCA tin plated wire command higher market prices and higher gross margins than plain CCA fine wire.

 

We draw pure copper wire from the refined pure copper rod we produce. The pure copper wire we produce has three main sub categories of products: fine wire, magnet wire and tin plated wire. These three copper wire products have similar characteristics as the three CCA wire products mentioned above.

 

We have expanded our business from the CCA superfine wire segment into the scrap copper refinery business because we believe that the scrap copper refinery business allows us to sell into the much bigger pure copper products market and offers us the ability to grow more rapidly while utilizing the proprietary equipment and technology that we possess relating to both the scrap copper cleaning as well as superfine wire drawing. We believe that the ability to sell into the large and growing copper and copper replacement products market in China offers us substantial opportunity to increase our sales in the future. We anticipate that we will continue to expand production capacity in both refined copper products and new CCA products. Since 2009, the majority of our investment, and resulting sales volume growth, occurred in the refined copper products business, which caters to a much bigger pure copper products market, compared with the CCA wire market.

 

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We sell our products primarily in China, either through distributors or directly to users, including distributors in the wire and cable industries and copper conglomerates, as well as manufacturers in the consumer electronics, white goods, automotive, utility, telecommunications and specialty cable industries.

 

Our market for copper anode is very large and diverse, as copper anode is the raw material for copper cathode, which in turn is the foundation for most pure copper products. With respect to our other three main product categories (copper rod, copper wire and CCA wire), our markets overlap to a degree, and are characterized by their breadth and depth, with a large number of current and potential customers for each product category. Copper rod is a raw material used in wire and cable production. Our refined copper products (copper anode, copper rod and copper wire), which are manufactured from recycled scrap copper, compete directly with copper products made from “virgin” (e.g. newly mined) copper. To date, our raw material costs for bulk scrap copper have been lower than prices for “virgin” copper, which provides us with a pricing advantage in the market for the refined copper products we produce from scrap copper. Since inception of copper anode sales, we sold copper anode to a few copper conglomerates, which use our product to produce copper cathode. We utilize copper rod produced as raw material for the copper wire production and sell the excess copper rod to outside customers, most of which are producers of smaller diameter copper wire used in power cables ranging in size from high voltage power transmission cables to white good applications such as internal wiring in household appliances and consumer electronics. Our copper wire, which is sold in a variety of diameters and may have undergone further in-line processing such as coating with plastic, is sold to many of the same types of end-use customers who purchase copper wire from our copper rod customers. These include manufacturers of a wide range of power cables and products that incorporate wiring, such as household appliances, automobiles, consumer electronics and telecommunications equipment. Our CCA wire is sold to many of these manufacturers as well. CCA wire sells at a lower cost per unit of weight than pure copper wire, due to the relatively lower density of the aluminum core which makes up most of the volume of CCA wire. Our CCA wire offers conductivity performance characteristics that are only marginally below those of pure copper wire, which means they are attractive in a wide variety of product applications where a slight reduction in conductivity standards is tolerable (such as most of the household appliance, automotive, consumer electronics and telecommunications applications). Examples of relatively high tolerance product applications where our CCA wire would not provide an acceptable replacement option for pure copper wire would be military/space equipment and wiring in nuclear power plants. One low tolerance product category that requires pure copper wire rather than our less costly CCA wire is electric motors, which require pure copper wire windings. The markets for each of our product lines are growing rapidly, due both to growing demand in China for copper products including all types of basic wire raw materials and the relative cost advantages our product lines carry over “virgin” pure copper competitor products. We believe that our pricing advantage on our refined copper products can be maintained regardless of fluctuations in the commodity price of copper.

 

We believe that we are well positioned to continue to capture further market share in the copper and copper replacement product industry. Our refined copper products produced from recycled copper and CCA wire are increasingly being accepted as cheaper alternatives to pure copper products. As a result, our sales and net income have increased substantially during the last three years. We generated sales of $161.5 million, $370.5 million and $637.1 million for the years ended December 31, 2009, 2010 and 2011, respectively. We achieved net income of $13.7 million, $38.5 million and $53.1 million for the years ended December 31, 2009, 2010 and 2011, respectively. In 2009, we had a non-cash charge of $11.9 million, which resulted from the change in the fair value of the warrants issued to investors in conjunction with the Company’s issuance of convertible preferred stock in October 2008. Excluding the impact of this non-cash charge, net income for 2009 was $25.6 million, up 118.7%. In 2010, we had a $0.2 million non-cash gain on extinguishment of warrant liabilities and a non-cash charge of $1.4 million, which resulted from the change in the fair value of the warrants. Excluding the impact of these non-cash charges, net income for 2010 was $39.7 million, up 55.1% from 2009. In 2011, we had a $0.1 million non-cash gain on extinguishment of warrant liabilities and a non-cash gain of $3.1 million, which resulted from the change in fair value of the warrants. Excluding the impact of these non-cash warrant related items, net income for 2011 was $50.0 million, up 25.8% from 2010. For the three months ended June 30, 2012 and 2011, we recognized nil and $0.03 million, respectively, non-cash gain on extinguishment of warrant liabilities. For the three months ended June 30, 2012 and 2011, we recognized a non-cash loss of $0.04 million and a gain of $1.2 million, respectively, from the change of fair value of warrants. Excluding the impact of these non-cash items, net income for the three months ended June 30, 2012 was $13.5 million, up 2.7% from the same period last year. For the six months ended June 30, 2012 and 2011, we recognized $0.07 million and $0.09 million, respectively, non-cash gain on extinguishment of warrant liabilities. For the six months ended June 30, 2012 and 2011, we recognized a non-cash loss of $0.5 million and a gain of $2.6 million, respectively, from the change in fair value of the warrants. Excluding the impact of these non-cash items, net income for the six months ended June 30, 2012 was $25.3 million, up 4.6% from the same period last year.

 

27
 

 

Our capacity to sell our copper anode, copper rod, recycled copper wire products (drawn from copper rod) and CCA wire products (drawn from larger diameter CCA wire) is limited by the quantity and capacity of the equipment we have installed to produce these products. Our copper anode and copper rod are made from bulk scrap copper, which is cleaned, purified and smelted in large capacity smelter units. At the present time we have four smelting facilities, one of which is allocated to copper rod and the other three to copper anode production. Two of the copper anode smelters were newly constructed in 2012 and commenced production in June 2012. The copper anode smelters have a total annual production capacity of 85,000 tons and the copper rod smelter has a production capacity of 50,000 tons per annum. During the three months ended June 30, 2012 we sold 8,979 tons of copper anode, 11,863 tons of CCA and copper wire products, and 2,545 tons of copper rod. As of June 30, 2012, we operated approximately 80 high speed wire drawing machines, which draw larger diameter copper rod or CCA rod into much finer diameter wires, with a total capacity of approximately 7,500 tons per annum of superfine CCA wire and approximately 20,000-25,000 tons per annum of superfine copper wire, with a diameter range of 0.03mm to 1.60mm. The above referenced copper wire production capacity does not include the production of the thickest class of copper wire, with a diameter range of 1.65mm to 1.75mm. These drawing machines are manufactured to our design and specifications by custom equipment manufacturers located in China. We expanded our copper wire production capacity in the first half of 2010, at which time we added six new wire copper drawing production lines, expanding copper wire production capacity from 18,000 tons per annum to 20,000 – 25,000 ton per annum depending on the thickness of the copper wire we produced. As noted above, in October 2011, we completed capacity efficiency improvements to our copper anode and copper rod smelters and had increased annual production capacity of copper anode and copper rod to 35,000 tons and 50,000 tons, respectively. We started construction on a new plant, adjacent to the current plant, in November 2010, where we initially planned to add two new copper anode smelters with an annual capacity of 25,000 tons each. The construction of the two new anode smelters was completed and production began in June 2012. We have constructed more facilities on site to house production equipment for our new CCA cable and wire product, as well as warehousing of materials. We expect to complete the construction of the entire new plant site in 2013.

 

Significant Factors Affecting Our Results of Operations

 

The most significant factors that affect our financial condition and results of operations are:

          

·product mix and impact of gross margins
·supply and costs of principal raw materials;
·copper prices and supply and demand of copper;
·production capacity; and
·economic conditions in China.

 

Product mix and effect on gross margins

 

Our gross margin is affected by our product mix. We produce and sell products according to customer orders. In our wire products (pure copper wire and CCA wire), magnet wire and tin plated wire are the final products from which we will derive the highest production markup, or gross profit. We also generate a significant portion of revenue from selling semi-finished products such as fine wire at a lower production cost markup, or gross profit.

 

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Generally, copper anode and copper rod products contribute a lower gross profit margin compared to the wire products, which in comparison are further processed downstream products. However, given the quick turnover and large volume production of the refined copper products, as well as primarily cash on delivery payment terms with our customers, the return on invested capital for the refined copper products and working capital turnover are better than that of the wire products.

 

Supply and costs of principal raw materials

 

Our ability to manage our operating costs depends significantly on our ability to secure affordable and reliable supplies of raw materials. We have been able to secure a sufficient supply of raw materials, which consist primarily of scrap copper and CCA raw material wire.

 

The price of our primary raw materials varies with reference to copper prices, and changes in copper price affect our cost of sales. However, we are able to price our copper and CCA products based on our material procurement costs plus a fixed dollar mark-up, which is essentially our gross profit. Therefore, despite the impact of copper price movement on our gross and net profit margin figures, during the past three years the mark-up, or our gross and net profit in absolute dollars, has not been materially affected by the change of copper prices.

 

Copper prices and supply and demand of copper

 

Generally the price of our products is set at a certain discount to local retail copper prices, and we believe our products replace or supplement copper. For these reasons, our products are affected by the market price, demand and supply of copper.

 

We price our refined copper and CCA wire products based on the market price for materials plus a fixed dollar mark-up, which is essentially our gross profit. As copper prices rise, our fixed dollar mark-up per ton processed represents a relatively lower percentage of our gross sales (which is generally based on tons processed) and therefore our gross profit margin as a percentage of sales is relatively lower; as copper prices decline, the inverse is true and we report relatively higher gross profit margins on a percentage basis. Despite the implications of copper price volatility on our gross and net profit margins in percentage terms, during the past three years, because of our fixed dollar markup, our gross and net profit in absolute dollar terms, has not been materially affected by the exchange of copper prices. Shanghai Changjiang Commodity Market, one of the major metals trading markets in the PRC, publishes the copper trading prices twice daily. These prices typically set the range for the prices of our materials as well as finished products, and are generally followed by all industry participants.

 

Production capacity

 

In order to capture the market opportunity for our products, we have expanded, and plan to continue to expand, our production capacity. Increased capacity has had, and could continue to have, a significant effect on our results of operations, by allowing us to produce and sell more products to generate higher revenues and net income.

 

Economic conditions in the PRC

 

We operate our manufacturing facilities in the PRC and derive the majority of our revenues from sales to customers in the PRC. As such, economic conditions in the PRC will affect virtually all aspects of our operations, including the demand for our products, the availability and prices of our raw materials and our other expenses. The PRC has experienced significant economic growth, achieving a CAGR of 14.8% in gross domestic product from 1999 through 2011, according to National Bureau of Statistics of China. Domestic demand for and consumption of copper and CCA products have increased substantially as a result of this growth. We believe that economic conditions in the PRC will continue to affect our business and results of operations. Over the last few quarters there has been a slow down in the PRC’s economic growth. At this time, we don’t foresee that our copper anode business will be negatively impacted by the slow down in domestic economic growth, however, we have experienced and anticipate some continued pressure in the profitability of our wire and rod products as a result of the slow down.

 

PRINCIPAL INCOME STATEMENT COMPONENTS

 

Sales

 

Our sales are derived from sales of our products net of value-added taxes.

 

29
 

 

The most significant factors that affect our sales are shipment volume and average selling prices.

 

Our collection practices generally consist of cash payment on delivery. However, we also extend credit for 30 days to 60 days to certain of our established customers in the CCA wire category.

 

Cost of sales

 

Our cost of sales primarily consists of direct material costs, and, to a lesser extent, direct labor costs and manufacturing overhead costs. Direct material costs generally accounted for the majority of our cost of sales.

 

Gross profit

 

Our gross profit is affected by the cost of raw materials, which is defined with reference to the cost of copper. We are also able to price our products based on the market price for materials plus a fixed dollar mark-up, which is essentially our gross profit.

 

Operating expenses

 

Our operating expenses consist of selling, general and administrative expenses, and research and development expenses.

 

Selling, general and administrative expenses

 

Our selling expenses include shipping expenses, salaries and traveling expenses for our sales personnel. Our general and administrative expenses include administrative staff costs and other benefits, depreciation of office equipment, professional service fees and other miscellaneous expenses related to our administrative corporate activities.

 

Our sales activities are conducted through direct selling by our internal sales staff. Because of the strong demand for our products, we have not had to start to aggressively market and distribute our products, and our selling expenses have been relatively small as a percentage of our revenues.

 

We anticipate that our selling, general and administrative expenses will increase with the anticipated growth of our business and continued upgrades to our information technology infrastructure as well as a result of our R&D efforts, and compliance, investor-relations and other expenses associated with being a publicly listed company.

 

Other income and expense

 

Other income and expense includes interest income, interest expense, merger costs, foreign currency translation adjustments, and other income.

 

Our interest expense consists of expenses related to our short term bank borrowings. We expense all interest as it is incurred.

 

Change in fair value of warrants

 

The fair value of the Company’s issued and outstanding Series A Warrants and Series B Warrants, and the Warrants issued to placement agents in conjunction with the Company’s initial public offering in September 2009, was $704,000 as of June 30, 2012 and the Company recognized a $474,000 charge, which is a non-cash charge from the change in fair value of these warrants for the six-month period ended June 30, 2012. In future periods, we may experience significant gains or losses, as the value of these warrants fluctuates in response to changes in our stock price. All of the Series A Warrants have been exercised and none remained outstanding as of June 30, 2012.

 

Income taxes

 

Under the current laws of the Cayman Islands and British Virgin Islands, we are not subject to any income or capital gains tax, and dividend payments we make are not subject to any withholding tax in the Cayman Islands or British Virgin Islands. Under the current laws of Hong Kong, we are not subject to any income or capital gains tax and dividend payments we make are not subject to any withholding tax in Hong Kong.

 

30
 

 

The PRC’s New Tax Law imposes a 10% withholding income tax for dividends distributed by a foreign invested enterprise to its immediate holding company outside the PRC for distribution of earnings generated after January 1, 2008. Under the New Tax Law, the distribution of earnings generated prior to January 1, 2008 is exempt from the withholding tax. As we do not anticipate our subsidiaries in the PRC will distribute their earnings to the Company for the year ending December 31, 2012, and no dividends were distributed in the years ended December 31, 2011 and 2010, no deferred tax liability has been recognized for the undistributed earnings of these PRC subsidiaries through June 30, 2012.

 

Our two operating subsidiaries are governed by the PRC income tax laws and are subject to the PRC enterprise income tax (“EIT”). Each of the two entities files its own separate PRC tax return. According to the relevant laws and regulations in the PRC, foreign invested enterprises established prior to January 1, 2008 were entitled to full exemption from income tax for two years beginning from the first year when enterprises become profitable and have accumulative profits and a 50% income tax reduction for the subsequent three years. Being converted into a Sino-foreign joint equity enterprise in 2005, Lihua Electron was thus entitled to the EIT exemption in 2005 and 2006, and was subject to the 50% income tax reduction for the period from 2007 to 2009. Set out in the following table are the EIT rates for our two PRC operating companies from 2006 to 2012:

 

   2006   2007   2008   2009   2010   2011   2012 
Lihua Electron       12%   12.5%   12.5%   25%   25%   25%
Lihua Copper       25%   25%   25%   25%   25%   25%

 

Critical Accounting Policies

 

Management’s discussion and analysis of its financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. Our financial statements reflect the selection and application of accounting policies, which require management to make significant estimates and judgments. See Note 2 to our condensed consolidated financial statements, “Summary of Significant Accounting Policies”. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe that the following reflect the more critical accounting policies that currently affect our financial condition and results of operations.

 

Revenue recognition
Revenue is recognized when the following four revenue criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectability is reasonably assured.

 

Sales revenue is recognized net of value added tax, sales discounts and returns at the time when the merchandise is sold and delivered to the customer. Based on historical experience, management estimates that sales returns are immaterial and has not provided an allowance for estimated sales returns.

 

Accounts receivables
Accounts receivables are stated at cost, net of an allowance for doubtful accounts. We maintain allowances for doubtful accounts for estimated losses, if any, resulting from the failure of customers to make required payments. We review the accounts receivable on a periodic basis and provide allowances where there is doubt as to the collectability of individual balances. In evaluating the collectability of individual receivable balances, we consider many factors, including the age of the balance, the customer’s payment history, its current credit-worthiness and current economic trends.

 

Inventories
Inventories are stated at the lower of cost, determined on a weighted average basis, or market. Costs of inventories include purchase and related costs incurred in bringing the products to their present location and condition. Market value is determined by reference to selling prices after the balance sheet date or to management’s estimates based on prevailing market conditions. The management will write down the inventories to market value if it is below cost. The management also regularly evaluates the composition of its inventories to identify slow-moving and obsolete inventories to determine if a valuation allowance is required.

 

31
 

 

RESULTS OF OPERATIONS

 

THREE MONTHS ENDED JUNE 30, 2012 COMPARED TO THREE MONTHS ENDED JUNE 30, 2011

 

Sales

 

Our business for the three months ended June 30, 2012 continued to demonstrate growth. Net sales increased by 14.4% from $167.0 million in the three months ended June 30, 2011 to $191.0 million in the three months ended June 30, 2012. This growth was primarily driven by: i) increased sales across all of our product categories as a result of increased production volume and strong market demand for our products; and ii) the addition of copper rod sales as a result of the copper rod smelter production capacity increase that we completed in October 2011. The increase in sales was, however, negatively impacted by the reduction of copper prices during the second quarter of 2012 relative to the same period last year. However, robust sales volume led to an overall increase in sales for the second quarter of 2012.

 

The overall sales volume increase of 36.5% for the three months ended June 30, 2012 over the same period last year is the result of additional production and sales of all of our products. Sales volume of CCA and copper wire in the second quarter of 2012 increased 28.7% from the same period last year as a result of additional production quantity, as well as additional production and sales of the thicker fine copper wire, which was semi-processed from copper rod, as a result of increased copper rod smelting capacity. The sales volume growth of 13.5% of copper anode in the second quarter of 2012 compared to the same period in 2011 was primarily due to increased copper anode production capacity as a result of addition of two new copper anode smelters which started production in June 2012.

 

We sell our products based on the prevailing market price of the underlying product at the time of the sale. Factors impacting average selling prices of our products are copper price fluctuation, and in the case of the wire products, the average diameter of the wire products sold during the time - the thicker the wire diameter the lower the sale price, and vice versa.

 

Please see the table below for more details regarding the product sales breakdown by specific category.

  

  

Three months ended June 30,

 
  

2012

  

2011

 
  

Sales

  

Volume
(m.t.)

  

Average
Price/m.t.

  

Sales

  

Volume
(m.t.)

  

Average
Price/m.t.

 
CCA and copper wire  $100,397,360    11,863   $8,463   $93,513,329    9,217   $10,146 
Copper anode   70,202,817    8,979    7,819    73,499,198    7,912    9,290 
Copper rod   20,407,709    2,545    8,019    -    -    - 
Total  $191,007,886    23,387   $8,167   $167,012,527    17,129   $9,750 

 

Cost of Sales and Gross Margin

 

The following table sets forth our cost of sales and gross profit, both in amounts and as a percentage of total sales for the three months ended June 30, 2012 and 2011:

 

   Three Months ended June 30, 
   2012   2011 
 In thousands, except for percentage      % of       % of 
   Cost of Sales   Sales*   Cost of Sales   Sales* 
CCA and copper wire  $87,896    87.55%  $79,680    85.21%
Copper anode   63,085    89.86%   67,685    92.09%
Copper rod   19,316    94.65%   -    - 
Total  $170,297    89.16%  $147,365    88.24%

 

32
 

 

   Three Months ended June 30, 
   2012   2011 
In thousands, except for percentage      % of       % of 
  Gross Profit   Sales*   Gross Profit    Sales*   
CCA and copper wire  $12,502    12.45%  $13,833    14.79%
Copper anode   7,117    10.14%   5,814    7.91%
Copper rod   1,092    5.35%   -    - 
Total  $20,711    10.84%  $19,647    11.76%

* Percentage of sales of respective product category

 

Total cost of sales for the three months ended June 30, 2012 was $170.3 million, reflecting an increase of 15.6% from the same period last year. As a percentage of total sales, our cost of sales increased to 89.2% of total sales for the three months ended June 30, 2012, compared to 88.2% of total sales in the same period last year. Consequently, gross margin as a percentage of total sales decreased to 10.9% in the three months ended June 30, 2012 from 11.8% for the same period last year, principally due to the additional production and sales of lower margin products including copper anode, copper rode, and fine copper wire.

 

Gross profit for the three months ended June 30, 2012 was $20.7 million, up 5.4% from gross profit of $19.6 million for the same period in 2011.

 

Selling, General and Administrative Expenses

 

The following table sets forth operating expenses and income from operations both in amounts and as a percentage of total sales for the three months ended June 30, 2012 and 2011:

   Three months ended June 30,   Change in three
months ended June
30, 2012 compared
to three months
ended June 30, 2011
 
   2012   2011     
In thousands, except for percentage  US$   % of Sales   US$   % of Sales   % 
Gross profit   20,711    10.84%   19,647    11.76%   5%
Operating Expenses:                         
Selling expenses   (741)   (0.39)%   (668)   (0.40)%   11%
General & administrative expenses   (1,834)   (0.96)%   (1,339)   (0.80)%   37%
Total operating expense   (2,575)   (1.35)%   (2,007)   (1.2)%   28%
Income from operations   18,136    9.49%   17,640    10.56%   3%

 

33
 

 

Total selling, general and administrative expenses were approximately $2.6 million for the three months ended June 30, 2012, an increase of 28% compared to approximately $2.0 million for the same period last year.

 

Selling expenses were approximately $741,000 for the three months ended June 30, 2012, an increase of approximately $73,000 or $10.9% compared to the same period last year. The increase was attributable to:

 

·Increased costs related to product distribution and insurance as a result of expanded business volume; and

 

·Increased shipping and handling costs as a result of business growth during the period.

 

Included in selling expenses were shipping and handling costs of approximately $585,000 and $559,000 for the three months ended June 30, 2012 and 2011, respectively, representing an increase of 4.6%, while tons of products sold by us increased 36.5%. Depending on customer requests on a case-by-case basis, shipping and handling costs may either be borne by us or by our customers. The lesser percentage increase in shipping and handling costs compared to the percentage increase in tons of products sold during the quarter ended June 30, 2012 is attributable to fewer customers requesting us to bear these costs compared with the same period last year.

 

General & administrative expenses were approximately $1.8 million for the three months ended June 30, 2012, an increase of 37.0% compared to the same period last year. The primary factor that caused this increase was the increase in R&D expenses of $310,000 incurred on new technology and product research and development.

 

Interest Expense

 

Interest expense was nil for the three months ended June 30, 2012, compared to $49,000 for the same period last year. During the quarter ended June 30, 2012, the Company did not incur any bank borrowings.

 

Income Tax

 

For the three months ended June 30, 2012, income tax expense was $4.8 million, reflecting an effective tax rate of 26.5%. The effective tax rate for the same period in 2011 was 24.2%. Excluding the non-taxable gain/loss on warrants and the operating loss of the US entity, the effective tax rate was 25.3% and 25.0% for the three months ended June 30, 2012 and 2011, respectively.

 

Commencing in 2010, both Lihua Electron and Lihua Copper have been subject to an EIT rate of 25%.

 

Net Income

 

Net income for the three months ended June 30, 2012 was $13.4 million, or 7.04% of net revenue, compared to $14.4 million, or 8.6% of net revenue, down 6.2% from the same period in 2011.

 

Foreign Currency Translation Gains And Losses

 

During the three months ended June 30, 2012, the RMB declined against the U.S. dollars, and we recognized a foreign currency translation loss of $1.2 million. During the three months ended June 30, 2011, the RMB rose against the U.S. dollars, and we recognized a foreign currency translation gain of $2.3 million. RMB at June 30, 2012 declined against the U.S. dollars by less than 0.5% when compared to March 31, 2012. RMB at June 30, 2011 appreciated against the US dollars by about 1% when compared to March 31, 2011.

 

34
 

 

SIX MONTHS ENDED JUNE 30, 2012 COMPARED TO SIX MONTHS ENDED JUNE 30, 2011

 

Sales

 

Sales

 

Our business for the six months ended June 30, 2012 continued to demonstrate growth. Net sales increased by 18.5% from $303.9 million in the six months ended June 30, 2011 to $360.1 million in the six months ended June 30, 2012. This growth was primarily driven by: i) increased sales across all of product categories as a result of increased production volume and strong market demand for our products; and ii) the addition of copper rod sales as a result of the copper rod smelter production capacity increase that we completed in October 2011. Sales growth was, however, negatively impacted by the reduction of copper prices during the first half of 2012 relative to the same period last year. However, robust sales volume led to an overall increase in sales for the first half of 2012.

 

The overall sales volume increase of 41.4% for the six months ended June 30, 2012 over the same period last year is the result of additional production and sales of all of our products. Sales volume of CCA and copper wire in the first six months 2012 increased 39.0% from the same period last year as a result of additional production quantity, as well as additional production and sales of the thicker fine copper wire, which was semi-processed from copper rod, as a result of increased copper rod smelting capacity. The sales volume growth of 12.4% of copper anode in first half 2012 compared to the same period in 2011 was primarily due to increased copper anode production capacity as a result of the addition of two new copper anode smelters which started production in June 2012.

 

We sell our products based on the prevailing market price of the underlying product at the time of the sale. Factors impacting average selling prices of our products are copper price fluctuation, and in the case of the wire products, the average diameter of the wire products sold during the time - the thicker the wire diameter the lower the sale price, and vice versa.

 

Please see the table below for more details regarding the product sales breakdown by specific category.

 

   Six months ended June 30, 
   2012   2011 
   Sales   Volume
(m.t.)
   Average
Price/m.t.
   Sales   Volume
(m.t.)
   Average
Price/m.t.
 
CCA and copper wire  $190,044,806    22,163   $8,575   $164,424,965    15,941   $10,315 
Copper anode   133,171,370    16,763    7,944    139,518,658    14,908    9,359 
Copper rod   36,877,977    4,682    7,877    -    -    - 
Total  $360,094,153    43,608   $8,258   $303,943,623    30,849   $9,853 

 

Cost of Sales and Gross Margin

 

The following table sets forth our cost of sales and gross profit, both in amounts and as a percentage of total sales for the six months ended June 30, 2012 and 2011:

 

35
 

 

   Six Months ended June 30, 
   2012   2011 
In thousands, except for percentage      % of       % of 
   Cost of Sales   Sales*   Cost of Sales   Sales* 
CCA and copper wire  $166,700    87.72%  $139,614    84.91%
Copper anode   119,029    89.38%   127,774    91.58%
Copper rod   35,019    94.96%   -    - 
Total  $320,748    89.07%  $267,388    87.97%

 

   Six Months ended June  30, 
   2012   2011 
In thousands, except for percentage      % of       % of 
  Gross Profit   Sales*   Gross Profit     Sales*  
CCA and copper wire  $23,345    12.28%  $24,811    15.09%
Copper anode   14,142    10.62%   11,745    8.42%
Copper rod   1,859    5.04%   -    - 
Total  $39,346    10.93%  $36,556    12.03%

* Percentage of sales of respective product category

 

Total cost of sales for the six months ended June 30, 2012 was $320.7 million, reflecting an increase of 20.0% from the same period last year. As a percentage of total sales, our cost of sales increased to 89.1% of total sales for the six months ended June 30, 2012, compared to 88.0% of total sales in the same period last year. Consequently, gross margin as a percentage of total sales decreased to 10.9% in the six months ended June 30, 2012 from 12.0% for the same period last year, principally due to the additional production and sales of lower margin products including copper anode, copper rode, and fine copper wire.

 

Gross profit for the six months ended June 30, 2012 was $39.3 million, up 7.6% from gross profit of $36.6 million for the same period in 2011.

 

Selling, General and Administrative Expenses

 

The following table sets forth operating expenses and income from operations both in amounts and as a percentage of total sales for the six months ended June 30, 2012 and 2011:

 

  

Six months ended June 30,

  

Change in six

months ended June

30, 2012 compared
to six months ended

June 30, 2011

 
  

2012

  

2011

     
In thousands, except for percentage 

US$

  

% of Sales

  

US$

  

% of Sales

  

%

 
Gross profit   39,346    10.93%   36,556    12.03%   8%
Operating Expenses:                         
Selling expenses   (1,427)   (0.4)%   (1,191)   (0.39)%   20%
General & administrative expenses   (3,932)   (1.09)%   (2,912)   (0.96)%   35%
Total operating expense   (5,359)   (1.49)%   (4,103)   (1.35)%   30.6%
Income from operations   33,987    9.44%   32,453    10.68%   4.7%

 

36
 

 

Total selling, general and administrative expenses were approximately $5.4 million for the six months ended June 30, 2012, an increase of 30.6% compared to approximately $4.1 million for the same period last year.

 

Selling expenses were approximately $1.4 million for the six months ended June 30, 2012, an increase of approximately $0.2 million or 19.8% compared to the same period last year. The increase was attributable to:

 

·Increased costs related to product distribution and insurance as a result of expanded business volume; and

 

·Increased shipping and handling costs as a result of business growth during the period.

 

Included in selling expenses were shipping and handling costs of approximately $1.2 million and $1.0 million for the six months ended June 30, 2012 and 2011, representing an increase of 16.4%, while tons of products sold by us increased 41.4%. Depending on customer requests on a case-by-case basis, shipping and handling costs may either be borne by us or by our customers. The lesser percentage increase in shipping and handling costs compared to the percentage increase in tons of products sold during the six months ended June 30, 2012 is attributable to fewer customers requesting us to bear these costs compared with the same period last year.

 

General & administrative expenses were approximately $3.9 million for the six months ended June 30, 2012, an increase of 35.0% compared to the same period last year. The primary factor that caused this increase was the increase in R&D expenses of $637,000 incurred on new technology and product research and development.

 

Interest Expense

 

Interest expense was nil for the six months ended June 30, 2012, compared to $70,000 for the same period last year. During the six months ended June 30, 2012, the Company did not incur any bank borrowings.

 

Income Tax

 

For the six months ended June 30, 2012, income tax expense was $9.1 million, reflecting an effective tax rate of 26.8%. The effective tax rate for the same period in 2011 was 24.1%. Excluding the non-taxable gain/loss on warrants and the operating loss of the US entity, the effective tax rate was 24.9% and 25.0% for the six months ended June 30, 2012 and 2011, respectively.

 

Commencing in 2010, both Lihua Electron and Lihua Copper have been subject to an EIT rate of 25%.

 

Net Income

Net income for the six months ended June 30, 2012 was $24.9 million, or 6.9% of net revenue, compared to $26.9 million, or 8.8% of net revenue, down 7.2% from the same period in 2011. The net income for the six months ended June 30, 2012 was impacted by a $73,291 non-cash gain on extinguishment of warrant liabilities and a non-cash charge of $474,000 as a result of the change of the fair value of the warrants. Excluding the impact of these non-cash warrant related items, net income for the six months ended June 30, 2012 was $25.3 million.

 

Foreign Currency Translation Gains And Losses

During the six months ended June 30, 2012, the RMB declined against the U.S. dollars, and we recognized a foreign currency translation loss of $1 million. During the six months ended June 30, 2011, the RMB rose against the U.S. dollars, and we recognized a foreign currency gain of $4.0 million. RMB at June 30, 2012 declined against the U.S. dollars by less than 0.4% when compared to December 31, 2011. RMB at June 30, 2011 appreciated against the US dollars by about 2% when compared to December 31, 2010.

 

LIQUIDITY AND CAPITAL RESOURCES

 

We have historically financed our operations and capital expenditures through cash flows from operations, bank loans and fund raising through issuing new shares in the capital markets.

 

We have not transferred cash between our operating subsidiaries and the U.S. parent company. As of June 30, 2012, total cash held in Renminbi and U.S. dollars were RMB791.8 million (or $125.2 million based on the conversion rate of US$1 = RMB6.3249 on the same date). We maintain cash in U.S. dollars in an offshore account in Hong Kong, to pay for U.S. related expenses such as legal fees and external investor relation firm fees as a result of being a public company in the U.S. Currently we do not have any need to transfer cash between our operating subsidiaries.

 

37
 

 

As of June 30, 2012, we had approximately $125.2 million in cash, up $19.6 million from $105.6 million at December 31, 2011. The following table summarizes our cash flows for each of the periods indicated:

 

   Six Months Ended June 30, 
   2012   2011 
   (US$) 
Net cash provided by operating activities  $28,020,359   $12,684,153 
Net cash used in investing activities   (6,925,483)   (6,626,317)
Net cash used in provided by financing activities   (992,846)   (88,548)
Effect of exchange rate on cash and cash equivalents   (550,690)   2,150,410 
Cash and cash equivalents at beginning of period   105,637,627    90,609,340 
Cash and cash equivalents at end of period  $125,188,967   $98,729,038 

 

Operating activities 

For the six months ended June 30, 2012, cash provided by operating activities totaled $28.0 million compared to $12.7 million in the same period of 2011. This was primarily attributable to: i) $24.9 million net income; ii) a $3.9 million reduction in prepayments for raw material purchases, which resulted from advance payment for the importation of our raw material from overseas; offset by iii) a $2.3 million inventory increase, resulting from the expansion of production capacity and revenue growth; iv) a $0.9 million decrease in accounts payable.

 

Investing activities 

For the six months ended June 30, 2012, we had a net cash outflow of $6.9 million for investing activities for the addition to construction in progress and purchase of property, plant and equipment, primarily as a result of capital investment in new equipment and machinery and building of new workshops, all of which was part of our planned expansion.

 

Financing activities 

For the six months ended June 30, 2012, we had a net cash outflow of $1.0 million from financing activities, as a result of the payment of two special dividend distributions approved by the Board.

 

In October 2011, the Board of Directors approved two special dividends. The amount of each special dividend was $0.03 per outstanding share of Lihua common stock on the respective record dates. The first dividend was paid on January 13, 2012 to Lihua shareholders of record on December 31, 2011 and the second dividend was paid on April 13, 2012 to Lihua shareholders of record on March 31, 2012. The per share amount of each special dividend was calculated on an annualized method based on 5% of the Company’s full-year GAAP net income of $38.5 million for the twelve months ended December 31, 2010. Magnify Wealth Enterprise Ltd. (“Magnify Wealth”), the Company’s largest shareholder and an affiliate of Mr. Jianhua Zhu, the Company’s founder, Chairman and CEO, had agreed to waive payment of the two special dividends. Accordingly, the two special dividends were distributed among approximately 16.8 million shares. The first dividend payment of $0.5 million was made in January 2012 and second dividend payment of $0.5 million was made in April 2012.

 

On May 19, 2011, Magnify Wealth, an affiliated entity of Mr. Jianhua Zhu, agreed to loan us up to $4 million pursuant to the terms of a demand promissory note (the “Note ”) to partially fund our previously announced $15 million stock repurchase program to make open market purchases of the our common stock. While our operating subsidiaries in the PRC have substantial cash reserves available, the laws of the PRC restrict the conversion of RMB to US dollars, such that we have encountered difficulty funding the repurchase program with US dollars from cash held by our PRC subsidiaries. We explored possible alternative arrangements for funding the repurchase program in US dollars with financial institutions, but our management determined that such alternatives would have been costly or otherwise not appropriate for us.

 

On January 9 and March 15, 2012, in order to partially fund the 2011 special dividend payment and operating expenses, Magnify Wealth loaned $1 million and $0.6 million respectively under the Note, of which RMB6.3 million and RMB3.8 million were repaid on January 9 and March 31, 2012, respectively, in RMB, at the average rate of 6.3126 RMB per US dollars, which was based upon the exchange rate between US dollars and RMB as set forth by Standard Chartered Bank in Hong Kong. The loans under the Note were unsecured, payable on demand and bore interest at 2% per annum.

 

38
 

 

On April 6 and April 26, 2012, in order to partially fund the 2011 special dividend payment and U.S. dollar operating expenses, upon Board approval, Magnify Wealth loaned $0.5 million and $0.9 million, respectively, under the Note, of which RMB3.15 million and RMB 5.65 million were repaid, respectively, in RMB, at the average rate of 6.2916 RMB per US dollars, based upon the exchange rate between US dollars and RMB as set forth by Standard Chartered Bank in Hong Kong. The loans under the Note were unsecured, payable on demand and bore interest at 2% per annum.

 

As of June 30, 2012, there were no outstanding loans under the Note.

 

Capital expenditures

 

Our capital expenditures are principally comprised of construction and purchases of property, plant and equipment for expansion of our production facilities. In 2009, 2010 and 2011, we funded our capital expenditures primarily through cash flows from operating activities, the proceeds of bank borrowings, and equity issuance.

 

In 2012, as we accelerate our expansion, we expect continued capital expenditures for maintaining existing machinery and adding manufacturing equipment in our new facility, which is adjacent to our existing facility. With two new copper anode smelters added in June 2012, we currently have four smelting facilities, which can produce a total of 135,000 tons of refined copper products per year, up from 85,000 tons of capacity per year. With our current capacity of wire production lines, we can produce 7,500 tons of CCA wire and 20,000-25,000 tons of copper wire with the diameter range of 0.03mm – 1.60mm. For the 2012 capacity expansion, we believe that our existing cash, cash equivalents and cash flows from operations will be sufficient to meet our presently anticipated future cash needs to bring all of our facilities into full production. We may, however, require additional cash resources due to changing business conditions or other future developments, including any investments or acquisitions we may decide to pursue.

 

Accounts receivable

 

For the six months ended June 30, 2012, we sold 22,163 tons of CCA and copper wire, 16,763 tons of copper anode and 4,682 tons of copper rod. In the same period last year, we sold 15,941 tons of CCA and copper wire, 14,908 tons of copper anode and 0 tons of copper rod. As CCA is an emerging product in the PRC, we extend credit terms to some of our larger customers. However, pure copper products, such as our copper anode and copper rod, are in such high demand that we do not have to extend credit terms. Our customers often purchase more than one type of product from us (for example, one customer may purchase both CCA wire and copper wire). CCA wire purchases are generally accorded 30 to 60 day payment terms, depending upon the creditworthiness of the customer, while the copper anode (and copper rod) purchases are 70% payable upon delivery to the customer, which may occur two to seven days after we ship the product and recognize our revenue, with the remaining 30% generally collected within 30 days after the delivery. This decision to extend terms or to collect payment upon delivery, is based primarily upon the product type. We may extend terms for CCA purchases to a credit-worthy customer, but for that same customer require 70% payment upon delivery for purchases of copper rod and/or copper anode.

 

The table below shows the breakdown of accounts receivable by product: 

 

   As of June 30, 
   2012   2011 
CCA Wire and Copper Wire  $13,365,400   $10,692,744 
Copper Anode   12,690,548    13,118,771 
Copper Rod   4,983,886     
Total  $31,039,834   $23,811,515 

 

Off-balance sheet arrangements

 

As of June 30, 2012 and December 31, 2011, we had no off balance sheet arrangements.

 

39
 

 

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Foreign Exchange Risk

 

Substantially all of our revenues and expenditures are denominated in Renminbi. As a result, fluctuations in the exchange rate between the U.S. dollars and Renminbi will affect our financial results in U.S. dollars terms without giving effect to any underlying change in our business or results of operations. The Renminbi’s exchange rate with the U.S. dollars and other currencies is affected by, among other things, changes in the PRC’s political and economic conditions. The exchange rate for conversion of Renminbi into foreign currencies is heavily influenced by intervention in the foreign exchange market by the People’s Bank of China. From 1995 until July 2005, the People’s Bank of China intervened in the foreign exchange market to maintain an exchange rate of approximately 8.3 Renminbi per U.S. dollars. On July 21, 2005, the PRC government changed this policy and began allowing modest appreciation of the Renminbi versus the U.S. dollars. However, the Renminbi is restricted to a rise or fall of no more than 0.5% per day versus the U.S. dollars, and the People’s Bank of China continues to intervene in the foreign exchange market to prevent significant short-term fluctuations in the Renminbi exchange rate. Nevertheless, under China’s current exchange rate regime, the Renminbi may appreciate or depreciate significantly in value against the U.S. dollars in the medium to long term. There remains significant international pressure on the PRC government to adopt a substantial liberalization of its currency policy, which could result in a further and more significant appreciation or depreciation in the value of the Renminbi against the U.S. dollars.

 

Any devaluation of the Renminbi against the U.S. dollars would consequently have an adverse effect on our financial performance and asset values when measured in terms of U.S. dollars. On the other hand, the appreciation of the Renminbi could make our customers’ products more expensive to purchase because many of our customers are involved in the export of goods, which may have an adverse impact on their sales. A decrease in sales by our customers could have an adverse effect on our operating results. In addition, as of June 30, 2012 and December 31, 2011, we have cash denominated in Renminbi amounting to RMB792 million ($125 million) and RMB665 million ($106 million), respectively. Also, from time to time we may have U.S. dollars denominated borrowings. Accordingly, a decoupling of the Renminbi may affect our financial performance in the future.

 

We recognized foreign currency translation adjustments of approximately $(1.2) million and $(1.0) million for the three and six months ended June 30, 2012, respectively.

 

Very limited hedging transactions are available in the PRC to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may decide to enter into hedging transactions in the future, the availability and effectiveness of these hedging transactions may be limited and we may not be able to successfully hedge our exposure at all. In addition, our currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert Renminbi into foreign currency.

 

Inflation

 

In recent years, the PRC has not experienced significant inflation, and thus inflation has not had a material impact on our results of operations. According to the National Bureau of Statistics of China, the change in Consumer Price Index in China was -0.7%, 3.3% and 4.1% in 2009, 2010 and 2011, respectively.

 

Item 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

Disclosure controls and procedures are designed to ensure that information required to be disclosed by us in reports filed or submitted under the Securities Exchange Act of 1934, as amended (“Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed under the Exchange Act is accumulated and communicated to management, including the principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.

 

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In connection with the preparation of the quarterly report on Form 10-Q for the quarter ended June 30, 2012, our management, including our principal executive officer and principal financial officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures, which are defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Act is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

 

Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of June 30, 2012.

 

Changes in Internal Control over Financial Reporting

 

There have been no changes in our internal control over financial reporting that occurred during the second fiscal quarter of 2012 covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II — OTHER INFORMATION

 

Item 1. LEGAL PROCEEDINGS

 

None.

 

Item 1A. RISK FACTORS

 

There have been no material changes in the Company’s risk factors from those previously disclosed in the Company’s Form 10-K for the year ended December 31, 2011.

 

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

 

None.

 

Item 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

Item 4. MINE SAFETY DISCLOSURES

 

None.

 

Item 5. OTHER INFORMATION

 

None.

 

Item 6. EXHIBITS

 

(b) Exhibits 

 

Exhibit
No.

 

Document Description

31.1   Certification of Chief Executive Officer (Principal Executive Officer) pursuant to Rule 13A-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2   Certification of the Chief Financial Officer (Principal Financial Officer) pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1   Certification of Chief Executive Officer Pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).
32.2   Certification of Chief Financial Officer Pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).
101   Interactive Data File

 

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SIGNATURES

 

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

  LIHUA INTERNATIONAL, INC.
   
August 9, 2012 By:  /s/ Jianhua Zhu
    Jianhua Zhu, Chairman and Chief Executive Officer
    (Principal Executive Officer)
     
August 9, 2012 By: /s/ Daphne Yan Huang
    Daphne Yan Huang, Chief Financial Officer
    (Principal Accounting Officer)

 

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