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EX-32.2 - EXHIBIT 32.2 - LIHUA INTERNATIONAL INC.v230362_ex32-2.htm
EX-31.1 - EXHIBIT 31.1 - LIHUA INTERNATIONAL INC.v230362_ex31-1.htm
EX-32.1 - EXHIBIT 32.1 - LIHUA INTERNATIONAL INC.v230362_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - LIHUA INTERNATIONAL INC.v230362_ex31-2.htm
 
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 

 
FORM 10-Q
 

 
x
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended June 30, 2011
 
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 30,032,450 shares of the Registrant’s Common Stock issued and outstanding on August 4, 2011.

 
 

 
 
Lihua International, Inc.
Index to Form 10-Q
 
     
Page
       
Part I.
Financial Information
    3
       
 
Item 1. Unaudited Condensed Consolidated Financial Statements
    3
       
 
Condensed Consolidated Balance Sheets as of June 30, 2011 (Unaudited) and December 31, 2010 (Audited)
    3
       
 
Condensed Consolidated Statements of Income and Comprehensive Income (Unaudited) for the three and six months ended June 30, 2011 and 2010
    4
       
 
Condensed Consolidated Statements of Stockholders’ Equity (Unaudited) for the six months ended June 30, 2011
    5
       
 
Condensed Consolidated Statements of Cash Flows (Unaudited) for the six months ended June 30, 2011 and 2010
    6
       
 
Notes to Unaudited Condensed Consolidated Financial Statements
    7
       
 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
    23
       
 
Item 3. Quantitative and Qualitative Disclosures About Market Risk
    33
       
 
Item 4. Controls and Procedures
    35
       
Part II.
Other Information
    36
       
 
Item 1. Legal Proceedings
    36
       
 
Item 1A. Risk Factors
    36
       
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    36
       
 
Item 3. Defaults Upon Senior Securities
    36
       
 
Item 4. (Removed and Reserved)
    36
       
 
Item 5. Other Information
    36
       
 
Item 6. Exhibits
    37
       
SIGNATURES
    38

 
2

 

PART I — 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,
 
   
2011
   
2010
 
ASSETS
           
CURRENT ASSETS
           
Cash and cash equivalents
  $ 98,729,038     $ 90,609,340  
Bills receivable, net
    -       528,576  
Accounts receivable, net
    23,811,515       32,973,704  
Prepayments for raw material purchases
    23,594,404       -  
Other receivables and current assets
    548,468       21,967  
Prepaid land use right – current portion
    394,350       211,499  
Deferred income tax assets
    149,849       127,317  
Inventories
    17,845,910       16,155,862  
Total current assets
    165,073,534       140,628,265  
OTHER ASSETS
               
Property, plant and equipment, net
    18,021,183       18,189,255  
Construction in progress
    7,344,878       916,782  
Prepaid land use right – long-term portion
    18,604,728       18,546,744  
Intangible assets
    1,897       3,547  
Total non-current assets
    43,972,686       37,656,328  
Total assets
  $ 209,046,220     $ 178,284,593  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
CURRENT LIABILITIES
               
Short term bank loans
  $ 2,317,819     $ 2,264,937  
Accounts payable
    8,692,421       6,012,035  
Other payables and accruals
    3,044,274       3,186,174  
Due to a related party
    140,000       -  
Income taxes payable
    4,727,549       4,981,383  
Warrant liabilities
    1,145,000       8,682,441  
Total current liabilities
    20,067,063       25,126,970  
Total liabilities
    20,067,063       25,126,970  
                 
STOCKOLDERS' 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,
               
30,032,450  and 29,385,326 shares issued and outstanding as of June 30, 2011 and December 31, 2010, respectively
    3,003       2,938  
Additional paid-in capital
    78,312,835       71,251,843  
Treasury stock, at cost, 264,047 shares and nil, as of June 30,2011 and December 31, 2010, respectively
    (2,126,597 )     -  
Statutory reserves
    8,869,528       7,556,187  
Retained earnings
    92,655,810       67,091,089  
Accumulated other comprehensive income
    11,264,578       7,255,566  
Total stockholders' equity
    188,979,157       153,157,623  
Total liabilities and stockholders' equity
  $ 209,046,220     $ 178,284,593  
 
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
   
For the Six Months
 
  
 
Ended June 30,
   
Ended June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Revenue
 
$
167,012,527
   
$
75,502,350
   
$
303,943,623
   
$
138,723,052
 
                                 
Cost of goods sold
   
(147,365,064
   
(61,002,044
   
(267,388,087
   
  (112,401,462
)
                                 
Gross profit
   
19,647,463
     
14,500,306
     
36,555,536
     
26,321,590
 
                                 
Selling expenses
   
(668,366
)
   
(570,420
   
(1,191,402
)
   
(1,021,297
)
General and administrative expenses
   
(1,339,062
)
   
(1,484,893
   
(2,912,374
)
   
(2,778,496
)
                                 
Income from operations
   
17,640,035
     
12,444,993
     
32,451,760
     
22,521,797
 
                                 
Other income (expenses):
                               
Interest income
   
136,941
     
61,065
     
270,046
     
94,416
 
Interest expenses
   
(49,014
)
   
(40,288
   
(70,480
)
   
(69,458
)
Gain on extinguishment of warrant liabilities
   
26,531
     
-
     
87,255
     
135,369
 
Change in fair value of warrants
   
1,179,151
     
888,975
     
2,554,252
     
2,234,829
 
Other income (expenses)
   
23,879
     
(68,397
   
99,830
     
(68,397
                                 
Total other income (expenses), net
   
1,317,488
     
841,355
     
2,940,903
     
2,326,759
 
                                 
Income before income tax
   
18,957,523
     
13,286,348
     
35,392,663
     
24,848,556
 
                                 
Provision for income tax
   
(4,591,447
)
   
(3,388,056
   
(8,514,601
)
   
(6,093,706
)
                                 
Net income
   
14,366,076
     
9,898,292
     
26,878,062
     
18,754,850
 
                                 
Other comprehensive income:
                               
Foreign currency translation adjustment
   
2,344,495
     
698,345
     
4,009,012
     
746,801
 
                                 
Total comprehensive income
 
$
16,710,571
   
$
10,596,637
   
$
30,887,074
   
$
19,501,651
 
                                 
Earnings per share
                               
Basic
 
0.48
   
$
0.35
   
$
0.90
   
$
0.70
 
Diluted
 
$
0.48
   
$
0.34
   
$
0.89
   
$
0.68
 
                                 
Weighted average number of shares outstanding
                               
Basic
   
29,872,934
     
28,484,091
     
29,865,896
     
26,625,272
 
Diluted
   
30,111,142
     
29,326,571
     
30,200,087
     
27,477,388
 

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)

                                 
Accumulated
       
   
Common Stock
   
Additional
                     
Other
       
   
Number of
         
Paid-in
   
Treasury
   
Statutory
   
Retained
   
Comprehensive
       
   
Shares
   
Amount
   
Capital
   
Stock
   
Reserves
   
Earnings
   
Income
   
Total
 
                                                                 
At January 1, 2011
    29,385,326     $ 2,938     $ 71,251,843     $ -     $ 7,556,187     $ 67,091,089     $ 7,255,566     $ 153,157,623  
                                                                 
Net income
    -       -       -       -       -       26,878,062       -       26,878,062  
Foreign currency translation adjustment
    -       -       -       -       -       -       4,009,012       4,009,012  
Comprehensive income
    -       -       -       -       -       -       -       30,887,074  
                                                                 
Exercise  of warrants
    647,124       65       6,793,918       -       -       -       -       6,793,983  
                                                                 
Repurchase of common stock
    -       -       -       (2,126,597 )     -       -       -       (2,126,597 )
                                                                 
Share-based payments to employees and directors
    -       -       267,074       -       -       -       -       267,074  
                              -                                  
Appropriation of statutory reserves
    -       -       -       -       1,313,341       (1,313,341 )     -       -  
                                                                 
At June 30, 2011 (Unaudited)
    30,032,450     $ 3,003     $ 78,312,835     $ (2,126,597 )   $ 8,869,528     $ 92,655,810     $ 11,264,578     $ 188,979,157  

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,
 
   
2011
   
2010
 
CASH FLOWS FROM OPERATING ACTIVITIES
           
Net income
  $ 26,878,062     $ 18,754,850  
Adjustments to reconcile net income to cash provided by operating activities:
               
Depreciation and amortization
    1,289,649       1,009,020  
Loss on disposal of fixed assets
    -       123,182  
Share-based compensation
    267,074       201,953  
Gain on extinguishment of warrant liabilities
    (87,255 )     (135,369 )
Change in fair value of warrants
    (2,554,252 )     (2,234,829 )
Deferred income tax benefits
    (19,351 )     59,020  
(Increase) decrease in assets:
               
Accounts receivable
    9,826,535       (6,112,822 )
Bills receivable
    535,170       -  
Prepayments for raw material purchases
    (23,343,711 )     -  
Other receivables and current assets
    (525,338 )     274,600  
Trade receivable from a related company
    -       (228,887 )
Inventories
    (1,298,889 )     2,232,887  
Increase (decrease) in liabilities:
               
Accounts payable
    2,513,027       2,382,124  
Other payables and accruals
    (430,361 )     446,769  
Income taxes payable
    (366,207 )     1,693,808  
Net cash provided by operating activities
    12,684,153       18,466,306  
                 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Purchase of property, plant and equipment
    (506,313 )     (1,067,485 )
Addition to construction in progress
    (6,120,004 )     -  
Net cash used in investing activities
    (6,626,317 )     (1,067,485 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES
               
Proceeds from public offering of common stock, net of expenses of $2,430,489
    -       32,069,517  
Release of restricted cash related to private placement
    -       575,000  
Repurchase of common stock
    (2,126,597 )     -  
Proceeds from a related party
    140,000       -  
Proceeds from exercise of warrants
    1,898,049       2,450,000  
Net cash (used in) provided by financing activities
    (88,548 )     35,094,517  
                 
Foreign currency translation adjustment
    2,150,410       491,718  
                 
INCREASE IN CASH AND CASH EQUIVALENTS
    8,119,698       52,985,056  
CASH AND CASH EQUIVALENTS, at the beginning of the period
    90,609,340       34,614,838  
                 
CASH AND CASH EQUIVALENTS, at the end of the period
  $ 98,729,038     $ 87,599,894  
                 
NON-CASH INVESTING AND FINANCING TRANSACTIONS:
               
Share-based compensation to employees and directors
  $ 267,074     $ 201,953  
Issue of common stock to settle warrant liabilities, net of cash received
    4,895,934       4,766,160  
                 
SUPPLEMENTAL DISCLOSURE INFORMATION
               
Cash paid for interest
  $ 70,480     $ 69,458  
Cash paid for income taxes
  $ 8,835,772     $ 4,340,878  

 
6

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010

NOTE 1
DESCRIPTION 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, 2011, 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 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

NOTE 2
SUMMARY 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 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, 2010, 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, 2010.

 
7

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010

NOTE 2
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – CONTINUED

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 and bills receivables
Accounts and bills receivables 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 provides 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.

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. 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.

 
8

 
 
LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010

NOTE 2
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – CONTINUED

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
 
20
 
Machinery
 
10
 
Office equipment & motor vehicles
 
5
 

The carrying value of property, plant and equipment is assessed annually and when factors indicating impairment are present, the carrying value of the fixed assets is reduced by the amount of the impairment. The Company determines the existence of such impairment by measuring the expected future cash flows (undiscounted and without interest charges) and comparing such amount to the net asset carrying value. An impairment loss, if it exists, is measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset.

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

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

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 to the customer. Based on historical experience, management estimates that sales returns are immaterial and has not made allowance for estimated sales returns.

 
9

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010

NOTE 2
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – CONTINUED

Research and development costs
Research and development costs are expensed as incurred, and charged to general and administrative expense. For the six months ended June 30, 2011 and 2010, research and development costs were $99,493 and $69,703, respectively. For the three months ended June 30, 2011 and 2010, research and development costs were $55,003 and $34,860, respectively.
 
Advertising costs
The Company expenses all advertising costs as incurred.  The total amount of advertising costs charged to general and administrative expense was $13,759 and $1,465 for the six months ended June 30, 2011 and 2010, and $13,759 and $733 for the three months ended June 30, 2011 and 2010, respectively.

 
Shipping and handling costs
Substantially all costs of shipping and handling of products to customers are included in selling expense.  Shipping and handling costs for the six months ended June 30, 2011 and 2010 were $990,014 and $810,943, and for the three months ended June 30, 2011 and 2010 were $559,257 and $453,406, respectively.

 
Foreign currency
The Company uses the United States dollar (“U.S. Dollar” or “US$” or “$”) for financial reporting purposes.  The PRC subsidiaries of the Company maintain their books and records in their functional currency, Chinese Renminbi (“RMB”), being the lawful currency in the PRC.  Assets and liabilities of the PRC subsidiaries are translated from RMB into US Dollars using the applicable exchange rates prevailing at the balance sheet date.  Items on the statement of operations are translated at average exchange rates during the reporting period.  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. 

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, 2011
 
December 31, 2010
Balance sheet items, except for equity accounts
US$1=RMB 6.4716
 
US$1=RMB6.6227
       
 
Three months ended June 30,
 
2011
 
2010
Items in the statements of income and cash flows
US$1=RMB 6.5011
 
US$1=RMB6.8235
       
 
Six months ended June 30,
 
2011
 
2010
Items in the statements of income and cash flows
US$1=RMB 6.5411
 
US$1=RMB6.8252

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.

 
10

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010

NOTE 2
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  – CONTINUED

Recent accounting pronouncements
In January 2011, the FASB issued ASU No. 2011-01- Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20. The amendments in this update temporarily delay the effective date of the disclosures about troubled debt restructurings in ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, for public entities. The delay is intended to allow the FASB time to complete its deliberations on what constitutes a troubled debt restructuring. The effective date of the new disclosures about troubled debt restructurings for public entities and the guidance for determining what constitutes a troubled debt restructuring will then be coordinated. This deferral will have no material impact on the Company’s consolidated financial statements.

In January 2011, the FASB issued ASU No. 2011-02- Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The amendments in this update provide additional guidance to assist creditors in determining whether a restructuring of a receivable meets the criteria to be considered a troubled debt restructuring.  For public companies, the new guidance is effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption within those annual periods. Early application is permitted. The adoption of the provisions in ASU 2011-02 will have no material impact on the Company’s consolidated financial statements.
 
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 will have no 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 he 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 will have no material impact on the Company’s consolidated financial statements.
 
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 3 
FAIR 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.

 
11

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30,, 2011 AND 2010

NOTE 3 
FAIR VALUE MEASUREMENTS AND FINANCIAL INSTRUMENTS– CONTINUED

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

 
Assets and liabilities measured at fair value on a recurring basis using significant observable inputs (Level 2) from January 1, 2011 to June 30, 2011 are summarized as follows:

   
Warrant
Liability
 
Balance at January 1, 2011
 
$
8,682,441
 
Exercise of warrants
   
(4,983,189
)
Change in fair value included in earnings
   
(2,554,252
)
Balance at June 30, 2011
 
$
1,145,000
 
 
The Company did not identify any other assets and liabilities that are required to be presented on 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, and short-term bank loans and debts approximate their fair values due to the short maturities of these instruments.
   
Derivative Instruments – Warrants
 
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 estimates the fair value of its warrants as of June 30, 2011 using the Black-Scholes option pricing model using the following assumptions:

Market price of common stock:
 
$
6.09
   
$
6.09
 
Exercise price:
 
3.50
   
$
4.80
 
Remaining contractual life (years):
   
2.33
     
3.18
 
Dividend yield:
   
     
 
Expected volatility:
   
32.36
%
   
43.80
%
Risk-free interest rate:
   
0.57
%
   
0.88
%
 
During the six months ended June 30, 2011, 542,300 warrants were exercised at $3.50 each in cash and 174,664 warrants were exercised on a cashless basis to purchase 104,824 shares of common stock. 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”. In accordance with ASC 470-50-40, “Debt – Modification and Extinguishments – Derecognition”, an aggregate gain of $60,724 was recognized.  For details, please refer to the following table.

 
Exercise date:
 
January 14,
   
March 3,
   
March 14,
   
March 17,
   
April 7,
 
Market price of common stock:
  $ 10.64     $ 10.98     $ 10.19     $ 9.79     $ 8.39  
Exercise warrants:
    549,300       20,000       28,814       74,000       44,850  
Exercise price:
  $ 3.50     $ 3.50     $ 4.80     $ 3.50     $ 4.80  
Remaining contractual life (years):
    2.79       2.66       3.47       2.62       3.41  
Dividend yield:
                             
Expected volatility:
    46.34 %     48.00 %     44.05 %     48.54 %     44.05 %
Risk-free interest rate:
    0.90 %     1.09 %     1.27 %     0.86 %     1.46 %
Fair values:
  $ 7.2301     $ 7.7083     $ 6.0599     $ 6.5324     $ 4.4485  
Gain on extinguishment of warrant liabilities
  $ 48,210     $ 8,153     $ 5,722     $ (1,361 )   $ 26,531  

 
12

 
 
LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010

NOTE 4
ACCOUNTS RECEIVABLE AND BILLS RECEIVABLE, NET

Accounts receivable consisted of the following:
   
June 30,
   
December 31,
 
   
2011
   
2010
 
             
Accounts receivable
 
$
23,811,515
   
$
32,973,704
 
Less: Allowance for doubtful debts
   
-
     
-
 
                 
Accounts receivable, net
 
$
23,811,515
   
$
32,973,704
 

Bills receivable arose from sale of goods and represented commercial drafts issued by customers to the Company that were guaranteed by customers’ bank.  Bills receivable are interest-free with maturity dates of 3 to 6 months from date of issuance. Bills receivable consisted of the following:
   
June 30,
   
December 31,
 
   
2011
   
2010
 
             
Bills receivable
 
$
-
   
$
528,576
 
Less: Allowance for doubtful debts
   
-
     
-
 
                 
Bills receivable, net
 
$
-
   
$
528,576
 

NOTE 5
PREPAYMENTS, OTHER RECEIVABLES AND CURRENT ASSETS
 
In 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, 2011, such prepayments were $23,594,404.
 
Other receivables and current assets consisted of the following:
   
June 30,
   
December 31,
 
   
2011
   
2010
 
             
Prepaid insurance
 
$
369,750
   
$
-
 
Other prepayments
   
59,895
     
-
 
Other receivables
   
118,823
     
21,967
 
Less: Allowance for valuation and doubtful debts
   
-
     
-
 
                 
   
$
548,468
   
$
21,967
 

 
13

 
 
LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010

NOTE 6
INVENTORIES

Inventories by major categories are summarized as follows:
   
June 30,
   
December 31,
 
   
2011
   
2010
 
                 
Raw materials
 
$
9,023,460
   
$
9,177,495
 
Work in progress
   
1,958,028
     
531,616
 
CCA and copper wire
   
3,868,511
     
4,372,682
 
Copper rod and anode
   
2,995,911
     
2,074,069
 
                 
   
$
17,845,910
   
$
16,155,862
 

NOTE 7
INTANGIBLE ASSETS

   
June 30,
   
December 31,
 
   
2011
   
2010
 
                 
Computer software, cost
 
$
11,379
   
$
11,120
 
Less: Accumulated amortization
   
(9,482
   
(7,573
                 
   
$
1,897
   
$
3,547
 

Amortization expense for the six months ended June 30, 2011 and 2010 was $1,836 and $1,486, respectively. Amortization expense for the three months ended June 30, 2011 and 2010 was $985 and $821, respectively .The estimated amortization expense of intangible assets for the remainder of the fiscal year ending December 31, 2011 will be $1,897.

NOTE 8
PREPAID LAND USE RIGHTS

The Company has recorded as prepaid land use rights the lump sum payments paid to acquire long-term interests to utilize the land underlying its 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 $195,041 and $86,316 for the six months ended June 30, 2011 and 2010, and $98,144 and $43,179 for the three months ended June 30, 2011 and 2010, respectively.  The estimated expense of the prepaid land use rights over each of the next five years and thereafter is $394,350 per annum.

As of June 30, 2011, prepaid land use rights included RMB32,399,100 ($5,006,351) 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, 2011, RMB2,399,100 ($370,712) remained unpaid and no land use right certificate had been issued and the relevant formalities were not completed. Apart from the payment of $5,006,351 to the local authority, the Company also paid $5,606,162 to various local authorities primarily as compensation to the local communities in connection with the Company’s acquisition of these land use rights.

 
14

 
 
LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010

NOTE 9
PROPERTY, PLANT AND EQUIPMENT, NET

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

   
June 30,
   
December 31,
 
   
2011
   
2010
 
             
Cost:
           
Buildings
  $ 10,558,397     $ 10,026,230  
Office equipment
    356,568       348,433  
Motor vehicles
    618,991       604,869  
Machinery
    13,005,364       12,499,837  
                 
Total cost
    24,539,320       23,479,369  
Less: Accumulated depreciation
    (6,518,137 )     (5,290,114 )
                 
Net book value
  $ 18,021,183     $ 18,189,255  

Depreciation expense was $1,092,772 and $921,218 for the six months ended June 30, 2011 and 2010, and $567,765 and $471,421 for the three months ended June 30, 2011 and 2010, respectively.

NOTE 10
CONSTRUCTION IN PROGRESS

Construction in progress consisted of the following:

   
June 30,
   
December 31,
 
   
2011
   
2010
 
             
Construction of equipment
  $ 533,555     $ 164,038  
Construction of buildings
    6,811,323       752,744  
                 
    $ 7,344,878     $ 916,782  

NOTE 11
SHORT TERM BANK LOANS

Short-term bank loans consisted of the following:

   
June 30,
   
December 31,
 
   
2011
   
2010
 
             
Bank loan of RMB15,000,000 granted by Agricultural Bank of China, Danyang Branch with an interest rate of 6.31% p.a., guaranteed by Mr. Jianhua Zhu and Tianyi Telecom and matures on April 20, 2012
  $ 2,317,819     $ 2,264,937  
                 
Total
  $ 2,317,819     $ 2,264,937  
 
 
15

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010

NOTE 12
OTHER PAYABLES AND ACCRUALS

Other payables and accruals consisted of the following:

   
June 30,
   
December 31,
 
    2011,     2010,  
                 
Accrued staff costs
  $ 479,871     $ 564,943  
Accrued expenses
    3,656       183,341  
Other taxes payable
    1,925,750       1,838,501  
Other payables
    634,997       599,389  
                 
    $ 3,044,274     $ 3,186,174  

NOTE 13
COMMON STOCK COMMON STOCK PURCHASE WARRANTS AND TREASURY STOCK
 
During the six months ended June 30, 2011, 542,300 shares of common stock were issued for cash upon exercise of 542,300 warrants at an exercise price of $3.50 per share, 101,000 warrants were exercised on a cashless basis to purchase 67,632 shares of common stock at an exercise price of $3.50 per share, and  73,664  warrants were exercised on a cashless basis to purchase 37,192 shares of common stock at an exercise price of $4.80 per share.
 
Warrants issued and outstanding at June 30, 2011, 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, December 31, 2010
    1,138,420     $ 3.62       2.91       1,138,420     $ 3.62       2.91  
Granted / Vested
    -                                          
Forfeited
    -                                          
Exercised
    (716,964 )     3.63                                  
                                                  
Balance, June 30, 2011
    421,456     $ 3.59       2.39       421,456     $ 3.59       2.39  
 
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. The repurchase authorization may be modified, suspended, or discontinued by the Board of Directors at any time. During the six months ended June 30, 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. As of June 30, 2011, the Company had approximately $12.9 million available under the existing $15 million share repurchase authorization.
 
 
16

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30,2011 AND 2010

NOTE 14
SHARE-BASED COMPENSATION
 
Common Stock awarded to Employees by a Majority Shareholder
 
The Company recognized compensation expense of $127,125 and $63,562, related to the restricted shares granted by a principal stockholder to Mr. Yang “Roy” Yu, the Company’s Chief Financial Officer (CFO), based on the grant-date fair value of the Company’s common stock of $2.26 per share, for the six and three months ended June 30, 2011, respectively.
 
Options granted to Independent Directors and Employees
 
On January 14, 2011, the Company granted options to one of its independent directors, Mr. Kelvin Lau to purchase 15,000 shares of the Company’s common stock at a strike price of $10.64 per share, in consideration of his services to the Company. The option vests and becomes exercisable in equal installments on December 3, 2010, January 16, 2011, March 1, 2011 and April 14, 2011 and will expire 10 years from the date of grant.
 
On June 3, 2011, 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 $6.49 per share, in consideration of their services to the Company. The options vest and become exercisable in equal installments on July 14, 2011, October 14, 2011, January 14, 2012 and April 14, 2012 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 granted to directors and employees 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 $139,949 and $57,213 for the six and three months ended June 30, 2011, respectively.
 
Options granted to Independent Directors and Employees
 
Options issued and outstanding at June 30, 2011 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, 2010
    115,000     $ 6.74     $ 465,450       9  
Granted
    75,000       7.32       -       10  
Exercised
    -       -       -       -  
Expired
    -       -       -       -  
Forfeited
    -       -       -       -  
Outstanding at June 30, 2011 (Unaudited)
    190,000     $ 6.97     $ 116,700       8.86  
                                 
Exercisable at June 30, 2011 (Unaudited)
    130,000     $ 7.19     $ 116,700       8.36  

(1)
The intrinsic value of the stock option at June 30, 2011 is the amount by which the market value of the Company’s common stock of $6.09 as of June 30, 2011 exceeds the exercise price of the option.
 
 
17

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CCONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010

NOTE 15
INCOME TAXES
 
The Company is subject to income tax on an entity basis on income arising from the tax jurisdiction in which they operate.
 
The Company’s two operating subsidiaries, Lihua Electron and Lihua Copper, are generally subject to PRC enterprise income tax (“EIT”). Before January 1, 2008, Lihua Electron was subject to an EIT rate of 24% on its taxable income because it is located in an economic development zone.  Furthermore, Lihua Electron is a production-based foreign investment enterprise and was granted an EIT holiday for the two years ended December 31, 2006 and 2005 and a 50% reduction on the EIT rate for the three years ended December 31, 2007, 2008 and 2009.
 
On March 16, 2007, the PRC government promulgated a new tax law, China’s Unified Enterprise Income Tax Law (“New EIT Law”), which took effect from January 1, 2008. Under the New EIT Law, foreign-owned enterprises as well as domestic companies are subject to a uniform tax rate of 25%. The New EIT Law provides for a grandfathering and five-year transition period from its effective date for those enterprises which were established before the promulgation date of the New EIT Law and which were entitled to a preferential EIT treatment. Accordingly, Lihua Electron’s exemption period on its EIT expired at December 31, 2009 and it has been subject to an EIT rate of 25% for the years ending December 31, 2011 and 2010 under the New EIT Law.
 
Lihua Copper also has been subject to an EIT rate of 25% for the years ended December 31, 2011 and 2010 under the New EIT Law.
 
The New EIT 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 EIT 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, 2011, and no dividends were distributed in the years ended December 31, 2010 and 2009, no deferred tax liability has been recognized for the undistributed earnings of these PRC subsidiaries through June 30, 2011. Total undistributed earnings of these PRC subsidiaries at June 30, 2011 was RMB775,177,422 ($120,090,460).
 
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,
 
   
2011
   
2010
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
PRC income tax:
                       
Current – PRC
  $ 4,581,443     $ 3,371,730     $ 8,533,952     $ 6,034,686  
Deferred
    10,004       16,326       (19,351 )     59,020  
                                 
    $ 4,591,447     $ 3,388,056     $ 8,514,601     $ 6,093,706  
 
 
18

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CCONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010

NOTE 15
INCOME TAXES – CONTINUED
 
A reconciliation of the provision for income taxes determined at the United States 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,
 
   
2011
   
2010
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
                         
Pre-tax income
  $ 18,957,523     $ 13,286,348     $ 35,392,663     $ 24,848,556  
                                 
United States federal corporate income tax rate
    34 %     34 %     34 %     34 %
Income tax computed at United States statutory corporate income tax rate
    6,445,557       4,517,358       12,033,505       8,448,509  
Reconciling items:
                               
Loss not recognized as deferred tax assets
    196,876       225,106       425,909       458,539  
Change in fair value of warrants
    (409,933 )     (302,251 )     (898,113 )     (805,867
Rate differential for PRC earnings
    (1,645,697 )     (1,175,420 )     (3,055,799 )     (2,139,845 )
Other
    4,644       123,263       9,099       132,370  
                                 
    $ 4,591,447     $ 3,388,056     $ 8,514,601     $ 6,093,706  
 
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,
 
   
2011
   
2010
 
Deferred income tax assets:
           
Net operating loss carryforward
  $ 3,285,962     $ 2,860,053  
Unrealized intercompany profit in inventory
    30,580       74,363  
Excess of accounting depreciation over tax depreciation
    119,269       52,954  
Less: Valuation allowance
    (3,285,962 )     (2,860,053 )
                 
    $ 149,849     $ 127,317  

As of June 30, 2011 and December 31, 2010, our U.S. entity, i.e. Lihua International, Inc., had net operating loss carryforwards of $9,644,594 and $8,411,921, 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’s U.S. operations will not generate any operating profits in the foreseeable future. As a result, the full amount of the valuation allowance was provided against the potential tax benefits.

As of June 30, 2011 and December 31, 2010, 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, 2011 and 2010, and no provision for interest and penalties is deemed necessary as of June 30, 2011 and December 31, 2010.

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.
 
 
19

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010

NOTE 16
EARNINGS 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,
 
   
2011
   
2010
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
Income available to common shareholders:
                       
- Basic and diluted
  $ 14,366,076     $ 9,898,292     $ 26,878,062     $ 18,754,850  
                                 
Weighted average number of shares:
                               
- Basic
    29,872,935       28,484,091       29,865,896       26,625,272  
- Effect of dilutive warrants and options
    238,207       842,480       334,191       852,116  
- Diluted
    30,111,142       29,326,571       30,200,087       27,477,388  
                                 
Net income per share
                               
- Basic
  $ 0.48     $ 0.35     $ 0.90     $ 0.70  
                                 
- Diluted
  $ 0.48     $ 0.34     $ 0.89     $ 0.68  

NOTE 17
RELATED PARTY TRANSACTIONS

(1)
Sales
For the six months ended June 30, 2011 and 2010, sales included $620,295 and $429,349, respectively that were made to Tianyi Telecom.  For the three months ended June 30, 2011 and 2010, sales included nil and $429,349, respectively that were made to Tianyi Telecom The controlling stockholders of Tianyi Telecom are related to Ms. Yaying Wang, the Company’s COO and one of the Company’s directors.

(2)
Guarantees
As of June 30, 2011, and December 31, 2010, Mr. Jianhua Zhu, the Company’s CEO and director, and Tianyi Telecom provided guarantees for the Company’s short-term bank loans of $2,317,819 and $2,264,937, respectively (See Note 11 above).

(3)
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.

On May 23, 2011, Magnify Wealth loaned $1 million under the Note, which amount the Company repaid in full on May 25, 2011 in RMB. On June 14, 2011, Magnify Wealth loaned $300,000 under the Note, which amount the Company repaid in full on June 14, 2011 in RMB. The total amount repaid was RMB8,434,660, which was repaid at the average rate of 6.4822 RMB per US dollar, 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.

As of June 30, 2011, there was no outstanding loan under the Note.
 
 
20

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010

NOTE 17
RELATED PARTY TRANSACTIONS – CONTINUED

(4)
Amount due to a related party

Amount due to Mr. Jianhua Zhu was unsecured, payable on demand and non-interest bearing. The amount was repaid in August 2011.

NOTE 18
CERTAIN RISKS AND CONCENTRATION

Credit risk and major customers

As of June 30, 2011 and December 31, 2010, 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, 2011 and 2010, all of the Company’s sales arose in the PRC.  In addition, all accounts receivable as of June 30, 2011 and December 31, 2010 were due from customers located in the PRC.

Except for two customers which accounted for 14.85% and 13.03% 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, 2011 or 2010.

Except for one customer which accounted for 14.83% 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, 2011 or 2010.

There were two customers who accounted for 22.2% and 12.73%, respectively, of total accounts receivable of the Company as of June 30, 2011. There were two customers who accounted for 20.5% and 15.2%, respectively, of total accounts receivable of the Company as of December 31, 2010. There was no other customer who accounted for 10% or more of the Company’s accounts receivable as of June 30, 2011 or December 31, 2010.

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.

NOTE 19
COMMITMENTS AND CONTINGENCIES

Lease commitments
 
The Company has entered into tenancy agreements for the lease of factory premises and warehouse 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, 2011 are as follows:

Payable within:
     
- remainder of fiscal year ending December 31, 2011
  $ 25,960  
- fiscal year ending December 31, 2012
    55,627  
- fiscal year ending December 31, 2013
    59,955  
- fiscal year ending December 31, 2014 and thereafter
    20,397  
         
Total
  $ 161,939  
 
 
21

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010

NOTE 19
COMMITMENTS AND CONTINGENCIES - CONTINUED

   
June 30,
   
December 31,
 
   
2011
   
2010
 
Capital commitments – contracted but not provided for:
           
             
Acquisition or construction of buildings - within one year
  $ 4,791,705     $ 1,664,997  
Purchase of machinery - within one year
    145,250       -  
                 
    $ 4,936,955     $ 1,664,997  

NOTE 20
SEGMENT 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,
 
   
2011
   
2010
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
                         
Net revenue from unaffiliated customers:
                       
Copper and CCA wire
  $ 93,513,329     $ 68,318,870     $ 164,424,965     $ 108,937,801  
Copper anode
    73,499,198       -       139,518,658       -  
Refined copper rod
    -       7,183,480       -       29,785,251  
    $ 167,012,527     $ 75,502,350     $ 303,943,623     $ 138,723,052  
                                 
Gross profit:
                               
Copper and CCA wire
  $ 13,833,862     $ 13,799,167     $ 24,810,315     $ 23,697,804  
Copper anode
    5,813,601       -       11,745,221       -  
Refined copper rod
    -       701,139       -       2,623,786  
    $ 19,647,463     $ 14,500,306     $ 36,555,536     $ 26,321,590  
 
 
22

 
 
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, 2010 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.
 
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 all of the copper rod we produce is being used internally as a raw material for superfine 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 (also known as “superfine” copper wire). We believe this recycled superfine 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 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 holds a wide range of potential end market uses.  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 we were among the first manufacturers to commercialize CCA superfine wire production in China. 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 based upon our proprietary technology 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. 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 CCA wire.  For 2011 and 2012, we expect the majority of our investment and resulting planned growth in sales volume will occur in the refined copper products business, which caters to a much bigger pure copper products market, compared with the CCA wire market.
 
 
23

 
 
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 very 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.  During 2010 and the first half of 2011, we sold copper anode to a few copper conglomerates which use our product to produce copper cathode.  We sold copper rod to approximately 50 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 also.  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 we are well positioned to continue to capture further market share in the copper and 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 $50.0 million, $161.5 million and $370.5 million for the years ended December 31, 2008 and 2009 and 2010, respectively. We achieved net income of $11.7 million, $13.7 million and $38.5 million for the years ended December 31, 2008 and 2009 and 2010, 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% from the same period last year.  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. The Company recognized a $2.6 million non-cash gain, which is a non-cash benefit from the change in fair value of these warrants for the six-month period ended June 30, 2011. Excluding the impact of this non-cash gain, net income for the first half of 2011 was $24.3 million, up 47.2% from the same period last year.
 
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 two smelting facilities one of which is allocated to copper rod and one to copper anode production. Each smelting facility is capable of producing 25,000 tons per year.  During the six months ended June 30, 2011, we sold 14,908 tons of copper anode and 15,941 tons of CCA and copper wire products.  As of June 30, 2011, 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 CCA wire and approximately 20,000 tons per annum of copper wire.  Certain of these drawing machines incorporate additional production steps such as coating, annealing or magnetizing the fine wire produced.  These drawing machines are manufactured to our design and specifications by custom equipment manufacturers located in China.  We are not dependent on any single custom equipment manufacturer for the fabrication of our drawing lines.  We added six high-capacity copper wire drawing production lines in first half 2010, all of which are used to draw copper wire from our copper rod, and increased our annual capacity to 20,000 tons of copper wire, close to the 25,000 tons annual output of the smelter for copper rod production.  As noted above, in the third quarter of 2010 we added a second smelter with 25,000 tons of annual capacity and started copper anode production.  On our new plant construction site (adjacent to our current facility), we are planning to add two new smelters with 25,000 tons of annual capacity each, which are anticipated to be completed in the fourth quarter of this year. Our sales of copper anode are currently capacity-constrained and we expect this surplus of orders to continue into the near future,
 
 
24

 
 
Significant Factors Affecting Our Results of Operations
 
The most significant factors that affect our financial condition and results of operations are:
 
 
·
economic conditions in China;
 
 
·
the market price for copper;
 
 
·
production capacity;
 
 
·
supply and costs of principal raw materials; and
 
 
·
product mix and implications on gross margins.
 
Economic conditions in the PRC
 
We operate our manufacturing facilities in the PRC and derive all 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 9.65% in gross domestic product from 1999 through 2009, 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.
 
Copper prices
 
Copper is a global commodity, with major trading and pricing centers located in London, New York and Shanghai.
 
Generally the price of our products is set at a certain discount to Shanghai spot copper prices, and we believe our products replace or supplement “virgin” copper (non-recycled 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 per ton of copper or CCA processed, during the past three years the markup, or our gross and net profit in absolute dollar terms per ton processed, has not been materially affected by the change of copper prices. The Shanghai Changjiang Commodity Market, one of the major metals trading markets in the world, 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 in China.
 
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.
 
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. To date, we have been able to secure a sufficient supply of raw materials, which consist primarily of scrap copper and CCA raw material wire. Given the global supply of scrap copper, and multiple vendors for CCA raw material wire, we do not anticipate problems in the near future obtaining sufficient amounts of raw material at a reasonable price for use in our production operations.
 
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 implications of copper price movement on our gross and net profit margin figures in percentage terms, during the past three years the mark-up, or our gross and net profit in absolute dollars per ton processed, have not been materially affected by the change in copper prices.
 
 
25

 
 
Product mix and effect on gross margins
 
Our gross margin is also 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.
 
Generally, copper anode and copper rod products contribute a substantially lower gross profit margin compared to the wire 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.
 
PRINCIPAL INCOME STATEMENT COMPONENTS
 
Sales
 
Our sales are derived from sales of our products net of value-added taxes.
 
Our collection practices vary on a product line basis.  For our copper anode sales, we generally receive 70% of the order value upon delivery, which can take two to seven days from shipment from our facilities, with the remaining 30% due within 30 days. For our wire products, we generally receive payment in full upon 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 our product mix, as copper anode and copper rod provide lower margins compared to our copper and CCA wire products.  Our gross profit as a percentage of revenue is also affected by the relative cost of raw materials (scrap copper and large diameter CCA wire), which is defined with reference to the cost of copper.  We price our products based on the market price for materials plus a fixed dollar mark-up per ton processed, 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 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. We expect that our selling, general and administrative expenses will increase as a result of compliance, investor-relations and other expenses associated with being a publicly listed company.
 
 
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Other income and expense
 
Other income and expense includes interest income, interest expense, merger costs, foreign currency translation adjustments, and other income.
 
Our interest expe